-----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, BDNNdsLVHwHx9v2vFSqbWwFjp6LDqnwosWPjiivnL7hEuzM566b4RvSxyBYmnr1j OVgAqgh78zFnOWIiBmuJHA== 0000825063-06-000010.txt : 20060228 0000825063-06-000010.hdr.sgml : 20060228 20060228163456 ACCESSION NUMBER: 0000825063-06-000010 CONFORMED SUBMISSION TYPE: N-CSR PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060228 DATE AS OF CHANGE: 20060228 EFFECTIVENESS DATE: 20060228 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 SEC ACT: 1940 Act SEC FILE NUMBER: 811-05387 FILM NUMBER: 06651422 BUSINESS ADDRESS: STREET 1: 101 JOHN F KENNEDY PKWY CITY: SHORT HILLS STATE: NJ ZIP: 07078 BUSINESS PHONE: 973-912-2000 MAIL ADDRESS: STREET 1: 101 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 0000825063 S000007860 MUTUAL BEACON FUND C000021373 CLASS A TEBIX C000021374 CLASS B TEBBX C000021375 CLASS C TEMEX C000021376 CLASS Z BEGRX 0000825063 S000007861 MUTUAL DISCOVERY FUND C000021377 CLASS A TEDIX C000021378 CLASS B TEDBX C000021379 CLASS C TEDSX C000021380 CLASS Z MDISX C000021381 CLASS R TEDRX 0000825063 S000007862 MUTUAL EUROPEAN FUND C000021382 CLASS A TEMIX C000021383 CLASS B TEUBX C000021384 CLASS C TEURX C000021385 CLASS Z MEURX 0000825063 S000007863 MUTUAL QUALIFIED FUND C000021386 CLASS A TEQIX C000021387 CLASS B TEBQX C000021388 CLASS C TEMQX C000021389 CLASS Z MQIFX 0000825063 S000007864 MUTUAL SHARES FUND C000021390 CLASS A TESIX C000021391 CLASS B FMUBX C000021392 CLASS C TEMTX C000021393 CLASS Z MUTHX C000021394 CLASS R TESRX 0000825063 S000007865 MUTUAL FINANCIAL SERVICES FUND C000021395 CLASS A TFSIX C000021396 CLASS B TBFSX C000021397 CLASS C TMFSX C000021398 CLASS Z TEFAX N-CSR 1 fmsf-annual1205.txt FMSF ANNUAL REPORTS DTD 12/31/05 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number 811-05387 FRANKLIN MUTUAL SERIES FUND INC. ----------------------------------------------------- (Exact name of registrant as specified in charter) 101 JOHN F. KENNEDY PARKWAY, SHORT HILLS, NJ 07078-2705 ---------------------------------------------------------- (Address of principal executive offices) (Zip code) CRAIG S. TYLE, 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: 12/31/05 --------- ITEM 1. REPORTS TO STOCKHOLDERS. MUTUAL BEACON FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2005 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 TEMPLETON 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 what we believe are undervalued stocks, as well as arbitrage situations and distressed securities. Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. Templeton pioneered international investing and, with offices in over 25 countries, offers investors a truly global perspective. TRUE DIVERSIFICATION Because these management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why the funds can be used to build truly diversified allocation plans 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, accurate and personal service that has 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 ................................................... 30 Notes to Financial Statements .......................................... 34 Report of Independent Registered Public Accounting Firm ................ 50 Tax Designation ........................................................ 51 Board Members and Officers ............................................. 52 Shareholder Information ................................................ 57 - -------------------------------------------------------------------------------- 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 mainly in equity securities of companies the Fund's managers believe are at prices below their intrinsic value. The Fund may invest up to 35% of its assets in foreign securities. - -------------------------------------------------------------------------------- PERFORMANCE DATA 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 for the fiscal year ended December 31, 2005. PERFORMANCE OVERVIEW Mutual Beacon Fund - Class Z posted a +9.25% cumulative total return for the 12 months ended December 31, 2005. The Fund outperformed its benchmark, the Standard & Poor's 500 Index (S&P 500), which returned +4.91% 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 12 months ended December 31, 2005, U.S. economic expansion was driven by strength across most industries, sectors and regions. Gross domestic product (GDP) rose during the period, benefiting primarily from increased personal consumption, business investment and federal spending. The U.S. dollar rallied in 2005, supported by relatively strong domestic economic growth and rising short-term domestic interest rates, as the Federal Reserve Board raised the federal funds target rate from 2.25% to 4.25% during the period. Compared with the rise in short-term interest rates, long-term rates remained relatively stable, supporting overall robust housing and commercial real estate activity, which contributed to economic growth. Oil prices remained high during the period, and natural gas prices rose during the second half of 2005. Despite these high commodity prices, inflation remained relatively contained for the 12 months ended December 31, 2005, (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. 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 as measured by the 2.2% rise for the core Consumer Price Index (CPI).(2) In this environment, the blue chip stocks of the Dow Jones Industrial Average posted a one-year total return of +1.72%, while the broader S&P 500 and the technology-heavy NASDAQ Composite Index returned +4.91% and +2.12%.(3) Outside the U.S., the global economy overcame fears of derailment generated by higher energy costs and advanced at a solid clip during 2005, with Europe surpassing expectations. Excluding the volatile energy and food sectors, inflation remained relatively subdued worldwide. In addition to high energy prices, prices for other commodities such as industrial metals also rose. This contributed to economic growth in countries that are tied to mining and industrial commodities, such as Australia and Canada, and some Asian and Latin American emerging markets. For the 12 months under review, equity markets outside the U.S. performed strongly. The Morgan Stanley Capital International (MSCI) All Country (AC) World ex US Index rose +17.11%.(4) In terms of sectors, energy and materials led equity market performance, and telecommunication services and consumer-related sectors lagged. INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks. When selecting undervalued equities, we are always attracted to fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. We also look for asset rich companies whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy or other perceived negatives. This strict value approach is not only intended to improve the likelihood of upside potential, but it is also intended to reduce the risk of substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies globally, we may invest occasionally in privately held companies as well. GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/05 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] U.S. 56.0% U.K. 9.1% France 4.9% Spain 2.5% Denmark 2.2% Japan 1.7% Switzerland 1.6% Norway 1.6% Ireland 1.5% Belgium 1.2% South Korea 1.1% Canada 1.1% Italy 1.0% Other 3.6% Short-Term Investments & Other Net Assets 10.9% (2) Source: Bureau of Labor Statistics. Core CPI excludes food and energy costs. (3) 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 NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes more than 3,000 companies. (4) Source: Standard & Poor's Micropal. The MSCI AC World ex US Index is a free float-adjusted market capitalization-weighted index designed to measure equity market performance in global developed and emerging markets excluding the U.S. Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/05 - --------------------------------------------------- % OF TOTAL NET ASSETS - --------------------------------------------------- Insurance 11.9% - --------------------------------------------------- Tobacco 10.0% - --------------------------------------------------- Media 8.6% - --------------------------------------------------- Commercial Banks 6.8% - --------------------------------------------------- Beverages 4.6% - --------------------------------------------------- Food Products 4.4% - --------------------------------------------------- Diversified Telecommunication Services 4.1% - --------------------------------------------------- Paper & Forest Products 3.9% - --------------------------------------------------- Metals & Mining 3.3% - --------------------------------------------------- Oil, Gas & Consumable Fuels 3.2% - --------------------------------------------------- We complement this more traditional investment strategy with two others. One is 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 debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed 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. In addition, 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. MANAGER'S DISCUSSION The Fund's outperformance relative to U.S. equities as measured by the S&P 500 during the year was driven primarily by its shares in companies located outside the U.S. Specifically, eight of the top ten performers during the period represented international exposure, primarily companies located in Western Europe. The MSCI Europe Index returned +9.93% in U.S. dollars in 2005, versus a +4.91% return from the S&P 500.(5) London-based British American Tobacco (BAT) was the largest contributor to Fund performance during year under review. BAT is the world's second-largest cigarette manufacturer behind Philip Morris. With about a 15% global market share, BAT enjoys strong market positions in Europe, North America and several emerging markets. The company's stock appreciated 52% in local currency in 2005 as the company delivered robust operational performance driven by increasing sales volumes and an improving product mix. BAT benefited from an acceleration of its sales in emerging markets, a focused development of its (5) Source: Standard & Poor's Micropal. The MSCI Europe Index is a free float-adjusted market capitalization-weighted index designed to measure equity market performance in Europe. 6 | Annual Report higher-margin global brands, and a further reduction of its cost base. During the year, the company returned most of its free cash flow to shareholders through dividends and share buybacks. This caused a number of analysts to raise their earnings growth projections for BAT. Another top performer for the period was Canadian Oil Sands Trust (appreciated 91% in local currency), which exploits the massive oil reserves contained in western Canada's oil sands. The company, along with the entire energy sector, benefited from historically high oil prices in 2005. The Fund also benefited from a private investment made across the Mutual Series Funds in an entity that owns a controlling position in Aozora Bank. This Japanese bank, formerly known as Nippon Credit Bank, was nationalized and then reprivatized by the Japanese government. The Fund invested in a vehicle created by Cerberus Partners, which owns more than 60% of the bank. The position benefited from significant appreciation in Japanese banking stocks in general, and recently, the investment vehicle made a significant capital distribution to shareholders. Unfortunately, not every security in the Fund's portfolio appreciated during the 12 months under review. Three positions that detracted from performance included White Mountains Insurance Group, a U.S. insurance company; Washington Post, a U.S. newspaper and publishing company; and Kindred Healthcare, a U.S. health care provider. White Mountains' shares weakened 12% largely due to the company's exposure to areas devastated by Hurricane Katrina, which may have caused the largest total insured loss in history. Shares in Washington Post underperformed (declined 22%) as Kaplan, the company's education business, reported limited margin expansion; and hurricane damage to the Gulf Coast negatively impacted Cable One, its cable operations. Additionally, the advertising market was soft overall, but particularly pronounced for weekly publications, which hurt revenues at Newsweek. Kindred shares declined 14% in 2005 after the company posted disappointing results in its second and third quarters. Valuations at year-end also reflected the industry's challenging Medicare reimbursement climate, which was pressured by high federal deficits.(6) TOP 10 HOLDINGS 12/31/05 - ----------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - ----------------------------------------------------- White Mountains Insurance Group Inc. 3.7% INSURANCE, U.S. - ----------------------------------------------------- Berkshire Hathaway Inc., A & B 3.0% INSURANCE, U.S. - ----------------------------------------------------- Weyerhaeuser Co. 3.0% PAPER & FOREST PRODUCTS, U.S. - ----------------------------------------------------- Altadis SA 2.5% TOBACCO, SPAIN - ----------------------------------------------------- News Corp., A 2.4% MEDIA, U.S. - ----------------------------------------------------- Reynolds American Inc. 1.7% TOBACCO, U.S. - ----------------------------------------------------- Altria Group Inc. 1.6% TOBACCO, U.S. - ----------------------------------------------------- Orkla ASA 1.6% FOOD PRODUCTS, NORWAY - ----------------------------------------------------- British American Tobacco PLC, ord. & ADR 1.6% TOBACCO, U.K. - ----------------------------------------------------- Washington Post Co., B 1.5% MEDIA, U.S. - ----------------------------------------------------- (6) A member of Franklin Mutual Advisers, Inc., serves on Kindred's board of directors. Annual Report | 7 Finally, investors should note that we entered 2005 less than fully hedged in foreign currencies and increased the hedges on foreign currency exposure over the course of the year. Thank you for your continued participation in Mutual Beacon Fund. We look forward to serving your future investment needs. [PHOTO OMITTED] /s/ Michael J. Embler Michael J. Embler 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, 2005, 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. - -------------------------------------------------------------------------------- MICHAEL EMBLER has been a member of the management team of the Mutual Series Funds since 2001, with primary responsibility for special situation investments. In addition to his portfolio management responsibilities for another fund, Mr. Embler assumed the duties of portfolio manager of Mutual Beacon Fund in May 2005. Before joining Franklin Templeton Investments in 2001, he was Managing Director and portfolio manager at Nomura Holding America, Inc. CHARLES LAHR is an assistant portfolio manager of Mutual Beacon, Mutual European and Mutual Financial Services Funds. He is also an analyst for Franklin Mutual Advisers specializing in foreign equities and focusing 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. - -------------------------------------------------------------------------------- 8 | Annual Report Performance Summary as of 12/31/05 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 that a shareholder would pay 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 (SYMBOL: BEGRX) CHANGE 12/31/05 12/31/04 - ---------------------------------------------------------------------------- Net Asset Value (NAV) -$ 0.42 $ 15.52 $ 15.94 - ---------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - ---------------------------------------------------------------------------- Dividend Income $ 0.2992 - ---------------------------------------------------------------------------- Short-Term Capital Gain $ 0.1034 - ---------------------------------------------------------------------------- Long-Term Capital Gain $ 1.4914 - ---------------------------------------------------------------------------- TOTAL $ 1.8940 - ---------------------------------------------------------------------------- - ---------------------------------------------------------------------------- CLASS A (SYMBOL: TEBIX) CHANGE 12/31/05 12/31/04 - ---------------------------------------------------------------------------- Net Asset Value (NAV) -$ 0.43 $ 15.44 $ 15.87 - ---------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - ---------------------------------------------------------------------------- Dividend Income $ 0.2460 - ---------------------------------------------------------------------------- Short-Term Capital Gain $ 0.1034 - ---------------------------------------------------------------------------- Long-Term Capital Gain $ 1.4914 - ---------------------------------------------------------------------------- TOTAL $ 1.8408 - ---------------------------------------------------------------------------- - ---------------------------------------------------------------------------- CLASS B (SYMBOL: TEBBX) CHANGE 12/31/05 12/31/04 - ---------------------------------------------------------------------------- Net Asset Value (NAV) -$ 0.45 $ 15.09 $ 15.54 - ---------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - ---------------------------------------------------------------------------- Dividend Income $ 0.1352 - ---------------------------------------------------------------------------- Short-Term Capital Gain $ 0.1034 - ---------------------------------------------------------------------------- Long-Term Capital Gain $ 1.4914 - ---------------------------------------------------------------------------- TOTAL $ 1.7300 - ---------------------------------------------------------------------------- - ---------------------------------------------------------------------------- CLASS C (SYMBOL: TEMEX) CHANGE 12/31/05 12/31/04 - ---------------------------------------------------------------------------- Net Asset Value (NAV) -$ 0.44 $ 15.33 $ 15.77 - ---------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - ---------------------------------------------------------------------------- Dividend Income $ 0.1371 - ---------------------------------------------------------------------------- Short-Term Capital Gain $ 0.1034 - ---------------------------------------------------------------------------- Long-Term Capital Gain $ 1.4914 - ---------------------------------------------------------------------------- TOTAL $ 1.7319 - ---------------------------------------------------------------------------- Mutual Beacon Fund paid distributions derived from long-term capital gains totaling $1.4914 per share in June and December 2005. The Fund designates such distributions as capital gain dividends per Internal Revenue Code Section 852(b)(3)(C). 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) +9.25% +52.88% +211.45% - ----------------------------------------------------------------------------- Average Annual Total Return(3) +9.25% +8.86% +12.03% - ----------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 10,925 $ 15,288 $ 31,145 - ----------------------------------------------------------------------------- - ----------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (11/1/96) - ----------------------------------------------------------------------------- Cumulative Total Return(2) +8.89% +50.23% +164.67% - ----------------------------------------------------------------------------- Average Annual Total Return(3) +2.62% +7.21% +10.49% - ----------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 10,262 $ 14,163 $ 24,947 - ----------------------------------------------------------------------------- - ----------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - ----------------------------------------------------------------------------- Cumulative Total Return(2) +8.17% +45.45% +89.87% - ----------------------------------------------------------------------------- Average Annual Total Return(3) +4.28% +7.48% +9.60% - ----------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 10,428 $ 14,345 $ 18,987 - ----------------------------------------------------------------------------- - ----------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (11/1/96) - ----------------------------------------------------------------------------- Cumulative Total Return(2) +8.12% +45.37% +149.46% - ----------------------------------------------------------------------------- Average Annual Total Return(3) +7.15% +7.77% +10.49% - ----------------------------------------------------------------------------- Value of $10,000 Investment(4) $ 10,715 $ 14,537 $ 24,946 - ----------------------------------------------------------------------------- PERFORMANCE DATA 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. AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS Z 12/31/05 - -------------------------------------------- 1-Year +9.25% - -------------------------------------------- 5-Year +8.86% - -------------------------------------------- 10-Year +12.03% - -------------------------------------------- CLASS Z (1/1/96-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL BEACON DATE FUND - CLASS Z S&P 500 INDEX(5) - ---------- -------------- ---------------- 1/1/1996 $10,000 $10,000 1/31/1996 $10,384 $10,340 2/29/1996 $10,662 $10,436 3/31/1996 $10,801 $10,537 4/30/1996 $10,949 $10,692 5/31/1996 $11,102 $10,967 6/30/1996 $11,031 $11,009 7/31/1996 $10,598 $10,523 8/31/1996 $10,962 $10,745 9/30/1996 $11,269 $11,349 10/31/1996 $11,369 $11,662 11/30/1996 $11,943 $12,543 12/31/1996 $12,119 $12,295 1/31/1997 $12,536 $13,062 2/28/1997 $12,806 $13,165 3/31/1997 $12,629 $12,625 4/30/1997 $12,704 $13,378 5/31/1997 $13,226 $14,192 6/30/1997 $13,609 $14,827 7/31/1997 $14,364 $16,006 8/31/1997 $14,212 $15,110 9/30/1997 $14,915 $15,937 10/31/1997 $14,440 $15,406 11/30/1997 $14,649 $16,118 12/31/1997 $14,905 $16,395 1/31/1998 $14,821 $16,576 2/28/1998 $15,623 $17,771 3/31/1998 $16,288 $18,680 4/30/1998 $16,499 $18,868 5/31/1998 $16,552 $18,544 6/30/1998 $16,436 $19,297 7/31/1998 $16,036 $19,092 8/31/1998 $13,843 $16,334 9/30/1998 $13,553 $17,381 10/31/1998 $14,359 $18,793 11/30/1998 $15,176 $19,932 12/31/1998 $15,258 $21,080 1/31/1999 $15,525 $21,961 2/28/1999 $15,351 $21,278 3/31/1999 $16,060 $22,130 4/30/1999 $17,328 $22,987 5/31/1999 $17,491 $22,445 6/30/1999 $17,970 $23,689 7/31/1999 $17,591 $22,951 8/31/1999 $16,962 $22,837 9/30/1999 $16,522 $22,212 10/31/1999 $16,985 $23,617 11/30/1999 $17,389 $24,097 12/31/1999 $17,820 $25,515 1/31/2000 $17,382 $24,233 2/29/2000 $16,893 $23,775 3/31/2000 $18,580 $26,099 4/30/2000 $18,361 $25,314 5/31/2000 $18,592 $24,796 6/30/2000 $18,375 $25,408 7/31/2000 $18,843 $25,011 8/31/2000 $19,627 $26,564 9/30/2000 $19,668 $25,162 10/31/2000 $19,998 $25,055 11/30/2000 $19,475 $23,081 12/31/2000 $20,373 $23,194 1/31/2001 $21,698 $24,017 2/28/2001 $21,576 $21,828 3/31/2001 $20,952 $20,446 4/30/2001 $21,820 $22,034 5/31/2001 $22,550 $22,181 6/30/2001 $22,724 $21,642 7/31/2001 $22,864 $21,429 8/31/2001 $22,381 $20,089 9/30/2001 $20,406 $18,466 10/31/2001 $20,391 $18,819 11/30/2001 $21,122 $20,262 12/31/2001 $21,619 $20,440 1/31/2002 $21,536 $20,141 2/28/2002 $21,668 $19,753 3/31/2002 $22,265 $20,496 4/30/2002 $22,463 $19,254 5/31/2002 $22,546 $19,113 6/30/2002 $20,988 $17,752 7/31/2002 $19,615 $16,368 8/31/2002 $19,799 $16,475 9/30/2002 $18,727 $14,686 10/31/2002 $18,978 $15,978 11/30/2002 $19,347 $16,917 12/31/2002 $19,231 $15,924 1/31/2003 $19,027 $15,508 2/28/2003 $18,601 $15,275 3/31/2003 $18,652 $15,421 4/30/2003 $19,860 $16,692 5/31/2003 $20,931 $17,571 6/30/2003 $21,296 $17,795 7/31/2003 $21,536 $18,109 8/31/2003 $22,153 $18,462 9/30/2003 $22,118 $18,266 10/31/2003 $23,026 $19,299 11/30/2003 $23,849 $19,469 12/31/2003 $24,892 $20,489 1/31/2004 $24,995 $20,865 2/29/2004 $25,843 $21,155 3/31/2004 $25,808 $20,836 4/30/2004 $25,117 $20,509 5/31/2004 $25,255 $20,790 6/30/2004 $25,680 $21,194 7/31/2004 $25,349 $20,493 8/31/2004 $25,558 $20,575 9/30/2004 $26,011 $20,798 10/31/2004 $26,359 $21,116 11/30/2004 $27,735 $21,970 12/31/2004 $28,507 $22,717 1/31/2005 $27,917 $22,163 2/28/2005 $28,793 $22,629 3/31/2005 $28,614 $22,229 4/30/2005 $28,382 $21,808 5/31/2005 $28,972 $22,501 6/30/2005 $29,339 $22,533 7/31/2005 $30,116 $23,371 8/31/2005 $30,260 $23,158 9/30/2005 $30,640 $23,345 10/31/2005 $29,772 $22,956 11/30/2005 $30,585 $23,823 12/31/2005 $31,145 $23,832 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS A 12/31/05 - -------------------------------------------- 1-Year +2.62% - -------------------------------------------- 5-Year +7.21% - -------------------------------------------- Since Inception (11/1/96) +10.49% - -------------------------------------------- CLASS A (11/1/96-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL BEACON DATE FUND - CLASS Z S&P 500 INDEX(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 $22,953 $19,479 1/31/2005 $22,476 $19,004 2/28/2005 $23,185 $19,404 3/31/2005 $23,026 $19,061 4/30/2005 $22,823 $18,699 5/31/2005 $23,300 $19,294 6/30/2005 $23,605 $19,322 7/31/2005 $24,218 $20,040 8/31/2005 $24,321 $19,857 9/30/2005 $24,613 $20,018 10/31/2005 $23,926 $19,684 11/30/2005 $24,569 $20,428 12/31/2005 $24,947 $20,435 Annual Report | 11 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS B 12/31/05 - -------------------------------------------- 1-Year +4.28% - -------------------------------------------- 5-Year +7.48% - -------------------------------------------- Since Inception (1/1/99) +9.60% - -------------------------------------------- CLASS B (1/1/99-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL BEACON DATE FUND - CLASS B S&P 500 INDEX(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 $17,554 $10,777 1/31/2005 $17,181 $10,514 2/28/2005 $17,712 $10,735 3/31/2005 $17,588 $10,545 4/30/2005 $17,430 $10,345 5/31/2005 $17,769 $10,674 6/30/2005 $17,985 $10,690 7/31/2005 $18,453 $11,087 8/31/2005 $18,510 $10,986 9/30/2005 $18,738 $11,075 10/31/2005 $18,190 $10,890 11/30/2005 $18,681 $11,301 12/31/2005 $18,987 $11,305 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS C 12/31/05 - -------------------------------------------- 1-Year +7.15% - -------------------------------------------- 5-Year +7.77% - -------------------------------------------- Since Inception (11/1/96) +10.49% - -------------------------------------------- CLASS C (11/1/96-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL BEACON DATE FUND - CLASS C S&P 500 INDEX(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 $23,119 $19,479 1/31/2005 $22,621 $19,004 2/28/2005 $23,324 $19,404 3/31/2005 $23,148 $19,061 4/30/2005 $22,943 $18,699 5/31/2005 $23,397 $19,294 6/30/2005 $23,679 $19,322 7/31/2005 $24,285 $20,040 8/31/2005 $24,374 $19,857 9/30/2005 $24,670 $20,018 10/31/2005 $23,960 $19,684 11/30/2005 $24,581 $20,428 12/31/2005 $24,946 $20,435 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 7/1/05 VALUE 12/31/05 PERIOD* 7/1/05-12/31/05 - ------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 1,061.60 $ 4.83 - ------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,020.52 $ 4.74 - ------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------- CLASS A - ------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 1,058.90 $ 6.59 - ------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,018.80 $ 6.46 - ------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------- CLASS B - ------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 1,055.70 $ 10.00 - ------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,015.48 $ 9.80 - ------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------- CLASS C - ------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 1,055.70 $ 10.00 - ------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,015.48 $ 9.80 - -------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 0.93%; A: 1.27%; B: 1.93%; and C: 1.93%), multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period. Annual Report | 15 Mutual Beacon Fund FINANCIAL HIGHLIGHTS
-------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2005 2004 2003 2002 2001 -------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............. $ 15.94 $ 14.40 $ 11.31 $ 13.05 $ 13.38 -------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ..................... 0.31 0.30 0.19 0.23 0.21 Net realized and unrealized gains (losses) ... 1.16 1.76 3.13 (1.66) 0.60 -------------------------------------------------------------------------- Total from investment operations ................ 1.47 2.06 3.32 (1.43) 0.81 -------------------------------------------------------------------------- Less distributions from: Net investment income ........................ (0.30) (0.37) (0.23) (0.20) (0.20) Net realized gains ........................... (1.59) (0.15) -- (0.11) (0.94) -------------------------------------------------------------------------- Total distributions ............................. (1.89) (0.52) (0.23) (0.31) (1.14) -------------------------------------------------------------------------- Redemption fees ................................. --(c) --(c) -- -- -- -------------------------------------------------------------------------- Net asset value, end of year .................... $ 15.52 $ 15.94 $ 14.40 $ 11.31 $ 13.05 ========================================================================== Total return .................................... 9.25% 14.52% 29.44% (11.05)% 6.11% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................. $ 3,433,665 $ 3,359,389 $ 3,112,212 $ 2,572,002 $ 3,090,827 Ratios to average net assets:* Expenses(b) .................................. 0.89% 0.83% 0.86% 0.80% 0.79% Net investment income ........................ 1.91% 1.99% 1.48% 1.88% 1.47% Portfolio turnover rate ......................... 35.36% 29.17% 49.61% 52.27% 55.25% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ..................................... 0.84% 0.82% 0.83% 0.79% 0.78%
(a) Based on average daily shares outstanding. (b) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (c) Amount is less than $0.01 per share. 16 | See notes to financial statements. | Annual Report Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2005 2004 2003 2002 2001 -------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............. $ 15.87 $ 14.34 $ 11.27 $ 13.01 $ 13.34 -------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ..................... 0.26 0.25 0.14 0.19 0.16 Net realized and unrealized gains (losses) ... 1.15 1.75 3.12 (1.66) 0.60 -------------------------------------------------------------------------- Total from investment operations ................ 1.41 2.00 3.26 (1.47) 0.76 -------------------------------------------------------------------------- Less distributions from: Net investment income ........................ (0.25) (0.32) (0.19) (0.16) (0.15) Net realized gains ........................... (1.59) (0.15) -- (0.11) (0.94) -------------------------------------------------------------------------- Total distributions ............................. (1.84) (0.47) (0.19) (0.27) (1.09) -------------------------------------------------------------------------- Redemption fees ................................. --(d) --(d) -- -- -- -------------------------------------------------------------------------- Net asset value, end of year .................... $ 15.44 $ 15.87 $ 14.34 $ 11.27 $ 13.01 ========================================================================== Total return(b) ................................. 8.89% 14.13% 28.99% (11.41)% 5.78% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................. $ 1,633,022 $ 1,462,133 $ 1,301,620 $ 918,983 $ 977,558 Ratios to average net assets:* Expenses(c) .................................. 1.22% 1.18% 1.21% 1.15% 1.14% Net investment income ........................ 1.58% 1.64% 1.13% 1.53% 1.12% Portfolio turnover rate ......................... 35.36% 29.17% 49.61% 52.27% 55.25% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ..................................... 1.17% 1.17% 1.18% 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. (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 $0.01 per share. Annual Report | See notes to financial statements. | 17 Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2005 2004 2003 2002 2001 -------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................. $ 15.54 $ 14.06 $ 11.07 $ 12.80 $ 13.18 -------------------------------------------------------------- Income from investment operations: Net investment income(a) ........................ 0.14 0.15 0.05 0.11 0.06 Net realized and unrealized gains (losses) ...... 1.14 1.71 3.06 (1.63) 0.60 -------------------------------------------------------------- Total from investment operations ................... 1.28 1.86 3.11 (1.52) 0.66 -------------------------------------------------------------- Less distributions from: Net investment income ........................... (0.14) (0.23) (0.12) (0.10) (0.10) Net realized gains .............................. (1.59) (0.15) -- (0.11) (0.94) -------------------------------------------------------------- Total distributions ................................ (1.73) (0.38) (0.12) (0.21) (1.04) -------------------------------------------------------------- Redemption fees .................................... --(d) --(d) -- -- -- -------------------------------------------------------------- Net asset value, end of year ....................... $ 15.09 $ 15.54 $ 14.06 $ 11.07 $ 12.80 ============================================================== Total return(b) .................................... 8.17% 13.32% 28.22% (11.96)% 5.12% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .................... $ 186,169 $ 186,840 $ 155,572 $ 100,405 $ 64,512 Ratios to average net assets:* Expenses(c) ..................................... 1.89% 1.83% 1.86% 1.80% 1.79% Net investment income ........................... 0.91% 0.99% 0.48% 0.88% 0.44% Portfolio turnover rate ............................ 35.36% 29.17% 49.61% 52.27% 55.25% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ........................................ 1.84% 1.82% 1.83% 1.79% 1.78%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. 18 | See notes to financial statements. | Annual Report Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2005 2004 2003 2002 2001 -------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................. $ 15.77 $ 14.26 $ 11.22 $ 12.94 $ 13.28 -------------------------------------------------------------- Income from investment operations: Net investment income(a) ........................ 0.15 0.14 0.06 0.11 0.07 Net realized and unrealized gains (losses) ...... 1.14 1.74 3.09 (1.64) 0.60 -------------------------------------------------------------- Total from investment operations ................... 1.29 1.88 3.15 (1.53) 0.67 -------------------------------------------------------------- Less distributions from: Net investment income ........................... (0.14) (0.23) (0.11) (0.08) (0.07) Net realized gains .............................. (1.59) (0.14) -- (0.11) (0.94) -------------------------------------------------------------- Total distributions ................................ (1.73) (0.37) (0.11) (0.19) (1.01) -------------------------------------------------------------- Redemption fees .................................... --(d) --(d) -- -- -- -------------------------------------------------------------- Net asset value, end of year ....................... $ 15.33 $ 15.77 $ 14.26 $ 11.22 $ 12.94 ============================================================== Total return(b) .................................... 8.12% 13.39% 28.24% (11.99)% 5.06% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) .................... $ 697,400 $ 658,813 $ 579,825 $ 443,683 $482,080 Ratios to average net assets:* Expenses(c) ..................................... 1.89% 1.83% 1.86% 1.79% 1.78% Net investment income ........................... 0.91% 0.99% 0.48% 0.89% 0.48% Portfolio turnover rate ............................ 35.36% 29.17% 49.61% 52.27% 55.25% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ........................................ 1.84% 1.82% 1.83% 1.78% 1.77%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. Annual Report | See notes to financial statements. | 19 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005
- ------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 86.1% AIRLINES 0.5% (a)ACE Aviation Holdings Inc. ............................. Canada 828,902 $ 27,099,953 (a),b)ACE Aviation Holdings Inc., A, 144A .................... Canada 101,565 3,320,545 (a)ACE Aviation Holdings Inc., B .......................... Canada 1,670 54,397 (a),(c)Air Canada Inc., Contingent Distribution ............... Canada 288,242,292 -- ------------ 30,474,895 ------------ AUTO COMPONENTS 0.0%(d) (a),(e)Lancer Industries Inc., B .............................. United States 1 764,320 ------------ BEVERAGES 4.6% Brown-Forman Corp., A .................................. United States 308,260 21,867,964 Brown-Forman Corp., B .................................. United States 362,618 25,136,680 Carlsberg AS, A ........................................ Denmark 74,900 3,743,633 Carlsberg AS, B ........................................ Denmark 1,296,233 69,518,550 Coca-Cola Enterprises Inc. ............................. United States 2,972,225 56,977,553 Diageo PLC ............................................. United Kingdom 3,705,621 53,712,201 Pernod Ricard SA ....................................... France 252,985 44,145,754 ------------ 275,102,335 ------------ CAPITAL MARKETS 0.6% Bear Stearns Cos. Inc. ................................. United States 286,002 33,041,811 ------------ CHEMICALS 0.6% Givaudan AG ............................................ Switzerland 55,850 37,856,841 Koninklijke DSM NV ..................................... Netherlands 14,800 604,474 ------------ 38,461,315 ------------ COMMERCIAL BANKS 7.3% Allied Irish Banks PLC ................................. Ireland 1,666,118 35,839,122 Banca Intesa SpA ....................................... Italy 11,287,551 59,798,384 Bank of Ireland ........................................ Ireland 1,870,698 29,454,524 BNP Paribas SA ......................................... France 565,850 45,786,402 Chinatrust Financial Holding Co. Ltd. .................. Taiwan 57,832,000 45,805,431 Danske Bank ............................................ Denmark 1,770,010 62,349,019 (a),(e),(f)FE Capital Holdings Ltd. ............................... Japan 13,981 19,922,914 ForeningsSparbanken AB, A .............................. Sweden 1,816,300 49,490,775 Mitsubishi UFJ Financial Group Inc. .................... Japan 5,727 77,634,500 (a),(e)NCB Warrant Holdings Ltd., A ........................... Japan 67,420 10,892,382 ------------ 436,973,453 ------------ COMMERCIAL SERVICES & SUPPLIES 0.0%(d) (a)Comdisco Holding Co. Inc. .............................. United States 453 8,607 (c)Comdisco Holding Co. Inc., Contingent Distribution ..... United States 54,914,113 -- (a),(c)Safety Kleen Corp., Contingent Distribution ............ United States 630,000 -- ------------ 8,607 ------------ COMPUTERS & PERIPHERALS 0.5% (a),(e),(f)DecisionOne Corp. ...................................... United States 1,142,353 814,498 (a)Lexmark International Inc., A .......................... United States 592,200 26,548,326 ------------ 27,362,824 ------------
20 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- -------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - -------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) CONSUMER FINANCE 0.6% MBNA Corp. ............................................. United States 1,328,500 $ 36,068,775 ------------- CONTAINERS & PACKAGING 1.3% Temple-Inland Inc. ..................................... United States 1,672,900 75,029,565 ------------- DIVERSIFIED FINANCIAL SERVICES 2.2% Fortis Group NV ........................................ Belgium 2,265,821 72,129,527 Leucadia National Corp. ................................ United States 1,297,560 61,582,197 (a),(c)Marconi Corp., Contingent Distribution ................. United Kingdom 42,651,300 -- ------------- 133,711,724 ------------- DIVERSIFIED TELECOMMUNICATION SERVICES 4.1% (a),(e),(g)AboveNet Inc. .......................................... United States 439,477 10,531,363 (a),(c),(g)AboveNet Inc., Contingent Distribution ................. United States 61,502,000 -- (a),(e),(g)AboveNet Inc., wts., 9/08/08 ........................... United States 14,770 59,080 (a),(e),(g)AboveNet Inc., wts., 9/08/10 ........................... United States 17,376 13,901 Chunghwa Telecom Co. Ltd., ADR ......................... Taiwan 299,300 5,492,155 (a),(c)Global Crossing Holdings Ltd., Contingent Distribution . United States 60,632,757 -- MCI Inc. ............................................... United States 1,601,623 31,600,022 (a)NTL Inc. ............................................... United Kingdom 1,161,195 79,054,155 (a),(c)Telewest Communications PLC, Contingent Distribution ... United Kingdom 64,216,863 -- (a),(c)Telewest Finance Ltd., Contingent Distribution ......... United Kingdom 7,240,000 -- (a)Telewest Global Inc. ................................... United Kingdom 3,785,613 90,173,302 Verizon Communications Inc. ............................ United States 820,500 24,713,460 ------------- 241,637,438 ------------- ELECTRIC UTILITIES 0.8% E.ON AG ................................................ Germany 441,388 45,701,103 (a),(b)Entegra/Union Power, 144A .............................. United States 147,820 -- ------------- 45,701,103 ------------- FOOD & STAPLES RETAILING 1.0% Albertson's Inc. ....................................... United States 787,600 16,815,260 Carrefour SA ........................................... France 881,638 41,310,721 ------------- 58,125,981 ------------- FOOD PRODUCTS 4.8% Cadbury Schweppes PLC .................................. United Kingdom 4,497,511 42,518,895 (f)Farmer Brothers Co. .................................... United States 1,033,896 19,995,549 Groupe Danone .......................................... France 640,200 66,884,744 Nestle SA .............................................. Switzerland 198,235 59,300,746 Orkla ASA .............................................. Norway 2,332,900 96,605,065 ------------- 285,304,999 -------------
Annual Report | 21 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- -------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - -------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) HEALTH CARE EQUIPMENT & SUPPLIES 2.0% Guidant Corp. .......................................... United States 956,700 $ 61,946,325 Hillenbrand Industries Inc. ............................ United States 1,170,900 57,854,169 ------------- 119,800,494 ------------- HEALTH CARE PROVIDERS & SERVICES 1.0% (a)Beverly Enterprises Inc. ............................... United States 1,499,100 17,494,497 (a),(e),(g)Kindred Healthcare Inc. ................................ United States 1,364,570 33,393,757 (a),(e),(g)Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 ...... United States 657 10,116 (a),(e),(g)Kindred Healthcare Inc., Jan. 25.99 Calls, 1/01/14 ..... United States 325 -- (a),(e),(g)Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 ..... United States 989 -- (a),(e),(g)Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 ..... United States 4,380 3,162 (a),(e),(g)Kindred Healthcare Inc., wts., Series A, 4/20/06 ....... United States 121,432 2,348,738 (a),(e),(g)Kindred Healthcare Inc., wts., Series B, 4/20/06 ....... United States 303,580 4,989,337 WellPoint Inc. ......................................... United States 19 1,516 ------------- 58,241,123 ------------- HOTELS, RESTAURANTS & LEISURE 0.3% (a),(f)FHC Delaware Inc. ...................................... United States 507,977 1,765,677 (a),(c)Trump Atlantic, Contingent Distribution ................ United States 26,587,000 1,002,330 (a)Trump Entertainment Resorts Inc. ....................... United States 890,620 17,928,181 ------------- 20,696,188 ------------- INDUSTRIAL CONGLOMERATES 1.0% Tyco International Ltd. ................................ United States 2,115,600 61,056,216 ------------- INSURANCE 11.9% (a)Alleghany Corp. ........................................ United States 163,026 46,299,384 (a)Berkshire Hathaway Inc., A ............................. United States 741 65,667,420 (a)Berkshire Hathaway Inc., B ............................. United States 38,925 114,264,337 Hartford Financial Services Group Inc. ................. United States 741,800 63,713,202 Irish Life & Permanent PLC ............................. Ireland 1,597,279 32,448,509 Montpelier Re Holdings Ltd. ............................ Bermuda 388,350 7,339,815 Old Republic International Corp. ....................... United States 2,225,245 58,434,934 (a),(e)Olympus Re Holdings Ltd. ............................... Bermuda 106,700 1,973,950 Prudential Financial Inc. .............................. United States 541,900 39,661,661 (a),(e)Symetra Financial ...................................... United States 511,600 58,834,000 White Mountains Insurance Group Inc. ................... United States 389,021 217,287,680 ------------- 705,924,892 ------------- LEISURE EQUIPMENT & PRODUCTS 0.8% Mattel Inc. ............................................ United States 3,049,400 48,241,508 ------------- MACHINERY 1.4% (a)Agco Corp. ............................................. United States 2,497,400 41,381,918 Deere & Co. ............................................ United States 511,500 34,838,265 Schindler Holding AG ................................... Switzerland 23,838 9,453,547 ------------- 85,673,730 -------------
22 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MEDIA 8.6% Clear Channel Communications Inc. ..................... United States 1,788,300 $ 56,242,035 (a)Comcast Corp., A ...................................... United States 1,012,900 26,021,401 E.W. Scripps Co., A ................................... United States 146,750 7,046,935 Hollinger International Inc. .......................... United States 985,458 8,388,219 Knight Ridder Inc. .................................... United States 129,900 8,222,670 (a)Liberty Media Corp., A ................................ United States 6,957,360 54,754,423 News Corp., A ......................................... United States 9,347,100 145,347,405 (e)Time Warner Inc. ...................................... United States 2,833,800 48,433,043 (e)Time Warner Inc., Jan. 10.00 Calls, 1/21/06 ........... United States 10,958 8,054,130 (a)TVMAX Holdings Inc. ................................... United States 133,855 133,855 Viacom Inc., B ........................................ United States 1,702,100 55,488,460 Washington Post Co., B ................................ United States 119,022 91,051,830 -------------- 509,184,406 -------------- METALS & MINING 2.7% Anglo American PLC .................................... South Africa 1,737,547 59,159,487 Anglo American PLC, ADR ............................... South Africa 1,200 41,736 (a)Coeur d'Alene Mines Corp. ............................. United States 549,600 2,198,400 (a)Goldcorp Inc., wts., 5/30/07 .......................... Canada 930,257 3,881,738 Newmont Mining Corp. .................................. United States 1,145,600 61,175,040 Placer Dome Inc. ...................................... Canada 1,128,993 25,857,174 (a),(f)PMG LLC ............................................... United States 48,890 4,204,554 (a)Rio Narcea Gold Mines Ltd. ............................ Canada 1,213,700 1,670,756 -------------- 158,188,885 -------------- MULTI-UTILITIES & UNREGULATED POWER 1.0% NorthWestern Corp. .................................... United States 389,255 12,094,153 (a),(c)NorthWestern Corp., Contingent Distribution ........... United States 11,805,000 1,003,425 Suez SA ............................................... France 1,580,555 49,210,984 -------------- 62,308,562 -------------- OIL, GAS & CONSUMABLE FUELS 3.8% (a),(f)Anchor Resources LLC .................................. United States 69,184 -- BP PLC ................................................ United Kingdom 2,690,300 28,650,579 BP PLC, ADR ........................................... United Kingdom 26,100 1,676,142 Burlington Resources Inc. ............................. United States 579,450 49,948,590 Canadian Oil Sands Trust .............................. Canada 44,900 4,867,418 (a),(b)CNX Gas Corp., 144A ................................... United States 443,000 9,192,250 CONSOL Energy Inc. .................................... United States 973,110 63,427,310 Oil & Natural Gas Corp. Ltd. .......................... India 392,114 10,239,234 Pogo Producing Co. .................................... United States 794,600 39,579,026 Vintage Petroleum Inc. ................................ United States 353,060 18,828,690 -------------- 226,409,239 -------------- PAPER & FOREST PRODUCTS 3.9% International Paper Co. ............................... United States 1,520,500 51,104,005 Weyerhaeuser Co. ...................................... United States 2,709,391 179,740,999 -------------- 230,845,004 --------------
Annual Report | 23 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) PHARMACEUTICALS 2.0% (a)IVAX Corp. ............................................ United States 137,800 $ 4,317,274 Pfizer Inc. ........................................... United States 1,505,700 35,112,924 Sanofi-Aventis ........................................ France 391,320 34,281,550 Valeant Pharmaceuticals International ................. 36,300 656,304 Wyeth ................................................. United States 1,023,300 47,143,431 -------------- 121,511,483 -------------- REAL ESTATE 2.7% (a)Alexander's Inc. ...................................... United States 38,800 9,525,400 Canary Wharf Group PLC ................................ United Kingdom 10,069,634 41,578,323 iStar Financial Inc. .................................. United States 1,426,334 50,848,807 (a),(e)Security Capital European Realty ...................... Luxembourg 20,244 147,123 Shurgard Storage Centers Inc., A ...................... United States 113,400 6,430,914 St. Joe Co. ........................................... United States 482,598 32,440,238 Ventas Inc. ........................................... United States 608,900 19,496,978 -------------- 160,467,783 -------------- ROAD & RAIL 1.3% (e),(f)Florida East Coast Industries Inc. .................... United States 1,967,636 79,200,300 -------------- SOFTWARE 0.8% Microsoft Corp. ....................................... United States 1,778,800 46,515,620 -------------- TEXTILES APPAREL & LUXURY GOODS 0.2% Reebok International Ltd. ............................. United States 209,700 12,210,831 -------------- THRIFTS & MORTGAGE FINANCE 1.8% First Niagara Financial Group Inc. .................... United States 427,550 6,186,648 Hudson City Bancorp Inc. .............................. United States 4,654,880 56,417,146 Sovereign Bancorp Inc. ................................ United States 2,044,600 44,204,252 -------------- 106,808,046 -------------- TOBACCO 10.0% Altadis SA ............................................ Spain 3,285,375 149,041,472 (h)Altria Group Inc. ..................................... United States 1,297,959 96,983,496 British American Tobacco PLC .......................... United Kingdom 4,189,876 93,710,135 British American Tobacco PLC, ADR ..................... United Kingdom 40,400 1,819,616 Imperial Tobacco Group PLC ............................ United Kingdom 2,703,833 80,801,928 KT&G Corp. ............................................ South Korea 835,850 37,374,732 (b)KT&G Corp., GDR, 144A ................................. South Korea 1,579,000 34,738,000 (h)Reynolds American Inc. ................................ United States 1,055,718 100,641,597 -------------- 595,110,976 -------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $3,708,202,488) .............................. 5,126,164,431 -------------- PREFERRED STOCKS 1.0% DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(d) PTV Inc., 10.00%, pfd., A ............................. United Kingdom 114,246 239,916 -------------- ELECTRIC UTILITIES 0.0%(d) (a)Montana Power Co., 8.45%, pfd. ........................ United States 58,900 485,925 --------------
24 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE - ----------------------------------------------------------------------------------------------------------------------- PREFERRED STOCKS (CONTINUED) METALS & MINING 0.7% (e),(f),(g)Esmark Inc., Series A, 10.00%, cvt. pfd. .............. United States 28,644 $ 30,037,244 Falconbridge Ltd. ..................................... Canada 195,493 5,802,726 Falconbridge Ltd., 6.00%, cvt. pfd., 1 ................ Canada 26,025 657,132 Falconbridge Ltd., 6.25%, cvt. pfd., 2 ................ Canada 26,025 657,131 Falconbridge Ltd., 6.50%, cvt. pfd., 3 ................ Canada 13,012 329,854 -------------- 37,484,087 -------------- REAL ESTATE 0.3% iStar Financial Inc., 7.80%, pfd. ..................... United States 770,100 19,291,005 -------------- TOTAL PREFERRED STOCKS (COST $57,543,135) ............. 57,500,933 -------------- ------------------- PRINCIPAL AMOUNT(k) ------------------- CORPORATE BONDS & NOTES 1.9% (b)ACE Aviation Holdings Inc., cvt., 144A, 4.25%, 6/01/35 ............................................ Canada 1,993,000 CAD 1,680,410 (i)Collins & Aikman Products Co., Revolver, FRN, 10.75%, 8/31/09 ..................... United States 453,400 439,798 Tranche B1 Term Loan, FRN, 10.75%, 8/31/11 ......... United States 1,061,996 1,030,136 Dana Corp., 5.85%, 1/15/15 ..................................... United States 5,055,000 3,614,325 7.00%, 3/01/29 ..................................... United States 745,000 538,262 (e),(f)DecisionOne Corp., 144A, 12.00%, 4/15/10 .............. United States 1,240,025 1,240,025 Entegra/Union Power, Term Loan A, 4.00%, 6/01/12 ........................ United States 7,530,458 6,476,194 Term Loan B, 9.00%, 6/01/20 ........................ United States 7,251,552 6,236,335 Eurotunnel PLC, Participating Loan Note, 1.00%, 4/30/40 ............ United Kingdom 858,000 GBP 140,234 (i)Tier 2, FRN, 5.796%, 12/31/18 ...................... United Kingdom 7,592,095 GBP 11,102,546 (i)Tier 3, FRN, 5.796%, 12/31/25 ...................... United Kingdom 28,404,485 GBP 22,968,193 Eurotunnel SA, Senior Tranche H1 Term Loan (KfW Advance), 8.78%, 12/15/12 ......................................... France 605,300 EUR 680,755 (i)Tier 2 (LIBOR), FRN, 3.393%, 12/31/18 .............. France 1,880,987 EUR 1,892,785 (i)Tier 2 (PIBOR), FRN, 3.393%, 12/31/18 .............. France 832,034 EUR 837,253 (i)Tier 3 (LIBOR), FRN, 3.393%, 12/31/25 .............. France 20,347,101 EUR 11,321,320 (i)Tier 3 (PIBOR), FRN, 3.393%, 12/31/25 .............. France 1,048,320 EUR 583,295 (i)Motor Coach Industries International Inc., FRN, 17.406%, 12/01/08 .................................. United States 28,727,281 27,290,917 Trump Entertaiment Resorts Inc., 8.50%, 5/20/15 ....... United States 17,380,260 17,032,655 TVMAX Holdings Inc., PIK, 11.50%, 1/16/06 .................................... United States 249,584 249,584 (j)14.00%, 1/16/06 .................................... United States 646,911 646,911 -------------- TOTAL CORPORATE BONDS & NOTES (COST $124,910,667) ..... 116,001,933 --------------
Annual Report | 25 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT(k) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- CORPORATE BONDS & NOTES IN REORGANIZATION 1.3% (l)Adelphia Communications Corp., 9.25%, 10/01/02 ............................................ United States 3,244,000 $ 1,816,640 8.125%, 7/15/03 ............................................ United States 825,000 470,250 7.50%, 1/15/04 ............................................. United States 2,160,000 1,231,200 10.50%, 7/15/04 ............................................ United States 3,375,000 1,923,750 9.875%, 3/01/05 ............................................ United States 1,304,000 740,020 10.25%, 11/01/06 ........................................... United States 5,565,000 3,116,400 9.875%, 3/01/07 ............................................ United States 493,000 281,010 8.375%, 2/01/08 ............................................ United States 4,959,000 2,826,630 7.75%, 1/15/09 ............................................. United States 10,231,000 5,780,515 7.875%, 5/01/09 ............................................ United States 4,398,000 2,440,890 9.375%, 11/15/09 ........................................... United States 4,390,000 2,590,100 10.875%, 10/01/10 .......................................... United States 4,080,000 2,305,200 10.25%, 6/15/11 ............................................ United States 4,305,000 2,604,525 (l)Armstrong World Industries Inc., 6.35%, 8/15/03 ............................................. United States 9,183,000 6,611,760 6.50%, 8/15/05 ............................................. United States 723,000 513,330 9.75%, 4/15/08 ............................................. United States 2,583,000 1,911,420 7.45%, 5/15/29 ............................................. United States 1,519,000 1,124,060 Revolver, 10/29/03 ......................................... United States 1,880,775 1,318,893 Trade Claim ................................................ United States 5,042,800 3,511,050 (l)Century Communications Corp., (m)8.875%, 1/15/07 ............................................ United States 266,000 255,360 8.75%, 10/01/07 ............................................ United States 2,620,000 2,462,800 8.375%, 12/15/07 ........................................... United States 500,000 480,000 senior note, 9.50%, 3/01/05 ................................ United States 773,000 749,810 Series B, zero cpn., 1/15/08 ............................... United States 4,386,000 2,434,230 zero cpn., 3/15/03 ......................................... United States 8,441,000 7,174,850 (j),(l)Owens Corning, Revolver, 6/26/02 ................................ United States 16,720,570 23,408,798 (l)Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ......... United States 50,000 25 --------------- TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $76,555,782) ........................................... 80,083,516 --------------- ---------------- SHARES/PRINCIPAL AMOUNT(k) ---------------- COMPANIES IN LIQUIDATION 0.0%(d) (a)City Investing Co. Liquidating Trust ............................ United States 423,187 46,550 (a)MBOP Liquidating Trust .......................................... United States 205,135 27 (a)United Cos. Financial Corp., Bank Claim ......................... United States 112,077 -- --------------- TOTAL COMPANIES IN LIQUIDATION (COST $--) ....................... 46,577 ---------------
26 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- ISSUER COUNTRY PRINCIPAL AMOUNT(k) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- GOVERNMENT AGENCIES 8.1% (h)Federal Home Loan Bank, 2.125% - 3.60%, 1/03/06 - 1/26/07 ......... United States 448,310,000 $ 443,226,593 Federal Home Loan Mortgage Corp., 2.50%, 05/19/06 ................. United States 10,000,000 9,922,420 Federal National Mortgage Association, 2.15% - 2.20%, 12/18/06 - 12/29/06 ............................................ United States 20,000,000 19,515,700 (n)U.S. Treasury Bills, 2/02/06 - 2/16/06 ............................ United States 8,000,000 7,967,123 --------------- TOTAL GOVERNMENT AGENCIES (COST $482,991,348) ..................... 480,631,836 --------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $4,450,203,420) .......................................... 5,860,429,226 --------------- REPURCHASE AGREEMENTS 0.0%(d) (o),(p)Bank of America LLC, 4.32%, 1/03/06 (Maturity Value $44,026) Collateralized by U.S. Government Agency Securities, 5.00% - 5.50%, 9/01/33 - 10/01/35 .............................. United States 44,005 44,005 (o),(p)Bear Stearns & Co. Inc., 4.25%, 1/03/06 (Maturity Value $47,028) Collateralized by U.S. Government Agency Securities, 3.282% - 7.155%, 3/01/07 - 9/01/45 ............................. United States 47,006 47,006 (o),(p)J.P. Morgan Securites, 4.31%, 1/03/06 (Maturity Value $48,029) Collateralized by U.S. Government Agency Securities, 3.614% - 5.625%, 12/01/11 - 9/01/35 ............................ United States 48,006 48,006 (o),(p)Merrill Lynch GSI, 4.25%, 1/03/06 (Maturity Value $60,035) Collateralized by U.S. Government Agency Securities, 3.987% - 5.828%, 8/01/27 - 5/01/38 ............................. United States 60,007 60,007 (o),(p)Morgan Stanley & Co. Inc., 4.31%, 1/03/06 (Maturity Value $62,014) Collateralized by U.S. Government Agency Securities, 5.00%, 6/01/35 - 7/01/35 ....................................... United States 62,007 62,007 --------------- TOTAL REPURCHASE AGREEMENTS (COST $261,031) ....................... 261,031 --------------- TOTAL INVESTMENTS (COST $4,450,464,451) 98.4% ..................... 5,860,690,257 OPTIONS WRITTEN 0.0%(d) ........................................... (6,000) SECURITIES SOLD SHORT (1.8)% ...................................... (110,046,110) NET UNREALIZED GAIN ON FORWARD EXCHANGE CONTRACTS 0.6% ................................................. 34,974,122 OTHER ASSETS, LESS LIABILITIES 2.8% ............................... 164,643,538 --------------- NET ASSETS 100.0% ................................................. $ 5,950,255,807 =============== ------------------ CONTRACTS ------------------ (q)OPTIONS WRITTEN (PREMIUMS RECEIVED $25,199) 0.0%(d) PHARMACEUTICALS 0.0%(d) Pfizer Inc., Jan. 22.50 Puts, 1/21/06 ............................. United States 300 $ 6,000 ---------------
Annual Report | 27 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE - ----------------------------------------------------------------------------------------------------------------------------------- (r)SECURITIES SOLD SHORT 1.8% COMMERCIAL BANKS 0.5% Bank of America Corp. ............................................. United States 666,125 $ 30,741,669 --------------- FOOD PRODUCTS 0.4% Kraft Foods Inc., A ............................................... United States 776,718 21,856,844 --------------- HEALTH CARE EQUIPMENT & SUPPLIES 0.1% Alcon Inc. ........................................................ Switzerland 63,100 8,177,760 --------------- HEALTH CARE PROVIDERS & SERVICES 0.0%(d) UnitedHealth Group Inc. ........................................... United States 130 8,078 --------------- METALS & MINING 0.1% Inco Ltd. ......................................................... Canada 102,352 4,447,024 --------------- OIL, GAS & CONSUMABLE FUELS 0.6% ConocoPhillips .................................................... United States 418,010 24,319,822 Occidental Petroleum Corp. ........................................ United States 148,200 11,838,216 --------------- 36,158,038 --------------- PHARMACEUTICALS 0.0%(d) Teva Pharmaceutical Industries Ltd., ADR .......................... Israel 58,400 2,511,784 --------------- REAL ESTATE 0.1% Public Storage Inc. ............................................... United States 90,740 6,144,913 --------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $112,788,699) ............... $ 110,046,110 ---------------
28 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED) CURRENCY ABBREVIATIONS CAD - Canadian Dollar EUR - Euro GBP - British Pound SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FRN - Floating Rate Note GDR - Global Depository Receipt LIBOR - London InterBank Offered Rate PIBOR - Paris InterBank Offered Rate PIK - Payment In Kind (a) Non-income producing. (b) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. These securities have been deemed liquid under guidelines approved by the Fund's Board of Directors. At December 31, 2005, the aggregate value of these securities was $48,931,205, representing 0.82% of net assets. (c) 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. (d) Rounds to less than 0.05% of net assets. (e) See Note 11 regarding restricted and illiquid securities. (f) See Note 13 regarding holdings of 5% voting securities. (g) See Note 14 regarding other considerations. (h) See Note 1(g) regarding securities segregated with broker for securities sold short. (i) The coupon rate shown represents the rate at period end. (j) See Note 12 regarding unfunded loan commitments. (k) The principal amount is stated in U.S. dollars unless otherwise indicated. (l) See Note 10 regarding defaulted securities. (m) A portion or all of the security is on loan as of December 31, 2005. See Note 1(i). (n) The security is traded on a discount basis with no stated coupon rate. (o) See Note 1(c) regarding repurchase agreements. (p) Investment from cash collateral received for loaned securities. See Note 1(i). (q) See Note 1(f) regarding written options. (r) See Note 1(g) regarding securities sold short. Annual Report | See notes to financial statements. | 29 Mutual Beacon Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2005 Assets: Investments in securities: Cost - Unaffiliated issuers .............................................. $ 4,346,258,584 Cost - Controlled affiliates issuers (Note 13) ........................... 3,422,311 Cost - Non-controlled affiliated issuers (Note 13) ....................... 100,522,525 Cost - Repurchase agreements ............................................. 261,031 ================ Total cost of investments ................................................ $ 4,450,464,451 ================ Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $124,535,400) .. $ 5,703,248,465 Value - Controlled affiliated issuers (Note 13) .......................... 4,204,554 Value - Non-controlled affiliated issuers (Note 13) ...................... 152,976,207 Value - Repurchase agreements ............................................ 261,031 ================ Total value of investments ............................................... 5,860,690,257 Cash ........................................................................ 538,867 Foreign currency, at value (cost $39,285,820) ............................... 38,800,201 Receivables: Investment securities sold ............................................... 24,630,771 Capital shares sold ...................................................... 5,442,522 Dividends and interest ................................................... 10,822,952 Unrealized gain on forward exchange contracts (Note 8) ...................... 43,164,573 Unrealized gain on unfunded loan commitments (Note 12) ...................... 709,701 Cash on deposits with brokers for securities sold short ..................... 122,184,369 Due from broker - synthetic equity swaps .................................... 7,671,251 ---------------- Total assets .......................................................... 6,114,655,464 ---------------- Liabilities: Payables: Investment securities purchased .......................................... 28,119,036 Capital shares redeemed .................................................. 10,155,723 Affiliates ............................................................... 6,680,906 Options written, at value (premiums received $25,199) ....................... 6,000 Securities sold short, at value (proceeds $112,788,699) ..................... 110,046,110 Payable upon return of securities loaned .................................... 261,031 Unrealized loss on forward exchange contracts (Note 8) ...................... 8,190,451 Accrued expenses and other liabilities ...................................... 940,400 ---------------- Total liabilities ..................................................... 164,399,657 ---------------- Net assets, at value ............................................... $ 5,950,255,807 ================ Net assets consist of: Paid-in capital ............................................................. $ 4,365,102,108 Undistributed net investment income ......................................... 4,564,461 Net unrealized appreciation (depreciation) .................................. 1,449,095,256 Accumulated net realized gain (loss) ........................................ 131,493,982 ---------------- Net assets, at value ............................................... $ 5,950,255,807 ================
30 | See notes to financial statements. | Annual Report Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2005 CLASS Z: Net assets, at value ........................................................ $ 3,433,665,052 ================ Shares outstanding .......................................................... 221,282,669 ================ Net asset value and maximum offering price per share(a) ..................... $ 15.52 ================ CLASS A: Net assets, at value ........................................................ $ 1,633,021,745 ================ Shares outstanding .......................................................... 105,752,574 ================ Net asset value per share(a) ................................................ $ 15.44 ================ Maximum offering price per share (net asset value per share / 94.25%) ....... $ 16.38 ================ CLASS B: Net assets, at value ........................................................ $ 186,168,554 ================ Shares outstanding .......................................................... 12,341,125 ================ Net asset value and maximum offering price per share(a) ..................... $ 15.09 ================ CLASS C: Net assets, at value ........................................................ $ 697,400,456 ================ Shares outstanding .......................................................... 45,506,651 ================ Net asset value and maximum offering price per share(a) ..................... $ 15.33 ================
(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 Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2005 Investment income: Dividends (net of foreign taxes of $3,706,051) Unaffiliated issuers ..................................................... $ 120,985,125 Non-controlled affiliated issuers (Note 13) .............................. 1,919,625 Interest Unaffiliated issuers ..................................................... 37,274,351 Non-controlled affiliated issuers (Note 13) .............................. 118,558 Income from securities loaned - net ......................................... 8,300 Other income (Note 15) ...................................................... 289,755 ---------------- Total investment income .............................................. 160,595,714 ---------------- Expenses: Management fees (Note 3a) ................................................... 34,249,367 Administrative fees (Note 3b) ............................................... 4,415,575 Distribution fees (Note 3c) Class A .................................................................. 5,087,936 Class B .................................................................. 1,849,594 Class C .................................................................. 6,714,359 Transfer agent fees (Note 3e) ............................................... 5,968,700 Custodian fees (Note 4) ..................................................... 516,600 Reports to shareholders ..................................................... 403,100 Registration and filing fees ................................................ 393,104 Professional fees ........................................................... 1,808,561 Directors' fees and expenses ................................................ 152,300 Dividends on securities sold short .......................................... 2,651,538 Other ....................................................................... 404,874 ---------------- Total expenses ....................................................... 64,615,608 Expense reductions (Note 4) .......................................... (41,094) ---------------- Net expenses ....................................................... 64,574,514 ---------------- Net investment income ........................................... 96,021,200 ---------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments Unaffiliated issuers .................................................. 602,197,318 Non-controlled affiliated issuers (Note 13) ........................... 12,634,531 Written options .......................................................... 396,640 Foreign currency transactions ............................................ 12,146,932 Securities sold short .................................................... (1,896,827) ---------------- Net realized gain (loss) ........................................... 625,478,594 ---------------- Net change in unrealized appreciation (depreciation) on: Investments .............................................................. (308,930,486) Translation of assets and liabilities denominated in foreign currencies .. 87,593,570 ---------------- Net change in unrealized appreciation (depreciation) ............... (221,336,916) ---------------- Net realized and unrealized gain (loss) ..................................... 404,141,678 ---------------- Net increase (decrease) in net assets resulting from operations ............. $ 500,162,878 ================
32 | See notes to financial statements. | Annual Report Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
--------------------------------- YEAR ENDED DECEMBER 31, --------------------------------- 2005 2004 --------------------------------- Increase (decrease) in net assets: Operations: Net investment income .................................................................... $ 96,021,200 $ 92,816,059 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions .................................................... 625,478,594 232,630,254 Net change in unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ............................. (221,336,916) 387,316,410 --------------------------------- Net increase (decrease) in net assets resulting from operations ................... 500,162,878 712,762,723 ================================= Distributions to shareholders from: Net investment income: Class Z ................................................................................ (60,342,727) (77,913,804) Class A ................................................................................ (23,520,169) (29,186,869) Class B ................................................................................ (1,530,106) (2,726,902) Class C ................................................................................ (5,682,282) (9,336,828) Net realized gains: Class Z ................................................................................ (321,411,244) (30,107,862) Class A ................................................................................ (152,696,307) (13,165,077) Class B ................................................................................ (18,000,266) (1,717,371) Class C ................................................................................ (66,098,869) (5,979,789) --------------------------------- Total distributions to shareholders ........................................................ (649,281,970) (170,134,502) --------------------------------- Capital share transactions: (Note 2) Class Z ................................................................................ 155,432,764 (76,914,860) Class A ................................................................................ 215,432,427 21,294,207 Class B ................................................................................ 4,237,354 13,963,459 Class C ................................................................................ 57,084,985 16,973,359 --------------------------------- Total capital share transactions ........................................................... 432,187,530 (24,683,835) --------------------------------- Redemption fees ............................................................................ 11,659 2,731 --------------------------------- Net increase (decrease) in net assets ................................................. 283,080,097 517,947,117 Net assets Beginning of year .......................................................................... 5,667,175,710 5,149,228,593 --------------------------------- End of year ................................................................................ $ 5,950,255,807 $5,667,175,710 ================================= Undistributed net investment income/distributions in excess of net investment income included in net assets: End of year ................................................................................ $ 4,564,461 $ (12,838,004) =================================
Annual Report | See notes to financial statements. | 33 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Mutual Beacon Fund (the Fund) is a separate, diversified series of Franklin Mutual Series Fund Inc. (the Series Fund), consisting of six separate series. The Series Fund 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 following summarizes the Funds' 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 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. 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 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. 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. 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. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. Occasionally, events occur between the 34 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) 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 Fund, with the value of the underlying securities marked to market daily to maintain coverage of at least 100%. Repurchase agreements are valued at cost. At December 31, 2005, all repurchase agreements held by the Fund had been entered into on December 30, 2005. Annual Report | 35 Mutual Beacon 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 the net unrealized gain or loss on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, 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, which may be in excess of the amount reflected in the Statement of Assets and Liabilities. 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. 36 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) F. OPTIONS 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. 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 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. 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 receives interest income 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 | 37 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) I. INCOME TAXES No provision has been made for U.S. income taxes because the Fund's policy is to continue to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. Foreign securities held by the Fund may be subject to foreign taxation. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. J. 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. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with generally accepted accounting principles. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. 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 of the Series Fund. Fund specific expenses are charged directly to the fund that incurred the expense. K. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. 38 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) L. REDEMPTION FEES A short term trading redemption fee will be imposed, with some exceptions, on Fund shares that are redeemed or exchanged within seven calendar days following their purchase date. The redemption fee is 2% of the amount redeemed. Such fees are retained by the Fund and accounted for as an addition to paid-in capital. M. GUARANTEES AND INDEMNIFICATIONS Under the Series Fund's organizational documents, its officers and directors are indemnified by the Fund against certain liabilities 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 are only offered to existing Class B shareholders in the form of reinvested distributions and certain exchanges from other Franklin Templeton Class B shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. At December 31, 2005, there were 1.55 billion shares authorized ($0.001 par value) of which 750 million shares were designated as Class Z, 300 million shares as Class A, 200 million shares as Class B and 300 million shares as Class C. Transactions in the Fund's shares were as follows:
--------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2005 2004 --------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT --------------------------------------------------------------------- CLASS Z SHARES: Shares sold ........................ 9,627,199 $ 157,823,087 9,311,423 $ 138,383,364 Shares issued in reinvestment of distributions ................ 22,556,761 353,149,844 6,402,049 98,844,650 Shares redeemed .................... (21,717,045) (355,540,167) (21,085,193) (314,142,874) --------------------------------------------------------------------- Net increase (decrease) ............ 10,466,915 $ 155,432,764 (5,371,721) $ (76,914,860) ===================================================================== CLASS A SHARES: Shares sold ........................ 20,638,795 $ 336,110,441 17,626,495 $ 260,036,176 Shares issued in reinvestment of distributions ................ 10,784,005 167,935,388 2,612,744 40,150,928 Shares redeemed .................... (17,798,261) (288,613,402) (18,863,471) (278,892,897) --------------------------------------------------------------------- Net increase (decrease) ............ 13,624,539 $ 215,432,427 1,375,768 $ 21,294,207 =====================================================================
Annual Report | 39 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
--------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2005 sc2004 --------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT --------------------------------------------------------------------- CLASS B SHARES: Shares sold ........................ 441,856 $ 6,909,193 1,843,917 $ 26,599,867 Shares issued in reinvestment of distributions ................... 1,187,718 18,082,957 273,719 4,112,587 Shares redeemed .................... (1,309,590) (20,754,796) (1,158,155) (16,748,995) --------------------------------------------------------------------- Net increase (decrease) ............ 319,984 $ 4,237,354 959,481 $ 13,963,459 ===================================================================== CLASS C SHARES: Shares sold ........................ 5,683,466 $ 91,278,462 6,114,281 $ 89,688,362 Shares issued in reinvestment of distributions ................... 4,219,758 65,245,399 908,460 13,841,462 Shares redeemed .................... (6,181,561) (99,438,876) (5,908,416) (86,556,465) --------------------------------------------------------------------- Net increase (decrease) ............ 3,721,663 $ 57,084,985 1,114,325 $ 16,973,359 =====================================================================
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and directors 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 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% Up to and including $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% In excess of $10 billion 40 | Annual Report Mutual Beacon 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 Series Fund's aggregate average daily net assets as follows: - -------------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - -------------------------------------------------------------------------------- 0.150% Up to and including $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% In excess of $1.2 billion C. DISTRIBUTION FEES The Fund's Board of Directors has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors up to 0.35% per year of Class A's average daily net assets for costs incurred in connection with the sale and distribution of the Fund's shares. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. Under the Fund's compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the sale and distribution of the Fund's shares up to a certain percentage per year of its average daily net assets of each class as follows: Class B ............................................................. 1.00% Class C ............................................................. 1.00% 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 charge received(a) ........................................ $853,183 Contingent deferred sales charges retained .......................... $298,601 (a) Net of commissions paid to unaffiliated broker/dealers. E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $5,968,700, of which $3,734,685 was retained by Investor Services. Annual Report | 41 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 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, 2005, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES Net investment income differs for financial statement and tax purposes primarily due to differing treatment 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 (losses) differ for financial statement and tax purposes primarily due to differing treatment of defaulted securities, wash sales, foreign currency transactions, passive foreign investment company shares, bond discounts and premiums and certain dividends on securities sold short. At December 31, 2005, 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 .......................................... $ 4,467,981,560 =============== Unrealized appreciation ...................................... $ 1,539,612,177 Unrealized depreciation ...................................... (146,903,480) --------------- Net unrealized appreciation (depreciation) ................... $ 1,392,708,697 =============== Undistributed ordinary income ................................ $ 17,803,197 Undistributed long term capital gains ........................ 157,258,364 --------------- Distributable earnings ....................................... $ 175,061,561 =============== The tax character of distributions paid during the years ended December 31, 2005 and 2004, was as follows: --------------------------- 2005 2004 --------------------------- Distributions paid from: Ordinary income ............................... $127,255,911 $119,164,403 Long term capital gain ........................ 522,026,059 50,970,099 --------------------------- $649,281,970 $170,134,502 --------------------------- 42 | Annual Report Mutual Beacon 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, 2005, aggregated $2,502,297,864 and $1,825,823,484, respectively. Transactions in options written during the year ended December 31, 2005, were as follows: --------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED --------------------------- Options outstanding at December 31, 2004 ............................. 943 $ 113,289 Options written .................................. 10,641 756,897 Options expired .................................. (3,383) (259,156) Options exercised ................................ (687) (99,520) Options closed ................................... (7,214) (486,311) --------------------------- Options outstanding at December 31, 2005 ............................. 300 $ 25,199 =========================== 7. SYNTHETIC EQUITY SWAPS As of December 31, 2005, the Fund had the following synthetic equity swaps outstanding:
- -------------------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - -------------------------------------------------------------------------------------------- Christian Dior SA (46.76 - 54.99 EUR) ............ 72,087 $ 6,409,049 $ 2,236,839 02 PLC (1.95 - 1.97 GBP) ......................... 12,449,912 42,410,512 403,930 ----------- Total contracts to buy ........................... 2,640,769 -----------
- -------------------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - -------------------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (54.61 - 61.76 EUR) ........................... 71,930 $ 6,390,833 $(1,365,226) ----------- Total contracts to sell .......................... (1,365,226) =========== Net unrealized gain (loss) ....................... $ 1,275,543 ===========
Annual Report | 43 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS At December 31, 2005, the Fund has outstanding forward exchange contracts as set out below.
- -------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO BUY AMOUNT(a) DATE GAIN (LOSS) - -------------------------------------------------------------------------------------------- 93,475,264 Canadian Dollar .................. 79,377,056 1/23/06 $ 1,104,050 -------------
- -------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - -------------------------------------------------------------------------------------------- 6,750,000 Euro ............................. 8,003,003 1/17/06 $ 3,860 57,475,000 Euro ............................. 70,905,231 1/23/06 2,770,834 34,960,448 Swiss Franc ...................... 28,050,000 2/02/06 1,344,580 24,425,000 British Pound .................... 44,042,141 2/15/06 2,025,583 9,638,443 Canadian Dollar .................. 8,342,036 2/15/06 37,909 33,800,000 Euro ............................. 41,028,433 2/27/06 883,305 67,088,438 Norwegian Krone .................. 9,983,398 3/06/06 7,096 47,423,155 Euro ............................. 56,531,659 3/15/06 201,861 340,107,678 Swedish Krona .................... 43,535,087 3/15/06 495,741 791,797,067 Danish Krone ..................... 140,963,688 3/17/06 14,790,808 14,025,000 British Pound .................... 25,261,830 3/21/06 1,133,481 26,900,000 British Pound .................... 47,361,156 4/04/06 1,078,770 39,461,542 Euro ............................. 50,549,924 4/25/06 3,527,914 31,500,000 British Pound .................... 54,895,050 5/15/06 673,674 60,010,000 Euro ............................. 74,901,063 5/23/06 3,279,876 221,114,000 Taiwan Dollar .................... 6,775,000 5/30/06 39,152 14,395,040 Norwegian Krone .................. 2,200,000 6/06/06 48,211 4,440,813 Swiss Franc ...................... 3,450,660 6/06/06 19,929 13,750,000 Euro ............................. 16,698,519 6/15/06 266,580 3,468,632,983 Japanese Yen ..................... 31,674,734 6/28/06 1,602,923 8,400,000 Euro ............................. 10,063,305 7/17/06 7,160 37,754,299 British Pound .................... 65,892,215 8/14/06 830,793 38,615,000 Euro ............................. 48,172,935 8/23/06 1,852,203 45,557,500 British Pound .................... 79,293,331 9/08/06 757,236 45,540,000 Euro ............................. 57,703,342 9/13/06 3,013,667 51,755,687 Euro ............................. 63,472,392 10/18/06 1,205,825 ------------ 41,898,971 ------------ Net unrealized gain on offsetting forward exchange contracts ........................ 161,552 ------------ Unrealized gain on forward exchange contracts ................................. $ 43,164,573 ============
- -------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO BUY AMOUNT(a) DATE GAIN (LOSS) - -------------------------------------------------------------------------------------------- 7,737,588 Canadian Dollar .................. 6,632,199 1/23/06 $ (4,133) 9,333,491 Danish Krone ..................... 1,511,207 3/17/06 (23,915) ------------ $ (28,048) ------------
44 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- -------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - -------------------------------------------------------------------------------------------- 5,762,585,000 Korean Won ....................... 5,605,000 1/18/06 $ (115,766) 155,705,240 Canadian Dollar .................. 127,984,559 1/23/06 (6,075,827) 150,849,105 Norwegian Krone .................. 22,381,173 2/06/06 (16,017) 12,138,917 Canadian Dollar .................. 10,214,110 2/15/06 (244,333) 130,000,000 Norwegian Krone .................. 19,309,607 3/06/06 (21,880) 20,000,000 Euro ............................. 23,564,000 3/15/06 (212,231) 29,637,312,600 Korean Won ....................... 28,676,800 3/22/06 (767,846) 463,668,185 Taiwan Dollar .................... 14,023,576 5/30/06 (101,257) 140,000,000 Norwegian Krone .................. 20,879,940 6/06/06 (47,442) 48,121,515 Swiss Franc ...................... 37,117,336 6/06/06 (78,460) 31,789,484 Euro ............................. 37,904,497 6/15/06 (85,529) 789,243,900 Japanese Yen ..................... 6,820,000 6/28/06 (22,463) 42,326,483 Euro ............................. 50,298,224 7/17/06 (373,352) ------------ (8,162,403) ------------ Unrealized loss on forward exchange contracts ................................. (8,190,451) ------------ Net unrealized gain on forward exchange contracts .................................. $ 34,974,122 ============
(a) In U.S. Dollar unless otherwise indicated. 9. CONCENTRATION OF RISK Investing in foreign securities may include certain risks and considerations not typically associated with investing in U.S. securities, such as fluctuating currency values and changing local and regional economic, political and social conditions, which may result in greater market volatility. In addition, certain foreign securities may not be as liquid as U.S. securities. 10. DEFAULTED SECURITIES The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressed companies are financially troubled and are about to be/or are already involved in financial restructuring or bankruptcy. The Fund does not accrue income on these securities, if it becomes probable that the income will not be collected. The risks of purchasing these securities are that the issuer is unable to meet its obligation and any subsequent bankruptcy proceeding may result in unfavorable consequences to the Fund. At December 31, 2005, the value of these securities was $80,083,516, representing 1.35% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. Annual Report | 45 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. RESTRICTED AND ILLIQUID SECURITIES At December 31, 2005, investments in securities included issues that are restricted and illiquid. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration under the Securities Act of 1933, unless the sale is pursuant to an exemption under the 1933 Act. The Fund has registration rights for all restricted securities held at period end. The issuer generally incurs all registration costs. A security may 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, 2005, the Fund held investments in restricted and illiquid securities, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- ----------------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT, SHARES, CONTRACTS ACQUISITION AND WARRANTS ISSUER DATE COST VALUE - ----------------------------------------------------------------------------------------------------------------- 439,477 AboveNet Inc. ................................. 10/02/01 $ 20,497,153 $ 10,531,363 14,770 AboveNet Inc., wts., 9/08/08 .................. 10/02/01 1,836,931 59,080 17,376 AboveNet Inc., wts., 9/08/10 .................. 10/02/01 1,972,095 13,901 1,142,353 DecisionOne Corp. ............................. 3/12/99 793,798 814,498 1,240,025 DecisionOne Corp., 144A, 12.00%, 4/15/10 .................................... 3/12/99 4,346,610 1,240,025 28,644 Esmark Inc., Series A, 10.00%, cvt. pfd ....... 11/08/04 28,644,000 30,037,244 13,981 FE Capital Holdings Ltd. ...................... 8/29/03 -- 19,922,914 1,967,636 Florida East Coast Industries Inc. ............ 1/17/86 46,735,956 79,200,300 1,364,570 Kindred Healthcare Inc. ....................... 4/28/99 14,230,143 33,393,757 657 Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 .................................... 1/1/04 -- 10,116 325 Kindred Healthcare Inc., Jan. 25.99 Calls, 1/01/14 .................................... 1/4/05 -- -- 989 Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 .................................... 1/13/03 -- -- 4,380 Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 .................................... 7/17/02 -- 3,162 121,432 Kindred Healthcare Inc., wts., Series A, 4/20/06 .................................... 4/24/01 1,092,889 2,348,738 303,580 Kindred Healthcare Inc., wts., Series B, 4/20/06 .................................... 4/24/01 2,428,643 4,989,337 1 Lancer Industries Inc., B ..................... 8/11/89 -- 764,320 67,420 NCB Warrant Holdings Ltd., A .................. 12/16/05 -- 10,892,382 106,700 Olympus Re Holdings Ltd. ...................... 12/19/01 10,670,000 1,973,950 20,244 Security Capital European Realty .............. 4/08/98 1,108,993 147,123 511,600 Symetra Financial ............................. 7/27/04 51,160,000 58,834,000 2,833,800 Time Warner Inc. .............................. 8/02/05 48,945,601 48,433,043 10,958 Time Warner Inc., Jan 10.00 Calls, 1/21/06 .................................... 8/17/05 9,179,627 8,054,130 TOTAL RESTRICTED AND ILLIQUID SECURITIES (5.24% of Net Assets) ........ $ 311,663,383 =============
46 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 12. UNFUNDED LOAN COMMITMENTS The Fund may enter into certain credit agreements, all or a portion of which may be unfunded. The Fund is obligated to fund these loan commitments at the borrowers' discretion. At December 31, 2005, unfunded commitments were as follows:
- ------------------------------------------------------------------------------------------ BORROWER UNFUNDED COMMITMENT - ------------------------------------------------------------------------------------------ Entegra/Union Power, LOC Facility, FRN, 6/01/12 .................... $ 2,081,545 Entegra/Union Power, Working Capital Facility, FRN, 6/01/12 ........ 312,232 Mirant Corp., 4 Year Revolver, 7/17/05 ............................. 297,276 Owens Corning, Revolver, 6/26/02 ................................... 955,030 TVMAX Holdings Inc., PIK, 14.00%, 1/16/06 .......................... 31 ----------- $ 3,646,114 ===========
Unfunded loan commitments are marked to market daily and any unrealized gain or loss is included in the Statement of Assets and Liabilities and Statement of Operations. 13. 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, 2005 were as shown below.
- ----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF NUMBER OF SHARES/ SHARES/ PRINCIPAL AMOUNT PRINCIPAL AMOUNT VALUE REALIZED HELD AT BEGINNING GROSS GROSS HELD AT END AT END INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS OF YEAR OF YEAR INCOME (LOSS) GAINS (LOSS) - ----------------------------------------------------------------------------------------------------------------------------------- CONTROLLED AFFILIATES(A) PMG, LLC ................ 48,890 -- -- 48,890 $ 4,204,554 $ -- $ -- ------------------------------------------ NON-CONTROLLED AFFILIATES Anchor Resources LLC ...... 69,184 -- -- 69,184 $ -- $ -- $ -- Anchor Resources LLC, 12.00%, 12/17/2006 ...... 32,368 -- 32,368 -- -- 3,874 -- DecisionOne Corp. ......... 278,121 864,232 -- 1,142,353 814,498 -- -- DecisionOne Corp., 144A, 12.00%, 4/15/10 ......... -- 1,441,175 201,150 1,240,025 1,240,025 114,684 (802,217) Esmark Inc., Series A, 10.00% cvt. pfd. ........ 19,151 9,493 -- 28,644 30,037,244 2,801,797 -- Farmer Brothers Co. ....... 1,033,896 -- -- 1,033,896 19,995,549 418,728 -- FE Capital Holdings Ltd. .. 13,981 -- -- 13,981 19,922,914 (1,753,456) 15,440,621 FHC Delaware Inc. ......... 507,977 -- -- 507,977 1,765,677 -- -- Florida East Coast Industries Inc. ......... 1,967,636 -- -- 1,967,636 79,200,300 452,556 -- Nippon Investment, LLC .... 10,862,000 -- 10,862,00 -- -- -- (2,003,873) ------------------------------------------ TOTAL NON-CONTROLLED AFFILIATES .............. $ 152,976,207 $ 2,038,183 $ 12,634,531 ------------------------------------------ TOTAL AFFILIATED SECURITIES (2.64% of Net Assets) .. $ 157,180,761 $ 2,038,183 $ 12,634,531 ==========================================
(a) Issuer in which the Fund owns 25% or more of the outstanding voting securities. Annual Report | 47 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 14. OTHER CONSIDERATIONS Directors or employees of Franklin Mutual, as the Fund's Investment Manager, may serve as members 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, 2005, such individuals serve in one or more of these capacities for Kindred Healthcare Inc., AboveNet Inc. and Esmark Inc. As a result of this involvement, such individuals 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. 15. REGULATORY MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, 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 (collectively, the "Company"), entered into settlements with certain of those regulators. Specifically, the Company entered into settlements with the Securities and Exchange Commission ("SEC") concerning market timing (the "August 2, 2004 SEC Order") and marketing support payments to securities dealers who sell fund shares (the "December 13, 2004 SEC Order") and with the California Attorney General's Office ("CAGO") concerning marketing support payments to securities dealers who sell fund shares (the "CAGO Settlement"). Under the terms of the settlements with the SEC and the CAGO, the Company retained an Independent Distribution Consultant ("IDC") to develop a plan for distribution of the respective settlement monies. The CAGO approved the distribution plan under the CAGO Settlement and, in accordance with the terms and conditions of that settlement, the monies were disbursed to the relevant funds and are recorded as other income in the current period. The SEC has not yet approved the distribution plan pertaining to the December 13, 2004 SEC Order. When approved, disbursements of settlement monies will be made promptly to the relevant funds, in accordance with the terms and conditions of that order. The IDC continues to develop the plan of distribution under the August 2, 2004 SEC Order that resolved the SEC's market timing investigation. 48 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 15. REGULATORY MATTERS (CONTINUED) In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, directors, and/or employees, have been named in private lawsuits (styled as shareholder class actions, or as derivative actions on behalf of either the named funds or Franklin Resources, Inc.) relating to the industry practices referenced above, as well as to allegedly excessive advisory fees, commissions, and/or 12b-1 fees. The lawsuits were filed in different courts throughout the country. Many of those suits are now pending in a multi-district litigation in the United States District Court for the District of Maryland. The Company and fund management strongly believe that the claims made in each of the private lawsuits referenced above are without merit and intend to defend against them vigorously. The Company cannot predict with certainty the eventual outcome of these lawsuits, nor whether they will have a material negative impact on the Company. 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. Annual Report | 49 Mutual Beacon Fund REPORT OF 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 of the Mutual Beacon Fund (one of the portfolio constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2005, 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. We were not engaged to perform an audit of the Fund's internal control over financial reporting. Our audits included 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, and evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2005, by correspondence with the custodian and brokers, or by other appropriate auditing procedures where replies from the 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. at December 31, 2005, 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 10, 2006 50 | Annual Report Mutual Beacon Fund TAX DESIGNATION (UNAUDITED) Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Funds designate the maximum amount allowable but no less than $634,603,162 as a capital gain dividends for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $96,850,147 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2005. In January 2006, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2005. 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 871(k)(1)(C) of the Code, the Fund designates the maximum amount allowable but no less than $30,077,560 as interest-related dividends for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section 871(k)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $44,302,035 as a short-term capital gain dividend for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates 41.15% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2005. Annual Report | 51 Mutual Beacon Fund BOARD MEMBERS AND OFFICERS The name, year of birth 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 NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ EDWARD I. ALTMAN, PH.D. Director Since 1987 7 Director, A.T.D. Inc.(financial (1941) technology and investment company). 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, Salomon Center; editor and author of numerous financial publications; financial consultant; and serves on the Investment Advisory Committee of the New York State Common Retirement Fund; and FORMERLY, Vice Director, NYU Salomon Center, Stern School of Business, New York University. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE BATES (1958) Director Since 1994 7 Independent Director, SLM Corporation 101 John F. Kennedy Parkway (Sallie Mae) and Allied Capital Short Hills, NJ 07078-2789 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 (1929) Director Since 2002 13 Director, Fiduciary Emerging Markets 101 John F. Kennedy Parkway Bond Fund PLC and Fiduciary Short Hills, NJ 07078-2789 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 (1930) Director Since 1974 7 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers). - ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (1930) Director Since 1998 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------
52 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (1925) Director Since 1996 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 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 (1946) Director and Director since 13 Director, El Oro and Exploration Co., 101 John F. Kennedy Parkway Chairman of 1991 and p.l.c., and ARC Wireless Solutions, Short Hills, NJ 07078-2789 the Board Chairman of the Inc. Board since 2005 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. - ------------------------------------------------------------------------------------------------------------------------------------
INTERESTED BOARD MEMBERS AND OFFICERS
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ **WILLIAM J. LIPPMAN (1925) Director Since 1996 14 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024-2920 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Advisory Services, LLC; Director, Templeton Worldwide, Inc.; and officer and/or director or trustee, as the case may be, of five of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ **ANNE M. TATLOCK (1939) Director Since 2002 7 Director, Fortune Brands, Inc. 600 Fifth Avenue, 7th Floor (consumer products) and Merck & Co. New York, NY 10020-2302 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. - ------------------------------------------------------------------------------------------------------------------------------------ PHILIPPE BRUGERE-TRELAT (1949) Vice President Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Mutual Advisers, LLC; Portfolio Manager of Eurovest SA (French registered Investment Company, Sicav); and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 53
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL J. EMBLER (1964) Senior Vice Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President and Chief Investment Officer, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ PETER A. LANGERMAN (1955) President, and Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway Chief Short Hills, NJ 07078-2702 Executive Officer - Investment Management PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (1952) Chief Since 2004 Not Applicable Not Applicable One Franklin Parkway Compliance San Mateo, CA 94403-1906 Officer PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (1947) 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 47 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ DAVID P. GOSS (1947) 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 47 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). - ------------------------------------------------------------------------------------------------------------------------------------
54 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ STEVEN J. GRAY (1955) Secretary Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Resources, Inc.; officer of 33 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chief Legal Counsel, Atlas Advisers, Inc. (until 2000). - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (1947) 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, LLC, 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 47 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 (1937) 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, Franklin Templeton Institutional Suisse S.A., 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 45 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ GREGORY R. SEWARD (1956) Treasurer Since December Not Applicable Not Applicable 500 East Broward Blvd. 2005 Suite 2100 Fort Lauderdale, FL 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 16 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPMorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ------------------------------------------------------------------------------------------------------------------------------------ CRAIG S. TYLE (1960) Vice President Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Partner, Shearman & Sterling, LLP (2004-2005); and General Counsel, Investment Company Institute (ICI) (1997-2004). - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 55
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (1951) Chief Financial Since 2004 Not Applicable Not Applicable 500 East Broward Blvd. Officer and Suite 2100 Chief Fort Lauderdale, FL 33394-3091 Accounting Officer PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Managing Director, RSM McGladrey, Inc. (1999-2004); and Partner, McGladrey & Pullen, LLP (1979-1987 and 1991-2004). - ------------------------------------------------------------------------------------------------------------------------------------
* 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. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE BATES, 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. 56 | Annual Report 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 U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. 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 | 57 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 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 MidCap Value Fund 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 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(4) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(4) 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(4) Templeton Global Bond Fund Templeton Income Fund TAX-FREE INCOME(5) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(6) 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(7) Colorado Connecticut Florida(7) Georgia Kentucky Louisiana Maryland Massachusetts(6) Michigan(6) Minnesota(6) Missouri New Jersey New York(7) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (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) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (5) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (6) Portfolio of insured municipal securities. (7) 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). (8) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 09/05 Not part of the annual report [LOGO](R) FRANKLIN TEMPLETON 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 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 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 A2005 02/06 MUTUAL DISCOVERY FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2005 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 TEMPLETON 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 what we believe are undervalued stocks, as well as arbitrage situations and distressed securities. Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. Templeton pioneered international investing and, with offices in over 25 countries, offers investors a truly global perspective. TRUE DIVERSIFICATION Because these management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why the funds can be used to build truly diversified allocation plans 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, accurate and personal service that has 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 ................. 53 Tax Designation ......................................................... 54 Board Members and Officers ............................................. 58 Shareholder Information ................................................. 63 - -------------------------------------------------------------------------------- ANNUAL REPORT MUTUAL DISCOVERY FUND YOUR FUND'S GOAL AND MAIN INVESTMENTS: Mutual Discovery Fund seeks long-term capital appreciation by investing mainly in equity securities of companies of any nation the Fund's managers believe are at prices below their intrinsic value. The Fund may invest up to 100% of its assets in foreign securities. - -------------------------------------------------------------------------------- PERFORMANCE DATA 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 for the fiscal year ended December 31, 2005. PERFORMANCE OVERVIEW Mutual Discovery Fund - Class Z posted a +15.70% cumulative total return for the 12 months ended December 31, 2005. The Fund outperformed its benchmarks, the Standard & Poor's 500 Index (S&P 500) and the Morgan Stanley Capital International (MSCI) World Index, which returned +4.91% and +10.02% for 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 The global economy overcame fears of derailment generated by higher energy costs and advanced at a solid pace during 2005, with Europe surpassing expectations. Excluding the volatile energy and food sectors, inflation remained relatively subdued worldwide, and monetary policy remained fairly accommodative. The U.S. Federal Reserve Board raised the short-term federal funds target rate with eight quarter-point increases, bringing it to 4.25%. The European Central Bank (ECB) made one quarter-point rise in short-term rates, its first increase after keeping rates at historically low levels for more than two and a half years. Even after the increases, both rates remained at levels considered accommodative for economic growth. (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. 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 Strong demand for oil sustained high prices during most of the year, while prices for other commodities such as industrial metals were also high, led by copper, whose contract price rose 45.4% during 2005.(2) This contributed to economic growth in countries such as Australia and Canada, and emerging markets in Asia and Latin America that are tied to mining and industrial commodities. In this environment, global equity markets performed strongly, particularly outside the U.S. One-year total return for the MSCI All Country (AC) World ex US Index was +17.11% in U.S. dollar terms.(3) By comparison the total return for the MSCI USA Index was +5.72%.(4) In terms of sectors, energy and materials led equity market performance, and telecommunication services and consumer-related sectors lagged. Among developed countries, the Japanese equity market performed well, returning +44.70% in local currency terms for the year under review.(4) However, this market benefited primarily from investors outside Japan, and the return was significantly less (+25.62%) after conversion into U.S. dollars.(4) In contrast, the conversion into dollars enhanced equity market returns in Brazil (+57.04%), Mexico (+49.11%) and South Korea (+58.00%).(4) At the beginning of the year, the consensus of many analysts appeared to be that the U.S. dollar would decline in value relative to major currencies. In fact, for the year the dollar appreciated versus the yen, the euro, the pound and most other currencies. INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks. When selecting undervalued equities, we are always attracted to fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. We also look for asset rich companies GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/05 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] U.S 29.4% U.K 10.8% France 8.4% South Korea 5.1% Canada 4.4% Hong Kong 3.4% Switzerland 3.3% Norway 3.1% Japan 2.9% Netherlands 2.7% Ireland 2.3% Spain 2.0% Denmark 1.7% Germany 1.6% South Africa 1.5% India 1.2% Other 5.7% Short-Term Investments & Other Net Assets 10.5% (2) Source: New York Mercantile Exchange. (3) Source: Standard & Poor's Micropal. The MSCI AC World ex US Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed and emerging markets excluding the U.S. (4) Source: Standard & Poor's Micropal. Individual country market returns are measured by MSCI country-specific indexes. The MSCI USA Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in the U.S. Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/05 - ----------------------------------------------- % OF TOTAL NET ASSETS - ----------------------------------------------- Tobacco 11.6% - ----------------------------------------------- Food Products 7.8% - ----------------------------------------------- Insurance 7.6% - ----------------------------------------------- Commercial Banks 7.0% - ----------------------------------------------- Beverages 6.2% - ----------------------------------------------- Media 5.6% - ----------------------------------------------- Metals & Mining 4.8% - ----------------------------------------------- Diversified Financial Services 4.6% - ----------------------------------------------- Paper & Forest Products 4.0% - ----------------------------------------------- Diversified Telecommunication Services 3.4% - ----------------------------------------------- whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy or other perceived negatives. This strict value approach is not only intended to improve the likelihood of upside potential, but it is also intended to reduce the risk of substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies globally, we may invest occasionally in privately held companies as well. We complement this more traditional investment strategy with two others. One is 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 debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed 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. In addition, 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. MANAGER'S DISCUSSION While our distressed debt and risk arbitrage portfolios were positive contributors to performance, the Fund's equity portfolio was the strongest contributor to performance for the 12 months under review. Three of our best performing stock investments were British American Tobacco (BAT), Mitsubishi UFJ Financial Group (MUFG) and Anglo American. 6 | Annual Report London-based BAT is the world's second-largest cigarette manufacturer behind Philip Morris. With about a 15% global market share, BAT enjoys strong market positions in Europe, North America and several emerging markets. The company's stock appreciated 52% in local currency in 2005 as the company delivered robust operational performance driven by increasing sales volumes and an improving product mix. BAT benefited from an acceleration of its sales in emerging markets, a focused development of its higher-margin global brands, and a further reduction of its cost base. During the year, the company returned most of its free cash flow to shareholders through dividends and share buybacks. This caused a number of analysts to raise their earnings growth projections for BAT. MUFG contributed positively to the Fund's performance during the period with a stock price appreciation of 55% in local currency. MUFG, the largest of Japan's megabanks, as well as the largest bank in the world by assets, experienced a significant expansion in profitability as Japan's credit quality recovery and economic turnaround continued throughout 2005. Foreign investors purchased shares as they anticipated growth in fee income, a pickup in loan demand, and higher interest rates as Japan's economy grows. Further bolstering MUFG's prospects was the integration of UFJ Holdings, which has the potential to deliver significant cost and tax synergies in coming years. We continued to find Japan an interesting market given that the banks are seeing the return of consumer confidence and are finally building adequate capital ratios. Further, much of the rest of the world has seen a peak in the credit cycle while Japan continues to experience a recovery. U.K.-headquartered Anglo American is a global mining and natural resources company with substantial interests in platinum, gold, diamonds, base and ferrous metals, coal, industrial minerals, and paper and packaging. The company is geographically diverse with operations in Africa, Europe, the Americas, Australia and Asia. The stock appreciated 66% in local currency during the year. In 2005, Anglo and its peers in the mining sector benefited from a strong commodity cycle and high metal prices driven by sustained world demand, particularly from China. Furthermore, management announced in October that the company would strategically refocus activities on its core mining businesses and return capital to shareholders. This development was positively received by investors and resulted in a reduction of the conglomerate discount traditionally given to Anglo by the markets. TOP 10 HOLDINGS 12/31/05 - -------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------- British American Tobacco PLC 2.8% TOBACCO, U.K. - -------------------------------------------------------- Weyerhaeuser Co. 2.4% PAPER & FOREST PRODUCTS, U.S. - -------------------------------------------------------- Orkla ASA 2.4% FOOD PRODUCTS, NORWAY - -------------------------------------------------------- Berkshire Hathaway Inc., A & B 2.1% INSURANCE, U.S. - -------------------------------------------------------- KT&G Corp., GDR & 144A 2.1% TOBACCO, SOUTH KOREA - -------------------------------------------------------- Imperial Tobacco Group PLC 2.1% TOBACCO, U.K. - -------------------------------------------------------- Mitsubishi UFJ Financial Group Inc. 1.7% COMMERCIAL BANKS, JAPAN - -------------------------------------------------------- Altadis SA 1.7% TOBACCO, SPAIN - -------------------------------------------------------- Pernod Ricard SA 1.6% BEVERAGES, FRANCE - -------------------------------------------------------- Potlatch Corp. 1.6% PAPER & FOREST PRODUCTS, U.S. - -------------------------------------------------------- Annual Report | 7 Detractors from Fund performance during the 12 months under review included Kindred Healthcare, a U.S. health care provider; White Mountains Insurance Group, a U.S. insurance company; and Washington Post, a U.S. newspaper and publishing company. Kindred shares declined 14% in 2005 after the company posted disappointing results in its second and third quarters. Valuations at year-end also reflected the industry's challenging Medicare reimbursement climate, which was pressured by high federal deficits.(5) White Mountains' shares weakened 12% largely due to the company's exposure to areas devastated by Hurricane Katrina, which may have caused the largest total insured loss in history. Shares in Washington Post underperformed (declined 22%) as Kaplan, the company's education business, reported limited margin expansion; and hurricane damage to the Gulf Coast negatively impacted Cable One, its cable operations. Additionally, the advertising market was soft overall, but particularly pronounced for weekly publications, which hurt revenues at Newsweek. Finally, investors should note that we entered 2005 less than fully hedged in foreign currencies and increased the hedges on foreign currency exposure over the course of the year. (5) A member of Franklin Mutual Advisers, Inc., serves on Kindred's board of directors. 8 | Annual Report Thank you for your continued participation in Mutual Discovery Fund. We look forward to serving your future investment needs. [PHOTO] /s/ Anne E. Gudefin Anne E. Gudefin, CFA Portfolio Manager [PHOTO] /s/ F. David Segal F. David Segal, CFA Assistant Portfolio Manager Mutual Discovery Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2005, 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. ANNE GUDEFIN has been a member of the management team of the Funds since 2000, when she joined Franklin Templeton Investments. Ms. Gudefin has been a portfolio manager for Mutual Qualified Fund since 2002. She assumed the duties of portfolio manager for Mutual Discovery Fund in May 2005. Previously, she was an analyst at Perry Capital. F. DAVID SEGAL has been an assistant portfolio manager for Mutual Discovery Fund since 2004. He assumed the duties of assistant portfolio manager for Mutual Shares Fund in May 2005. He joined Franklin Templeton Investments in 2002. Previously, he was an analyst in the Structured Finance Group of MetLife for the period 1999-2002. Annual Report | 9 PERFORMANCE SUMMARY AS OF 12/31/05 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 that a shareholder would pay 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 (SYMBOL: MDISX) CHANGE 12/31/05 12/31/04 - -------------------------------------------------------------------------------- Net Asset Value (NAV) +$2.02 $26.28 $24.26 - -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - -------------------------------------------------------------------------------- Dividend Income $0.4412 - -------------------------------------------------------------------------------- Short-Term Capital Gain $0.1274 - -------------------------------------------------------------------------------- Long-Term Capital Gain $1.2118 - -------------------------------------------------------------------------------- TOTAL $1.7804 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CLASS A (SYMBOL: TEDIX) CHANGE 12/31/05 12/31/04 - -------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.97 $26.04 $24.07 - -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - -------------------------------------------------------------------------------- Dividend Income $0.3668 - -------------------------------------------------------------------------------- Short-Term Capital Gain $0.1274 - -------------------------------------------------------------------------------- Long-Term Capital Gain $1.2118 - -------------------------------------------------------------------------------- TOTAL $1.7060 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CLASS B (SYMBOL: TEDBX) CHANGE 12/31/05 12/31/04 - -------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.90 $25.57 $23.67 - -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - -------------------------------------------------------------------------------- Dividend Income $0.1983 - -------------------------------------------------------------------------------- Short-Term Capital Gain $0.1274 - -------------------------------------------------------------------------------- Long-Term Capital Gain $1.2118 - -------------------------------------------------------------------------------- TOTAL $1.5375 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CLASS C (SYMBOL: TEDSX) CHANGE 12/31/05 12/31/04 - -------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.93 $25.90 $23.97 - -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - -------------------------------------------------------------------------------- Dividend Income $0.2169 - -------------------------------------------------------------------------------- Short-Term Capital Gain $0.1274 - -------------------------------------------------------------------------------- Long-Term Capital Gain $1.2118 - -------------------------------------------------------------------------------- TOTAL $1.5561 - -------------------------------------------------------------------------------- 10 | Annual Report PERFORMANCE SUMMARY (CONTINUED) PRICE AND DISTRIBUTION INFORMATION (CONTINUED) - -------------------------------------------------------------------------------- CLASS R (SYMBOL: TEDRX) CHANGE 12/31/05 12/31/04 - -------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.94 $25.88 $23.94 - -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - -------------------------------------------------------------------------------- Dividend Income $0.3391 - -------------------------------------------------------------------------------- Short-Term Capital Gain $0.1274 - -------------------------------------------------------------------------------- Long-Term Capital Gain $1.2118 - -------------------------------------------------------------------------------- TOTAL $1.6783 - -------------------------------------------------------------------------------- Mutual Discovery Fund paid distributions derived from long-term capital gains totaling $1.2118 per share in June and December 2005. The Fund designates such distributions as capital gain dividends per Internal Revenue Code Section 852(b)(3)(C). 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) +15.70% +67.34% +259.96% - -------------------------------------------------------------------------------- Average Annual Total Return(3) +15.70% +10.85% +13.66% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,570 $16,734 $35,996 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CLASS A(1) 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------- Cumulative Total Return(2) +15.29% +64.40% +192.46% - -------------------------------------------------------------------------------- Average Annual Total Return(3) +8.66% +9.15% +11.70% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,866 $15,494 $27,561 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CLASS B(1) 1-YEAR 5-YEAR INCEPTION (1/1/99) - -------------------------------------------------------------------------------- Cumulative Total Return(2) +14.59% +59.21% +122.86% - -------------------------------------------------------------------------------- Average Annual Total Return(3) +10.59% +9.47% +12.13% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,059 $15,721 $22,286 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CLASS C(1) 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------- Cumulative Total Return(2) +14.56% +59.19% +176.02% - -------------------------------------------------------------------------------- Average Annual Total Return(3) +13.56% +9.74% +11.72% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,356 $15,919 $27,602 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CLASS R 1-YEAR 3-YEAR INCEPTION (1/1/02) - -------------------------------------------------------------------------------- Cumulative Total Return(2) +15.13% +79.05% +62.07% - -------------------------------------------------------------------------------- Average Annual Total Return(3) +14.13% +21.43% +12.85% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,413 $17,905 $16,207 - -------------------------------------------------------------------------------- PERFORMANCE DATA 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. AVERAGE ANNUAL TOTAL RETURN(1) - ------------------------------------------ CLASS Z 12/31/05 - ------------------------------------------ 1-Year +15.70% - ------------------------------------------ 5-Year +10.85% - ------------------------------------------ 10-Year +13.66% - ------------------------------------------ CLASS Z (1/196-12/31/05)(1) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL DISCOVERY DATE FUND - CLASS Z S&P 500 INDEX(5) MSCI WORLD INDEX(5) ---------- ---------------- ---------------- ------------------ 1/1/1996 $10,000 $10,000 $10,000 1/31/1996 $10,369 $10,340 $10,183 2/29/1996 $10,719 $10,436 $10,247 3/31/1996 $10,871 $10,537 $10,419 4/30/1996 $11,108 $10,692 $10,666 5/31/1996 $11,299 $10,967 $10,677 6/30/1996 $11,285 $11,009 $10,733 7/31/1996 $10,948 $10,523 $10,356 8/31/1996 $11,325 $10,745 $10,477 9/30/1996 $11,601 $11,349 $10,889 10/31/1996 $11,890 $11,662 $10,967 11/30/1996 $12,382 $12,543 $11,583 12/31/1996 $12,493 $12,295 $11,400 1/31/1997 $13,089 $13,062 $11,539 2/28/1997 $13,343 $13,165 $11,674 3/31/1997 $13,220 $12,625 $11,445 4/30/1997 $13,242 $13,378 $11,821 5/31/1997 $13,722 $14,192 $12,553 6/30/1997 $14,231 $14,827 $13,181 7/31/1997 $14,849 $16,006 $13,790 8/31/1997 $14,708 $15,110 $12,869 9/30/1997 $15,449 $15,937 $13,570 10/31/1997 $15,004 $15,406 $12,858 11/30/1997 $15,093 $16,118 $13,088 12/31/1997 $15,359 $16,395 $13,249 1/31/1998 $15,367 $16,576 $13,621 2/28/1998 $16,156 $17,771 $14,544 3/31/1998 $17,083 $18,680 $15,161 4/30/1998 $17,400 $18,868 $15,311 5/31/1998 $17,636 $18,544 $15,121 6/30/1998 $17,197 $19,297 $15,483 7/31/1998 $16,792 $19,092 $15,460 8/31/1998 $14,503 $16,334 $13,401 9/30/1998 $13,853 $17,381 $13,640 10/31/1998 $14,236 $18,793 $14,875 11/30/1998 $14,952 $19,932 $15,762 12/31/1998 $15,067 $21,080 $16,535 1/31/1999 $15,172 $21,961 $16,899 2/28/1999 $14,998 $21,278 $16,452 3/31/1999 $15,687 $22,130 $17,139 4/30/1999 $16,743 $22,987 $17,817 5/31/1999 $16,751 $22,445 $17,169 6/30/1999 $17,347 $23,689 $17,972 7/31/1999 $17,152 $22,951 $17,920 8/31/1999 $16,948 $22,837 $17,891 9/30/1999 $16,726 $22,212 $17,720 10/31/1999 $17,072 $23,617 $18,643 11/30/1999 $17,968 $24,097 $19,170 12/31/1999 $19,105 $25,515 $20,725 1/31/2000 $19,033 $24,233 $19,540 2/29/2000 $19,640 $23,775 $19,595 3/31/2000 $20,482 $26,099 $20,952 4/30/2000 $20,255 $25,314 $20,069 5/31/2000 $20,373 $24,796 $19,563 6/30/2000 $20,431 $25,408 $20,224 7/31/2000 $20,693 $25,011 $19,657 8/31/2000 $21,304 $26,564 $20,299 9/30/2000 $21,091 $25,162 $19,222 10/31/2000 $21,256 $25,055 $18,903 11/30/2000 $20,897 $23,081 $17,758 12/31/2000 $21,511 $23,194 $18,047 1/31/2001 $22,170 $24,017 $18,398 2/28/2001 $22,170 $21,828 $16,845 3/31/2001 $21,511 $20,446 $15,742 4/30/2001 $22,136 $22,034 $16,909 5/31/2001 $22,807 $22,181 $16,699 6/30/2001 $22,913 $21,642 $16,178 7/31/2001 $22,867 $21,429 $15,965 8/31/2001 $22,636 $20,089 $15,202 9/30/2001 $20,712 $18,466 $13,865 10/31/2001 $20,770 $18,819 $14,132 11/30/2001 $21,300 $20,262 $14,970 12/31/2001 $21,784 $20,440 $15,066 1/31/2002 $21,856 $20,141 $14,611 2/28/2002 $22,071 $19,753 $14,487 3/31/2002 $22,802 $20,496 $15,130 4/30/2002 $23,197 $19,254 $14,622 5/31/2002 $23,376 $19,113 $14,656 6/30/2002 $21,942 $17,752 $13,770 7/31/2002 $20,495 $16,368 $12,611 8/31/2002 $20,700 $16,475 $12,637 9/30/2002 $19,615 $14,686 $11,250 10/31/2002 $19,687 $15,978 $12,082 11/30/2002 $19,977 $16,917 $12,736 12/31/2002 $19,811 $15,924 $12,122 1/31/2003 $19,480 $15,508 $11,755 2/28/2003 $18,953 $15,275 $11,554 3/31/2003 $19,038 $15,421 $11,522 4/30/2003 $20,497 $16,692 $12,551 5/31/2003 $21,650 $17,571 $13,275 6/30/2003 $22,018 $17,795 $13,510 7/31/2003 $22,289 $18,109 $13,786 8/31/2003 $22,955 $18,462 $14,088 9/30/2003 $23,079 $18,266 $14,177 10/31/2003 $24,066 $19,299 $15,021 11/30/2003 $24,904 $19,469 $15,253 12/31/2003 $26,060 $20,489 $16,214 1/31/2004 $26,386 $20,865 $16,478 2/29/2004 $27,225 $21,155 $16,760 3/31/2004 $27,125 $20,836 $16,655 4/30/2004 $26,662 $20,509 $16,323 5/31/2004 $26,649 $20,790 $16,483 6/30/2004 $27,157 $21,194 $16,829 7/31/2004 $26,879 $20,493 $16,284 8/31/2004 $27,056 $20,575 $16,362 9/30/2004 $27,787 $20,798 $16,677 10/31/2004 $28,354 $21,116 $17,089 11/30/2004 $29,979 $21,970 $17,994 12/31/2004 $31,114 $22,717 $18,686 1/31/2005 $30,421 $22,163 $18,269 2/28/2005 $31,729 $22,629 $18,856 3/31/2005 $31,460 $22,229 $18,499 4/30/2005 $31,216 $21,808 $18,108 5/31/2005 $31,883 $22,501 $18,443 6/30/2005 $32,572 $22,533 $18,611 7/31/2005 $33,682 $23,371 $19,265 8/31/2005 $33,812 $23,158 $19,419 9/30/2005 $34,767 $23,345 $19,929 10/31/2005 $33,682 $22,956 $19,450 11/30/2005 $34,741 $23,823 $20,109 12/31/2005 $35,996 $23,832 $20,559 AVERAGE ANNUAL TOTAL RETURN(1) - ------------------------------------------ CLASS A 12/31/05 - ------------------------------------------ 1-Year +8.66% - ------------------------------------------ 5-Year +9.15% - ------------------------------------------ Since Inception (11/1/96) +11.70% - ------------------------------------------ CLASS A (11/1/96-12/31/05)(1) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL DISCOVERY DATE FUND - CLASS A S&P 500 INDEX(5) MSCI WORLD INDEX(5) ---------- ---------------- ---------------- ------------------- 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 $23,918 $19,479 $17,039 1/31/2005 $23,372 $19,004 $16,659 2/28/2005 $24,375 $19,404 $17,194 3/31/2005 $24,157 $19,061 $16,869 4/30/2005 $23,968 $18,699 $16,512 5/31/2005 $24,465 $19,294 $16,818 6/30/2005 $24,992 $19,322 $16,971 7/31/2005 $25,832 $20,040 $17,567 8/31/2005 $25,922 $19,857 $17,708 9/30/2005 $26,652 $20,018 $18,173 10/31/2005 $25,812 $19,684 $17,736 11/30/2005 $26,612 $20,428 $18,336 12/31/2005 $27,561 $20,435 $18,747 12 | Annual Report PERFORMANCE SUMMARY (CONTINUED) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL DISCOVERY DATE FUND - CLASS B S&P 500 INDEX(5) MSCI WORLD INDEX(5) ---------- ---------------- ---------------- ------------------- 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 $19,450 $10,777 $11,301 1/31/2005 $18,998 $10,514 $11,049 2/28/2005 $19,803 $10,735 $11,404 3/31/2005 $19,614 $10,545 $11,188 4/30/2005 $19,450 $10,345 $10,951 5/31/2005 $19,844 $10,674 $11,154 6/30/2005 $20,261 $10,690 $11,256 7/31/2005 $20,931 $11,087 $11,651 8/31/2005 $20,997 $10,986 $11,745 9/30/2005 $21,576 $11,075 $12,053 10/31/2005 $20,881 $10,890 $11,763 11/30/2005 $21,518 $11,301 $12,161 12/31/2005 $22,286 $11,305 $12,434 AVERAGE ANNUAL TOTAL RETURN(1) - -------------------------------------------- CLASS B 12/31/05 - -------------------------------------------- 1-Year +10.59% - -------------------------------------------- 5-Year +9.47% - -------------------------------------------- Since Inception (1/1/99) +12.13% - -------------------------------------------- CLASS B (11/1/99-12/31/05)(1) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL DISCOVERY DATE FUND - CLASS C S&P 500 INDEX(5) MSCI WORLD INDEX(5) ---------- ---------------- ---------------- ------------------- 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 $24,107 $19,479 $17,039 1/31/2005 $23,544 $19,004 $16,659 2/28/2005 $24,550 $19,404 $17,194 3/31/2005 $24,319 $19,061 $16,869 4/30/2005 $24,107 $18,699 $16,512 5/31/2005 $24,600 $19,294 $16,818 6/30/2005 $25,112 $19,322 $16,971 7/31/2005 $25,942 $20,040 $17,567 8/31/2005 $26,023 $19,857 $17,708 9/30/2005 $26,742 $20,018 $18,173 10/31/2005 $25,881 $19,684 $17,736 11/30/2005 $26,671 $20,428 $18,336 12/31/2005 $27,602 $20,435 $18,747 AVERAGE ANNUAL TOTAL RETURN(1) - -------------------------------------------- CLASS C 12/31/05 - -------------------------------------------- 1-Year +13.56% - -------------------------------------------- 5-Year +9.74% - -------------------------------------------- Since Inception (11/1/96) +11.72% - -------------------------------------------- CLASS C (11/1/99-12/31/05)(1) Annual Report | 13 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS R 12/31/05 - -------------------------------------------- 1-Year +14.13% - -------------------------------------------- 3-Year +21.43% - -------------------------------------------- Since Inception (1/1/02) +12.85% - -------------------------------------------- CLASS R (1/1/02-12/31/05)(1) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL DISCOVERY DATE FUND - CLASS R S&P 500 INDEX(5) MSCI WORLD INDEX(5) - ---------- ---------------- ---------------- ------------------- 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 $14,076 $11,114 $12,403 1/31/2005 $13,753 $10,843 $12,126 2/28/2005 $14,341 $11,071 $12,516 3/31/2005 $14,211 $10,876 $12,279 4/30/2005 $14,100 $10,669 $12,019 5/31/2005 $14,394 $11,009 $12,242 6/30/2005 $14,699 $11,024 $12,353 7/31/2005 $15,190 $11,434 $12,788 8/31/2005 $15,243 $11,330 $12,890 9/30/2005 $15,669 $11,422 $13,228 10/31/2005 $15,178 $11,231 $12,910 11/30/2005 $15,646 $11,655 $13,347 12/31/2005 $16,207 $11,660 $13,646 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. 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 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 7/1/05 VALUE 12/31/05 PERIOD* 7/1/05-12/31/05 - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 1,105.20 $ 5.68 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,019.81 $ 5.45 - -------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 1,103.40 $ 7.53 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,018.05 $ 7.22 - -------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 1,100.00 $ 10.96 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,014.77 $ 10.51 - -------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 1,099.80 $ 10.96 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,014.77 $ 10.51 - -------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------- CLASS R - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 1,102.60 $ 8.32 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,017.29 $ 7.98 - --------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 1.07%; A: 1.42%; B: 2.07%; C: 2.07%; and R: 1.57%), multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period. 16 | Annual Report Mutual Discovery Fund FINANCIAL HIGHLIGHTS
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2005 2004 2003 2002 2001 ---------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............ $ 24.26 $ 20.81 $ 16.16 $ 18.19 $ 18.93 ---------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... 0.37 0.41 0.28 0.33 0.37 Net realized and unrealized gains (losses).. 3.43 3.58 4.80 (1.96) (0.14) ---------------------------------------------------------------------- Total from investment operations .............. 3.80 3.99 5.08 (1.63) 0.23 ---------------------------------------------------------------------- Less distributions from: Net investment income ...................... (0.44) (0.54) (0.43) (0.32) (0.34) Net realized gains ......................... (1.34) -- -- (0.08) (0.63) ---------------------------------------------------------------------- Total distributions ........................... (1.78) (0.54) (0.43) (0.40) (0.97) ---------------------------------------------------------------------- Redemption fees ............................... --(c) --(c) -- -- -- ---------------------------------------------------------------------- Net asset value, end of year .................. $ 26.28 $ 24.26 $ 20.81 $ 16.16 $ 18.19 ====================================================================== Total return .................................. 15.70% 19.39% 31.55% (9.06)% 1.26% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............... $ 3,033,756 $ 2,578,585 $ 2,168,161 $ 1,673,786 $ 1,931,117 Ratios to average net assets:* Expenses(b) ................................ 1.07% 1.07% 1.11% 1.04% 1.04% Net investment income ...................... 1.42% 1.87% 1.55% 1.88% 1.93% Portfolio turnover rate ....................... 25.69% 34.34% 46.34% 40.95% 59.32% * Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.04% 1.06% 1.08% 1.03% 1.02%
(a) Based on average daily shares outstanding. (b) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (c) Amount is less than $0.01 per share. Annual Report | See notes to financial statements. | 17 Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2005 2004 2003 2002 2001 ---------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............ $ 24.07 $ 20.67 $ 16.06 $ 18.08 $ 18.83 ---------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... 0.27 0.33 0.21 0.27 0.30 Net realized and unrealized gains (losses).. 3.41 3.54 4.78 (1.95) (0.14) ---------------------------------------------------------------------- Total from investment operations .............. 3.68 3.87 4.99 (1.68) 0.16 ---------------------------------------------------------------------- Less distributions from: Net investment income ...................... (0.37) (0.47) (0.38) (0.26) (0.28) Net realized gains ......................... (1.34) -- -- (0.08) (0.63) ---------------------------------------------------------------------- Total distributions ........................... (1.71) (0.47) (0.38) (0.34) (0.91) ---------------------------------------------------------------------- Redemption fees ............................... --(d) --(d) -- -- -- ---------------------------------------------------------------------- Net asset value, end of year .................. $ 26.04 $ 24.07 $ 20.67 $ 16.06 $ 18.08 ====================================================================== Total return(b) ............................... 15.29% 18.98% 31.13% (9.39)% 0.86% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............... $ 3,545,288 $ 2,106,695 $ 1,439,579 $ 925,278 $ 911,434 Ratios to average net assets:* Expenses(c) ................................ 1.42% 1.42% 1.46% 1.39% 1.39% Net investment income ...................... 1.07% 1.52% 1.20% 1.53% 1.57% Portfolio turnover rate ....................... 25.69% 34.34% 46.34% 40.95% 59.32% * Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.39% 1.41% 1.43% 1.38% 1.37%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the sales commissions or the contingent deferred sales charge. (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 $0.01 per share. 18 | See notes to financial statements. | Annual Report Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2005 2004 2003 2002 2001 ---------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............ $ 23.67 $ 20.35 $ 15.85 $ 17.87 $ 18.66 ---------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... 0.11 0.18 0.09 0.16 0.16 Net realized and unrealized gains (losses).. 3.33 3.49 4.69 (1.92) (0.12) ---------------------------------------------------------------------- Total from investment operations .............. 3.44 3.67 4.78 (1.76) 0.04 ---------------------------------------------------------------------- Less distributions from: Net investment income ...................... (0.20) (0.35) (0.28) (0.18) (0.20) Net realized gains ......................... (1.34) -- -- (0.08) (0.63) ---------------------------------------------------------------------- Total distributions ........................... (1.54) (0.35) (0.28) (0.26) (0.83) ---------------------------------------------------------------------- Redemption fees ............................... --(d) --(d) -- -- -- ---------------------------------------------------------------------- Net asset value, end of year .................. $ 25.57 $ 23.67 $ 20.35 $ 15.85 $ 17.87 ====================================================================== Total return(b) ............................... 14.59% 18.22% 30.22% (9.94)% 0.21% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............... $ 225,158 $ 186,841 $ 115,801 $ 64,747 $ 41,346 Ratios to average net assets:* Expenses(c) ................................ 2.07% 2.07% 2.11% 2.04% 2.04% Net investment income ...................... 0.42% 0.87% 0.55% 0.88% 0.85% Portfolio turnover rate ....................... 25.69% 34.34% 46.34% 40.95% 59.32% * Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 2.04% 2.06% 2.08% 2.03% 2.02%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. Annual Report | See notes to financial statements. | 19 Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2005 2004 2003 2002 2001 ---------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............ $ 23.97 $ 20.59 $ 16.02 $ 18.03 $ 18.77 ---------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... 0.11 0.19 0.10 0.16 0.18 Net realized and unrealized gains (losses).. 3.38 3.53 4.73 (1.94) (0.13) ---------------------------------------------------------------------- Total from investment operations .............. 3.49 3.72 4.83 (1.78) 0.05 ---------------------------------------------------------------------- Less distributions from: Net investment income ...................... (0.22) (0.34) (0.26) (0.15) (0.16) Net realized gains ......................... (1.34) -- -- (0.08) (0.63) ---------------------------------------------------------------------- Total distributions ........................... (1.56) (0.34) (0.26) (0.23) (0.79) ---------------------------------------------------------------------- Redemption fees ............................... --(d) --(d) -- -- -- ---------------------------------------------------------------------- Net asset value, end of year .................. $ 25.90 $ 23.97 $ 20.59 $ 16.02 $ 18.03 ====================================================================== Total return(b) ............................... 14.56% 18.17% 30.29% (9.98)% 0.25% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............... $ 1,435,702 $ 968,934 $ 725,489 $ 525,375 $ 561,808 Ratios to average net assets:* Expenses(c) ................................ 2.07% 2.07% 2.11% 2.03% 2.03% Net investment income ...................... 0.42% 0.87% 0.55% 0.89% 0.93% Portfolio turnover rate ....................... 25.69% 34.34% 46.34% 40.95% 59.32% * Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 2.04% 2.06% 2.08% 2.02% 2.01%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. 20 | See notes to financial statements. | Annual Report Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------ YEAR ENDED DECEMBER 31, CLASS R 2005 2004 2003 2002(e) ------------------------------------------------ PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............ $ 23.94 $ 20.57 $ 16.01 $ 18.08 ------------------------------------------------ Income from investment operations: Net investment income(a) ................... 0.22 0.29 0.17 0.25 Net realized and unrealized gains (losses).. 3.40 3.54 4.76 (1.95) ------------------------------------------------ Total from investment operations .............. 3.62 3.83 4.93 (1.70) ================================================ Less distributions from: Net investment income ...................... (0.34) (0.46) (0.37) (0.29) Net realized gains ......................... (1.34) -- -- (0.08) ------------------------------------------------ Total distributions ........................... (1.68) (0.46) (0.37) (0.37) ------------------------------------------------ Redemption fees ............................... --(d) --(d) -- -- ------------------------------------------------ Net asset value, end of year .................. $ 25.88 $ 23.94 $ 20.57 $ 16.01 ================================================ Total return(b) ............................... 15.13% 18.84% 30.87% (9.49)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............... $ 99,501 $ 46,690 $ 19,546 $ 3,932 Ratios to average net assets:* Expenses(c) ................................ 1.57% 1.57% 1.61% 1.54%(f) Net investment income ...................... 0.92% 1.37% 1.05% 1.38%(f) Portfolio turnover rate ....................... 25.69% 34.34% 46.34% 40.95% * Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.54% 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 $0.01 per share. (e) For the period January 2, 2002 (effective date) to December 31, 2002. (f) Annualized. Annual Report | See notes to financial statements. | 21 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS 87.8% AEROSPACE & DEFENSE 0.2% Northrop Grumman Corp. ...................................... United States 280,140 $ 16,839,215 ------------------ AIRLINES 0.5% (a)ACE Aviation Holdings Inc. .................................. Canada 917,052 29,981,911 (a),(b)ACE Aviation Holdings Inc., A, 144A ......................... Canada 375,491 12,276,227 (a)ACE Aviation Holdings Inc., B ............................... Canada 1,378 44,886 (a),(c)Air Canada Inc., Contingent Distribution .................... Canada 249,992,001 -- ------------------ 42,303,024 ------------------ AUTOMOBILES 0.2% Hero Honda Motors Ltd. ...................................... India 1,042,903 19,926,296 ------------------ BEVERAGES 6.2% Brown-Forman Corp., A ....................................... United States 143,200 10,158,608 Brown-Forman Corp., B ....................................... United States 391,650 27,149,178 Carlsberg AS, A ............................................. Denmark 113,300 5,662,933 Carlsberg AS, B ............................................. Denmark 1,876,968 100,664,072 Coca-Cola Enterprises Inc. .................................. United States 2,520,300 48,314,151 Diageo PLC .................................................. United Kingdom 2,985,315 43,271,516 Fomento Economico Mexicano SA de CV (Femsa), ADR ............ Mexico 1,050,228 76,152,032 Heineken Holding NV, A ...................................... Netherlands 981,549 28,841,009 (a)Lotte Chilsung Beverage Co. Ltd. ............................ South Korea 38,846 37,824,244 Pernod Ricard SA ............................................ France 772,613 134,820,576 ------------------ 512,858,319 ------------------ CAPITAL MARKETS 0.0%(d) (a)A.B. Watley Group Inc. ...................................... United States 128,355 2,054 ------------------ CHEMICALS 1.7% Givaudan AG ................................................. Switzerland 88,065 59,693,155 Linde AG .................................................... Germany 440,300 34,287,770 (a)Sika AG ..................................................... Switzerland 53,892 44,713,439 ------------------ 138,694,364 ------------------ COMMERCIAL BANKS 7.3% Allied Irish Banks PLC ...................................... Ireland 4,877,727 104,922,614 Banca Intesa SpA ............................................ Italy 12,705,212 67,308,768 Bank of Ireland ............................................. Ireland 2,475,126 38,971,367 BNP Paribas SA .............................................. France 594,632 48,115,331 Chinatrust Financial Holding Co. Ltd. ....................... Taiwan 52,774,000 41,799,278 Danske Bank ................................................. Denmark 1,352,880 47,655,516 (a),(e),(f)FE Capital Holdings Ltd. .................................... Japan 11,589 16,513,832 ForeningsSparbanken AB, A ................................... Sweden 3,112,200 84,801,623 (a)Investors Bancorp Inc. ...................................... United States 1,775 19,578 Mitsubishi UFJ Financial Group Inc. ......................... Japan 10,709 145,169,872 (a),(e)NCB Warrant Holdings Ltd., A ................................ Japan 55,890 9,029,594 ------------------ 604,307,373 ------------------
22 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMMERCIAL SERVICES & SUPPLIES 0.4% (a)Comdisco Holding Co. Inc. ................................... United States 344 $ 6,536 (c)Comdisco Holding Co. Inc., Contingent Distribution .......... United States 41,726,153 -- (a)Fursys Inc. ................................................. South Korea 387,960 8,760,387 Republic Services Inc. ...................................... United States 600,900 22,563,795 (a),(c)Safety Kleen Corp., Contingent Distribution ................. United States 520,000 -- ------------------ 31,330,718 ------------------ COMPUTERS & PERIPHERALS 0.4% (a),(e)DecisionOne Corp. ........................................... United States 359,884 256,597 (a)Lexmark International Inc., A ............................... United States 678,100 30,399,223 ------------------ 30,655,820 ------------------ CONSTRUCTION MATERIALS 0.9% Ciments Francais SA ......................................... France 399,572 51,939,058 (a)Hanil Cement Manufacturing Co. Ltd. ......................... South Korea 321,760 23,058,136 ------------------ 74,997,194 ------------------ CONSUMER FINANCE 0.4% MBNA Corp. .................................................. United States 1,143,500 31,046,025 ------------------ CONTAINERS & PACKAGING 0.7% Temple-Inland Inc. .......................................... United States 1,371,420 61,508,187 ------------------ DISTRIBUTORS 0.3% Compania de Distribucion Integral Logista SA ................ Spain 564,170 27,717,545 ------------------ DIVERSIFIED FINANCIAL SERVICES 4.6% Euronext .................................................... Netherlands 1,357,836 70,728,863 Fortis Group NV ............................................. Belgium 2,222,940 70,764,465 Guinness Peat Group PLC ..................................... New Zealand 22,027,831 31,571,388 Jardine Matheson Holdings Ltd. .............................. Hong Kong 4,554,012 78,329,007 Jardine Strategic Holdings Ltd. ............................. Hong Kong 7,356,100 78,710,270 Leucadia National Corp. ..................................... United States 1,027,170 48,749,488 (a),(c)Marconi Corp., Contingent Distribution ...................... United Kingdom 33,909,700 -- (b)Spinrite Income Fund, 144A .................................. Canada 274,300 1,472,625 ------------------ 380,326,106 ------------------ DIVERSIFIED TELECOMMUNICATION SERVICES 3.4% (a),(e),(g)AboveNet Inc. ............................................... United States 332,512 7,968,118 (a),(e),(g)AboveNet Inc., Contingent Distribution ...................... United States 46,367,000 -- (a),(e),(g)AboveNet Inc., wts., 9/08/08 ................................ United States 11,105 44,420 (a),(e),(g)AboveNet Inc., wts., 9/08/10 ................................ United States 13,066 10,453 Belgacom SA ................................................. Belgium 545,400 17,788,258 Chunghwa Telecom Co. Ltd., ADR .............................. Taiwan 1,169,682 21,463,665 (a),(c)Global Crossing Holdings Ltd., Contingent Distribution ...... United States 45,658,716 -- Koninklijke KPN NV .......................................... Netherlands 2,428,999 24,356,082 MCI Inc. .................................................... United States 1,148,134 22,652,684 (a)NTL Inc. .................................................... United Kingdom 1,344,522 91,535,058 Sprint Nextel Corp. ......................................... United States 160,782 3,755,867 (a),(c)Telewest Communications PLC, Contingent Distribution ........ United Kingdom 53,009,022 --
Annual Report | 23 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) DIVERSIFIED TELECOMMUNICATION SERVICES (CONTINUED) (a),(c)Telewest Finance Ltd., Contingent Distribution .............. United Kingdom 5,738,000 $ -- (a)Telewest Global Inc. ........................................ United Kingdom 3,124,100 74,416,062 Verizon Communications Inc. ................................. United States 726,600 21,885,192 ------------------ 285,875,859 ------------------ ELECTRIC UTILITIES 0.5% E.ON AG ..................................................... Germany 415,020 42,970,972 (a),(b)Entegra/Union Power, 144A ................................... United States 131,128 -- ------------------ 42,970,972 ------------------ FOOD & STAPLES RETAILING 1.5% Albertson's Inc. ............................................ United States 383,400 8,185,590 Carrefour SA ................................................ France 2,187,570 102,502,494 RHM PLC ..................................................... United Kingdom 3,574,200 16,280,092 ------------------ 126,968,176 ------------------ FOOD PRODUCTS 8.0% Cadbury Schweppes PLC ....................................... United Kingdom 5,477,342 51,782,092 (a)Cermaq ASA .................................................. Norway 1,368,728 11,102,563 CSM NV ...................................................... Netherlands 3,219,606 87,779,550 (f)Farmer Brothers Co. ......................................... United States 904,637 17,495,680 General Mills Inc. .......................................... United States 478,600 23,604,552 Groupe Danone ............................................... France 772,770 80,734,963 (a)Lotte Confectionary Co. Ltd. ................................ South Korea 52,189 61,953,394 Nestle SA ................................................... Switzerland 219,229 65,580,968 (a)Nong Shim Co. Ltd. .......................................... South Korea 153,896 42,770,104 Orkla ASA ................................................... Norway 4,856,682 201,114,528 Rieber & Son ASA ............................................ Norway 3,472,090 25,849,313 ------------------ 669,767,707 ------------------ HEALTH CARE EQUIPMENT & SUPPLIES 0.4% Guidant Corp. ............................................... United States 444,400 28,774,900 ------------------ HEALTH CARE PROVIDERS & SERVICES 0.6% (a),(e),(g)Kindred Healthcare Inc. ..................................... United States 934,740 22,874,957 (a),(e),(g)Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 ........... United States 449 6,913 (a),(e),(g)Kindred Healthcare Inc., Jan. 25.99 Calls, 1/01/14 .......... United States 223 -- (a),(e),(g)Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 .......... United States 675 -- (a),(e),(g)Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 .......... United States 3,002 2,167 (a),(e),(g)Kindred Healthcare Inc., wts., Series A, 4/20/06 ............ United States 88,766 1,716,912 (a),(e),(g)Kindred Healthcare Inc., wts., Series B, 4/20/06 ............ United States 221,915 3,647,173 MDS Inc. .................................................... Canada 750,400 12,983,347 Rhoen-Klinikum AG ........................................... Germany 189,234 7,233,757 UnitedHealth Group Inc. ..................................... United States 620 38,527 ------------------ 48,503,753 ------------------
24 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) HOTELS, RESTAURANTS & LEISURE 0.8% (a)FHC Delaware Inc. ........................................... United States 212,022 $ 736,967 (a),(e),(f)Hancock Discovery LLC ....................................... United States 8,758,216 500,007 Hilton Group ................................................ United Kingdom 6,917,939 43,293,408 (a),(c)Trump Atlantic, Contingent Distribution ..................... United States 24,246,000 914,074 (a)Trump Entertainment Resorts Inc. ............................ United States 835,578 16,820,185 ------------------ 62,264,641 ------------------ HOUSEHOLD DURABLES 0.2% Hunter Douglas NV ........................................... Netherlands 329,019 17,909,631 ------------------ INDUSTRIAL CONGLOMERATES 1.1% Siemens AG .................................................. Germany 654,803 56,100,395 Tyco International Ltd. ..................................... United States 1,282,600 37,015,836 ------------------ 93,116,231 ------------------ INSURANCE 7.6% (a)Alleghany Corp. ............................................. United States 73,574 20,895,016 (a)Berkshire Hathaway Inc., A .................................. United States 853 75,592,860 (a)Berkshire Hathaway Inc., B .................................. United States 34,470 101,186,685 Catlin Group ................................................ United Kingdom 1,993,464 16,650,975 E-L Financial Corp. Ltd. .................................... Canada 177,619 81,757,004 Hartford Financial Services Group Inc. ...................... United States 511,000 43,889,790 (a),(e),(f)Imagine Group Holdings Ltd. ................................. Bermuda 4,551,501 46,614,334 IPC Holdings Ltd. ........................................... United States 404,624 11,078,605 Irish Life & Permanent PLC .................................. Ireland 2,899,665 58,906,307 Montpelier Re Holdings Ltd. ................................. Bermuda 348,227 6,581,490 Old Republic International Corp. ............................ United States 1,518,550 39,877,123 (a),(e)Olympus Re Holdings Ltd. .................................... Bermuda 47,160 872,460 Prudential Financial Inc. ................................... United States 421,200 30,827,628 White Mountains Insurance Group Inc. ........................ United States 175,415 97,978,048 ------------------ 632,708,325 ------------------ LEISURE EQUIPMENT & PRODUCTS 0.2% Mattel Inc. ................................................. United States 721,400 11,412,548 Shimano Inc. ................................................ Japan 339,500 8,916,801 ------------------ 20,329,349 ------------------ MACHINERY 1.4% Metso OYJ ................................................... Finland 373,898 10,233,817 Schindler Holding AG ........................................ Switzerland 212,277 84,183,686 Schindler Holding AG, Reg D ................................. Switzerland 65,126 25,752,964 ------------------ 120,170,467 ------------------ MEDIA 5.6% (a)CJ CGV Co. Ltd. ............................................. South Korea 849,040 25,070,908 Clear Channel Communications Inc. ........................... United States 1,598,100 50,260,245 (a)Comcast Corp., A ............................................ United States 179,400 4,608,786 Daekyo Co. Ltd. ............................................. South Korea 127,920 10,005,058 E.W. Scripps Co., A ......................................... United States 116,100 5,575,122 (a)EchoStar Communications Corp., A ............................ United States 581,900 15,810,223 Hollinger International Inc. ................................ United States 880,440 7,494,305
Annual Report | 25 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MEDIA (CONTINUED) (a)JC Decaux SA ................................................ France 2,791,333 $ 65,099,036 Knight Ridder Inc. .......................................... United States 174,900 11,071,170 (a),(h)Liberty Media Corp., A ...................................... United States 4,255,518 33,490,927 News Corp., A ............................................... United States 3,489,300 54,258,615 Omnicom Group Inc. .......................................... United States 197,900 16,847,227 Pearson PLC ................................................. United Kingdom 3,178,598 37,596,754 (e)Time Warner Inc. ............................................ United States 2,833,800 48,433,043 (e)Time Warner Inc., Jan. 10.00 Calls, 1/21/06 ................. United States 18,832 13,841,520 (a)TVMAX Holdings Inc. ......................................... United States 118,432 118,432 Viacom Inc., B .............................................. United States 658,900 21,480,140 Washington Post Co., B ...................................... United States 60,003 45,902,295 ------------------ 466,963,806 ------------------ METALS & MINING 4.4% Anglo American PLC .......................................... South Africa 3,729,617 126,984,897 Anglo American PLC, ADR ..................................... South Africa 1,000 34,780 Dofasco Inc. ................................................ Canada 597,441 33,400,771 Freeport-McMoRan Copper & Gold Inc., B ...................... United States 118,300 6,364,540 (a),(f)Gammon Lake Resources Inc. .................................. Canada 4,402,100 52,304,053 (a)Glamis Gold Ltd. ............................................ Canada 719,700 19,795,930 Gold Fields Ltd. ............................................ South Africa 20,244 357,689 Goldcorp Inc. ............................................... Canada 538,769 12,005,116 (a)Goldcorp Inc., wts., 5/30/07 ................................ Canada 600,670 2,506,451 (a)Harmony Gold Mining Co. Ltd., ADR ........................... South Africa 438,500 5,722,425 (a)Kinross Gold Corp. .......................................... Canada 687,500 6,352,706 (a)LionOre Mining International Ltd. ........................... Canada 4,500,000 19,164,587 Newmont Mining Corp. ........................................ United States 1,357,100 72,469,140 Placer Dome Inc. ............................................ Canada 496,500 11,371,273 ------------------ 368,834,358 ------------------ MULTI-UTILITIES & UNREGULATED POWER 1.1% NorthWestern Corp. .......................................... United States 322,840 10,030,639 (a),(c)NorthWestern Corp., Contingent Distribution ................. United States 9,790,000 832,150 Suez SA ..................................................... France 2,793,883 86,988,261 ------------------ 97,851,050 ------------------ MULTILINE RETAIL 0.1% Jelmoli Holding AG .......................................... Switzerland 8,345 11,910,086 ------------------ OIL, GAS & CONSUMABLE FUELS 3.7% (a)Anchor Resources LLC ........................................ United States 53,272 -- BP PLC ...................................................... United Kingdom 2,095,000 22,310,881 BP PLC, ADR ................................................. United Kingdom 180,900 11,617,398 Burlington Resources Inc. ................................... United States 546,590 47,116,058 Canadian Oil Sands Trust .................................... Canada 313,392 33,973,494 Eni SpA ..................................................... Italy 847,600 23,510,395 Oil & Natural Gas Corp. Ltd. ................................ India 1,095,168 28,598,014 Statoil ASA ................................................. Norway 932,557 21,415,541 Suncor Energy Inc. .......................................... Canada 695,584 43,878,705
26 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) OIL, GAS & CONSUMABLE FUELS (CONTINUED) Total SA, B .................................................. France 127,671 $ 32,072,611 Total SA, B, ADR ............................................. France 208,648 26,373,107 Vintage Petroleum Inc. ....................................... United States 304,910 16,260,850 ------------------ 307,127,054 ------------------ PAPER & FOREST PRODUCTS 4.0% (f)Potlatch Corp. ............................................... United States 2,580,250 131,541,145 (h)Weyerhaeuser Co. ............................................. United States 3,052,200 202,482,948 ------------------ 334,024,093 ------------------ PERSONAL PRODUCTS 0.6% (a)Amorepacific Corp. ........................................... South Korea 160,937 50,477,511 ------------------ PHARMACEUTICALS 2.0% Bristol-Myers Squibb Co. ..................................... United States 641,300 14,737,074 (a)IVAX Corp. ................................................... United States 43,600 1,365,988 Merck & Co. Inc. ............................................. United States 468,600 14,906,166 Pfizer Inc. .................................................. United States 2,593,430 60,478,788 Sanofi-Aventis ............................................... France 686,623 60,151,540 Wyeth ........................................................ United States 395,300 18,211,471 ------------------ 169,851,027 ------------------ REAL ESTATE 2.8% Canary Wharf Group PLC ....................................... United Kingdom 5,400,183 22,297,787 Great Eagle Holdings Ltd. .................................... Hong Kong 12,345,700 34,551,687 iStar Financial Inc. ......................................... United States 1,056,000 37,646,400 (a)Link REIT .................................................... Hong Kong 3,337,130 6,326,802 (a),(e)Security Capital European Realty ............................. Luxembourg 14,787 107,465 Shurgard Storage Centers Inc., A ............................. United States 146,600 8,313,686 Swire Pacific Ltd., A ........................................ Hong Kong 7,563,600 67,894,032 Swire Pacific Ltd., B ........................................ Hong Kong 13,605,000 23,687,876 (a),(e),(f)Torre Mayor Investments LP ................................... Mexico 170 11,730,000 Ventas Inc. .................................................. United States 516,500 16,538,330 ------------------ 229,094,065 ------------------ ROAD & RAIL 1.1% (e),(f)Florida East Coast Industries Inc. ........................... United States 2,247,600 90,469,271 ------------------ SOFTWARE 0.5% Microsoft Corp. .............................................. United States 1,517,700 39,687,855 ------------------ TEXTILES APPAREL & LUXURY GOODS 0.2% Reebok International Ltd. .................................... United States 268,600 15,640,578 ------------------ THRIFTS & MORTGAGE FINANCE 0.6% Hudson City Bancorp Inc. ..................................... United States 2,326,520 28,197,422 Sovereign Bancorp Inc. ....................................... United States 920,800 19,907,696 ------------------ 48,105,118 ------------------ TOBACCO 11.6% Altadis SA ................................................... Spain 3,181,151 144,313,337 (h)Altria Group Inc. ............................................ United States 995,105 74,354,246 British American Tobacco PLC ................................. United Kingdom 10,342,443 231,317,521
Annual Report | 27 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) TOBACCO (CONTINUED) Gallaher Group PLC ........................................... United Kingdom 2,904,884 $ 43,854,883 Imperial Tobacco Group PLC ................................... United Kingdom 5,733,336 171,336,248 ITC Ltd. ..................................................... India 18,037,005 56,923,096 Japan Tobacco Inc. ........................................... Japan 5,097 74,276,370 KT&G Corp. ................................................... South Korea 1,586,130 70,923,232 (b)KT&G Corp., GDR, 144A ........................................ South Korea 4,680,078 102,961,716 ------------------ 970,260,649 ------------------ TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $5,270,155,096) ..................................... 7,322,168,772 ------------------ PREFERRED STOCKS 0.4% DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(d) PTV Inc., 10.00%, pfd., A .................................... United Kingdom 86,280 181,188 ------------------ ELECTRIC UTILITIES 0.0%(d) (a)Montana Power Co., 8.45%, pfd. ............................... United States 49,500 408,375 ------------------ METALS & MINING 0.4% (e),(f),(g)Esmark Inc., Series A, 10.00%, cvt. pfd. ..................... United States 27,889 29,245,521 Falconbridge Ltd., 6.00%, cvt. pfd., 1 ....................... Canada 24,284 613,171 Falconbridge Ltd., 6.25%, cvt. pfd., 2 ....................... Canada 24,284 613,171 Falconbridge Ltd., 6.50%, cvt. pfd., 3 ....................... Canada 12,142 307,800 ------------------ 30,779,663 ------------------ TOTAL PREFERRED STOCKS (COST $31,280,649) .................... 31,369,226 ------------------ ------------------- PRINCIPAL AMOUNT(j) ------------------- CORPORATE BONDS & NOTES 1.4% (b)ACE Aviation Holdings Inc., cvt., 144A, 4.25%, 6/01/35 ....... Canada 2,761,000 CAD 2,327,953 (i)Collins & Aikman Products Co., Revolver, FRN, 10.75%, 8/31/09 ............................ United States 592,200 574,434 Tranche B1 Term Loan, FRN, 10.75%, 8/31/11 ................ United States 1,387,200 1,345,584 Dana Corp., 5.85%, 1/15/15 ............................................ United States 6,756,000 4,830,540 7.00%, 3/01/29 ............................................ United States 913,000 659,643 (e)DecisionOne Corp., 144A, 12.00%, 4/15/10 ..................... United States 390,655 390,655 Entegra/Union Power, Term Loan A, 4.00%, 6/01/12 ............................... United States 6,680,085 5,744,873 Term Loan B, 9.00%, 6/01/20 ............................... United States 6,432,674 5,532,100 Eurotunnel PLC, (b),(i)Senior Tranche G2 Term Loan A, 144A, FRN, 5.618%, 12/15/12 .............................................. United Kingdom 657,069 GBP 1,088,063 (i)Tier 2, FRN, 5.796%, 12/31/18 ......................... United Kingdom 6,155,799 GBP 9,002,132 (i)Tier 3, FRN, 5.796%, 12/31/25 ......................... United Kingdom 24,432,938 GBP 19,756,754 Eurotunnel SA, Senior Tranche H1 Term Loan (KfW Advance), 8.78%, 12/15/12 ........................................... France 706,000 EUR 794,008 (i)Tier 2 (LIBOR), FRN, 3.393%, 12/31/18 .................. France 1,420,047 EUR 1,428,955 (i)Tier 2 (PIBOR), FRN, 3.393%, 12/31/18 .................. France 628,134 EUR 632,074 (i)Tier 3 (LIBOR), FRN, 3.393%, 12/31/25 .................. France 27,236,561 EUR 15,154,681 (i)Tier 3 (PIBOR), FRN, 3.393%, 12/31/25 .................. France 5,943,809 EUR 3,307,192
28 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT VALUE - ---------------------------------------------------------------------------------------------------------------------------------- CORPORATE BONDS & NOTES (CONTINUED) (i)Motor Coach Industries International Inc., FRN, 17.406%, 12/01/08 .................................................. United States 26,151,608 $ 24,844,027 Trump Entertaiment Resorts Inc., 8.50%, 5/20/15 .............. United States 17,141,134 16,798,311 TVMAX Holdings Inc., PIK, 11.50%, 1/16/06 ........................................... United States 195,016 195,016 (k)14.00%, 1/16/06 ........................................... United States 549,381 549,381 ------------------ TOTAL CORPORATE BONDS & NOTES (COST $124,006,556) ............ 114,956,376 ------------------ CORPORATE BONDS & NOTES IN REORGANIZATION 0.9% (l)Adelphia Communications Corp., 9.25%, 10/01/02 ........................................... United States 4,491,000 2,514,960 8.125%, 7/15/03 ........................................... United States 650,000 370,500 7.50%, 1/15/04 ............................................ United States 1,655,000 943,350 10.50%, 7/15/04 ........................................... United States 2,605,000 1,484,850 9.875%, 3/01/05 ........................................... United States 1,168,000 662,840 10.25%, 11/01/06 .......................................... United States 5,186,000 2,904,160 9.875%, 3/01/07 ........................................... United States 528,000 300,960 8.375%, 2/01/08 ........................................... United States 4,053,000 2,310,210 7.75%, 1/15/09 ............................................ United States 8,875,000 5,014,375 7.875%, 5/01/09 ........................................... United States 4,280,000 2,375,400 9.375%, 11/15/09 .......................................... United States 4,509,000 2,660,310 10.875%, 10/01/10 ......................................... United States 3,769,000 2,129,485 10.25%, 6/15/11 ........................................... United States 4,712,000 2,850,760 (l)Armstrong World Industries Inc., 6.35%, 8/15/03 ............................................ United States 11,769,000 8,473,680 6.50%, 8/15/05 ............................................ United States 939,000 666,690 9.75%, 4/15/08 ............................................ United States 2,542,000 1,881,080 7.45%, 5/15/29 ............................................ United States 1,511,000 1,118,140 Revolver, 10/29/03 ........................................ United States 1,912,950 1,341,456 Trade Claim ............................................... United States 5,129,100 3,571,136 (l)Century Communications Corp., (m)8.875%, 1/15/07 ........................................... United States 262,000 251,520 8.75%, 10/01/07 ........................................... United States 2,620,000 2,462,800 8.375%, 12/15/07 .......................................... United States 392,000 376,320 senior note, 9.50%, 3/01/05 ............................... United States 735,000 712,950 Series B, zero cpn., 1/15/08 .............................. United States 4,045,000 2,244,975 zero cpn., 3/15/03 ........................................ United States 7,228,000 6,143,800 (k),(l)Owens Corning, Revolver, 6/26/02 ............................. United States 13,143,250 18,400,550 (l)Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ...... United States 40,000 20 ------------------ TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $73,759,223) 74,167,277 ------------------
Annual Report | 29 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- SHARES/ COUNTRY PRINCIPAL AMOUNT(j) VALUE - ---------------------------------------------------------------------------------------------------------------------------------- COMPANIES IN LIQUIDATION 0.0%(d) (a)City Investing Co. Liquidating Trust ......................... United States 125,500 $ 13,805 (a)MBOP Liquidating Trust ....................................... United States 273,144 35 (a)Petrie Stores Liquidating Trust, CBI ......................... United States 1,213,700 436,932 (a)United Cos. Financial Corp., Bank Claim ...................... United States 77,701 -- ------------------ TOTAL COMPANIES IN LIQUIDATION (COST $--) .................... 450,772 ------------------ GOVERNMENT AGENCIES 6.9% Federal Home Loan Bank, 2.26% - 3.35%, 1/03/06 - 9/27/07 ..... United States 563,155,000 558,399,374 Federal National Mortgage Association, 2.20%, 12/18/06 ....... United States 10,000,000 9,764,380 Government of Norway, 6.75%, 1/15/07 ......................... Norway 51,550,000 NOK 7,939,369 (n)U.S. Treasury Bill, 2/02/06 .................................. United States 3,000,000 2,990,388 ------------------ TOTAL GOVERNMENT AGENCIES (COST $579,478,308) ................ 579,093,511 ------------------ TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $6,078,679,832) ..................................... 8,122,205,934 ------------------ REPURCHASE AGREEMENTS 0.0%(d) (o),(p)Bank of America LLC, 4.32%, 1/03/06 (Maturity Value $45,027) Collateralized by U.S. Government Agency Securities, 5.00% - 5.50%, 9/01/33-10/01/35 ............... United States 45,005 45,005 (o),(p)Bear Stearns & Co. Inc., 4.25%, 1/03/06 (Maturity Value $52,031) Collateralized by U.S. Government Agencies, 3.282% - 7.155%, 3/01/07 - 9/01/45 ........................ United States 52,006 52,006 (o),(p)Citigroup Global Markets Inc., 4.26%, 1/03/06 (Maturity Value $39,023) Collateralized by U.S. Government Agency Securities and (n)U.S. Treasury Bills, 0.00% - 14.00%, 1/03/06 - 8/06/38 .. United States 39,005 39,005 (o),(p)Merrill Lynch GSI, 4.25%, 1/03/06 (Maturity Value $58,034) Collateralized by (n)U.S. Government Agency Securities, 1/03/06 - 1/04/06 ......................................... United States 58,007 58,007 (o),(p)Morgan Stanley & Co. Inc., 4.31%, 1/03/06 (Maturiy Value $63,008) Collateralized by U.S. Government Agency Securities, 5.00%, 6/01/35 - 7/01/35 ...................... United States 63,008 63,008 ------------------ TOTAL REPURCHASE AGREEMENTS (COST $257,031) .................. 257,031 ------------------ TOTAL INVESTMENTS (COST $6,078,936,863) 97.4% ................ 8,122,462,965 OPTIONS WRITTEN 0.0%(d) ...................................... (8,000) SECURITIES SOLD SHORT (1.1)% ................................. (91,331,667) NET UNREALIZED GAIN ON FORWARD EXCHANGE CONTRACTS 0.7% ....... 61,924,563 OTHER ASSETS, LESS LIABILITIES 2.9% .......................... 246,355,956 ------------------ NET ASSETS 100.0% ............................................ $ 8,339,403,817 ------------------
30 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- COUNTRY CONTRACTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- (q)OPTIONS WRITTEN (PREMIUMS RECEIVED $33,599) 0.0%(d) PHARMACEUTICALS 0.0%(D) Pfizer Inc., Jan. 22.50 Puts, 1/21/06 ........................ United States 400 $ 8,000 ------------------ ------ SHARES ------ (r)SECURITIES SOLD SHORT 1.1% COMMERCIAL BANKS 0.3% Bank of America Corp. ........................................ United States 573,391 26,461,995 ------------------ FOOD PRODUCTS 0.2% Kraft Foods Inc., A .......................................... United States 661,443 18,613,006 ------------------ HEALTH CARE EQUIPMENT & SUPPLIES 0.1% Alcon Inc. ................................................... Switzerland 34,100 4,419,360 ------------------ HEALTH CARE PROVIDERS & SERVICES 0.0%(d) WellPoint Inc. ............................................... United States 15 1,197 ------------------ OIL & GAS, & CONSUMABLE FUELS 0.4% ConocoPhillips ............................................... United States 394,150 22,931,647 Occidental Petroleum Corp. ................................... United States 127,310 10,169,523 ------------------ 33,101,170 ------------------ PHARMACEUTICALS 0.0%(d) Teva Pharmaceutical Industries Ltd., ADR ..................... Israel 18,400 791,384 ------------------ REAL ESTATE 0.1% Public Storage Inc. .......................................... United States 117,300 7,943,555 ------------------ TOTAL SECURITIES SOLD SHORT (PROCEEDS $93,334,499) ........... $ 91,331,667 ------------------
CURRENCY ABBREVIATIONS CAD - Canadian Dollar EUR - Euro GBP - British Pound NOK - Norwegian Krone Annual Report | 31 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED) SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt CBI - Certificate of Beneficial Interest FRN - Floating Rate Note GDR - Global Depository Receipt LIBOR - London InterBank Offered Rate PIBOR - Paris InterBank Offered Rate PIK - Payment In Kind REIT - Real Estate Investment Trust (a) Non-income producing. (b) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. These securities have been deemed liquid under guidelines approved by the Fund's Board of Directors. At December 31, 2005, the aggregate value of these securities was $120,126,584, representing 1.44% of net assets. (c) 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. (d) Rounds to less than 0.05% of net assets. (e) See Note 11 regarding restricted and illiquid securities. (f) See Note 13 regarding holdings of 5% voting securities. (g) See Note 14 regarding other considerations. (h) See Note 1(g) regarding securities segregated with broker for securities sold short. (i) The coupon rate shown represents the rate at period end. (j) The principal amount is stated in U.S. dollars unless otherwise indicated. (k) See Note 12 regarding unfunded loan commitments. (l) See Note 10 regarding defaulted securities. (m) A portion or all of the security is on loan as of December 31, 2005. See Note 1(i). (n) A portion or all of the security is traded on a discount basis with no stated coupon rate. (o) See Note 1(c) regarding repurchase agreements. (p) Investment from cash collateral received for loaned security. See Note 1(i). (q) See Note 1(f) regarding written options. (r) See Note 1(g) regarding securities sold short. 32 | See notes to financial statements. | Annual Report Mutual Discovery Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2005 Assets: Investments in securities: Cost - Unaffiliated issuers ................................................................ $ 5,765,665,686 Cost - Controlled affiliated issuers (Note 13) ............................................. 12,872,099 Cost - Non-controlled affiliated issuers (Note 13) ......................................... 300,142,047 Cost - Repurchase agreements ............................................................... 257,031 --------------- Total cost of investments .................................................................. $ 6,078,936,863 =============== Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $170,128,000) ......................... $ 7,725,792,091 Value - Controlled affiliated issuers (Note 13) ............................................ 500,007 Value - Non-controlled affiliated issuers (Note 13) ........................................ 395,913,836 Value - Repurchase agreements .............................................................. 257,031 --------------- Total value of investments ................................................................. 8,122,462,965 Cash .......................................................................................... 910,477 Foreign currency, at value (cost $107,462,080 ) ............................................... 107,604,420 Receivables: Investment securities sold ................................................................. 25,901,771 Capital shares sold ........................................................................ 39,042,583 Dividends and interest ..................................................................... 10,971,785 Unrealized gain on forward exchange contracts (Note 8) ........................................ 81,701,561 Unrealized gain on unfunded loan commitments (Note 12) ........................................ 557,395 Cash on deposits with brokers for securities sold short ....................................... 97,475,601 Due from broker - synthetic equity swaps ...................................................... 10,284,999 --------------- Total assets ............................................................................ 8,496,913,557 --------------- Liabilities: Payables: Investment securities purchased ............................................................... 18,058,571 Capital shares redeemed .................................................................... 14,922,513 Affiliates ................................................................................. 11,505,988 Options written, at value (premiums received $33,599) ......................................... 8,000 Securities sold short, at value (proceeds $93,334,499) ........................................ 91,331,667 Payable upon return of securities loaned ...................................................... 257,031 Unrealized loss on forward exchange contracts (Note 8) ........................................ 19,776,998 Deferred tax .................................................................................. 212,578 Accrued expenses and other liabilities ........................................................ 1,436,394 --------------- Total liabilities ....................................................................... 157,509,740 --------------- Net assets, at value ................................................................. $ 8,339,403,817 =============== Net assets consist of: Paid-in capital ............................................................................... $ 6,139,428,539 Distributions in excess of net investment income .............................................. (1,761,200) Net unrealized appreciation (depreciation) .................................................... 2,109,711,128 Accumulated net realized gain (loss) .......................................................... 92,025,350 --------------- Net assets, at value ................................................................. $ 8,339,403,817 ===============
Annual Report | See notes to financial statements. | 33 Mutual Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2005 CLASS Z: Net assets, at value ............................................................................. $ 3,033,755,606 =============== Shares outstanding ............................................................................... 115,456,745 =============== Net asset value and maximum offering price per share(a) .......................................... $ 26.28 =============== CLASS A: Net assets, at value ............................................................................. $ 3,545,288,399 =============== Shares outstanding ............................................................................... 136,142,798 =============== Net asset value per share(a) ..................................................................... $ 26.04 =============== Maximum offering price per share (net asset value per share / 94.25%) ............................ $ 27.63 =============== CLASS B: Net assets, at value ............................................................................. $ 225,157,668 =============== Shares outstanding ............................................................................... 8,805,916 =============== Net asset value and maximum offering price per share(a) .......................................... $ 25.57 =============== CLASS C: Net assets, at value ............................................................................. $ 1,435,701,504 =============== Shares outstanding ............................................................................... 55,442,603 =============== Net asset value and maximum offering price per share(a) .......................................... $ 25.90 =============== CLASS R: Net assets, at value ............................................................................. $ 99,500,640 =============== Shares outstanding ............................................................................... 3,844,449 =============== Net asset value and maximum offering price per share(a) .......................................... $ 25.88 ===============
(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, 2005 Investment income: Dividends (net of foreign taxes of $8,544,990) Unaffiliated issuers ....................................................................... $ 141,624,235 Controlled affiliated issuers (Note 13) .................................................... (170,273) Non-controlled affiliated issuers (Note 13) ................................................ (1,022,289) Interest ...................................................................................... 30,117,220 Income from securities loaned - net ........................................................... 9,835 Other income (Note 15) ........................................................................ 166,932 --------------- Total investment income ................................................................. 170,725,660 =============== Expenses: Management fees (Note 3a) ..................................................................... 54,005,775 Administrative fees (Note 3b) ................................................................. 5,274,950 Distribution fees (Note 3c) Class A .................................................................................... 9,360,408 Class B .................................................................................... 2,029,470 Class C .................................................................................... 11,640,631 Class R .................................................................................... 362,842 Transfer agent fees (Note 3e) ................................................................. 8,042,700 Custodian fees (Note 4) ....................................................................... 1,707,300 Reports to shareholders ....................................................................... 608,400 Registration and filing fees .................................................................. 416,650 Professional fees ............................................................................. 412,312 Directors' fees and expenses .................................................................. 174,400 Dividends on securities sold short ............................................................ 2,377,235 Other ......................................................................................... 217,843 --------------- Total expenses .......................................................................... 96,630,916 Expense reductions (Note 4) ............................................................. (44,935) --------------- Net expenses ......................................................................... 96,585,981 --------------- Net investment income ............................................................. 74,139,679 =============== Realized and unrealized gains (losses): Net realized gain (loss) from: Investments Unaffiliated issuers .................................................................... 493,383,294 Non-controlled affiliated issuers (Note 13) ............................................. 15,783,841 Written options ............................................................................ 506,328 Foreign currency transactions .............................................................. 36,652,813 Securities sold short ...................................................................... (1,033,170) --------------- Net realized gain (loss) .......................................................... 545,293,106 =============== Net change in unrealized appreciation (depreciation) on: Investments ................................................................................ 269,117,949 Translation of assets and liabilities denominated in foreign currencies .............................................................................. 140,860,149 Change in deferred taxes on unrealized appreciation ........................................... 351,072 --------------- Net change in unrealized appreciation (depreciation) .............................. 410,329,170 --------------- Net realized and unrealized gain (loss) .......................................................... 955,622,276 --------------- Net increase (decrease) in net assets resulting from operations .................................. $ 1,029,761,955 ===============
Annual Report | See notes to financial statements. | 35 Mutual Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
---------------------------------- YEAR ENDED DECEMBER 31, ---------------------------------- 2005 2004 ---------------------------------- Increase (decrease) in net assets: Operations: Net investment income .................................................... $ 74,139,679 $ 77,174,072 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions .............. 545,293,106 189,690,486 Net change in unrealized appreciation (depreciation) on investments, translation of assets and liabilities denominated in foreign currencies, and deferred taxes ........................................ 410,329,170 641,209,947 ---------------------------------- Net increase (decrease) in net assets resulting from operations .... 1,029,761,955 908,074,505 ---------------------------------- Distributions to shareholders from: Net investment income: Class Z ............................................................... (48,037,194) (56,656,081) Class A ............................................................... (42,518,253) (39,448,944) Class B ............................................................... (1,634,133) (2,633,811) Class C ............................................................... (10,283,880) (13,213,407) Class R ............................................................... (1,080,128) (815,309) Net realized gains: Class Z ............................................................... (146,590,402) -- Class A ............................................................... (171,167,526) -- Class B ............................................................... (11,212,671) -- Class C ............................................................... (70,203,636) -- Class R ............................................................... (4,839,461) -- ---------------------------------- Total distributions to shareholders ......................................... (507,567,284) (112,767,552) ---------------------------------- Capital share transactions: (Note 2) Class Z ............................................................... 236,977,632 50,114,536 Class A ............................................................... 1,242,352,449 391,763,708 Class B ............................................................... 22,746,797 47,123,925 Class C ............................................................... 379,781,109 113,386,535 Class R ............................................................... 47,560,961 21,446,986 ---------------------------------- Total capital share transactions ............................................ 1,929,418,948 623,835,690 ---------------------------------- Redemption fees ............................................................. 45,185 25,982 ---------------------------------- Net increase (decrease) in net assets .............................. 2,451,658,804 1,419,168,625 Net assets: Beginning of year ........................................................... 5,887,745,013 4,468,576,388 ---------------------------------- End of year ................................................................. $ 8,339,403,817 $ 5,887,745,013 ================================== Distributions in excess of net investment income included in net assets: End of year ................................................................. $ (1,761,200) $ (31,462,123) ==================================
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 six separate series. The Series Fund 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 following summarizes the Funds' 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 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. 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 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. 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. 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. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. 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 | 37 Mutual Discovery 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. 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 Fund, with the value of the underlying securities marked to market daily to maintain coverage of at least 100%. Repurchase agreements are valued at cost. At December 31, 2005, all repurchase agreements held by the Fund had been entered into on December 30, 2005. 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 the net unrealized gain or loss on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, 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. 38 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. FOREIGN CURRENCY CONTRACTS (CONTINUED) When the Fund purchases or sells foreign securities it may enter into foreign exchange contracts to minimize foreign exchange risk from the trade date to the settlement date of the transactions. Realized and unrealized gains and losses 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, which may be in excess of the amount reflected in the Statement of Assets and Liabilities. 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. OPTIONS 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 | 39 Mutual Discovery 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 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. 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 receives interest income 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. I. INCOME AND DEFERRED TAXES No provision has been made for U.S. income taxes because the Fund's policy is to continue to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund is subject to a tax imposed on net realized gains on securities of certain foreign countries. The Fund records an estimated deferred tax liability for net unrealized gains on these securities in an amount that would be payable if the securities were disposed of on the valuation date. Foreign securities held by the Fund may be subject to foreign tax. The foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign market in which the Fund invests. 40 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. 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. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Such distributions are reinvested in additional shares of the Fund. Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with generally accepted accounting principles. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. 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 of the Series Fund. Fund specific expenses are charged directly to the fund that incurred the expense. K. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. L. REDEMPTION FEES A short term trading redemption fee will be imposed, with some exceptions, on any Fund shares that are redeemed or exchanged within seven calendar days following their purchase date (30 days or less prior to June 1, 2004. The redemption fee is 2% of the amount redeemed. Such fees are retained by the Fund and accounted for as an addition to paid-in capital. Annual Report | 41 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) M. GUARANTEES AND INDEMNIFICATIONS Under the Series Fund's organizational documents, its officers and directors are indemnified by the Fund against certain liabilities 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 are only offered to existing Class B shareholders in the form of reinvested distributions and certain exchanges from other Franklin Templeton Class B shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. At December 31, 2005, there were 800 million shares authorized ($0.001 par value) of which 300 million shares were designated as Class Z, 100 million shares as Class A, 100 million shares as Class B, 100 million shares as Class C and 200 million shares as Class R. Transactions in the Fund's shares were as follows:
------------------------------------------------------------ YEAR ENDED DECEMBER 31, 2005 2004 ------------------------------------------------------------ SHARES AMOUNT SHARES AMOUNT ------------------------------------------------------------ CLASS Z SHARES: Shares sold .................... 11,753,534 $ 299,204,550 7,946,686 $ 174,333,866 Shares issued in reinvestment of distributions ............... 6,789,554 177,729,592 2,248,630 51,872,202 Shares redeemed ................ (9,384,324) (239,956,510) (8,088,625) (176,091,532) ------------------------------------------------------------ Net increase (decrease) ........ 9,158,764 $ 236,977,632 2,106,691 $ 50,114,536 ============================================================ CLASS A SHARES: Shares sold .................... 56,645,618 $ 1,439,893,472 28,991,422 $ 629,994,733 Shares issued in reinvestment of distributions ............... 7,726,972 200,597,742 1,608,954 36,824,687 Shares redeemed ................ (15,740,243) (398,138,765) (12,750,856) (275,055,712) ------------------------------------------------------------ Net increase (decrease) ........ 48,632,347 $ 1,242,352,449 17,849,520 $ 391,763,708 ============================================================
42 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED) CLASS B SHARES: Shares sold ....................... 1,235,020 $ 30,441,216 2,611,993 $ 55,685,546 Shares issued in reinvestment of distributions .................. 458,269 11,673,181 106,415 2,382,517 Shares redeemed ................... (781,874) (19,367,600) (514,048) (10,944,138) ------------------------------------------------------------ Net increase (decrease) ........... 911,415 $ 22,746,797 2,204,360 $ 47,123,925 ============================================================ CLASS C SHARES: Shares sold ....................... 17,305,812 $ 435,052,733 9,235,697 $ 199,753,205 Shares issued in reinvestment of distributions .................. 2,753,526 71,071,498 519,083 11,739,964 Shares redeemed ................... (5,039,587) (126,343,122) (4,560,279) (98,106,634) ------------------------------------------------------------ Net increase (decrease) ........... 15,019,751 $ 379,781,109 5,194,501 $ 113,386,535 ============================================================ CLASS R SHARES: Shares sold ....................... 2,257,530 $ 56,609,057 1,223,108 $ 26,261,073 Shares issued in reinvestment of distributions .................. 224,837 5,801,526 35,218 803,727 Shares redeemed ................... (587,868) (14,849,622) (258,493) (5,617,814) ------------------------------------------------------------ Net increase (decrease) ........... 1,894,499 $ 47,560,961 999,833 $ 21,446,986 ============================================================
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain directors of the Series Fund are also officers and/or directors of the following subsidiaries:
- -------------------------------------------------------------------------------------- SUBSIDIARY AFFILIATION - -------------------------------------------------------------------------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Investment Management Limited (FTIML) 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 The Fund pay 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% Up to and including $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% In excess of $10 billion Effective May 19, 2005, under a subadvisory agreement, FTIML, an affiliate of Franklin Mutual, provides subadvisory services to the Fund and receives from Franklin Mutual fees based on the average daily net assets of the Fund. Annual Report | 43 Mutual Discovery 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 Series Fund's aggregate average daily net assets as follows: - -------------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - -------------------------------------------------------------------------------- 0.150% Up to and including $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% In excess of $1.2 billion C. DISTRIBUTION FEES The Fund's Board of Directors has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors up to 0.35% per year of Class A's average daily net assets for costs incurred in connection with the sale and distribution of the Fund's shares. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. Under the Fund's compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the sale and distribution of the Fund's shares up to a certain percentage per year of its average daily net assets of each class as follows: Class B ................................................................ 1.00% Class C ................................................................ 1.00% Class R ................................................................ 0.50% 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 charge received(a) ..................................... $ 3,043,646 Contingent deferred sales charges retained ....................... $ 299,536 (a) Net of commissions paid to unaffiliated broker/dealers. E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $8,042,700, of which $5,363,139 was retained by Investor Services. 44 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 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, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES During the year ended December 31, 2005, the Fund utilized $20,570,378 of capital loss carry-forwards. For tax purposes, realized currency losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2005, the Fund deferred realized currency losses of $2,381,508. Net investment income 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, certain dividends on securities sold short and foreign taxes paid on net realized gains. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatments of defaulted securities, passive foreign investment company shares, wash sales, foreign currency transactions, bond discounts and premiums, foreign taxes paid on net realized gains and certain dividends on securities sold short. At December 31, 2005, 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 ......................................... $ 6,116,705,735 =============== Unrealized appreciation ..................................... $ 2,144,287,075 Unrealized depreciation ..................................... (138,529,845) --------------- Net unrealized appreciation (depreciation) .................. $ 2,005,757,230 =============== Undistributed ordinary income ............................... $ 56,789,348 Undistributed long term capital gains ....................... 122,452,041 --------------- Distributable earnings ...................................... $ 179,241,389 =============== Annual Report | 45 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) The tax character of distributions paid during the years ended December 31, 2005 and 2004, was as follows: ----------------------------- 2005 2004 ----------------------------- Distributions paid from: Ordinary income ................................ $ 141,987,989 $ 112,767,552 Long term capital gain ......................... 365,579,295 -- ----------------------------- $ 507,567,284 $ 112,767,552 ============================= 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the year ended December 31, 2005, aggregated $2,988,697,832 and $1,695,819,654, respectively. Transactions in options written during the year ended December 31, 2005, were as follows: NUMBER PREMIUMS OF CONTRACTS RECEIVED -------------------------- Options outstanding at December 31, 2004 .......... 1,370 $ 187,538 Options written ................................... 128,100 673,620 Options expired ................................... (124,793) (288,456) Options exercised ................................. (428) (74,935) Options closed .................................... (3,849) (464,168) -------------------------- Options outstanding at December 31, 2005 .......... 400 $ 33,599 ========================== 7. SYNTHETIC EQUITY SWAPS As of December 31, 2005, the Fund had the following synthetic equity swaps outstanding:
- ---------------------------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - ---------------------------------------------------------------------------------------------------- Christian Dior SA (46.76 - 54.99 EUR) ................... 75,476 $ 6,710,355 $ 2,350,179 02 PLC (1.95 - 1.97 GBP) ................................ 14,418,653 49,117,010 360,544 ------------ Total contracts to buy .............................................................. 2,710,723 ------------
- ---------------------------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - ---------------------------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (54.61 - 61.76 EUR) .... 75,332 $ 6,693,093 $ (1,499,564) Total contracts to sell ............................................................. (1,499,564) ============ Net unrealized gain (loss) .......................................................... $ 1,211,159 ============
46 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS At December 31, 2005, the Fund had outstanding forward exchange contracts as set out below.
- ------------------------------------------------------------------------------------------ CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO BUY AMOUNT(a) DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------ 5,824,365 Canadian Dollar ........... 4,932,190 1/23/06 $ 82,521 ------------
- ------------------------------------------------------------------------------------------ CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------ 11,250,000 Euro ................... 13,338,338 1/17/06 $ 6,433 132,084,834 Euro ................... 163,202,674 1/23/06 6,620,007 38,699,382 Swiss Franc ............ 31,050,000 2/02/06 1,488,501 60,025,000 British Pound .......... 107,400,618 2/15/06 4,143,961 2,826,994 Canadian Dollar ........ 2,450,000 2/15/06 14,367 50,308,098 Euro ................... 61,105,631 2/27/06 1,353,411 103,060,213 Norwegian Krone ........ 15,336,341 3/06/06 10,901 41,543,824 Euro ................... 49,508,459 3/15/06 202,154 572,724,389 Swedish Krone .......... 73,314,940 3/15/06 838,824 888,354,094 Danish Krone ........... 160,466,764 3/17/06 18,907,520 2,325,000 Euro ................... 18,006,892 DKK 3/17/06 105,095 25,292,410 British Pound .......... 45,556,689 3/21/06 2,044,098 47,200,000 British Pound .......... 83,299,515 4/04/06 2,090,272 170,984,993 Euro ................... 213,503,317 4/25/06 9,759,171 121,873,910 Norwegian Krone ........ 18,945,113 5/08/06 756,809 39,750,000 British Pound .......... 69,272,325 5/15/06 850,112 40,200,000 Euro ................... 50,602,090 5/23/06 2,623,891 224,017,000 Taiwan Dollar .......... 6,875,000 5/30/06 50,718 31,101,956 Norwegian Krone ........ 4,751,686 6/06/06 102,525 12,165,938 Swiss Franc ............ 9,500,000 6/06/06 95,808 36,705,000 New Zealand Dollar ..... 25,987,140 6/07/06 1,250,892 31,980,000 Euro ................... 38,840,955 6/15/06 623,253
- ------------------------------------------------------------------------------------------ CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------ 12,834,949,648 Japanese Yen ........... 117,632,320 6/28/06 $ 6,357,886 18,830,000 Euro ................... 22,558,547 7/17/06 16,023 47,666,230 British Pound .......... 83,191,455 8/14/06 1,048,950 170,265,714 Euro ................... 212,031,918 8/23/06 7,789,202 122,396,814 British Pound .......... 212,989,708 9/08/06 1,991,124 130,641,355 Euro ................... 163,983,550 9/13/06 7,094,371 130,963,072 Euro ................... 160,942,663 10/18/06 3,382,761 ------------ 81,619,040 ------------ Unrealized gain on forward exchange contracts ............................. $ 81,701,561 ============
- ------------------------------------------------------------------------------------------ CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO BUY AMOUNT(a) DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------ 1,105,337 Canadian Dollar ........ 947,429 1/23/06 $ (590) ------------
Annual Report | 47 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- ------------------------------------------------------------------------------------------ CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------ 27,686,380,000 Korean Won ............. 26,940,000 1/18/06 $ (545,461) 333,831,351 Canadian Dollar ........ 276,399,554 1/23/06 (11,025,325) 422,533,736 Norwegian Krone ........ 62,690,465 2/06/06 (44,864) 79,495,789 Canadian Dollar ........ 67,853,546 2/15/06 (637,088) 1,789,238 South African Rand ..... 275,000 2/15/06 (6,782) 364,000,000 Norwegian Krone ........ 54,066,900 3/06/06 (61,264) 73,750,000 Euro ................... 86,892,250 3/15/06 (782,603) 4,425,000 Euro ................... 32,956,260 DKK 3/17/06 (9,514) 184,267,115,625 Korean Won ............. 178,112,500 3/22/06 (4,956,733) 328,137,892 Taiwan Dollar .......... 9,924,505 5/30/06 (71,636) 392,000,000 Norwegian Krone ........ 58,463,833 6/06/06 (132,837) 239,125,814 Swiss Francs ........... 184,368,383 6/06/06 (474,340) 1,458,022 Euro ................... 1,739,041 6/15/06 (3,368) 268,750,400 Japanese Yen ........... 2,300,000 6/28/06 (29,971) 111,129,253 Euro ................... 132,044,881 7/17/06 (994,622) ------------ (19,776,408) ------------ Unrealized loss on forward exchange contracts .......................... (19,776,998) ------------ Net unrealized gain on forward exchange contracts ................... $ 61,924,563 ============
(a)In U.S. Dollar unless otherwise indicated. CURRENCY ABBREVIATIONS DKK - Danish Krone 9. CONCENTRATION OF RISK Investing in foreign securities may include certain risks and considerations not typically associated with investing in U.S. securities, such as fluctuating currency values, and changing local and regional economic, political and social conditions, which may result in greater market volatility. In addition, certain foreign securities may not be as liquid as U.S. securities. 10. DEFAULTED SECURITIES The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressed companies are financially troubled and are about to be/or are already involved in financial restructuring or bankruptcy. The Fund does not accrue income on these securities, if it becomes probable that the income will not be collected. The risks of purchasing these securities are that the issuer is unable to meet its obligation and any subsequent bankruptcy proceeding may result in unfavorable consequences to the Fund. At December 31, 2005, the value of these securities was $74,167,277, representing 0.89% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 48 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. RESTRICTED AND ILLIQUID SECURITIES At December 31, 2005, investments in securities included issues that are restricted and illiquid. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration under the Securities Act of 1933, unless the sale is pursuant to an exemption under the 1933 Act. The Fund has registration rights for all restricted securities held at period end. The issuer generally incurs all registration costs. A security may 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, 2005, the Fund held investments in restricted and illiquid securities, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL AMOUNT, SHARES, CONTRACTS ACQUISITION AND WARRANTS ISSUER DATE COST VALUE - ------------------------------------------------------------------------------------------------------------------------------------ 332,512 AboveNet Inc. ....................................................... 10/02/01 $ 15,655,782 $ 7,968,118 11,105 AboveNet Inc., wts., 9/08/08 ........................................ 10/02/01 1,437,838 44,420 13,066 AboveNet Inc., wts., 9/08/10 ........................................ 10/02/01 1,768,651 10,453 359,884 DecisionOne Corp. ................................................... 9/28/99 273,004 256,597 390,655 DecisionOne Corp., 144A, 12.00%, 4/15/10 ............................ 10/21/99 1,460,727 390,655 27,889 Esmark Inc., Series A, 10.00%, cvt. pfd. ............................ 11/08/04 27,889,000 29,245,521 11,589 FE Capital Holdings Ltd. ............................................ 8/29/03 -- 16,513,832 2,247,600 Florida East Coast Industries Inc. .................................. 12/29/95 67,070,841 90,469,271 8,758,216 Hancock Discovery LLC ............................................... 3/06/97 12,872,099 500,007 4,551,501 Imagine Group Holdings Ltd. ......................................... 8/31/04 46,614,197 46,614,334 934,740 Kindred Healthcare Inc. ............................................. 12/12/01 9,954,196 22,874,957 449 Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 ................... 1/01/05 -- 6,913 223 Kindred Healthcare Inc., Jan. 25.99 Calls, 1/01/14 .................. 1/01/05 -- -- 675 Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 .................. 1/01/05 -- -- 3,002 Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 .................. 7/17/05 -- 2,167 88,766 Kindred Healthcare Inc., wts., Series A, 4/20/06 .................... 4/24/01 798,892 1,716,912 221,915 Kindred Healthcare Inc., wts., Series B, 4/20/06 .................... 4/24/01 1,775,317 3,647,173 55,890 NCB Warrant Holdings Ltd., A ........................................ 12/16/05 -- 9,029,594 47,160 Olympus Re Holdings Ltd. ............................................ 12/19/01 4,716,000 872,460 14,787 Security Capital European Realty .................................... 4/08/98 810,051 107,465 2,833,800 Time Warner Inc. .................................................... 8/02/05 48,945,601 48,433,043 18,832 Time Warner Inc., Jan 10.00 calls, 1/21/06 .......................... 8/17/05 15,790,114 13,841,520 170 Torre Mayor Investments LP .......................................... 10/28/02 14,065,434 11,730,000 ------------- TOTAL RESTRICTED AND ILLIQUID SECURITIES (3.65% of Net Assets) .............................. $ 304,275,412 =============
Annual Report | 49 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 12. UNFUNDED LOAN COMMITMENTS The Fund may enter into certain credit agreements, all or a portion of which may be unfunded. The Fund is obligated to fund these loan commitments at the borrowers' discretion. At December 31, 2005, unfunded commitments were as follows:
- ---------------------------------------------------------------------------------- BORROWER UNFUNDED COMMITMENT - ---------------------------------------------------------------------------------- Entegra/Union Power, LOC Facility, FRN, 6/01/12 ............. $1,837,389 Entegra/Union Power, Working Capital Facility FRN, 6/01/12 .. 275,608 Mirant Corp, 4 Year Revolver, 7/17/05 ....................... 243,193 Owens Corning, Revolver, 6/26/02 ............................ 750,784 TVMAX Holdings, PIK, 14.00%, 1/16/06 ........................ 26 ---------- $3,107,000 ==========
Unfunded loan commitments are marked to market daily and any unrealized gain or loss is included in the Statement of Assets and Liabilities and Statement of Operations. 13. 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, 2005, were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF SHARES NUMBER OF SHARES INVESTMENT REALIZED HELD AT GROSS GROSS HELD AT VALUE AT INCOME CAPITAL NAME OF ISSUER BEGINNING OF YEAR ADDITIONS REDUCTIONS END OF YEAR END OF YEAR (LOSS) GAIN (LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ CONTROLLED AFFILIATES(a) Hancock Discovery LLC ......... 8,758,216 -- -- 8,758,216 $ 500,007 $ (170,273) $ -- --------------------------------------- NON-CONTROLLED AFFILIATES Esmark Inc., Series A, 10%, cvt. pdf. ................... 18,647 9,242 -- 27,889 $ 29,245,521 $ 2,727,954 $ -- Farmer Brothers Co. ........... 904,637 -- -- 904,637 17,495,680 366,378 -- FE Capital Holdings Ltd. ...... 11,589 -- -- 11,589 16,513,832 (1,453,416) 12,798,519 Florida East Coast Industries Inc. ............. 2,247,600 -- -- 2,247,600 90,469,271 516,948 -- Gammon Lake Resources Inc. .... 2,136,800 2,265,300 -- 4,402,100 52,304,053 -- -- Gammon Lake Resources, Inc., wts., 4/30/05 ............... 2,265,300 -- 2,265,300 -- -- -- -- Imagine Group Holdings Ltd. ... 4,551,501 -- -- 4,551,501 46,614,334 -- -- Nippon Investment LLC ......... 8,656,000 -- 8,656,000 -- -- -- (1,597,970) Pig Iron, LLC ................. -- 2,645,800 2,645,800 -- -- -- (12,025) Potlatch Corp. ................ 2,190,150 667,600 277,500 2,580,250 131,541,145 1,531,260 2,818,470 Torre Mayor Investments, LP ... 170 -- -- 170 11,730,000 (4,711,413) 1,776,847 --------------------------------------- TOTAL NON-CONTROLLED AFFILIATES .................. $395,913,836 $(1,022,289) $15,783,841 --------------------------------------- TOTAL AFFILIATED SECURITIES (4.75% of Net Assets) ....... $396,413,843 $(1,192,562) $15,783,841 =======================================
(a) Issuer in which the Fund owns 25% or more of the outstanding voting securities. 50 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 14. OTHER CONSIDERATIONS Directors or employees of Franklin Mutual, as the Fund's Investment Manager, may serve as members 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, 2005, such individuals serve in one or more of these capacities for Kindred Healthcare Inc., AboveNet Inc. and Esmark Inc. As a result of this involvement, such individuals 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. 15. REGULATORY MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, 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 (collectively, the "Company"), entered into settlements with certain of those regulators. Specifically, the Company entered into settlements with the Securities and Exchange Commission ("SEC") concerning market timing (the "August 2, 2004 SEC Order") and marketing support payments to securities dealers who sell fund shares (the "December 13, 2004 SEC Order") and with the California Attorney General's Office ("CAGO") concerning marketing support payments to securities dealers who sell fund shares (the "CAGO Settlement"). Under the terms of the settlements with the SEC and the CAGO, the Company retained an Independent Distribution Consultant ("IDC") to develop a plan for distribution of the respective settlement monies. The CAGO approved the distribution plan under the CAGO Settlement and, in accordance with the terms and conditions of that settlement, the monies were disbursed to the relevant funds and are recorded as other income in the current period. The SEC has not yet approved the distribution plan pertaining to the December 13, 2004 SEC Order. When approved, disbursements of settlement monies will be made promptly to the relevant funds, in accordance with the terms and conditions of that order. The IDC continues to develop the plan of distribution under the August 2, 2004 SEC Order that resolved the SEC's market timing investigation. In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, directors, and/or employees, have been named in private lawsuits (styled as shareholder class actions, or as derivative actions on behalf of either the named funds or Franklin Resources, Inc.) relating to the industry practices referenced above, as well as to allegedly excessive advisory fees, commissions, and/or 12b-1 fees. The lawsuits were filed in different courts throughout the country. Many of those suits are now pending in a multi-district litigation in the United States District Court for the District of Maryland. Annual Report | 51 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 15. REGULATORY MATTERS (CONTINUED) The Company and fund management strongly believe that the claims made in each of the private lawsuits referenced above are without merit and intend to defend against them vigorously. The Company cannot predict with certainty the eventual outcome of these lawsuits, nor whether they will have a material negative impact on the Company. 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. 52 | Annual Report Mutual Discovery Fund REPORT OF 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 of the Mutual Discovery Fund (one of the portfolio constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2005, 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. We were not engaged to perform an audit of the Fund's internal control over financial reporting. Our audits included 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, and evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2005, by correspondence with the custodian and brokers, or by other appropriate auditing procedures where replies from the 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. at December 31, 2005, 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 10, 2006 Annual Report | 53 Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) TAX DESIGNATION (UNAUDITED) Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund designates the maximum amount allowable but no less than $488,033,336 as a capital gain dividend for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $126,351,826 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2005. In January 2006, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2005. 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 871(k)(1)(C) of the Code, the Fund designates the maximum amount allowable but no less than $17,055,277 as interest-related dividends for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section 871(k)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $69,736,181 as a short-term capital gain dividend for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates 26.54% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2005. At December 31, 2005, more than 50% of the 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 designates to shareholders the foreign source income and foreign taxes paid as allowed, pursuant to Section 853 of the Code. This designation will allow shareholders of record on December 22, 2005, 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, and foreign qualified dividends as designated by the Fund, to Class Z, Class A, Class B, Class C and Class R shareholders of record. 54 | Annual Report Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) (CONTINUED) RECORD DATE: 12/22/2005 - -------------------------------------------------------------------------------- CLASS Z FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED COUNTRY PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Belgium .............. $0.0012 $0.0054 $0.0054 Bermuda .............. 0.0000 0.0049 0.0024 Canada ............... 0.0015 0.0072 0.0044 Denmark .............. 0.0020 0.0086 0.0085 France ............... 0.0032 0.0194 0.0145 Germany .............. 0.0007 0.0035 0.0030 Hong Kong ............ 0.0000 0.0080 0.0000 India ................ 0.0000 0.0059 0.0059 Ireland .............. 0.0000 0.0157 0.0157 Italy ................ 0.0007 0.0030 0.0030 Japan ................ 0.0005 0.0045 0.0045 Luxembourg ........... 0.0012 0.0053 0.0053 Mexico ............... 0.0000 0.0013 0.0013 Netherlands .......... 0.0050 0.0213 0.0120 New Zealand .......... 0.0001 0.0009 0.0000 Norway ............... 0.0044 0.0229 0.0229 South Africa ......... 0.0000 0.0050 0.0031 South Korea .......... 0.0016 0.0062 0.0062 Spain ................ 0.0021 0.0090 0.0090 Switzerland .......... 0.0029 0.0127 0.0127 Taiwan ............... 0.0011 0.0037 0.0037 United Kingdom ....... 0.0000 0.0921 0.0531 ------------------------------------------------------- Total ................ $0.0282 $0.2665 $0.1966 ======================================================= - -------------------------------------------------------------------------------- CLASS A FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED COUNTRY PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Belgium .............. $0.0012 $0.0046 $0.0046 Bermuda .............. 0.0000 0.0041 0.0020 Canada ............... 0.0015 0.0060 0.0037 Denmark .............. 0.0020 0.0072 0.0071 France ............... 0.0032 0.0163 0.0122 Germany .............. 0.0007 0.0029 0.0025 Hong Kong ............ 0.0000 0.0067 0.0000 India ................ 0.0000 0.0049 0.0049 Ireland .............. 0.0000 0.0132 0.0132 Italy ................ 0.0007 0.0025 0.0025 Japan ................ 0.0005 0.0037 0.0037 Luxembourg ........... 0.0012 0.0045 0.0045 Mexico ............... 0.0000 0.0011 0.0011 Netherlands .......... 0.0050 0.0179 0.0101 New Zealand .......... 0.0001 0.0008 0.0000 Norway ............... 0.0044 0.0193 0.0193 South Africa ......... 0.0000 0.0042 0.0026 South Korea .......... 0.0016 0.0052 0.0052 Spain ................ 0.0021 0.0076 0.0076 Switzerland .......... 0.0029 0.0106 0.0106 Taiwan ............... 0.0011 0.0031 0.0031 United Kingdom ....... 0.0000 0.0773 0.0445 ------------------------------------------------------- Total ................ $0.0282 $0.2237 $0.1650 ======================================================= Annual Report | 55 Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- CLASS B FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED COUNTRY PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Belgium .............. $0.0012 $0.0025 $0.0025 Bermuda .............. 0.0000 0.0023 0.0011 Canada ............... 0.0015 0.0034 0.0021 Denmark .............. 0.0020 0.0040 0.0040 France ............... 0.0032 0.0091 0.0068 Germany .............. 0.0007 0.0016 0.0014 Hong Kong ............ 0.0000 0.0037 0.0000 India ................ 0.0000 0.0027 0.0027 Ireland .............. 0.0000 0.0074 0.0074 Italy ................ 0.0007 0.0014 0.0014 Japan ................ 0.0005 0.0021 0.0021 Luxembourg ........... 0.0012 0.0025 0.0025 Mexico ............... 0.0000 0.0006 0.0006 Netherlands .......... 0.0050 0.0100 0.0056 New Zealand .......... 0.0001 0.0004 0.0000 Norway ............... 0.0044 0.0107 0.0107 South Africa ......... 0.0000 0.0023 0.0014 South Korea .......... 0.0016 0.0029 0.0029 Spain ................ 0.0021 0.0042 0.0042 Switzerland .......... 0.0029 0.0059 0.0059 Taiwan ............... 0.0011 0.0018 0.0018 United Kingdom ....... 0.0000 0.0431 0.0248 ------------------------------------------------------- Total ................ $0.0282 $0.1246 $0.0919 ======================================================= - -------------------------------------------------------------------------------- CLASS C FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED COUNTRY PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Belgium .............. $0.0012 $0.0029 $0.0029 Bermuda .............. 0.0000 0.0026 0.0013 Canada ............... 0.0015 0.0038 0.0023 Denmark .............. 0.0020 0.0046 0.0046 France ............... 0.0032 0.0103 0.0077 Germany .............. 0.0007 0.0018 0.0016 Hong Kong ............ 0.0000 0.0042 0.0000 India ................ 0.0000 0.0031 0.0031 Ireland .............. 0.0000 0.0083 0.0083 Italy ................ 0.0007 0.0016 0.0016 Japan ................ 0.0005 0.0024 0.0024 Luxembourg ........... 0.0012 0.0028 0.0028 Mexico ............... 0.0000 0.0007 0.0007 Netherlands .......... 0.0050 0.0113 0.0064 New Zealand .......... 0.0001 0.0005 0.0000 Norway ............... 0.0044 0.0122 0.0122 South Africa ......... 0.0000 0.0027 0.0017 South Korea .......... 0.0016 0.0033 0.0033 Spain ................ 0.0021 0.0048 0.0048 Switzerland .......... 0.0029 0.0067 0.0067 Taiwan ............... 0.0011 0.0020 0.0020 United Kingdom ....... 0.0000 0.0489 0.0282 ------------------------------------------------------- Total ................ $0.0282 $0.1415 $0.1046 ======================================================= 56 | Annual Report Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- CLASS R FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED COUNTRY PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Belgium .............. $0.0012 $0.0042 $0.0042 Bermuda .............. 0.0000 0.0038 0.0019 Canada ............... 0.0015 0.0056 0.0034 Denmark .............. 0.0020 0.0067 0.0066 France ............... 0.0032 0.0151 0.0113 Germany .............. 0.0007 0.0027 0.0023 Hong Kong ............ 0.0000 0.0062 0.0000 India ................ 0.0000 0.0046 0.0046 Ireland .............. 0.0000 0.0123 0.0123 Italy ................ 0.0007 0.0023 0.0023 Japan ................ 0.0005 0.0035 0.0035 Luxembourg ........... 0.0012 0.0042 0.0042 Mexico ............... 0.0000 0.0010 0.0010 Netherlands .......... 0.0050 0.0166 0.0093 New Zealand .......... 0.0001 0.0007 0.0000 Norway ............... 0.0044 0.0179 0.0179 South Africa ......... 0.0000 0.0039 0.0024 South Korea .......... 0.0016 0.0049 0.0049 Spain ................ 0.0021 0.0070 0.0070 Switzerland .......... 0.0029 0.0099 0.0099 Taiwan ............... 0.0011 0.0029 0.0029 United Kingdom ....... 0.0000 0.0719 0.0414 ------------------------------------------------------- Total ................ $0.0282 $0.2079 $0.1533 ======================================================= Foreign Tax Paid per Share (Column 1) is the amount per share available to you, as a tax credit (assuming you held your shares in the Fund for a minimum of 16 days during the 31-day period beginning 15 days before the ex-dividend date of the Fund's distribution to which the foreign taxes relate), or, as a tax deduction. 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 that have not been adjusted for the rate differential applicable to such dividend income.(1) 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.(1) In January 2006, shareholders will receive Form 1099-DIV which will include their share of taxes paid and foreign source income distributed during the calendar year 2005. The Foreign Source Income reported on Form 1099-DIV has not been adjusted for the rate differential on foreign source qualified dividend income. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their 2005 individual income tax returns. (1) Qualified dividends are taxed at a maximum rate of 15% (5% for those in the 10% and 15% income tax bracket). In determining the amount of foreign tax credit that may be applied against the U.S. tax liability of individuals receiving foreign source qualified dividends, adjustments may be required to the foreign tax credit limitation calculation to reflect the rate differential applicable to such dividend income. The rules however permit certain individuals to elect not to apply the rate differential adjustments for capital gains and/or dividends for any taxable year. Please consult your tax advisor and the instructions to Form 1116 for more information. Annual Report | 57 Mutual Discovery Fund BOARD MEMBERS AND OFFICERS The name, year of birth 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 NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ EDWARD I. ALTMAN, PH.D. (1941) Director Since 1987 7 Director, A.T.D. Inc.(financial technology and investment company). 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, Salomon Center; editor and author of numerous financial publications; financial consultant; and serves on the Investment Advisory Committee of the New York State Common Retirement Fund; and FORMERLY, Vice Director, NYU Salomon Center, Stern School of Business, New York University. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE BATES (1958) Director Since 1994 7 Independent Director, SLM Corporation 101 John F. Kennedy Parkway (Sallie Mae) and Allied Capital Short Hills, NJ 07078-2789 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 (1929) Director Since 2002 13 Director, Fiduciary Emerging Markets 101 John F. Kennedy Parkway Bond Fund PLC and Fiduciary Short Hills, NJ 07078-2789 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 (1930) Director Since 1974 7 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers). - ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (1930) Director Since 1998 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------
58 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (1925) Director Since 1996 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ 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 (1946) Director and Director since 13 Director, El Oro and Exploration Co., 101 John F. Kennedy Parkway Chairman of 1991 and p.l.c., and ARC Wireless Solutions, Short Hills, NJ 07078-2789 the Board Chairman of the Inc. Board since 2005 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. - ------------------------------------------------------------------------------------------------------------------------------------
INTERESTED BOARD MEMBERS AND OFFICERS
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ **WILLIAM J. LIPPMAN (1925) Director Since 1996 14 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024-2920 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Advisory Services, LLC; Director, Templeton Worldwide, Inc.; and officer and/or director or trustee, as the case may be, of five of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ **ANNE M. TATLOCK (1939) Director Since 2002 7 Director, Fortune Brands, Inc. 600 Fifth Avenue, 7th Floor (consumer products) and Merck & Co. New York, NY 10020-2302 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. - ------------------------------------------------------------------------------------------------------------------------------------ PHILIPPE BRUGERE-TRELAT (1949) Vice President Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Mutual Advisers, LLC; Portfolio Manager of Eurovest SA (French registered Investment Company, Sicav); and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 59
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL J. EMBLER (1964) Senior Vice Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President and Chief Investment Officer, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ PETER A. LANGERMAN (1955) President, and Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway Chief Short Hills, NJ 07078-2702 Executive Officer - Investment Management - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (1952) Chief Since 2004 Not Applicable Not Applicable One Franklin Parkway Compliance San Mateo, CA 94403-1906 Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (1947) 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 47 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ DAVID P. GOSS (1947) 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 47 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). - ------------------------------------------------------------------------------------------------------------------------------------
60 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ STEVEN J. GRAY (1955) Secretary Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Resources, Inc.; officer of 33 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chief Legal Counsel, Atlas Advisers, Inc. (until 2000). - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (1947) 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, LLC, 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 47 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 (1937) 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, Franklin Templeton Institutional Suisse S.A., 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 45 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ GREGORY R. SEWARD (1956) Treasurer Since December Not Applicable Not Applicable 500 East Broward Blvd. 2005 Suite 2100 Fort Lauderdale, FL 33394-3091 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 16 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPMorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ------------------------------------------------------------------------------------------------------------------------------------ CRAIG S. TYLE (1960) Vice President Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Partner, Shearman & Sterling, LLP (2004-2005); and General Counsel, Investment Company Institute (ICI) (1997-2004). - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 61
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (1951) Chief Financial Since 2004 Not Applicable Not Applicable 500 East Broward Blvd. Officer and Suite 2100 Chief Fort Lauderdale, FL 33394-3091 Accounting Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Managing Director, RSM McGladrey, Inc. (1999-2004); and Partner, McGladrey & Pullen, LLP (1979-1987 and 1991-2004). - ------------------------------------------------------------------------------------------------------------------------------------
* 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. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE BATES, 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. 62 | 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 U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. 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 | 63 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 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 MidCap Value Fund 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 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(4) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(4) 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(4) Templeton Global Bond Fund Templeton Income Fund TAX-FREE INCOME(5) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(6) 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(7) Colorado Connecticut Florida(7) Georgia Kentucky Louisiana Maryland Massachusetts(6) Michigan(6) Minnesota(6) Missouri New Jersey New York(7) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (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.) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (5.) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (6.) Portfolio of insured municipal securities. (7.) 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). (8.) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 09/05 Not part of the annual report [LOGO](R) FRANKLIN TEMPLETON 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 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 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 & R) 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 A2005 02/06 MUTUAL EUROPEAN FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2005 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 TEMPLETON 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 what we believe are undervalued stocks, as well as arbitrage situations and distressed securities. Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. Templeton pioneered international investing and, with offices in over 25 countries, offers investors a truly global perspective. TRUE DIVERSIFICATION Because these management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why the funds can be used to build truly diversified allocation plans 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, accurate and personal service that has 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 ................ 42 Tax Designation ........................................................ 43 Board Members and Officers ............................................. 47 Shareholder Information ................................................ 52 - -------------------------------------------------------------------------------- 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 at least 80% of its net assets in securities of European companies that the manager believes are available at market prices less than their intrinsic value. The Fund defines European companies as 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 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, 2005. PERFORMANCE OVERVIEW Mutual European Fund - Class Z posted a +18.03% cumulative total return for the 12 months ended December 31, 2005. The Fund outperformed its benchmark, the Morgan Stanley Capital International (MSCI) All Country (AC) Europe Index, which returned +10.71% in U.S. dollars 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 For the year under review, Europe's economic environment remained subdued despite sustained growth in the global economy. Continued high unemployment, rising energy and raw materials prices, and a strong U.S. dollar adversely impacted the region's economy, particularly during the first six months of the year. In the second half, signs of a pick-up in corporate spending became visible, in sharp contrast to consumer confidence, which remained depressed throughout the region. The French and Dutch electorates' rejection in May of the proposed European constitution, and France's racial riots in the fall, (1) Source: Standard & Poor's Micropal. The MSCI AC Europe Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in the European region. 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. 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 deepened an already morose social climate. Despite this uninspiring backdrop, European equities had a good year, driven primarily by a decline in the equity risk premium demanded by investors, strong corporate earnings, ample liquidity, and a reawakened mergers and acquisitions market. Excluding the volatile energy and food sectors, inflation remained relatively subdued worldwide, and monetary policy remained fairly accommodative. The U.S. Federal Reserve Board raised the short-term federal funds target rate with eight quarter-point increases, bringing it to 4.25%. The European Central Bank (ECB) made one quarter-point rise in short-term rates, its first increase after keeping rates at historically low levels for more than two and a half years. Even after the increases, both rates remained at levels considered accommodative for economic growth. Strong demand for oil sustained high prices during most of the year, while prices for other commodities such as industrial metals were also high, led by copper, whose contract price rose 45.4% during 2005.(2) This contributed to economic growth in countries such as Australia and Canada, and emerging markets in Asia and Latin America that are tied to mining and industrial commodities. In this environment, global equity markets performed strongly, particularly outside the U.S. One-year total return for the MSCI AC World ex US Index was +17.11% in U.S. dollar terms.(3) European equity markets returned +25.52%, as measured by the MSCI Europe Index, using the local currencies of this index's constituents.(4) By comparison the total return for the MSCI USA Index was +5.72%.(5) In terms of sectors, energy and materials led equity market performance, and telecommunication services and consumer-related sectors lagged. At the beginning of the year, the consensus of many analysts appeared to be that the U.S. dollar would decline in value relative to major currencies. In fact, for the year the dollar appreciated versus the yen, the euro, the pound and most other currencies. GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/05 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] - ------------------------------------------------ U.K. 15.7% - ------------------------------------------------ France 14.0% - ------------------------------------------------ U.S. 9.9% - ------------------------------------------------ Switzerland 8.4% - ------------------------------------------------ Germany 6.7% - ------------------------------------------------ Netherlands 5.8% - ------------------------------------------------ Norway 4.8% - ------------------------------------------------ Belgium 4.2% - ------------------------------------------------ Ireland 4.2% - ------------------------------------------------ South Africa 3.5% - ------------------------------------------------ Spain 3.5% - ------------------------------------------------ Italy 2.5% - ------------------------------------------------ Denmark 2.5% - ------------------------------------------------ Sweden 1.9% - ------------------------------------------------ Finland 1.7% - ------------------------------------------------ Other 1.5% - ------------------------------------------------ Short-Term Investments & Other Net Assets 9.2% - ------------------------------------------------ (2) Source: New York Mercantile Exchange. (3) Source: Standard & Poor's Micropal. The MSCI AC World ex US Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed and emerging markets excluding the U.S. (4) Source: Standard & Poor's Micropal. The MSCI Europe Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in Europe. (5) Source: Standard & Poor's Micropal. The MSCI USA Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in the U.S. Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/05 - ---------------------------------------------------- % OF TOTAL NET ASSETS - ---------------------------------------------------- Tobacco 11.4% - ---------------------------------------------------- Commercial Banks 11.0% - ---------------------------------------------------- Food Products 10.4% - ---------------------------------------------------- Insurance 5.3% - ---------------------------------------------------- Metals & Mining 5.1% - ---------------------------------------------------- Machinery 5.1% - ---------------------------------------------------- Beverages 4.3% - ---------------------------------------------------- Diversified Telecommunication Services 4.3% - ---------------------------------------------------- Oil, Gas & Consumable Fuels 4.0% - ---------------------------------------------------- Diversified Financial Services 3.4% - ---------------------------------------------------- INVESTMENT STRATEGY We follow a distinctive value 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. In addition, 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. MANAGER'S DISCUSSION While our investment approach contributed to positive Fund performance during the year under review, our equity portfolio was our strongest contributor. Three of the Fund's best performing stock investments included British American Tobacco (BAT), Anglo American and Euronext. London-based BAT was the largest contributor to Fund performance during the year under review. BAT is the world's second-largest cigarette manufacturer behind Philip Morris. With about a 15% global market share, BAT enjoys strong market positions in Europe, North America and several emerging markets. The company's stock appreciated 52% in local currency in 2005 as the company delivered robust operational performance driven by increasing sales volumes and an improving product mix. BAT benefited from an acceleration of its sales in emerging markets, a focused development of its higher-margin global brands, and a further reduction of its cost base. During the year, the company returned most of its free cash flow to shareholders through dividends and share buybacks. This caused a number of analysts to raise their earnings growth projections for BAT. U.K.-headquartered Anglo American is a global mining and natural resources company with substantial interests in platinum, gold, diamonds, base and ferrous metals, coal, industrial minerals, and paper and packaging. The company is geographically diverse with operations in Africa, Europe, the Americas, Australia and Asia. The stock appreciated 66% in local currency during the year. In 2005, Anglo and its peers in the mining sector benefited 6 | Annual Report from a strong commodity cycle and high metal prices driven by sustained world demand, particularly from China. Furthermore, management announced in October that the company would strategically refocus activities on its core mining businesses and return capital to shareholders. This development was positively received by investors and resulted in a reduction of the conglomerate discount traditionally given to Anglo by the markets. Euronext, the Netherlands-based pan-European stock and derivatives exchange, also performed well during the period as investors focused on the company's attractive fundamentals and valuation. Despite uncertainty about a formal bid for the London Stock Exchange, Euronext's share price appreciated 100% in local currency in 2005, reflecting the strength of the company's business model and buoyant trading environment. The market backdrop remained positive for Euronext, and management's focus on value creation continued to be resolute. Although many of our investments performed well in 2005, some of the Fund's securities posted negative performance. Three positions that declined in value during the year included Rio Narcea Gold Mines, a Canada-based mining company with operations in Western Europe as well as other geographic locations; White Mountains Insurance Group, a U.S. insurance company; and NTL, a communication services provider with operations in the U.K. Our investment in Rio Narcea performed poorly and declined 42% in local currency due to a delay in the start-up date of a new nickel mine in Spain. The stock continued to trade at very low valuations. White Mountains' shares weakened 12% largely due to the company's exposure to areas devastated by Hurricane Katrina, which may have caused the largest total insured loss in history. Cable company NTL's shares declined modestly (down 7%) in 2005. However, the company's core consumer business continued to perform solidly. Additionally, in October 2005, the company announced its acquisition of Telewest Communications, the other significant player in the U.K. cable market. We believed that this transaction should generate meaningful cost savings, and that NTL shares remained attractively valued relative to the cash flow generating capacity of the combined businesses. Finally, investors should note that we entered 2005 less than fully hedged in foreign currencies and increased the hedges on foreign currency exposure over the course of the year. TOP 10 HOLDINGS 12/31/05 - -------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------- British American Tobacco PLC 4.5% TOBACCO, U.K. - -------------------------------------------------------- Anglo American PLC, ord. & ADR 3.6% METALS & MINING, SOUTH AFRICA - -------------------------------------------------------- Orkla ASA 3.2% FOOD PRODUCTS, NORWAY - -------------------------------------------------------- Imperial Tobacco Group PLC 2.8% TOBACCO, U.K. - -------------------------------------------------------- Nestle SA 2.8% FOOD PRODUCTS, SWITZERLAND - -------------------------------------------------------- Altadis SA 2.7% TOBACCO, SPAIN - -------------------------------------------------------- Schindler Holding AG, ord. & Reg D 2.7% MACHINERY, SWITZERLAND - -------------------------------------------------------- NTL Inc. 2.4% DIVERSIFIED TELECOMMUNICATION SERVICES, U.K. - -------------------------------------------------------- Allied Irish Banks PLC 2.2% COMMERCIAL BANKS, IRELAND - -------------------------------------------------------- Siemens AG 2.2% INDUSTRIAL CONGLOMERATES, GERMANY - -------------------------------------------------------- Annual Report | 7 Thank you for your continued participation in Mutual European Fund. We look forward to serving your future investment needs. [PHOTO] /s/ Philippe Brugere-Trelat Philippe Brugere-Trelat Portfolio Manager [PHOTO] /s/ Charles M. Lahr Charles M. Lahr, CFA Assistant Portfolio Manager Mutual European Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2005, 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 has been a manager of Mutual European Fund since January 2005 and assumed the duties of lead portfolio manager in May 2005. He has been a member of the management team of the Mutual Series Funds since 2004, when he rejoined Franklin Templeton Investments. Previously, he was president and portfolio manager of Eurovest. Between 1984 and 1994, Mr. Brugere-Trelat was employed at Heine Securities Corporation, the Fund's former manager. CHARLES LAHR is an assistant portfolio manager of Mutual Beacon, Mutual European and Mutual Financial Services Funds. He is also an analyst for Franklin Mutual Advisers specializing in foreign equities and focusing 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. - -------------------------------------------------------------------------------- 8 | Annual Report PERFORMANCE SUMMARY AS OF 12/31/05 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 that a shareholder would pay 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 (SYMBOL: MEURX) CHANGE 12/31/05 12/31/04 - ------------------------------------------------------------------------ Net Asset Value (NAV) +$1.55 $ 21.30 $ 19.75 - ------------------------------------------------------------------------ DISTRIBUTIONS (1/1/05-12/31/05) - ------------------------------------------------------------------------ Dividend Income $0.5525 - ------------------------------------------------------------------------ Short-Term Capital Gain $0.3817 - ------------------------------------------------------------------------ Long-Term Capital Gain $1.0448 - ------------------------------------------------------------------------ TOTAL $1.9790 - ------------------------------------------------------------------------ CLASS A (SYMBOL: TEMIX) CHANGE 12/31/05 12/31/04 - ------------------------------------------------------------------------ Net Asset Value (NAV) +$1.49 $ 20.99 $ 19.50 - ------------------------------------------------------------------------ DISTRIBUTIONS (1/1/05-12/31/05) - ------------------------------------------------------------------------ Dividend Income $0.4882 - ------------------------------------------------------------------------ Short-Term Capital Gain $0.3817 - ------------------------------------------------------------------------ Long-Term Capital Gain $1.0448 - ------------------------------------------------------------------------ TOTAL $1.9147 - ------------------------------------------------------------------------ CLASS B (SYMBOL: TEUBX) CHANGE 12/31/05 12/31/04 - ------------------------------------------------------------------------ Net Asset Value (NAV) +$1.44 $ 20.58 $ 19.14 - ------------------------------------------------------------------------ DISTRIBUTIONS (1/1/05-12/31/05) - ------------------------------------------------------------------------ Dividend Income $0.3456 - ------------------------------------------------------------------------ Short-Term Capital Gain $0.3817 - ------------------------------------------------------------------------ Long-Term Capital Gain $1.0448 - ------------------------------------------------------------------------ TOTAL $1.7721 - ------------------------------------------------------------------------ CLASS C (SYMBOL: TEURX) CHANGE 12/31/05 12/31/04 - ------------------------------------------------------------------------ Net Asset Value (NAV) +$1.48 $ 20.98 $ 19.50 - ------------------------------------------------------------------------ DISTRIBUTIONS (1/1/05-12/31/05) - ------------------------------------------------------------------------ Dividend Income $0.3489 - ------------------------------------------------------------------------ Short-Term Capital Gain $0.3817 - ------------------------------------------------------------------------ Long-Term Capital Gain $1.0448 - ------------------------------------------------------------------------ TOTAL $1.7754 - ------------------------------------------------------------------------ Mutual European Fund paid distributions derived from long-term capital gains of $1.0448 per share in December 2005. The Fund designates such distributions as capital gain dividends per Internal Revenue Code Section 852(b)(3)(C). 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) +18.03% +67.60% +316.36% - --------------------------------------------------------------------------- Average Annual Total Return(3) +18.03% +10.88% +16.21% - --------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,803 $16,760 $41,636 - --------------------------------------------------------------------------- - --------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (11/1/96) - --------------------------------------------------------------------------- Cumulative Total Return(2) +17.56% +64.66% +269.24% - --------------------------------------------------------------------------- Average Annual Total Return(3) +10.80% +9.18% +14.58% - --------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,080 $15,516 $34,809 - --------------------------------------------------------------------------- - --------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - --------------------------------------------------------------------------- Cumulative Total Return(2) +16.87% +59.48% +162.34% - --------------------------------------------------------------------------- Average Annual Total Return(3) +12.87% +9.51% +14.78% - --------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,287 $15,748 $26,234 - --------------------------------------------------------------------------- - --------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (11/1/96) - --------------------------------------------------------------------------- Cumulative Total Return(2) +16.78% +59.40% +249.83% - --------------------------------------------------------------------------- Average Annual Total Return(3) +15.78% +9.77% +14.64% - --------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,578 $15,940 $34,983 - --------------------------------------------------------------------------- PERFORMANCE DATA 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. CLASS Z (7/3/96-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] - -------------------------------------------------------------------------------- DATE MUTUAL EUROPEAN FUND - CLASS Z MSCI AC EUROPE 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 $11,984 $11,468 2/28/1997 $12,236 $11,625 3/31/1997 $12,397 $11,992 4/30/1997 $12,376 $11,926 5/31/1997 $12,537 $12,443 6/30/1997 $12,960 $13,065 7/31/1997 $13,525 $13,668 8/31/1997 $13,282 $12,900 9/30/1997 $14,163 $14,168 10/31/1997 $13,627 $13,472 11/30/1997 $13,768 $13,673 12/31/1997 $14,115 $14,215 1/31/1998 $14,350 $14,726 2/28/1998 $15,134 $15,878 3/31/1998 $16,221 $17,013 4/30/1998 $16,635 $17,381 5/31/1998 $17,218 $17,652 6/30/1998 $16,826 $17,824 7/31/1998 $16,691 $18,208 8/31/1998 $14,792 $15,837 9/30/1998 $13,433 $15,203 10/31/1998 $13,825 $16,423 11/30/1998 $14,723 $17,319 12/31/1998 $14,783 $18,079 1/31/1999 $14,819 $17,989 2/28/1999 $15,007 $17,553 3/31/1999 $15,349 $17,757 4/30/1999 $16,245 $18,310 5/31/1999 $16,281 $17,466 6/30/1999 $16,847 $17,764 7/31/1999 $16,871 $17,958 8/31/1999 $17,026 $18,148 9/30/1999 $17,026 $18,019 10/31/1999 $17,575 $18,671 11/30/1999 $19,054 $19,193 12/31/1999 $21,704 $21,215 1/31/2000 $22,192 $19,731 2/29/2000 $25,032 $20,747 3/31/2000 $24,261 $21,246 4/30/2000 $23,592 $20,318 5/31/2000 $23,631 $20,143 6/30/2000 $23,648 $20,530 7/31/2000 $23,797 $20,206 8/31/2000 $24,393 $19,952 9/30/2000 $23,797 $19,020 10/31/2000 $24,068 $18,867 11/30/2000 $23,973 $18,064 12/31/2000 $24,843 $19,334 1/31/2001 $25,531 $19,364 2/28/2001 $25,387 $17,635 3/31/2001 $24,395 $16,325 4/30/2001 $25,131 $17,519 5/31/2001 $25,563 $16,692 6/30/2001 $25,404 $16,066 7/31/2001 $25,260 $16,085 8/31/2001 $25,019 $15,675 9/30/2001 $22,160 $14,099 10/31/2001 $22,883 $14,567 11/30/2001 $23,365 $15,166 12/31/2001 $23,666 $15,566 1/31/2002 $24,174 $14,780 2/28/2002 $24,535 $14,759 3/31/2002 $25,504 $15,572 4/30/2002 $26,029 $15,481 5/31/2002 $26,177 $15,449 6/30/2002 $25,177 $14,905 7/31/2002 $23,224 $13,255 8/31/2002 $23,257 $13,260 9/30/2002 $21,784 $11,530 10/31/2002 $21,850 $12,645 11/30/2002 $22,065 $13,271 12/31/2002 $21,841 $12,788 1/31/2003 $21,235 $12,187 2/28/2003 $20,578 $11,804 3/31/2003 $20,881 $11,625 4/30/2003 $22,548 $13,220 5/31/2003 $23,979 $14,102 6/30/2003 $24,299 $14,249 7/31/2003 $24,858 $14,532 8/31/2003 $25,383 $14,533 9/30/2003 $25,790 $14,835 10/31/2003 $26,874 $15,812 11/30/2003 $27,857 $16,480 12/31/2003 $29,014 $17,842 1/31/2004 $29,342 $18,058 2/29/2004 $30,310 $18,603 3/31/2004 $30,189 $18,066 4/30/2004 $29,947 $17,901 5/31/2004 $30,034 $18,202 6/30/2004 $30,709 $18,456 7/31/2004 $30,360 $17,953 8/31/2004 $30,447 $17,982 9/30/2004 $31,353 $18,715 10/31/2004 $32,155 $19,399 11/30/2004 $33,863 $20,809 12/31/2004 $35,275 $21,697 1/31/2005 $34,685 $21,311 2/28/2005 $36,454 $22,415 3/31/2005 $35,686 $21,825 4/30/2005 $35,221 $21,295 5/31/2005 $35,793 $21,409 6/30/2005 $36,633 $21,733 7/31/2005 $37,998 $22,556 8/31/2005 $38,627 $22,937 9/30/2005 $39,489 $23,546 10/31/2005 $38,878 $22,775 11/30/2005 $39,991 $23,202 12/31/2005 $41,636 $24,020 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------ CLASS Z 12/31/05 - ------------------------------------------ 1-Year +18.03% - ------------------------------------------ 5-Year +10.88% - ------------------------------------------ Since Inception (7/3/96) +16.21% - ------------------------------------------ CLASS A (11/1/96-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] - -------------------------------------------------------------------------------- DATE MUTUAL EUROPEAN FUND - CLASS A MSCI AC EUROPE 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 $29,662 $20,400 1/31/2005 $29,144 $20,038 2/28/2005 $30,620 $21,076 3/31/2005 $29,966 $20,521 4/30/2005 $29,570 $20,023 5/31/2005 $30,042 $20,130 6/30/2005 $30,733 $20,434 7/31/2005 $31,864 $21,207 8/31/2005 $32,384 $21,566 9/30/2005 $33,102 $22,139 10/31/2005 $32,582 $21,414 11/30/2005 $33,515 $21,815 12/31/2005 $34,869 $22,585 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------ CLASS A 12/31/05 - ------------------------------------------ 1-Year +10.80% - ------------------------------------------ 5-Year +9.18% - ------------------------------------------ Since Inception (11/1/96) +14.58% - ------------------------------------------ Annual Report | 11 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------ CLASS B 12/31/05 - ------------------------------------------ 1-Year +12.87% - ------------------------------------------ 5-Year +9.51% - ------------------------------------------ Since Inception (1/1/99) +14.78% - ------------------------------------------ CLASS B (1/1/99-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] - -------------------------------------------------------------------------------- DATE MUTUAL EUROPEAN FUND - CLASS B MSCI AC EUROPE 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 $22,448 $12,001 1/31/2005 $22,060 $11,788 2/28/2005 $23,163 $12,399 3/31/2005 $22,647 $12,072 4/30/2005 $22,342 $11,779 5/31/2005 $22,682 $11,842 6/30/2005 $23,191 $12,021 7/31/2005 $24,039 $12,476 8/31/2005 $24,416 $12,687 9/30/2005 $24,946 $13,024 10/31/2005 $24,533 $12,598 11/30/2005 $25,216 $12,834 12/31/2005 $26,234 $13,286 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------ CLASS C 12/31/05 - ------------------------------------------ 1-Year +15.78% - ------------------------------------------ 5-Year +9.77% - ------------------------------------------ Since Inception (11/1/96) +14.64% - ------------------------------------------ CLASS C (11/1/96-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] - -------------------------------------------------------------------------------- DATE MUTUAL EUROPEAN FUND - CLASS C MSCI AC EUROPE 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 $30,013 $20,400 1/31/2005 $29,490 $20,038 2/28/2005 $30,952 $21,076 3/31/2005 $30,275 $20,521 4/30/2005 $29,859 $20,023 5/31/2005 $30,321 $20,130 6/30/2005 $31,004 $20,434 7/31/2005 $32,132 $21,207 8/31/2005 $32,627 $21,566 9/30/2005 $33,338 $22,139 10/31/2005 $32,797 $21,414 11/30/2005 $33,709 $21,815 12/31/2005 $35,048 $22,585 12 | Annual Report PERFORMANCE SUMMARY (CONTINUED) ENDNOTES BECAUSE THE FUND INVESTS IN ISSUERS LOCATED IN EUROPE, IT MAY EXPERIENCE GREATER VOLATILITY THAN A MORE GEOGRAPHICALLY DIVERSIFIED FUND. FOREIGN SECURITIES RISKS INCLUDE EXPOSURE TO CURRENCY FLUCTUATIONS AND ECONOMIC AND POLITICAL UNCERTAINTIES. IN ADDITION, THE FUND'S INVESTMENTS IN SMALLER-COMPANY STOCKS CARRY AN INCREASED RISK OF PRICE FLUCTUATION, ESPECIALLY OVER THE SHORT TERM. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, AS WELL AS LOWER-RATED 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 a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in the European region. 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 7/1/05 VALUE 12/31/05 PERIOD* 7/1/05-12/31/05 - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,136.60 $ 5.76 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.81 $ 5.45 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,134.60 $ 7.48 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,018.20 $ 7.07 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,131.20 $11.12 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.77 $10.51 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,130.40 $11.12 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.77 $10.51 - --------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 1.07%; A: 1.39%; B: 2.07%; and C: 2.07%), multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period. Annual Report | 15 MUTUAL EUROPEAN FUND FINANCIAL HIGHLIGHTS
---------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2005 2004 2003 2002 2001 ---------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............. $ 19.75 $ 16.79 $ 12.97 $ 14.43 $ 15.52 ---------------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ..................... 0.42 0.37 0.32 0.27 0.35 Net realized and unrealized gains (losses) ... 3.11 3.21 3.93 (1.38) (1.08) ---------------------------------------------------------------------------------- Total from investment operations ............... 3.53 3.58 4.25 (1.11) (0.73) ---------------------------------------------------------------------------------- Less distributions from: Net investment income ........................ (0.55) (0.60) (0.43) (0.25) (0.32) Net realized gains ........................... (1.43) (0.02) -- (0.10) (0.04) ---------------------------------------------------------------------------------- Total distributions ............................ (1.98) (0.62) (0.43) (0.35) (0.36) ---------------------------------------------------------------------------------- Redemption fees ................................ --(c) --(c) --(c) -- -- ---------------------------------------------------------------------------------- Net asset value, end of year ................... $ 21.30 $ 19.75 $ 16.79 $ 12.97 $ 14.43 ================================================================================== Total return ................................... 18.03% 21.58% 32.84% (7.71)% (4.74)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................ $ 788,228 $ 650,547 $ 498,667 $ 376,828 $ 448,732 Ratios to average net assets:* Expenses(b) .................................. 1.05% 1.07% 1.08% 1.05% 1.05% Net investment income ........................ 1.99% 2.10% 2.19% 1.88% 2.27% Portfolio turnover rate ........................ 29.84% 33.11% 52.33% 29.86% 52.15% * Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ..................................... 1.04% 1.07% 1.08% 1.04% 1.04%
(a) Based on average daily shares outstanding. (b) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (c) Amount is less than $0.01 per share. 16 | See notes to financial statements. | Annual Report MUTUAL EUROPEAN FUND FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2005 2004 2003 2002 2001 ---------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............. $ 19.50 $ 16.59 $ 12.83 $ 14.27 $ 15.36 ---------------------------------------------------------------------------------- Income from investment operations: Net investment income(a)...................... 0.34 0.31 0.26 0.22 0.28 Net realized and unrealized gains (losses) ... 3.07 3.16 3.88 (1.35) (1.06) ---------------------------------------------------------------------------------- Total from investment operations ............... 3.41 3.47 4.14 (1.13) (0.78) ---------------------------------------------------------------------------------- Less distributions from: Net investment income ........................ (0.49) (0.54) (0.38) (0.21) (0.27) Net realized gains ........................... (1.43) (0.02) -- (0.10) (0.04) ---------------------------------------------------------------------------------- Total distributions ............................ (1.92) (0.56) (0.38) (0.31) (0.31) ---------------------------------------------------------------------------------- Redemption fees . ............................. --(d) --(d) --(d) -- -- ---------------------------------------------------------------------------------- Net asset value, end of year ................... $ 20.99 $ 19.50 $ 16.59 $ 12.83 $ 14.27 ================================================================================== Total return(b) ................................ 17.56% 21.23% 32.34% (8.05)% (5.05)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................ $ 707,995 $ 545,120 $ 417,630 $ 302,735 $ 254,632 Ratios to average net assets:* Expenses(c) .................................. 1.38% 1.42% 1.43% 1.40% 1.40% Net investment income ........................ 1.66% 1.75% 1.84% 1.53% 1.88% Portfolio turnover rate ....................... 29.84% 33.11% 52.33% 29.86% 52.15% * Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ..................................... 1.37% 1.42% 1.43% 1.39% 1.39%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the sales commissions or the contingent deferred sales charge. (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 $0.01 per share. Annual Report | See notes to financial statements. | 17 MUTUAL EUROPEAN FUND FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2005 2004 2003 2002 2001 ---------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............. $ 19.14 $ 16.31 $ 12.64 $ 14.09 $ 15.19 ---------------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ..................... 0.21 0.19 0.16 0.10 0.18 Net realized and unrealized gains (losses) ... 3.01 3.10 3.81 (1.31) (1.03) ---------------------------------------------------------------------------------- Total from investment operations ............... 3.22 3.29 3.97 (1.21) (0.85) ---------------------------------------------------------------------------------- Less distributions from: Net investment income ........................ (0.35) (0.44) (0.30) (0.14) (0.21) Net realized gains ........................... (1.43) (0.02) -- (0.10) (0.04) ---------------------------------------------------------------------------------- Total distributions ............................ (1.78) (0.46) (0.30) (0.24) (0.25) ---------------------------------------------------------------------------------- Redemption fees ................................ --(d) --(d) --(d) -- -- ---------------------------------------------------------------------------------- Net asset value, end of year ................... $ 20.58 $ 19.14 $ 16.31 $ 12.64 $ 14.09 ================================================================================== Total return(b) ................................ 16.87% 20.41% 31.45% (8.61)% (5.66)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................ $ 55,303 $ 50,216 $ 38,526 $ 24,855 $ 12,960 Ratios to average net assets:* Expenses(c) .................................. 2.05% 2.07% 2.08% 2.05% 2.03% Net investment income ........................ 0.99% 1.10% 1.19% 0.87% 1.20% Portfolio turnover rate ........................ 29.84% 33.11% 52.33% 29.86% 52.15% * Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ..................................... 2.04% 2.07% 2.08% 2.04% 2.02%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. 18 | See notes to financial statements. | Annual Report MUTUAL EUROPEAN FUND FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2005 2004 2003 2002 2001 ---------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............. $ 19.50 $ 16.60 $ 12.85 $ 14.29 $ 15.37 ---------------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ..................... 0.21 0.20 0.17 0.13 0.19 Net realized and unrealized gains (losses) ... 3.05 3.15 3.87 (1.35) (1.06) ---------------------------------------------------------------------------------- Total from investment operations ............... 3.26 3.35 4.04 (1.22) (0.87) ---------------------------------------------------------------------------------- Less distributions from: Net investment income ........................ (0.35) (0.43) (0.29) (0.12) (0.17) Net realized gains ........................... (1.43) (0.02) -- (0.10) (0.04) ---------------------------------------------------------------------------------- Total distributions ............................ (1.78) (0.45) (0.29) (0.22) (0.21) ---------------------------------------------------------------------------------- Redemption fees ................................ --(d) --(d) --(d) -- -- ---------------------------------------------------------------------------------- Net asset value, end of year ................... $ 20.98 $ 19.50 $ 16.60 $ 12.85 $ 14.29 ================================================================================== Total return(b) ................................ 16.78% 20.43% 31.49% (8.65)% (5.65)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................ $ 242,894 $ 205,197 $ 166,758 $ 123,374 $ 117,238 Ratios to average net assets:* Expenses(c) .................................. 2.05% 2.07% 2.08% 2.02% 2.04% Net investment income ........................ 0.99% 1.10% 1.19% 0.91% 1.27% Portfolio turnover rate ........................ 29.84% 33.11% 52.33% 29.86% 52.15% * Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ..................................... 2.04% 2.07% 2.08% 2.01% 2.03%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. Annual Report | See notes to financial statements. | 19 MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 88.4% BEVERAGES 4.3% Carlsberg AS, A ......................................................... Denmark 28,600 $ 1,429,478 Carlsberg AS, B ......................................................... Denmark 539,506 28,934,362 Diageo PLC .............................................................. United Kingdom 1,356,822 19,666,851 Heineken Holding NV, A .................................................. Netherlands 43,154 1,268,001 Pernod Ricard SA ........................................................ France 152,649 26,637,173 --------------- 77,935,865 --------------- BUILDING PRODUCTS 0.3% Geberit AG .............................................................. Switzerland 7,100 5,620,552 --------------- CHEMICALS 2.9% Givaudan AG ............................................................. Switzerland 32,675 22,148,116 Koninklijke DSM NV ...................................................... Netherlands 58,844 2,403,355 Linde AG ................................................................ Germany 184,723 14,385,055 (a)Sika AG ................................................................. Switzerland 16,481 13,674,055 --------------- 52,610,581 --------------- COMMERCIAL BANKS 11.0% (a)Aareal Bank AG .......................................................... Germany 22,600 856,160 Allied Irish Banks PLC .................................................. Ireland 1,813,400 39,007,240 Banca Intesa SpA ........................................................ Italy 4,272,870 22,636,507 Bank of Ireland ......................................................... Ireland 1,034,775 16,292,745 BNP Paribas SA .......................................................... France 450,100 36,420,358 Danske Bank ............................................................. Denmark 444,900 15,671,707 ForeningsSparbanken AB, A ............................................... Sweden 1,243,700 33,888,497 KBC Bancassurance Holding NV ............................................ Belgium 358,389 33,369,529 --------------- 198,142,743 --------------- COMMERCIAL SERVICES & SUPPLIES 0.5% (a)Techem AG ............................................................... Germany 190,982 8,532,789 --------------- CONSTRUCTION & ENGINEERING 1.1% Imtech NV ............................................................... Netherlands 606,012 19,729,251 --------------- CONSTRUCTION MATERIALS 1.6% Ciments Francais SA ..................................................... France 113,977 14,815,498 Italcementi SpA ......................................................... Italy 722,765 13,493,527 --------------- 28,309,025 --------------- DISTRIBUTORS 1.0% Compania de Distribucion Integral Logista SA ............................ Spain 322,008 15,820,181 Inchcape PLC ............................................................ United Kingdom 61,661 2,419,791 --------------- 18,239,972 ---------------
20 | Annual Report MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) DIVERSIFIED FINANCIAL SERVICES 3.4% Euronext ................................................................ Netherlands 459,879 $ 23,954,822 Fortis Group NV ......................................................... Belgium 1,151,880 36,668,633 (a,b)Marconi Corp., Contingent Distribution .................................. United Kingdom 28,582,000 -- --------------- 60,623,455 --------------- DIVERSIFIED TELECOMMUNICATION SERVICES 4.3% (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 11,264 (a,c,d)AboveNet Inc., wts., 9/08/10 ............................................ United States 3,313 2,650 Belgacom SA ............................................................. Belgium 241,430 7,874,256 Koninklijke KPN NV ...................................................... Netherlands 1,352,764 13,564,448 (a)NTL Inc. ................................................................ United Kingdom 630,105 42,897,549 Telekom Austria AG ...................................................... Austria 236,254 5,314,097 (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 4,742,776 --------------- 76,413,088 --------------- ELECTRIC UTILITIES 1.7% E.ON AG ................................................................. Germany 302,100 31,279,290 --------------- ENERGY EQUIPMENT & SERVICES 0.7% Fugro NV ................................................................ Netherlands 371,192 11,921,889 --------------- FOOD & STAPLES RETAILING 2.5% Bourbon SA .............................................................. France 169,849 14,869,551 Carrefour SA ............................................................ France 553,880 25,953,035 RHM PLC ................................................................. United Kingdom 808,100 3,680,808 --------------- 44,503,394 --------------- FOOD PRODUCTS 10.4% Cadbury Schweppes PLC ................................................... United Kingdom 2,410,112 22,784,891 CSM NV .................................................................. Netherlands 442,856 12,074,055 Groupe Danone ........................................................... France 323,470 33,794,452 Nestle SA ............................................................... Switzerland 166,037 49,668,918 Orkla ASA ............................................................... Norway 1,387,640 57,461,980 Rieber & Son ASA ........................................................ Norway 1,507,950 11,226,515 --------------- 187,010,811 --------------- HEALTH CARE PROVIDERS & SERVICES 1.0% Rhoen-Klinikum AG ....................................................... Germany 455,450 17,410,267 --------------- HOTELS RESTAURANTS & LEISURE 1.7% Hilton Group ............................................................ United Kingdom 4,922,359 30,804,795 ---------------
Annual Report | 21 MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) HOUSEHOLD DURABLES 1.1% Hunter Douglas NV ....................................................... Netherlands 370,265 $ 20,154,792 --------------- INDUSTRIAL CONGLOMERATES 2.2% Siemens AG .............................................................. Germany 452,472 38,765,641 --------------- INSURANCE 5.3% (a)Berkshire Hathaway Inc., A .............................................. United States 203 17,989,860 Catlin Group ............................................................ United Kingdom 490,821 4,099,722 (a)CNP Assurances .......................................................... France 244,200 19,253,805 Irish Life & Permanent PLC .............................................. Ireland 1,045,905 21,247,420 (a,c)Olympus Re Holdings Ltd. ................................................ Bermuda 16,080 297,480 White Mountains Insurance Group Inc. .................................... United States 58,172 32,491,971 --------------- 95,380,258 --------------- MACHINERY 4.5% (a)Kone OYJ ................................................................ Finland 579,380 22,998,194 Metso OYJ ............................................................... Finland 344,623 9,432,542 Schindler Holding AG .................................................... Switzerland 73,082 28,982,472 Schindler Holding AG, Reg D ............................................. Switzerland 49,081 19,408,243 --------------- 80,821,451 --------------- MEDIA 2.5% Hollinger International Inc. ............................................ United States 215,694 1,835,987 (a)JC Decaux SA ............................................................ France 619,833 14,455,649 Pearson PLC ............................................................. United Kingdom 759,700 8,985,803 (c)Time Warner Inc. ........................................................ United States 1,183,200 20,222,308 --------------- 45,499,747 --------------- METALS & MINING 5.1% (a)African Platinum PLC .................................................... United Kingdom 2,631,000 1,007,147 Anglo American PLC ...................................................... South Africa 1,919,281 65,347,112 Anglo American PLC, ADR ................................................. South Africa 200 6,956 Highland Gold Mining Ltd. ............................................... United Kingdom 1,567,170 6,619,263 (a,e,f)International Metal Enterprises Inc., 144A .............................. United States 2,050,000 10,762,500 (a,e,f)International Metal Enterprises Inc., wts., 144A, 10/03/06 .............. United States 4,100,000 2,255,000 (a)Rio Narcea Gold Mines Ltd. .............................................. Canada 4,430,100 6,098,391 --------------- 92,096,369 --------------- MULTI-UTILITIES & UNREGULATED POWER 1.1% Suez SA ................................................................. France 621,656 19,355,418 --------------- MULTILINE RETAIL 0.7% Jelmoli Holding AG ...................................................... Switzerland 8,844 12,622,265 --------------- OIL, GAS & CONSUMABLE FUELS 4.0% BP PLC .................................................................. United Kingdom 747,800 7,963,760 Eni SpA ................................................................. Italy 361,200 10,018,823 (a,c,e)Euro Wagon LP ........................................................... Jersey Islands 14,000,000 16,573,900 Norsk Hydro ASA ......................................................... Norway 88,200 9,055,737 Royal Dutch Shell PLC, A ................................................ United Kingdom 222,837 6,800,908 Statoil ASA ............................................................. Norway 327,362 7,517,647 Total SA, B ............................................................. France 53,750 13,502,697 --------------- 71,433,472 ---------------
22 | Annual Report MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES/WARRANTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) PHARMACEUTICALS 1.3% Sanofi-Aventis .......................................................... France 269,626 $ 23,620,559 --------------- REAL ESTATE 0.1% Canary Wharf Group PLC .................................................. United Kingdom 192,100 793,196 (a,c)Security Capital European Realty ........................................ Luxembourg 5,281 38,380 --------------- 831,576 --------------- THRIFTS & MORTGAGE FINANCE 0.7% Sovereign Bancorp Inc. .................................................. United States 593,900 12,840,118 --------------- TOBACCO 11.4% Altadis SA .............................................................. Spain 1,086,551 49,291,530 British American Tobacco PLC ............................................ United Kingdom 3,627,758 81,137,888 Gallaher Group PLC ...................................................... United Kingdom 1,487,125 22,451,049 Imperial Tobacco Group PLC .............................................. United Kingdom 1,706,404 50,994,545 --------------- 203,875,012 --------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $1,112,363,807) ................................................ 1,586,384,445 --------------- PREFERRED STOCKS 0.6% DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(g) PTV Inc., 10.00%, pfd., A ............................................... United Kingdom 46,841 98,366 --------------- MACHINERY 0.6% Jungheinrich AG, pfd. ................................................... Germany 452,549 10,500,703 --------------- TOTAL PREFERRED STOCKS (COST $9,849,000) ................................ 10,599,069 --------------- ------------------- PRINCIPAL AMOUNT(j) ------------------- CORPORATE BONDS & NOTES 1.8% Eurotunnel PLC, Participating Loan Note, 1.00%, 4/30/40 ........................... United Kingdom 210,000 GBP 34,323 (f,h)Senior Tranche G2 Term Loan A, 144A, FRN, 5.618%, 12/15/12 .......................................................... United Kingdom 380,300 GBP 629,751 (h)Tier 2, FRN, 5.796%, 12/31/18 ..................................... United Kingdom 7,595,283 GBP 11,107,208 (h)Tier 3, FRN, 5.796%, 12/31/25 ..................................... United Kingdom 14,544,322 GBP 11,760,706 Eurotunnel SA, Senior Tranche H1 Term Loan (KfW Advance), 8.78%, 12/15/12 ........ France 163,300 EUR 183,657 (h)Tier 2 (LIBOR), FRN, 3.393%, 12/31/18 ............................. France 988,713 EUR 994,915 (h)Tier 2 (PIBOR), FRN, 3.393%, 12/31/18 ............................. France 437,395 EUR 440,138 (h)Tier 3 (LIBOR), FRN, 3.393%, 12/31/25 ............................. France 8,732,014 EUR 4,858,576 (h)Tier 3 (PIBOR), FRN, 3.393%, 12/31/25 ............................. France 5,798,977 EUR 3,226,606 --------------- TOTAL CORPORATE BONDS & NOTES (COST $35,960,040) ........................ 33,235,880 --------------- GOVERNMENT AGENCIES 4.5% (i)Federal Home Loan Bank, 1/03/06-12/01/06 ................................ United States 79,305,000 78,456,980 Government of Norway, 6.75%, 1/15/07 .................................... Norway 13,450,000 NOK 2,071,475 --------------- TOTAL GOVERNMENT AGENCIES (COST $80,471,021) ............................ 80,528,455 ---------------
Annual Report | 23 MUTUAL EUROPEAN FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- VALUE - ----------------------------------------------------------------------------------------------------------------------------------- TOTAL INVESTMENTS (COST $1,238,643,868) 95.3% ........................... $ 1,710,747,849 NET UNREALIZED GAIN ON FORWARD EXCHANGE CONTRACTS 1.8% .................. 32,493,149 OTHER ASSETS, LESS LIABILITIES 2.9% ..................................... 51,177,794 --------------- NET ASSETS 100.0% ....................................................... $ 1,794,418,792 ===============
CURRENCY ABBREVIATIONS EUR - Euro GBP - British Pound NOK - Norwegian Krone SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FRN - Floating Rate Note LIBOR - London InterBank Offered Rate PIBOR - Paris InterBank Offered Rate (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 and illiquid securities. (d) See Note 12 regarding other considerations. (e) See Note 11 regarding holdings of 5% voting securities. (f) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. These securities have been deemed liquid under guidelines approved by the Fund's Board of Directors. At December 31, 2005, the aggreggate value of these securities was $13,647,251, representing 0.76% of net assets. (g) Rounds to less than 0.05% of net assets. (h) The coupon shown represents the rate at period end. (i) The security is traded on a discount basis with no stated coupon rate. (j) 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, 2005 Assets: Investments in securities: Cost - Unaffiliated issuers ................................................................................. $ 1,209,797,947 Cost - Non-controlled affiliated issuers (Note 11) .......................................................... 28,845,921 --------------- Total cost of investments ................................................................................... $ 1,238,643,868 =============== Value - Unaffiliated issuers ................................................................................ $ 1,681,156,449 Value - Non-controlled affiliated issuers (Note 11) ......................................................... 29,591,400 --------------- Total value of investments .................................................................................. 1,710,747,849 Cash .......................................................................................................... 37,590 Foreign currency, at value (cost $42,624,601) ................................................................. 42,251,875 Receivables: Investment securities sold .................................................................................. 2,317,839 Capital shares sold ......................................................................................... 4,362,352 Dividends and interest ...................................................................................... 3,480,734 Unrealized gain on forward exchange contracts (Note 8) ........................................................ 33,817,447 Cash on deposits with brokers for securities sold short ....................................................... 181,712 Due from broker - synthetic equity swaps ...................................................................... 4,298,416 --------------- Total assets .............................................................................................. 1,801,495,814 --------------- Liabilities: Payables: Investment securities purchased ............................................................................. 316,650 Capital shares redeemed ..................................................................................... 2,752,156 Affiliates .................................................................................................. 2,428,066 Unrealized loss on forward exchange contracts (Note 8) ........................................................ 1,324,298 Accrued expenses and other liabilities ........................................................................ 255,852 --------------- Total liabilities ......................................................................................... 7,077,022 --------------- Net assets, at value .................................................................................... $ 1,794,418,792 =============== Net assets consist of: Paid-in capital ............................................................................................... $ 1,284,572,375 Undistributed net investment income ........................................................................... 249,169 Net unrealized appreciation (depreciation) .................................................................... 507,331,518 Accumulated net realized gain (loss) .......................................................................... 2,265,730 --------------- Net assets, at value .................................................................................... $ 1,794,418,792 ===============
Annual Report | See notes to financial statements. | 25 MUTUAL EUROPEAN FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2005 CLASS Z: Net assets, at value .......................................................................................... $ 788,227,627 =============== Shares outstanding ............................................................................................ 37,014,289 =============== Net asset value and maximum offering price per share(a) ....................................................... $ 21.30 =============== CLASS A: Net assets, at value .......................................................................................... $ 707,994,832 =============== Shares outstanding ............................................................................................ 33,727,052 =============== Net asset value per share(a) .................................................................................. $ 20.99 =============== Maximum offering price per share (net asset value per share / 94.25%) ......................................... $ 22.27 =============== CLASS B: Net assets, at value .......................................................................................... $ 55,302,640 =============== Shares outstanding ............................................................................................ 2,687,790 =============== Net asset value and maximum offering price per share(a) ....................................................... $ 20.58 =============== CLASS C: Net assets, at value .......................................................................................... $ 242,893,693 =============== Shares outstanding ............................................................................................ 11,574,915 =============== Net asset value and maximum offering price per share(a) ....................................................... $ 20.98 ===============
(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, 2005 Investment income: Dividends (net of foreign taxes of $3,699,272) ........... $ 35,473,490 Interest ................................................. 12,951,067 Other income (Note 13) ................................... 17,202 --------------- Total investment income ............................ 48,441,759 --------------- Expenses: Management fees (Note 3a) ................................ 12,548,913 Administrative fees (Note 3b) ............................ 1,222,491 Distribution fees (Note 3c) Class A ............................................... 2,017,925 Class B ............................................... 518,007 Class C ............................................... 2,188,839 Transfer agent fees (Note 3e) ............................ 1,992,500 Custodian fees (Note 4) .................................. 385,660 Reports to shareholders .................................. 157,500 Registration and filing fees ............................. 63,950 Professional fees ........................................ 187,631 Directors' fees and expenses ............................. 41,400 Dividends on securities sold short ....................... 134,922 Other .................................................... 48,074 --------------- Total expenses ..................................... 21,507,812 Expense reductions (Note 4) ........................ (2,457) --------------- Net expenses .................................... 21,505,355 --------------- Net investment income ........................ 26,936,404 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments ........................................... 108,312,499 Written options ....................................... 7,955 Foreign currency transactions ......................... 21,574,619 --------------- Net realized gain (loss) ........................ 129,895,073 --------------- Net change in unrealized appreciation (depreciation) on: Investments ........................................... 55,835,340 Translation of assets and liabilities denominated in foreign currencies ................................. 53,466,055 --------------- Net change in unrealized appreciation (depreciation) ............................... 109,301,395 --------------- Net realized and unrealized gain (loss) ..................... 239,196,468 --------------- Net increase (decrease) in net assets resulting from operations .......................................... $ 266,132,872 =============== Annual Report | See notes to financial statements. | 27 MUTUAL EUROPEAN FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
------------------------------------ YEAR ENDED DECEMBER 31, ------------------------------------ 2005 2004 ------------------------------------ Increase (decrease) in net assets: Operations: Net investment income ................................ $ 26,936,404 $ 21,993,224 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transaction ............................... 129,895,073 50,281,482 Net change in unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ...... 109,301,395 175,300,161 ------------------------------------ Net increase (decrease) in net assets resulting from operations ................................ 266,132,872 247,574,867 ------------------------------------ Distributions to shareholders from: Net investment income: Class Z ............................................ (18,812,712) (19,099,453) Class A ............................................ (15,200,452) (14,530,645) Class B ............................................ (869,707) (1,110,260) Class C ............................................ (3,747,958) (4,388,373) Net realized gains: Class Z ............................................ (48,659,125) (737,739) Class A ............................................ (45,158,712) (624,939) Class B ............................................ (3,565,400) (59,493) Class C ............................................ (15,354,401) (236,978) ------------------------------------ Total distributions to shareholders ..................... (151,368,467) (40,787,880) ------------------------------------ Capital share transactions: (Note 2) Class Z ............................................ 84,943,484 58,975,823 Class A ............................................ 120,359,620 50,452,466 Class B ............................................ 1,351,079 4,515,208 Class C ............................................ 21,918,475 8,767,698 ------------------------------------ Total capital share transactions ........................ 228,572,658 122,711,195 ------------------------------------ Redemption fees ......................................... 1,678 787 ------------------------------------ Net increase (decrease) in net assets ............ 343,338,741 329,498,969 Net assets: Beginning of year ....................................... 1,451,080,051 1,121,581,082 ------------------------------------ End of year ............................................. $ 1,794,418,792 $ 1,451,080,051 ==================================== Undistributed net investment income/distributions in excess of net investment included in net assets: End of year ............................................. $ 249,169 $ (7,485,194) ====================================
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 six separate series. The Series Fund 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 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 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. 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 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. 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. 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. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. 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 | 29 MUTUAL EUROPEAN 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. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in foreign exchange rates on foreign denominated assets and liabilities other than investments in securities held at the end of the reporting period. C. FOREIGN CURRENCY CONTRACTS The Fund may enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates. A forward exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. These contracts are valued daily by the Fund and the net unrealized gain or loss on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, 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, which may be in excess of the amount reflected in the Statement of Assets and Liabilities. 30 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. SYNTHETIC EQUITY SWAPS The Fund may engage in synthetic equity swaps. Synthetic equity swaps are contracts entered into between a broker and the Fund under which the parties agree to make payments to each other so as to replicate the economic consequences that would apply had a purchase or sale of the underlying security taken place. Upon entering into synthetic equity swaps, the Fund is required to pledge 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. E. OPTIONS 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. F. SECURITIES SOLD SHORT The Fund is engaged in selling securities short, which obligates the Fund to replace a borrowed security with the same security at current market value. The Fund 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 | 31 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) F. 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 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. G. INCOME TAXES No provision has been made for U.S. income taxes because the Fund's policy is to continue to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. Foreign securities held by the Fund may be subject to foreign taxation. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. H. 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. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with generally accepted accounting principles. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. 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 of the Series Fund. Fund specific expenses are charged directly to the fund that incurred the expense. 32 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) I. 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. J. REDEMPTION FEES A short term trading redemption fee will be imposed, with some exceptions, on any Fund shares that are redeemed or exchanged within seven calendar days following their purchase date (30 days or less prior to June 1, 2004). The redemption fee is 2% of the amount redeemed. Such fees are retained by the Fund and accounted for as an addition to paid-in capital. K. GUARANTEES AND INDEMNIFICATIONS Under the Series Fund's organizational documents, its officers and directors are indemnified by the Fund against certain liabilities 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 are only offered to existing Class B shareholders in the form of reinvested distributions and certain exchanges from other Franklin Templeton Class B shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. Annual Report | 33 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED) At December 31, 2005, there were 500 million shares authorized ($0.001 par value) of which 200 million shares were designated as Class Z, 100 million shares as Class A, 100 million shares as Class B and 100 million shares as Class C. Transactions in the Fund's shares were as follows:
------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2005 2004 ------------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ------------------------------------------------------------------------- CLASS Z SHARES: Shares sold ................. 5,377,432 $ 112,505,328 5,037,189 $ 89,701,240 Shares issued in reinvestment of distributions ........... 2,984,092 63,192,364 985,268 18,482,745 Shares redeemed ............. (4,294,224) (90,754,208) (2,784,547) (49,208,162) ------------------------------------------------------------------------- Net increase (decrease) ..... 4,067,300 $ 84,943,484 3,237,910 $ 58,975,823 ========================================================================= CLASS A SHARES: Shares sold ................. 9,974,175 $ 205,918,108 7,412,359 $ 130,660,983 Shares issued in reinvestment of distributions ........... 2,152,673 44,944,939 644,632 11,925,302 Shares redeemed ............. (6,359,520) (130,503,427) (5,274,697) (92,133,819) ------------------------------------------------------------------------- Net increase (decrease) ..... 5,767,328 $ 120,359,620 2,782,294 $ 50,452,466 ========================================================================= CLASS B SHARES: Shares sold ................. 177,278 $ 3,527,919 470,582 $ 8,073,637 Shares issued in reinvestment of distributions ........... 196,622 4,024,563 57,630 1,042,916 Shares redeemed ............. (309,160) (6,201,403) (267,734) (4,601,345) ------------------------------------------------------------------------- Net increase (decrease) ..... 64,740 $ 1,351,079 260,478 $ 4,515,208 ========================================================================= CLASS C SHARES: Shares sold ................. 1,782,398 $ 36,506,909 1,880,792 $ 33,100,927 Shares issued in reinvestment of distributions ........... 823,947 17,201,713 224,707 4,138,711 Shares redeemed ............. (1,554,721) (31,790,147) (1,629,046) (28,471,940) ------------------------------------------------------------------------- Net increase (decrease) ..... 1,051,624 $ 21,918,475 476,453 $ 8,767,698 =========================================================================
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and directors of the Series Fund are also officers and/or directors of the following subsidiaries:
- -------------------------------------------------------------------------------------- SUBSIDIARY 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
34 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) A. MANAGEMENT FEES 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% Up to and including $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% In excess of $5 billion 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 of the Fund as follows: - -------------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - -------------------------------------------------------------------------------- 0.150% Up to and including $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% In excess of $1.2 billion C. DISTRIBUTION FEES The Fund's Board of Directors has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors up to 0.35% per year of Class A's average daily net assets for costs incurred in connection with the sale and distribution of the Fund's shares. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. Under the Fund's compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the sale and distribution of the Fund's shares up to a certain percentage per year of its average daily net assets of each class as follows: Class B ........................................................... 1.00% Class C ........................................................... 1.00% Annual Report | 35 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) 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(a) .............................. $ 198,243 Contingent deferred sales charges retained ................. $ 87,504 (a) Net of commissions paid to unaffiliated broker/dealers. E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $1,992,500, of which $1,233,362 was retained by 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, 2005, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES For tax purposes, realized currency losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2005, the Fund deferred realized currency losses of $108,521. Net investment income differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares and bond discounts and premiums. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions and bond discounts and premiums. 36 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) At December 31, 2005, 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 ........................................ $ 1,240,752,333 ---------------- Unrealized appreciation .................................... $ 491,537,033 Unrealized depreciation .................................... (21,541,517) ---------------- Net unrealized appreciation (depreciation) ................. $ 469,995,516 ================ Undistributed ordinary income .............................. $ 15,023,830 Undistributed long term capital gains ...................... 16,086,535 ---------------- Distributable earnings ..................................... $ 31,110,365 ================ The tax character of distributions paid during the years ended December 31, 2005and 2004, were as follows: --------------------------------- 2005 2004 --------------------------------- Distributions paid from: Ordinary income ........................ $ 68,796,936 $ 39,137,765 Long term capital gain ................. 82,571,531 1,650,115 --------------------------------- $ 151,368,467 $ 40,787,880 ================================= 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the year ended December 31, 2005, aggregated $570,815,722 and $437,722,940, respectively. Transactions in options written during the year ended December 31, 2005, were as follows: ----------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED ----------------------------- Options outstanding at December 31, 2004 .. -- $ -- Options written ........................... 25,380 7,955 Options expired ........................... (25,380) (7,955) Options exercised ......................... -- -- Options closed ............................ -- -- ----------------------------- Options outstanding at December 31, 2005 .. -- $ -- ============================= Annual Report | 37 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. SYNTHETIC EQUITY SWAPS As of December 31, 2005, the Fund had the following synthetic equity swaps outstanding:
- ------------------------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - ------------------------------------------------------------------------------------------------- O2 PLC (1.9550 - 1.9715 GBP) .......................... 3,686,887 $12,559,347 $ 90,697 AAReal Bank AG (23.48 - 25.89 EUR) .................... 284,453 10,775,990 2,510,575 Christian Dior SA (46.76 - 54.99 EUR) ................. 38,450 3,418,479 1,204,287 ------------- Total contracts to buy ................................ 3,805,559 -------------
- ------------------------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - ------------------------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (54.61 - 61.76 EUR) .. 39,268 $ 3,488,881 $ (777,748) ------------- Total contacts to sell ................................ (777,748) ============= Net unrealized gain (loss) ............................ $ 3,027,811 =============
8. FORWARD EXCHANGE CONTRACTS At December 31, 2005, the Fund had outstanding forward exchange contracts as set out below.
- -------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO BUY AMOUNT(a) DATE GAIN (LOSS) - -------------------------------------------------------------------------------------- 700,000 Canadian Dollar ....... 593,623 1/23/06 $ 9,069 -------------
- -------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - -------------------------------------------------------------------------------------- 4,250,000 Euro .................. 5,038,927 1/17/06 $ 2,430 66,195,000 Euro .................. 81,868,284 1/23/06 3,396,662 29,314,577 Swiss Franc ........... 23,525,000 2/02/06 1,132,321 20,075,000 British Pound ......... 36,027,236 2/15/06 1,493,669 57,694 Canadian Dollar ....... 50,000 2/15/06 293 18,450,000 Euro .................. 22,435,227 2/27/06 521,688 37,398,338 Norwegian Krone ....... 5,565,229 3/06/06 3,956 9,407,173 Euro .................. 11,238,471 3/15/06 55,114 230,009,152 Swedish Krona ......... 29,443,321 3/15/06 336,528 286,255,419 Danish Krone .......... 51,729,476 3/17/06 6,114,669 1,750,000 Euro .................. 13,553,575 DKK 3/17/06 79,104 18,356,107 British Pound ......... 33,063,019 3/21/06 1,483,516 24,175,000 British Pound ......... 42,589,916 4/04/06 995,987 79,025,000 Euro .................. 98,932,212 4/25/06 4,766,748 41,893,120 Norwegian Krone ....... 6,512,221 5/08/06 260,147 15,500,000 British Pound ......... 27,011,850 5/15/06 331,490 43,964,938 Euro .................. 54,872,996 5/23/06 2,401,390 11,123,440 Norwegian Krone ....... 1,700,000 6/06/06 37,254 8,708,108 Swiss Franc ........... 6,800,000 6/06/06 68,689 16,770,000 Euro .................. 20,369,569 6/15/06 328,579 23,200,000 Euro .................. 27,785,160 7/17/06 11,046 18,464,746 British Pound ......... 32,226,147 8/14/06 406,125 94,043,121 Euro .................. 117,383,208 8/23/06 4,573,518 37,773,470 British Pound ......... 65,778,043 9/08/06 660,755
38 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- -------------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - -------------------------------------------------------------------------------------------------- 64,797,282 Euro ............................... 81,065,087 9/13/06 $ 3,249,051 40,758,240 Euro ............................... 50,133,336 10/18/06 1,097,649 ------------- 33,808,378 ------------- Unrealized gain on forward exchange contracts .......................... $ 33,817,447 =============
- -------------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - -------------------------------------------------------------------------------------------------- 6,284,233 Canadian Dollar .................... 5,309,416 1/23/06 $ (101,235) 136,337,740 Norwegian Krone .................... 20,228,151 2/06/06 (14,476) 813,641 Canadian Dollar .................... 699,000 2/15/06 (2,003) 117,000,000 Norwegian Krone .................... 17,378,647 3/06/06 (19,692) 38,750,000 Euro ............................... 45,655,250 3/15/06 (411,198) 3,150,000 Euro ............................... 23,460,360 DKK 3/17/06 (6,778) 126,000,000 Norwegian Krone .................... 18,791,946 6/06/06 (42,697) 103,722,044 Swiss Franc ........................ 79,970,736 6/06/06 (205,740) 58,214,751 Euro ............................... 69,171,896 7/17/06 (520,479) ------------- Unrealized loss on forward exchange contracts .................................. (1,324,298) ------------- Net unrealized gain on forward exchange contracts ....................... $ 32,493,149 =============
(a) In U.S. Dollar unless other wise indicated. CURRENCY ABBREVIATIONS DKK - Danish Krone 9. CONCENTRATION OF RISK Investing in foreign securities may include certain risks and considerations not typically associated with investing in U.S. securities, such as fluctuating currency values and changing local and regional economic, political and social conditions, which may result in greater market volatility. In addition, certain foreign securities may not be as liquid as U.S. securities. 10. RESTRICTED AND ILLIQUID SECURITIES At December 31, 2005, investments in securities included issues that are restricted and illiquid. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration under the Securities Act of 1933, unless the sale is pursuant to an exemption under the 1933 Act. The Fund has registration rights for all restricted securities held at period end. The issuer generally incurs all registration costs. Annual Report | 39 MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. RESTRICTED AND ILLIQUID SECURITIES (CONTINUED) A security may 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, 2005, the Fund held investments in restricted and illiquid securities, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- --------------------------------------------------------------------------------------------- SHARES AND ACQUISITION WARRANTS ISSUER DATE COST VALUE - --------------------------------------------------------------------------------------------- 83,713 AboveNet Inc. ..................... 10/02/01 $ 4,201,546 $ 2,006,048 2,816 AboveNet Inc., wts., 9/08/08 ...... 10/02/01 348,479 11,264 3,313 AboveNet Inc., wts., 9/08/10 ...... 10/02/01 373,672 2,650 14,000,000 Euro Wagon LP ..................... 12/08/05 16,545,921 16,573,900 16,080 Olympus Re Holdings Ltd. .......... 12/19/01 1,608,000 297,480 1,183,200 Time Warner Inc. .................. 8/02/05 20,436,258 20,222,308 5,281 Security Capital European Realty .. 4/08/98 289,278 38,380 ------------- TOTAL RESTRICTED AND ILLIQUID SECURITIES (2.18% of Net Assets) ........................ $ 39,152,030 =============
11. HOLDINGS OF 5% VOTING SECURITIES 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 securiites. Investments in "affiliated companies" for the Fund at December 31, 2005 were as shown below.
- ----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF SHARES/ NUMBER OF SHARES/ WARRANTS HELD WARRANTS HELD VALUE REALIZED AT BEGINNING GROSS GROSS AT END AT END INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS OF YEAR OF YEAR INCOME GAIN (LOSS) - ----------------------------------------------------------------------------------------------------------------------------------- NON-CONTROLLED AFFILIATES Euro Wagon LP ................. -- 14,000,000 -- 14,000,000 $16,573,900 $ -- $ -- International Metal Enterprises Inc., 144A ...... -- 2,050,000 -- 2,050,000 10,762,500 -- -- International Metal Enterprises Inc., wts., 144A, 10/03/06 .. -- 4,100,000 -- 4,100,000 2,255,000 -- -- ------------------------------------ TOTAL AFFILIATED SECURITIES (1.65% of Net Assets) ....... $29,591,400 $ -- $ -- ====================================
12. OTHER CONSIDERATIONS Directors or employees of Franklin Mutual, as the Fund's Investment Manager, may serve as members 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, 2005, such individuals serve in one or more of these capacities for AboveNet Inc. As a result of this involvement, such individuals 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. 40 | Annual Report MUTUAL EUROPEAN FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, 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 (collectively, the "Company"), entered into settlements with certain of those regulators. Specifically, the Company entered into settlements with the Securities and Exchange Commission ("SEC") concerning market timing (the "August 2, 2004 SEC Order") and marketing support payments to securities dealers who sell fund shares (the "December 13, 2004 SEC Order") and with the California Attorney General's Office ("CAGO") concerning marketing support payments to securities dealers who sell fund shares (the "CAGO Settlement"). Under the terms of the settlements with the SEC and the CAGO, the Company retained an Independent Distribution Consultant ("IDC") to develop a plan for distribution of the respective settlement monies. The CAGO approved the distribution plan under the CAGO Settlement and, in accordance with the terms and conditions of that settlement, the monies were disbursed to the relevant funds and are recorded as other income in the current period. The SEC has not yet approved the distribution plan pertaining to the December 13, 2004 SEC Order. When approved, disbursements of settlement monies will be made promptly to the relevant funds, in accordance with the terms and conditions of that order. The IDC continues to develop the plan of distribution under the August 2, 2004 SEC Order that resolved the SEC's market timing investigation. In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, directors, and/or employees, have been named in private lawsuits (styled as shareholder class actions, or as derivative actions on behalf of either the named funds or Franklin Resources, Inc.) relating to the industry practices referenced above, as well as to allegedly excessive advisory fees, commissions, and/or 12b-1 fees. The lawsuits were filed in different courts throughout the country. Many of those suits are now pending in a multi-district litigation in the United States District Court for the District of Maryland. The Company and fund management strongly believe that the claims made in each of the private lawsuits referenced above are without merit and intend to defend against them vigorously. The Company cannot predict with certainty the eventual outcome of these lawsuits, nor whether they will have a material negative impact on the Company. 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. Annual Report | 41 MUTUAL EUROPEAN FUND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF THE MUTUAL EUROPEAN FUND: We have audited the accompanying statement of assets and liabilities of the Mutual European Fund (one of the portfolio constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2005, 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. We were not engaged to perform an audit of the Fund's internal control over financial reporting. Our audits included 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, and evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2005, by correspondence with the custodian and brokers, or by other appropriate auditing procedures where replies from the 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 European Fund of the Franklin Mutual Series Fund Inc. at December 31, 2005, 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 10, 2006 42 | Annual Report MUTUAL EUROPEAN FUND TAX DESIGNATION (UNAUDITED) Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund designates the maximum amount allowable but no less than $98,658,066 as a capital gain dividend for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $35,228,828 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2005. In January 2006, shareholders will receive Form 1099 DIV which will include their share of qualified dividends distributed during the calendar year 2005. 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 871(k)(1)(C) of the Code, the Fund designates the maximum amount allowable but no less than $2,184,797 as interest-related dividends for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section (k)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $43,789,349 as a short-term capital gain dividend for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates 1.23% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2005. At December 31, 2005, more than 50% of the 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 designates to shareholders the foreign source income and foreign taxes paid as allowed, pursuant to Section 853 of the Code. This designation will allow shareholders of record on December 22, 2005, 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, and foreign qualified dividends as designated by the Fund, to Class Z, Class A, Class B and C shareholders of record. Annual Report | 43 MUTUAL EUROPEAN FUND TAX DESIGNATION (UNAUDITED) (CONTINUED) RECORD DATE: 12/22/2005 - -------------------------------------------------------------------------------- CLASS Z FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED COUNTRY PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Austria ............... $0.0004 $0.0019 $0.0019 Belgium ............... 0.0031 0.0165 0.0165 Bermuda ............... 0.0000 0.0053 0.0024 Denmark ............... 0.0024 0.0131 0.0129 Finland ............... 0.0014 0.0075 0.0075 France ................ 0.0049 0.0369 0.0255 Germany ............... 0.0019 0.0198 0.0081 Ireland ............... 0.0000 0.0296 0.0292 Italy ................. 0.0016 0.0088 0.0088 Luxembourg ............ 0.0013 0.0071 0.0071 Netherlands ........... 0.0120 0.0626 0.0460 Norway ................ 0.0069 0.0369 0.0369 Poland ................ 0.0018 0.0098 0.0003 South Africa .......... 0.0000 0.0056 0.0056 Spain ................. 0.0030 0.0159 0.0159 Switzerland ........... 0.0061 0.0326 0.0317 United Kingdom ........ 0.0000 0.1845 0.0885 ------------------------------------------------------- TOTAL ................. $0.0468 $0.4944 $0.3448 ======================================================= - -------------------------------------------------------------------------------- CLASS A FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED COUNTRY PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Austria ............... $0.0004 $0.0017 $0.0017 Belgium ............... 0.0031 0.0153 0.0153 Bermuda ............... 0.0000 0.0049 0.0023 Denmark ............... 0.0024 0.0122 0.0120 Finland ............... 0.0014 0.0069 0.0069 France ................ 0.0049 0.0342 0.0236 Germany ............... 0.0019 0.0184 0.0075 Ireland ............... 0.0000 0.0274 0.0271 Italy ................. 0.0016 0.0082 0.0082 Luxembourg ............ 0.0013 0.0066 0.0066 Netherlands ........... 0.0120 0.0580 0.0426 Norway ................ 0.0069 0.0342 0.0342 Poland ................ 0.0018 0.0091 0.0003 South Africa .......... 0.0000 0.0052 0.0052 Spain ................. 0.0030 0.0148 0.0148 Switzerland ........... 0.0061 0.0302 0.0294 United Kingdom ........ 0.0000 0.1711 0.0821 ------------------------------------------------------- TOTAL ................. $0.0468 $0.4584 $0.3198 ======================================================= 44 | Annual Report MUTUAL EUROPEAN FUND TAX DESIGNATION (UNAUDITED) (CONTINUED) - -------------------------------------------------------------------------------- CLASS B FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED COUNTRY PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Austria ............... $0.0004 $0.0014 $0.0014 Belgium ............... 0.0031 0.0125 0.0125 Bermuda ............... 0.0000 0.0041 0.0019 Denmark ............... 0.0024 0.0100 0.0099 Finland ............... 0.0014 0.0057 0.0057 France ................ 0.0049 0.0282 0.0195 Germany ............... 0.0019 0.0151 0.0062 Ireland ............... 0.0000 0.0225 0.0222 Italy ................. 0.0016 0.0067 0.0067 Luxembourg ............ 0.0013 0.0054 0.0054 Netherlands ........... 0.0120 0.0478 0.0351 Norway ................ 0.0069 0.0281 0.0281 Poland ................ 0.0018 0.0075 0.0003 South Africa .......... 0.0000 0.0042 0.0042 Spain ................. 0.0030 0.0121 0.0121 Switzerland ........... 0.0061 0.0248 0.0241 United Kingdom ........ 0.0000 0.1407 0.0675 ------------------------------------------------------- TOTAL ................. $0.0468 $0.3768 $0.2628 ======================================================= - -------------------------------------------------------------------------------- CLASS C FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED COUNTRY PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Austria ............... $0.0004 $0.0014 $0.0014 Belgium ............... 0.0031 0.0126 0.0126 Bermuda ............... 0.0000 0.0041 0.0019 Denmark ............... 0.0024 0.0101 0.0100 Finland ............... 0.0014 0.0057 0.0057 France ................ 0.0049 0.0283 0.0196 Germany ............... 0.0019 0.0152 0.0062 Ireland ............... 0.0000 0.0227 0.0224 Italy ................. 0.0016 0.0068 0.0068 Luxembourg ............ 0.0013 0.0054 0.0054 Netherlands ........... 0.0120 0.0480 0.0352 Norway ................ 0.0069 0.0283 0.0283 Poland ................ 0.0018 0.0075 0.0003 South Africa .......... 0.0000 0.0043 0.0043 Spain ................. 0.0030 0.0122 0.0122 Switzerland ........... 0.0061 0.0250 0.0243 United Kingdom ........ 0.0000 0.1416 0.0679 ------------------------------------------------------- TOTAL ................. $0.0468 $0.3792 $0.2645 ======================================================= Foreign Tax Paid per Share (Column 1) is the amount per share available to you, as a tax credit (assuming you held your shares in the Fund for a minimum of 16 days during the 31-day period beginning 15 days before the ex-dividend date of the Fund's distribution to which the foreign taxes relate), or, as a tax deduction. Annual Report | 45 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 that have not been adjusted for the rate differential applicable to such dividend income.(1) 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.(1) In January 2006, shareholders will receive Form 1099-DIV which will include their share of taxes paid and foreign source income distributed during the calendar year 2005. The Foreign Source Income reported on Form 1099-DIV has not been adjusted for the rate differential on foreign source qualified dividend income. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their 2005 individual income tax returns. (1) Qualified dividends are taxed at a maximum rate of 15% (5% for those in the 10% and 15% income tax bracket). In determining the amount of foreign tax credit that may be applied against the U.S. tax liability of individuals receiving foreign source qualified dividends, adjustments may be required to the foreign tax credit limitation calculation to reflect the rate differential applicable to such dividend income. The rules however permit certain individuals to elect not to apply the rate differential adjustments for capital gains and/or dividends for any taxable year. Please consult your tax advisor and the instructions to Form 1116 for more information. 46 | Annual Report MUTUAL EUROPEAN FUND BOARD MEMBERS AND OFFICERS The name, year of birth 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 NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ EDWARD I. ALTMAN, PH.D. (1941) Director Since 1987 7 Director, A.T.D. Inc. (financial 101 John F. Kennedy Parkway technology and investment ShortHills, NJ 07078-2789 company). - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, Salomon Center; editor and author of numerous financial publications; financial consultant; and serves on the Investment Advisory Committee of the New York State Common Retirement Fund; and FORMERLY, Vice Director, NYU Salomon Center, Stern School of Business, New York University. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE BATES (1958) Director Since 1994 7 Independent Director, SLM 101 John F. Kennedy Parkway Corporation(Sallie Mae) and Allied Short Hills, NJ 07078-2789 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 (1929) Director Since 2002 13 Director, Fiduciary Emerging 101 John F. Kennedy Parkway Markets Bond Fund PLC and Short Hills, NJ 07078-2789 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 (1930) Director Since 1974 7 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers). - ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (1930) Director Since 1998 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 47
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (1925) Director Since 1996 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ 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 (1946) Director and Director since 13 Director, El Oro and Exploration 101 John F. Kennedy Parkway Chairman of 1991 and Co., p.l.c., and ARC Wireless Short Hills, NJ 07078-2789 the Board Chairman of the Solutions, Inc. Board since 2005 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. - ------------------------------------------------------------------------------------------------------------------------------------
INTERESTED BOARD MEMBERS AND OFFICERS
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ **WILLIAM J. LIPPMAN (1925) Director Since 1996 14 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024-2920 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Advisory Services, LLC; Director, Templeton Worldwide, Inc.; and officer and/or director or trustee, as the case may be, of five of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ **ANNE M. TATLOCK (1939) 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. - ------------------------------------------------------------------------------------------------------------------------------------ PHILIPPE BRUGERE-TRELAT (1949) Vice President Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Mutual Advisers, LLC; Portfolio Manager of Eurovest SA (French registered Investment Company, Sicav); and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------
48 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL J. EMBLER (1964) Senior Vice Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President and Chief Investment Officer, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ PETER A. LANGERMAN (1955) President, and Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway Chief Short Hills, NJ 07078-2702 Executive Officer - Investment Management - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (1952) Chief Since 2004 Not Applicable Not Applicable One Franklin Parkway Compliance San Mateo, CA 94403-1906 Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (1947) 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 47 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ DAVID P. GOSS (1947) 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 47 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 | 49
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ STEVEN J. GRAY (1955) Secretary Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Resources, Inc.; officer of 33 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chief Legal Counsel, Atlas Advisers, Inc. (until 2000). - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (1947) 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, LLC, 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 47 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 (1937) Vice Since 2002 Not Applicable Not Applicable 600 Fifth Avenue President - 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, Franklin Templeton Institutional Suisse S.A., 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 45 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ GREGORY R. SEWARD (1956) Treasurer Since December Not Applicable Not Applicable 500 East Broward Blvd. 2005 Suite 2100 Fort Lauderdale, FL 33394-3091 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 16 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPMorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ------------------------------------------------------------------------------------------------------------------------------------ CRAIG S. TYLE (1960) Vice President Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Partner, Shearman & Sterling, LLP (2004-2005); and General Counsel, Investment Company Institute (ICI) (1997-2004). - ------------------------------------------------------------------------------------------------------------------------------------
50 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (1951) Chief Financial Since 2004 Not Applicable Not Applicable 500 East Broward Blvd. Officer and Suite 2100 Chief Fort Lauderdale, FL 33394-3091 Accounting Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Managing Director, RSM McGladrey, Inc. (1999-2004); and Partner, McGladrey & Pullen, LLP (1979-1987 and 1991-2004). - ------------------------------------------------------------------------------------------------------------------------------------
* 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. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE BATES, ARE AUDIT COMMITTEE FINANCIAL EXPERTS, AND "INDEPENDENT," UNDER THOSE PROVISIONS OF THE SARBANES-OXLEY ACT OF 2002, AND THE RULES AND FORM AMENDMENTS ADOPTED BY THE SECURITIES AND EXCHANGE COMMISSION, RELATING TO AUDIT COMMITTEE FINANCIAL EXPERTS. THE STATEMENT OF ADDITIONAL INFORMATION (SAI) INCLUDES ADDITIONAL INFORMATION ABOUT THE BOARD MEMBERS AND IS AVAILABLE, WITHOUT CHARGE, UPON REQUEST. SHAREHOLDERS MAY CALL 1-800/DIAL BEN (1-800/342-5236) TO REQUEST THE SAI. Annual Report | 51 MUTUAL 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 U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. 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. 52 | 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 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 MidCap Value Fund 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 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(4) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(4) 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(4) Templeton Global Bond Fund Templeton Income Fund TAX-FREE INCOME(5) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(6) 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(7) Colorado Connecticut Florida(7) Georgia Kentucky Louisiana Maryland Massachusetts(6) Michigan(6) Minnesota(6) Missouri New Jersey New York(7) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (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) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (5) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (6) Portfolio of insured municipal securities. (7) 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). (8) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 09/05 Not part of the annual report [LOGO](R) FRANKLIN TEMPLETON 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 EUROPEAN FUND INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 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 A2005 02/06 MUTUAL QUALIFIED FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2005 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 TEMPLETON 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 what we believe are undervalued stocks, as well as arbitrage situations and distressed securities. Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. Templeton pioneered international investing and, with offices in over 25 countries, offers investors a truly global perspective. TRUE DIVERSIFICATION Because these management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why the funds can be used to build truly diversified allocation plans 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, accurate and personal service that has 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 ................................................... 29 Notes to Financial Statements .......................................... 33 Report of Independent Registered Public Accounting Firm ................ 48 Tax Designation ........................................................ 49 Board Members and Officers ............................................. 50 Shareholder Information ................................................ 55 - -------------------------------------------------------------------------------- ANNUAL REPORT MUTUAL QUALIFIED FUND YOUR FUND'S GOAL AND MAIN INVESTMENTS: Mutual Qualified Fund seeks capital appreciation, with income as a secondary goal, by investing mainly in equity securities of companies the Fund's managers believe are at prices below their intrinsic value. The Fund may invest up to, but less than, 50% of its assets in foreign securiteis. - -------------------------------------------------------------------------------- PERFORMANCE DATA 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 for the fiscal year ended December 31, 2005. PERFORMANCE OVERVIEW Mutual Qualified Fund - Class Z posted a +11.26% cumulative total return for the 12 months ended December 31, 2005. The Fund outperformed its benchmark, the Standard & Poor's 500 Index (S&P 500), which returned +4.91% 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 12 months ended December 31, 2005, U.S. economic expansion was driven by strength across most industries, sectors and regions. Gross domestic product (GDP) rose during the period, benefiting primarily from increased personal consumption, business investment and federal spending. The U.S. dollar rallied in 2005, supported by relatively strong domestic economic growth and rising short-term domestic interest rates, as the Federal Reserve Board raised the federal funds target rate from 2.25% to 4.25% during the period. Compared with the rise in short-term interest rates, long-term rates remained relatively stable, supporting overall robust housing and commercial real estate activity, which contributed to economic growth. Oil prices remained high during the period, and natural gas prices rose during the second half of 2005. Despite these high commodity prices, inflation remained relatively contained for the 12 months ended December 31, 2005, as (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. 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 measured by the 2.2% rise for the core Consumer Price Index (CPI).(2) In this environment, the blue chip stocks of the Dow Jones Industrial Average posted a one-year total return of +1.72%, while the broader S&P 500 and the technology-heavy NASDAQ Composite Index returned +4.91% and +2.12%.(3) Outside the U.S., the global economy overcame fears of derailment generated by higher energy costs and advanced at a solid clip during 2005, with Europe surpassing expectations. Excluding the volatile energy and food sectors, inflation remained relatively subdued worldwide. In addition to high energy prices, prices for other commodities such as industrial metals also rose. This contributed to economic growth in countries that are tied to mining and industrial commodities, such as Australia and Canada, and some Asian and Latin American emerging markets. For the 12 months under review, equity markets outside the U.S. performed strongly. The Morgan Stanley Capital International (MSCI) All Country (AC) World ex US Index rose +17.11%.(4) In terms of sectors, energy and materials led equity market performance, and telecommunication services and consumer-related sectors lagged. INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks. When selecting undervalued equities, we are always attracted to fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. We also look for asset rich companies whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy or other perceived negatives. This strict value approach is not only intended to improve the likelihood of upside potential, but it is also intended to reduce the risk of substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies globally, we may invest occasionally in privately held companies as well. GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/05 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] U.S. 46.8% France 9.5% U.K. 9.3% South Korea 4.3% Canada 2.6% Ireland 2.4% Spain 2.3% Japan 2.0% Germany 2.0% Norway 1.9% Switzerland 1.6% Finland 1.2% Netherlands 1.0% Other 6.8% Short-Term Investments & Other Net Assets 6.3% (2) Source: Bureau of Labor Statistics. Core CPI excludes food and energy costs. (3) 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 NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes more than 3,000 companies. (4) Source: Standard & Poor's Micropal. The MSCI AC World ex US Index is a free float-adjusted market capitalization-weighted index designed to measure equity market performance in global developed and emerging markets excluding the U.S. Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/05 - -------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------- Insurance 11.1% - -------------------------------------------------- Tobacco 10.2% - -------------------------------------------------- Commercial Banks 8.2% - -------------------------------------------------- Food Products 7.1% - -------------------------------------------------- Media 5.9% - -------------------------------------------------- Metals & Mining 5.3% - -------------------------------------------------- Diversified Telecommunication Services 4.3% - -------------------------------------------------- Oil, Gas & Consumable Fuels 3.5% - -------------------------------------------------- Real Estate 3.3% - -------------------------------------------------- Beverages 3.2% - -------------------------------------------------- We complement this more traditional investment strategy with two others. One is 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 debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed 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. In addition, 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. MANAGER'S DISCUSSION The main contributors to the Fund's performance during the 12 months under review were undervalued, foreign equities. They include Generale de Sante, British American Tobacco (BAT) and Mitsubishi UFJ Financial Group (MUFG). Generale de Sante is France's leading clinic operator with a market share of approximately 12%. The stock appreciated 92% in local currency during 2005 as the company benefited from many positive factors: strong revenue growth in excess of 8%, a new reimbursement system that favors private hospitals, the continued optimization and restructuring of its existing portfolio, significant savings from its cost-cutting program, and a 20% cost of debt reduction following a refinancing. The stock price also benefited from an announcement that the company will sell and lease back its real estate portfolio, which represents more than 50% of its market capitalization. In addition, Generale de Sante acquired several clinics this year from Groupe Chiche and Hexagone, reinforcing its dominance in the French market while paying multiples typical of the sector. London-based BAT is the world's second-largest cigarette manufacturer behind Philip Morris. With about a 15% global market share, BAT enjoys 6 | Annual Report strong market positions in Europe, North America and several emerging markets. The company's stock appreciated 52% in local currency in 2005 as the company delivered robust operational performance driven by increasing sales volumes and an improving product mix. BAT benefited from an acceleration of its sales in emerging markets, a focused development of its higher-margin global brands, and a further reduction of its cost base. During the year, the company returned most of its free cash flow to shareholders through dividends and share buybacks. This caused a number of analysts to raise their earnings growth projections for BAT. MUFG contributed positively to the Fund's performance during the period with a stock price appreciation of 55% in local currency. MUFG, the largest of Japan's megabanks, as well as the largest bank in the world by assets, experienced a significant expansion in profitability as Japan's credit quality recovery and economic turnaround continued throughout 2005. Foreign investors purchased shares as they anticipated growth in fee income, a pickup in loan demand, and higher interest rates as Japan's economy grows. Further bolstering MUFG's prospects was the integration of UFJ Holdings, which has the potential to deliver significant cost and tax synergies in coming years. We continued to find Japan an interesting market given that the banks are seeing the return of consumer confidence and are finally building adequate capital ratios. Further, much of the rest of the world has seen a peak in the credit cycle while Japan continues to experience a recovery. As always, some stocks didn't meet our expectations in 2005 and detracted from Fund performance. They included Kindred Healthcare, a U.S. health care provider; White Mountains Insurance Group, a U.S. insurance company; and Washington Post, a U.S. newspaper and publishing company. Kindred shares declined 14% in 2005 after the company posted disappointing results in its second and third quarters. Valuations at year-end also reflected the industry's challenging Medicare reimbursement climate, which was pressured by high federal deficits.(5) White Mountains' shares weakened 12% largely due to the company's exposure to areas devastated by Hurricane Katrina, which may have caused the largest total insured loss in history. Shares in Washington Post underperformed (declined 22%) as Kaplan, the company's education business, reported limited margin expansion; and hurricane damage to the Gulf Coast negatively impacted Cable One, its cable TOP 10 HOLDINGS 12/31/05 - -------------------------------------------------------------- COMPANY % OFTOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------- White Mountains Insurance Group Inc. 4.1% INSURANCE, U.S. - -------------------------------------------------------------- Weyerhaeuser Co. 2.9% PAPER & FOREST PRODUCTS, U.S. - -------------------------------------------------------------- KT&G Corp., common & restricted 2.7% TOBACCO, SOUTH KOREA - -------------------------------------------------------------- Altadis SA 2.3% TOBACCO, SPAIN - -------------------------------------------------------------- Berkshire Hathaway Inc., A & B 2.0% INSURANCE, U.S. - -------------------------------------------------------------- Orkla ASA 1.9% FOOD PRODUCTS, NORWAY - -------------------------------------------------------------- Pernod Ricard SA 1.9% BEVERAGES, FRANCE - -------------------------------------------------------------- British American Tobacco PLC 1.8% TOBACCO, U.K. - -------------------------------------------------------------- Allied Irish Banks PLC 1.8% COMMERCIAL BANKS, IRELAND - -------------------------------------------------------------- Groupe Danone 1.7% FOOD PRODUCTS, FRANCE - -------------------------------------------------------------- (5) A member of Franklin Mutual Advisers, Inc., serves on Kindred's board of directors. Annual Report | 7 operations. Additionally, the advertising market was soft overall, but particularly pronounced for weekly publications, which hurt revenues at Newsweek. Finally, investors should note that we entered 2005 less than fully hedged in foreign currencies and increased the hedges on foreign currency exposure over the course of the year. Thank you for your continued participation in Mutual Qualified Fund. We look forward to serving your future investment needs. /s/ Anne E. Gudefin [PHOTO] Anne E. Gudefin, CFA Portfolio Manager /s/ Shawn M. Tumulty [PHOTO] Shawn M. Tumulty, CFA Assistant Portfolio Manager Mutual Qualified Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2005, 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. - -------------------------------------------------------------------------------- ANNE GUDEFIN has been a member of the management team of the Mutual Series Funds since 2000, when she joined Franklin Templeton Investments. Ms. Gudefin has been a portfolio manager for Mutual Qualified Fund since 2002. She assumed the duties of portfolio manager for Mutual Discovery Fund in May 2005. Previously, she was an analyst at Perry Capital. SHAWN TUMULTY has been an assistant portfolio manager for Mutual Qualified Fund since 2003. He joined Franklin Templeton Investments in 2000. Prior to joining Franklin Templeton Investments, Mr. Tumulty was an analyst and portfolio manager at Hamilton Partners Limited. - -------------------------------------------------------------------------------- 8 | Annual Report PERFORMANCE SUMMARY AS OF 12/31/05 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 that a shareholder would pay 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 (SYMBOL: MQIFX) CHANGE 12/31/05 12/31/04 - -------------------------------------------------------------------------------- Net Asset Value (NAV) +$ 0.32 $ 19.81 $ 19.49 - -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - -------------------------------------------------------------------------------- Dividend Income $ 0.4181 - -------------------------------------------------------------------------------- Short-Term Capital Gain $ 0.2269 - -------------------------------------------------------------------------------- Long-Term Capital Gain $ 1.2171 - -------------------------------------------------------------------------------- TOTAL $ 1.8621 - -------------------------------------------------------------------------------- CLASS A (SYMBOL: TEQIX) CHANGE 12/31/05 12/31/04 - -------------------------------------------------------------------------------- Net Asset Value (NAV) +$ 0.30 $ 19.71 $ 19.41 - -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - -------------------------------------------------------------------------------- Dividend Income $ 0.3495 - -------------------------------------------------------------------------------- Short-Term Capital Gain $ 0.2269 - -------------------------------------------------------------------------------- Long-Term Capital Gain $ 1.2171 - -------------------------------------------------------------------------------- TOTAL $ 1.7935 - -------------------------------------------------------------------------------- CLASS B (SYMBOL: TEBQX) CHANGE 12/31/05 12/31/04 - -------------------------------------------------------------------------------- Net Asset Value (NAV) +$ 0.26 $ 19.34 $ 19.08 - -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - -------------------------------------------------------------------------------- Dividend Income $ 0.2178 - -------------------------------------------------------------------------------- Short-Term Capital Gain $ 0.2269 - -------------------------------------------------------------------------------- Long-Term Capital Gain $ 1.2171 - -------------------------------------------------------------------------------- TOTAL $ 1.6618 - -------------------------------------------------------------------------------- CLASS C (SYMBOL: TEMQX) CHANGE 12/31/05 12/31/04 - -------------------------------------------------------------------------------- Net Asset Value (NAV) +$ 0.28 $ 19.58 $ 19.30 - -------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - -------------------------------------------------------------------------------- Dividend Income $ 0.2219 - -------------------------------------------------------------------------------- Short-Term Capital Gain $ 0.2269 - -------------------------------------------------------------------------------- Long-Term Capital Gain $ 1.2171 - -------------------------------------------------------------------------------- TOTAL $ 1.6659 - -------------------------------------------------------------------------------- Mutual Qualified Fund paid distributions derived from long-term capital gains totaling $1.2171 per share in June and December 2005. The Fund designates such distributions as capital gain dividends per Internal Revenue Code Section 852(b)(3)(C). 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) +11.26% +59.98% +218.90% - -------------------------------------------------------------------------------- Average Annual Total Return(3) +11.26% +9.85% +12.30% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,126 $15,998 $31,890 - -------------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------- Cumulative Total Return(2) +10.85% +57.19% +168.24% - -------------------------------------------------------------------------------- Average Annual Total Return(3) +4.49% +8.18% +10.65% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,449 $14,815 $25,279 - -------------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - -------------------------------------------------------------------------------- Cumulative Total Return(2) +10.12% +52.18% +93.75% - -------------------------------------------------------------------------------- Average Annual Total Return(3) +6.12% +8.47% +9.91% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,612 $15,018 $19,375 - -------------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------- Cumulative Total Return(2) +10.08% +52.18% +152.81% - -------------------------------------------------------------------------------- Average Annual Total Return(3) +9.08% +8.76% +10.65% - -------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,908 $15,218 $25,281 - -------------------------------------------------------------------------------- PERFORMANCE DATA 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. AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------ CLASS Z 12/31/05 - ------------------------------------------ 1-Year +11.26% - ------------------------------------------ 5-Year +9.85% - ------------------------------------------ 10-Year +12.30% - ------------------------------------------ CLASS Z (1/1/96-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL QUALIFIED DATE FUND S&P 500(5) ---------- ---------------- ------------ 1/1/1996 $10,000 $10,000 1/31/1996 $10,465 $10,340 2/29/1996 $10,760 $10,436 3/31/1996 $10,872 $10,537 4/30/1996 $10,930 $10,692 5/31/1996 $11,086 $10,967 6/30/1996 $11,021 $11,009 7/31/1996 $10,661 $10,523 8/31/1996 $11,018 $10,745 9/30/1996 $11,350 $11,349 10/31/1996 $11,480 $11,662 11/30/1996 $12,071 $12,543 12/31/1996 $12,230 $12,295 1/31/1997 $12,629 $13,062 2/28/1997 $12,904 $13,165 3/31/1997 $12,738 $12,625 4/30/1997 $12,851 $13,378 5/31/1997 $13,469 $14,192 6/30/1997 $13,913 $14,827 7/31/1997 $14,636 $16,006 8/31/1997 $14,514 $15,110 9/30/1997 $15,241 $15,937 10/31/1997 $14,820 $15,406 11/30/1997 $14,996 $16,118 12/31/1997 $15,277 $16,395 1/31/1998 $15,201 $16,576 2/28/1998 $16,083 $17,771 3/31/1998 $16,714 $18,680 4/30/1998 $16,730 $18,868 5/31/1998 $16,672 $18,544 6/30/1998 $16,562 $19,297 7/31/1998 $16,074 $19,092 8/31/1998 $13,683 $16,334 9/30/1998 $13,631 $17,381 10/31/1998 $14,426 $18,793 11/30/1998 $15,143 $19,932 12/31/1998 $15,353 $21,080 1/31/1999 $15,456 $21,961 2/28/1999 $15,036 $21,278 3/31/1999 $15,801 $22,130 4/30/1999 $17,191 $22,987 5/31/1999 $17,405 $22,445 6/30/1999 $17,920 $23,689 7/31/1999 $17,584 $22,951 8/31/1999 $16,757 $22,837 9/30/1999 $16,372 $22,212 10/31/1999 $16,815 $23,617 11/30/1999 $17,305 $24,097 12/31/1999 $17,447 $25,515 1/31/2000 $16,962 $24,233 2/29/2000 $16,188 $23,775 3/31/2000 $17,953 $26,099 4/30/2000 $17,973 $25,314 5/31/2000 $18,365 $24,796 6/30/2000 $18,074 $25,408 7/31/2000 $18,621 $25,011 8/31/2000 $19,448 $26,564 9/30/2000 $19,504 $25,162 10/31/2000 $19,672 $25,055 11/30/2000 $19,057 $23,081 12/31/2000 $19,934 $23,194 1/31/2001 $21,002 $24,017 2/28/2001 $20,966 $21,828 3/31/2001 $20,510 $20,446 4/30/2001 $21,482 $22,034 5/31/2001 $22,250 $22,181 6/30/2001 $22,597 $21,642 7/31/2001 $22,696 $21,429 8/31/2001 $22,302 $20,089 9/30/2001 $20,230 $18,466 10/31/2001 $20,082 $18,819 11/30/2001 $20,933 $20,262 12/31/2001 $21,570 $20,440 1/31/2002 $21,479 $20,141 2/28/2002 $21,583 $19,753 3/31/2002 $22,329 $20,496 4/30/2002 $22,486 $19,254 5/31/2002 $22,486 $19,113 6/30/2002 $20,955 $17,752 7/31/2002 $19,478 $16,368 8/31/2002 $19,651 $16,475 9/30/2002 $18,374 $14,686 10/31/2002 $18,627 $15,978 11/30/2002 $19,092 $16,917 12/31/2002 $18,831 $15,924 1/31/2003 $18,683 $15,508 2/28/2003 $18,291 $15,275 3/31/2003 $18,332 $15,421 4/30/2003 $19,587 $16,692 5/31/2003 $20,680 $17,571 6/30/2003 $21,021 $17,795 7/31/2003 $21,334 $18,109 8/31/2003 $21,863 $18,462 9/30/2003 $21,755 $18,266 10/31/2003 $22,679 $19,299 11/30/2003 $23,440 $19,469 12/31/2003 $24,574 $20,489 1/31/2004 $24,807 $20,865 2/29/2004 $25,412 $21,155 3/31/2004 $25,412 $20,836 4/30/2004 $24,670 $20,509 5/31/2004 $24,876 $20,790 6/30/2004 $25,345 $21,194 7/31/2004 $24,960 $20,493 8/31/2004 $25,290 $20,575 9/30/2004 $25,896 $20,798 10/31/2004 $26,186 $21,116 11/30/2004 $27,811 $21,970 12/31/2004 $28,662 $22,717 1/31/2005 $28,030 $22,163 2/28/2005 $28,809 $22,629 3/31/2005 $28,574 $22,229 4/30/2005 $28,338 $21,808 5/31/2005 $29,044 $22,501 6/30/2005 $29,640 $22,533 7/31/2005 $30,608 $23,371 8/31/2005 $30,563 $23,158 9/30/2005 $31,055 $23,345 10/31/2005 $30,251 $22,956 11/30/2005 $31,159 $23,823 12/31/2005 $31,890 $23,832 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------ CLASS A 12/31/05 - ------------------------------------------ 1-Year +4.49% - ------------------------------------------ 5-Year +8.18% - ------------------------------------------ Since Inception (11/1/96) +10.65% - ------------------------------------------ CLASS A (11/1/96-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL QUALIFIED DATE FUND S&P 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 $22,864 $19,479 1/31/2005 $22,346 $19,004 2/28/2005 $22,970 $19,404 3/31/2005 $22,770 $19,061 4/30/2005 $22,581 $18,699 5/31/2005 $23,135 $19,294 6/30/2005 $23,594 $19,322 7/31/2005 $24,357 $20,040 8/31/2005 $24,321 $19,857 9/30/2005 $24,715 $20,018 10/31/2005 $24,059 $19,684 11/30/2005 $24,774 $20,428 12/31/2005 $25,279 $20,435 Annual Report | 11 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------ CLASS B 12/31/05 - ------------------------------------------ 1-Year +6.12% - ------------------------------------------ 5-Year +8.47% - ------------------------------------------ Since Inception (1/1/99) +9.91% - ------------------------------------------ CLASS B (1/1/99-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL QUALIFIED DATE FUND S&P 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 $17,594 $10,777 1/31/2005 $17,188 $10,514 2/28/2005 $17,658 $10,735 3/31/2005 $17,502 $10,545 4/30/2005 $17,336 $10,345 5/31/2005 $17,760 $10,674 6/30/2005 $18,100 $10,690 7/31/2005 $18,678 $11,087 8/31/2005 $18,632 $10,986 9/30/2005 $18,921 $11,075 10/31/2005 $18,408 $10,890 11/30/2005 $18,949 $11,301 12/31/2005 $19,375 $11,305 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------ CLASS C 12/31/05 - ------------------------------------------ 1-Year +9.08% - ------------------------------------------ 5-Year +8.76% - ------------------------------------------ Since Inception (11/1/96) +10.65% - ------------------------------------------ CLASS C (11/1/96-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] MUTUAL QUALIFIED DATE FUND S&P 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 $23,022 $19,479 1/31/2005 $22,485 $19,004 2/28/2005 $23,105 $19,404 3/31/2005 $22,890 $19,061 4/30/2005 $22,676 $18,699 5/31/2005 $23,224 $19,294 6/30/2005 $23,675 $19,322 7/31/2005 $24,436 $20,040 8/31/2005 $24,376 $19,857 9/30/2005 $24,750 $20,018 10/31/2005 $24,086 $19,684 11/30/2005 $24,786 $20,428 12/31/2005 $25,281 $20,435 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 7/1/05 VALUE 12/31/05 PERIOD* 7/1/05-12/31/05 - ------------------------------------------------------------------------------------------------------- Actual $1,000 $1,075.90 $4.55 - ------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,050.82 $4.43 - ------------------------------------------------------------------------------------------------------- CLASS A - ------------------------------------------------------------------------------------------------------- Actual $1,000 $1,074.20 $6.38 - ------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.06 $6.21 - ------------------------------------------------------------------------------------------------------- CLASS B - ------------------------------------------------------------------------------------------------------- Actual $1,000 $1,070.50 $9.76 - ------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.78 $9.50 - ------------------------------------------------------------------------------------------------------- CLASS C - ------------------------------------------------------------------------------------------------------- Actual $1,000 $1,070.40 $9.76 - ------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.78 $9.50 - -------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 0.87%; A: 1.22%; B: 1.87%; and C: 1.87%), multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period. Annual Report | 15 MUTUAL QUALIFIED FUND FINANCIAL HIGHLIGHTS
---------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2005 2004 2003 2002 2001 ---------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 19.49 $ 17.88 $ 13.95 $ 16.49 $ 16.61 ---------------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... 0.41 0.37 0.20 0.28 0.23 Net realized and unrealized gains (losses) . 1.77 2.56 4.04 (2.34) 1.12 ---------------------------------------------------------------------------------- Total from investment operations ............ 2.18 2.93 4.24 (2.06) 1.35 ---------------------------------------------------------------------------------- Less distributions from: Net investment income ...................... (0.42) (0.39) (0.31) (0.26) (0.20) Net realized gains ......................... (1.44) (0.93) -- (0.22) (1.27) ---------------------------------------------------------------------------------- Total distributions ......................... (1.86) (1.32) (0.31) (0.48) (1.47) ---------------------------------------------------------------------------------- Redemption fees ............................. --(c) --(c) -- -- -- ---------------------------------------------------------------------------------- Net asset value, end of year ................ $ 19.81 $ 19.49 $ 17.88 $ 13.95 $ 16.49 ================================================================================== Total return ................................ 11.26% 16.64% 30.50% (12.70)% 8.21% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 3,646,593 $ 3,419,744 $ 3,102,506 $ 2,503,544 $ 3,022,299 Ratios to average net assets:* Expenses(b) ................................ 0.85% 0.82% 0.85% 0.80% 0.80% Net investment income ...................... 2.04% 2.01% 1.34% 1.81% 1.29% Portfolio turnover rate ..................... 20.98% 37.61% 49.70% 51.24% 52.64% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 0.81% 0.81% 0.82% 0.79% 0.79%
(a) Based on average daily shares outstanding. (b) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (c) Amount is less than $0.01 per share. 16 | See notes to financial statements. | Annual Report MUTUAL QUALIFIED FUND FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2005 2004 2003 2002 2001 ---------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 19.41 $ 17.81 $ 13.91 $ 16.44 $ 16.56 ---------------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... 0.34 0.31 0.15 0.23 0.17 Net realized and unrealized gains (losses) . 1.75 2.55 4.01 (2.33) 1.12 ---------------------------------------------------------------------------------- Total from investment operations ............ 2.09 2.86 4.16 (2.10) 1.29 ---------------------------------------------------------------------------------- Less distributions from: Net investment income ...................... (0.35) (0.33) (0.26) (0.21) (0.14) Net realized gains ......................... (1.44) (0.93) -- (0.22) (1.27) ---------------------------------------------------------------------------------- Total distributions ......................... (1.79) (1.26) (0.26) (0.43) (1.41) ---------------------------------------------------------------------------------- Redemption fees ............................. --(d) --(d) -- -- -- ---------------------------------------------------------------------------------- Net asset value, end of year ................ $ 19.71 $ 19.41 $ 17.81 $ 13.91 $ 16.44 ================================================================================== Total return(b) ............................. 10.85% 16.27% 29.98% (13.00)% 7.85% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 794,789 $ 692,523 $ 625,088 $ 449,507 $ 482,182 Ratios to average net assets:* Expenses(c) ................................ 1.20% 1.17% 1.20% 1.15% 1.15% Net investment income ...................... 1.69% 1.66% 0.99% 1.46% 0.94% Portfolio turnover rate ..................... 20.98% 37.61% 49.70% 51.24% 52.64% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.16% 1.16% 1.17% 1.14% 1.14%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the sales commissions or the contingent deferred sales charge. (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 $0.01 per share. Annual Report | See notes to financial statements. | 17 MUTUAL QUALIFIED FUND FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2005 2004 2003 2002 2001 ---------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 19.08 $ 17.54 $ 13.72 $ 16.25 $ 16.44 ---------------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... 0.20 0.19 0.05 0.13 0.04 Net realized and unrealized gains (losses) . 1.72 2.50 3.94 (2.30) 1.13 ---------------------------------------------------------------------------------- Total from investment operations ............ 1.92 2.69 3.99 (2.17) 1.17 ---------------------------------------------------------------------------------- Less distributions from: Net investment income ...................... (0.22) (0.22) (0.17) (0.14) (0.09) Net realized gains ......................... (1.44) (0.93) -- (0.22) (1.27) ---------------------------------------------------------------------------------- Total distributions ......................... (1.66) (1.15) (0.17) (0.36) (1.36) ---------------------------------------------------------------------------------- Redemption fees ............................. --(d) --(d) -- -- -- ---------------------------------------------------------------------------------- Net asset value, end of year ................ $ 19.34 $ 19.08 $ 17.54 $ 13.72 $ 16.25 ================================================================================== Total return(b) ............................. 10.12% 15.46% 29.22% (13.58)% 7.17% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 69,847 $ 67,714 $ 53,760 $ 36,023 $ 20,581 Ratios to average net assets:* Expenses(c) ................................ 1.85% 1.82% 1.85% 1.80% 1.80% Net investment income ...................... 1.04% 1.01% 0.34% 0.81% 0.24% Portfolio turnover rate ..................... 20.98% 37.61% 49.70% 51.24% 52.64% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.81% 1.81% 1.82% 1.79% 1.79%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. 18 | See notes to financial statements. | Annual Report MUTUAL QUALIFIED FUND FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2005 2004 2003 2002 2001 ---------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 19.30 $ 17.72 $ 13.85 $ 16.36 $ 16.49 ---------------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................... 0.20 0.19 0.05 0.13 0.05 Net realized and unrealized gains (losses) . 1.74 2.52 3.98 (2.31) 1.12 ---------------------------------------------------------------------------------- Total from investment operations ............ 1.94 2.71 4.03 (2.18) 1.17 ---------------------------------------------------------------------------------- Less distributions from: Net investment income ...................... (0.22) (0.20) (0.16) (0.11) (0.03) Net realized gains ......................... (1.44) (0.93) -- (0.22) (1.27) ---------------------------------------------------------------------------------- Total distributions ......................... (1.66) (1.13) (0.16) (0.33) (1.30) ---------------------------------------------------------------------------------- Redemption fees ............................. --(d) --(d) -- -- -- ---------------------------------------------------------------------------------- Net asset value, end of year ................ $ 19.58 $ 19.30 $ 17.72 $ 13.85 $ 16.36 ================================================================================== Total return(b) ............................. 10.08% 15.52% 29.16% (13.53)% 7.16% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 336,786 $ 311,071 $ 285,668 $ 225,699 $ 251,798 Ratios to average net assets:* Expenses(c) ................................ 1.85% 1.82% 1.85% 1.79% 1.79% Net investment income ...................... 1.04% 1.01% 0.34% 0.82% 0.30% Portfolio turnover rate ..................... 20.98% 37.61% 49.70% 51.24% 52.64% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................... 1.81% 1.81% 1.82% 1.78% 1.78%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. Annual Report | See notes to financial statements. | 19 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 90.2% AEROSPACE & DEFENSE 0.4% Northrop Grumman Corp. ...................................... United States 283,930 $ 17,067,032 --------------- AIRLINES 0.8% (a) ACE Aviation Holdings Inc. .................................. Canada 849,428 27,771,026 (a),(b) ACE Aviation Holdings Inc., A, 144A ......................... Canada 323,217 10,567,191 (a) ACE Aviation Holdings Inc., B ............................... Canada 1,330 43,323 (a),(c) Air Canada Inc., Contingent Distribution .................... Canada 238,886,992 -- --------------- 38,381,540 --------------- AUTO COMPONENTS 0.2% (a),(d),(e) Lancer Industries Inc., B ................................... United States 4 7,641,080 --------------- BEVERAGES 3.2% Brown-Forman Corp., A ....................................... United States 79,200 5,618,448 Coca-Cola Enterprises Inc. .................................. United States 1,570,200 30,100,734 Diageo PLC .................................................. United Kingdom 1,989,960 28,844,054 Pernod Ricard SA ............................................ France 523,094 91,279,637 --------------- 155,842,873 --------------- CAPITAL MARKETS 1.6% (a) A.B. Watley Group Inc. ...................................... United States 128,325 2,053 (b) KKR Financial Corp., 144A ................................... United States 2,581,600 61,932,584 MCG Capital Corp. ........................................... United States 938,382 13,690,993 --------------- 75,625,630 --------------- CHEMICALS 0.0%(f) (a) Sika AG ..................................................... Switzerland 696 577,461 --------------- COMMERCIAL BANKS 8.6% Allied Irish Banks PLC ...................................... Ireland 4,041,494 86,934,778 Bank of Ireland ............................................. Ireland 2,248,075 35,396,402 BNP Paribas SA .............................................. France 515,209 41,688,728 (a) Centennial Bank Holdings Inc. ............................... United States 1,735,639 21,469,854 Chinatrust Financial Holding Co. Ltd. ....................... Taiwan 29,259,000 23,174,386 Danske Bank ................................................. Denmark 1,249,080 43,999,137 (a),(d),(e) Elephant Capital Holdings Ltd. .............................. Japan 11,087 15,798,424 ForeningsSparbanken AB, A ................................... Sweden 974,500 26,553,301 Mitsubishi UFJ Financial Group Inc. ......................... Japan 5,648 76,563,585 (a),(d) NCB Warrant Holdings Ltd., A ................................ Japan 53,490 8,641,850 (a),(e) State National Bancshares Inc. .............................. United States 1,375,000 34,876,875 --------------- 415,097,320 --------------- COMMERCIAL SERVICES & SUPPLIES 1.4% (a) Comdisco Holding Co. Inc. ................................... United States 370 7,030 (c) Comdisco Holding Co. Inc., Contingent Distribution .......... United States 44,591,246 -- (a),(e) Insun ENT Co. Ltd. .......................................... South Korea 687,953 9,218,229 Republic Services Inc. ...................................... United States 1,571,600 59,013,580 (a),(c) Safety Kleen Corp., Contingent Distribution ................. United States 535,000 -- --------------- 68,238,839 ---------------
20 | Annual Report MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMPUTERS & PERIPHERALS 0.4% (a),(d),(e) DecisionOne Corp. ........................................... United States 1,008,199 $ 718,846 (a) Lexmark International Inc., A ............................... United States 422,800 18,954,124 --------------- 19,672,970 --------------- CONSUMER FINANCE 0.6% MBNA Corp. .................................................. United States 818,800 22,230,420 (a),(e) White River Capital Inc. .................................... United States 549,751 7,833,952 --------------- 30,064,372 --------------- CONTAINERS & PACKAGING 1.0% Temple-Inland Inc. .......................................... United States 1,042,200 46,742,670 --------------- DIVERSIFIED FINANCIAL SERVICES 1.6% Euronext .................................................... Netherlands 51,422 2,678,541 Fortis Group NV ............................................. Belgium 795,800 25,333,280 Leucadia National Corp. ..................................... United States 1,037,460 49,237,852 (a),(c) Marconi Corp., Contingent Distribution ...................... United Kingdom 34,293,500 -- --------------- 77,249,673 --------------- DIVERSIFIED TELECOMMUNICATION SERVICES 4.3% (a),(d),(g) AboveNet Inc. ............................................... United States 365,293 8,753,662 (a),(c),(g) AboveNet Inc., Contingent Distribution ...................... United States 50,430,000 -- (a),(d),(g) AboveNet Inc., wts., 9/08/08 ................................ United States 11,991 47,964 (a),(d),(g) AboveNet Inc., wts., 9/08/10 ................................ United States 14,107 11,286 Belgacom SA ................................................. Belgium 396,300 12,925,351 Chunghwa Telecom Co. Ltd., ADR .............................. Taiwan 974,078 17,874,331 (a),(c) Global Crossing Holdings Ltd., Contingent Distribution ...... United States 49,411,586 -- MCI Inc. .................................................... United States 754,046 14,877,328 (a) NTL Inc. .................................................... United Kingdom 947,728 64,521,322 Sprint Nextel Corp. ......................................... United States 118,861 2,776,593 (a),(c) Telewest Communications PLC, Contingent Distribution ........ United Kingdom 53,559,146 -- (a),(c) Telewest Finance Ltd., Contingent Distribution .............. United Kingdom 5,795,000 -- (a) Telewest Global Inc. ........................................ United Kingdom 3,122,294 74,373,043 Verizon Communications Inc. ................................. United States 484,600 14,596,152 --------------- 210,757,032 --------------- ELECTRIC UTILITIES 0.3% E.ON AG ..................................................... Germany 153,710 15,915,060 (b) Entegra/Union Power, 144A ................................... United States 115,572 -- --------------- 15,915,060 --------------- FOOD & STAPLES RETAILING 1.7% Bourbon SA .................................................. France 215,723 18,885,623 Carrefour SA ................................................ France 1,305,508 61,171,906 --------------- 80,057,529 ---------------
Annual Report | 21 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) FOOD PRODUCTS 7.4% Cadbury Schweppes PLC ....................................... United Kingdom 2,728,621 $ 25,796,035 CSM NV ...................................................... Netherlands 1,909,144 52,051,028 Groupe Danone ............................................... France 789,560 82,489,094 (a) Lotte Confectionary Co. Ltd. ................................ South Korea 30,405 36,093,677 Nestle SA ................................................... Switzerland 160,750 48,087,345 (a) Nong Shim Co. Ltd. .......................................... South Korea 81,743 22,717,658 Orkla ASA ................................................... Norway 2,216,900 91,801,522 --------------- 359,036,359 --------------- HEALTH CARE EQUIPMENT & SUPPLIES 0.8% Guidant Corp. ............................................... United States 570,300 36,926,925 --------------- HEALTH CARE PROVIDERS & SERVICES 3.1% Generale de Sante ........................................... France 2,010,450 69,260,074 (a),(d),(g) Kindred Healthcare Inc. ..................................... United States 1,208,060 29,563,644 (a),(d),(g) Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 ........... United States 582 8,961 (a),(d),(g) Kindred Healthcare Inc., Jan. 25.99 Calls, 1/01/14 .......... United States 288 -- (a),(d),(g) Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 .......... United States 876 -- (a),(d),(g) Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 .......... United States 3,876 2,798 (a),(d),(g) Kindred Healthcare Inc., wts., Series A, 4/20/06 ............ United States 104,567 2,022,535 (a),(d),(g) Kindred Healthcare Inc., wts., Series B, 4/20/06 ............ United States 261,416 4,296,372 Rhoen-Klinikum AG ........................................... Germany 1,157,046 44,229,839 UnitedHealth Group Inc. ..................................... United States 250 15,535 WellPoint Inc. .............................................. United States 46 3,670 --------------- 149,403,428 --------------- HOTELS, RESTAURANTS & LEISURE 0.6% (a) FHC Delaware Inc. ........................................... United States 452,571 1,573,092 Hilton Group ................................................ United Kingdom 1,739,118 10,883,638 (a),(c) Trump Atlantic, Contingent Distribution ..................... United States 20,453,000 774,471 (a) Trump Entertainment Resorts Inc. ............................ United States 690,230 13,894,330 --------------- 27,125,531 --------------- INDUSTRIAL CONGLOMERATES 0.8% Siemens AG .................................................. Germany 460,520 39,455,155 --------------- INSURANCE 11.1% (a) Alleghany Corp. ............................................. United States 140,978 40,037,752 (a) Berkshire Hathaway Inc., A .................................. United States 468 41,474,160 (a),(h) Berkshire Hathaway Inc., B .................................. United States 18,875 55,407,563 Hartford Financial Services Group Inc. ...................... United States 482,200 41,416,158 (a),(d),(e) Imagine Group Holdings Ltd. ................................. Bermuda 2,814,856 28,828,432 Montpelier Re Holdings Ltd. ................................. Bermuda 332,216 6,278,882 Old Republic International Corp. ............................ United States 1,708,400 44,862,584 (a),(d) Olympus Re Holdings Ltd. .................................... Bermuda 97,300 1,800,050 Prudential Financial Inc. ................................... United States 461,000 33,740,590 (a),(d) Symetra Financial ........................................... United States 394,800 45,402,000 White Mountains Insurance Group Inc. ........................ United States 352,130 196,682,211 --------------- 535,930,382 ---------------
22 | Annual Report MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MACHINERY 1.8% (a) Kone OYJ .................................................... Finland 1,438,600 $ 57,104,495 NACCO Industries Inc., A .................................... United States 274,700 32,181,105 --------------- 89,285,600 --------------- MEDIA 5.9% (a) CJ CGV Co. Ltd. ............................................. South Korea 574,910 16,976,251 Clear Channel Communications Inc. ........................... United States 658,200 20,700,390 (a) Comcast Corp., A ............................................ United States 146,500 3,763,585 E.W. Scripps Co., A ......................................... United States 31,900 1,531,838 (a) EchoStar Communications Corp., A ............................ United States 529,300 14,381,081 Hollinger International Inc. ................................ United States 767,234 6,530,696 Knight Ridder Inc. .......................................... United States 84,300 5,336,190 (a) Liberty Media Corp., A ...................................... United States 6,148,259 48,386,798 News Corp., A ............................................... United States 1,126,900 17,523,295 Omnicom Group Inc. .......................................... United States 177,700 15,127,601 Pearson PLC ................................................. United Kingdom 2,228,900 26,363,637 (d) Time Warner Inc. ............................................ United States 2,364,120 46,221,441 (a) TVMAX Holdings Inc. ......................................... United States 111,391 111,391 Viacom Inc., B .............................................. United States 428,100 13,956,060 Washington Post Co., B ...................................... United States 66,050 50,528,250 --------------- 287,438,504 --------------- METALS & MINING 4.8% Anglo American PLC .......................................... South Africa 1,226,724 41,767,136 (a) Apex Silver Mines Ltd. ...................................... Bolivia 1,081,300 17,192,670 Barrick Gold Corp. .......................................... Canada 313,800 8,745,606 Dofasco Inc. ................................................ Canada 284,910 15,928,290 (a) Eldorado Gold Corp. ......................................... Canada 3,158,200 15,460,860 Freeport-McMoRan Copper & Gold Inc., B ...................... United States 204,600 11,007,480 (a) Glamis Gold Ltd. ............................................ Canada 677,100 18,624,182 Gold Fields Ltd. ............................................ South Africa 146,300 2,584,961 Goldcorp Inc. ............................................... Canada 577,581 12,870,100 (a) Goldcorp Inc., wts., 5/30/07 ................................ Canada 777,331 3,243,618 (a) Harmony Gold Mining Co. Ltd., ADR ........................... South Africa 341,800 4,460,490 Newmont Mining Corp. ........................................ United States 1,334,880 71,282,592 Placer Dome Inc. ............................................ Canada 470,800 10,782,669 --------------- 233,950,654 --------------- MULTI-UTILITIES 0.2% NorthWestern Corp. .......................................... United States 306,642 9,527,367 (a),(c) NorthWestern Corp., Contingent Distribution ................. United States 9,300,000 790,500 --------------- 10,317,867 --------------- MULTILINE RETAIL 0.7% Jelmoli Holding AG .......................................... Switzerland 24,399 34,822,550 ---------------
Annual Report | 23 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) OIL, GAS & CONSUMABLE FUELS 3.5% (a) Anchor Resources LLC ........................................ United States 58,923 $ -- BP PLC ...................................................... United Kingdom 1,221,600 13,009,533 BP PLC, ADR ................................................. United Kingdom 193,700 12,439,414 Consol Energy Inc. .......................................... United States 624,220 40,686,660 Eni SpA ..................................................... Italy 1,452,100 40,277,777 Oil & Natural Gas Corp. Ltd. ................................ India 833,600 21,767,715 Total SA, B ................................................. France 166,368 41,793,800 --------------- 169,974,899 --------------- PAPER & FOREST PRODUCTS 3.0% Abitibi-Consolidated Inc. ................................... Canada 1,139,500 4,568,588 (h) Weyerhaeuser Co. ............................................ United States 2,142,200 142,113,548 --------------- 146,682,136 --------------- PHARMACEUTICALS 2.5% Bristol-Myers Squibb Co. .................................... United States 398,200 9,150,636 (a) IVAX Corp. .................................................. United States 111,500 3,493,295 Merck & Co. Inc. ............................................ United States 162,700 5,175,487 Pfizer Inc. ................................................. United States 1,751,030 40,834,019 Sanofi-Aventis .............................................. France 321,748 28,186,702 Valeant Pharmaceuticals International ....................... United States 1,025,100 18,533,808 Wyeth ....................................................... United States 344,500 15,871,115 --------------- 121,245,062 --------------- REAL ESTATE 3.3% (a) Alexander's Inc. ............................................ United States 108,590 26,658,845 Canary Wharf Group PLC ...................................... United Kingdom 8,298,072 34,263,402 (b) Medical Properties Trust Inc., 144A ......................... United States 823,500 8,053,830 (e) Saxon Capital Inc. .......................................... United States 2,663,585 30,178,418 (a),(d) Security Capital European Realty ............................ Luxembourg 17,603 127,930 Swire Pacific Ltd., A ....................................... Hong Kong 3,620,800 32,501,813 Swire Pacific Ltd., B ....................................... Hong Kong 5,292,600 9,215,028 Ventas Inc. ................................................. United States 669,525 21,438,190 --------------- 162,437,456 --------------- ROAD & RAIL 1.2% (d) Florida East Coast Industries Inc. .......................... United States 1,497,000 60,256,495 --------------- SOFTWARE 0.2% Microsoft Corp. ............................................. United States 383,200 10,020,680 --------------- THRIFTS & MORTGAGE FINANCE 3.0% (a) Franklin Bancorp ............................................ United States 889,879 16,008,923 Hudson City Bancorp Inc. .................................... United States 2,308,140 27,974,657 (a),(e) ITLA Capital Corp. .......................................... United States 445,796 21,777,135 Sovereign Bancorp Inc. ...................................... United States 3,735,520 80,761,942 --------------- 146,522,657 ---------------
24 | Annual Report MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) TOBACCO 10.2% Altadis SA .................................................. Spain 2,499,700 $ 113,399,222 (h) Altria Group Inc. ........................................... United States 796,507 59,515,003 British American Tobacco PLC ................................ United Kingdom 3,939,454 88,109,234 Imperial Tobacco Group PLC .................................. United Kingdom 1,301,759 38,902,046 KT&G Corp. .................................................. South Korea 2,193,720 98,091,400 (b) KT&G Corp., GDR, 144A ....................................... South Korea 1,433,500 31,537,000 (h) Reynolds American Inc. ...................................... United States 686,300 65,424,979 --------------- 494,978,884 --------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $2,943,244,584)..................................... 4,374,742,305 --------------- PREFERRED STOCKS 0.5% DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(f) PTV Inc., 10.00%, A, pfd. ................................... United Kingdom 92,939 195,172 --------------- ELECTRIC UTILITIES 0.0%(f) (a) Montana Power Co., 8.45%, pfd. .............................. United States 46,450 383,212 --------------- METALS & MINING 0.5% (d),(e),(g) Esmark Inc., Series A, 10.00%, cvt. pfd. .................... United States 22,360 23,447,591 Falconbridge Ltd., 6.00%, cvt. pfd., 1 ...................... Canada 21,509 543,102 Falconbridge Ltd., 6.25%, cvt. pfd., 2 ...................... Canada 21,509 543,102 Falconbridge Ltd., 6.50%, cvt. pfd., 3 ...................... Canada 10,754 272,614 --------------- 24,806,409 --------------- TOTAL PREFERRED STOCKS (COST $25,444,306).................... 25,384,793 --------------- ------------------- PRINCIPAL AMOUNT(J) ------------------- CORPORATE BONDS & NOTES 2.5% (b) ACE Aviation Holdings Inc., cvt., 144A, 4.25%, 6/01/35 ...... Canada 2,505,000 CAD 2,112,105 (i) Collins & Aikman Products Co., Revolver, FRN, 10.75%, 8/31/09 ...................... United States 366,400 355,408 Tranche B1 Term Loan, FRN, 10.75%, 8/31/11 .......... United States 858,200 832,454 Dana Corp., 5.85%, 1/15/15 ...................................... United States 4,088,000 2,922,920 7.00%, 3/01/29 ...................................... United States 600,000 433,500 (d),(e) DecisionOne Corp., 144A, 12.00%, 4/15/10 .................... United States 1,094,401 1,094,401 Entegra/Union Power, Term Loan A, 4.00%, 6/01/12 ......................... United States 5,887,605 5,063,340 Term Loan B, 9.00%, 6/01/20 ......................... United States 5,669,545 4,875,809 Eurotunnel PLC, (b),(i) Senior Tranche G2 Term Loan A, 144A, FRN, 5.618%, 12/15/12 ........................................... United Kingdom 828,649 GBP 1,372,187 (i) Tier 2, FRN, 5.796%, 12/31/18 ....................... United Kingdom 10,332,415 GBP 15,109,943 (i) Tier 3, FRN, 5.796%, 12/31/25 ....................... United Kingdom 24,858,208 GBP 20,100,632 Participating Loan Note, 1.00%, 4/30/40 ............. United Kingdom 1,020,000 GBP 166,712
Annual Report | 25 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY PRINCIPAL AMOUNT(J) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- CORPORATE BONDS & NOTES (CONTINUED) Eurotunnel SA, Senior Tranche H1 Term Loan (KfW Advance), 8.78%, 12/15/12 ............................................. France 482,500 EUR $ 542,647 (i) Tier 2 LIBOR, FRN, 3.393%, 12/31/18 ................... France 2,479,106 EUR 2,494,657 (i) Tier 2 PIBOR, FRN, 3.393%, 12/31/18 ................... France 1,096,535 EUR 1,103,413 (i) Tier 3 LIBOR, FRN, 3.393%, 12/31/25 ................... France 37,541,397 EUR 20,888,390 (i) Tier 3 PIBOR, FRN, 3.393%, 12/31/25 ................... France 6,693,302 EUR 3,724,217 (i) Motor Coach Industries International Inc., FRN, 17.406%, 12/01/08 ................................................. United States 22,189,395 21,079,925 Trump Entertaiment Resorts Inc., 8.50%, 5/20/15 ............. United States 13,553,108 13,282,046 TVMAX Holdings Inc., PIK, 11.50%, 1/16/06 ....................................... United States 216,407 216,407 (k) 14.00%, 1/16/06 ....................................... United States 546,720 546,720 --------------- TOTAL CORPORATE BONDS & NOTES (COST $128,596,675)............ 118,317,833 --------------- CORPORATE BONDS & NOTES IN REORGANIZATION 1.3% (l) Adelphia Communications Corp., 9.25%, 10/01/02 ....................................... United States 2,551,000 1,428,560 8.125%, 7/15/03 ....................................... United States 660,000 376,200 7.50%, 1/15/04 ........................................ United States 1,740,000 991,800 10.50%, 7/15/04 ....................................... United States 2,715,000 1,547,550 9.875%, 3/01/05 ....................................... United States 1,013,000 574,878 10.25%, 11/01/06 ...................................... United States 4,368,000 2,446,080 9.875%, 3/01/07 ....................................... United States 390,000 222,300 8.375%, 2/01/08 ....................................... United States 3,934,000 2,242,380 7.75%, 1/15/09 ........................................ United States 8,148,000 4,603,620 7.875%, 5/01/09 ....................................... United States 3,491,000 1,937,505 9.375%, 11/15/09 ...................................... United States 3,471,000 2,047,890 10.875%, 10/01/10 ..................................... United States 3,183,000 1,798,395 10.25%, 6/15/11 ....................................... United States 3,429,000 2,074,545 (l) Armstrong World Industries Inc., 6.35%, 8/15/03 ........................................ United States 7,435,000 5,353,200 6.50%, 8/15/05 ........................................ United States 584,000 414,640 9.75%, 4/15/08 ........................................ United States 2,010,000 1,487,400 7.45%, 5/15/29 ........................................ United States 1,180,000 873,200 Revolver, 10/29/03 .................................... United States 1,483,875 1,040,567 Trade Claim ........................................... United States 3,978,800 2,770,240 (l) Century Communications Corp., (m) 8.875%, 1/15/07 ....................................... United States 210,000 201,600 8.75%, 10/01/07 ....................................... United States 2,062,000 1,938,280 8.375%, 12/15/07 ...................................... United States 400,000 384,000 senior note, 9.50%, 3/01/05 ........................... United States 610,000 591,700 Series B, zero cpn., 1/15/08 .......................... United States 3,450,000 1,914,750 zero cpn., 3/15/03 .................................... United States 6,765,000 5,750,250 (k),(l) Owens Corning, Revolver, 6/26/02 ............................ United States 13,688,022 19,163,231 (l) Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ..... United States 40,000 20 --------------- TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $60,919,005)........................................ 64,174,781 ---------------
26 | Annual Report MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES COUNTRY PRINCIPAL AMOUNT(J) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMPANIES IN LIQUIDATION 0.0%(f) (a) City Investing Co. Liquidating Trust ........................... United States 1,607,485 $ 176,824 (a),(e) MBOP Liquidating Trust ......................................... United States 412,418 54 (a) United Cos. Financial Corp., Bank Claim ........................ United States 98,521 -- --------------- TOTAL COMPANIES IN LIQUIDATION (COST $--)....................... 176,878 --------------- GOVERNMENT AGENCIES 3.7% (n) Federal Home Loan Bank, 0.00% - 3.35%, 1/03/06 - 7/02/07 ....... United States 151,084,000 149,108,965 Federal Home Loan Mortgage Corp., 2.50%, 5/19/06 ............... United States 10,000,000 9,922,420 Federal National Mortgage Association, 2.15% - 2.20%, 12/18/06 - 12/29/06 ......................................... United States 20,000,000 19,515,700 --------------- TOTAL GOVERNMENT AGENCIES (COST $180,048,679)................... 178,547,085 --------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $3,338,253,249)........................................ 4,761,343,675 --------------- REPURCHASE AGREEMENTS 0.0%(f) (o),(p) Bank of America LLC, 4.32%, 1/03/06 (Maturity Value $38,023) Collateralized by U.S. Government Agency Securities, 5.00-5.50%, 9/01/33-10/01/35 ................................ United States 38,005 38,005 (o),(p) Bear Stearns & Co. Inc., 4.25%, 1/03/06 (Maturity Value $38,022) Collateralized by U.S. Government Agency Securities, 3.282-7.155%, 3/01/17-9/01/45 ............................... United States 38,004 38,004 (o),(p) Citigroup Global Markets Inc., 4.26%, 1/03/06 (Maturity Value $35,021) Collateralized by U.S. Government Agency Securities and (n)U.S. Treasury Bills, 0.00-14.00%, 1/03/06-8/06/38 .... United States 35,004 35,004 (o),(p) J.P. Morgan Securities, 4.31%, 1/03/06 (Maturity Value $31,019) Collateralized by U.S. Government Agency Securities, 3.614-5.625%, 12/01/11-9/01/35 .............................. United States 31,004 31,004 (o),(p) Merrill Lynch GSI, 4.25%, 1/03/06 (Maturity Value $36,021) Collateralized by U.S. Government Agency Securities, 5.00%, 6/01/35-7/01/35 ............................................. United States 36,004 36,004 (o),(p) Morgan Stanley & Co. Inc., 4.31%, 1/03/06 (Maturity Value $28,016) Collateralized by U.S. Government Agency Securities, 5.00%, 6/01/35-7/01/35 ...................................... United States 28,003 28,003 --------------- TOTAL REPURCHASE AGREEMENTS (COST $206,024)..................... 206,024 --------------- TOTAL INVESTMENTS (COST $3,338,459,273) 98.2%................... 4,761,549,699 OPTIONS WRITTEN 0.0%(f)......................................... (4,000) SECURITIES SOLD SHORT (0.8)% ................................... (39,027,843) NET UNREALIZED GAIN ON FORWARD EXCHANGE CONTRACTS 0.7%............................................... 31,632,232 OTHER ASSETS, LESS LIABILITIES 1.9% ............................ 93,865,020 --------------- NET ASSETS 100.0%............................................... $ 4,848,015,108 =============== ----------------- CONTRACTS ----------------- (q) OPTIONS WRITTEN (PREMIUMS RECEIVED $16,799) 0.00%(f) PHARMACEUTICALS 0.0%(f) Pfizer Inc., Jan. 22.50 Puts, 1/21/06 .......................... United States 200 $ 4,000 ---------------
Annual Report | 27 MUTUAL QUALIFIED FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE - ----------------------------------------------------------------------------------------------------------------------------------- (r) SECURITIES SOLD SHORT 0.8% COMMERCIAL BANKS 0.4% Bank of America Corp. .......................................... United States 409,900 $ 18,916,885 --------------- FOOD PRODUCTS 0.3% Kraft Foods Inc., A ............................................ United States 527,089 14,832,284 --------------- HEALTH CARE EQUIPMENT & SUPPLIES 0.1% Alcon Inc. ..................................................... Switzerland 25,000 3,240,000 --------------- PHARMACEUTICALS 0.0%(f) Teva Pharmaceutical Industries Ltd., ADR ....................... Israel 47,400 2,038,674 --------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $41,535,207).............. $ 39,027,843 ---------------
CURRENCY ABBREVIATIONS CAD - Canadian Dollar EUR - Euro GBP - British Pound SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FRN - Floating Rate Note GDR - Global Depository Receipt LIBOR - London InterBank Offered Rate PIBOR - Paris InterBank Offered Rate PIK - Payment In Kind (a) Non-income producing. (b) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. These securities have been deemed liquid under guidelines approved by the Fund's Board of Directors. At December 31, 2005, the aggregate value of these securities was $115,574,897, representing 2.38% of net assets. (c) 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. (d) See Note 11 regarding restricted and illiquid securities. (e) See Note 13 regarding Holdings of 5% Voting Securities. (f) Rounds to less than 0.05% of net assets. (g) See Note 14 regarding other considerations. (h) See Note 1(g) regarding securities segregated with broker for securities sold short. (i) The coupon rate shown represents the rate at period end. (j) The principal amount is stated in U.S. dollars unless otherwise indicated. (k) See Note 12 regarding unfunded loan commitments (l) See Note 10 regarding defaulted securities. (m) A portion or all of the security is on loan as of December 31, 2005. See Note 1(i). (n) A portion of the security is traded on a discount basis with no stated coupon rate. (o) Investments from cash collateral received for loaned securities. See Note 1(i). (p) See Note 1(c) regarding repurchase agreements. (q) See Note 1(f) regarding written options. (r) See Note 1(g) regarding securities sold short. 28 | See notes to financial statements. | Annual Report MUTUAL QUALIFIED FUND FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2005 Investments in securities: Cost - Unaffiliated issuers ............................................................................ $ 3,160,208,522 Cost - Non-controlled affiliated issuers (Note 13) ..................................................... 178,044,727 Cost - Repurchase agreements ........................................................................... 206,024 --------------- Total cost of investments .............................................................................. $ 3,338,459,273 =============== Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $210,421,500) ....................................................................... $ 4,510,670,164 Value - Non-controlled affiliated issuers (Note 13) .................................................... 250,673,511 Value - Repurchase agreements .......................................................................... 206,024 --------------- Total value of investments ............................................................................. 4,761,549,699 Cash .................................................................................................... 11,929 Foreign currency, at value (cost $38,870,005) ........................................................... 38,651,771 Receivables: Investment securities sold ............................................................................. 13,420,259 Capital shares sold .................................................................................... 4,215,376 Dividends and interest ................................................................................. 11,278,554 Unrealized gain on forward exchange contracts (Note 8) .................................................. 37,992,807 Unrealized gain on unfunded loan commitments (Note 12) .................................................. 581,056 Cash on deposits with brokers for securities sold short ................................................. 44,266,057 Due from broker - synthetic equity swaps ................................................................ 6,481,108 --------------- Total assets ....................................................................................... 4,918,448,616 --------------- Liabilities: Payables: Investment securities purchased ........................................................................ 7,428,877 Capital shares redeemed ................................................................................ 11,990,296 Affiliates ............................................................................................. 4,423,784 Options written, at value (premiums received $16,799) ................................................... 4,000 Securities sold short, at value (proceeds $41,535,207) .................................................. 39,027,843 Payable upon return of securities loaned ................................................................ 206,024 Deferred tax ............................................................................................ 145,034 Unrealized loss on forward exchange contracts (Note 8) .................................................. 6,360,575 Accrued expenses and other liabilities .................................................................. 847,075 --------------- Total liabilities .................................................................................. 70,433,508 --------------- Net assets, at value ............................................................................. $ 4,848,015,108 =============== Net assets consist of: Paid-in capital ......................................................................................... $ 3,360,563,755 Undistributed net investment income ..................................................................... 372,372 Net unrealized appreciation (depreciation) .............................................................. 1,458,798,540 Accumulated net realized gain (loss) .................................................................... 28,280,441 --------------- Net assets, at value ............................................................................. $ 4,848,015,108 ===============
Annual Report | See notes to financial statements. | 29 MUTUAL QUALIFIED FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2005 CLASS Z: Net assets, at value .................................................................................... $ 3,646,592,696 =============== Shares outstanding ...................................................................................... 184,095,955 =============== Net asset value and maximum offering price per share(a) ................................................. $ 19.81 =============== CLASS A: Net assets, at value .................................................................................... $ 794,789,086 =============== Shares outstanding ...................................................................................... 40,321,938 =============== Net asset value per share(a) ............................................................................ $ 19.71 =============== Maximum offering price per share (net asset value per share / 94.25%) ................................... $ 20.91 =============== CLASS B: Net assets, at value .................................................................................... $ 69,847,022 =============== Shares outstanding ...................................................................................... 3,610,690 =============== Net asset value and maximum offering price per share(a) ................................................. $ 19.34 =============== CLASS C: Net assets, at value .................................................................................... $ 336,786,304 =============== Shares outstanding ...................................................................................... 17,204,433 =============== Net asset value and maximum offering price per share(a) ................................................. $ 19.58 ===============
(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 QUALIFIED FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2005 Investment income: Dividends Unaffiliated issuers ................................................................................... $ 96,042,922 Non-controlled affiliated issuers (Note 13) ............................................................ 9,797,477 Interest Unaffiliated issuers ................................................................................... 26,994,694 Non-controlled affiliated issuers (Note 13) ............................................................ 49,586 Other income (Note 15) .................................................................................. 189,854 --------------- Total investment income............................................................................. 133,074,533 --------------- Expenses: Management fees (Note 3a) ............................................................................... 27,629,949 Administrative fees (Note 3b) ........................................................................... 3,539,026 Distribution fees (Note 3c) Class A ................................................................................................ 2,577,370 Class B ................................................................................................ 677,516 Class C ................................................................................................ 3,145,515 Transfer agent fees (Note 3e) ........................................................................... 4,367,150 Custodian fees (Note 4) ................................................................................. 746,500 Reports to shareholders ................................................................................. 361,910 Registration and filing fees ............................................................................ 304,300 Professional fees ....................................................................................... 255,921 Directors' fees and expenses ............................................................................ 125,300 Dividends on securities sold short ...................................................................... 1,860,659 Other ................................................................................................... 165,644 --------------- Total expenses ..................................................................................... 45,756,760 Expense reductions (Note 4) ........................................................................ (33,578) --------------- Net expenses ..................................................................................... 45,723,182 --------------- Net investment income .......................................................................... 87,351,351 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments Unaffiliated issuers .................................................................................. 271,386,358 Non-controlled affiliated issuers (Note 13) ........................................................... 9,838,691 Written options ........................................................................................ 327,368 Foreign currency transactions .......................................................................... 25,931,564 Securities sold short .................................................................................. (1,870,646) --------------- Net realized gain (loss) ........................................................................... 305,613,335 --------------- Net change in unrealized appreciation (depreciation) on: Investments ........................................................................................... 33,935,610 Translation of assets and liabilities denominated in foreign currencies ............................... 64,399,116 Change in deferred taxes on unrealized appreciation ..................................................... (139,151) --------------- Net change in unrealized appreciation (depreciation) ............................................... 98,195,575 --------------- Net realized and unrealized gain (loss) .................................................................. 403,808,910 --------------- Net increase (decrease) in net assets resulting from operations .......................................... $ 491,160,261 ===============
Annual Report | See notes to financial statements. | 31 MUTUAL QUALIFIED FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
------------------------------- YEAR ENDED DECEMBER 31, ------------------------------- 2005 2004 ------------------------------- Increase (decrease) in net assets: Operations: Net investment income ....................................................................... $ 87,351,351 $ 76,958,090 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions .......................................................... 305,613,335 254,342,080 Net change in unrealized appreciation (depreciation) on investments, translation of assets and liabilities denominated in foreign currencies, and deferred taxes ...................... 98,195,575 311,468,670 ------------------------------- Net increase (decrease) in net assets resulting from operations ........................... 491,160,261 642,768,840 ------------------------------- Distributions to shareholders from: Net investment income: Class Z ..................................................................................... (71,711,158) (64,408,817) Class A ..................................................................................... (13,135,480) (10,952,485) Class B ..................................................................................... (738,983) (717,882) Class C ..................................................................................... (3,553,228) (3,064,752) Net realized gains: Class Z ..................................................................................... (247,747,070) (154,113,777) Class A ..................................................................................... (54,231,833) (31,509,731) Class B ..................................................................................... (4,898,744) (3,127,895) Class C ..................................................................................... (23,121,799) (14,229,787) ------------------------------- Total distributions to shareholders............................................................ (419,138,295) (282,125,126) Capital share transactions: (Note 2) Class Z ..................................................................................... 170,136,182 40,783,518 Class A ..................................................................................... 91,917,900 13,145,836 Class B ..................................................................................... 1,140,288 8,909,619 Class C ..................................................................................... 21,731,076 544,813 ------------------------------- Total capital share transactions .............................................................. 284,925,446 63,383,786 ------------------------------- Redemption fees ............................................................................... 16,510 1,353 ------------------------------- Net increase (decrease) in net assets ..................................................... 356,963,922 424,028,853 Net assets: Beginning of year ............................................................................. 4,491,051,186 4,067,022,333 ------------------------------- End of year ................................................................................... $4,848,015,108 $4,491,051,186 =============================== Undistributed net investment income/distributions in excess of net investment income included in net assets: End of year ................................................................................... $ 372,372 $ (1,816,447) ===============================
32 | See notes to financial statements. | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Mutual Qualified Fund (the Fund) is a separate, diversified series of Franklin Mutual Series Fund Inc. (the Series Fund), consisting of six separate series. The Series Fund 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 following summarizes the Funds' 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 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. 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 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. 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. 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. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. 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 | 33 MUTUAL QUALIFIED 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. 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 Fund, with the value of the underlying securities marked to market daily to maintain coverage of at least 100%. Repurchase agreements are valued at cost. At December 31, 2005, all repurchase agreements held by the Fund had been entered into on December 30, 2005. 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 the net unrealized gain or loss on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, 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. 34 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. FOREIGN CURRENCY CONTRACTS (CONTINUED) When the Fund purchases or sells foreign securities it may enter into foreign exchange contracts to minimize foreign exchange risk from the trade date to the settlement date of the transactions. Realized and unrealized gains and losses 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, which may be in excess of the amount reflected in the Statement of Assets and Liabilities. 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. OPTIONS 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 | 35 MUTUAL QUALIFIED 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 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. 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 receives interest income 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. I. INCOME AND DEFERRED TAXES No provision has been made for U.S. income taxes because the Fund's policy is to continue to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund is subject to a tax imposed on net realized gains on securities of certain foreign countries. The Fund records an estimated deferred tax liability for net unrealized gains on these securities in an amount that would be payable if the securities were disposed of on the valuation date. Foreign securities held by the Fund may be subject to foreign taxation. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. 36 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. 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. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Such distributions are reinvested in additional shares of the Fund. Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with generally accepted accounting principles. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. 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 of the Series Fund. Fund specific expenses are charged directly to the fund that incurred the expense. K. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. L. REDEMPTION FEES A short term trading redemption fee will be imposed, with some exceptions, on Fund shares that are redeemed or exchanged within seven calendar days following their purchase date. The redemption fee is 2% of the amount redeemed. Such fees are retained by the Fund and accounted for as an addition to paid-in capital. Annual Report | 37 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) M. GUARANTEES AND INDEMNIFICATIONS Under the Series Fund's organizational documents, its officers and Directors are indemnified by the Fund against certain liabilities 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 are only offered to existing Class B shareholders in the form of reinvested distributions and certain exchanges from other Franklin Templeton Class B shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. At December 31, 2005, there were 1.00 billion shares authorized ($0.001 par value) of which 500 million shares were designated as Class Z, 200 million shares as Class A, 100 million shares as Class B and 200 million shares as Class C. Transactions in the Fund's shares were as follows:
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2005 2004 -------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------------- CLASS Z SHARES: Shares sold .................... 8,224,844 $ 164,565,279 7,659,738 $ 141,932,586 Shares issued in reinvestment of distributions ................. 15,292,237 304,242,087 10,886,980 207,607,638 Shares redeemed ................ (14,850,176) (298,671,184) (16,670,287) (308,756,706) -------------------------------------------------------------- Net increase (decrease) ........ 8,666,905 $ 170,136,182 1,876,431 $ 40,783,518 ============================================================== CLASS A SHARES: Shares sold .................... 9,309,485 $ 185,621,526 6,141,435 $ 113,698,317 Shares issued in reinvestment of distributions ................. 3,259,149 64,510,221 2,136,124 40,591,446 Shares redeemed ................ (7,920,762) (158,213,847) (7,698,298) (141,143,927) -------------------------------------------------------------- Net increase (decrease) ........ 4,647,872 $ 91,917,900 579,261 $ 13,145,836 ==============================================================
38 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2005 2004 -------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------------- CLASS B SHARES: Shares sold .................... 270,527 $ 5,213,646 606,427 $ 11,012,963 Shares issued in reinvestment of distributions ................ 271,363 5,272,612 191,893 3,585,999 Shares redeemed ................ (479,421) (9,345,970) (314,344) (5,689,343) -------------------------------------------------------------- Net increase (decrease) ........ 62,469 $ 1,140,288 483,976 $ 8,909,619 ============================================================== CLASS C SHARES: Shares sold .................... 2,410,025 $ 47,732,679 1,768,138 $ 32,469,438 Shares issued in reinvestment of distributions ................ 1,253,716 24,647,883 848,386 16,032,272 Shares redeemed ................ (2,578,585) (50,649,486) (2,620,734) (47,956,897) -------------------------------------------------------------- Net increase (decrease) ........ 1,085,156 $ 21,731,076 (4,210) $ 544,813 ==============================================================
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and directors of the Series Fund are also officers and/or directors of the following subsidiaries:
- ----------------------------------------------------------------------------------------- SUBSIDIARY AFFILIATION - ----------------------------------------------------------------------------------------- Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager Franklin Templeton Investment Management Limitied (FTIML) 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 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% Up to and including $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% In excess of $10 billion Effective March 1, 2005, under a subadvisory agreement, FTIML, an affiliate of Franklin Mutual, provides subadvisory services to the Fund and receives from Franklin Mutual fees based on the average daily net assets of the Fund. Annual Report | 39 MUTUAL QUALIFIED 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 Series Fund's aggregate average daily net assets of the Fund as follows: - -------------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - -------------------------------------------------------------------------------- 0.150% Up to and including $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% In excess of $1.2 billion C. DISTRIBUTION FEES The Funds' Board of Directors has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plans, the Fund reimburse Distributors up to 0.35% per year of Class A's average daily net assets for costs incurred in connection with the sale and distribution of the Fund's shares. Under the Class A reimbursement distribution plans, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. Under the Funds' compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the sale and distribution of each Fund's shares up to a certain percentage per year of their average daily net assets of each class as follows: Class B............................................... 1.00% Class C............................................... 1.00% 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 charge received(a).......................... $411,335 Contingent deferred sales charges retained............ $119,924 (a) Net of commissions paid to unaffiliated broker/dealers. E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $4,367,150, of which $3,190,443 was retained by Investor Services. 40 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 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 , the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES For tax purposes, realized currency losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2005, the Fund deferred realized currency losses of $1,330,877. Net investment income 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 (losses) differ for financial statement and tax purposes primarily due to differing treatment of wash sales, foreign currency transactions, bond discounts and premiums and certain dividends on securities sold short. At December 31, 2005, 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 .................................. $3,353,524,606 ============== Unrealized appreciation .............................. $1,549,271,622 Unrealized depreciation .............................. (141,246,529) -------------- Net unrealized appreciation (depreciation) ........... $1,408,025,093 ============== Undistributed ordinary income......................... $ 16,009,203 Undistributed long term capital gains................. 59,169,703 -------------- Distributable earnings................................ $ 75,178,906 ============== The tax character of distributions paid during the years ended December 31, 2005 and 2004, was as follows: ----------------------------- 2005 2004 ----------------------------- Distributions paid from: Ordinary income ................... $140,988,207 $106,282,089 Long term capital gain............. 278,150,088 175,843,037 ----------------------------- $419,138,295 $282,125,126 ============================= 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, 2005, aggregated $1,496,739,392 and $920,844,252, respectively. Transactions in options written during the year ended December 31, 2005, were as follows: --------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED --------------------- Options outstanding at December 31, 2004......................... 1,062 $ 146,018 Options written............................ 4,239 437,906 Options expired............................ (1,911) (166,121) Options exercised.......................... (2,857) (342,571) Options closed............................. (333) (58,433) --------------------- Options outstanding at December 31, 2005......................... 200 $ 16,799 ===================== 7. SYNTHETIC EQUITY SWAPS As of December 31, 2005, the Fund had the following synthetic equity swaps outstanding:
- ------------------------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - ------------------------------------------------------------------------------------------------- Christian Dior SA (46.76 - 54.99 EUR)..... 67,145 $ 5,969,670 $ 2,092,041 O2 PLC (1.96 - 1.97 GBP).................. 7,463,459 25,424,205 180,340 ----------- Total contracts to buy....................................................... 2,272,381 -----------
- ------------------------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - ------------------------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (54.61 - 61.76 EUR)........................ 67,024 $ 5,954,945 $(1,325,709) ----------- Total contracts to sell...................................................... (1,325,709) ----------- Net unrealized gain (loss)................................................... $ 946,692 ===========
8. FORWARD EXCHANGE CONTRACTS At December 31, 2005, the Fund had outstanding forward exchange contracts as set out below.
- --------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN/(LOSS) - --------------------------------------------------------------------------------------------- 6,250,000 Euro........................... 7,410,188 1/17/06 $ 3,574 85,470,059 Euro........................... 105,492,987 1/23/06 4,171,526 28,347,992 Swiss Franc.................... 22,750,000 2/02/06 1,095,671 22,275,000 British Pound.................. 39,883,678 2/15/06 1,565,609 1,271,410 Canadian Dollar................ 1,105,704 2/15/06 10,304 61,800,000 Euro........................... 74,993,163 2/27/06 1,591,716 64,519,025 Norwegian Krone................ 9,601,045 3/06/06 6,824 15,100,000 Euro........................... 18,007,050 3/15/06 80,890 179,173,815 Swedish Krona.................. 22,935,778 3/15/06 262,006 218,764,156 Danish Krone................... 38,996,517 3/17/06 4,136,444
42 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- --------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN/(LOSS) - --------------------------------------------------------------------------------------------- 2,846,506 British Pound.................. 5,127,126 3/21/06 230,051 23,175,000 British Pound.................. 40,813,859 4/04/06 940,465 69,006,954 Euro........................... 87,400,085 4/25/06 5,172,033 25,250,000 British Pound.................. 44,003,175 5/15/06 540,008 85,182,989 Euro........................... 106,270,956 5/23/06 4,606,121 144,947,000 Taiwan Dollar.................. 4,450,000 5/30/06 34,446 13,086,400 Norwegian Krone................ 2,000,000 6/06/06 43,828 21,300,000 Euro........................... 25,880,118 6/15/06 425,551 3,361,262,513 Japanese Yen................... 30,679,051 6/28/06 1,538,104 12,000,000 Euro........................... 14,376,150 7/17/06 10,229 30,417,876 British Pound.................. 53,088,297 8/14/06 669,623 60,477,285 Euro........................... 75,361,023 8/23/06 2,815,326 35,256,706 British Pound.................. 61,358,996 9/08/06 580,329 93,181,780 Euro........................... 117,722,533 9/13/06 5,819,125 69,652,665 Euro........................... 85,441,183 10/18/06 1,643,004 ----------- Unrealized gain on forward exchange contracts.......................... $37,992,807 ===========
- --------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN/(LOSS) - --------------------------------------------------------------------------------------------- 16,126,130,000 Korean Won..................... 15,690,000 1/18/06 $ (319,103) 86,367,103 Canadian Dollar................ 72,024,997 1/23/06 (2,336,066) 142,446,671 Norwegian Krone................ 21,134,521 2/06/06 (15,125) 37,781,630 Canadian Dollar................ 32,329,436 2/15/06 (221,820) 12,844,608 South African Rand............. 1,975,000 2/15/06 (47,864) 123,500,000 Norwegian Krone................ 18,344,127 3/06/06 (20,786) 33,750,000 Euro........................... 39,764,250 3/15/06 (358,140) 90,856,310,000 Korean Won..................... 87,895,000 3/22/06 (2,370,672) 164,079,202 Taiwan Dollar.................. 4,962,563 5/30/06 (35,820) 133,000,000 Norwegian Krone................ 19,835,943 6/06/06 (45,070) 40,501,882 Swiss Franc.................... 31,227,347 6/06/06 (80,349) 816,954,400 Japanese Yen................... 7,060,000 6/28/06 (22,703) 57,241,683 Euro........................... 68,040,401 7/17/06 (487,057) ----------- Unrealized loss on forward exchange contracts......................... (6,360,575) ----------- Net unrealized gain on forward exchange contracts.................... $31,632,232 ===========
(a) In U.S. Dollar unless otherwise indicated. 9. CONCENTRATION OF RISK Investing in foreign securities may include certain risks and considerations not typically associated with investing in U.S. securities, such as fluctuating currency values and changing local and regional economic, political and social conditions, which may result in greater market volatility. In addition, certain foreign securities may not be as liquid as U.S. securities. Annual Report | 43 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. DEFAULTED SECURITIES The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressed companies are financially troubled and are about to be/or are already involved in financial restructuring or bankruptcy. The Fund does not accrue income on these securities, if it becomes probable that the income will not be collected. The risks of purchasing these securities are that the issuer is unable to meet its obligation and any subsequent bankruptcy proceeding may result in unfavorable consequences to the Fund. At December 31, 2005, the value of these securities was $64,174,781, representing 1.32% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 11. RESTRICTED AND ILLIQUID SECURITIES At December 31, 2005, investments in securities included issues that are restricted and illiquid. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration under the Securities Act of 1933, unless the sale is pursuant to an exemption under the 1933 Act. The Fund has registration rights for all restricted securities held at period end. The issuer generally incurs all registration costs. A security may 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, 2005, the Fund held investments in restricted and illiquid securities, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- --------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT, SHARES, WARRANTS ACQUISITION AND CONTRACTS 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 47,964 14,107 AboveNet Inc., wts., 9/08/10............... 10/02/01 1,600,719 11,286 1,008,199 DecisionOne Corp........................... 3/12/99 700,978 718,846 1,094,401 DecisionOne Corp., 144A, 12.00%, 4/15/10 .. 3/12/99 3,837,361 1,094,401 11,087 Elephant Capital Holdings Ltd.............. 8/29/03 -- 15,798,424 22,360 Esmark Inc., Series A, 10.00%, cvt. pfd.... 11/08/04 22,360,000 23,447,591 1,497,000 Florida East Coast Industries Inc.......... 11/16/87 31,051,609 60,256,495 2,814,856 Imagine Group Holdings Ltd................. 8/31/04 28,828,348 28,828,432 1,208,060 Kindred Healthcare Inc..................... 4/28/99 12,589,374 29,563,644 582 Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13.................................. 1/1/04 -- 8,961 288 Kindred Healthcare Inc., Jan. 25.99 Calls, 1/01/14.................................. 1/1/05 -- -- 876 Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12.................................. 1/13/03 -- -- 3,876 Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11.................................. 7/17/02 -- 2,798
44 | Annual Report MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. RESTRICTED AND ILLIQUID SECURITIES (CONTINUED)
- --------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT, SHARES, WARRANTS ACQUISITION AND CONTRACTS ISSUER DATE COST VALUE - --------------------------------------------------------------------------------------------------------- 104,567 Kindred Healthcare Inc., wts., Series A, 4/20/06.................................. 4/24/01 941,099 2,022,535 261,416 Kindred Healthcare Inc., wts., Series B, 4/20/06.................................. 4/24/01 2,091,332 4,296,372 4 Lancer Industries Inc., B.................. 8/11/89 -- 7,641,080 53,490 NCB Warrant Holdings Ltd., A .............. 12/16/05 -- 8,641,850 97,300 Olympus Re Holdings Ltd.................... 12/19/01 9,730,000 1,800,050 17,603 Security Capital European Realty........... 4/08/98 964,314 127,930 394,800 Symetra Financial.......................... 7/27/04 39,480,000 45,402,000 2,364,120 Time Warner Inc............................ 8/02/05 46,713,081 46,221,441 ------------ TOTAL RESTRICTED AND ILLIQUID SECURITIES (5.87% of Net Assets)........ $284,685,762 ============
12. UNFUNDED LOAN COMMITMENTS The Fund may enter into certain credit agreements, all or a portion of which may be unfunded. The Fund is obligated to fund these loan commitments at the borrowers' discretion. At December 31, 2005, unfunded commitments were as follows:
- ------------------------------------------------------------------------------------------------------ BORROWER UNFUNDED COMMITMENT - ------------------------------------------------------------------------------------------------------ Entegra/Union Power, LOC Facility, FRN, 6/01/12............................... $1,628,289 Entegra/Union Power, Working Capital Facility, FRN 6/01/12.................... 244,243 Mirant Corp, 4 Year Revolver, 7/17/05......................................... 236,759 Owens Corning, Revolver, 6/26/02.............................................. 781,820 TVMAX Holdings Inc., PIK, 14.00%, 1/16/06..................................... 26 ---------- $2,891,137 ==========
Unfunded loan commitments are marked to market daily and any unrealized gain or loss is included in the Statement of Assets and Liabilities and Statement of Operations. Annual Report | 45 MUTUAL QUALIFIED FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. 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, 2005, were as shown below.
- ----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF SHARES/ NUMBER OF PRINCIPAL SHARES/ AMOUNT PRINCIPAL HELD AT AMOUNT REALIZED BEGINNING GROSS GROSS HELD AT VALUE AT INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS END OF YEAR END OF YEAR INCOME (LOSS) GAIN (LOSS) - ----------------------------------------------------------------------------------------------------------------------------------- NON-CONTROLLED AFFILIATES DecisionOne Corp ............. -- 1,008,199 -- 1,008,199 $ 718,846 $ -- $ -- DecisionOne Corp., 144A 12.00%, 4/15/10 ............. -- 1,271,929 177,528 1,094,401 1,094,401 49,586 (708,358) Elephant Capital Holdings Ltd. 11,087 -- -- 11,087 15,798,424 (1,390,451) 12,244,256 Esmark Inc., Series A, 10.00%, cvt., pfd. .......... 14,950 7,410 -- 22,360 23,447,591 2,187,134 -- FHC Delaware Inc. ............ 452,571 -- -- 452,571 --(a) -- -- Generale de Sante ............ 1,984,113 26,337 -- 2,010,450 69,260,074 530,212 -- Imagine Group Holdings Ltd. .. 2,814,856 -- -- 2,814,856 28,828,432 -- -- Insun ENT Co. Ltd. ........... 408,527 279,426 -- 687,953 9,218,229 -- -- ITLA Capital Corp. ........... 445,796 -- -- 445,796 21,777,135 -- -- KKR Financial Corp., 144A .... 5,163,200 -- 2,581,600 2,581,600 --(a) 2,504,152 -- Lancer Industries Inc., B .... 4 -- -- 4 7,641,080 -- -- MBOP Liquidating Trust ....... 412,418 -- -- 412,418 54 -- -- Nippon Investment, LLC ....... 9,112,000 -- 9,112,000 -- -- -- (1,681,347) Pig Iron LLC ................. -- 1,872,000 1,872,000 -- -- -- (15,405) Saxon Capital Inc. ........... 2,663,585 -- -- 2,663,585 30,178,418 5,966,430 -- State National Bancshares Inc. ............. 1,375,000 -- -- 1,375,000 34,876,875 -- -- Union Acceptance Corp., A .... 3,595,994 -- 3,595,994 -- -- -- -- White River Capital Inc. ..... -- 549,752 1 549,751 7,833,952 -- (455) ------------------------------------------- TOTAL NON-CONTROLLED AFFILIATES (5.17% of Net Assets) $ 250,673,511 $ 9,847,063 $ 9,838,691 ===========================================
(a) As of December 31, 2005, no longer an affiliate. 14. OTHER CONSIDERATIONS Directors or employees of Franklin Mutual, as the Fund's Investment Manager, may serve as members 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, 2005, such individuals serve in one or more of these capacities for Kindred Healthcare Inc., AboveNet Inc. and Esmark Inc. As a result of this involvement, such individuals 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) 15. REGULATORY MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, 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 (collectively, the "Company"), entered into settlements with certain of those regulators. Specifically, the Company entered into settlements with the Securities and Exchange Commission ("SEC") concerning market timing (the "August 2, 2004 SEC Order") and marketing support payments to securities dealers who sell fund shares (the "December 13, 2004 SEC Order") and with the California Attorney General's Office ("CAGO") concerning marketing support payments to securities dealers who sell fund shares (the "CAGO Settlement"). Under the terms of the settlements with the SEC and the CAGO, the Company retained an Independent Distribution Consultant ("IDC") to develop a plan for distribution of the respective settlement monies. The CAGO approved the distribution plan under the CAGO Settlement and, in accordance with the terms and conditions of that settlement, the monies were disbursed to the relevant funds and are recorded as other income in the current period. The SEC has not yet approved the distribution plan pertaining to the December 13, 2004 SEC Order. When approved, disbursements of settlement monies will be made promptly to the relevant funds, in accordance with the terms and conditions of that order. The IDC continues to develop the plan of distribution under the August 2, 2004 SEC Order that resolved the SEC's market timing investigation. In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, directors, and/or employees, have been named in private lawsuits (styled as shareholder class actions, or as derivative actions on behalf of either the named funds or Franklin Resources, Inc.) relating to the industry practices referenced above, as well as to allegedly excessive advisory fees, commissions, and/or 12b-1 fees. The lawsuits were filed in different courts throughout the country. Many of those suits are now pending in a multi-district litigation in the United States District Court for the District of Maryland. The Company and fund management strongly believe that the claims made in each of the private lawsuits referenced above are without merit and intend to defend against them vigorously. The Company cannot predict with certainty the eventual outcome of these lawsuits, nor whether they will have a material negative impact on the Company. 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. Annual Report | 47 MUTUAL QUALIFIED FUND REPORT OF 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 of the Mutual Qualified Fund (one of the portfolio constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2005, 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. We were not engaged to perform an audit of the Fund's internal control over financial reporting. Our audits included 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, and evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2005, by correspondence with the custodian and brokers, or by other appropriate auditing procedures where replies from the 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 Qualified Fund of the Franklin Mutual Series Fund Inc. at December 31, 2005, 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 10, 2006 48 | Annual Report MUTUAL QUALIFIED FUND TAX DESIGNATION (UNAUDITED) Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund designates the maximum amount allowable but no less than $304,782,242 as a capital gain dividend for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $79,592,218 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2005. In January 2006, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2005. 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 871(k)(1)(C) of the Code, the Fund designates the maximum amount allowable but no less than $16,167,879 as interest-related dividends for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section 871(k)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $58,876,721 as a short-term capital gain dividend for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates 23.44% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2005. Annual Report | 49 MUTUAL QUALIFIED FUND BOARD MEMBERS AND OFFICERS The name, year of birth 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 NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ EDWARD I. ALTMAN, PH.D. Director Since 1987 7 Director, A.T.D. Inc.(financial (1941) technology and investment company). 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, Salomon Center; editor and author of numerous financial publications; financial consultant; and serves on the Investment Advisory Committee of the New York State Common Retirement Fund; and FORMERLY, Vice Director, NYU Salomon Center, Stern School of Business, New York University. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE BATES (1958) Director Since 1994 7 Independent Director, SLM Corporation 101 John F. Kennedy Parkway (Sallie Mae) and Allied Capital Short Hills, NJ 07078-2789 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 (man- ager of multifamily housing) (1995-1997); and Vice President and Treasurer, US Airways, Inc. (until 1995). - ------------------------------------------------------------------------------------------------------------------------------------ BURTON J. GREENWALD (1929) Director Since 2002 13 Director, Fiduciary Emerging Markets 101 John F. Kennedy Parkway Bond Fund PLC and Fiduciary Short Hills, NJ 07078-2789 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 (1930) Director Since 1974 7 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers). - ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (1930) Director Since 1998 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------
50 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (1925) Director Since 1996 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ 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 (1946) Director and Director since 13 Director, El Oro and Exploration Co., 101 John F. Kennedy Parkway Chairman of 1991 and p.l.c., and ARC Wireless Solutions, Short Hills, NJ 07078-2789 the Board Chairman of the Inc. Board since 2005 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. - ------------------------------------------------------------------------------------------------------------------------------------
INTERESTED BOARD MEMBERS AND OFFICERS
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ **WILLIAM J. LIPPMAN (1925) Director Since 1996 14 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024-2920 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Advisory Services, LLC; Director, Templeton Worldwide, Inc.; and officer and/or director or trustee, as the case may be, of five of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ **ANNE M. TATLOCK (1939) Director Since 2002 7 Director, Fortune Brands, Inc. 600 Fifth Avenue, 7th Floor (consumer products) and Merck & Co. New York, NY 10020-2302 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. - ------------------------------------------------------------------------------------------------------------------------------------ PHILIPPE BRUGERE-TRELAT (1949) Vice President Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Mutual Advisers, LLC; Portfolio Manager of Eurovest SA (French registered Investment Company, Sicav); and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 51
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL J. EMBLER (1964) Senior Vice Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President and Chief Investment Officer, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ PETER A. LANGERMAN (1955) President, and Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway Chief Short Hills, NJ 07078-2702 Executive Officer - Investment Management - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (1952) Chief Since 2004 Not Applicable Not Applicable One Franklin Parkway Compliance San Mateo, CA 94403-1906 Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (1947) 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 47 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ DAVID P. GOSS (1947) 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 47 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). - ------------------------------------------------------------------------------------------------------------------------------------
52 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ STEVEN J. GRAY (1955) Secretary Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Resources, Inc.; officer of 33 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chief Legal Counsel, Atlas Advisers, Inc. (until 2000). - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (1947) 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, LLC, 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 47 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 (1937) 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, Franklin Templeton Institutional Suisse S.A., 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 45 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ GREGORY R. SEWARD (1956) Treasurer Since December Not Applicable Not Applicable 500 East Broward Blvd. 2005 Suite 2100 Fort Lauderdale, FL 33394-3091 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 16 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPMorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ------------------------------------------------------------------------------------------------------------------------------------ CRAIG S. TYLE (1960) Vice President Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Partner, Shearman & Sterling, LLP (2004-2005); and General Counsel, Investment Company Institute (ICI) (1997-2004). - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 53
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (1951) Chief Financial Since 2004 Not Applicable Not Applicable 500 East Broward Blvd. Officer and Suite 2100 Chief Fort Lauderdale, FL 33394-3091 Accounting Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Managing Director, RSM McGladrey, Inc. (1999-2004); and Partner, McGladrey & Pullen, LLP (1979-1987 and 1991-2004). - ------------------------------------------------------------------------------------------------------------------------------------
* 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. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE BATES, 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. 54 | Annual Report 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 U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. 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 | 55 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 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 MidCap Value Fund 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 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(4) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(4) 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(4) Templeton Global Bond Fund Templeton Income Fund TAX-FREE INCOME(5) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(6) 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(7) Colorado Connecticut Florida(7) Georgia Kentucky Louisiana Maryland Massachusetts(6) Michigan(6) Minnesota(6) Missouri New Jersey New York(7) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (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) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (5) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (6) Portfolio of insured municipal securities. (7) 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). (8) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 09/05 Not part of the annual report [LOGO](R) FRANKLIN TEMPLETON 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 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078 DISTRIBUTOR Franklin Templeton Distributors, Inc. 1-800/DIAL BEN(R) franklintempleton.com SHARE HOLDER 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 A2005 02/06 MUTUAL SHARES FUND [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2005 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 TEMPLETON 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 what we believe are undervalued stocks, as well as arbitrage situations and distressed securities. Franklin is a recognized leader in fixed income investing and also brings expertise in growth- and value-style U.S. equity investing. Templeton pioneered international investing and, with offices in over 25 countries, offers investors a truly global perspective. TRUE DIVERSIFICATION Because these management groups work independently and adhere to different investment approaches, Franklin, Templeton and Mutual Series funds typically have distinct portfolios. That's why the funds can be used to build truly diversified allocation plans 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, accurate and personal service that has 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 ................... 52 Tax Designation ........................................................... 53 Board Members and Officers ................................................ 54 Shareholder Information ................................................... 59 - -------------------------------------------------------------------------------- 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 mainly in equity securities of companies the Fund's managers believe are at prices below their intrinsic value. The Fund may invest up to 35% of its assets in foreign securities. - -------------------------------------------------------------------------------- PERFORMANCE DATA 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 for the fiscal year ended December 31, 2005. PERFORMANCE OVERVIEW Mutual Shares Fund - Class Z posted a +10.39% cumulative total return for the 12 months ended December 31, 2005. The Fund outperformed its benchmark, the Standard & Poor's 500 Index (S&P 500), which returned +4.91% 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 12 months ended December 31, 2005, U.S. economic expansion was driven by strength across most industries, sectors and regions. Gross domestic product (GDP) rose during the period, benefiting primarily from increased personal consumption, business investment and federal spending. The U.S. dollar rallied in 2005, supported by relatively strong domestic economic growth and rising short-term domestic interest rates, as the Federal Reserve Board raised the federal funds target rate from 2.25% to 4.25% during the period. Compared with the rise in short-term interest rates, long-term rates remained relatively stable, supporting overall robust housing and commercial real estate activity, which contributed to economic growth. (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. 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 Oil prices remained high during the period, and natural gas prices rose during the second half of 2005. Despite these high commodity prices, inflation remained relatively contained for the 12 months ended December 31, 2005, as measured by the 2.2% rise for the core Consumer Price Index (CPI).(2) In this environment, the blue chip stocks of the Dow Jones Industrial Average posted a one-year total return of +1.72%, while the broader S&P 500 and the technology-heavy NASDAQ Composite Index returned +4.91% and +2.12%.(3) Outside the U.S., the global economy overcame fears of derailment generated by higher energy costs and advanced at a solid clip during 2005, with Europe surpassing expectations. Excluding the volatile energy and food sectors, inflation remained relatively subdued worldwide. In addition to high energy prices, prices for other commodities such as industrial metals also rose. This contributed to economic growth in countries that are tied to mining and industrial commodities, such as Australia and Canada, and some Asian and Latin American emerging markets. For the 12 months under review, equity markets outside the U.S. performed strongly. The Morgan Stanley Capital International (MSCI) All Country (AC) World ex US Index rose +17.11%.(4) In terms of sectors, energy and materials led equity market performance, and telecommunication services and consumer-related sectors lagged. INVESTMENT STRATEGY At Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks. When selecting undervalued equities, we are always attracted to fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies' intrinsic or business value. We also look for asset rich companies whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy or other perceived negatives. This strict value approach is not only intended to GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/05 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR GRAPH IN THE PRINTED MATERIAL.] U.S. 49.4% U.K. 9.3% Canada 4.5% France 4.2% Spain 2.3% Norway 1.8% Japan 1.5% South Africa 1.3% Belgium 1.3% Ireland 1.2% Italy 1.2% Switzerland 1.0% Other 3.3% Short-Term Investments & Other Net Assets 17.7% (2) Source: Bureau of Labor Statistics. Core CPI excludes food and energy costs. (3) 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 NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The index is market value weighted and includes more than 3,000 companies. (4) Source: Standard & Poor's Micropal. The MSCI AC World ex US Index is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed and emerging markets excluding the U.S. Annual Report | 5 improve the likelihood of upside potential, but it is also intended to reduce the risk of substantial declines. While the vast majority of our undervalued equity investments are made in publicly traded companies globally, we may invest occasionally in privately held companies as well. We complement this more traditional investment strategy with two others. One is 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 debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed 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. In addition, 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. MANAGER'S DISCUSSION While all three parts of our investment strategy contributed to the Fund's performance during the year under review, the strongest contributor was our equity portfolio, most notably, the foreign holdings. Three of our best performing stock investments in 2005 included British American Tobacco (BAT), OPTI Canada and Anglo American. London-based BAT is the world's second-largest cigarette manufacturer behind Philip Morris. With about a 15% global market share, BAT enjoys strong market positions in Europe, North America and several emerging markets. The company's stock appreciated 52% in local currency in 2005 as the company delivered robust operational performance driven by increasing sales volumes and an improving product mix. BAT benefited from an acceleration of its sales in emerging markets, a focused development of its higher-margin 6 | Annual Report global brands, and a further reduction of its cost base. During the year, the company returned most of its free cash flow to shareholders through dividends and share buybacks. This caused a number of analysts to raise their earnings growth projections for BAT. OPTI Canada (appreciated 96% in local currency) is a Calgary-based company that is developing projects in Canada's Athabasca oil sands region. Canada's oil sands are the largest known oil reserve base outside of Saudi Arabia and are estimated to contain 180 billion barrels of recoverable oil. We were initially attracted to the company due to the asset value of the recoverable oil on its land and its proprietary low-cost refining process. The company utilizes a patented technology to refine the oil sands into synthetic crude oil in a cost-effective manner. The company's first project in Canada's oil sands is a fifty-fifty joint venture with Nexen that should begin producing in 2007. OPTI Canada's stock performed well in 2005 as the project remained on-time and on-budget, other assets in the region were purchased for large premiums, and oil prices remained high. U.K.-headquartered Anglo American is a global mining and natural resources company with substantial interests in platinum, gold, diamonds, base and ferrous metals, coal, industrial minerals, and paper and packaging. The company is geographically diverse with operations in Africa, Europe, the Americas, Australia and Asia. The stock appreciated 66% in local currency during the year. In 2005, Anglo and its peers in the mining sector benefited from a strong commodity cycle and high metal prices driven by sustained world demand, particularly from China. Furthermore, management announced in October that the company would strategically refocus activities on its core mining businesses and return capital to shareholders. This development was positively received by investors and resulted in a reduction of the conglomerate discount traditionally given to Anglo by the markets. Although many of our investments performed well during the year, some of the Fund's securities underperformed during the 12 months under review. Three positions that declined include Washington Post, a U.S. newspaper and publishing company; Kindred Healthcare, a U.S. health care provider; and White Mountains Insurance Group, a U.S. insurance company. Shares in Washington Post underperformed (declined 22%) as Kaplan, the company's education business, reported limited margin expansion; and hurricane damage to the Gulf Coast negatively impacted Cable One, its cable operations. Additionally, the advertising market was soft overall, but particularly pronounced for weekly publications, which hurt revenues at Newsweek. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/05 - --------------------------------------------------- % OF TOTAL NET ASSETS - --------------------------------------------------- Insurance 10.0% - --------------------------------------------------- Tobacco 9.4% - --------------------------------------------------- Media 6.4% - --------------------------------------------------- Commercial Banks 6.2% - --------------------------------------------------- Oil, Gas & Consumable Fuels 5.1% - --------------------------------------------------- Metals & Mining 4.3% - --------------------------------------------------- Food Products 4.2% - --------------------------------------------------- Beverages 3.9% - --------------------------------------------------- Paper & Forest Products 3.6% - --------------------------------------------------- Diversified Telecommunication Services 3.2% - --------------------------------------------------- Annual Report | 7 TOP 10 HOLDINGS 12/31/05 - --------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - --------------------------------------------------- Berkshire Hathaway Inc., A & B 3.7% INSURANCE, U.S. - --------------------------------------------------- British American Tobacco PLC, ord. & ADR 2.9% TOBACCO, U.K. - --------------------------------------------------- Weyerhaeuser Co. 2.6% PAPER & FOREST PRODUCTS, U.S. - --------------------------------------------------- White Mountains Insurance Group Inc. 2.6% INSURANCE, U.S. - --------------------------------------------------- Altadis SA 2.2% TOBACCO, SPAIN - --------------------------------------------------- OPTI Canada 2.0% OIL, GAS & CONSUMABLE FUELS, CANADA - --------------------------------------------------- Orkla ASA 1.7% FOOD PRODUCTS, NORWAY - --------------------------------------------------- Reynolds American Inc. 1.7% TOBACCO, U.S. - --------------------------------------------------- Pernod Ricard SA 1.5% BEVERAGES, FRANCE - --------------------------------------------------- Imperial Tobacco Group PLC 1.3% TOBACCO, U.K. - --------------------------------------------------- Kindred shares declined 14% in 2005 after the company posted disappointing results in its second and third quarters. Valuations at year-end also reflected the industry's challenging Medicare reimbursement climate, which was pressured by high federal deficits.(5) White Mountains' shares weakened 12% largely due to the company's exposure to areas devastated by Hurricane Katrina, which may have caused the largest total insured loss in history. Finally, investors should note that we entered 2005 less than fully hedged in foreign currencies and increased the hedges on foreign currency exposure over the course of the year. Thank you for your continued participation in Mutual Shares Fund. We look forward to serving your future investment needs. /s/ Peter A. Langerman [PHOTO OMITTED] Peter A. Langerman Portfolio Manager /s/ Debbie A. Turner [PHOTO OMITTED] Debbie A. Turner, CFA Assistant Portfolio Manager /s/ F. David Segal [PHOTO OMITTED] F. David Segal, CFA Assistant Portfolio Manager Mutual Shares Fund (5) A member of Franklin Mutual Advisers, Inc., serves on Kindred's board of directors. 8 | Annual Report THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2005, 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. - -------------------------------------------------------------------------------- PETER LANGERMAN rejoined Franklin Templeton Investments in April 2005 and assumed the duties of portfolio manager of Mutual Shares Fund in May 2005. He joined Franklin Templeton in 1996, serving in various capacities, including President and Chief Executive Officer of Franklin Mutual and member of the management team of the Funds, including Mutual Shares Fund, before leaving in 2002 and serving as director of New Jersey's Division of Investment, overseeing employee pension funds. Between 1986 and 1996, Mr. Langerman was employed at Heine Securities Corporation, the Funds' former manager. DEBBIE TURNER has been an assistant portfolio manager for Mutual Shares Fund since 2001. She joined Franklin Templeton Investments in 1996. Between 1993 and 1996, Ms. Turner was employed at Heine Securities Corporation, the Funds' former manager. F. DAVID SEGAL has been an assistant portfolio manager for Mutual Discovery Fund since 2004. He assumed the duties of assistant portfolio manager for Mutual Shares Fund in May 2005. He joined Franklin Templeton Investments in 2002. Previously, he was an analyst in the Structured Finance Group of MetLife for the period 1999-2002. - -------------------------------------------------------------------------------- Annual Report | 9 PERFORMANCE SUMMARY AS OF 12/31/05 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 that a shareholder would pay 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 (SYMBOL: MUTHX) CHANGE 12/31/05 12/31/04 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$0.90 $23.95 $23.05 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - ------------------------------------------------------------------------------------------------- Dividend Income $0.2943 - ------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.2193 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.9787 - ------------------------------------------------------------------------------------------------- TOTAL $1.4923 - ------------------------------------------------------------------------------------------------- CLASS A (SYMBOL: TESIX) CHANGE 12/31/05 12/31/04 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$0.88 $23.82 $22.94 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - ------------------------------------------------------------------------------------------------- Dividend Income $0.2213 - ------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.2193 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.9787 - ------------------------------------------------------------------------------------------------- TOTAL $1.4193 - ------------------------------------------------------------------------------------------------- CLASS B (SYMBOL: FMUBX) CHANGE 12/31/05 12/31/04 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$0.85 $23.35 $22.50 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - ------------------------------------------------------------------------------------------------- Dividend Income $0.0575 - ------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.2193 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.9787 - ------------------------------------------------------------------------------------------------- TOTAL $1.2555 - ------------------------------------------------------------------------------------------------- CLASS C (SYMBOL: TEMTX) CHANGE 12/31/05 12/31/04 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$0.72 $23.48 $22.76 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - ------------------------------------------------------------------------------------------------- Dividend Income $0.2034 - ------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.2193 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.9787 - ------------------------------------------------------------------------------------------------- TOTAL $1.4014 - -------------------------------------------------------------------------------------------------
10 | Annual Report PERFORMANCE SUMMARY (CONTINUED) PRICE AND DISTRIBUTION INFORMATION (CONTINUED)
- ------------------------------------------------------------------------------------------------- CLASS R (SYMBOL: TESRX) CHANGE 12/31/05 12/31/04 - ------------------------------------------------------------------------------------------------- Net Asset Value (NAV) +$0.87 $23.72 $22.85 - ------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/05-12/31/05) - ------------------------------------------------------------------------------------------------- Dividend Income $0.1892 - ------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.2193 - ------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.9787 - ------------------------------------------------------------------------------------------------- TOTAL $1.3872 - -------------------------------------------------------------------------------------------------
Mutual Shares Fund paid distributions derived from long-term capital gains totaling 97.87 cents ($0.9787) per share in June and December 2005. The Fund designates such distributions as capital gain dividends per Internal Revenue Code Section 852(b)(3)(C). 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) +10.39% +50.82% +202.67% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) +10.39% +8.57% +11.71% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $11,039 $15,082 $30,267 - -------------------------------------------------------------------------------------------- CLASS A(1) 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------------------- Cumulative Total Return(2) +9.98% +48.18% +158.93% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) +3.66% +6.91% +10.22% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,366 $13,968 $24,404 - -------------------------------------------------------------------------------------------- CLASS B(1) 1-YEAR 5-YEAR INCEPTION (1/1/99) - -------------------------------------------------------------------------------------------- Cumulative Total Return(2) +9.31% +43.43% +68.12% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) +5.31% +7.18% +9.10% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,531 $14,143 $18,397 - -------------------------------------------------------------------------------------------- CLASS C(1) 1-YEAR 5-YEAR INCEPTION (11/1/96) - -------------------------------------------------------------------------------------------- Cumulative Total Return(2) +9.27% +43.46% +144.13% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) +8.27% +7.48% +10.23% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,827 $14,346 $24,413 - -------------------------------------------------------------------------------------------- CLASS R 1-YEAR 3-YEAR INCEPTION (1/1/02) - -------------------------------------------------------------------------------------------- Cumulative Total Return(2) +9.88% +56.93% +39.27% - -------------------------------------------------------------------------------------------- Average Annual Total Return(3) +8.88% +16.21% +8.64% - -------------------------------------------------------------------------------------------- Value of $10,000 Investment(4) $10,888 $15,693 $13,927 - --------------------------------------------------------------------------------------------
PERFORMANCE DATA 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(1) - ----------------------------------- CLASS Z 12/31/05 - ----------------------------------- 1-Year +10.39% - ----------------------------------- 5-Year +8.57% - ----------------------------------- 10-Year +11.71% - ----------------------------------- CLASS Z (1/1/96-12/31/05)(1) [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] Mutual Shares Date Fund S&P 500(5) --------------------------------------------- 1/1/1996 $10,000 $10,000 1/31/1996 $10,400 $10,340 2/29/1996 $10,682 $10,436 3/31/1996 $10,760 $10,537 4/30/1996 $10,745 $10,692 5/31/1996 $10,924 $10,967 6/30/1996 $10,819 $11,009 7/31/1996 $10,452 $10,523 8/31/1996 $10,841 $10,745 9/30/1996 $11,190 $11,349 10/31/1996 $11,286 $11,662 11/30/1996 $11,939 $12,543 12/31/1996 $12,075 $12,295 1/31/1997 $12,455 $13,062 2/28/1997 $12,751 $13,165 3/31/1997 $12,582 $12,625 4/30/1997 $12,719 $13,378 5/31/1997 $13,324 $14,192 6/30/1997 $13,733 $14,827 7/31/1997 $14,494 $16,006 8/31/1997 $14,395 $15,110 9/30/1997 $15,052 $15,937 10/31/1997 $14,790 $15,406 11/30/1997 $14,980 $16,118 12/31/1997 $15,260 $16,395 1/31/1998 $15,153 $16,576 2/28/1998 $16,027 $17,771 3/31/1998 $16,565 $18,680 4/30/1998 $16,507 $18,868 5/31/1998 $16,357 $18,544 6/30/1998 $16,285 $19,297 7/31/1998 $15,848 $19,092 8/31/1998 $13,611 $16,334 9/30/1998 $13,524 $17,381 10/31/1998 $14,412 $18,793 11/30/1998 $15,184 $19,932 12/31/1998 $15,329 $21,080 1/31/1999 $15,571 $21,961 2/28/1999 $15,368 $21,278 3/31/1999 $16,081 $22,130 4/30/1999 $17,329 $22,987 5/31/1999 $17,416 $22,445 6/30/1999 $17,910 $23,689 7/31/1999 $17,415 $22,951 8/31/1999 $16,743 $22,837 9/30/1999 $16,312 $22,212 10/31/1999 $16,951 $23,617 11/30/1999 $17,271 $24,097 12/31/1999 $17,628 $25,515 1/31/2000 $17,050 $24,233 2/29/2000 $16,352 $23,775 3/31/2000 $18,043 $26,099 4/30/2000 $17,852 $25,314 5/31/2000 $18,077 $24,796 6/30/2000 $17,760 $25,408 7/31/2000 $18,255 $25,011 8/31/2000 $19,180 $26,564 9/30/2000 $19,161 $25,162 10/31/2000 $19,617 $25,055 11/30/2000 $19,002 $23,081 12/31/2000 $20,067 $23,194 1/31/2001 $21,253 $24,017 2/28/2001 $21,264 $21,828 3/31/2001 $20,726 $20,446 4/30/2001 $21,568 $22,034 5/31/2001 $22,317 $22,181 6/30/2001 $22,454 $21,642 7/31/2001 $22,444 $21,429 8/31/2001 $21,932 $20,089 9/30/2001 $20,000 $18,466 10/31/2001 $19,916 $18,819 11/30/2001 $20,751 $20,262 12/31/2001 $21,335 $20,440 1/31/2002 $21,138 $20,141 2/28/2002 $21,237 $19,753 3/31/2002 $21,873 $20,496 4/30/2002 $22,004 $19,254 5/31/2002 $22,015 $19,113 6/30/2002 $20,588 $17,752 7/31/2002 $19,351 $16,368 8/31/2002 $19,552 $16,475 9/30/2002 $18,493 $14,686 10/31/2002 $18,782 $15,978 11/30/2002 $19,162 $16,917 12/31/2002 $19,012 $15,924 1/31/2003 $18,855 $15,508 2/28/2003 $18,550 $15,275 3/31/2003 $18,595 $15,421 4/30/2003 $19,690 $16,692 5/31/2003 $20,695 $17,571 6/30/2003 $21,008 $17,795 7/31/2003 $21,133 $18,109 8/31/2003 $21,634 $18,462 9/30/2003 $21,543 $18,266 10/31/2003 $22,339 $19,299 11/30/2003 $23,055 $19,469 12/31/2003 $24,075 $20,489 1/31/2004 $24,270 $20,865 2/29/2004 $24,901 $21,155 3/31/2004 $24,866 $20,836 4/30/2004 $24,453 $20,509 5/31/2004 $24,488 $20,790 6/30/2004 $24,896 $21,194 7/31/2004 $24,515 $20,493 8/31/2004 $24,734 $20,575 9/30/2004 $25,057 $20,798 10/31/2004 $25,356 $21,116 11/30/2004 $26,589 $21,970 12/31/2004 $27,418 $22,717 1/31/2005 $26,883 $22,163 2/28/2005 $27,704 $22,629 3/31/2005 $27,502 $22,229 4/30/2005 $27,240 $21,808 5/31/2005 $27,822 $22,501 6/30/2005 $28,136 $22,533 7/31/2005 $28,864 $23,371 8/31/2005 $28,984 $23,158 9/30/2005 $29,425 $23,345 10/31/2005 $28,841 $22,956 11/30/2005 $29,569 $23,823 12/31/2005 $30,267 $23,832 AVERAGE ANNUAL TOTAL RETURN(1) - ----------------------------------- CLASS A 12/31/05 - ----------------------------------- 1-Year +3.66% - ----------------------------------- 5-Year +6.91% - ----------------------------------- Since Inception (11/1/96) +10.22% - ----------------------------------- CLASS A (11/1/96-12/31/05)(1) [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] Mutual Shares Date Fund S&P 500(5) -------------------------------------------- 11/1/1996 $ 9,425 $10,000 11/30/1996 $ 9,968 $10,755 12/31/1996 $10,077 $10,542 1/31/1997 $10,391 $11,200 2/28/1997 $10,635 $11,288 3/31/1997 $10,494 $10,825 4/30/1997 $10,602 $11,471 5/31/1997 $11,102 $12,169 6/30/1997 $11,438 $12,714 7/31/1997 $12,072 $13,725 8/31/1997 $11,989 $12,957 9/30/1997 $12,533 $13,666 10/31/1997 $12,308 $13,210 11/30/1997 $12,462 $13,821 12/31/1997 $12,698 $14,058 1/31/1998 $12,597 $14,213 2/28/1998 $13,325 $15,238 3/31/1998 $13,767 $16,018 4/30/1998 $13,714 $16,179 5/31/1998 $13,582 $15,901 6/30/1998 $13,517 $16,546 7/31/1998 $13,149 $16,371 8/31/1998 $11,293 $14,006 9/30/1998 $11,214 $14,904 10/31/1998 $11,948 $16,115 11/30/1998 $12,585 $17,091 12/31/1998 $12,699 $18,075 1/31/1999 $12,901 $18,831 2/28/1999 $12,726 $18,246 3/31/1999 $13,318 $18,975 4/30/1999 $14,341 $19,710 5/31/1999 $14,407 $19,245 6/30/1999 $14,819 $20,313 7/31/1999 $14,401 $19,679 8/31/1999 $13,837 $19,582 9/30/1999 $13,479 $19,046 10/31/1999 $14,003 $20,251 11/30/1999 $14,262 $20,662 12/31/1999 $14,557 $21,878 1/31/2000 $14,072 $20,779 2/29/2000 $13,493 $20,386 3/31/2000 $14,886 $22,379 4/30/2000 $14,722 $21,706 5/31/2000 $14,907 $21,262 6/30/2000 $14,639 $21,786 7/31/2000 $15,040 $21,446 8/31/2000 $15,797 $22,777 9/30/2000 $15,774 $21,575 10/31/2000 $16,152 $21,484 11/30/2000 $15,635 $19,791 12/31/2000 $16,511 $19,888 1/31/2001 $17,482 $20,593 2/28/2001 $17,482 $18,717 3/31/2001 $17,030 $17,532 4/30/2001 $17,724 $18,893 5/31/2001 $18,335 $19,020 6/30/2001 $18,443 $18,557 7/31/2001 $18,434 $18,374 8/31/2001 $18,004 $17,225 9/30/2001 $16,409 $15,834 10/31/2001 $16,340 $16,137 11/30/2001 $17,012 $17,374 12/31/2001 $17,491 $17,526 1/31/2002 $17,329 $17,271 2/28/2002 $17,401 $16,938 3/31/2002 $17,916 $17,575 4/30/2002 $18,015 $16,510 5/31/2002 $18,024 $16,388 6/30/2002 $16,845 $15,221 7/31/2002 $15,836 $14,035 8/31/2002 $15,992 $14,127 9/30/2002 $15,130 $12,593 10/31/2002 $15,350 $13,701 11/30/2002 $15,662 $14,506 12/31/2002 $15,533 $13,654 1/31/2003 $15,403 $13,297 2/28/2003 $15,144 $13,098 3/31/2003 $15,181 $13,223 4/30/2003 $16,070 $14,313 5/31/2003 $16,884 $15,066 6/30/2003 $17,127 $15,259 7/31/2003 $17,230 $15,528 8/31/2003 $17,631 $15,830 9/30/2003 $17,547 $15,663 10/31/2003 $18,200 $16,548 11/30/2003 $18,768 $16,694 12/31/2003 $19,599 $17,569 1/31/2004 $19,749 $17,891 2/29/2004 $20,266 $18,140 3/31/2004 $20,228 $17,866 4/30/2004 $19,890 $17,586 5/31/2004 $19,909 $17,827 6/30/2004 $20,237 $18,173 7/31/2004 $19,916 $17,572 8/31/2004 $20,086 $17,643 9/30/2004 $20,350 $17,833 10/31/2004 $20,585 $18,106 11/30/2004 $21,575 $18,838 12/31/2004 $22,245 $19,479 1/31/2005 $21,799 $19,004 2/28/2005 $22,458 $19,404 3/31/2005 $22,283 $19,061 4/30/2005 $22,070 $18,699 5/31/2005 $22,545 $19,294 6/30/2005 $22,786 $19,322 7/31/2005 $23,369 $20,040 8/31/2005 $23,457 $19,857 9/30/2005 $23,816 $20,018 10/31/2005 $23,330 $19,684 11/30/2005 $23,914 $20,428 12/31/2005 $24,404 $20,435 12 | Annual Report PERFORMANCE SUMMARY (CONTINUED) CLASS B (1/1/99-12/31/05)(1) [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] Mutual Shares Date Fund S&P 500(5) --------------------------------------------- 1/1/1999 $10,000 $10,000 1/31/1999 $10,154 $10,418 2/28/1999 $10,005 $10,094 3/31/1999 $10,467 $10,498 4/30/1999 $11,262 $10,905 5/31/1999 $11,313 $10,647 6/30/1999 $11,627 $11,238 7/31/1999 $11,293 $10,887 8/31/1999 $10,844 $10,834 9/30/1999 $10,556 $10,537 10/31/1999 $10,964 $11,203 11/30/1999 $11,157 $11,431 12/31/1999 $11,382 $12,104 1/31/2000 $11,000 $11,496 2/29/2000 $10,539 $11,279 3/31/2000 $11,618 $12,381 4/30/2000 $11,489 $12,009 5/31/2000 $11,624 $11,763 6/30/2000 $11,411 $12,053 7/31/2000 $11,720 $11,865 8/31/2000 $12,303 $12,601 9/30/2000 $12,279 $11,936 10/31/2000 $12,558 $11,886 11/30/2000 $12,157 $10,949 12/31/2000 $12,827 $11,003 1/31/2001 $13,574 $11,393 2/28/2001 $13,568 $10,355 3/31/2001 $13,213 $ 9,699 4/30/2001 $13,745 $10,453 5/31/2001 $14,204 $10,523 6/30/2001 $14,279 $10,267 7/31/2001 $14,265 $10,166 8/31/2001 $13,921 $ 9,530 9/30/2001 $12,691 $ 8,760 10/31/2001 $12,624 $ 8,927 11/30/2001 $13,144 $ 9,612 12/31/2001 $13,501 $ 9,696 1/31/2002 $13,367 $ 9,555 2/28/2002 $13,416 $ 9,371 3/31/2002 $13,805 $ 9,723 4/30/2002 $13,875 $ 9,134 5/31/2002 $13,875 $ 9,067 6/30/2002 $12,964 $ 8,421 7/31/2002 $12,175 $ 7,765 8/31/2002 $12,290 $ 7,816 9/30/2002 $11,616 $ 6,967 10/31/2002 $11,781 $ 7,580 11/30/2002 $12,017 $ 8,025 12/31/2002 $11,908 $ 7,554 1/31/2003 $11,800 $ 7,357 2/28/2003 $11,605 $ 7,246 3/31/2003 $11,619 $ 7,316 4/30/2003 $12,297 $ 7,919 5/31/2003 $12,910 $ 8,335 6/30/2003 $13,093 $ 8,442 7/31/2003 $13,166 $ 8,591 8/31/2003 $13,464 $ 8,758 9/30/2003 $13,391 $ 8,665 10/31/2003 $13,885 $ 9,155 11/30/2003 $14,313 $ 9,236 12/31/2003 $14,934 $ 9,720 1/31/2004 $15,043 $ 9,898 2/29/2004 $15,428 $10,036 3/31/2004 $15,385 $ 9,884 4/30/2004 $15,115 $ 9,729 5/31/2004 $15,123 $ 9,863 6/30/2004 $15,362 $10,054 7/31/2004 $15,114 $ 9,722 8/31/2004 $15,238 $ 9,761 9/30/2004 $15,428 $ 9,866 10/31/2004 $15,596 $10,017 11/30/2004 $16,340 $10,422 12/31/2004 $16,830 $10,777 1/31/2005 $16,493 $10,514 2/28/2005 $16,979 $10,735 3/31/2005 $16,837 $10,545 4/30/2005 $16,673 $10,345 5/31/2005 $17,017 $10,674 6/30/2005 $17,193 $10,690 7/31/2005 $17,620 $11,087 8/31/2005 $17,680 $10,986 9/30/2005 $17,935 $11,075 10/31/2005 $17,560 $10,890 11/30/2005 $17,987 $11,301 12/31/2005 $18,397 $11,305 AVERAGE ANNUAL TOTAL RETURN(1) - ----------------------------------- CLASS B 12/31/05 - ----------------------------------- 1-Year +5.31% - ----------------------------------- 5-Year +7.18% - ----------------------------------- Since Inception (1/1/99) +9.10% - ----------------------------------- CLASS C (11/1/96-12/31/05)(1) [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] Mutual Shares Date Fund S&P 500(5) --------------------------------------------- 11/1/1996 $10,000 $10,000 11/30/1996 $10,573 $10,755 12/31/1996 $10,683 $10,542 1/31/1997 $11,011 $11,200 2/28/1997 $11,266 $11,288 3/31/1997 $11,105 $10,825 4/30/1997 $11,214 $11,471 5/31/1997 $11,738 $12,169 6/30/1997 $12,089 $12,714 7/31/1997 $12,750 $13,725 8/31/1997 $12,652 $12,957 9/30/1997 $13,222 $13,666 10/31/1997 $12,977 $13,210 11/30/1997 $13,135 $13,821 12/31/1997 $13,368 $14,058 1/31/1998 $13,261 $14,213 2/28/1998 $14,018 $15,238 3/31/1998 $14,473 $16,018 4/30/1998 $14,410 $16,179 5/31/1998 $14,265 $15,901 6/30/1998 $14,189 $16,546 7/31/1998 $13,798 $16,371 8/31/1998 $11,838 $14,006 9/30/1998 $11,755 $14,904 10/31/1998 $12,517 $16,115 11/30/1998 $13,177 $17,091 12/31/1998 $13,295 $18,075 1/31/1999 $13,494 $18,831 2/28/1999 $13,302 $18,246 3/31/1999 $13,912 $18,975 4/30/1999 $14,973 $19,710 5/31/1999 $15,042 $19,245 6/30/1999 $15,459 $20,313 7/31/1999 $15,013 $19,679 8/31/1999 $14,421 $19,582 9/30/1999 $14,038 $19,046 10/31/1999 $14,575 $20,251 11/30/1999 $14,839 $20,662 12/31/1999 $15,140 $21,878 1/31/2000 $14,625 $20,779 2/29/2000 $14,013 $20,386 3/31/2000 $15,453 $22,379 4/30/2000 $15,281 $21,706 5/31/2000 $15,461 $21,262 6/30/2000 $15,177 $21,786 7/31/2000 $15,587 $21,446 8/31/2000 $16,361 $22,777 9/30/2000 $16,329 $21,575 10/31/2000 $16,699 $21,484 11/30/2000 $16,167 $19,791 12/31/2000 $17,059 $19,888 1/31/2001 $18,050 $20,593 2/28/2001 $18,041 $18,717 3/31/2001 $17,572 $17,532 4/30/2001 $18,276 $18,893 5/31/2001 $18,893 $19,020 6/30/2001 $18,996 $18,557 7/31/2001 $18,969 $18,374 8/31/2001 $18,522 $17,225 9/30/2001 $16,876 $15,834 10/31/2001 $16,795 $16,137 11/30/2001 $17,475 $17,374 12/31/2001 $17,956 $17,526 1/31/2002 $17,779 $17,271 2/28/2002 $17,845 $16,938 3/31/2002 $18,367 $17,575 4/30/2002 $18,460 $16,510 5/31/2002 $18,460 $16,388 6/30/2002 $17,242 $15,221 7/31/2002 $16,201 $14,035 8/31/2002 $16,343 $14,127 9/30/2002 $15,454 $12,593 10/31/2002 $15,672 $13,701 11/30/2002 $15,984 $14,506 12/31/2002 $15,841 $13,654 1/31/2003 $15,698 $13,297 2/28/2003 $15,432 $13,098 3/31/2003 $15,461 $13,223 4/30/2003 $16,353 $14,313 5/31/2003 $17,180 $15,066 6/30/2003 $17,420 $15,259 7/31/2003 $17,506 $15,528 8/31/2003 $17,908 $15,830 9/30/2003 $17,812 $15,663 10/31/2003 $18,463 $16,548 11/30/2003 $19,036 $16,694 12/31/2003 $19,859 $17,569 1/31/2004 $20,003 $17,891 2/29/2004 $20,520 $18,140 3/31/2004 $20,472 $17,866 4/30/2004 $20,108 $17,586 5/31/2004 $20,118 $17,827 6/30/2004 $20,442 $18,173 7/31/2004 $20,105 $17,572 8/31/2004 $20,269 $17,643 9/30/2004 $20,528 $17,833 10/31/2004 $20,749 $18,106 11/30/2004 $21,739 $18,838 12/31/2004 $22,396 $19,479 1/31/2005 $21,943 $19,004 2/28/2005 $22,593 $19,404 3/31/2005 $22,406 $19,061 4/30/2005 $22,179 $18,699 5/31/2005 $22,642 $19,294 6/30/2005 $22,874 $19,322 7/31/2005 $23,436 $20,040 8/31/2005 $23,525 $19,857 9/30/2005 $23,860 $20,018 10/31/2005 $23,357 $19,684 11/30/2005 $23,929 $20,428 12/31/2005 $24,413 $20,435 AVERAGE ANNUAL TOTAL RETURN(1) - ----------------------------------- CLASS C 12/31/05 - ----------------------------------- 1-Year +8.27% - ----------------------------------- 5-Year +7.48% - ----------------------------------- Since Inception (11/1/96) +10.23% - ----------------------------------- Annual Report | 13 PERFORMANCE SUMMARY (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ----------------------------------- CLASS R 12/31/05 - ----------------------------------- 1-Year +8.88% - ----------------------------------- 3-Year +16.21% - ----------------------------------- Since Inception (1/1/02) +8.64% - ----------------------------------- CLASS R (1/1/02-12/31/05) [THE FOLLOWING TABLE WAS REPRESENTED AS A LINE GRAPH IN THE PRINTED MATERIAL.] Mutual Shares Date Fund S&P 500(5) --------------------------------------------- 1/1/2002 $10,000 $10,000 1/31/2002 $ 9,917 $ 9,854 2/28/2002 $ 9,958 $ 9,664 3/31/2002 $10,258 $10,028 4/30/2002 $10,314 $ 9,420 5/31/2002 $10,320 $ 9,351 6/30/2002 $ 9,643 $ 8,685 7/31/2002 $ 9,066 $ 8,008 8/31/2002 $ 9,150 $ 8,061 9/30/2002 $ 8,656 $ 7,185 10/31/2002 $ 8,782 $ 7,817 11/30/2002 $ 8,956 $ 8,277 12/31/2002 $ 8,878 $ 7,791 1/31/2003 $ 8,804 $ 7,587 2/28/2003 $ 8,661 $ 7,473 3/31/2003 $ 8,677 $ 7,545 4/30/2003 $ 9,182 $ 8,167 5/31/2003 $ 9,648 $ 8,596 6/30/2003 $ 9,792 $ 8,706 7/31/2003 $ 9,846 $ 8,860 8/31/2003 $10,075 $ 9,032 9/30/2003 $10,022 $ 8,937 10/31/2003 $10,390 $ 9,442 11/30/2003 $10,716 $ 9,525 12/31/2003 $11,190 $10,024 1/31/2004 $11,276 $10,208 2/29/2004 $11,566 $10,350 3/31/2004 $11,544 $10,194 4/30/2004 $11,351 $10,034 5/31/2004 $11,362 $10,171 6/30/2004 $11,543 $10,369 7/31/2004 $11,360 $10,026 8/31/2004 $11,457 $10,066 9/30/2004 $11,608 $10,175 10/31/2004 $11,737 $10,331 11/30/2004 $12,304 $10,749 12/31/2004 $12,680 $11,114 1/31/2005 $12,430 $10,843 2/28/2005 $12,802 $11,071 3/31/2005 $12,702 $10,876 4/30/2005 $12,580 $10,669 5/31/2005 $12,846 $11,009 6/30/2005 $12,984 $11,024 7/31/2005 $13,312 $11,434 8/31/2005 $13,362 $11,330 9/30/2005 $13,562 $11,422 10/31/2005 $13,284 $11,231 11/30/2005 $13,618 $11,655 12/31/2005 $13,927 $11,660 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, OR PROPOSED TO BE ENGAGED, IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, TENDER OFFERS 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 7/1/05 VALUE 12/31/05 PERIOD* 7/1/05-12/31/05 - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,075.70 $4.34 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,021.02 $4.23 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,073.70 $6.71 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.26 $6.01 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,070.10 $9.55 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.98 $9.30 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,069.90 $9.55 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.98 $9.30 - -------------------------------------------------------------------------------------------------------- CLASS R - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,073.20 $6.95 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,018.50 $6.77 - --------------------------------------------------------------------------------------------------------
* Expenses are equal to the annualized expense ratio for each class (Z: 0.83%; A: 1.18%; B:1.83%; C: 1.83%; and R: 1.33%) multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period. 16 | Annual Report MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS
----------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2005 2004 2003 2002 2001 ----------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 23.05 $ 20.99 $ 16.84 $ 19.44 $ 19.79 ----------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................. 0.47 0.35 0.24 0.33 0.29 Net realized and unrealized gains (losses) .............................. 1.92 2.52 4.23 (2.42) 0.95 ----------------------------------------------------------------------------- Total from investment operations ............ 2.39 2.87 4.47 (2.09) 1.24 ----------------------------------------------------------------------------- Less distributions from: Net investment income .................... (0.29) (0.39) (0.32) (0.25) (0.24) Net realized gains ....................... (1.20) (0.42) -- (0.26) (1.35) ----------------------------------------------------------------------------- Total distributions ......................... (1.49) (0.81) (0.32) (0.51) (1.59) ----------------------------------------------------------------------------- Redemption fees ............................. --(c) --(c) -- -- -- ----------------------------------------------------------------------------- Net asset value, end of year ................ $ 23.95 $ 23.05 $ 20.99 $ 16.84 $ 19.44 ============================================================================= Total return ................................ 10.39% 13.89% 26.62% (10.89)% 6.32% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 8,951,080 $ 7,240,641 $ 5,782,145 $ 4,585,605 $ 5,465,075 Ratios to average net assets:* Expenses(b) .............................. 0.81% 0.81% 0.84% 0.79% 0.78% Net investment income .................... 1.99% 1.62% 1.28% 1.79% 1.40% Portfolio turnover rate ..................... 21.57% 33.22% 54.65% 51.22% 52.98% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................. 0.76% 0.80% 0.81% 0.78% 0.77%
(a) Based on average daily shares outstanding. (b) Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. (c) Amount is less than $0.01 per share. Annual Report | See notes to financial statements. | 17 MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
----------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2005 2004 2003 2002 2001 ----------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .......... $ 22.94 $ 20.90 $ 16.78 $ 19.37 $ 19.73 ----------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ................. 0.39 0.27 0.17 0.26 0.22 Net realized and unrealized gains (losses) .............................. 1.91 2.51 4.21 (2.40) 0.95 ----------------------------------------------------------------------------- Total from investment operations ............ 2.30 2.78 4.38 (2.14) 1.17 ----------------------------------------------------------------------------- Less distributions from: Net investment income .................... (0.22) (0.32) (0.26) (0.19) (0.18) Net realized gains ....................... (1.20) (0.42) -- (0.26) (1.35) ----------------------------------------------------------------------------- Total distributions ......................... (1.42) (0.74) (0.26) (0.45) (1.53) ----------------------------------------------------------------------------- Redemption fees ............................. --(d) --(d) -- -- -- ----------------------------------------------------------------------------- Net asset value, end of year ................ $ 23.82 $ 22.94 $ 20.90 $ 16.78 $ 19.37 ============================================================================= Total return(b) ............................. 9.98% 13.50% 26.18% (11.20)% 5.94% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ............. $ 4,211,238 $ 2,940,029 $ 2,257,336 $ 1,543,833 $ 1,580,046 Ratios to average net assets:* Expenses(c) .............................. 1.16% 1.16% 1.19% 1.14% 1.13% Net investment income .................... 1.64% 1.27% 0.93% 1.44% 1.05% Portfolio turnover rate ..................... 21.57% 33.22% 54.65% 51.22% 52.98% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ................................. 1.11% 1.15% 1.16% 1.13% 1.12%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the sales commissions or the contingent deferred sales charge. (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 $0.01 per share. 18 | See notes to financial statements. | Annual Report MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2005 2004 2003 2002 2001 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............. $ 22.50 $ 20.54 $ 16.53 $ 19.12 $ 19.56 ---------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ..................... 0.23 0.13 0.04 0.15 0.08 Net realized and unrealized gains (losses) ... 1.88 2.44 4.14 (2.36) 0.95 ---------------------------------------------------------------------------- Total from investment operations ................ 2.11 2.57 4.18 (2.21) 1.03 ---------------------------------------------------------------------------- Less distributions from: Net investment income ........................ (0.06) (0.19) (0.17) (0.12) (0.12) Net realized gains ........................... (1.20) (0.42) -- (0.26) (1.35) ---------------------------------------------------------------------------- Total distributions ............................. (1.26) (0.61) (0.17) (0.38) (1.47) ---------------------------------------------------------------------------- Redemption fees ................................. --(d) --(d) -- -- -- ---------------------------------------------------------------------------- Net asset value, end of year .................... $ 23.35 $ 22.50 $ 20.54 $ 16.53 $ 19.12 ============================================================================ Total return(b) ................................. 9.31% 12.70% 25.41% (11.80)% 5.26% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................. $ 612,007 $ 588,401 $ 444,671 $ 235,470 $ 126,579 Ratios to average net assets:* Expenses(c) .................................. 1.81% 1.81% 1.84% 1.79% 1.78% Net investment income ........................ 0.99% 0.62% 0.28% 0.79% 0.37% Portfolio turnover rate ......................... 21.57% 33.22% 54.65% 51.22% 52.98% *Ratio to average net assets, excluding dividend expense on securities sold short: Expenses ..................................... 1.76% 1.80% 1.81% 1.78% 1.77%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. Annual Report | See notes to financial statements. | 19 MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2005 2004 2003 2002 2001 ---------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............. $ 22.76 $ 20.75 $ 16.68 $ 19.26 $ 19.63 ---------------------------------------------------------------------------- Income from investment operations: Net investment income(a) ..................... 0.23 0.13 0.05 0.15 0.08 Net realized and unrealized gains (losses) ... 1.89 2.49 4.17 (2.39) 0.95 ---------------------------------------------------------------------------- Total from investment operations ................ 2.12 2.62 4.22 (2.24) 1.03 ---------------------------------------------------------------------------- Less distributions from: Net investment income ........................ (0.20) (0.19) (0.15) (0.08) (0.05) Net realized gains ........................... (1.20) (0.42) -- (0.26) (1.35) ---------------------------------------------------------------------------- Total distributions ............................. (1.40) (0.61) (0.15) (0.34) (1.40) --------------------------------------------------------------------------- Redemption fees ................................. --(d) --(d) -- -- -- ---------------------------------------------------------------------------- Net asset value, end of year .................... $ 23.48 $ 22.76 $ 20.75 $ 16.68 $ 19.26 ============================================================================ Total return(b) ................................. 9.27% 12.77% 25.37% (11.78)% 5.26% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................. $ 1,834,009 $ 1,551,111 $ 1,272,590 $ 866,422 $ 885,658 Ratios to average net assets:* Expenses(c) .................................. 1.81% 1.81% 1.84% 1.78% 1.78% Net investment income ........................ 0.99% 0.62% 0.28% 0.80% 0.40% Portfolio turnover rate ......................... 21.57% 33.22% 54.65% 51.22% 52.98% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ..................................... 1.76% 1.80% 1.81% 1.77% 1.77%
(a) Based on average daily shares outstanding. (b) Total return does not reflect the contingent deferred sales charge. (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 $0.01 per share. 20| See notes to financial statements. | Annual Report MUTUAL SHARES FUND FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS R 2005 2004 2003 2002(e) --------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............. $ 22.85 $ 20.83 $ 16.75 $ 19.36 --------------------------------------------------------------- Income from investment operations: Net investment income(a) ..................... 0.35 0.24 0.13 0.24 Net realized and unrealized gains (losses) ... 1.91 2.50 4.21 (2.37) --------------------------------------------------------------- Total from investment operations ................ 2.26 2.74 4.34 (2.13) --------------------------------------------------------------- Less distributions from: Net investment income ........................ (0.19) (0.30) (0.26) (0.22) Net realized gains ........................... (1.20) (0.42) -- (0.26) --------------------------------------------------------------- Total distributions ............................. (1.39) (0.72) (0.26) (0.48) --------------------------------------------------------------- Redemption fees ................................. --(d) --(d) -- -- --------------------------------------------------------------- Net asset value, end of year .................... $ 23.72 $ 22.85 $ 20.83 $ 16.75 =============================================================== Total return(b) ................................. 9.88% 13.32% 26.02% (11.26)% RATIOS/SUPPLEMENTAL DATA Net assets, end of year (000's) ................. $ 109,305 $ 74,763 $ 46,933 $ 13,392 Ratios to average net assets:* Expenses(c) .................................. 1.31% 1.31% 1.34% 1.29%(f) Net investment income ........................ 1.49% 1.12% 0.78% 1.29%(f) Portfolio turnover rate ......................... 21.57% 33.22% 54.65% 51.22% *Ratios to average net assets, excluding dividend expense on securities sold short: Expenses ..................................... 1.26% 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. (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 $0.01 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, 2005
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS 81.2% AEROSPACE & DEFENSE 0.5% (a) GenCorp Inc. .................................................... United States 1,148,300 $ 20,382,325 Northrop Grumman Corp. .......................................... United States 891,940 53,614,513 -------------- 73,996,838 -------------- AIRLINES 0.5% (a) ACE Aviation Holdings Inc. ...................................... Canada 2,284,333 74,683,519 (a),(b) ACE Aviation Holdings Inc., A, 144A ............................. Canada 150,465 4,919,272 (a) ACE Aviation Holdings Inc., B ................................... Canada 3,080 100,326 (a),(c) Air Canada Inc., Contingent Distribution ........................ Canada 537,421,436 -- -------------- 79,703,117 -------------- AUTO COMPONENTS 0.0%(d) (a),(e),(f) Lancer Industries Inc., B ....................................... United States 3 6,494,600 -------------- BEVERAGES 3.9% Brown-Forman Corp., A ........................................... United States 125,460 8,900,132 Brown-Forman Corp., B ........................................... United States 606,036 42,010,416 Coca-Cola Enterprises Inc. ...................................... United States 7,032,260 134,808,424 Diageo PLC ...................................................... United Kingdom 13,878,432 201,164,968 Pernod Ricard SA ................................................ France 1,336,851 233,279,820 -------------- 620,163,760 -------------- CAPITAL MARKETS 0.5% Bear Stearns Cos.Inc. ........................................... United States 656,304 75,822,801 -------------- CHEMICALS 0.0%(d) Koninklijke DSM NV .............................................. Netherlands 19,300 788,267 -------------- COMMERCIAL BANKS 6.7% Allied Irish Banks PLC .......................................... Ireland 5,252,030 112,974,079 Banca Intesa SpA ................................................ Italy 34,121,292 180,765,352 Bank of Ireland ................................................. Ireland 5,404,128 85,089,104 BNP Paribas SA .................................................. France 536,357 43,399,942 (a),(f) Centennial Bank Holdings Inc. ................................... United States 3,845,467 47,568,427 Chinatrust Financial Holding Co. Ltd. ........................... Taiwan 99,733,000 78,992,825 Danske Bank ..................................................... Denmark 3,475,500 122,425,305 (a),(e),(f) Elephant Capital Holdings Ltd. .................................. Japan 25,721 36,652,032 ForeningsSparbanken AB, A ....................................... Sweden 4,761,679 129,746,838 (a) Investors Bancorp Inc. .......................................... United States 1,796 19,810 Mitsubishi UFJ Financial Group Inc. ............................. Japan 13,932 188,860,459 (a),(e) NCB Warrant Holdings Ltd., A .................................... Japan 124,040 20,039,915 -------------- 1,046,534,088 -------------- COMMERCIAL SERVICES & SUPPLIES 1.3% Cendant Corp. ................................................... United States 3,062,590 52,829,677 (a) Comdisco Holding Co. Inc. ....................................... United States 790 15,010 (c) Comdisco Holding Co. Inc., Contingent Distribution .............. United States 95,431,240 -- Republic Services Inc. .......................................... United States 3,077,650 115,565,757 (a),(c) Safety Kleen Corp., Contingent Distribution ..................... United States 1,085,000 -- (a) United Stationers Inc. .......................................... United States 725,439 35,183,792 -------------- 203,594,236 --------------
22 | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMPUTERS & PERIPHERALS 1.1% (a),(e),(f) DecisionOne Corp. ............................................... United States 1,879,100 $ 1,339,798 (a) Lexmark International Inc., A ................................... United States 3,062,560 137,294,565 (a) Maxtor Corp. .................................................... United States 5,989,900 41,569,906 -------------- 180,204,269 -------------- CONSUMER FINANCE 0.6% MBNA Corp. ...................................................... United States 3,218,500 87,382,275 -------------- CONTAINERS & PACKAGING 1.1% Temple-Inland Inc. .............................................. United States 3,700,000 165,945,000 -------------- DIVERSIFIED FINANCIAL SERVICES 2.0% Fortis Group NV ................................................. Belgium 6,331,992 201,570,904 Leucadia National Corp. ......................................... United States 2,326,843 110,431,969 (a),(c) Marconi Corp., Contingent Distribution .......................... United Kingdom 77,739,439 -- -------------- 312,002,873 -------------- DIVERSIFIED TELECOMMUNICATION SERVICES 3.2% (a),(e),(f),(g) AboveNet Inc. ................................................... United States 763,805 18,303,365 (a),(c),(f),(g) AboveNet Inc., Contingent Distribution .......................... United States 106,869,000 -- (a),(e),(f),(g) AboveNet Inc., wts., 9/08/08 .................................... United States 25,659 102,636 (a),(e),(f),(g) AboveNet Inc., wts., 9/08/10 .................................... United States 30,186 24,149 Chunghwa Telecom Co. Ltd., ADR .................................. Taiwan 363,800 6,675,730 (a),(c) Global Crossing Holdings Ltd., Contingent Distribution .......... United States 105,649,309 -- Koninklijke KPN NV .............................................. Netherlands 3,088,868 30,972,727 MCI Inc. ........................................................ United States 3,815,442 75,278,670 (a) NTL Inc. ........................................................ United Kingdom 1,883,548 128,231,948 Sprint Nextel Corp. ............................................. United States 336,452 7,859,519 (a),(c) Telewest Communications PLC, Contingent Distribution ............ United Kingdom 120,209,615 -- (a),(c) Telewest Finance Ltd., Contingent Distribution .................. United Kingdom 12,987,000 -- (a) Telewest Global Inc. ............................................ United Kingdom 7,073,342 168,487,006 Verizon Communications Inc. ..................................... United States 2,117,100 63,767,052 -------------- 499,702,802 -------------- ELECTRIC UTILITIES 0.3% E.ON AG ......................................................... Germany 454,370 47,045,253 (a),(b) Entegra/Union Power, 144A ....................................... United States 288,690 -- -------------- 47,045,253 -------------- FOOD & STAPLES RETAILING 1.3% Albertson's Inc. ................................................ United States 2,114,150 45,137,102 Carrefour SA .................................................... France 1,480,284 69,361,347 (a) Kroger Co. ...................................................... United States 4,420,770 83,464,138 -------------- 197,962,587 -------------- FOOD PRODUCTS 4.5% Cadbury Schweppes PLC ........................................... United Kingdom 12,700,586 120,069,719 General Mills Inc. .............................................. United States 1,037,600 51,174,432 Groupe Danone ................................................... France 671,351 70,139,237 Nestle SA ....................................................... Switzerland 653,170 195,391,673 Orkla ASA ....................................................... Norway 6,435,750 266,503,515 -------------- 703,278,576 --------------
Annual Report | 23 MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) HEALTH CARE PROVIDERS & SERVICES 2.2% Guidant Corp. ................................................... United States 2,321,300 $ 150,304,175 Hillenbrand Industries Inc. ..................................... United States 2,061,300 101,848,833 (a),(e),(f),(g) Kindred Healthcare Inc. ......................................... United States 2,380,966 58,267,000 (a),(e),(f),(g) Kindred Healthcare Inc., Jan.9.07 Calls, 1/01/13 ................ United States 1,146 17,645 (a),(e),(f),(g) Kindred Healthcare Inc., Jan.25.99 Calls, 1/01/14 ............... United States 568 -- (a),(e),(f),(g) Kindred Healthcare Inc., Jan.26.00 Calls, 1/01/12 ............... United States 1,724 -- (a),(e),(f),(g) Kindred Healthcare Inc., Jul.23.75 Calls, 7/17/11 ............... United States 7,640 5,516 (a),(e),(f),(g) Kindred Healthcare Inc., wts., Series A, 4/20/06 ................ United States 211,977 4,100,059 (a),(e),(f),(g) Kindred Healthcare Inc., wts., Series B, 4/20/06 ................ United States 529,943 8,709,613 MDS Inc. ........................................................ Canada 1,030,100 17,822,689 -------------- 341,075,530 -------------- HOTELS, RESTAURANTS & LEISURE 0.3% (a),(f) FHC Delaware Inc. ............................................... United States 784,457 2,726,694 (a),(c) Trump Atlantic, Contingent Distribution ......................... United States 53,232,000 2,006,847 (a) Trump Entertainment Resorts Inc. ................................ United States 1,814,341 36,522,684 -------------- 41,256,225 -------------- INDUSTRIAL CONGLOMERATES 1.9% Siemens AG ...................................................... Germany 1,307,326 112,005,450 Tyco International Ltd. ......................................... United States 6,701,100 193,393,746 -------------- 305,399,196 -------------- INSURANCE 10.0% (a) Alleghany Corp. ................................................. United States 341,815 97,075,460 (a) Berkshire Hathaway Inc., A ...................................... United States 1,590 140,905,800 (a) Berkshire Hathaway Inc., B ...................................... United States 149,920 440,090,160 (a) Conseco Inc. .................................................... United States 3,742,800 86,720,676 Hartford Financial Services Group Inc. .......................... United States 1,221,700 104,931,813 Montpelier Re Holdings Ltd. ..................................... Bermuda 863,889 16,327,502 Nationwide Financial Services Inc., A ........................... United States 1,794,150 78,942,600 Old Republic International Corp. ................................ United States 4,881,042 128,176,163 (a),(e) Olympus Re Holdings Ltd. ........................................ Bermuda 202,380 3,744,030 Prudential Financial Inc. ....................................... United States 948,700 69,435,353 (f) White Mountains Insurance Group Inc. ............................ United States 740,448 413,577,230 -------------- 1,579,926,787 -------------- LEISURE EQUIPMENT & PRODUCTS 0.6% Mattel Inc. ..................................................... United States 5,907,650 93,459,023 -------------- MACHINERY 1.3% Deere & Co. ..................................................... United States 2,155,880 146,836,987 (f) Federal Signal Corp. ............................................ United States 3,360,800 50,445,608 -------------- 197,282,595 -------------- MEDIA 6.4% (a) Cablevision Systems Corp., A .................................... United States 1,650,900 38,746,623 Clear Channel Communications Inc. ............................... United States 3,336,400 104,929,780 (a) Comcast Corp., A ................................................ United States 2,928,427 75,231,290 E.W.Scripps Co., A .............................................. United States 696,850 33,462,737 (a) EchoStar Communications Corp., A ................................ United States 1,277,791 34,717,581
24 | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MEDIA (CONTINUED) Hollinger International Inc. .................................... United States 1,929,706 $ 16,425,661 Knight Ridder Inc. .............................................. United States 336,100 21,275,130 (a) Liberty Media Corp., A .......................................... United States 14,398,624 113,317,171 News Corp., A ................................................... United States 12,748,322 198,236,407 Omnicom Group Inc. .............................................. United States 432,800 36,844,264 (e) Time Warner Inc. ................................................ United States 2,833,800 48,433,043 (e) Time Warner Inc., Jan.10.00 Calls, 1/21/06 ...................... United States 59,140 43,467,900 (a),(f) TVMAX Holdings Inc. ............................................. United States 257,217 257,217 Viacom Inc., B .................................................. United States 1,884,600 61,437,960 Washington Post Co., B .......................................... United States 238,238 182,252,070 -------------- 1,009,034,834 -------------- METALS & MINING 4.0% Anglo American PLC .............................................. South Africa 5,759,845 196,109,499 Anglo American PLC, ADR ......................................... South Africa 2,300 79,994 Barrick Gold Corp. .............................................. Canada 398,200 11,097,834 Dofasco Inc. .................................................... Canada 1,209,736 67,631,976 Falconbridge Ltd. ............................................... Canada 505,003 14,989,765 Freeport-McMoRan Copper & Gold Inc., B .......................... United States 447,300 24,064,740 (a) Glamis Gold Ltd. ................................................ Canada 1,306,700 35,941,839 Gold Fields Ltd. ................................................ South Africa 642,754 11,356,760 Goldcorp Inc. ................................................... Canada 998,079 22,239,564 (a) Goldcorp Inc., wts., 5/30/07 .................................... Canada 1,819,489 7,592,292 (a) Harmony Gold Mining Co. Ltd., ADR ............................... South Africa 933,000 12,175,650 Newmont Mining Corp. ............................................ United States 2,968,110 158,497,074 Placer Dome Inc. ................................................ Canada 2,923,875 66,965,114 -------------- 628,742,101 -------------- MULTI-UTILITIES & UNREGULATED POWER 0.4% NorthWestern Corp. .............................................. United States 711,831 22,116,589 (a),(c) NorthWestern Corp., Contingent Distribution ..................... United States 21,590,000 1,835,150 Suez SA ......................................................... France 1,349,071 42,003,670 -------------- 65,955,409 -------------- OIL, GAS & CONSUMABLE FUELS 5.7% (a) Anchor Resources LLC ............................................ United States 123,013 -- (a) Apco Oil Corp. .................................................. United States 9,200 -- BP PLC .......................................................... United Kingdom 5,707,068 60,777,906 BP PLC, ADR ..................................................... United Kingdom 46,400 2,979,808 Burlington Resources Inc. ....................................... United States 1,523,500 131,325,700 Oil & Natural Gas Corp. Ltd. .................................... India 2,308,558 60,283,148 (a) OPTI Canada ..................................................... Canada 9,481,276 311,365,659 Pogo Producing Co. .............................................. United States 1,332,500 66,371,825 Statoil ASA ..................................................... Norway 1,593,324 36,589,608 Suncor Energy Inc. .............................................. Canada 1,389,492 87,651,685 Total SA, B ..................................................... France 380,938 95,696,567 Vintage Petroleum Inc. .......................................... United States 897,550 47,866,342 -------------- 900,908,248 --------------
Annual Report | 25 Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) PAPER & FOREST PRODUCTS 3.6% Abitibi-Consolidated Inc. ....................................... Canada 538,387 $ 2,158,551 International Paper Co. ......................................... United States 4,270,400 143,528,144 Potlatch Corp. .................................................. United States 233,800 11,919,124 Weyerhaeuser Co. ................................................ United States 6,235,207 413,643,632 -------------- 571,249,451 -------------- PHARMACEUTICALS 3.0% Bristol-Myers Squibb Co. ........................................ United States 3,308,740 76,034,845 (a) IVAX Corp. ...................................................... United States 330,800 10,363,964 Merck & Co. Inc. ................................................ United States 1,123,000 35,722,630 Pfizer Inc. ..................................................... United States 7,671,040 178,888,653 Sanofi-Aventis .................................................. France 689,026 60,362,054 Valeant Pharmaceuticals International ........................... United States 3,520,835 63,656,697 Wyeth ........................................................... United States 890,500 41,025,335 -------------- 466,054,178 -------------- REAL ESTATE 1.8% (a),(f) Alexander's Inc. ................................................ United States 326,675 80,198,713 Canary Wharf Group PLC .......................................... United Kingdom 14,262,931 58,892,781 Fieldstone Investment Corp. ..................................... United States 2,365,900 28,059,574 (a),(e) Security Capital European Realty ................................ Luxembourg 28,412 206,484 Shurgard Storage Centers Inc., A ................................ United States 299,900 17,007,329 St.Joe Co. ...................................................... United States 1,052,935 70,778,291 Ventas Inc. ..................................................... United States 1,072,765 34,349,935 -------------- 289,493,107 -------------- ROAD & RAIL 1.1% (e) Florida East Coast Industries Inc. .............................. United States 4,423,071 178,035,242 -------------- SOFTWARE 0.7% Microsoft Corp. ................................................. United States 4,439,759 116,099,698 -------------- TEXTILES APPAREL & LUXURY GOODS 0.2% Reebok International Ltd. ....................................... United States 524,300 30,529,989 -------------- THRIFTS & MORTGAGE FINANCE 1.1% Hudson City Bancorp Inc. ........................................ United States 4,121,569 49,953,416 Sovereign Bancorp Inc. .......................................... United States 5,828,890 126,020,602 -------------- 175,974,018 -------------- TOBACCO 9.4% Altadis SA ...................................................... Spain 7,776,607 352,786,807 Altria Group Inc. ............................................... United States 2,479,677 185,281,466 British American Tobacco PLC .................................... United Kingdom 20,437,626 457,104,861 British American Tobacco PLC, ADR ............................... United Kingdom 70,550 3,177,572 Imperial Tobacco Group PLC ...................................... United Kingdom 6,933,289 207,195,902 Reynolds American Inc. .......................................... United States 2,778,000 264,826,740 -------------- 1,470,373,348 -------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $9,220,498,558) ........................................ 12,761,470,321 --------------
26 | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ----------------------------------------------------------------------------------------------------------------------------------- PREFERRED STOCKS 0.4% DIVERSIFIED TELECOMMUNICATION SERVICES 0.0%(d) PTV Inc., 10.00%, pfd., A ...................................... United Kingdom 199,565 $ 419,086 --------------- ELECTRIC UTILITIES 0.0%(d) (a) Montana Power Co., 8.45%, pfd. ................................. United States 109,220 901,065 --------------- METALS & MINING 0.4% (e),(f),(g) Esmark Inc., Series A, 10.00%, cvt. pfd. ....................... United States 60,419 63,357,780 Falconbridge Ltd., 6.00%, cvt. pfd., 1 ......................... Canada 46,262 1,168,115 Falconbridge Ltd., 6.25%, cvt. pfd., 2 ......................... Canada 46,262 1,168,116 Falconbridge Ltd., 6.50%, cvt. pfd., 3 ......................... Canada 23,131 586,371 --------------- 66,280,382 --------------- TOTAL PREFERRED STOCKS (COST $67,167,005) ...................... 67,600,533 --------------- ----------------- PRINCIPAL AMOUNT(j) ----------------- CORPORATE BONDS & NOTES 1.7% (b) ACE Aviation Holdings Inc., cvt., 144A, 4.25%, 6/01/35 ......... Canada 5,190,000CAD 4,375,979 (h) Collins & Aikman Products Co., Revolver, FRN, 10.75%, 8/31/09 .............................. United States 1,157,404 1,122,682 Tranche B1 Term Loan, FRN, 10.75%, 8/31/11 .................. United States 2,711,000 2,629,670 Dana Corp., 5.85%, 1/15/15 .............................................. United States 13,032,000 9,317,880 7.00%, 3/01/29 .............................................. United States 1,834,000 1,325,065 (e),(f) DecisionOne Corp., 144A, 12.00%, 4/15/10 ....................... United States 2,039,765 2,039,765 Entegra/Union Power, Term Loan A, 4.00%, 6/01/12 ................................. United States 14,706,857 12,647,897 Term Loan B, 9.00%, 6/01/20 ................................. United States 14,162,158 12,179,456 Eurotunnel PLC, Participating Loan Note, 1.00%, 4/30/40 ..................... United Kingdom 1,482,000GBP 242,222 (b),(h) Senior Tranche G2 Term Loan A, 144A, FRN, 5.618%, 12/15/12 .................................................... United Kingdom 1,627,232GBP 2,694,587 (h) Tier 2, FRN, 5.796%, 12/31/18 ............................... United Kingdom 13,617,682GBP 19,914,259 (h) Tier 3, FRN, 5.796%, 12/31/25 ............................... United Kingdom 53,591,168GBP 43,334,433 Eurotunnel SA, Senior Tranche H1 Term Loan (KfW Advance), 8.78%, 12/15/12 .. France 1,427,326EUR 1,605,253 (h) Tier 2 (PIBOR), FRN, 3.393%, 12/31/18 ....................... France 1,393,972EUR 1,402,715 (h) Tier 2 (LIBOR), FRN, 3.393%, 12/31/18 ....................... France 3,151,383EUR 3,171,150 (h) Tier 3 (PIBOR), FRN, 3.393%, 12/31/25 ....................... France 13,502,354EUR 7,512,838 (h) Tier 3 (LIBOR), FRN, 3.393%, 12/31/25 ....................... France 77,744,116EUR 43,257,565 (h) Motor Coach Industries International Inc., FRN, 17.406%, 12/01/08 .................................................... United States 58,046,343 55,144,026 Trump Entertaiment Resorts Inc., 8.50%, 5/20/15 ................ United States 36,590,212 35,858,408 (f) TVMAX Holdings Inc., PIK, 11.50%, 1/16/06 ............................................. United States 433,314 433,314 (i) 14.00%, 1/16/06 ............................................. United States 1,203,322 1,203,322 --------------- TOTAL CORPORATE BONDS & NOTES (COST $286,520,729) .............. 261,412,486 ---------------
Annual Report | 27 MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- SHARES/PRINCIPAL COUNTRY AMOUNT(j) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- CORPORATE BONDS & NOTES IN REORGANIZATION 1.0% (k) Adelphia Communications Corp., 9.25%, 10/01/02 ............................................. United States 11,465,000 $ 6,420,400 8.125%, 7/15/03 ............................................. United States 1,442,000 821,940 7.50%, 1/15/04 .............................................. United States 3,750,000 2,137,500 10.50%, 7/15/04 ............................................. United States 6,320,000 3,602,400 9.875%, 3/01/05 ............................................. United States 2,564,000 1,455,070 10.25%, 11/01/06 ............................................ United States 11,760,000 6,585,600 9.875%, 3/01/07 ............................................. United States 1,090,000 621,300 8.375%, 2/01/08 ............................................. United States 9,037,000 5,151,090 7.75%, 1/15/09 .............................................. United States 19,364,000 10,940,660 7.875%, 5/01/09 ............................................. United States 7,952,000 4,413,360 9.375%, 11/15/09 ............................................ United States 9,522,000 5,617,980 10.875%, 10/01/10 ........................................... United States 8,130,000 4,593,450 10.25%, 6/15/11 ............................................. United States 9,783,000 5,918,715 (k) Armstrong World Industries Inc., 6.35%, 8/15/03 .............................................. United States 23,041,000 16,589,520 6.50%, 8/15/05 .............................................. United States 1,835,000 1,302,850 9.75%, 4/15/08 .............................................. United States 5,498,000 4,068,520 7.45%, 5/15/29 .............................................. United States 3,239,000 2,396,860 Revolver, 10/29/03 .......................................... United States 4,049,775 2,839,905 Trade Claim ................................................. United States 10,859,300 7,560,788 (k) Century Communications Corp., (l) 8.875%, 1/15/07 ............................................. United States 559,000 536,640 8.75%, 10/01/07 ............................................. United States 5,509,000 5,178,460 8.375%, 12/15/07 ............................................ United States 875,000 840,000 senior note, 9.50%, 3/01/05 ................................. United States 1,578,000 1,530,660 Series B, zero cpn., 1/15/08 ................................ United States 8,769,000 4,866,795 zero cpn., 3/15/03 .......................................... United States 15,848,000 13,470,800 (i),(k) Owens Corning, Revolver, 6/26/02 ............................... United States 29,722,681 41,611,754 (k) Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ........ United States 85,000 42 --------------- TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $159,262,219) ......................................... 161,073,059 --------------- COMPANIES IN LIQUIDATION 0.0%(d) (a) City Investing Co. Liquidating Trust ........................... United States 4,373,476 481,082 (a) MBOP Liquidating Trust ......................................... United States 574,712 75 (a) Peregrine Investments Holdings Ltd., 6.70%, 1/15/98 .............................................. Hong Kong 95,000,000JPY 24,147 6.70%, 6/30/00 .............................................. Hong Kong 250,000,000JPY 63,543 zero cpn., 1/22/98 .......................................... Hong Kong 500,000 15,000 (a) PIV Investment Finance (Cayman) Ltd. ........................... Hong Kong 22,710,000 1,362,600 (a) United Cos. Financial Corp., Bank Claim ........................ United States 179,680 -- --------------- TOTAL COMPANIES IN LIQUIDATION (COST $--) ...................... 1,946,447 ---------------
28 | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- PRINCIPAL COUNTRY AMOUNT(o) VALUE - ----------------------------------------------------------------------------------------------------------------------------------- GOVERNMENT AGENCIES 14.2% (m),(n) Federal Home Loan Bank, 0.00% - 3.60%, 1/23/06 - 7/02/07 ....... United States 2,184,005,000 $ 2,160,350,484 Federal Home Loan Mortgage Corp., 2.50%, 05/19/06 .............. United States 25,000,000 24,806,050 Federal National Mortgage Association, 2.15% - 2.20%, 12/18/06 - 12/29/06 ......................................... United States 30,000,000 29,280,080 (m),(n) U.S. Treasury Bills, 2/02/06 - 2/16/06 ......................... United States 20,000,000 19,914,185 --------------- TOTAL GOVERNMENT AGENCIES (COST $2,240,042,154) ................ 2,234,350,799 --------------- TOTAL INVESTMENTS BEFORE REPURCHASE AGREEMENTS (COST $11,973,490,665) ...................................... 15,487,853,645 --------------- REPURCHASE AGREEMENTS 0.0%(d) (o),(p) Bank of America LLC, 4.32%, 1/03/06 (Maturity Value $92,055) Collateralized by U.S. Government Agency Securities, 5.00-5.50%, 9/01/33-10/01/35 ................................ 92,011 92,011 (o),(p) Bear Stearns & Co. Inc., 4.25%, 1/03/06 (Maturity Value $78,046) Collateralized by U.S. Government Agency Securities, 3.22-7.155%, 3/01/17-9/01/45 ................................ 78,009 78,009 (o),(p) Merrill Lynch GSI, 4.25%, 1/03/06 (Maturity Value $378,224) Collateralized by U.S. Government Agency Securities, 3.99-5.83%, 11/01/27-8/01/35 ................................ 378,045 378,045 --------------- TOTAL REPURCHASE AGREEMENTS (COST $548,065) .................... 548,065 --------------- TOTAL INVESTMENTS (COST $11,974,038,730) 98.5% ................. 15,488,401,710 OPTIONS WRITTEN 0.0%(d) ........................................ (27,500) SECURITIES SOLD SHORT (2.0)% ................................... (314,673,194) NET UNREALIZED GAIN ON FORWARD EXCHANGE CONTRACTS 0.4% ......... 58,900,240 OTHER ASSETS, LESS LIABILITIES 3.1% ............................ 485,037,741 --------------- NET ASSETS 100.0% .............................................. $15,717,638,997 =============== ------------ CONTRACTS ------------ (q) OPTIONS WRITTEN 0.0%(d) MEDIA 0.0%(d) Cablevision Systems Corp., Jan. 22.50 Puts, 1/21/06 ............ United States 300 $ 13,500 --------------- PHARMACEUTICALS 0.0%(d) Pfizer Inc., Jan. 22.50 Puts, 1/21/06 .......................... United States 700 14,000 --------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $80,997) .............. 27,500 ---------------
Annual Report | 29 MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE - ----------------------------------------------------------------------------------------------------------------------------------- (r) SECURITIES SOLD SHORT 2.0% COMMERCIAL BANKS 0.5% Bank of America Corp. .......................................... United States 1,611,360 $ 74,364,264 --------------- COMPUTERS & PERIPHERALS 0.3% Seagate Technology ............................................. United States 2,216,300 44,303,837 --------------- FOOD PRODUCTS 0.3% Kraft Foods Inc., A ............................................ United States 1,623,881 45,696,011 --------------- HEALTH CARE EQUIPMENT & SUPPLIES 0.1% Alcon Inc. ..................................................... Switzerland 173,200 22,446,720 --------------- HEALTH CARE PROVIDERS & SERVICES 0.0%(d) UnitedHealth Group Inc. ........................................ United States 1,060 65,869 WellPoint Inc. ................................................. United States 214 17,075 --------------- 82,944 --------------- METALS & MINING 0.1% Inco Ltd. ...................................................... Canada 264,342 11,485,220 --------------- OIL, GAS & CONSUMER FUELS 0.6% ConocoPhillips ................................................. United States 1,099,140 63,947,965 Occidental Petroleum Corp. ..................................... United States 376,900 30,106,772 --------------- 94,054,737 --------------- PHARMACEUTICALS 0.0%(d) Teva Pharmaceutical Industries Ltd., ADR ....................... Israel 140,200 6,030,002 --------------- REAL ESTATE 0.1% Public Storage Inc. ............................................ United States 239,360 16,209,459 --------------- TOTAL SECURITIES SOLD SHORT (PROCEEDS $319,254,070) ............ $ 314,673,194 ---------------
30 | See notes to financial statements. | Annual Report MUTUAL SHARES FUND STATEMENT OF INVESTMENTS, DECEMBER 31, 2005 (CONTINUED) CURRENCY ABBREVIATIONS CAD - Canadian Dollar EUR - Euro GBP - British Pound JPY - Japanese Yen SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FRN - Floating Rate Note LIBOR - London InterBank Offered Rate PIBOR - Paris InterBank Offered Rate PIK - Payment-In-Kind (a) Non-income producing. (b) Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. These securities have been deemed liquid under guidelines approved by the Fund's Board of Directors. At December 31, 2005, the aggregate value of these securities was $11,989,838, representing 0.08% of net assets. (c) 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. (d) Rounds to less than 0.05% of net assets. (e) See Note 11 regarding restricted and illiquid securities. (f) See Note 13 regarding holdings of 5% voting securities. (g) See Note 14 regarding other considerations. (h) The coupon rate shown represents the rate at period end. (i) See Note 12 regarding unfunded loan commitments. (j) The principal amount is stated in U.S. dollars unless otherwise indicated. (k) See Note 10 regarding defaulted securities. (l) A portion or all of the security is on loan as of December 31, 2005. See Note 1(i). (m) See Note 1(g) regarding securities segregated with broker for securities sold short. (n) A portion or all of the security is traded on a discount basis with no stated coupon rate. (o) See Note 1(c) regarding repurchase agreements. (p) Investments from cash collateral received for loaned securities. See Note 1(i). (q) See Note 1(f) regarding written options. (r) See Note 1(g) regarding securities sold short. Annual Report | 31 MUTUAL SHARES FUND FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2005 Assets: Investments in securities: Cost - Unaffiliated issuers ............................................... $11,342,483,729 Cost - Non-controlled affiliated issuers (Note 13) ........................ 631,006,936 Cost - Repurchase agreements .............................................. 548,065 --------------- Total cost of investments ................................................. $11,974,038,730 =============== Value - Unaffiliated issuers (includes securities segregated with broker for securities sold short in the amount of $213,322,802) ....... $14,202,147,047 Value - Non-controlled affiliated issuers (Note 13) ....................... 1,285,706,598 Value - Repurchase agreements ............................................. 548,065 --------------- Total value of investments ................................................ 15,488,401,710 Cash ......................................................................... 2,800,084 Foreign currency, at value (cost $134,438,633) ............................... 134,880,008 Receivables: Investment securities sold ................................................ 58,390,840 Capital shares sold ....................................................... 30,076,066 Dividends and interest .................................................... 26,657,885 Unrealized gain on forward exchange contracts (Note 8) ....................... 81,846,110 Unrealized gains on unfunded loan commitments (Note 12) ...................... 1,260,314 Cash on deposits with brokers for securities sold short ...................... 333,351,680 Due from broker - synthetic equity swaps ..................................... 24,443,705 --------------- Total assets ........................................................... 16,182,108,402 --------------- Liabilities: Payables: Investment securities purchased ........................................... 87,230,579 Capital shares redeemed ................................................... 20,706,731 Affiliates ................................................................ 16,106,297 Options written, at value (premiums received $80,997) ........................ 27,500 Securities sold short, at value (proceeds $319,254,070) ...................... 314,673,194 Payable upon return of securities loaned ..................................... 548,065 Deferred tax ................................................................. 431,279 Unrealized loss on forward exchange contracts (Note 8) ....................... 22,945,870 Accrued expenses and other liabilities ....................................... 1,799,890 --------------- Total liabilities ...................................................... 464,469,405 --------------- Net assets, at value ................................................ $15,717,638,997 =============== Net assets consist of: Paid-in capital .............................................................. $11,992,736,589 Undistributed net investment income .......................................... 72,585,668 Net unrealized appreciation (depreciation) ................................... 3,583,199,810 Accumulated net realized gain (loss) ......................................... 69,116,930 --------------- Net assets, at value ................................................ $15,717,638,997 ===============
32 | See notes to financial statements. | Annual Report MUTUAL SHARES FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2005 CLASS Z: Net assets, at value ....................................................... $8,951,079,511 ============== Shares outstanding ......................................................... 373,683,325 ============== Net asset value and maximum offering price per share(a) .................... $ 23.95 ============== CLASS A: Net assets, at value ....................................................... $4,211,238,126 ============== Shares outstanding ......................................................... 176,814,791 ============== Net asset value per share(a) ............................................... $ 23.82 ============== Maximum offering price per share (net asset value per share / 94.25%) ...... $ 25.27 ============== CLASS B: Net assets, at value ....................................................... $ 612,006,662 ============== Shares outstanding ......................................................... 26,215,051 ============== Net asset value and maximum offering price per share(a) .................... $ 23.35 ============== CLASS C: Net assets, at value ....................................................... $1,834,009,291 ============== Shares outstanding ......................................................... 78,115,113 ============== Net asset value and maximum offering price per share(a) .................... $ 23.48 ============== CLASS R: Net assets, at value ....................................................... $ 109,305,407 ============== Shares outstanding ......................................................... 4,608,220 ============== Net asset value and maximum offering price per share(a) .................... $ 23.72 ==============
(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, 2005 Investment income: Dividends Unaffiliated issuers ........................................................ $ 250,945,243 Non-controlled affiliated issuers (Note 13) ................................. 10,413,317 Interest Unaffiliated issuers ........................................................ 124,018,913 Non-controlled affiliated issuers (Note 13) ................................. 347,004 Income from securities loaned - net ............................................ 21,209 Other income (Note 15) ......................................................... 471,068 --------------- Total investment income ................................................ 386,216,754 --------------- Expenses: Management fees (Note 3a) ...................................................... 79,196,080 Administrative fees (Note 3b) .................................................. 10,578,037 Distribution fees (Note 3c) Class A ..................................................................... 12,018,793 Class B ..................................................................... 5,937,243 Class C ..................................................................... 16,651,011 Class R ..................................................................... 452,529 Transfer agent fees (Note 3e) .................................................. 11,856,300 Custodian fees (Note 4) ........................................................ 1,345,783 Reports to shareholders ........................................................ 826,700 Registration and filing fees ................................................... 524,500 Professional fees .............................................................. 629,721 Directors' fees and expenses ................................................... 361,200 Dividends on securities sold short ............................................. 6,255,734 Other .......................................................................... 457,495 --------------- Total expenses ......................................................... 147,091,126 Expense reductions (Note 4) ............................................ (113,876) --------------- Net expenses ........................................................ 146,977,250 --------------- Net investment income ............................................ 239,239,504 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments Unaffiliated issuers ..................................................... 537,991,986 Controlled affiliate issuers (Note 13) ................................... (3,491,624) Non-controlled affiliated issuers (Note 13) .............................. 168,964,508 Written options ............................................................. 1,201,296 Foreign currency transactions ............................................... 54,556,077 Securities sold short ....................................................... (4,809,078) --------------- Net realized gain (loss) ............................................... 754,413,165 --------------- Net change in unrealized appreciation (depreciation) on: Investments ................................................................. 256,294,033 Translation of assets and liabilities denominated in foreign currencies ..... 134,601,496 Change in deferred taxes on unrealized appreciation ............................ (415,208) --------------- Net change in unrealized appreciation (depreciation) ................... 390,480,321 --------------- Net realized and unrealized gain (loss) ........................................... 1,144,893,486 --------------- Net increase (decrease) in net assets resulting from operations ................... $ 1,384,132,990 ===============
34 | See notes to financial statements. | Annual Report MUTUAL SHARES FUND FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
------------------------------------ YEAR ENDED DECEMBER 31, ------------------------------------ 2005 2004 ------------------------------------ Increase (decrease) in net assets: Operations: Net investment income .............................................................. $ 239,239,504 $ 146,639,688 Net realized gain (loss) from investments, written options, securities sold short, and foreign currency transactions ........................................ 754,413,165 320,840,913 Net change in unrealized appreciation (depreciation) on investments, translation of assets and liabilities denominated in foreign currencies and deferred taxes .. 390,480,321 970,977,637 ------------------------------------ Net increase (decrease) in net assets resulting from operations .............. 1,384,132,990 1,438,458,238 ------------------------------------ Distributions to shareholders from: Net investment income: Class Z ......................................................................... (103,197,432) (118,691,555) Class A ......................................................................... (35,896,189) (39,459,758) Class B ......................................................................... (1,459,350) (4,845,646) Class C ......................................................................... (14,954,125) (12,290,974) Class R ......................................................................... (802,093) (913,976) Net realized gains: Class Z ......................................................................... (423,357,278) (128,945,088) Class A ......................................................................... (199,279,526) (52,647,915) Class B ......................................................................... (30,001,973) (10,792,182) Class C ......................................................................... (88,516,570) (28,220,750) Class R ......................................................................... (5,204,999) (1,342,860) ------------------------------------ Total distributions to shareholders ................................................... (902,669,535) (398,150,704) ------------------------------------ Capital share transactions: (Note 2) Class Z ......................................................................... 1,416,100,652 847,945,959 Class A ......................................................................... 1,158,479,828 438,813,545 Class B ......................................................................... 1,693,456 95,341,685 Class C ......................................................................... 233,434,044 146,965,374 Class R ......................................................................... 31,485,467 21,886,122 ------------------------------------ Total capital share transactions ...................................................... 2,841,193,447 1,550,952,685 ------------------------------------ Redemption fees ....................................................................... 37,371 9,352 ------------------------------------ Net increase (decrease) in net assets ........................................ 3,322,694,273 2,591,269,571 Net assets: Beginning of year .................................................................. 12,394,944,724 9,803,675,153 ------------------------------------ End of year ........................................................................ $ 15,717,638,997 $ 12,394,944,724 ==================================== Undistributed net investment income/distributions in excess of net investment income included in net assets: End of year ........................................................................ $ 72,585,668 $ (5,984,486) ====================================
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 six separate series. The Series Fund 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 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 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. 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 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. 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. 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. Due to the inherent uncertainty of valuations of such securities, the fair values may differ significantly from the values that would have been used had a ready market for such investments existed. 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. 36 | Annual Report MUTUAL SHARES 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. 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 Fund, with the value of the underlying securities marked to market daily to maintain coverage of at least 100%. Repurchase agreements are valued at cost. At December 31, 2005, all repurchase agreements held by the Fund had been entered into on December 30, 2005. 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 the net unrealized gain or loss on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, 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. Annual Report | 37 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) D. FOREIGN CURRENCY CONTRACTS (CONTINUED) When the Fund purchases or sells foreign securities it may enter into foreign exchange contracts to minimize foreign exchange risk from the trade date to the settlement date of the transactions. Realized and unrealized gains and losses 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, which may be in excess of the amount reflected in the Statement of Assets and Liabilities. 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. OPTIONS 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. 38 | Annual Report MUTUAL SHARES 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 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. 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 receives interest income 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. I. INCOME AND DEFERRED TAXES No provision has been made for U.S. income taxes because the Fund's policy is to continue to qualify as a regulated investment company under the Internal Revenue Code and to distribute to shareholders substantially all of its taxable income and net realized gains. The Fund is subject to a tax imposed on net realized gains on securities of certain foreign countries. The Fund records an estimated deferred tax liability for net unrealized gains on these securities in an amount that would be payable if the securities were disposed of on the valuation date. Foreign securities held by the Fund may be subject to foreign tax. The foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign market in which the Fund invests. Annual Report | 39 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. 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. Amortization of premium and accretion of discount on debt securities are included in interest income. Dividend income and dividends declared on securities sold short are recorded on the ex-dividend date except that certain dividends from foreign securities are recognized as soon as the Fund is notified of the ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and are determined according to income tax regulations (tax basis). Such distributions are reinvested in additional shares of the Fund. Distributable earnings determined on a tax basis may differ from earnings recorded in accordance with generally accepted accounting principles. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods. 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 of the Series Fund. Fund specific expenses are charged directly to the fund that incurred the expense. K. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. L. REDEMPTION FEES A short term trading redemption fee will be imposed, with some exceptions, on Fund shares that are redeemed or exchanged within seven calendar days following their purchase date. The redemption fee is 2% of the amount redeemed. Such fees are retained by the Fund and accounted for as an addition to paid-in capital. 40| Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) M. GUARANTEES AND INDEMNIFICATIONS Under the Series Fund's organizational documents, its officers and directors are indemnified by the Fund against certain liabilities 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 are only offered to existing Class B shareholders in the form of reinvested distributions and certain exchanges from other Franklin Templeton Class B shares. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. At December 31, 2005, there were 1.9 billion shares authorized ($0.001 par value) of which 1 billion shares were designated as Class Z, 250 million shares as Class A, 200 million shares as Class B, 250 million shares as Class C and 200 million shares as Class R. Transactions in the Fund's shares were as follows:
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2005 2004 -------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT CLASS Z SHARES: Shares sold ...................................... 58,317,629 $ 1,382,140,067 50,806,616 $ 1,104,922,147 Shares issued in reinvestment of distributions ... 19,934,438 478,389,881 9,758,882 219,303,487 Shares redeemed .................................. (18,728,837) (444,429,296) (21,921,975) (476,279,675) -------------------------------------------------------------- Net increase (decrease) .......................... 59,523,230 $ 1,416,100,652 38,643,523 $ 847,945,959 ============================================================== CLASS A SHARES: Shares sold ...................................... 62,183,806 $ 1,476,618,967 37,809,209 $ 815,970,082 Shares issued in reinvestment of distributions ... 9,031,555 215,572,318 3,786,200 84,685,091 Shares redeemed .................................. (22,579,055) (533,711,457) (21,439,414) (461,841,628) -------------------------------------------------------------- Net increase (decrease) .......................... 48,636,306 $ 1,158,479,828 20,155,995 $ 438,813,545 ============================================================== CLASS B SHARES: Shares sold ...................................... 1,344,083 $ 30,694,786 6,156,400 $ 129,929,525 Shares issued in reinvestment of distributions ... 1,266,719 29,636,484 670,932 14,717,392 Shares redeemed .................................. (2,541,813) (58,637,814) (2,332,950) (49,305,232) -------------------------------------------------------------- Net increase (decrease) .......................... 68,989 $ 1,693,456 4,494,382 $ 95,341,685 ==============================================================
Annual Report | 41 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
-------------------------------------------------------- YEAR ENDED DECEMBER 31, 2005 2004 -------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------- CLASS C SHARES: Shares sold ........................................ 15,473,104 $ 361,085,892 13,913,529 $ 297,054,287 Shares issued in reinvestment of distributions ..... 4,035,616 94,971,880 1,682,221 37,310,819 Shares redeemed .................................... (9,546,635) (222,623,728) (8,770,041) (187,399,732) -------------------------------------------------------- Net increase (decrease) ............................ 9,962,085 $ 233,434,044 6,825,709 $ 146,965,374 ======================================================== CLASS R SHARES: Shares sold ........................................ 2,060,687 $ 48,448,915 1,573,958 $ 33,763,040 Shares issued in reinvestment of distributions ..... 251,253 5,971,962 100,387 2,237,745 Shares redeemed .................................... (975,186) (22,935,410) (656,261) (14,114,663) -------------------------------------------------------- Net increase (decrease) ............................ 1,336,754 $ 31,485,467 1,018,084 $ 21,886,122 ========================================================
3. TRANSACTIONS WITH AFFILIATES Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton Investments. Certain officers and directors of the Series Fund are also officers and/or directors of the following subsidiaries:
- ---------------------------------------------------------------------------------------- SUBSIDIARY 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 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% Up to and including $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% In excess of $20 billion 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 Series Fund aggregate average daily net assets of the Fund as follows: - -------------------------------------------------------------------------------- ANNUALIZED FEE RATE NET ASSETS - -------------------------------------------------------------------------------- 0.150% Up to and including $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% In excess of $1.2 billion C. DISTRIBUTION FEES The Fund's Board of Directors has adopted distribution plans for each share class, with the exception of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund's Class A reimbursement distribution plan, the Fund reimburses Distributors up to 0.35% per year of Class A's average daily net assets for costs incurred in connection with the sale and distribution of the Fund's shares. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. Under the Fund's compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the sale and distribution of the Fund's shares up to a certain percentage per year of its average daily net assets of each class as follows: Class B ................................................................ 1.00% Class C ................................................................ 1.00% Class R ................................................................ 0.50% 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 charge received(a) ...................................... $5,088,424 Contingent deferred sales charges retained ........................ $1,051,595 (a) Net of commissions paid to unaffiliated broker/dealers. E. TRANSFER AGENT FEES The Fund paid transfer agent fees of $11,856,300, of which $8,017,740 was retained by Investor Services. Annual Report | 43 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 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, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES For tax purposes, realized currency losses occurring subsequent to October 31, may be deferred and treated as occurring on the first day of the following fiscal year. At December 31, 2005, the Fund deferred realized currency losses of $1,890,361. Net investment income 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 (losses) differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, bond discounts and premiums, defaulted securities and certain dividends on securities sold short. At December 31, 2005, 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 ........................................ $ 12,007,500,996 ================ Unrealized appreciation .................................... $ 3,799,681,538 Unrealized depreciation .................................... (318,780,824) ---------------- Net unrealized appreciation (depreciation) ................. $ 3,480,900,714 ================ Undistributed ordinary income .............................. $ 82,659,865 Undistributed long term capital gains ...................... 146,277,137 ---------------- Distributable earnings ..................................... $ 228,937,002 ================ The tax character of distributions paid during the years ended December 31, 2005 and 2004, was as follows: -------------------------------- 2005 2004 -------------------------------- Distributions paid from: Ordinary income ......................... $ 293,157,500 $ 176,201,909 Long term capital gain .................. 609,512,035 221,948,795 -------------------------------- $ 902,669,535 $ 398,150,704 ================================ 44 | Annual Report MUTUAL SHARES 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, 2005, aggregated $5,683,294,847 and $2,424,071,919, respectively. Transactions in options written during the year ended December 31, 2005, were as follows: --------------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED --------------------------------- Options outstanding at December 31, 2004 ....................... 2,826 $ 392,341 Options written ............................ 281,658 1,803,696 Options expired ............................ (269,352) (701,526) Options exercised .......................... (2,360) (292,955) Options closed ............................. (11,772) (1,120,559) --------------------------------- Options outstanding at December 31, 2005 ... 1,000 $ 80,997 ================================= 7. SYNTHETIC EQUITY SWAPS As of December 31, 2005, the Fund had the following synthetic equity swaps outstanding: - -------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO BUY CONTRACTS VALUE GAIN (LOSS) - -------------------------------------------------------------------------------- Christian Dior SA (47.22 - 54.99 EUR ... 164,222 $ 14,600,508 $5,116,867 O2 PLC (1.96 -1.97 GBP) ................ 32,170,426 109,588,263 835,161 ----------- Total contracts to buy ........................................... 5,952,028 ----------- - -------------------------------------------------------------------------------- NUMBER OF NOTIONAL UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN (LOSS) - -------------------------------------------------------------------------------- LVMH Moet Hennessy Louis Vuitton (54.61 - 61.76 EUR) ................. 163,903 $ 14,562,444 $(3,256,934) ----------- Total contracts to sell .......................................... (3,256,934) ----------- Net unrealized gain .............................................. $ 2,695,094 =========== 8. FORWARD EXCHANGE CONTRACTS At December 31, 2005, the Fund had outstanding forward exchange contracts as set out below.
- ------------------------------------------------------------------------------------------ CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO BUY AMOUNT(a) DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------ 42,476,972 Canadian Dollars .......... 36,060,503 1/23/06 $ 511,672 11,798,280,000 Korean Won ................ 11,700,000 3/22/06 21,582 ----------- $ 533,254 -----------
Annual Report | 45 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- ------------------------------------------------------------------------------------------ CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------ 13,500,000 Euro ..................... 16,006,005 1/17/06 $ 7,719 122,195,000 Euro ..................... 150,829,788 1/23/06 5,972,324 115,295,729 Swiss Franc .............. 92,500,000 2/02/06 4,428,449 118,125,000 British Pound ............ 211,814,165 2/15/06 8,612,288 49,697,172 Canadian Dollar .......... 43,043,439 2/15/06 226,192 100,900,000 Euro ..................... 122,447,819 2/27/06 2,606,298 175,287,475 Norwegian Krone .......... 26,084,446 3/06/06 18,541 105,954,175 Euro ..................... 126,252,963 3/15/06 449,573 888,192,791 Swedish Krona ............ 113,694,103 3/15/06 1,296,648 619,712,909 Danish Krone ............. 106,926,254 3/17/06 8,174,989 22,758,361 British Pound ............ 40,992,361 3/21/06 1,839,299 5,277,495,500 Korean Won ............... 5,230,422 3/22/06 4,808 78,775,000 British Pound ............ 138,924,310 4/04/06 3,389,182 121,782,398 Euro ..................... 153,911,725 4/25/06 8,796,939 211,035,600 Norwegian Krone .......... 32,805,161 5/08/06 1,310,483 97,000,000 British Pound ............ 169,041,900 5/15/06 2,074,487 192,046,975 Euro ..................... 238,560,315 5/23/06 9,354,645 541,790,000 Taiwan Dollar ............ 16,600,000 5/30/06 95,324 37,950,560 Norwegian Krone .......... 5,800,000 6/06/06 127,101 35,500,000 Euro ..................... 43,126,453 6/15/06 702,175 8,629,956,115 Japanese Yen ............. 84,126,723 6/28/06 4,008,082 20,000,000 Euro ..................... 23,960,144 7/17/06 16,943 116,251,078 British Pound ............ 202,891,875 8/14/06 2,558,121 85,305,373 Euro ..................... 106,417,966 8/23/06 4,089,665 80,507,500 British Pound ............ 140,117,496 9/08/06 1,331,461 97,734,103 Euro ..................... 123,775,540 9/13/06 6,405,178 146,373,611 Euro ..................... 179,516,052 10/18/06 3,415,942 ----------- 81,312,856 ----------- Unrealized gain on forward exchange contracts ............................. $81,846,110 ===========
- ------------------------------------------------------------------------------------------ CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO BUY AMOUNT(a) DATE GAIN (LOSS) - ------------------------------------------------------------------------------------------ 2,638,747,750 Korean Won ............... 2,620,925 3/22/06 $ (8,119) -----------
46 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. FORWARD EXCHANGE CONTRACTS (CONTINUED)
- --------------------------------------------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED CONTRACTS TO SELL AMOUNT(a) DATE GAIN (LOSS) - --------------------------------------------------------------------------------------------------- 621,051,346 Canadian Dollars ............. 515,465,161 1/23/06 $ (19,252,767) 416,719,071 Norwegian Krone .............. 61,827,755 2/06/06 (44,247) 106,607,713 Canadian Dollars ............. 90,769,402 2/15/06 (1,079,864) 56,104,513 South African Rand ........... 8,625,000 2/15/06 (210,755) 364,000,000 Norwegian Krone .............. 54,066,900 3/06/06 (61,264) 50,000,000 Euro ......................... 58,910,000 3/15/06 (530,579) 9,159,532,250 Korean Won ................... 8,862,000 3/22/06 (237,988) 599,098,077 Taiwan Dollar ................ 18,119,609 5/30/06 (130,856) 392,000,000 Norwegian Krone .............. 58,463,833 6/06/06 (132,837) 1,819,200,500 Japanese Yen ................. 15,720,000 6/28/06 (51,819) 120,302,450 Euro ......................... 142,912,110 7/17/06 (1,109,179) -------------- (22,842,155) -------------- Net unrealized loss on offsetting forward exchange contracts ..................... (95,596) -------------- Unrealized loss on forward exchange contracts ................................. (22,945,870) ============== Net unrealized gain on forward exchange contracts .......................... $ 58,900,240 ==============
(a) In U.S. Dollar unless other wise indicated. 9. CONCENTRATION OF RISK Investing in foreign securities may include certain risks and considerations not typically associated with investing in U.S. securities, such as fluctuating currency values and changing local and regional economic, political and social conditions, which may result in greater market volatility. In addition, certain foreign securities may not be as liquid as U.S. securities. 10. DEFAULTED SECURITIES The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressed companies are financially troubled and are about to be/or are already involved in financial restructuring or bankruptcy. The Fund does not accrue income on these securities, if it becomes probable that the income will not be collected. The risks of purchasing these securities are that the issuer is unable to meet its obligation and any subsequent bankruptcy proceeding may result in unfavorable consequences to the Fund. At December 31, 2005, the value of these securities was $161,073,059, representing 1.02% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. Annual Report | 47 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. RESTRICTED AND ILLIQUID SECURITIES At December 31, 2005, investments in securities included issues that are restricted and illiquid. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration under the Securities Act of 1933, unless the sale is pursuant to an exemption under the 1933 Act. The Fund has registration rights for all restricted securities held at period end. The issuer generally incurs all registration costs. A security may 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, 2005, the Fund held investments in restricted and illiquid securities, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- ------------------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT, SHARES, WARRANTS ACQUISITION AND CONTRACTS 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 3,196,155 102,636 30,186 AboveNet Inc., wts., 9/08/10 ................. 10/02/01 3,430,956 24,149 1,879,100 DecisionOne Corp. ............................ 3/12/99 1,313,384 1,339,798 2,039,765 DecisionOne Corp., 144A, 12.00%, 4/15/10 ................................... 3/12/99 7,177,316 2,039,765 25,721 Elephant Capital Holdings Ltd. ............... 8/29/03 -- 36,652,032 60,419 Esmark Inc., Series A, 10.00%, cvt. pfd. ..... 11/08/04 60,419,000 63,357,780 4,423,071 Florida East Coast Industries Inc. ........... 10/03/75 108,943,491 178,035,242 2,380,966 Kindred Healthcare Inc. ...................... 12/12/01 24,899,635 58,267,000 1,146 Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 ................................... 1/01/05 -- 17,645 568 Kindred Healthcare Inc., Jan. 25.99 Calls, 1/01/14 ................................... 1/01/05 -- -- 1,724 Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 ................................... 1/01/05 -- -- 7,640 Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 ................................... 7/17/05 -- 5,516 211,977 Kindred Healthcare Inc., wts., Series A, 4/20/06 ................................... 4/24/01 1,907,794 4,100,059 529,943 Kindred Healthcare Inc., wts., Series B, 4/20/06 ................................... 4/24/01 4,239,543 8,709,613 3 Lancer Industries Inc., B .................... 8/11/89 -- 6,494,600 124,040 NCB Warrant Holdings Ltd., A ................. 12/16/05 -- 20,039,915 202,380 Olympus Re Holdings Ltd. ..................... 12/19/01 20,238,000 3,744,030 28,412 Security Capital European Realty ............. 4/08/98 1,556,398 206,484 2,833,800 Time Warner Inc. ............................. 8/02/05 48,945,601 48,433,043 59,140 Time Warner Inc., Jan. 10.00 calls, 1/21/06 .. 8/17/05 49,640,524 43,467,900 ---------------- TOTAL RESTRICTED AND ILLIQUID SECURITIES (3.14% of Net Assets) ............. $ 493,340,572 ================
48 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 12. UNFUNDED LOAN COMMITMENTS The Fund may enter into certain credit agreements, all or a portion of which may be unfunded. The Fund is obligated to fund these loan commitments at the borrowers' discretion. At December 31, 2005, unfunded commitments were as follows: - -------------------------------------------------------------------------------- BORROWER UNFUNDED COMMITMENT - -------------------------------------------------------------------------------- Entegra/Union Power, LOC Facility, FRN, 6/01/12 .......... $ 4,044,371 Entegra/Union Power, Working Capital Facility, FRN 6/01/12 ........................................... 606,656 Mirant Corp, 4 Year Revolver, 7/17/05 .................... 543,268 Owens Corning, Revolver, 6/26/02 ......................... 1,697,673 TVMAX Holdings, PIK, 14.00%, 1/16/06 ..................... 57 ----------- $ 6,892,025 =========== Unfunded loan commitments are marked to market daily and any unrealized gain or loss is included in the Statement of Assets and Liabilities and Statement of Operations. 13. 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, 2005, were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------ NUMBER OF NUMBER OF PRINCIPAL PRINCIPAL AMOUNT/ AMOUNT/ SHARES/ SHARES/ CONTRACTS/ CONTRACTS/ WARRANTS WARRANTS HELD AT HELD AT VALUE AT INVESTMENT REALIZED BEGINNING GROSS GROSS END END OF INCOME CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS OF YEAR YEAR (LOSS) GAIN (LOSS) - ------------------------------------------------------------------------------------------------------------------------------ CONTROLLED AFFILIATES(a) Nippon Investment LLC .......... 18,938,000 -- 18,938,000 -- $ -- $ -- $(3,491,624) --------------------------------------- NON-CONTROLLED AFFILIATES AboveNet Inc. .................. 763,805 -- -- 763,805 $18,303,365 $ -- $ -- AboveNet Inc., Contingent Distribution ................ 106,869,000 -- -- 106,869,000 -- -- -- AboveNet Inc., wts., 9/08/08.... 25,659 -- -- 25,659 102,636 -- -- AboveNet Inc., wts., 9/08/10.... 30,186 -- -- 30,186 24,149 -- -- Alexander's Inc. ............... 326,675 -- -- 326,675 80,198,713 -- -- Anchor Resources LLC ........ 123,013 -- -- 123,013 -- -- -- Anchor Resources LLC, 12.00%, 12/17/06 .................... 57,551 -- 57,551 -- -- 6,887 -- Centennial Bank Holdings Inc. .. 3,845,467 -- -- 3,845,467 47,568,427 -- -- City Investing Company Liquidating Trust ........... 4,373,476 -- -- 4,373,476 481,082 -- 8,065,663 DecisionOne Corp. .............. 457,492 1,421,608 -- 1,879,100 1,339,798 -- -- DecisionOne Corp., Term Loan.... 13,775,874 -- 13,775,874 -- -- -- -- DecisionOne Corp., 12.00%, 4/15/10, 144A ............... -- 2,370,645 330,880 2,039,765 2,039,765 141,743 (1,311,378) Elephant Capital Holdings Ltd.......................... 25,721 -- -- 25,721 36,652,032 (3,225,820) 28,406,431 Esmark Inc., Series A, 10.00%, cvt. pfd. ........... 40,396 20,023 -- 60,419 63,357,780 5,909,847 Federal Signal Corp. ........... 2,899,000 461,800 -- 3,360,800 50,445,608 788,400
Annual Report | 49 MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES (CONTINUED)
- -------------------------------------------------------------------------------------------------------------------------------- NUMBER OF NUMBER OF PRINCIPAL PRINCIPAL AMOUNT/ AMOUNT/ SHARES/ SHARES/ CONTRACTS/ CONTRACTS/ WARRANTS WARRANTS HELD AT HELD AT VALUE AT INVESTMENT REALIZED BEGINNING GROSS GROSS END END OF INCOME CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS OF YEAR YEAR (LOSS) GAIN (LOSS) - ----------------------------------------------------------------------------------------------------------------------------------- NON-CONTROLLED AFFILIATES (CONTINUED) FHC Delaware Inc. ........... 784,457 -- -- 784,457 2,726,694 -- -- Florida East Coast Industries Inc. ..................... 4,423,071 -- -- 4,423,071 178,035,242 1,017,306 -- International Steel Group ... 6,143,191 -- 6,143,191 -- -- -- 132,258,167 Kindred Healthcare Inc. ..... 2,380,966 -- -- 2,380,966 58,267,000 -- -- Kindred Healthcare Inc., Jan. 9.07 Calls, 1/01/13 ...... 578 568 -- 1,146 17,645 -- -- Kindred Healthcare Inc., Jan. 25.99 Calls, 1/01/14 ..... -- 568 -- 568 -- -- -- Kindred Healthcare Inc., Jan. 26.00 Calls, 1/01/12 ..... 1,156 568 -- 1,724 -- -- -- Kindred Healthcare Inc., Jul. 23.75 Calls, 7/17/11 ..... 5,748 1,892 -- 7,640 5,516 -- -- Kindred Healthcare Inc., wts Series A, 4/20/06 ........ 211,977 -- -- 211,977 4,100,059 -- -- Kindred Healthcare Inc., wts Series B, 4/20/06 ........ 529,943 -- -- 529,943 8,709,613 -- -- Lancer Industries Inc., B ... 3 -- -- 3 6,494,600 -- -- MBOP Liquidating Trust ...... 574,712 -- -- 574,712 75 -- -- OPTI Canada ................. 9,695,676 -- 214,400 9,481,276 311,365,659 -- 1,545,625 TVMAX Holdings Inc. ......... 257,217 -- -- 257,217 257,217 -- -- TVMAX Holdings Inc., PIK, 11.50%, 6/30/05 .......... 264,487 168,827 -- 433,314 433,314 42,182 -- TVMAX Holdings Inc., PIK, 14.00%, 6/30/05 .......... 1,045,014 158,365 -- 1,203,379 1,203,379 156,192 -- White Mountains Insurance Group Inc. ............... 740,448 -- -- 740,448 413,577,230 5,923,584 -- ------------------------------------------- TOTAL NON-CONTROLLED AFFILIATES ................................................. $1,285,706,598 $10,760,321 $168,964,508 ------------------------------------------- TOTAL AFFILIATED SECURITIES (8.18% of Net Assets) ............................... $1,285,706,598 $10,760,321 $165,472,884 ===========================================
(a) Issuer in which the Fund owns 25% or more of the outstanding voting securities. 14. OTHER CONSIDERATIONS Directors or employees of Franklin Mutual, as the Fund's Investment Manager, may serve as members 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, 2005, such individuals serve in one or more of these capacities for Kindred Healthcare Inc., AboveNet Inc. and Esmark Inc. As a result of this involvement, such individuals 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. 50 | Annual Report MUTUAL SHARES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 15. REGULATORY MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, 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 (collectively, the "Company"), entered into settlements with certain of those regulators. Specifically, the Company entered into settlements with the Securities and Exchange Commission ("SEC") concerning market timing (the "August 2, 2004 SEC Order") and marketing support payments to securities dealers who sell fund shares (the "December 13, 2004 SEC Order") and with the California Attorney General's Office ("CAGO") concerning marketing support payments to securities dealers who sell fund shares (the "CAGO Settlement"). Under the terms of the settlements with the SEC and the CAGO, the Company retained an Independent Distribution Consultant ("IDC") to develop a plan for distribution of the respective settlement monies. The CAGO approved the distribution plan under the CAGO Settlement and, in accordance with the terms and conditions of that settlement, the monies were disbursed to the relevant funds and are recorded as other income in the current period. The SEC has not yet approved the distribution plan pertaining to the December 13, 2004 SEC Order. When approved, disbursements of settlement monies will be made promptly to the relevant funds, in accordance with the terms and conditions of that order. The IDC continues to develop the plan of distribution under the August 2, 2004 SEC Order that resolved the SEC's market timing investigation. In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, directors, and/or employees, have been named in private lawsuits (styled as shareholder class actions, or as derivative actions on behalf of either the named funds or Franklin Resources, Inc.) relating to the industry practices referenced above, as well as to allegedly excessive advisory fees, commissions, and/or 12b-1 fees. The lawsuits were filed in different courts throughout the country. Many of those suits are now pending in a multi-district litigation in the United States District Court for the District of Maryland. The Company and fund management strongly believe that the claims made in each of the private lawsuits referenced above are without merit and intend to defend against them vigorously. The Company cannot predict with certainty the eventual outcome of these lawsuits, nor whether they will have a material negative impact on the Company. 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. Annual Report | 51 MUTUAL SHARES FUND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF THE MUTUAL SHARES FUND: We have audited the accompanying statement of assets and liabilities of the Mutual Shares Fund (one of the portfolio constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2005, 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. We were not engaged to perform an audit of the Fund's internal control over financial reporting. Our audits included 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, and evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of December 31, 2005, by correspondence with the custodian and brokers, or by other appropriate auditing procedures where replies from the 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. at December 31, 2005, 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 10, 2006 52 | Annual Report MUTUAL SHARES FUND TAX DESIGNATION (UNAUDITED) Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund designates the maximum amount allowable but no less than $747,515,744 as a capital gain dividend for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $225,510,729 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2005. In January 2006, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2005. 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 871(k)(1)(C) of the Code, the Fund designates the maximum amount allowable but no less than $100,418,191 as interest-related dividends for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section 871(k)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $136,848,311 as a short-term capital gain dividend for purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2005. Under Section 854(b)(2) of the Code, the Fund designates 36.40% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2005. Annual Report | 53 MUTUAL SHARES FUND BOARD MEMBERS AND OFFICERS The name, year of birth 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 NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ EDWARD I. ALTMAN, PH.D. Director Since 1987 7 Director, A.T.D. Inc.(financial (1941) technology and investment company). 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, Salomon Center; editor and author of numerous financial publications; financial consultant; and serves on the Investment Advisory Committee of the New York State Common Retirement Fund; and FORMERLY, Vice Director, NYU Salomon Center, Stern School of Business, New York University. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE BATES (1958) Director Since 1994 7 Independent Director, SLM Corporation 101 John F. Kennedy Parkway (Sallie Mae) and Allied Capital Short Hills, NJ 07078-2789 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 (1929) Director Since 2002 13 Director, Fiduciary Emerging Markets 101 John F. Kennedy Parkway Bond Fund PLC and Fiduciary Short Hills, NJ 07078-2789 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 (1930) Director Since 1974 7 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Retired, former Chairman, A.A. MacPherson, Inc., Canton, MA (representative for electrical manufacturers). - ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (1930) Director Since 1998 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------
54 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ LEONARD RUBIN (1925) Director Since 1996 13 None 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ 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 (1946) Director and Director since 13 Director, El Oro and Exploration Co., 101 John F. Kennedy Parkway Chairman of 1991 and p.l.c., and ARC Wireless Solutions, Short Hills, NJ 07078-2789 the Board Chairman of the Inc. Board since 2005 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Practicing attorney. - ------------------------------------------------------------------------------------------------------------------------------------
INTERESTED BOARD MEMBERS AND OFFICERS
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ **WILLIAM J. LIPPMAN (1925) Director Since 1996 14 None One Parker Plaza, 9th Floor Fort Lee, NJ 07024-2920 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Advisory Services, LLC; Director, Templeton Worldwide, Inc.; and officer and/or director or trustee, as the case may be, of five of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ **ANNE M. TATLOCK (1939) Director Since 2002 7 Director, Fortune Brands, Inc. 600 Fifth Avenue, 7th Floor (consumer products) and Merck & Co. New York, NY 10020-2302 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. - ------------------------------------------------------------------------------------------------------------------------------------ PHILIPPE BRUGERE-TRELAT (1949) Vice President Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Mutual Advisers, LLC; Portfolio Manager of Eurovest SA (French registered Investment Company, Sicav); and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 55
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL J. EMBLER (1964) Senior Vice Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President Short Hills, NJ 07078-2789 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President and Chief Investment Officer, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ PETER A. LANGERMAN (1955) President, Since May 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway and Chief Short Hills, NJ 07078-2702 Executive Officer - Investment Management - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; and officer of two of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (1952) Chief Since 2004 Not Applicable Not Applicable One Franklin Parkway Compliance San Mateo, CA 94403-1906 Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (1947) Senior Vice Since 2002 Not Applicable Not Applicable 500 East Broward Blvd. President Suite 2100 and 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 47 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ DAVID P. GOSS (1947) 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 47 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). - ------------------------------------------------------------------------------------------------------------------------------------
56 | Annual Report
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ STEVEN J. GRAY (1955) Secretary Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Resources, Inc.; officer of 33 of the investment companies in Franklin Templeton Investments; and FORMERLY, Chief Legal Counsel, Atlas Advisers, Inc. (until 2000). - ------------------------------------------------------------------------------------------------------------------------------------ BARBARA J. GREEN (1947) 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, LLC, 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 47 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 (1937) 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, Franklin Templeton Institutional Suisse S.A., 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 45 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ GREGORY R. SEWARD (1956) Treasurer Since December Not Applicable Not Applicable 500 East Broward Blvd. 2005 Suite 2100 Fort Lauderdale, FL 33394-3091 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 16 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPMorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ------------------------------------------------------------------------------------------------------------------------------------ CRAIG S. TYLE (1960) Vice President Since October Not Applicable Not Applicable One Franklin Parkway 2005 San Mateo, CA 94403-1906 - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Partner, Shearman & Sterling, LLP (2004-2005); and General Counsel, Investment Company Institute (ICI) (1997-2004). - ------------------------------------------------------------------------------------------------------------------------------------
Annual Report | 57
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ------------------------------------------------------------------------------------------------------------------------------------ GALEN G. VETTER (1951) Chief Since 2004 Not Applicable Not Applicable 500 East Broward Blvd. Financial Suite 2100 Officer and Fort Lauderdale, FL 33394-3091 Chief Accounting Officer - ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Vice President, Franklin Templeton Services, LLC; officer of 47 of the investment companies in Franklin Templeton Investments; and FORMERLY, Managing Director, RSM McGladrey, Inc. (1999-2004); and Partner, McGladrey & Pullen, LLP (1979-1987 and 1991-2004). - ------------------------------------------------------------------------------------------------------------------------------------
* 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. THE FUND'S BOARD OF DIRECTORS HAS DETERMINED THAT CERTAIN OF THE MEMBERS OF THE AUDIT COMMITTEE, INCLUDING ANN TORRE BATES, 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. 58 | 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 U.S. Securities and Exchange Commission's website at sec.gov and reflect the most recent 12-month period ended June 30. QUARTERLY STATEMENT OF INVESTMENTS The Fund files a complete statement of investments with the U.S. 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 | 59 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 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 MidCap Value Fund 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 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(4) Franklin's AGE High Income Fund Franklin Floating Rate Daily Access Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund(4) 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(4) Templeton Global Bond Fund Templeton Income Fund TAX-FREE INCOME(5) NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund(6) 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(7) Colorado Connecticut Florida(7) Georgia Kentucky Louisiana Maryland Massachusetts(6) Michigan(6) Minnesota(6) Missouri New Jersey New York(7) North Carolina Ohio(7) Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust(8) (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) An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. (5) For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. (6) Portfolio of insured municipal securities. (7) 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). (8) The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 09/05 Not part of the annual report [LOGO](R) FRANKLIN TEMPLETON 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 INVESTMENT MANAGER Franklin Mutual Advisers, LLC 101 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 & R) 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 A2005 02/06 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 12(a)(1), the Registrant is attaching as an exhibit a copy of its code of ethics that applies to its principal executive officers and principal 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 Bates, 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 $355,000 for the fiscal year ended December 31, 2005 and $298,000 for the fiscal year ended December 31, 2004. (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 $25,000 for the fiscal year ended December 31, 2005 and $50,000 for the fiscal year ended December 31, 2004. The services for which these fees were paid included tax compliance and advice. (d) All Other Fees There were no fees paid to the principal accountant for products and services rendered by the principal accountant to the registrant, other than the services reported in paragraphs (a)-(c) of Item 4. The aggregate 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 not reported in paragraphs (a)-(c) of Item 4 were $199,802 for the fiscal year ended December 31, 2005 and $0 for the fiscal year ended December 31, 2004. The services for which these fees were paid included financial due diligence. (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 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 $224,802 for the fiscal year ended December 31, 2005 and $50,000 for the fiscal year ended December 31, 2004. (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 sub-adviser 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. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES. N/A ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT COMPANY AND AFFILIATED PURCHASERS. N/A ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There have been no changes to the procedures by which shareholders may recommend nominees to the Registrant's Board of Directors that would require disclosure herein. ITEM 11. 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 12. EXHIBITS. (a)(1) Code of Ethics (a) (2) 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) 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 February 21, 2006 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By /s/JIMMY D. GAMBILL ---------------------- Jimmy D. Gambill Chief Executive Officer - Finance and Administration Date February 21, 2006 By /s/GALEN G. VETTER --------------------- Galen G. Vetter Chief Financial Officer Date February 21, 2006 EX-99.CODE ETH 2 ncsr-code1205.txt REVISED CODE OF ETHICS DTD 12/05 Exhibit 12(a)(1) CODE OF ETHICS FOR PRINCIPAL EXECUTIVES & SENIOR FINANCIAL OFFICERS - ------------------------------------------------------------------------------ PROCEDURES Revised December 2005 - ------------------------------------------------------------------------------- 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 December 2005 FRANKLIN GROUP OF FUNDS Edward B. Jamieson, President and Chief Executive Officer - Investment Management Charles B. 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 and Chief Accounting Officer FRANKLIN MUTUAL SERIES FUNDS Peter Langerman 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 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 DECEMBER 2005 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 c/o Maria Abbott within 10 days of becoming a Covered Officer and by January 30th of each subsequent year. INTER-OFFICE MAIL: Maria Abbott, Manager, Code of Ethics, Global Compliance SM-920/2 TELEPHONE: (650) 312-5698 Fax: (650) 312-5646 E-MAIL: Abbott, Maria (internal address); mabbott@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 fmsf1205-302cert.txt SECTION 302 CERTIFICATIONS Exhibit 12(a)(2) 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. February 21, 2006 /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. February 21, 2006 /s/GALEN G. VETTER Galen G. Vetter Chief Financial Officer EX-99.906 CERT 4 fmsf1205-906cert.txt SECTION 906 CERTIFICATIONS Exhibit 12(b) CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT 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 12/31/05 (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 21, 2006 /s/JIMMY D. GAMBILL Jimmy D. Gambill Chief Executive Officer - Finance and Administration CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT 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 12/31/05 (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 21, 2006 /s/GALEN G. VETTER Galen G. Vetter Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----