-----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, IBi0nj2EhX/cNfTbKlkdSM+S1O33K9rmYosmUuQlx2nmvaOiu74SgSQPlY6rTp9C Ju2AHyFqdc532szveancIw== 0000825063-08-000006.txt : 20080228 0000825063-08-000006.hdr.sgml : 20080228 20080228142309 ACCESSION NUMBER: 0000825063-08-000006 CONFORMED SUBMISSION TYPE: N-CSR PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20071231 FILED AS OF DATE: 20080228 DATE AS OF CHANGE: 20080228 EFFECTIVENESS DATE: 20080228 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: 08649841 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-annual_1207.txt ANNUAL NCSR FOR MUTUAL SERIES 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: 12/31/07 --------- Item 1. Reports to Stockholders. [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2007 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 ........................................................ 5 Performance Summary ....................................................... 11 Your Fund's Expenses ...................................................... 16 Financial Highlights and Statement of Investments ......................... 18 Financial Statements ...................................................... 31 Notes to Financial Statements ............................................. 35 Report of Independent Registered Public Accounting Firm ................... 50 Tax Designation ........................................................... 51 Board Members and Officers ................................................ 52 Shareholder Information ................................................... 56 - -------------------------------------------------------------------------------- Shareholder Letter - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN - --------------------------------------------------- CLASS Z 12/31/07 - --------------------------------------------------- 1-Year +3.03% - --------------------------------------------------- 5-Year +15.08% - --------------------------------------------------- 10-Year +10.05% - --------------------------------------------------- Dear Shareholder: The past year was a turbulent time for equities both in the U.S. and in many international markets. Several developments contributed to this volatility, including (1) credit problems centered around subprime mortgage lending; (2) declining home values in the U.S.; (3) a nearly complete evaporation of the corporate leveraged lending that fueled the leveraged buyout boom of the past several years; (4) a sharp increase in oil, agricultural and certain mining commodity prices; and (5) a sharp decline in the value of the U.S. dollar relative to most other currencies. For the year ended December 31, 2007, the Standard & Poor's (S&P) 500 Index rose 5.49% while the Morgan Stanley Capital International (MSCI) World Index gained 9.57%. 1 However, indicative of the impact of the developments noted here, the S&P 500 Financials Index declined 18.63%, the S&P Homebuilders Select Industry Index declined 48.39% and the S&P GSSI Natural Resources Index appreciated 34.44% during the year. 2 By comparison, Mutual Beacon Fund - Class Z gained 3.03% over this period. 1. Source: Standard & Poor's Micropal. The S&P 500 Index 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 Index 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. 2. Source: Standard & Poor's Micropal. The S&P 500 Financials Index is market value weighted and includes all the financial stocks in the S&P 500. The S&P Homebuilders Select Industry Index is an equal-weighted index that draws its constituents from the GICS (Global Industry Classification Standards) Homebuilding sub-industry. The S&P GSSI Natural Resources Index is a modified cap-weighted index designed to measure equity performance in the natural resources sector. The index includes companies involved in the following categories: extractive industries, energy companies, owners and operators of timber tracts, forestry services, producers of pulp and paper, and owners of plantations. 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. - -------------------------------------------------------------------------------- eDELIVERY DETAILS Log in at franklintempleton.com and click on edelivery. Shareholders who are registered at franklintempleton.com can receive these reports via email. Not all accounts are eligible for eDelivery. - ----------------------------------------------------- NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE - ----------------------------------------------------- Not part of the annual report | 1 The markets in 2007 were particularly challenging for us as value-driven, bottom-up stock pickers in a year when a thematic approach to investing based on macroeconomic factors would likely have enhanced performance. Value investors are always faced with the task of buying and owning companies when they are out of favor, whether for company-specific reasons or because of a perception of macroeconomic fundamentals. It is these very headwinds that create opportunities to buy well-managed companies with strong industry positions at valuations that can reward investors over the long term. Despite the challenges, a number of positive factors contributed to Fund performance this year. Many of our international holdings made strong gains, particularly among the tobacco, energy and industrial companies we owned. Fund shareholders also benefited from the fact that our international holdings were less than fully hedged back into U.S. dollars, reflecting our cautious view regarding the dollar. Investments in merger arbitrage situations were also generally profitable, particularly as we took advantage in late summer of concerns that deals would fall apart because of "buyer's remorse" or unavailability of financing. In the U.S., our focus over the past several years on larger capitalization companies with strong balance sheets and leading industry positions benefited our shareholders. For example, investments in Microsoft, Altria and Verizon Communications, all part of the large-cap Dow Jones Industrial Average, generated solid returns in 2007. 3 As we have discussed in previous reports, the multi-year outperformance of small- and mid-capitalization stocks going into 2007 resulted in attractive valuations among their mega-cap counterparts. At period-end, we continued to see real value in a number of these companies. The Fund's exposure to the financial sector negatively impacted Fund performance during the year. While we had limited direct exposure to the subprime mortgage originators, the spreading contagion of the credit crisis hurt valuations of most financial institutions, including some well-capitalized domestic and European banks owned by the Fund. We were disappointed by the breakdown in risk management processes at some of the largest U.S. financial institutions and have adjusted certain positions accordingly. Nevertheless, we believe the markets have overly penalized many stocks in the sector and accordingly have added selectively to certain holdings. 3. Mutual Beacon Fund's holdings are based on total net assets as of 12/31/07: Microsoft Corp.: 2.2%; Altria Group Inc.: 2.1%; and Verizon Communications Inc.: 0.0% (sold by period-end). 2 | Not part of the annual report Another difficult area for us in the latter half of the year was what we would term "event-driven" stocks. These are investments we believe are attractively valued and where we see an identifiable catalyst to unlock the value. While each investment is different, a few issues dominated the second half of 2007. One key driver was the abrupt absence of private equity buyers for companies (or divisions of companies) that were potential sale targets. Virgin Media, the U.K. cable company, was one example. Another key element was direct or indirect exposure to the residential construction or financial industries, where the catalyst was overwhelmed by the economic headwinds facing the company. Temple-Inland, which sold its timber assets and split into three companies including a packaging company, a savings bank and a real estate developer in 2007, exemplified this risk. Finally, we believe many of these event-driven investments were held in common with some of the hedge funds that faced pressure to sell in the latter half of 2007. Again, while somewhat painful in the short term, "technical" pressures often give us a chance to take advantage of temporary market dislocations to increase ownership in attractively valued companies. Fear and volatility can breed opportunity for patient investors. We believe the extended credit crisis has created a number of such opportunities. We have no crystal ball telling us precisely when the U.S. housing market will turn positive or where oil prices will be a year from now. However, we believe that if we stick to our discipline of buying good businesses at cheap valuations, we should reach our goal of limiting our downside risk while generating consistent returns over the long term. In the enclosed annual report for Mutual Beacon Fund, the portfolio managers discuss market conditions, investment management decisions and Fund performance during the period under review. You will also find performance data and financial information. Please remember that all securities markets fluctuate, as do mutual fund share prices. If you would like more frequent updates, FRANKLINTEMPLETON.COM provides daily prices, monthly performance figures, portfolio holdings and other information. You can also access your account, buy and sell shares, read timely articles, and find helpful financial planning tools. We hope you will take advantage of these online services. Not part of the annual report | 3 As always, we thank you for your trust and support and extend our best wishes for a happy, healthy and prosperous 2008. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC /s/ Michael J. Embler Michael J. Embler Senior Vice President and Chief Investment Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF DECEMBER 31, 2007. 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 INVESTMENT MANAGER 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. 4 | Not part of the annual report Annual Report Mutual Beacon Fund YOUR FUND'S GOALS AND MAIN INVESTMENTS: Mutual Beacon Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in 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. - -------------------------------------------------------------------------------- This annual report for Mutual Beacon Fund covers the fiscal year ended December 31, 2007. PERFORMANCE OVERVIEW Mutual Beacon Fund - Class Z posted a cumulative total return of +3.03% for the 12 months ended December 31, 2007. The Fund underperformed its benchmark, the Standard & Poor's 500 Index (S&P 500), which returned +5.49% for the same period. 1 You can find the Fund's long-term performance data in the Performance Summary beginning on page 11. ECONOMIC AND MARKET OVERVIEW During the 12 months ended December 31, 2007, the U.S. economy advanced at a moderate but uneven pace. After slow first quarter growth, gross domestic product (GDP) advanced solidly in the second quarter, supported by federal defense spending, accelerating exports and declining imports, and greater business spending. In the third quarter, growth accelerated despite a struggling housing market and the abrupt unraveling of the subprime mortgage market. The housing downturn affected the overall economy by fourth quarter 2007 when GDP growth decelerated as credit conditions worsened and consumer spending slowed. 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. Annual Report | 5 GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/07 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] U.S. 59.2% U.K. 6.4% Germany 4.9% France 4.4% Norway 2.7% Denmark 2.6% Switzerland 2.1% Spain 2.0% Belgium 2.0% South Korea 1.8% Italy 1.8% Japan 1.5% Sweden 1.4% Other 1.0% Short-Term Investments & Other Net Assets 6.2% Consumer confidence declined through period-end largely due to rising mortgage and fuel costs, falling home prices and a weaker job market. Oil prices were volatile and established a new record high in November, nearing $99 per barrel. For the 12 months ended December 31, 2007, the core Consumer Price Index (CPI), which excludes food and energy costs, rose 2.4%, which was higher than its 10-year average rate. 2 Facing the prospect of slower economic growth, the Federal Reserve Board lowered the federal funds target rate to 4.25% from 5.25% during the period. As investors fled riskier, poorer-performing assets, U.S. Treasuries rallied and the 10-year Treasury note yield fell from 4.71% at the beginning of the period to 4.04% on December 31, 2007. The global economy remained resilient despite elevated energy prices and widespread fears of contagion from the deteriorating U.S. housing situation. Consumer and corporate demand strength, particularly in China and other developing economies, generally favorable employment and accommodative monetary policies continued to underpin the current global expansionary period that began in 2002. These factors also contributed to the strength of global equity markets during 2007. However, concerns about slower growth and declining asset quality surfaced in the first quarter. Initially centered on the U.S. subprime mortgage market, they spread in August to global capital markets. Difficulties in assessing risk and the value of collateral in the structured finance industry contributed to declining risk appetite among lenders and investors. The private equity industry, which relies on the availability of cheap credit, played a pivotal role in several large and high-profile acquisitions, helped boost merger and acquisition activity in the first half of 2007, and was an important driver of equity performance. A second-half tightening of liquidity led to slower deal activity and weighed on market performance. However, in 2007, global merger and acquisition activity still reached record levels. To alleviate the credit crunch and restore investor confidence, the world's major central banks infused capital into the system. However, credit and equity markets continued to face headwinds as write-downs and losses from subprime mortgage financing affected many large financial institutions toward the end of the year, and equity prices remained volatile. For the year, however, global and non-U.S. equity markets registered the fifth consecutive year of double-digit total returns. Broad-based stock performance by European and Asian shares at least doubled 2. Source: Bureau of Labor Statistics. 6 | Annual Report that of U.S. stocks, while emerging market equity returns more than tripled those in developed markets. In addition, U.S. dollar weakness versus the currencies of many major trading partners enhanced equity returns for U.S.-based investors holding stocks denominated in these 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 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 for our shareholders. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/07 - -------------------------------------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------------------------------------- Tobacco 11.0% - -------------------------------------------------------------------------------- Media 8.9% - -------------------------------------------------------------------------------- Insurance 8.3% - -------------------------------------------------------------------------------- Commercial Banks 7.9% - -------------------------------------------------------------------------------- Paper & Forest Products 4.7% - -------------------------------------------------------------------------------- Industrial Conglomerates 4.2% - -------------------------------------------------------------------------------- Food Products 3.7% - -------------------------------------------------------------------------------- Health Care Providers & Services 2.9% - -------------------------------------------------------------------------------- Software 2.9% - -------------------------------------------------------------------------------- Real Estate 2.4% - -------------------------------------------------------------------------------- Annual Report | 7 TOP 10 HOLDINGS 12/31/07 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- White Mountains Insurance Group Ltd. 2.6% INSURANCE, U.S. - -------------------------------------------------------------------------------- Weyerhaeuser Co. 2.4% PAPER & FOREST PRODUCTS, U.S. - -------------------------------------------------------------------------------- U.S. Bancorp 2.3% COMMERCIAL BANKS, U.S. - -------------------------------------------------------------------------------- Microsoft Corp. 2.2% SOFTWARE, U.S. - -------------------------------------------------------------------------------- News Corp., A 2.2% MEDIA, U.S. - -------------------------------------------------------------------------------- Orkla ASA 2.1% INDUSTRIAL CONGLOMERATES, NORWAY - -------------------------------------------------------------------------------- Altria Group Inc. 2.1% TOBACCO, U.S. - -------------------------------------------------------------------------------- Berkshire Hathaway Inc., A & B 2.1% INSURANCE, U.S. - -------------------------------------------------------------------------------- Comcast Corp., A 2.0% MEDIA, U.S. - -------------------------------------------------------------------------------- Fortis 2.0% DIVERSIFIED FINANCIAL SERVICES, BELGIUM - -------------------------------------------------------------------------------- MANAGER'S DISCUSSION During the year under review, the largest contributor to Fund performance was our equity portfolio, most notably some of our long-term holdings. Three investments that performed well during 2007 were KT&G, Berkshire Hathaway and Transocean. Shares of South Korea-based KT&G appreciated 41% in local currency during 2007, due largely to the company's strong operating performance. Each division of KT&G reported positive news in 2007. The company's domestic tobacco sales and operating margins expanded due to increased average selling prices for a pack of cigarettes. Overseas sales and revenues registered high double-digit increases. KT&G owns a 100% stake in KGC, South Korea's leading red ginseng maker, which has a dominant position of more than 60% market share. Over the past five years, KGC's sales and earnings have grown at 20% and 27% compounded annual growth rates, respectively. We believe this trend could continue given the country's aging demographic, growing income levels, and KGC's aggressive distribution and production expansion plan. According to our analysis, not only is the outlook for earnings quite good but the company's ability to return cash to shareholders has been impressive as well. KT&G has announced that between 2006 and 2008 it will return 2.8 trillion won (the local currency, which equaled approximately $3.0 billion on December 31, 2007) to shareholders. After 2008, KT&G is expected to return an average 5% to 7% of market capitalization to shareholders annually through dividends and share buybacks. Berkshire Hathaway stock appreciated 29% as the company benefited from a lack of catastrophe losses in 2007, resulting in large insurance company profits after higher-than-average losses in 2004 and 2005 resulted in a favorable pricing environment for U.S. property insurers. Within Berkshire's non-insurance operations, the company benefited from an improving contribution from its utility business, Mid-American Energy. Most significantly for its share price value, Berkshire's cash stockpile of almost $40 billion, along with CEO Warren Buffett's willingness to wait until a bargain emerged before deploying this capital, positioned the company as a safe haven for investors who perceived 2007's subprime mortgage crisis as an investment opportunity rather than a threat. By the end of 2007 Berkshire management had successfully kept its capital mostly in reserve, for use in executing timely future transactions when the investment climate is right. 8 | Annual Report Transocean shares appreciated nearly 67% during 2007, driven by strong company fundamentals, the company's merger with GlobalSanteFe, and shareholder-friendly initiatives. Fundamentally, a continued tight supply and demand balance for offshore rig contractors resulted in higher day rates and favorable financial performance at Transocean. On the event-driven and shareholder-friendly side, the company completed a merger with GlobalSantaFe concurrently with a leveraged recapitalization that enabled a special distribution of $33.03 in late November. All of these actions were received with widespread shareholder appreciation. Although many of our investments appreciated during the year, some of the Fund's holdings underperformed. Three positions that declined significantly in value were Sovereign Bancorp, financial services conglomerate Citigroup, and U.K.-based cable company Virgin Media. In a difficult year for finance and banking stocks in general, the Fund's shares of Sovereign Bancorp fared poorly and lost 54% in value. While the company took early steps to restructure its balance sheet in an effort to lower its risk profile at the beginning of 2007, the bank's asset quality deteriorated in the second half of the year, consistent with many other U.S. financial companies. The Fund's Citigroup shares declined 38% during the time we held it in 2007 as the company's exposure to risky mortgage assets resulted in write-offs during the second half of the year, ultimately leading to the resignation of CEO Charles Prince. Although we believed Citigroup had some extremely valuable global franchises, we were disappointed by the company's apparently weak risk management systems, and exited the position during the year. Shares of Virgin Media, the U.K.'s largest cable company, declined 32% in local currency during 2007. First, the company was forced to pull several British Sky Broadcasting (BSkyB) channels from its offering due to a pricing dispute, which resulted in a reduction in subscribers. Second, the contraction of the leveraged corporate debt market scuttled a plan announced in June to sell the company. Finally, Virgin Media posted mediocre earnings results in 2007. Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during 2007, the Fund benefited to the extent it was not fully hedged. Annual Report | 9 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 Co-Portfolio Manager [PHOTO OMITTED] /s/ Christian Correa Christian Correa, CFA Co-Portfolio Manager Mutual Beacon Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2007, 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 INVESTMENT MANAGER 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, Chief Investment Officer for Franklin Mutual Advisers, LLC, has been portfolio manager for Mutual Beacon Fund since 2005. He also manages another fund for Franklin Mutual Advisers, and has been a member of the management team of the Mutual Series Funds since 2001. Before joining Franklin Templeton Investments in 2001, he was Managing Director and portfolio manager at Nomura Holding America, Inc. CHRISTIAN CORREA assumed responsibility as co-portfolio manager for Mutual Beacon Fund effective December 31, 2007. He has been an analyst for Franklin Mutual Advisers since 2003, when he joined Franklin Templeton Investments. Previously, he covered U.S. risk arbitrage and special situations at Lehman Brothers Holdings Inc. - -------------------------------------------------------------------------------- 10 | Annual Report Performance Summary as of 12/31/07 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 12/31/07 12/31/06 - ------------------------------------------------------------------------------------ Net Asset Value (NAV) -$0.98 $15.73 $16.71 - ------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/07-12/31/07) - ------------------------------------------------------------------------------------ Dividend Income $0.5651 - ------------------------------------------------------------------------------------ Short-Term Capital Gain $0.0017 - ------------------------------------------------------------------------------------ Long-Term Capital Gain $0.9218 - ------------------------------------------------------------------------------------ TOTAL $1.4886 - ------------------------------------------------------------------------------------ CLASS A (SYMBOL: TEBIX) CHANGE 12/31/07 12/31/06 - ------------------------------------------------------------------------------------ Net Asset Value (NAV) -$0.99 $15.62 $16.61 - ------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/07-12/31/07) - ------------------------------------------------------------------------------------ Dividend Income $0.5122 - ------------------------------------------------------------------------------------ Short-Term Capital Gain $0.0017 - ------------------------------------------------------------------------------------ Long-Term Capital Gain $0.9218 - ------------------------------------------------------------------------------------ TOTAL $1.4357 - ------------------------------------------------------------------------------------ CLASS B (SYMBOL: TEBBX) CHANGE 12/31/07 12/31/06 - ------------------------------------------------------------------------------------ Net Asset Value (NAV) -$0.98 $15.19 $16.17 - ------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/07-12/31/07) - ------------------------------------------------------------------------------------ Dividend Income $0.3851 - ------------------------------------------------------------------------------------ Short-Term Capital Gain $0.0017 - ------------------------------------------------------------------------------------ Long-Term Capital Gain $0.9218 - ------------------------------------------------------------------------------------ TOTAL $1.3086 - ------------------------------------------------------------------------------------ CLASS C (SYMBOL: TEMEX) CHANGE 12/31/07 12/31/06 - ------------------------------------------------------------------------------------ Net Asset Value (NAV) -$0.99 $15.47 $16.46 - ------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/07-12/31/07) - ------------------------------------------------------------------------------------ Dividend Income $0.3961 - ------------------------------------------------------------------------------------ Short-Term Capital Gain $0.0017 - ------------------------------------------------------------------------------------ Long-Term Capital Gain $0.9218 - ------------------------------------------------------------------------------------ TOTAL $1.3196 - ------------------------------------------------------------------------------------
Annual Report | 11 Performance Summary (CONTINUED) PERFORMANCE 1 CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z: NO SALES CHARGES; 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. THE FUND MAY CHARGE A 2% FEE ON REDEMPTIONS MADE WITHIN SEVEN DAYS OF PURCHASE.
- -------------------------------------------------------------------------------------------------- CLASS Z 1-YEAR 5-YEAR 10-YEAR - -------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +3.03% +101.87% +160.46% - -------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +3.03% +15.08% +10.05% - -------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $10,303 $ 20,187 $ 26,046 - -------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 0.85% - -------------------------------------------------------------------------------------------------- CLASS A 1-YEAR 5-YEAR 10-YEAR - -------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +2.67% +98.57% +151.67% - -------------------------------------------------------------------------------------------------- Average Annual Total Return 3 -3.21% +13.35% +9.02% - -------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $ 9,679 $ 18,712 $ 23,719 - -------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.15% - -------------------------------------------------------------------------------------------------- CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - -------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +1.95% +92.07% +133.66% - -------------------------------------------------------------------------------------------------- Average Annual Total Return 3 -1.80% +13.71% +9.89% - -------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $ 9,820 $ 19,007 $ 23,366 - -------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.85% - -------------------------------------------------------------------------------------------------- CLASS C 1-YEAR 5-YEAR 10-YEAR - -------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +1.99% +92.17% +135.88% - -------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +1.05% +13.96% +8.96% - -------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $10,105 $ 19,217 $ 23,588 - -------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.85% - --------------------------------------------------------------------------------------------------
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. 12 | 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 (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE Mutual Beacon Fund S&P 500 6 - -------------------------------------------------------------------------------- 1/1/1998 $10,000 $10,000 1/31/1998 $ 9,943 $10,111 2/28/1998 $10,482 $10,840 3/31/1998 $10,928 $11,395 4/30/1998 $11,069 $11,510 5/31/1998 $11,105 $11,312 6/30/1998 $11,027 $11,771 7/31/1998 $10,759 $11,646 8/31/1998 $ 9,288 $ 9,962 9/30/1998 $ 9,093 $10,600 10/31/1998 $ 9,634 $11,463 11/30/1998 $10,182 $12,157 12/31/1998 $10,237 $12,858 1/31/1999 $10,416 $13,396 2/28/1999 $10,299 $12,979 3/31/1999 $10,775 $13,498 4/30/1999 $11,625 $14,021 5/31/1999 $11,735 $13,690 6/30/1999 $12,057 $14,450 7/31/1999 $11,802 $13,999 8/31/1999 $11,380 $13,929 9/30/1999 $11,085 $13,548 10/31/1999 $11,396 $14,405 11/30/1999 $11,666 $14,698 12/31/1999 $11,956 $15,563 1/31/2000 $11,662 $14,781 2/29/2000 $11,334 $14,502 3/31/2000 $12,465 $15,920 4/30/2000 $12,318 $15,441 5/31/2000 $12,474 $15,124 6/30/2000 $12,328 $15,497 7/31/2000 $12,642 $15,255 8/31/2000 $13,168 $16,203 9/30/2000 $13,195 $15,347 10/31/2000 $13,417 $15,282 11/30/2000 $13,066 $14,078 12/31/2000 $13,668 $14,146 1/31/2001 $14,557 $14,648 2/28/2001 $14,475 $13,313 3/31/2001 $14,057 $12,469 4/30/2001 $14,639 $13,438 5/31/2001 $15,129 $13,528 6/30/2001 $15,245 $13,199 7/31/2001 $15,339 $13,069 8/31/2001 $15,016 $12,251 9/30/2001 $13,691 $11,262 10/31/2001 $13,680 $11,476 11/30/2001 $14,171 $12,357 12/31/2001 $14,504 $12,465 1/31/2002 $14,449 $12,283 2/28/2002 $14,537 $12,046 3/31/2002 $14,938 $12,499 4/30/2002 $15,071 $11,741 5/31/2002 $15,127 $11,655 6/30/2002 $14,081 $10,825 7/31/2002 $13,160 $ 9,981 8/31/2002 $13,283 $10,046 9/30/2002 $12,564 $ 8,955 10/31/2002 $12,733 $ 9,743 11/30/2002 $12,980 $10,316 12/31/2002 $12,902 $ 9,710 1/31/2003 $12,765 $ 9,456 2/28/2003 $12,480 $ 9,314 3/31/2003 $12,514 $ 9,404 4/30/2003 $13,324 $10,179 5/31/2003 $14,043 $10,715 6/30/2003 $14,288 $10,852 7/31/2003 $14,449 $11,043 8/31/2003 $14,862 $11,259 9/30/2003 $14,839 $11,139 10/31/2003 $15,449 $11,769 11/30/2003 $16,000 $11,873 12/31/2003 $16,700 $12,495 1/31/2004 $16,770 $12,725 2/29/2004 $17,338 $12,902 3/31/2004 $17,315 $12,707 4/30/2004 $16,851 $12,508 5/31/2004 $16,944 $12,679 6/30/2004 $17,229 $12,926 7/31/2004 $17,007 $12,498 8/31/2004 $17,147 $12,549 9/30/2004 $17,451 $12,684 10/31/2004 $17,685 $12,878 11/30/2004 $18,607 $13,399 12/31/2004 $19,126 $13,855 1/31/2005 $18,730 $13,518 2/28/2005 $19,318 $13,802 3/31/2005 $19,198 $13,558 4/30/2005 $19,042 $13,300 5/31/2005 $19,438 $13,724 6/30/2005 $19,684 $13,743 7/31/2005 $20,205 $14,254 8/31/2005 $20,302 $14,124 9/30/2005 $20,556 $14,239 10/31/2005 $19,975 $14,001 11/30/2005 $20,520 $14,531 12/31/2005 $20,896 $14,536 1/31/2006 $21,394 $14,921 2/28/2006 $21,663 $14,961 3/31/2006 $22,431 $15,147 4/30/2006 $22,552 $15,351 5/31/2006 $22,390 $14,909 6/30/2006 $22,303 $14,929 7/31/2006 $22,358 $15,021 8/31/2006 $23,134 $15,379 9/30/2006 $23,328 $15,775 10/31/2006 $24,214 $16,289 11/30/2006 $24,629 $16,599 12/31/2006 $25,279 $16,832 1/31/2007 $25,915 $17,086 2/28/2007 $25,839 $16,752 3/31/2007 $26,323 $16,939 4/30/2007 $27,004 $17,690 5/31/2007 $27,972 $18,307 6/30/2007 $27,709 $18,003 7/31/2007 $26,640 $17,445 8/31/2007 $26,472 $17,706 9/30/2007 $26,839 $18,368 10/31/2007 $27,419 $18,661 11/30/2007 $26,487 $17,880 12/31/2007 $26,046 $17,756 AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------- CLASS Z 12/31/07 - ---------------------------------------------- 1-Year +3.03% - ---------------------------------------------- 5-Year +15.08% - ---------------------------------------------- 10-Year +10.05% - ---------------------------------------------- CLASS A (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE Mutual Beacon Fund S&P 500 6 - -------------------------------------------------------------------------------- 1/1/1998 $ 9,425 $10,000 1/31/1998 $ 9,371 $10,111 2/28/1998 $ 9,873 $10,840 3/31/1998 $10,288 $11,395 4/30/1998 $10,421 $11,510 5/31/1998 $10,448 $11,312 6/30/1998 $10,375 $11,771 7/31/1998 $10,121 $11,646 8/31/1998 $ 8,732 $ 9,962 9/30/1998 $ 8,542 $10,600 10/31/1998 $ 9,052 $11,463 11/30/1998 $ 9,570 $12,157 12/31/1998 $ 9,615 $12,858 1/31/1999 $ 9,784 $13,396 2/28/1999 $ 9,666 $12,979 3/31/1999 $10,107 $13,498 4/30/1999 $10,901 $14,021 5/31/1999 $11,011 $13,690 6/30/1999 $11,305 $14,450 7/31/1999 $11,066 $13,999 8/31/1999 $10,661 $13,929 9/30/1999 $10,384 $13,548 10/31/1999 $10,668 $14,405 11/30/1999 $10,923 $14,698 12/31/1999 $11,192 $15,563 1/31/2000 $10,916 $14,781 2/29/2000 $10,600 $14,502 3/31/2000 $11,654 $15,920 4/30/2000 $11,516 $15,441 5/31/2000 $11,662 $15,124 6/30/2000 $11,514 $15,497 7/31/2000 $11,809 $15,255 8/31/2000 $12,293 $16,203 9/30/2000 $12,319 $15,347 10/31/2000 $12,527 $15,282 11/30/2000 $12,198 $14,078 12/31/2000 $12,747 $14,146 1/31/2001 $13,578 $14,648 2/28/2001 $13,492 $13,313 3/31/2001 $13,100 $12,469 4/30/2001 $13,635 $13,438 5/31/2001 $14,094 $13,528 6/30/2001 $14,189 $13,199 7/31/2001 $14,277 $13,069 8/31/2001 $13,965 $12,251 9/30/2001 $12,745 $11,262 10/31/2001 $12,726 $11,476 11/30/2001 $13,175 $12,357 12/31/2001 $13,484 $12,465 1/31/2002 $13,432 $12,283 2/28/2002 $13,505 $12,046 3/31/2002 $13,878 $12,499 4/30/2002 $14,002 $11,741 5/31/2002 $14,044 $11,655 6/30/2002 $13,065 $10,825 7/31/2002 $12,206 $ 9,981 8/31/2002 $12,321 $10,046 9/30/2002 $11,651 $ 8,955 10/31/2002 $11,798 $ 9,743 11/30/2002 $12,018 $10,316 12/31/2002 $11,945 $ 9,710 1/31/2003 $11,818 $ 9,456 2/28/2003 $11,553 $ 9,314 3/31/2003 $11,574 $ 9,404 4/30/2003 $12,326 $10,179 5/31/2003 $12,994 $10,715 6/30/2003 $13,218 $10,852 7/31/2003 $13,357 $11,043 8/31/2003 $13,731 $11,259 9/30/2003 $13,709 $11,139 10/31/2003 $14,275 $11,769 11/30/2003 $14,777 $11,873 12/31/2003 $15,407 $12,495 1/31/2004 $15,482 $12,725 2/29/2004 $15,988 $12,902 3/31/2004 $15,966 $12,707 4/30/2004 $15,525 $12,508 5/31/2004 $15,611 $12,679 6/30/2004 $15,882 $12,926 7/31/2004 $15,665 $12,498 8/31/2004 $15,784 $12,549 9/30/2004 $16,066 $12,684 10/31/2004 $16,271 $12,878 11/30/2004 $17,115 $13,399 12/31/2004 $17,585 $13,855 1/31/2005 $17,219 $13,518 2/28/2005 $17,762 $13,802 3/31/2005 $17,640 $13,558 4/30/2005 $17,485 $13,300 5/31/2005 $17,851 $13,724 6/30/2005 $18,084 $13,743 7/31/2005 $18,554 $14,254 8/31/2005 $18,632 $14,124 9/30/2005 $18,856 $14,239 10/31/2005 $18,330 $14,001 11/30/2005 $18,823 $14,531 12/31/2005 $19,149 $14,536 1/31/2006 $19,608 $14,921 2/28/2006 $19,856 $14,961 3/31/2006 $20,538 $15,147 4/30/2006 $20,650 $15,351 5/31/2006 $20,501 $14,909 6/30/2006 $20,415 $14,929 7/31/2006 $20,466 $15,021 8/31/2006 $21,168 $15,379 9/30/2006 $21,346 $15,775 10/31/2006 $22,137 $16,289 11/30/2006 $22,519 $16,599 12/31/2006 $23,102 $16,832 1/31/2007 $23,686 $17,086 2/28/2007 $23,603 $16,752 3/31/2007 $24,048 $16,939 4/30/2007 $24,646 $17,690 5/31/2007 $25,536 $18,307 6/30/2007 $25,289 $18,003 7/31/2007 $24,307 $17,445 8/31/2007 $24,138 $17,706 9/30/2007 $24,461 $18,368 10/31/2007 $24,994 $18,661 11/30/2007 $24,138 $17,880 12/31/2007 $23,719 $17,756 AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------- CLASS A 12/31/07 - ---------------------------------------------- 1-Year -3.21% - ---------------------------------------------- 5-Year +13.35% - ---------------------------------------------- 10-Year +9.02% - ---------------------------------------------- Annual Report | 13 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------- CLASS B 12/31/07 - ---------------------------------------------- 1-Year -1.80% - ---------------------------------------------- 5-Year +13.71% - ---------------------------------------------- Since Inception (1/1/99) +9.89% - ---------------------------------------------- CLASS B (1/1/99-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE Mutual Beacon Fund S&P 500 6 - -------------------------------------------------------------------------------- 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 $10,833 9/30/1999 $10,719 $10,536 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 $11,278 3/31/2000 $11,996 $12,382 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 $11,864 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 $11,002 1/31/2001 $13,896 $11,392 2/28/2001 $13,806 $10,354 3/31/2001 $13,390 $ 9,698 4/30/2001 $13,935 $10,451 5/31/2001 $14,401 $10,521 6/30/2001 $14,487 $10,265 7/31/2001 $14,568 $10,164 8/31/2001 $14,244 $ 9,528 9/30/2001 $12,990 $ 8,759 10/31/2001 $12,959 $ 8,926 11/30/2001 $13,415 $ 9,610 12/31/2001 $13,722 $ 9,694 1/31/2002 $13,658 $ 9,553 2/28/2002 $13,722 $ 9,369 3/31/2002 $14,097 $ 9,721 4/30/2002 $14,215 $ 9,132 5/31/2002 $14,258 $ 9,064 6/30/2002 $13,253 $ 8,419 7/31/2002 $12,375 $ 7,763 8/31/2002 $12,483 $ 7,813 9/30/2002 $11,801 $ 6,964 10/31/2002 $11,942 $ 7,577 11/30/2002 $12,169 $ 8,023 12/31/2002 $12,081 $ 7,552 1/31/2003 $11,950 $ 7,354 2/28/2003 $11,677 $ 7,244 3/31/2003 $11,688 $ 7,314 4/30/2003 $12,441 $ 7,917 5/31/2003 $13,107 $ 8,334 6/30/2003 $13,320 $ 8,440 7/31/2003 $13,463 $ 8,589 8/31/2003 $13,825 $ 8,756 9/30/2003 $13,793 $ 8,663 10/31/2003 $14,353 $ 9,153 11/30/2003 $14,848 $ 9,234 12/31/2003 $15,491 $ 9,718 1/31/2004 $15,546 $ 9,897 2/29/2004 $16,052 $10,034 3/31/2004 $16,019 $ 9,883 4/30/2004 $15,568 $ 9,728 5/31/2004 $15,645 $ 9,861 6/30/2004 $15,903 $10,053 7/31/2004 $15,681 $ 9,720 8/31/2004 $15,792 $ 9,759 9/30/2004 $16,069 $ 9,865 10/31/2004 $16,268 $10,016 11/30/2004 $17,099 $10,421 12/31/2004 $17,554 $10,776 1/31/2005 $17,181 $10,513 2/28/2005 $17,712 $10,734 3/31/2005 $17,588 $10,544 4/30/2005 $17,430 $10,344 5/31/2005 $17,769 $10,673 6/30/2005 $17,985 $10,689 7/31/2005 $18,453 $11,086 8/31/2005 $18,510 $10,985 9/30/2005 $18,738 $11,074 10/31/2005 $18,190 $10,889 11/30/2005 $18,681 $11,301 12/31/2005 $18,987 $11,305 1/31/2006 $19,441 $11,604 2/28/2006 $19,667 $11,636 3/31/2006 $20,334 $11,781 4/30/2006 $20,435 $11,939 5/31/2006 $20,272 $11,595 6/30/2006 $20,185 $11,611 7/31/2006 $20,211 $11,683 8/31/2006 $20,897 $11,961 9/30/2006 $21,053 $12,269 10/31/2006 $21,829 $12,669 11/30/2006 $22,192 $12,909 12/31/2006 $22,758 $13,091 1/31/2007 $23,334 $13,289 2/28/2007 $23,252 $13,029 3/31/2007 $23,692 $13,174 4/30/2007 $24,281 $13,758 5/31/2007 $25,158 $14,238 6/30/2007 $24,914 $14,001 7/31/2007 $23,947 $13,567 8/31/2007 $23,782 $13,771 9/30/2007 $24,101 $14,286 10/31/2007 $24,626 $14,513 11/30/2007 $23,782 $13,906 12/31/2007 $23,366 $13,810 AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------- CLASS C 12/31/07 - ---------------------------------------------- 1-Year +1.05% - ---------------------------------------------- 5-Year +13.96% - ---------------------------------------------- 10-Year +8.96% - ---------------------------------------------- CLASS C (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE Mutual Beacon Fund S&P 500 6 - -------------------------------------------------------------------------------- 1/1/1998 $10,000 $10,000 1/31/1998 $ 9,936 $10,111 2/28/1998 $10,470 $10,840 3/31/1998 $10,905 $11,395 4/30/1998 $11,033 $11,510 5/31/1998 $11,061 $11,312 6/30/1998 $10,976 $11,771 7/31/1998 $10,701 $11,646 8/31/1998 $ 9,231 $ 9,962 9/30/1998 $ 9,028 $10,600 10/31/1998 $ 9,557 $11,463 11/30/1998 $10,100 $12,157 12/31/1998 $10,140 $12,858 1/31/1999 $10,311 $13,396 2/28/1999 $10,179 $12,979 3/31/1999 $10,645 $13,498 4/30/1999 $11,477 $14,021 5/31/1999 $11,578 $13,690 6/30/1999 $11,887 $14,450 7/31/1999 $11,626 $13,999 8/31/1999 $11,198 $13,929 9/30/1999 $10,897 $13,548 10/31/1999 $11,190 $14,405 11/30/1999 $11,452 $14,698 12/31/1999 $11,727 $15,563 1/31/2000 $11,428 $14,781 2/29/2000 $11,095 $14,502 3/31/2000 $12,196 $15,920 4/30/2000 $12,042 $15,441 5/31/2000 $12,187 $15,124 6/30/2000 $12,028 $15,497 7/31/2000 $12,328 $15,255 8/31/2000 $12,828 $16,203 9/30/2000 $12,846 $15,347 10/31/2000 $13,055 $15,282 11/30/2000 $12,701 $14,078 12/31/2000 $13,276 $14,146 1/31/2001 $14,125 $14,648 2/28/2001 $14,035 $13,313 3/31/2001 $13,616 $12,469 4/30/2001 $14,165 $13,438 5/31/2001 $14,635 $13,528 6/30/2001 $14,727 $13,199 7/31/2001 $14,809 $13,069 8/31/2001 $14,483 $12,251 9/30/2001 $13,207 $11,262 10/31/2001 $13,176 $11,476 11/30/2001 $13,635 $12,357 12/31/2001 $13,947 $12,465 1/31/2002 $13,882 $12,283 2/28/2002 $13,958 $12,046 3/31/2002 $14,335 $12,499 4/30/2002 $14,454 $11,741 5/31/2002 $14,486 $11,655 6/30/2002 $13,472 $10,825 7/31/2002 $12,579 $ 9,981 8/31/2002 $12,688 $10,046 9/30/2002 $11,991 $ 8,955 10/31/2002 $12,144 $ 9,743 11/30/2002 $12,361 $10,316 12/31/2002 $12,274 $ 9,710 1/31/2003 $12,143 $ 9,456 2/28/2003 $11,858 $ 9,314 3/31/2003 $11,880 $ 9,404 4/30/2003 $12,647 $10,179 5/31/2003 $13,315 $10,715 6/30/2003 $13,539 $10,852 7/31/2003 $13,682 $11,043 8/31/2003 $14,057 $11,259 9/30/2003 $14,024 $11,139 10/31/2003 $14,586 $11,769 11/30/2003 $15,094 $11,873 12/31/2003 $15,741 $12,495 1/31/2004 $15,796 $12,725 2/29/2004 $16,316 $12,902 3/31/2004 $16,282 $12,707 4/30/2004 $15,830 $12,508 5/31/2004 $15,907 $12,679 6/30/2004 $16,165 $12,926 7/31/2004 $15,942 $12,498 8/31/2004 $16,054 $12,549 9/30/2004 $16,331 $12,684 10/31/2004 $16,531 $12,878 11/30/2004 $17,387 $13,399 12/31/2004 $17,849 $13,855 1/31/2005 $17,464 $13,518 2/28/2005 $18,007 $13,802 3/31/2005 $17,871 $13,558 4/30/2005 $17,713 $13,300 5/31/2005 $18,064 $13,724 6/30/2005 $18,281 $13,743 7/31/2005 $18,749 $14,254 8/31/2005 $18,818 $14,124 9/30/2005 $19,046 $14,239 10/31/2005 $18,498 $14,001 11/30/2005 $18,978 $14,531 12/31/2005 $19,298 $14,536 1/31/2006 $19,752 $14,921 2/28/2006 $19,991 $14,961 3/31/2006 $20,672 $15,147 4/30/2006 $20,772 $15,351 5/31/2006 $20,609 $14,909 6/30/2006 $20,509 $14,929 7/31/2006 $20,535 $15,021 8/31/2006 $21,235 $15,379 9/30/2006 $21,403 $15,775 10/31/2006 $22,193 $16,289 11/30/2006 $22,555 $16,599 12/31/2006 $23,127 $16,832 1/31/2007 $23,689 $17,086 2/28/2007 $23,591 $16,752 3/31/2007 $24,026 $16,939 4/30/2007 $24,617 $17,690 5/31/2007 $25,488 $18,307 6/30/2007 $25,238 $18,003 7/31/2007 $24,232 $17,445 8/31/2007 $24,062 $17,706 9/30/2007 $24,374 $18,368 10/31/2007 $24,870 $18,661 11/30/2007 $24,005 $17,880 12/31/2007 $23,588 $17,756 14 | Annual Report Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. THE FUND'S INVESTMENTS IN FOREIGN SECURITIES INVOLVE SPECIAL RISKS. FOREIGN SECURITIES RISKS INCLUDE CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, WHICH INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, 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. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated. 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. 5. Figures are as stated in the Fund's prospectus current as of the date of this report. 6. 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 | 15 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 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. 16 | 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 7/1/07 VALUE 12/31/07 PERIOD* 7/1/07-12/31/07 - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 940.00 $3.96 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $ 1,021.12 $4.13 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 937.90 $5.52 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $ 1,019.51 $5.75 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 934.60 $8.78 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $ 1,016.13 $9.15 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 934.60 $8.78 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $ 1,016.13 $9.15 - --------------------------------------------------------------------------------------------------------
* Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 0.81%; A: 1.13%; B: 1.80%; and C: 1.80%), multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period. Annual Report | 17 Mutual Beacon Fund FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2007 2006 2005 2004 2003 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................... $ 16.71 $ 15.52 $ 15.94 $ 14.40 $ 11.31 --------------------------------------------------------------------------- Income from investment operations a: Net investment income b ........................... 0.51 0.26 0.31 0.30 0.19 Net realized and unrealized gains (losses) ........ -- 2.91 1.16 1.76 3.13 --------------------------------------------------------------------------- Total from investment operations ..................... 0.51 3.17 1.47 2.06 3.32 --------------------------------------------------------------------------- Less distributions from: Net investment income ............................. (0.57) (0.28) (0.30) (0.37) (0.23) Net realized gains ................................ (0.92) (1.70) (1.59) (0.15) -- --------------------------------------------------------------------------- Total distributions .................................. (1.49) (1.98) (1.89) (0.52) (0.23) --------------------------------------------------------------------------- Redemption fees ...................................... -- d -- d -- d -- d -- --------------------------------------------------------------------------- Net asset value, end of year ......................... $ 15.73 $ 16.71 $ 15.52 $ 15.94 $ 14.40 =========================================================================== Total return ......................................... 3.03% 20.98% 9.25% 14.52% 29.44% RATIOS TO AVERAGE NET ASSETS Expenses c ........................................... 0.82% e 0.85% e 0.89% e 0.83% e 0.86% Expenses - excluding dividend expense on securities sold short ............................. 0.81% e 0.82% e 0.84% e 0.82% e 0.83% Net investment income ................................ 2.89% 1.59% 1.91% 1.99% 1.48% SUPPLEMENTAL DATA Net assets, end of year (000's) ...................... $3,883,935 $3,925,029 $3,433,665 $3,359,389 $3,112,212 Portfolio turnover rate .............................. 49.84% 40.72% 35.36% 29.17% 49.61%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. 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 rounds to less than $0.01 per share. e Benefit of expense reduction rounds to less than 0.01%. 18 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2007 2006 2005 2004 2003 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................... $ 16.61 $ 15.44 $ 15.87 $ 14.34 $ 11.27 --------------------------------------------------------------------------- Income from investment operations a: Net investment income b ........................... 0.45 0.21 0.26 0.25 0.14 Net realized and unrealized gains (losses) ........ -- 2.90 1.15 1.75 3.12 --------------------------------------------------------------------------- Total from investment operations ..................... 0.45 3.11 1.41 2.00 3.26 --------------------------------------------------------------------------- Less distributions from: Net investment income ............................. (0.52) (0.24) (0.25) (0.32) (0.19) Net realized gains ................................ (0.92) (1.70) (1.59) (0.15) -- --------------------------------------------------------------------------- Total distributions .................................. (1.44) (1.94) (1.84) (0.47) (0.19) --------------------------------------------------------------------------- Redemption fees ...................................... -- e -- e -- e -- e -- --------------------------------------------------------------------------- Net asset value, end of year ......................... $ 15.62 $ 16.61 $ 15.44 $ 15.87 $ 14.34 =========================================================================== Total return c ....................................... 2.67% 20.65% 8.89% 14.13% 28.99% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................... 1.14% f 1.15% f 1.22% f 1.18% f 1.21% Expenses - excluding dividend expense on securities sold short ........................................ 1.13% f 1.12% f 1.17% f 1.17% f 1.18% Net investment income ................................ 2.57% 1.29% 1.58% 1.64% 1.13% SUPPLEMENTAL DATA Net assets, end of year (000's) ...................... $2,654,731 $2,176,658 $1,633,022 $1,462,133 $1,301,620 Portfolio turnover rate .............................. 49.84% 40.72% 35.36% 29.17% 49.61%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 19 Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2007 2006 2005 2004 2003 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................... $ 16.17 $ 15.09 $ 15.54 $ 14.06 $ 11.07 --------------------------------------------------------------------------- Income from investment operations a: Net investment income b ........................... 0.32 0.10 0.14 0.15 0.05 Net realized and unrealized gains (losses) ........ 0.01 2.80 1.14 1.71 3.06 --------------------------------------------------------------------------- Total from investment operations ..................... 0.33 2.90 1.28 1.86 3.11 --------------------------------------------------------------------------- Less distributions from: Net investment income ............................. (0.39) (0.12) (0.14) (0.23) (0.12) Net realized gains ................................ (0.92) (1.70) (1.59) (0.15) -- --------------------------------------------------------------------------- Total distributions .................................. (1.31) (1.82) (1.73) (0.38) (0.12) --------------------------------------------------------------------------- Redemption fees ...................................... -- e -- e -- e -- e -- --------------------------------------------------------------------------- Net asset value, end of year ......................... $ 15.19 $ 16.17 $ 15.09 $ 15.54 $ 14.06 =========================================================================== Total return c ....................................... 1.95% 19.86% 8.17% 13.32% 28.22% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................... 1.81% f 1.85% f 1.89% f 1.83% f 1.86% Expenses - excluding dividend expense on securities sold short ........................................ 1.80% f 1.82% f 1.84% f 1.82% f 1.83% Net investment income ................................ 1.90% 0.59% 0.91% 0.99% 0.48% SUPPLEMENTAL DATA Net assets, end of year (000's) ...................... $ 171,628 $ 199,461 $ 186,169 $ 186,840 $ 155,572 Portfolio turnover rate .............................. 49.84% 40.72% 35.36% 29.17% 49.61%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. 20 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Beacon Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2007 2006 2005 2004 2003 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................... $ 16.46 $ 15.33 $ 15.77 $ 14.26 $ 11.22 --------------------------------------------------------------------------- Income from investment operations a: Net investment income b ........................... 0.33 0.10 0.15 0.14 0.06 Net realized and unrealized gains (losses) ........ -- 2.85 1.14 1.74 3.09 --------------------------------------------------------------------------- Total from investment operations ..................... 0.33 2.95 1.29 1.88 3.15 --------------------------------------------------------------------------- Less distributions from: Net investment income ............................. (0.40) (0.12) (0.14) (0.23) (0.11) Net realized gains ................................ (0.92) (1.70) (1.59) (0.14) -- --------------------------------------------------------------------------- Total distributions .................................. (1.32) (1.82) (1.73) (0.37) (0.11) --------------------------------------------------------------------------- Redemption fees ...................................... -- e -- e -- e -- e -- --------------------------------------------------------------------------- Net asset value, end of year ......................... $ 15.47 $ 16.46 $ 15.33 $ 15.77 $ 14.26 =========================================================================== Total return c ....................................... 1.99% 19.84% 8.12% 13.39% 28.24% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................... 1.81% f 1.85% f 1.89% f 1.83% f 1.86% Expenses - excluding dividend expense on securities sold short ........................................ 1.80% f 1.82% f 1.84% f 1.82% f 1.83% Net investment income ................................ 1.90% 0.59% 0.91% 0.99% 0.48% SUPPLEMENTAL DATA Net assets, end of year (000's) ...................... $ 875,060 $ 825,234 $ 697,400 $ 658,813 $ 579,825 Portfolio turnover rate .............................. 49.84% 40.72% 35.36% 29.17% 49.61%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 21 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS 94.4% COMMON STOCKS AND OTHER EQUITY INTERESTS 89.3% AIR FREIGHT & LOGISTICS 1.1% Deutsche Post AG .............................................. Germany 2,364,674 $ 80,440,173 ----------------- AIRLINES 0.6% a ACE Aviation Holdings Inc., A ................................. Canada 920,863 26,270,658 a,b ACE Aviation Holdings Inc., A, 144A ........................... Canada 46,508 1,326,794 a Northwest Airlines Corp. ...................................... United States 911,804 13,230,276 a,c Northwest Airlines Corp., Contingent Distribution ............. United States 35,952,000 1,213,380 ----------------- 42,041,108 ----------------- AUTO COMPONENTS 0.5% a,c Collins & Aikman Products Co., Contingent Distribution ........ United States 1,508,338 667,440 a Goodyear Tire & Rubber Co. .................................... United States 1,347,098 38,015,105 ----------------- 38,682,545 ----------------- AUTOMOBILES 1.5% General Motors Corp. .......................................... United States 2,956,699 73,592,238 a,d,e,f International Automotive Components Group Brazil LLC .......... Brazil 2,387,711 16,585,351 a,d,e,f International Automotive Components Group Japan LLC ........... Japan 378,194 3,391,418 a,d,e,f International Automotive Components Group LLC ................. Luxembourg 10,149,082 10,767,161 a,d,e,f International Automotive Components Group NA LLC .............. United States 6,469,826 8,896,011 ----------------- 113,232,179 ----------------- BEVERAGES 1.8% Brown-Forman Corp., A ......................................... United States 308,260 23,070,178 Brown-Forman Corp., B ......................................... United States 362,618 26,873,620 Carlsberg AS, A ............................................... Denmark 74,900 8,546,179 Carlsberg AS, B ............................................... Denmark 671,304 81,063,620 ----------------- 139,553,597 ----------------- BUILDING PRODUCTS 0.3% a,c Armstrong World Industries Inc., Contingent Distribution ...... United States 19,836,575 74,387 a Owens Corning Inc. ............................................ United States 1,090,603 22,051,993 ----------------- 22,126,380 ----------------- CHEMICALS 0.1% a,c Dow Corning Corp., Contingent Distribution .................... United States 12,598,548 6,425,259 ----------------- COMMERCIAL BANKS 7.9% a Banco Popolare SpA ............................................ Italy 2,450,074 54,204,812 BNP Paribas SA ................................................ France 727,050 78,748,933 Commerce Bancorp Inc. ......................................... United States 1,214,390 46,316,835 Danske Bank AS ................................................ Denmark 1,524,804 59,610,451 a,d,e,g FE Capital Holdings Ltd. ...................................... Japan 14,498 9,523,457 a,d,e,g First Chicago Bancorp ......................................... United States 1,157,143 16,200,002 Intesa Sanpaolo SpA ........................................... Italy 10,097,248 79,718,613 Mitsubishi UFJ Financial Group Inc. ........................... Japan 2,777,112 26,073,948 a,d,e NCB Warrant Holdings Ltd., A .................................. Japan 67,420 4,000,152 Svenska Handelsbanken AB, A ................................... Sweden 1,458,813 46,704,037 U.S. Bancorp .................................................. United States 5,538,540 175,793,260 ----------------- 596,894,500 -----------------
22 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMMERCIAL SERVICES & SUPPLIES 0.0% h a Comdisco Holding Co. Inc. ..................................... United States 1,202 $ 10,950 a,c Comdisco Holding Co. Inc., Contingent Distribution ............ United States 54,914,113 -- ----------------- 10,950 ----------------- COMMUNICATIONS EQUIPMENT 2.0% Motorola Inc. ................................................. United States 5,723,343 91,802,422 Telefonaktiebolaget LM Ericsson, B ............................ Sweden 19,859,426 46,625,437 Telefonaktiebolaget LM Ericsson, B, ADR ....................... Sweden 667,100 15,576,785 ----------------- 154,004,644 ----------------- COMPUTERS & PERIPHERALS 1.6% a,d,e,g DecisionOne Corp. ............................................. United States 1,142,353 -- a,d,e,g DecisionOne Corp., wts., 6/08/17 .............................. United States 627,237 -- a Dell Inc. ..................................................... United States 4,061,020 99,535,600 a Lexmark International Inc., A ................................. United States 664,600 23,167,956 ----------------- 122,703,556 ----------------- CONSUMER FINANCE 1.4% a,d,e Cerberus CG Investor I LLC .................................... United States 18,089,600 15,231,019 a,d,e Cerberus CG Investor II LLC ................................... United States 18,089,600 15,231,019 a,d,e Cerberus CG Investor III LLC .................................. United States 9,044,800 7,615,509 a,d,e Cerberus FIM Investors Auto Finance LLC ....................... United States 5,706,149 3,061,525 a,d,e Cerberus FIM Investors Commercial Finance LLC ................. United States 475,305 255,016 a,d,e Cerberus FIM Investors Commercial Mortgage LLC ................ United States 890,886 477,988 a,d,e Cerberus FIM Investors Insurance LLC .......................... United States 4,357,377 2,337,867 a,d,e Cerberus FIM Investors Rescap LLC ............................. United States 8,112,533 4,352,625 SLM Corp. ..................................................... United States 2,785,220 56,094,331 ----------------- 104,656,899 ----------------- CONTAINERS & PACKAGING 0.6% Temple-Inland Inc. ............................................ United States 2,158,767 45,010,292 ----------------- DIVERSIFIED FINANCIAL SERVICES 2.1% Fortis ........................................................ Belgium 5,623,830 148,385,020 a Fortis VVPR Strip ............................................. Belgium 2,249,532 32,828 a Guaranty Financial Group Inc. ................................. United States 719,589 11,513,423 a,c Marconi Corp., Contingent Distribution ........................ United Kingdom 42,651,300 -- ----------------- 159,931,271 ----------------- DIVERSIFIED TELECOMMUNICATION SERVICES 0.9% a,d,e,f AboveNet Inc. ................................................. United States 466,432 23,321,600 a,d,f AboveNet Inc., stock grants, grant price $20.95, expiration date 9/09/13 .................................... United States 613 25,409 a,d,e,f AboveNet Inc., wts., 9/08/08 .................................. United States 16,857 795,650 a,d,e,f AboveNet Inc., wts., 9/08/10 .................................. United States 19,829 866,131 a,c,e Global Crossing Holdings Ltd., Contingent Distribution ........ United States 60,632,757 -- Telefonica SA ................................................. Spain 1,317,275 42,714,955 ----------------- 67,723,745 -----------------
Annual Report | 23 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) ELECTRIC UTILITIES 0.5% E.ON AG ....................................................... Germany 182,802 $ 38,844,684 ---------------- ELECTRONIC EQUIPMENT & INSTRUMENTS 0.8% Tyco Electronics Ltd. ......................................... United States 1,705,745 63,334,312 ---------------- ENERGY EQUIPMENT & SERVICES 1.7% a Seadrill Ltd. ................................................. Bermuda 2,283,800 55,681,939 a,i Transocean Inc. ............................................... United States 507,510 72,650,057 ---------------- 128,331,996 ---------------- FOOD & STAPLES RETAILING 2.3% Carrefour SA .................................................. France 1,069,252 83,154,401 CVS Caremark Corp. ............................................ United States 2,211,114 87,891,782 ---------------- 171,046,183 ---------------- FOOD PRODUCTS 3.7% Cadbury Schweppes PLC ......................................... United Kingdom 4,497,511 55,494,609 g Farmer Brothers Co. ........................................... United States 1,033,896 23,769,269 Groupe Danone ................................................. France 852,980 76,430,494 a Lighthouse Caledonia ASA ...................................... Norway 615,270 584,193 a,j Marine Harvest ................................................ Norway 72,384,735 46,484,999 Nestle SA ..................................................... Switzerland 175,235 80,411,401 ---------------- 283,174,965 ---------------- HEALTH CARE EQUIPMENT & SUPPLIES 0.7% Hillenbrand Industries Inc. ................................... United States 889,128 49,551,103 ---------------- HEALTH CARE PROVIDERS & SERVICES 2.9% a Community Health Systems Inc. ................................. United States 1,692,360 62,380,390 a,d,e,f Kindred Healthcare Inc. ....................................... United States 1,639,289 38,901,967 a,d,e,f Kindred Healthcare Inc., stock grants: grant price $18.15, expiration date 7/17/11 ................... United States 5,731 31,985 grant price $19.87, expiration date 1/01/12 United States 1,720 6,641 grant price $6.94, expiration date 1/01/13 .................... United States 1,710 28,713 grant price $19.87, expiration date 1/01/14 ................... United States 1,276 4,927 grant price $21.33, expiration date 1/10/15 ................... United States 709 1,702 grant price $22.08, expiration date 1/10/16 ................... United States 354 584 Omnicare Inc. ................................................. United States 599,150 13,666,611 a PharMerica Inc. ............................................... United States 600,019 8,328,264 Quest Diagnostics Inc. ........................................ United States 938,540 49,648,766 a Tenet Healthcare Corp. ........................................ United States 9,752,777 49,544,107 ---------------- 222,544,657 ---------------- HOTELS, RESTAURANTS & LEISURE 0.1% a Trump Entertainment Resorts Inc. .............................. United States 895,133 3,849,072 ---------------- HOUSEHOLD DURABLES 0.2% a,j Hovnanian Enterprises Inc., A ................................. United States 2,255,390 16,171,146 ---------------- INDEPENDENT POWER PRODUCERS & ENERGY TRADERS 1.3% Constellation Energy Group .................................... United States 934,100 95,773,273 ----------------
24 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) INDUSTRIAL CONGLOMERATES 4.2% f Orkla ASA ..................................................... Norway 8,348,283 $ 161,681,256 Siemens AG .................................................... Germany 738,980 116,923,427 Tyco International Ltd. ....................................... United States 935,315 37,085,240 ---------------- 315,689,923 ---------------- INSURANCE 8.3% a Alleghany Corp. ............................................... United States 169,611 68,183,622 Allianz SE .................................................... Germany 244,340 52,802,006 American International Group Inc. ............................. United States 893,860 52,112,038 a Berkshire Hathaway Inc., A .................................... United States 741 104,925,600 a Berkshire Hathaway Inc., B .................................... United States 10,755 50,935,680 Old Republic International Corp. .............................. United States 2,217,426 34,170,535 a,d,e Olympus Re Holdings Ltd. ...................................... United States 106,700 349,464 d,e Symetra Financial ............................................. United States 4,450,920 71,303,738 White Mountains Insurance Group Ltd. .......................... United States 383,121 196,943,350 ---------------- 631,726,033 ---------------- IT SERVICES 0.5% a Alliance Data Systems Corp. ................................... United States 529,140 39,680,209 ---------------- LEISURE EQUIPMENT & PRODUCTS 1.0% Mattel Inc. ................................................... United States 3,854,432 73,388,385 ---------------- MACHINERY 0.0% a,d,e Motor Coach Industries International Inc., wts., 5/27/09 ...... United States 6 -- ---------------- MARINE 0.6% A.P. Moller - Maersk AS ....................................... Denmark 4,291 45,685,566 ---------------- MEDIA 8.9% a Adelphia Recovery Trust ....................................... United States 48,268,724 3,378,811 a,c Adelphia Recovery Trust Arohova Contingent Value Vehicle, Contingent Distribution .................................... United States 6,161,087 3,172,960 a,c Century Communications Corp., Contingent Distribution ......... United States 16,986,000 -- a Comcast Corp., A .............................................. United States 8,218,025 148,910,613 a Liberty Media Holding Corp.-Capital, A ........................ United States 347,868 40,523,143 News Corp., A ................................................. United States 7,966,387 163,231,270 a Sun-Times Media Group Inc., A ................................. United States 985,458 2,168,007 a Time Warner Cable Inc., A ..................................... United States 1,830,948 50,534,165 Time Warner Inc. .............................................. United States 6,400,710 105,675,722 a,e TVMAX Holdings Inc. ........................................... United States 133,855 -- a Viacom Inc., B ................................................ United States 1,958,560 86,019,955 Virgin Media Inc. ............................................. United Kingdom 3,991,350 68,411,739 ---------------- 672,026,385 ----------------
Annual Report | 25 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) METALS & MINING 1.3% Alcoa Inc. .................................................... United States 1,083,040 $ 39,585,112 a,d,e,g Esmark Inc. ................................................... United States 3,954,729 50,292,289 a,d,e,g PMG LLC ....................................................... United States 29,737 11,723,831 ----------------- 101,601,232 ----------------- MULTI-UTILITIES 1.5% Energy East Corp. ............................................. United States 1,323,585 36,014,748 a,c NorthWestern Corp., Contingent Distribution ................... United States 11,863,900 841,254 RWE AG ........................................................ Germany 566,745 79,771,797 ----------------- 116,627,799 ----------------- OIL, GAS & CONSUMABLE FUELS 0.0% h Royal Dutch Shell PLC, A ...................................... United Kingdom 5,673 238,018 ----------------- PAPER & FOREST PRODUCTS 4.7% a Domtar Corp. .................................................. United States 7,936,264 61,029,870 International Paper Co. ....................................... United States 1,930,820 62,519,952 MeadWestvaco Corp. ............................................ United States 1,560,233 48,835,293 Weyerhaeuser Co. .............................................. United States 2,468,965 182,061,479 ----------------- 354,446,594 ----------------- PHARMACEUTICALS 2.0% Novartis AG ................................................... Switzerland 1,399,344 76,684,842 Pfizer Inc. ................................................... United States 3,317,670 75,410,639 ----------------- 152,095,481 ----------------- REAL ESTATE 2.4% a Alexander's Inc. .............................................. United States 38,800 13,706,100 a,e Canary Wharf Group PLC ........................................ United Kingdom 10,069,634 100,639,538 a Forestar Real Estate Group .................................... United States 719,589 16,975,103 j The St. Joe Co. ............................................... United States 695,598 24,700,685 Ventas Inc. ................................................... United States 608,900 27,552,725 ----------------- 183,574,151 ----------------- SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT 0.7% a LSI Corp. ..................................................... United States 10,548,673 56,013,454 ----------------- SOFTWARE 2.9% a BEA Systems Inc. .............................................. United States 2,756,080 43,490,942 Microsoft Corp. ............................................... United States 4,637,880 165,108,528 a NAVTEQ Corp. .................................................. United States 167,800 12,685,680 ----------------- 221,285,150 ----------------- SPECIALTY RETAIL 0.8% The Home Depot Inc. ........................................... United States 2,253,250 60,702,555 ----------------- THRIFTS & MORTGAGE FINANCE 1.9% Hudson City Bancorp Inc. ...................................... United States 3,556,680 53,421,333 People's United Financial Inc. ................................ United States 1,692,640 30,128,992 Sovereign Bancorp Inc. ........................................ United States 3,288,580 37,489,812 Washington Mutual Inc. ........................................ United States 1,747,880 23,788,647 ----------------- 144,828,784 -----------------
26 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) TOBACCO 11.0% Altadis SA .................................................... Spain 1,469,777 $ 106,623,924 Altria Group Inc. ............................................. United States 2,138,378 161,618,609 British American Tobacco PLC .................................. United Kingdom 3,150,086 122,990,602 Imperial Tobacco Group PLC .................................... United Kingdom 2,532,443 136,463,444 Japan Tobacco Inc. ............................................ Japan 12,406 74,314,738 KT&G Corp. .................................................... South Korea 1,625,350 138,390,465 k Reynolds American Inc. ........................................ United States 1,481,724 97,734,515 ----------------- 838,136,297 ----------------- TRANSPORTATION INFRASTRUCTURE 0.0% h a Groupe Eurotunnel SA, wts., 12/30/11 .......................... France 1,570,655 527,191 ----------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $5,319,784,901) ...................................... 6,774,331,696 ----------------- PREFERRED STOCKS 0.2% AUTO COMPONENTS 0.1% d,e Dana Holding Corp., 4.00%, cvt., pfd., B ...................... United States 60,625 6,062,500 ----------------- CONSUMER FINANCE 0.1% a SLM Corp., cvt., pfd., C ...................................... United States 4,700 4,887,765 ----------------- DIVERSIFIED TELECOMMUNICATION SERVICES 0.0% h d PTV Inc., 10.00%, pfd., A ..................................... United Kingdom 114,246 137,095 ----------------- TOTAL PREFERRED STOCKS (COST $11,105,238) ..................... 11,087,360 ----------------- OPTIONS PURCHASED 1.4% CALL OPTIONS 0.0% h a,d Owens Corning Inc., exercise price $37.50, expiration date 1/02/08, shares ............................................ United States 310,123 15,506 ----------------- PUT OPTIONS 1.4% a Dow Jones EUROSTOXX 50, exercise price $4,088.73, expiration date 6/20/08, contracts ......................... United States 40,595 5,395,575 a Index basket consisting of 35% Dow Jones EUROSTOXX 50 (exercise price $4,091.31), 65% S&P 500 Index (exercise price $1,396.49), expiration date 7/18/08, contracts ....... United States 4,000,000 13,714,172 a S&P 500 Index, exercise price $1,250.00, expiration date 6/21/08, contracts ............................................ United States 1,468 4,022,320 a S&P 500 Index, exercise price $1,250.00, expiration date 12/20/08, contracts ........................................... United States 5,554 27,492,300 a S&P 500 Index, exercise price $1,300.00, expiration date 12/20/08, contracts ........................................... United States 5,186 31,479,020 a S&P 500 Index, exercise price $1,350.00, expiration date 9/20/08, contracts ............................................ United States 3,137 19,637,620
Annual Report | 27 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) PUT OPTIONS (CONTINUED) a S&P 500 Index, exercise price $1,375.00, expiration date 6/21/08, contracts ......................................... United States 456 $ 2,416,800 ----------------- 104,157,807 ----------------- TOTAL OPTIONS PURCHASED (COST $112,015,457) ................... 104,173,313 ----------------- --------------------- PRINCIPAL AMOUNT l --------------------- CORPORATE BONDS & NOTES 3.3% b ACE Aviation Holdings Inc., cvt., 144A, 4.25%, 6/01/35 ........ Canada 1,993,000 CAD 2,266,254 d,e Cerberus CG Investor I LLC, 12.00%, 7/31/14 ................... United States 18,089,600 15,231,019 d,e Cerberus CG Investor II LLC, 12.00%, 7/31/14 .................. United States 18,089,600 15,231,019 d,e Cerberus CG Investor III LLC, 12.00%, 7/31/14 ................. United States 9,044,800 7,615,509 d,e Cerberus FIM Investors Auto Finance LLC, 12.00%, 11/22/13 ..... United States 17,106,799 9,178,326 d,e Cerberus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 ................................................... United States 1,425,915 765,048 d,e Cerberus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 ................................................... United States 2,672,657 1,433,963 d,e Cerberus FIM Investors Insurance LLC, 12.00%, 11/22/13 ........ United States 13,072,130 7,013,602 d,e Cerberus FIM Investors Rescap LLC, 12.00%, 11/22/13 ........... United States 24,337,605 13,057,877 d,e,g DecisionOne Corp., 12.00%, 4/15/10 ............................................ United States 1,412,099 1,412,099 m FRN, 9.50%, 5/12/09 ........................................ United States 263,440 263,440 Groupe Eurotunnel SA, cvt., 3.00%, 6/28/09 ............................................. France 21,700 EUR 69,669 3.00%, 6/28/09 ............................................. France 24,211 GBP 105,833 3.00%, 7/28/10 ............................................. France 5,574,500 EUR 16,066,914 3.00%, 7/28/10 ............................................. France 5,182,586 GBP 20,337,642 6.00%, 7/28/10 ............................................. France 11,654,700 EUR 22,876,145 6.00%, 7/28/10 ............................................. France 14,069,455 GBP 37,599,887 sub. bond, T1, 3.00%, 7/28/08 .............................. France 21,700 EUR 77,586 sub. bond, T1, 3.00%, 7/28/08 France 24,211 GBP 117,860 b Indianapolis Downs LLC, senior secured note, 144A, 11.00%, 11/01/12 ................ United States 6,400,000 6,208,000 senior secured sub. note, 144A, PIK, 15.50%, 11/01/13 ...... United States 21,600,000 22,248,000 d,e,f International Automotive Components Group NA LLC, 9.00%, 4/01/17 .................................................... United States 1,947,800 1,947,800 d,e,m Motor Coach Industries International Inc., FRN, 18.081%, 12/01/08 ................................................... United States 32,534,499 32,209,154 Trump Entertainment Resorts Inc., 8.50%, 5/20/15 .............. United States 17,380,260 13,317,624 e TVMAX Holdings Inc., PIK, 11.50%, 2/28/08 ............................................ United States 364,554 255,188 14.00%, 2/28/08 ............................................ United States 857,882 600,517 ----------------- TOTAL CORPORATE BONDS & NOTES (COST $282,452,181) ............. 247,505,975 -----------------
28 | Annual Report Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL COUNTRY AMOUNT VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) CORPORATE BONDS & NOTES IN REORGANIZATION 0.2% b Calpine Corp., senior secured note, 144A, 8.50%, 7/15/10 ............................................. United States 3,119,000 $ 3,352,925 9.875%, 12/01/11 ........................................... United States 1,098,000 1,152,900 8.75%, 7/15/13 ............................................. United States 1,652,000 1,784,160 n Dana Corp., 6.50%, 3/01/09 ............................................. United States 2,594,000 1,958,470 5.85%, 1/15/15 ............................................. United States 11,335,000 8,331,225 7.00%, 3/01/29 ............................................. United States 2,425,000 1,830,875 senior note, 7.00%, 3/15/28 ................................ United States 536,000 393,960 e,n Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ....... United States 50,000 250 ----------------- TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $17,933,540) ......................................... 18,804,765 ----------------- TOTAL LONG TERM INVESTMENTS (COST $5,743,291,317) ............. 7,155,903,109 ----------------- SHORT TERM INVESTMENTS 5.8% U.S. GOVERNMENT AND AGENCY SECURITIES 5.3% k,o FHLB, 1/02/08 - 12/04/08 ...................................... United States 341,920,000 338,669,802 o U.S. Treasury Bills, 1/17/08 - 5/01/08 ........................ United States 61,000,000 60,767,270 ----------------- TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $399,017,374) ........................................ 399,437,072 ----------------- TOTAL INVESTMENTS BEFORE MONEY MARKET FUND (COST $6,142,308,691) ...................................... 7,555,340,181 ----------------- p INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES 0.5% MONEY MARKET FUND (COST $38,019,919) 0.5% q Bank of New York Institutional Cash Reserve Fund, 5.06% ....... United States 38,019,919 38,019,919 ----------------- TOTAL INVESTMENTS (COST $6,180,328,610) 100.2% ................ 7,593,360,100 OPTIONS WRITTEN (0.1)% ........................................ (4,616,520) SECURITIES SOLD SHORT (0.5)% .................................. (35,184,780) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (0.2)% ........................................... (12,601,713) OTHER ASSETS, LESS LIABILITIES 0.6% ........................... 44,396,552 ----------------- NET ASSETS 100.0% ............................................. $ 7,585,353,639 =================
Annual Report | 29 Mutual Beacon Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ r OPTIONS WRITTEN 0.1% ENERGY EQUIPMENT & SERVICES 0.1% a Transocean Inc., Feb. 120.00 Calls, 2/16/08 ................... United States 3,009 $ 4,363,050 a Transocean Inc., Feb. 130.00 Calls, 2/16/08 ................... United States 355 253,470 ----------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $2,764,825) .......... 4,616,520 ----------------- s SECURITIES SOLD SHORT (PROCEEDS $36,746,298) COMMERCIAL BANKS 0.5% Toronto-Dominion Bank ......................................... Canada 502,999 $ 35,184,780 -----------------
CURRENCY ABBREVIATIONS CAD - Canadian Dollar EUR - Euro GBP - British Pound SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FHLB - Federal Home Loan Bank FRN - Floating Rate Note PIK - Payment-In-Kind a Non-income producing for the twelve months ended December 31, 2007. 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, 2007, the aggregate value of these securities was $38,339,033, representing 0.51% 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 9 regarding restricted securities. e Security has been deemed illiquid because it may not be able to be sold within seven days. At December 31, 2007, the aggregate value of these securities was $528,472,191, representing 6.97% of net assets. f See Note 12 regarding other considerations. g See Note 11 regarding holdings of 5% voting securities. h Rounds to less than 0.1% of net assets. i A portion or all of the security is held in connection with written option contracts open at year end. j A portion or all of the security is on loan as of December 31, 2007. See Note 1(g). k Security or a portion of the security has been segregated as collateral for securities sold short. At December 31, 2007, the value of securities and or cash pledged amounted to $36,411,260. l The principal amount is stated in U.S. dollars unless otherwise indicated. m The coupon rate shown represents the rate at period end. n See Note 8 regarding defaulted securities. o The security is traded on a discount basis with no stated coupon rate. p See Note 1(g) regarding securities on loan. q The rate shown is the annualized seven-day yield at period end. r See Note 1(e) regarding written options. s See Note 1(f) regarding securities sold short. 30 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Beacon Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2007 Assets: Investments in securities: Cost - Unaffiliated issuers ............................................................................. $ 6,069,155,041 Cost - Controlled affiliated issuers (Note 11) .......................................................... 2,081,593 Cost - Non-controlled affiliated issuers (Note 11) ...................................................... 109,091,976 ------------------ Total cost of investments ............................................................................... $ 6,180,328,610 ------------------ Value - Unaffiliated issuers (includes securities loaned in the amount of $37,544,521) .................. $ 7,480,175,713 Value - Controlled affiliated issuers (Note 11) ......................................................... 11,723,831 Value - Non-controlled affiliated issuers (Note 11) ..................................................... 101,460,556 ------------------ Total value of investments .............................................................................. 7,593,360,100 Cash on deposits with brokers for securities sold short .................................................... 36,765,512 Foreign currency, at value (cost $5,045,994) ............................................................... 4,871,825 Receivables: Investment securities sold .............................................................................. 50,256,511 Capital shares sold ..................................................................................... 9,434,526 Dividends and interest .................................................................................. 19,962,672 Unrealized gain on forward exchange contracts (Note 7) ..................................................... 14,331,734 ------------------ Total assets ......................................................................................... 7,728,982,880 ------------------ Liabilities: Payables: Investment securities purchased ......................................................................... 7,509,668 Capital shares redeemed ................................................................................. 21,952,397 Affiliates .............................................................................................. 7,607,030 Funds advanced by custodian ................................................................................ 147,096 Options written, at value (premiums received $2,764,825) ................................................... 4,616,520 Securities sold short, at value (proceeds $36,746,298) ..................................................... 35,184,780 Payable upon return of securities loaned ................................................................... 38,019,919 Unrealized loss on forward exchange contracts (Note 7) ..................................................... 26,933,447 Accrued expenses and other liabilities ..................................................................... 1,658,384 ------------------ Total liabilities .................................................................................... 143,629,241 ------------------ Net assets, at value .............................................................................. $ 7,585,353,639 ================== Net assets consist of: Paid-in capital ............................................................................................ $ 6,015,164,418 Undistributed net investment income ........................................................................ 8,966,151 Net unrealized appreciation (depreciation) ................................................................. 1,400,037,760 Accumulated net realized gain (loss) ....................................................................... 161,185,310 ------------------ Net assets, at value ............................................................................... $ 7,585,353,639 ==================
Annual Report | The accompanying notes are an integral part of these financial statements. | 31 Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2007 CLASS Z: Net assets, at value ....................................................................................... $ 3,883,935,338 ------------------ Shares outstanding ......................................................................................... 246,983,110 ------------------ Net asset value and maximum offering price per share a ..................................................... $ 15.73 ------------------ CLASS A: Net assets, at value ....................................................................................... $ 2,654,730,649 ------------------ Shares outstanding ......................................................................................... 169,933,439 ------------------ Net asset value per share a ................................................................................ $ 15.62 ------------------ Maximum offering price per share (net asset value per share / 94.25%) ...................................... $ 16.57 ------------------ CLASS B: Net assets, at value ....................................................................................... $ 171,627,803 ------------------ Shares outstanding ......................................................................................... 11,297,423 ------------------ Net asset value and maximum offering price per share a ..................................................... $ 15.19 ------------------ CLASS C: Net assets, at value ....................................................................................... $ 875,059,849 ------------------ Shares outstanding ......................................................................................... 56,566,897 ------------------ Net asset value and maximum offering price per share a ..................................................... $ 15.47 ==================
a Redemption price is equal to net asset value less contingent deferred sales, if applicable, and redemption fees retained by the Fund. 32 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2007 Investment income: Dividends: (net of foreign taxes of $8,067,603) Unaffiliated issuers ....................................................................................... $ 195,040,417 Non-controlled affiliated issuers (Note 11) ................................................................ 44,997,448 Interest: (net of foreign taxes of $1,960) Unaffiliated issuers .................................................................................... 47,970,900 Non-controlled affiliated issuers (Note 11) ............................................................. 177,520 Income from securities loaned ................................................................................. 1,853,963 ------------------ Total investment income ........................................................................... 290,040,248 ------------------ Expenses: Management fees (Note 3a) .................................................................................. 45,902,016 Administrative fees (Note 3b) .............................................................................. 5,947,061 Distribution fees: (Note 3c) Class A ................................................................................................. 8,351,362 Class B ................................................................................................. 1,929,020 Class C ................................................................................................. 8,967,677 Transfer agent fees (Note 3e) .............................................................................. 8,458,166 Custodian fees (Note 4) .................................................................................... 830,957 Reports to shareholders .................................................................................... 447,176 Registration and filing fees ............................................................................... 244,110 Professional fees .......................................................................................... 955,572 Directors' fees and expenses ............................................................................... 112,296 Dividends on securities sold short ......................................................................... 633,546 Other ...................................................................................................... 250,842 ------------------ Total expenses .................................................................................... 83,029,801 Expenses reductions (Note 4) ...................................................................... (66,389) ------------------ Net expenses ................................................................................... 82,963,412 ------------------ Net investment income ....................................................................... 207,076,836 ------------------ Realized and unrealized gains (losses): Net realized gain (loss) from: Investments Unaffiliated issuers ................................................................................. 632,018,814 Controlled affiliated issuers (Note 11) .............................................................. 1,108,236 Non-controlled affiliated issuers (Note 11) .......................................................... 76,860,627 Written options ......................................................................................... 1,454,524 Foreign currency transactions ........................................................................... (133,359,382) Securities sold short ................................................................................... (18,877,587) Synthetic equity swaps .................................................................................. 3,231,971 ------------------ Net realized gain (loss) ....................................................................... 562,437,203 ------------------ Net change in unrealized appreciation (depreciation) on: Investments ............................................................................................. (589,986,350) Translation of assets and liabilities denominated in foreign currencies ................................. 2,794,502 ------------------ Net change in unrealized appreciation (depreciation) ........................................... (587,191,848) ------------------ Net realized and unrealized gain (loss) ....................................................................... (24,754,645) ------------------ Net increase (decrease) in net assets resulting from operations ............................................... $ 182,322,191 ==================
Annual Report | The accompanying notes are an integral part of these financial statements. | 33 Mutual Beacon Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
------------------------------------- YEAR ENDED DECEMBER 31, ------------------------------------- 2007 2006 ------------------------------------- Increase (decrease) in net assets: Operations: Net investment income ................................................................. $ 207,076,836 $ 86,974,083 Net realized gain (loss) from investments, written options, securities sold short, synthetic equity swaps, and foreign currency transactions .......................... 562,437,203 593,555,930 Net unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ...................................... (587,191,848) 538,134,352 ------------------------------------- Net increase (decrease) in net assets resulting from operations ................. 182,322,191 1,218,664,365 ===================================== Distributions to shareholders from: Net investment income: Class Z ............................................................................ (130,125,357) (61,295,783) Class A ............................................................................ (80,817,727) (28,014,668) Class B ............................................................................ (4,105,340) (1,358,698) Class C ............................................................................ (20,964,655) (5,635,292) Net realized gains: Class Z ............................................................................ (213,170,126) (367,390,486) Class A ............................................................................ (145,346,463) (199,838,408) Class B ............................................................................ (9,918,571) (19,518,901) Class C ............................................................................ (48,866,936) (78,148,401) ------------------------------------- Total distributions to shareholders ...................................................... (653,315,175) (761,200,637) ------------------------------------- Capital share transactions: (Note 2) Class Z ............................................................................ 183,737,378 223,773,762 Class A ............................................................................ 659,455,776 419,501,161 Class B ............................................................................ (18,583,161) (303,929) Class C ............................................................................ 105,335,071 75,680,025 ------------------------------------- Total capital share transactions ......................................................... 929,945,064 718,651,019 ------------------------------------- Redemption fees .......................................................................... 19,015 11,990 ------------------------------------- Net increase (decrease) in net assets ........................................... 458,971,095 1,176,126,737 Net assets: Beginning of year ........................................................................ 7,126,382,544 5,950,255,807 ------------------------------------- End of year .............................................................................. $ 7,585,353,639 $ 7,126,382,544 ===================================== Undistributed net investment income included in net assets: End of year .............................................................................. $ 8,966,151 $ 955,331 =====================================
34 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Fund Inc. (Series Fund) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of six separate funds. The Mutual Beacon Fund (Fund) included in this report is diversified. The financial statements of the remaining funds in the Series Fund are presented separately. The Fund offers four classes of shares: Class Z, Class A, Class B and Class C. 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. 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. Annual Report | 35 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. 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. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. 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. 36 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. FOREIGN CURRENCY CONTRACTS 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. A foreign exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. Realized and unrealized gains and losses on these contracts are included in the Statement of Operations. The Fund may also enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates or to gain exposure to certain foreign currencies. These contracts are valued daily by the Fund and the unrealized gains or losses on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, are included in the Statement of Assets and Liabilities. 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. 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 short 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 (margin account). Periodically, payments are made to recognize changes in value of the contract resulting from interest on the notional value of the contract, market value changes in the underlying security, and/or dividends paid by the issuer of the underlying security. The Fund recognizes a realized gain or loss when cash is received from, or paid to, the broker. Synthetic equity swaps are valued daily by the fund and the unrealized gains or losses on the contracts (as measured by the difference between the contract amount plus or minus cash received or paid and the market value of the underlying securities) are recorded in the Statement of Operations. The margin account and any net unrealized gains or losses on open synthetic equity swaps are included in the Statement of Assets and Liabilities. The risks of entering into synthetic equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. Annual Report | 37 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 or index 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. 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. SECURITIES LENDING The Fund may loan securities to certain brokers through a securities lending agent for which it receives initial cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of fund business each day; any additional collateral required due to changes in security values is delivered to the fund on the next business day. 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. 38 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy 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 on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. I. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. 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 accounting principles generally accepted in the United States of America. 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. 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. 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. Differences in per share distributions, by class, are generally due to differences in class specific expenses. J. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Annual Report | 39 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. 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. 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. L. GUARANTEES AND INDEMNIFICATIONS Under the Series Funds' 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. Currently, the Fund expects the risk of loss to be remote. 2. CAPITAL STOCK At December 31, 2007, there were 1.55 billion shares authorized ($0.001 par value). Transactions in the Fund's shares were as follows:
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 -------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------------- CLASS Z SHARES: Shares sold ...................... 14,093,045 $ 246,409,474 8,978,063 $ 149,701,821 Shares issued in reinvestment of distributions .................. 19,675,347 314,926,373 24,275,024 398,131,632 Shares redeemed .................. (21,723,780) (377,598,469) (19,597,258) (324,059,691) -------------------------------------------------------------- Net increase (decrease) .......... 12,044,612 $ 183,737,378 13,655,829 $ 223,773,762 ============================================================== CLASS A SHARES: Shares sold ...................... 53,732,297 $ 934,047,432 30,066,396 $ 499,708,886 Shares issued in reinvestment of distributions .................. 13,427,605 213,312,929 13,328,007 217,422,834 Shares redeemed .................. (28,289,809) (487,904,585) (18,083,631) (297,630,559) -------------------------------------------------------------- Net increase (decrease) .......... 38,870,093 $ 659,455,776 25,310,772 $ 419,501,161 ============================================================== CLASS B SHARES: Shares sold ...................... 337,672 $ 5,656,771 300,376 $ 4,821,000 Shares issued in reinvestment of distributions .................. 826,541 12,800,173 1,200,866 19,045,401 Shares redeemed .................. (2,198,565) (37,040,105) (1,510,592) (24,170,330) -------------------------------------------------------------- Net increase (decrease) .......... (1,034,352) $ (18,583,161) (9,350) $ (303,929) ==============================================================
40 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 -------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------------- CLASS C SHARES: Shares sold ...................... 9,340,352 $ 160,272,572 6,123,512 $ 100,268,679 Shares issued in reinvestment of distributions .................. 3,919,913 61,710,344 4,646,095 74,988,754 Shares redeemed .................. (6,837,573) (116,647,845) (6,132,053) (99,577,408) -------------------------------------------------------------- Net increase (decrease) .......... 6,422,692 $ 105,335,071 4,637,554 $ 75,680,025 ==============================================================
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 $7 billion 0.550% Over $7 billion, up to and including $10 billion 0.540% In excess of $10 billion 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 Annual Report | 41 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) 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 for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B and C compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ............................................ 0.35% 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: Sales charges retained net of commissions paid to unaffiliated broker/dealers ..................... $ 2,270,398 Contingent deferred sales charges retained ......... $ 222,294 E. TRANSFER AGENT FEES For the year ended December 31, 2007, the Fund paid transfer agent fees of $8,458,166, of which $3,945,435 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, 2007, the custodian fees were reduced as noted in the Statement of Operations. 42 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES The Fund has reviewed the tax positions taken on federal income tax returns, for each of the three open tax years and as of December 31, 2007 and has determined that no provision for income tax is required in the Fund's financial statements. The tax character of distributions paid during the years ended December 31, 2007 and 2006, was as follows: -------------------------------- 2007 2006 -------------------------------- Distributions paid from: Ordinary income .......................... $ 236,780,922 $ 140,317,569 Long term capital gain ................... 416,534,253 620,883,068 -------------------------------- $ 653,315,175 $ 761,200,637 ================================ At December 31, 2007, 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 .......................................... $6,221,989,022 =============== Unrealized appreciation ...................................... $1,916,699,324 Unrealized depreciation ...................................... (545,328,246) --------------- Net unrealized appreciation (depreciation) ................... $1,371,371,078 =============== Undistributed ordinary income ................................ $ 36,066,490 Undistributed long term capital gains ........................ 165,853,104 --------------- Distributable earnings ....................................... $ 201,919,594 =============== 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, synthetic equity swaps, pass-through entity income, 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, synthetic equity swaps and pass-through entity income. 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the year ended December 31, 2007, aggregated $4,247,405,300 and $3,669,351,370, respectively. Annual Report | 43 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 6. INVESTMENT TRANSACTIONS (CONTINUED) Transactions in options written during the year ended December 31, 2007, were as follows: -------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED -------------------------- Options outstanding at December 31, 2006 .......... 626 $ 70,335 Options written ................................... 46,835 4,663,969 Options expired ................................... (5,126) (627,741) Options exercised ................................. -- -- Options closed .................................... (38,971) (1,341,738) -------------------------- Options outstanding at December 31, 2007 .......... 3,364 $ 2,764,825 ========================== 7. FORWARD EXCHANGE CONTRACTS At December 31, 2007, the Fund had the following forward exchange contracts outstanding:
----------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED UNREALIZED AMOUNT DATE GAIN LOSS ----------------------------------------------------------- CONTRACTS TO BUY 130,643,385 Swedish Krona ................ $ 20,704,011 1/15/08 $ -- $ (495,045) 54,824,880 Norwegian Krone .............. 9,900,000 2/19/08 174,560 -- CONTRACTS TO SELL 612,500,000 Norwegian Krone .............. 112,494,094 1/09/08 -- (182,905) 90,936,321 British Pound ................ 183,685,064 1/10/08 3,051,732 -- 86,365,675 Euro ......................... 119,577,271 1/14/08 -- (6,493,717) 685,296,043 Swedish Krona ................ 107,811,068 1/15/08 1,803,985 -- 45,035,593 Euro ......................... 65,768,764 2/13/08 3,609 -- 75,736,488 Euro ......................... 105,591,455 2/13/08 -- (5,005,998) 323,200,000 Norwegian Krone .............. 59,651,076 2/19/08 260,200 -- 191,010,797 Norwegian Krone .............. 34,889,618 2/19/08 -- (210,316) 24,500,000 Euro ......................... 36,285,235 2/25/08 505,586 -- 99,299,261 Swiss Franc .................. 88,801,957 3/07/08 831,709 -- 114,644,017 British Pound ................ 231,948,331 3/10/08 4,589,678 -- 25,632,407 Euro ......................... 37,962,876 3/13/08 528,992 -- 71,061,344 Euro ......................... 98,926,576 3/13/08 -- (4,852,290) 7,016,930,000 Japanese Yen ................. 62,516,938 3/19/08 -- (950,809) 26,595,221 Canadian Dollar .............. 26,762,248 3/26/08 -- (23,019) 54,568,426,950 Korean Won ................... 59,795,000 3/27/08 1,198,031 -- 2,807,250,000 Korean Won ................... 3,000,000 3/27/08 -- (14,497) 747,283,632 Danish Krone ................. 142,089,524 4/23/08 -- (4,241,160) 99,440,800 Euro ......................... 141,217,868 4/24/08 -- (3,985,732) 3,800,000 Euro ......................... 5,652,747 5/19/08 104,707 -- 22,468,517 Euro ......................... 32,330,192 5/19/08 -- (474,077) 89,676,993 Euro ......................... 132,202,123 5/28/08 1,278,945 -- 1,590,000 Euro ......................... 2,317,425 5/28/08 -- (3,882) ----------------------------- UNREALIZED GAIN (LOSS) ON FORWARD EXCHANGE CONTRACTS ........................... 14,331,734 (26,933,447) ----------------------------- NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS ........................... $ (12,601,713) ==============
44 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. CREDIT RISK AND 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. Risks associated with purchasing these securities include the possibility that the bankruptcy or other restructuring process takes longer than expected, or that distributions in restructuring are less than anticipated, either or both of which may result in unfavorable consequences to the Fund. At December 31, 2007, the aggregate value of these securities was $12,514,780, representing 0.16% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 9. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. At December 31, 2007, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- ----------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------------------------------------------------------------------------------------------------- 466,432 AboveNet Inc. ......................... 10/02/01 - 12/12/07 $ 23,428,396 $ 23,321,600 613 AboveNet Inc., stock grants, grant price $20.95, expiration date 9/09/13 ............................. 4/17/06 - 9/08/06 -- 25,409 16,857 AboveNet Inc., wts., 9/08/08 .......... 10/02/01 - 9/07/07 1,927,924 795,650 19,829 AboveNet Inc., wts., 9/08/10 .......... 10/02/01 - 9/07/07 2,071,196 866,131 18,089,600 Cerberus CG Investor I LLC ............ 7/26/07 18,089,600 15,231,019 18,089,600 Cerberus CG Investor I LLC, 12.00%, 7/31/14 ..................... 7/26/07 18,089,600 15,231,019 18,089,600 Cerberus CG Investor II LLC ........... 7/26/07 18,089,600 15,231,019 18,089,600 Cerberus CG Investor II LLC, 12.00%, 7/31/14 ..................... 7/26/07 18,089,600 15,231,019 9,044,800 Cerberus CG Investor III LLC .......... 7/26/07 9,044,800 7,615,509 9,044,800 Cerberus CG Investor III LLC, 12.00%, 7/31/14 ..................... 7/26/07 9,044,800 7,615,509 5,706,149 Cerberus FIM Investors Auto Finance LLC ......................... 11/20/06 5,706,148 3,061,525
Annual Report | 45 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED)
- ----------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------------------------------------------------------------------------------------------------- 17,106,799 Cerberus FIM Investors Auto Finance LLC, 12.00%, 11/22/13 ............................ 11/21/06 $ 17,106,799 $ 9,178,326 475,305 Cerberus FIM Investors Commercial Finance LLC ......................... 11/20/06 475,305 255,016 1,425,915 Cerberus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 ............................ 11/20/06 1,425,915 765,048 890,886 Cerberus FIM Investors Commercial Mortgage LLC ........................ 11/20/06 890,886 477,988 2,672,657 Cerberus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 ............................ 11/20/06 2,672,657 1,433,963 4,357,377 Cerberus FIM Investors Insurance LLC ................................. 11/20/06 4,357,377 2,337,867 13,072,130 Cerberus FIM Investors Insurance LLC, 12.00%, 11/22/13 ............... 11/20/06 13,072,130 7,013,602 8,112,533 Cerberus FIM Investors Rescap LLC, ................................ 11/20/06 8,112,535 4,352,625 24,337,605 Cerberus FIM Investors Rescap LLC, 12.00%, 11/22/13 ............... 11/20/06 24,337,604 13,057,877 60,625 Dana Holding Corp., 4.00%, cvt., pfd., B ....................... 12/27/07 6,062,500 6,062,500 1,142,353 DecisionOne Corp. ..................... 3/12/99 - 7/18/00 793,798 -- 1,412,099 DecisionOne Corp., 12.00%, 4/15/10 ............................. 3/12/99 - 10/17/07 2,638,280 1,412,099 263,440 DecisionOne Corp., FRN, 9.50%, 5/12/09 ............................. 7/09/07 263,440 263,440 627,237 DecisionOne Corp., wts., 6/08/17 ............................. 7/07/07 -- -- 3,954,729 Esmark Inc. ........................... 11/08/04 - 11/28/07 73,249,520 50,292,289 14,498 FE Capital Holdings Ltd. .............. 8/29/03 - 3/22/07 516,568 9,523,457 1,157,143 First Chicago Bancorp ................. 11/16/06 16,200,002 16,200,002 2,387,711 International Automotive Components Group Brazil LLC ......... 4/13/06 - 8/21/06 1,431,796 16,585,351 378,194 International Automotive Components Group Japan LLC .......... 9/26/06 - 3/27/07 3,286,434 3,391,418 10,149,082 International Automotive Components Group LLC ................ 1/12/06 - 10/16/06 10,154,061 10,767,161 6,469,826 International Automotive Components Group NA LLC ............. 3/30/07 - 10/10/07 6,458,850 8,896,011 1,947,800 International Automotive Components Group NA LLC, 9.00%, 4/01/17 ...................... 3/30/07 1,977,017 1,947,800 1,639,289 Kindred Healthcare Inc. ............... 4/28/99 - 3/29/06 15,010,878 38,901,967
46 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED)
- ----------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------------------------------------------------------------------------------------------------- Kindred Healthcare Inc., stock grants: 5,731 grant price $18.15, expiration date 7/17/11 ............ 7/17/02 - 7/17/05 $ -- $ 31,985 1,720 grant price $19.87, expiration date 1/01/12 ............ 1/13/03 - 1/01/06 -- 6,641 1,710 grant price $6.94, expiration date 1/01/13 ............ 1/01/04 - 1/03/07 -- 28,713 1,276 grant price $19.87, expiration date 1/01/14 ............ 1/04/05 - 1/03/07 -- 4,927 709 grant price $21.33, expiration date 1/10/15 ............ 1/06/06 - 1/09/07 -- 1,702 354 grant price $22.08, expiration date 1/10/16 ............ 1/09/07 -- 584 32,534,499 Motor Coach Industries International Inc., FRN, 18.081%, 12/01/08 ................... 5/27/04 - 11/30/07 32,534,499 32,209,154 6 Motor Coach Industries International Inc., wts., 5/27/09 ............................. 3/30/07 -- -- 67,420 NCB Warrant Holdings Ltd., A .......... 12/16/05 -- 4,000,152 106,700 Olympus Re Holdings Ltd. .............. 12/19/01 10,670,000 349,464 310,123 Owens Corning Inc., exercise price $37.50, expiration date 1/02/08, shares a ............................ 12/20/06 32,455 15,506 29,737 PMG LLC ............................... 3/22/04 2,081,593 11,723,831 114,246 PTV Inc., 10.00%, pfd., A ............. 12/07/01 - 3/06/02 342,738 137,095 4,450,920 Symetra Financial ..................... 7/27/04 51,160,000 71,303,738 ------------- TOTAL RESTRICTED SECURITIES (5.63% of Net Assets) .......................... $427,154,708 =============
a The Fund also invests in unrestricted securities of the issuer, valued at $22,051,993 as of December 31, 2007. 10. UNFUNDED CAPITAL COMMITMENTS At December 31, 2007, the Fund had aggregate unfunded capital commitments to investments of $63,734,438. Annual Report | 47 Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act 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 for the year ended December 31, 2007, were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF NUMBER OF SHARES/WARRANTS/ SHARES/WARRANTS/ PRINCIPAL AMOUNT PRINCIPAL AMOUNT VALUE AT REALIZED HELD AT BEGINNING GROSS GROSS HELD AT END END OF INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS OF YEAR YEAR INCOME GAIN (LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ CONTROLLED AFFILIATES a PMG, LLC ....................... 31,748 -- 2,011 29,737 $ 11,723,831 $ -- $ 1,108,236 NON-CONTROLLED AFFILIATES Anchor Resources LLC ........... 69,184 -- 69,184 -- -- -- 256,739 DecisionOne Corp. .............. 1,142,353 -- -- 1,142,353 -- -- -- DecisionOne Corp., 12.00%, 4/15/10 ..................... 1,329,650 82,449 -- 1,412,099 1,412,099 164,044 -- DecisionOne Corp., FRN, 9.50%, 5/12/09 ..................... -- 263,440 -- 263,440 263,440 13,476 -- DecisionOne Corp., wts., 6/08/17 ..................... -- 627,237 -- 627,237 -- -- -- Esmark Inc. .................... 7,869 3,946,860 -- 3,954,729 50,292,289 188,856 -- Esmark Inc., 8.00%, cvt., pfd., A ..................... 28,644 626 29,270 -- -- 1,768,865 362,594 Farmer Brothers Co. ............ 1,033,896 -- -- 1,033,896 23,769,269 460,084 -- FE Capital Holdings Ltd. ....... 13,981 517 -- 14,498 9,523,457 -- -- First Chicago Bancorp .......... 1,157,143 -- -- 1,157,143 16,200,002 -- -- Florida East Coast Industries, Inc. ........................ 1,967,636 -- 1,967,636 -- -- 42,579,643 76,241,294 -------------------------------------- TOTAL NON-CONTROLLED AFFILIATES ........................................................... $101,460,556 $45,174,968 $76,860,627 -------------------------------------- TOTAL AFFILIATED SECURITIES (1.49% of Net Assets) ......................................... $113,184,387 $45,174,968 $77,968,863 ======================================
a Issuer in which the Fund owns 25% or more of the outstanding voting securities. 12. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. 48 | Annual Report Mutual Beacon Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY AND LITIGATION MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), 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 ("marketing support"), Franklin Resources, Inc. and certain of its subsidiaries (collectively, the "Company"), entered into settlements with certain of those regulators and governmental entities. Specifically, the Company entered into settlements with the SEC, among others, concerning market timing and marketing support. On June 6, 2007, the SEC posted for public comment the proposed plan of distribution for the market timing settlement. Once the SEC approves the final plan of distribution, disbursements of settlement monies will be made promptly to individuals who were shareholders of the designated funds during the relevant period, in accordance with the terms and conditions of the settlement and plan. In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, Company directors, fund directors, and 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.). The lawsuits relate to the industry practices referenced above. The Company and fund management 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. 14. NEW ACCOUNTING PRONOUNCEMENT In September 2006, Financial Accounting Standards Board (FASB) issued FASB Statement No. 157, "Fair Value Measurement" (SFAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Fund believes the adoption of SFAS 157 will have no material impact on its financial statements. 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 THE MUTUAL BEACON FUND: We have audited the accompanying statement of assets and liabilities of the Mutual Beacon Fund (one of the Funds constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2007, 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, 2007, 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, 2007, 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 14, 2008 50 | Annual Report Mutual Beacon 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 $523,360,348 as a long term capital gain dividend for the fiscal year ended December 31, 2007. Under Section 871(k)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $29,858,442 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, 2007. Under Section 854(b)(2) of the Code, the Fund designates 65.04% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2007. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $208,416,025 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2007. In January 2008, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2007. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their individual income tax returns. Annual Report | 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. (1941) Director Since 1987 7 None c/o Franklin Mutual Advisers, LLC 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, Stern School of Business, New York University; editor and author of numerous financial publications; financial consultant; a director to numerous financial publishing organizations; and FORMERLY, Vice Director, Dalomon Center, Stern School of Business, New York University. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE BATES (1958) Director Since 1994 7 SLM Corporation (Sallie Mae) and c/o Franklin Mutual Advisers, LLC Allied Capital Corporation (Financial 101 John F. Kennedy Parkway Services). Short Hills, NJ 07078-2789 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 14 Franklin Templeton Emerging Markets c/o Franklin Mutual Advisers, LLC Debt Opportunities Fund PLC and 101 John F. Kennedy Parkway Fiduciary International Ireland Short Hills, NJ 07078-2789 Limited. PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates (management consultants to the financial services industry); and FORMERLY, Chairman, Fiduciary Trust International Funds; Executive Vice President, L.F Rothschild Fund Management, Inc.; President and Director, Merit Mutual Funds; President, Underwriting Division and Director, National Securities & Research Corporation; Governor, Investment Company Institute and Chairman, ICI Public Information Committee. - ------------------------------------------------------------------------------------------------------------------------------------ BRUCE A. MACPHERSON (1930) Director Since 1974 7 None c/o Franklin Mutual Advisers, LLC 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (1930) Director Since 1998 14 None c/o Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private Investor. - ------------------------------------------------------------------------------------------------------------------------------------ ROBERT E. WADE (1946) Director and Director Since 34 El Oro and Exploration Co., P.l.c. c/o Franklin Mutual Advisers, LLC Chairman 1991 and (investments) and ARC Wireless 101 John F. Kennedy Parkway of the Board Chairman of the Solutions, Inc. (Wireless Components Short Hills, NJ 07078-2789 Board Since and network products). 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 - ------------------------------------------------------------------------------------------------------------------------------------ **GREGORY E. JOHNSON (1961) Director Since April 92 None One Franklin Parkway 2007 San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, President and Chief Executive Officer, Franklin Resources, Inc.; President, Templeton Worldwide, Inc.; Director, Templeton Asset Management Ltd.; and Officer And/or Director or Trustee, as the Case May Be, of Some of the Other Subsidiaries of Franklin Resources, Inc. and of 33 of the Investment Companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ **PETER A. LANGERMAN (1955) Director, Director Since 7 None c/o Franklin Mutual Advisers, LLC President April 2007 and 101 John F. Kennedy Parkway Andchief President and Short Hills, NJ 07078-2702 Executive Chief Executive Officer - Officer - Investment Investment Management Management Since 2005 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; Officer And/or Director, as the Case May Be, of Three of the Investment Companies in Franklin Templeton Investments; and Formerly, Director, New Jersey's Division of Investment. - ------------------------------------------------------------------------------------------------------------------------------------ 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 - -------------------------------------------------------------------------------------------------------------------------------- JAMES M. DAVIS (1952) Chief Chief Compliance Not Applicable Not Applicable One Franklin Parkway Compliance Officer Since 2004 San Mateo, Ca 94403-1906 Officer and and Vice President Vice President - Aml Compliance - Aml Since 2006 Compliance PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; Officer of Some of the Other Subsidiaries of Franklin Resources, Inc. and of 46 of the Investment Companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - -------------------------------------------------------------------------------------------------------------------------------- MICHAEL J. EMBLER (1964) Senior Vice Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President Short Hills, Nj 07078-2789 and chief Investment Officer 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. - -------------------------------------------------------------------------------------------------------------------------------- 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 Some of the Other Subsidiaries of Franklin Resources, Inc. and of 46 of the Investment Companies in Franklin Templeton Investments. - -------------------------------------------------------------------------------------------------------------------------------- STEVEN J. GRAY (1955) Secretary Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, Ca 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Templeton Investments; Secretary, Franklin Advisory Services, LLC, Franklin Mutual Advisers, LLC and Franklin Templeton Distributors, Inc.; and Officer of 41 of the Investment Companies in Franklin Templeton Investments. - -------------------------------------------------------------------------------------------------------------------------------- GREGORY R. SEWARD (1956) Treasurer Since 2005 Not Applicable Not Applicable 500 East Broward Blvd. Suite 2100 Fort Lauderdale, Fl 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; Officer of 18 of the Investment Companies in Franklin Templeton Investments; and FORMERLY, Vice President, Jpmorgan Chase (2000-2004) and American General Financial Group (1991-2000). - --------------------------------------------------------------------------------------------------------------------------------
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 - -------------------------------------------------------------------------------------------------------------------------------- CRAIG S. TYLE (1960) Vice President Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, Ca 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; Officer of Some of the Other Subsidiaries of Franklin Resources, Inc. and of 46 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). - -------------------------------------------------------------------------------------------------------------------------------- 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 Some of the Other Subsidiaries of Franklin Resources, Inc. and of 46 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 manager or affiliated investment managers. ** Gregory E. Johnson is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer and director of Franklin Resources, Inc., which is the parent company of the Fund's investment manager and distributor. Peter A. Langerman is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, which is the Fund's investment manager. Note 1: Officer information is current as of the date of this report. It is possible that after this date, information about officers may change. Note 2: Prior to December 31, 2007, William J. Lippman, Leonard Rubin and Anne M. Tatlock ceased to be directors of the Fund. THE FUND'S BOARD 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 | 55 Mutual Beacon Fund SHAREHOLDER INFORMATION PROXY VOTING POLICIES AND PROCEDURES The Fund has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at 1-954/527-7678 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. 56 | Annual Report Literature Request LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. FRANKLIN TEMPLETON FUNDS INTERNATIONAL Mutual European Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund 1 GLOBAL Mutual Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund 1 Templeton Growth Fund Templeton World Fund GROWTH Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Growth Opportunities Fund 2 Franklin Small Cap Growth Fund II 3 Franklin Small-Mid Cap Growth Fund VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund 1 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 1 Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Focused Core Equity Fund Franklin Growth Fund Franklin Rising Dividends Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Global Real Estate 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(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 5 Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund 5 Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 5 Templeton Global Bond Fund Templeton Income Fund Templeton International Bond Fund TAX-FREE INCOME 6 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California 8 Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts 7 Michigan 7 Minnesota 7 Missouri New Jersey New York 8 North Carolina Ohio 7 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 9 1. The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. 2. Effective 11/1/07, Franklin Aggressive Growth Fund changed its name to Franklin Growth Opportunities Fund. The fund's investment goal and strategy remained the same. 3. The fund is closed to new investors. Existing shareholders can continue adding to their accounts 4. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5. An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 6. For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. 7. The fund invests primarily in insured municipal securities. 8. 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). 9. The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 12/07 Not part of the annual report [LOGO (R)] FRANKLIN TEMPLETON INVESTMENT One Franklin Parkway 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 A2007 02/08 [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2007 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 ................................................. 11 Your Fund's Expenses ................................................ 16 Financial Highlights and Statement of Investments ................... 18 Financial Statements ................................................ 33 Notes to Financial Statements ....................................... 37 Report of Independent Registered Public Accounting Firm ............. 53 Tax Designation ..................................................... 54 Board Members and Officers .......................................... 56 Shareholder Information ............................................. 60 - -------------------------------------------------------------------------------- Shareholder Letter - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------- CLASS Z 12/31/07 - -------------------------------------------- 1-Year +11.32% - -------------------------------------------- 5-Year +20.08% - -------------------------------------------- 10-Year +12.41% - -------------------------------------------- Dear Shareholder: The past year was a turbulent time for equities both in the U.S. and in many international markets. Several developments contributed to this volatility, including (1) credit problems centered around subprime mortgage lending; (2) declining home values in the U.S.; (3) a nearly complete evaporation of the corporate leveraged lending that fueled the leveraged buyout boom of the past several years; (4) a sharp increase in oil, agricultural and certain mining commodity prices; and (5) a sharp decline in the value of the U.S. dollar relative to most other currencies. For the year ended December 31, 2007, the Standard & Poor's (S&P) 500 Index rose 5.49% while the Morgan Stanley Capital International (MSCI) World Index gained 9.57%. 1 However, indicative of the impact of the developments noted here, the S&P 500 Financials Index declined 18.63%, the S&P Homebuilders Select Industry Index declined 48.39% and the S&P GSSI Natural Resources Index appreciated 34.44% during the year. 2 By comparison, Mutual Discovery Fund-Class Z gained 11.32% over this period. 1. Source: Standard & Poor's Micropal. The S&P 500 Index 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 Index 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. 2. Source: Standard & Poor's Micropal. The S&P 500 Financials Index is market value weighted and includes all the financial stocks in the S&P 500. The S&P Homebuilders Select Industry Index is an equal-weighted index that draws its constituents from the GICS (Global Industry Classification Standards) Homebuilding sub-industry. The S&P GSSI Natural Resources Index is a modified cap-weighted index designed to measure equity performance in the natural resources sector. The index includes companies involved in the following categories: extractive industries, energy companies, owners and operators of timber tracts, forestry services, producers of pulp and paper, and owners of plantations. 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. - -------------------------------------------------------------------------------- eDELIVERY DETAILS Log in at franklintempleton.com and click on eDelivery. Shareholders who are registered at franklintempleton.com can receive these reports via email. Not all accounts are eligible for eDelivery. - ----------------------------------------------------- NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE - ----------------------------------------------------- Not part of the annual report | 1 Despite the challenges, a number of positive factors contributed to Fund performance this year. Many of our international holdings made strong gains, particularly among the tobacco, energy and industrial companies we owned. Fund shareholders also benefited from the fact that our international holdings were less than fully hedged back into U.S. dollars, reflecting our cautious view regarding the dollar. Investments in merger arbitrage situations were also generally profitable, particularly as we took advantage in late summer of concerns that deals would fall apart because of "buyer's remorse" or unavailability of financing. In the U.S., our focus over the past several years on larger capitalization companies with strong balance sheets and leading industry positions benefited our shareholders. For example, investments in Microsoft and Altria, both part of the large-cap Dow Jones Industrial Average, generated solid returns in 2007. 3 As we have discussed in previous reports, the multi-year outperformance of small- and mid-capitalization stocks going into 2007 resulted in attractive valuations among their mega-cap counterparts. At period-end, we continued to see real value in a number of these companies. A difficult area for us in the latter half of the year was what we would term "event-driven" stocks. These are investments we believe are attractively valued and where we see an identifiable catalyst to unlock the value. While each investment is different, a few issues dominated the second half of 2007. One key driver was the abrupt absence of private equity buyers for companies (or divisions of companies) that were potential sale targets. Virgin Media, the U.K. cable company, was one example. We believe many event-driven investments were held in common with some of the hedge funds that faced pressure to sell in the latter half of 2007. Again, while somewhat painful in the short term, "technical" pressures often give us a chance to take advantage of temporary market dislocations to increase ownership in attractively valued companies. Value investors are always faced with the task of buying and owning companies when they are out of favor, whether for company-specific reasons or because of a perception of macroeconomic fundamentals. It is these very headwinds that can create opportunities to buy well-managed companies with strong industry positions at valuations that have the potential to reward investors over the long term. We believe the extended credit crisis has created a number of such opportunities. We have no crystal ball telling us precisely when the U.S. housing market will turn positive or where oil prices will be a year from now. However, we believe that if we stick to our discipline of buying good 3. Mutual Discovery Fund's holdings are based on total net assets as of 12/31/07: Microsoft Corp.: 0.9% and Altria Group Inc.: 0.5%. 2 | Not part of the annual report businesses at cheap valuations, we should reach our goal of limiting our downside risk while generating consistent returns over the long term. In the enclosed annual report for Mutual Discovery Fund, the portfolio managers discuss market conditions, investment management decisions and Fund performance during the period under review. You will also find performance data and financial information. Please remember that all securities markets fluctuate, as do mutual fund share prices. If you would like more frequent updates, FRANKLINTEMPLETON.COM provides daily prices, monthly performance figures, portfolio holdings and other information. You can also access your account, buy and sell shares, read timely articles, and find helpful financial planning tools. We hope you will take advantage of these online services. As always, we thank you for your trust and support and extend our best wishes for a happy, healthy and prosperous 2008. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC /s/ Michael J. Embler Michael J. Embler Senior Vice President and Chief Investment Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2007. 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 INVESTMENT MANAGER 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. Not part of the annual report | 3 Annual Report Mutual Discovery Fund YOUR FUND'S GOAL AND MAIN INVESTMENTS: Mutual Discovery Fund seeks capital appreciation by investing primarily 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, 2007. PERFORMANCE OVERVIEW Mutual Discovery Fund - Class Z posted a cumulative total return of +11.32% for the 12 months ended December 31, 2007. 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 +5.49% and +9.57% for the same period. 1 You can find the Fund's long-term performance data in the Performance Summary beginning on page 11. ECONOMIC AND MARKET OVERVIEW In spite of elevated energy prices and widespread fears of contagion from the deteriorating U.S. housing situation, the global economy remained resilient in 2007. Consumer and corporate demand strength, particularly in China and other developing economies, generally favorable employment and accommodative monetary policies continued to underpin the current expansionary period that began in 2002. These factors also contributed to the strength of global equity markets during 2007. However, concerns about slower growth and declining asset quality surfaced in the first quarter. These were initially centered on the U.S. subprime 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 23. 4 | Annual Report mortgage market but spread in August to global capital markets. Difficulties in assessing risk and the value of collateral in the structured finance industry contributed to declining risk appetite among lenders and investors. The private equity industry, which relies on the availability of cheap credit, played a pivotal role in several large and high-profile acquisitions and helped boost merger and acquisition activity in the first half of the year. This was an important driver of equity performance, but as liquidity dried up in the second half of the year, significantly slower money flows from private equity weighed on market performance. However, global merger and acquisition activity still reached record levels. The staggering $4.5 trillion of deals announced in 2007 eclipsed the previous record from 2006 by 24%. 2 To alleviate the credit crunch and restore investor confidence, the world's major central banks infused capital into the system, and the U.S. Federal Reserve Board reduced its target interest rate by a full percentage point. However, credit and equity markets continued to face headwinds as write-downs and losses from subprime mortgage financing affected many large financial institutions toward the end of the year, and equity prices remained volatile. For the year, however, global and non-U.S. equity markets registered the fifth consecutive year of double-digit total returns, making this an exceptionally strong period for investors in global equities. Broad-based stock performance by European and Asian shares at least doubled that of U.S. stocks, while emerging market equity returns more than tripled those in developed markets. Led by the BRIC countries, Brazil, Russia, India and China, emerging market economies continued to grow at accelerated rates, supporting elevated prices for oil and other commodities. At the same time, investment inflows from developed economies continued to underpin equity prices in emerging markets. In addition, U.S. dollar weakness versus the currencies of many major trading partners enhanced equity returns for U.S.-based investors holding stocks denominated in these 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 2. Source: "For Deal Makers, Tale of Two Halves," THE WALL STREET JOURNAL, 1/2/08. GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/07 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] U.S. 17.2% France 13.0% U.K. 9.5% Germany 8.3% South Korea 4.9% Norway 4.8% Switzerland 4.1% Hong Kong 3.9% Japan 2.7% Denmark 2.6% Italy 2.4% Spain 1.9% Bermuda 1.6% Netherlands 1.5% Belguim 1.4% Sweden 1.0% Other 4.5% Short-Term Investments & Other Net Assets 14.7% Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/07 - -------------------------------------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------------------------------------- Tobacco 11.7% - -------------------------------------------------------------------------------- Commercial Banks 7.7% - -------------------------------------------------------------------------------- Food Products 6.1% - -------------------------------------------------------------------------------- Insurance 5.7% - -------------------------------------------------------------------------------- Media 5.7% - -------------------------------------------------------------------------------- Diversified Financial Services 5.0% - -------------------------------------------------------------------------------- Beverages 4.7% - -------------------------------------------------------------------------------- Industrial Conglomerates 4.2% - -------------------------------------------------------------------------------- Energy Equipment & Services 4.2% - -------------------------------------------------------------------------------- Real Estate 2.7% - -------------------------------------------------------------------------------- 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. 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 Among the Fund's top contributors to performance in 2007 were KT&G, a South Korea-based cigarette manufacturer; Berkshire Hathaway, the well-known investment conglomerate; and German securities exchange platform provider Deutsche Boerse. 6 | Annual Report Shares of KT&G appreciated 41% in local currency during 2007, due largely to the company's strong operating performance. Each division of KT&G reported positive news in 2007. The company's domestic tobacco sales and operating margins expanded due to increased average selling prices for a pack of cigarettes. Overseas sales and revenues registered high double-digit increases. KT&G owns a 100% stake in KGC, South Korea's leading red ginseng maker, which has a dominant position of more than 60% market share. Over the past five years, KGC's sales and earnings have grown at 20% and 27% compounded annual growth rates, respectively. We believe this trend could continue given the country's aging demographic, growing income levels, and KGC's aggressive distribution and production expansion plan. According to our analysis, not only is the outlook for earnings quite good but the company's ability to return cash to shareholders has been impressive as well. KT&G has announced that between 2006 and 2008 it will return 2.8 trillion won (the local currency, which equaled approximately $3.0 billion on December 31, 2007) to shareholders. After 2008, KT&G is expected to return an average 5% to 7% of market capitalization to shareholders annually through dividends and share buybacks. Berkshire Hathaway stock appreciated 29% as the company benefited from a lack of catastrophe losses in 2007, resulting in large insurance company profits after higher-than-average losses in 2004 and 2005 resulted in a favorable pricing environment for U.S. property insurers. Within Berkshire's non-insurance operations, the company benefited from an improving contribution from its utility business, Mid-American Energy. Most significantly for its share price value, Berkshire's cash stockpile of almost $40 billion, along with CEO Warren Buffett's willingness to wait until a bargain emerged before deploying this capital, positioned the company as a safe haven for investors who perceived 2007's subprime mortgage crisis as an investment opportunity rather than a threat. By the end of 2007 Berkshire management had successfully kept its capital mostly in reserve, for use in executing timely future transactions when the investment climate is right. The Fund's investment in Deutsche Boerse rose 97% in local currency as cash equity trading volumes surged 63%, the company resumed its buyback of shares, and investors appeared to recognize hidden potential embedded in the business. The exchange industry grew as such quasi-monopolies benefited from higher volumes in different product classes and generally beneficial pricing trends. Deutsche Boerse also tapped into the structural potential of its business by announcing future cost cutting of over 100 million euros per year to enhance profitability. We believed future exchange consolidation prospects placed the company in a good position for ongoing shareholder returns. Therefore, we increased our holdings in Deutsche Boerse throughout 2007 when we found the price attractive. TOP 10 HOLDINGS 12/31/07 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- KT&G Corp. 2.4% TOBACCO, SOUTH KOREA - -------------------------------------------------------------------------------- Imperial Tobacco Group PLC 2.3% TOBACCO, U.K. - -------------------------------------------------------------------------------- British American Tobacco PLC 2.3% TOBACCO, U.K. - -------------------------------------------------------------------------------- Orkla ASA 2.3% INDUSTRIAL CONGLOMERATES, NORWAY - -------------------------------------------------------------------------------- Carrefour SA 1.9% FOOD & STAPLES RETAILING, FRANCE - -------------------------------------------------------------------------------- Pernod Ricard SA 1.7% BEVERAGES, FRANCE - -------------------------------------------------------------------------------- Japan Tobacco Inc. 1.7% TOBACCO, JAPAN - -------------------------------------------------------------------------------- Carlsberg AS, A & B 1.7% BEVERAGES, DENMARK - -------------------------------------------------------------------------------- Berkshire Hathaway Inc., A & B 1.6% INSURANCE, U.S. - -------------------------------------------------------------------------------- Altadis SA 1.6% TOBACCO, SPAIN - -------------------------------------------------------------------------------- Annual Report | 7 Although the Fund performed well in 2007, some of our positions detracted from performance. Among them were Belgium-based Fortis, whose operations are focused in banking, insurance and investment management; Norway's Marine Harvest, one of the world's leading seafood companies; and Banca Popolare, an Italian financial services provider. Fortis declined 30% in local currency as the company raised a significant amount of capital to fund its acquisition of ABN Amro's Dutch retail banking, asset management and private banking units. Fortis was part of a consortium with Royal Bank of Scotland and Banco Santander, which together acquired these businesses and by year-end had completed the largest bank acquisition in European history. Fortis' stock price also came under pressure after the company announced weak third quarter 2007 operating results for its banking and insurance businesses. Marine Harvest, formerly known as Pan Fish, benefited from increased demand for salmon. But the company reported disappointing results in third quarter 2007 as it experienced difficult biological conditions due to a disease outbreak in its Chilean and Norwegian fisheries. Analysts responded by reducing the company's earnings estimate, and for 2007 Marine Harvest shares fell 38% in local currency. The Fund's shares of Banca Popolare declined 34% in local currency during 2007. As global economic fears became more evident in the markets, Banca Popolare suffered as investors became hesitant about the bank's growth prospects for the next few years. Also, concerns developed over the potential integration of its $10 billion BPI (Banca Popolare Italiana) acquisition and lost revenue stemming from the company's Banca Italease subsidiary. At period-end, we believed Banca Popolare should be able to weather an economic downturn due to its regional focus and potential future earnings growth from merger integration. Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during 2007, the Fund benefited to the extent it was not fully hedged. 8 | Annual Report Thank you for your continued participation in Mutual Discovery Fund. We look forward to serving your future investment needs. [PHOTO OMITTED] /s/ Anne E. Gudefin Anne E. Gudefin, CFA Co-Portfolio Manager [PHOTO OMITTED] /s/ Charles M. Lahr Charles M. Lahr, CFA Co-Portfolio Manager [PHOTO OMITTED] /s/ Mandana Hormozi Mandana Hormozi Assistant Portfolio Manager Mutual Discovery Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2007, 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 INVESTMENT MANAGER MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. Annual Report | 9 - -------------------------------------------------------------------------------- ANNE GUDEFIN has been portfolio manager for Mutual Discovery Fund since 2005. She is also portfolio manager for Mutual Qualified Fund, and has been a member of the management team of the Funds since 2000, when she joined Franklin Templeton Investments. Previously, she was an analyst at Perry Capital. CHARLES LAHR has been portfolio manager for Mutual Discovery Fund since 2007. He has also been portfolio manager for Mutual Financial Services Fund since 2004. He joined Franklin Templeton Investments in 2003. Previously, he was a senior analyst for the State of Wisconsin Investment Board and also worked for U.S. Bancorp and Principal Financial Group. MANDANA HORMOZI has been assistant portfolio manager for Mutual Discovery Fund since 2007. She joined Franklin Templeton Investments in 2003. Previously, she was a senior vice president in the equity research department at Lazard Freres. Also, she was an economic research analyst at Mitsubishi Bank. - -------------------------------------------------------------------------------- 10 | Annual Report Performance Summary as of 12/31/07 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 12/31/07 12/31/06 - ------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$2.00 $ 32.45 $ 30.45 - ------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/07-12/31/07) - ------------------------------------------------------------------------------------------ Dividend Income $0.7406 - ------------------------------------------------------------------------------------------ Long-Term Capital Gain $0.7061 - ------------------------------------------------------------------------------------------ TOTAL $1.4467 - ------------------------------------------------------------------------------------------ CLASS A (SYMBOL: TEDIX) CHANGE 12/31/07 12/31/06 - ------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$1.95 $ 32.09 $ 30.14 - ------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/07-12/31/07) - ------------------------------------------------------------------------------------------ Dividend Income $0.6474 - ------------------------------------------------------------------------------------------ Long-Term Capital Gain $0.7061 - ------------------------------------------------------------------------------------------ TOTAL $1.3535 - ------------------------------------------------------------------------------------------ CLASS B (SYMBOL: TEDBX) CHANGE 12/31/07 12/31/06 - ------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$1.91 $ 31.46 $ 29.55 - ------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/07-12/31/07) - ------------------------------------------------------------------------------------------ Dividend Income $0.4066 - ------------------------------------------------------------------------------------------ Long-Term Capital Gain $0.7061 - ------------------------------------------------------------------------------------------ TOTAL $1.1127 - ------------------------------------------------------------------------------------------ CLASS C (SYMBOL: TEDSX) CHANGE 12/31/07 12/31/06 - ------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$1.91 $ 31.84 $ 29.93 - ------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/07-12/31/07) - ------------------------------------------------------------------------------------------ Dividend Income $0.4394 - ------------------------------------------------------------------------------------------ Long-Term Capital Gain $0.7061 - ------------------------------------------------------------------------------------------ TOTAL $1.1455 - ------------------------------------------------------------------------------------------ CLASS R (SYMBOL: TEDRX) CHANGE 12/31/07 12/31/06 - ------------------------------------------------------------------------------------------ Net Asset Value (NAV) +$1.92 $ 31.85 $ 29.93 - ------------------------------------------------------------------------------------------ DISTRIBUTIONS (1/1/07-12/31/07) - ------------------------------------------------------------------------------------------ Dividend Income $0.5955 - ------------------------------------------------------------------------------------------ Long-Term Capital Gain $0.7061 - ------------------------------------------------------------------------------------------ TOTAL $1.3016 - ------------------------------------------------------------------------------------------
Annual Report | 11 Performance Summary (CONTINUED) PERFORMANCE CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z/R: NO SALES CHARGES; 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. THE FUND MAY CHARGE A 2% FEE ON REDEMPTIONS MADE WITHIN SEVEN DAYS OF PURCHASE.
- --------------------------------------------------------------------------------------------------- CLASS Z 1 1-YEAR 5-YEAR 10-YEAR - --------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +11.32% +149.67% +222.02% - --------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +11.32% +20.08% +12.41% - --------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $11,132 $24,967 $32,202 - --------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.05% - --------------------------------------------------------------------------------------------------- CLASS A 1 1-YEAR 5-YEAR 10-YEAR - --------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +10.96% +145.53% +210.86% - --------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +4.58% +18.27% +11.35% - --------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $10,458 $23,141 $29,297 - --------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.36% - --------------------------------------------------------------------------------------------------- CLASS B 1 1-YEAR 5-YEAR INCEPTION (1/1/99) - --------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +10.22% +137.52% +202.08% - --------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +6.22% +18.69% +13.07% - --------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $10,622 $23,552 $30,208 - --------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 2.05% - --------------------------------------------------------------------------------------------------- CLASS C 1 1-YEAR 5-YEAR 10-YEAR - --------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +10.24% +137.55% +191.31% - --------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +9.24% +18.89% +11.28% - --------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $10,924 $23,755 $29,131 - --------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 2.05% - --------------------------------------------------------------------------------------------------- CLASS R 1-YEAR 5-YEAR INCEPTION (1/2/02) - --------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +10.76% +143.50% +120.40% - --------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +10.76% +19.48% +14.09% - --------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $11,076 $24,350 $22,040 - --------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.55% - ---------------------------------------------------------------------------------------------------
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. 12 | Annual Report Performance Summary (CONTINUED) TOTAL RETURN INDEX COMPARISON FOR HYPOTHETICAL $10,000 INVESTMENT Total return represents the change in value of an investment over the periods shown. It includes any current, applicable, maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged indexes include reinvestment of any income or distributions. They differ from the Fund in composition and do not pay management fees or expenses. One cannot invest directly in an index. CLASS Z (1/1/98-12/31/07) 1 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] Date Mutual Discovery Fund S&P 500 6 MSCI World Index 6 1/1/1998 $10,000 $10,000 $10,000 1/31/1998 $10,005 $10,111 $10,280 2/28/1998 $10,519 $10,840 $10,977 3/31/1998 $11,122 $11,395 $11,443 4/30/1998 $11,329 $11,510 $11,556 5/31/1998 $11,482 $11,312 $11,413 6/30/1998 $11,196 $11,771 $11,685 7/31/1998 $10,933 $11,646 $11,668 8/31/1998 $ 9,442 $ 9,962 $10,114 9/30/1998 $ 9,020 $10,600 $10,295 10/31/1998 $ 9,269 $11,463 $11,227 11/30/1998 $ 9,735 $12,157 $11,897 12/31/1998 $ 9,810 $12,858 $12,480 1/31/1999 $ 9,878 $13,396 $12,755 2/28/1999 $ 9,765 $12,979 $12,417 3/31/1999 $10,213 $13,498 $12,936 4/30/1999 $10,901 $14,021 $13,448 5/31/1999 $10,906 $13,690 $12,958 6/30/1999 $11,294 $14,450 $13,564 7/31/1999 $11,167 $13,999 $13,525 8/31/1999 $11,034 $13,929 $13,503 9/30/1999 $10,890 $13,548 $13,374 10/31/1999 $11,115 $14,405 $14,071 11/30/1999 $11,699 $14,698 $14,469 12/31/1999 $12,439 $15,563 $15,642 1/31/2000 $12,392 $14,781 $14,748 2/29/2000 $12,787 $14,502 $14,789 3/31/2000 $13,335 $15,920 $15,814 4/30/2000 $13,188 $15,441 $15,147 5/31/2000 $13,265 $15,124 $14,765 6/30/2000 $13,302 $15,497 $15,264 7/31/2000 $13,473 $15,255 $14,836 8/31/2000 $13,871 $16,203 $15,321 9/30/2000 $13,732 $15,347 $14,508 10/31/2000 $13,839 $15,282 $14,267 11/30/2000 $13,606 $14,078 $13,402 12/31/2000 $14,006 $14,146 $13,621 1/31/2001 $14,435 $14,648 $13,886 2/28/2001 $14,435 $13,313 $12,714 3/31/2001 $14,006 $12,469 $11,881 4/30/2001 $14,413 $13,438 $12,762 5/31/2001 $14,849 $13,528 $12,604 6/30/2001 $14,918 $13,199 $12,211 7/31/2001 $14,888 $13,069 $12,050 8/31/2001 $14,738 $12,251 $11,474 9/30/2001 $13,485 $11,262 $10,464 10/31/2001 $13,523 $11,476 $10,666 11/30/2001 $13,868 $12,357 $11,298 12/31/2001 $14,183 $12,465 $11,371 1/31/2002 $14,230 $12,283 $11,028 2/28/2002 $14,370 $12,046 $10,934 3/31/2002 $14,846 $12,499 $11,419 4/30/2002 $15,103 $11,741 $11,036 5/31/2002 $15,220 $11,655 $11,061 6/30/2002 $14,286 $10,825 $10,393 7/31/2002 $13,344 $ 9,981 $ 9,518 8/31/2002 $13,477 $10,046 $ 9,538 9/30/2002 $12,771 $ 8,955 $ 8,491 10/31/2002 $12,818 $ 9,743 $ 9,119 11/30/2002 $13,006 $10,316 $ 9,613 12/31/2002 $12,898 $ 9,710 $ 9,149 1/31/2003 $12,683 $ 9,456 $ 8,872 2/28/2003 $12,340 $ 9,314 $ 8,720 3/31/2003 $12,396 $ 9,404 $ 8,697 4/30/2003 $13,345 $10,179 $ 9,473 5/31/2003 $14,096 $10,715 $10,019 6/30/2003 $14,336 $10,852 $10,196 7/31/2003 $14,512 $11,043 $10,405 8/31/2003 $14,946 $11,259 $10,633 9/30/2003 $15,026 $11,139 $10,700 10/31/2003 $15,669 $11,769 $11,337 11/30/2003 $16,215 $11,873 $11,513 12/31/2003 $16,967 $12,495 $12,238 1/31/2004 $17,179 $12,725 $12,437 2/29/2004 $17,726 $12,902 $12,649 3/31/2004 $17,661 $12,707 $12,570 4/30/2004 $17,359 $12,508 $12,320 5/31/2004 $17,351 $12,679 $12,441 6/30/2004 $17,681 $12,926 $12,701 7/31/2004 $17,501 $12,498 $12,290 8/31/2004 $17,616 $12,549 $12,349 9/30/2004 $18,091 $12,684 $12,587 10/31/2004 $18,461 $12,878 $12,898 11/30/2004 $19,519 $13,399 $13,581 12/31/2004 $20,258 $13,855 $14,103 1/31/2005 $19,807 $13,518 $13,789 2/28/2005 $20,658 $13,802 $14,232 3/31/2005 $20,483 $13,558 $13,962 4/30/2005 $20,324 $13,300 $13,667 5/31/2005 $20,759 $13,724 $13,920 6/30/2005 $21,207 $13,743 $14,047 7/31/2005 $21,930 $14,254 $14,540 8/31/2005 $22,014 $14,124 $14,657 9/30/2005 $22,636 $14,239 $15,042 10/31/2005 $21,930 $14,001 $14,680 11/30/2005 $22,620 $14,531 $15,177 12/31/2005 $23,437 $14,536 $15,517 1/31/2006 $24,240 $14,921 $16,213 2/28/2006 $24,829 $14,961 $16,196 3/31/2006 $25,766 $15,147 $16,559 4/30/2006 $25,989 $15,351 $17,071 5/31/2006 $25,329 $14,909 $16,503 6/30/2006 $25,384 $14,929 $16,505 7/31/2006 $25,620 $15,021 $16,611 8/31/2006 $26,302 $15,379 $17,051 9/30/2006 $26,557 $15,775 $17,259 10/31/2006 $27,402 $16,289 $17,896 11/30/2006 $28,030 $16,599 $18,344 12/31/2006 $28,928 $16,832 $18,722 1/31/2007 $29,745 $17,086 $18,946 2/28/2007 $29,526 $16,752 $18,856 3/31/2007 $30,390 $16,939 $19,209 4/30/2007 $31,635 $17,690 $20,067 5/31/2007 $32,736 $18,307 $20,649 6/30/2007 $32,657 $18,003 $20,497 7/31/2007 $31,992 $17,445 $20,048 8/31/2007 $31,583 $17,706 $20,041 9/30/2007 $32,410 $18,368 $21,001 10/31/2007 $33,085 $18,661 $21,650 11/30/2007 $32,191 $17,880 $20,775 12/31/2007 $32,202 $17,756 $20,513 AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------- CLASS Z 1 12/31/07 - ---------------------------------------------- 1-Year +11.32% - ---------------------------------------------- 5-Year +20.08% - ---------------------------------------------- 10-Year +12.41% - ---------------------------------------------- CLASS A (1/1/98-12/31/07) 1 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] Date Mutual Discovery Fund S&P 500 6 MSCI World Index 6 1/1/1998 $ 9,424 $10,000 $10,000 1/31/1998 $ 9,424 $10,111 $10,280 2/28/1998 $ 9,905 $10,840 $10,977 3/31/1998 $10,470 $11,395 $11,443 4/30/1998 $10,661 $11,510 $11,556 5/31/1998 $10,801 $11,312 $11,413 6/30/1998 $10,531 $11,771 $11,685 7/31/1998 $10,280 $11,646 $11,668 8/31/1998 $ 8,872 $ 9,962 $10,114 9/30/1998 $ 8,472 $10,600 $10,295 10/31/1998 $ 8,703 $11,463 $11,227 11/30/1998 $ 9,138 $12,157 $11,897 12/31/1998 $ 9,201 $12,858 $12,480 1/31/1999 $ 9,266 $13,396 $12,755 2/28/1999 $ 9,153 $12,979 $12,417 3/31/1999 $ 9,576 $13,498 $12,936 4/30/1999 $10,213 $14,021 $13,448 5/31/1999 $10,218 $13,690 $12,958 6/30/1999 $10,581 $14,450 $13,564 7/31/1999 $10,461 $13,999 $13,525 8/31/1999 $10,325 $13,929 $13,503 9/30/1999 $10,189 $13,548 $13,374 10/31/1999 $10,396 $14,405 $14,071 11/30/1999 $10,940 $14,698 $14,469 12/31/1999 $11,629 $15,563 $15,642 1/31/2000 $11,579 $14,781 $14,748 2/29/2000 $11,950 $14,502 $14,789 3/31/2000 $12,459 $15,920 $15,814 4/30/2000 $12,315 $15,441 $15,147 5/31/2000 $12,387 $15,124 $14,765 6/30/2000 $12,417 $15,497 $15,264 7/31/2000 $12,571 $15,255 $14,836 8/31/2000 $12,939 $16,203 $15,321 9/30/2000 $12,803 $15,347 $14,508 10/31/2000 $12,903 $15,282 $14,267 11/30/2000 $12,678 $14,078 $13,402 12/31/2000 $13,055 $14,146 $13,621 1/31/2001 $13,450 $14,648 $13,886 2/28/2001 $13,443 $13,313 $12,714 3/31/2001 $13,034 $12,469 $11,881 4/30/2001 $13,408 $13,438 $12,762 5/31/2001 $13,811 $13,528 $12,604 6/30/2001 $13,871 $13,199 $12,211 7/31/2001 $13,843 $13,069 $12,050 8/31/2001 $13,703 $12,251 $11,474 9/30/2001 $12,529 $11,262 $10,464 10/31/2001 $12,564 $11,476 $10,666 11/30/2001 $12,880 $12,357 $11,298 12/31/2001 $13,168 $12,465 $11,371 1/31/2002 $13,212 $12,283 $11,028 2/28/2002 $13,335 $12,046 $10,934 3/31/2002 $13,772 $12,499 $11,419 4/30/2002 $14,005 $11,741 $11,036 5/31/2002 $14,107 $11,655 $11,061 6/30/2002 $13,238 $10,825 $10,393 7/31/2002 $12,366 $ 9,981 $ 9,518 8/31/2002 $12,483 $10,046 $ 9,538 9/30/2002 $11,824 $ 8,955 $ 8,491 10/31/2002 $11,868 $ 9,743 $ 9,119 11/30/2002 $12,036 $10,316 $ 9,613 12/31/2002 $11,932 $ 9,710 $ 9,149 1/31/2003 $11,731 $ 9,456 $ 8,872 2/28/2003 $11,412 $ 9,314 $ 8,720 3/31/2003 $11,464 $ 9,404 $ 8,697 4/30/2003 $12,333 $10,179 $ 9,473 5/31/2003 $13,024 $10,715 $10,019 6/30/2003 $13,236 $10,852 $10,196 7/31/2003 $13,401 $11,043 $10,405 8/31/2003 $13,797 $11,259 $10,633 9/30/2003 $13,872 $11,139 $10,700 10/31/2003 $14,455 $11,769 $11,337 11/30/2003 $14,955 $11,873 $11,513 12/31/2003 $15,646 $12,495 $12,238 1/31/2004 $15,836 $12,725 $12,437 2/29/2004 $16,328 $12,902 $12,649 3/31/2004 $16,267 $12,707 $12,570 4/30/2004 $15,987 $12,508 $12,320 5/31/2004 $15,980 $12,679 $12,441 6/30/2004 $16,275 $12,926 $12,701 7/31/2004 $16,107 $12,498 $12,290 8/31/2004 $16,206 $12,549 $12,349 9/30/2004 $16,640 $12,684 $12,587 10/31/2004 $16,968 $12,878 $12,898 11/30/2004 $17,935 $13,399 $13,581 12/31/2004 $18,616 $13,855 $14,103 1/31/2005 $18,191 $13,518 $13,789 2/28/2005 $18,972 $13,802 $14,232 3/31/2005 $18,802 $13,558 $13,962 4/30/2005 $18,655 $13,300 $13,667 5/31/2005 $19,041 $13,724 $13,920 6/30/2005 $19,451 $13,743 $14,047 7/31/2005 $20,105 $14,254 $14,540 8/31/2005 $20,175 $14,124 $14,657 9/30/2005 $20,744 $14,239 $15,042 10/31/2005 $20,090 $14,001 $14,680 11/30/2005 $20,712 $14,531 $15,177 12/31/2005 $21,463 $14,536 $15,517 1/31/2006 $22,188 $14,921 $16,213 2/28/2006 $22,716 $14,961 $16,196 3/31/2006 $23,573 $15,147 $16,559 4/30/2006 $23,763 $15,351 $17,071 5/31/2006 $23,161 $14,909 $16,503 6/30/2006 $23,206 $14,929 $16,505 7/31/2006 $23,416 $15,021 $16,611 8/31/2006 $24,029 $15,379 $17,051 9/30/2006 $24,256 $15,775 $17,259 10/31/2006 $25,020 $16,289 $17,896 11/30/2006 $25,592 $16,599 $18,344 12/31/2006 $26,403 $16,832 $18,722 1/31/2007 $27,139 $17,086 $18,946 2/28/2007 $26,937 $16,752 $18,856 3/31/2007 $27,717 $16,939 $19,209 4/30/2007 $28,846 $17,690 $20,067 5/31/2007 $29,836 $18,307 $20,649 6/30/2007 $29,766 $18,003 $20,497 7/31/2007 $29,152 $17,445 $20,048 8/31/2007 $28,766 $17,706 $20,041 9/30/2007 $29,511 $18,368 $21,001 10/31/2007 $30,116 $18,661 $21,650 11/30/2007 $29,292 $17,880 $20,775 12/31/2007 $29,297 $17,756 $20,513 AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------- CLASS A 1 12/31/07 - ---------------------------------------------- 1-Year +4.58% - ---------------------------------------------- 5-Year +18.27% - ---------------------------------------------- 10-Year +11.35% - ---------------------------------------------- Annual Report | 13 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------- CLASS B 1 12/31/07 - ---------------------------------------------- 1-Year +6.22% - ---------------------------------------------- 5-Year +18.69% - ---------------------------------------------- Since Inception (1/1/99) +13.07% - ---------------------------------------------- CLASS B (1/1/99-12/31/07) 1 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] Date Mutual Discovery Fund S&P 500 6 MSCI World Index 6 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 $10,833 $10,820 9/30/1999 $11,018 $10,536 $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 $11,278 $11,851 3/31/2000 $13,420 $12,382 $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 $11,864 $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 $11,002 $10,915 1/31/2001 $14,411 $11,392 $11,127 2/28/2001 $14,396 $10,354 $10,188 3/31/2001 $13,961 $ 9,698 $ 9,520 4/30/2001 $14,351 $10,451 $10,227 5/31/2001 $14,771 $10,521 $10,100 6/30/2001 $14,832 $10,265 $ 9,785 7/31/2001 $14,787 $10,164 $ 9,656 8/31/2001 $14,627 $ 9,528 $ 9,194 9/30/2001 $13,373 $ 8,759 $ 8,385 10/31/2001 $13,403 $ 8,926 $ 8,547 11/30/2001 $13,730 $ 9,610 $ 9,054 12/31/2001 $14,028 $ 9,694 $ 9,112 1/31/2002 $14,068 $ 9,553 $ 8,837 2/28/2002 $14,193 $ 9,369 $ 8,761 3/31/2002 $14,656 $ 9,721 $ 9,151 4/30/2002 $14,892 $ 9,132 $ 8,843 5/31/2002 $14,994 $ 9,064 $ 8,864 6/30/2002 $14,061 $ 8,419 $ 8,328 7/31/2002 $13,121 $ 7,763 $ 7,627 8/31/2002 $13,247 $ 7,813 $ 7,643 9/30/2002 $12,536 $ 6,964 $ 6,804 10/31/2002 $12,576 $ 7,577 $ 7,307 11/30/2002 $12,749 $ 8,023 $ 7,703 12/31/2002 $12,633 $ 7,552 $ 7,331 1/31/2003 $12,410 $ 7,354 $ 7,110 2/28/2003 $12,068 $ 7,244 $ 6,988 3/31/2003 $12,115 $ 7,314 $ 6,969 4/30/2003 $13,032 $ 7,917 $ 7,591 5/31/2003 $13,749 $ 8,334 $ 8,029 6/30/2003 $13,971 $ 8,440 $ 8,170 7/31/2003 $14,131 $ 8,589 $ 8,338 8/31/2003 $14,540 $ 8,756 $ 8,520 9/30/2003 $14,612 $ 8,663 $ 8,574 10/31/2003 $15,221 $ 9,153 $ 9,085 11/30/2003 $15,742 $ 9,234 $ 9,225 12/31/2003 $16,452 $ 9,718 $ 9,806 1/31/2004 $16,646 $ 9,897 $ 9,966 2/29/2004 $17,155 $10,034 $10,136 3/31/2004 $17,082 $ 9,883 $10,073 4/30/2004 $16,775 $ 9,728 $ 9,872 5/31/2004 $16,759 $ 9,861 $ 9,969 6/30/2004 $17,058 $10,053 $10,178 7/31/2004 $16,871 $ 9,720 $ 9,848 8/31/2004 $16,969 $ 9,759 $ 9,895 9/30/2004 $17,416 $ 9,865 $10,086 10/31/2004 $17,749 $10,016 $10,335 11/30/2004 $18,757 $10,421 $10,883 12/31/2004 $19,450 $10,776 $11,301 1/31/2005 $18,998 $10,513 $11,049 2/28/2005 $19,803 $10,734 $11,404 3/31/2005 $19,614 $10,544 $11,188 4/30/2005 $19,450 $10,344 $10,951 5/31/2005 $19,844 $10,673 $11,154 6/30/2005 $20,261 $10,689 $11,256 7/31/2005 $20,931 $11,086 $11,651 8/31/2005 $20,997 $10,985 $11,745 9/30/2005 $21,576 $11,074 $12,053 10/31/2005 $20,881 $10,889 $11,763 11/30/2005 $21,518 $11,301 $12,161 12/31/2005 $22,286 $11,305 $12,434 1/31/2006 $23,027 $11,604 $12,992 2/28/2006 $23,559 $11,636 $12,978 3/31/2006 $24,439 $11,781 $13,269 4/30/2006 $24,622 $11,939 $13,679 5/31/2006 $23,977 $11,595 $13,224 6/30/2006 $24,011 $11,611 $13,225 7/31/2006 $24,215 $11,683 $13,311 8/31/2006 $24,837 $11,961 $13,663 9/30/2006 $25,059 $12,269 $13,830 10/31/2006 $25,831 $12,669 $14,341 11/30/2006 $26,409 $12,909 $14,699 12/31/2006 $27,224 $13,091 $15,002 1/31/2007 $27,984 $13,289 $15,182 2/28/2007 $27,776 $13,029 $15,109 3/31/2007 $28,579 $13,174 $15,392 4/30/2007 $29,745 $13,758 $16,080 5/31/2007 $30,766 $14,238 $16,547 6/30/2007 $30,692 $14,001 $16,425 7/31/2007 $30,059 $13,567 $16,064 8/31/2007 $29,663 $13,771 $16,059 9/30/2007 $30,431 $14,286 $16,828 10/31/2007 $31,055 $14,513 $17,348 11/30/2007 $30,204 $13,906 $16,647 12/31/2007 $30,208 $13,810 $16,437 AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------- CLASS C 1 12/31/07 - ---------------------------------------------- 1-Year +9.24% - ---------------------------------------------- 5-Year +18.89% - ---------------------------------------------- 10-Year +11.28% - ---------------------------------------------- CLASS C (1/1/98-12/31/07) 1 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] Date Mutual Discovery Fund S&P 500 6 MSCI World Index 6 1/1/1998 $10,000 $10,000 $10,000 1/31/1998 $ 9,995 $10,111 $10,280 2/28/1998 $10,495 $10,840 $10,977 3/31/1998 $11,091 $11,395 $11,443 4/30/1998 $11,288 $11,510 $11,556 5/31/1998 $11,426 $11,312 $11,413 6/30/1998 $11,139 $11,771 $11,685 7/31/1998 $10,866 $11,646 $11,668 8/31/1998 $ 9,375 $ 9,962 $10,114 9/30/1998 $ 8,951 $10,600 $10,295 10/31/1998 $ 9,190 $11,463 $11,227 11/30/1998 $ 9,642 $12,157 $11,897 12/31/1998 $ 9,708 $12,858 $12,480 1/31/1999 $ 9,765 $13,396 $12,755 2/28/1999 $ 9,646 $12,979 $12,417 3/31/1999 $10,082 $13,498 $12,936 4/30/1999 $10,749 $14,021 $13,448 5/31/1999 $10,749 $13,690 $12,958 6/30/1999 $11,126 $14,450 $13,564 7/31/1999 $10,988 $13,999 $13,525 8/31/1999 $10,845 $13,929 $13,503 9/30/1999 $10,695 $13,548 $13,374 10/31/1999 $10,908 $14,405 $14,071 11/30/1999 $11,470 $14,698 $14,469 12/31/1999 $12,184 $15,563 $15,642 1/31/2000 $12,131 $14,781 $14,748 2/29/2000 $12,509 $14,502 $14,789 3/31/2000 $13,033 $15,920 $15,814 4/30/2000 $12,882 $15,441 $15,147 5/31/2000 $12,946 $15,124 $14,765 6/30/2000 $12,968 $15,497 $15,264 7/31/2000 $13,123 $15,255 $14,836 8/31/2000 $13,496 $16,203 $15,321 9/30/2000 $13,353 $15,347 $14,508 10/31/2000 $13,447 $15,282 $14,267 11/30/2000 $13,210 $14,078 $13,402 12/31/2000 $13,588 $14,146 $13,621 1/31/2001 $13,994 $14,648 $13,886 2/28/2001 $13,979 $13,313 $12,714 3/31/2001 $13,552 $12,469 $11,881 4/30/2001 $13,936 $13,438 $12,762 5/31/2001 $14,341 $13,528 $12,604 6/30/2001 $14,397 $13,199 $12,211 7/31/2001 $14,360 $13,069 $12,050 8/31/2001 $14,199 $12,251 $11,474 9/30/2001 $12,982 $11,262 $10,464 10/31/2001 $13,011 $11,476 $10,666 11/30/2001 $13,326 $12,357 $11,298 12/31/2001 $13,622 $12,465 $11,371 1/31/2002 $13,660 $12,283 $11,028 2/28/2002 $13,781 $12,046 $10,934 3/31/2002 $14,227 $12,499 $11,419 4/30/2002 $14,453 $11,741 $11,036 5/31/2002 $14,559 $11,655 $11,061 6/30/2002 $13,651 $10,825 $10,393 7/31/2002 $12,738 $ 9,981 $ 9,518 8/31/2002 $12,860 $10,046 $ 9,538 9/30/2002 $12,176 $ 8,955 $ 8,491 10/31/2002 $12,206 $ 9,743 $ 9,119 11/30/2002 $12,381 $10,316 $ 9,613 12/31/2002 $12,264 $ 9,710 $ 9,149 1/31/2003 $12,049 $ 9,456 $ 8,872 2/28/2003 $11,720 $ 9,314 $ 8,720 3/31/2003 $11,758 $ 9,404 $ 8,697 4/30/2003 $12,646 $10,179 $ 9,473 5/31/2003 $13,351 $10,715 $10,019 6/30/2003 $13,562 $10,852 $10,196 7/31/2003 $13,716 $11,043 $10,405 8/31/2003 $14,116 $11,259 $10,633 9/30/2003 $14,186 $11,139 $10,700 10/31/2003 $14,778 $11,769 $11,337 11/30/2003 $15,279 $11,873 $11,513 12/31/2003 $15,979 $12,495 $12,238 1/31/2004 $16,165 $12,725 $12,437 2/29/2004 $16,662 $12,902 $12,649 3/31/2004 $16,584 $12,707 $12,570 4/30/2004 $16,289 $12,508 $12,320 5/31/2004 $16,274 $12,679 $12,441 6/30/2004 $16,567 $12,926 $12,701 7/31/2004 $16,387 $12,498 $12,290 8/31/2004 $16,481 $12,549 $12,349 9/30/2004 $16,910 $12,684 $12,587 10/31/2004 $17,238 $12,878 $12,898 11/30/2004 $18,205 $13,399 $13,581 12/31/2004 $18,881 $13,855 $14,103 1/31/2005 $18,440 $13,518 $13,789 2/28/2005 $19,228 $13,802 $14,232 3/31/2005 $19,047 $13,558 $13,962 4/30/2005 $18,881 $13,300 $13,667 5/31/2005 $19,267 $13,724 $13,920 6/30/2005 $19,668 $13,743 $14,047 7/31/2005 $20,318 $14,254 $14,540 8/31/2005 $20,382 $14,124 $14,657 9/30/2005 $20,945 $14,239 $15,042 10/31/2005 $20,271 $14,001 $14,680 11/30/2005 $20,889 $14,531 $15,177 12/31/2005 $21,631 $14,536 $15,517 1/31/2006 $22,358 $14,921 $16,213 2/28/2006 $22,876 $14,961 $16,196 3/31/2006 $23,720 $15,147 $16,559 4/30/2006 $23,903 $15,351 $17,071 5/31/2006 $23,277 $14,909 $16,503 6/30/2006 $23,311 $14,929 $16,505 7/31/2006 $23,507 $15,021 $16,611 8/31/2006 $24,111 $15,379 $17,051 9/30/2006 $24,324 $15,775 $17,259 10/31/2006 $25,082 $16,289 $17,896 11/30/2006 $25,635 $16,599 $18,344 12/31/2006 $26,425 $16,832 $18,722 1/31/2007 $27,149 $17,086 $18,946 2/28/2007 $26,937 $16,752 $18,856 3/31/2007 $27,706 $16,939 $19,209 4/30/2007 $28,809 $17,690 $20,067 5/31/2007 $29,789 $18,307 $20,649 6/30/2007 $29,696 $18,003 $20,497 7/31/2007 $29,068 $17,445 $20,048 8/31/2007 $28,662 $17,706 $20,041 9/30/2007 $29,395 $18,368 $21,001 10/31/2007 $29,979 $18,661 $21,650 11/30/2007 $29,139 $17,880 $20,775 12/31/2007 $29,131 $17,756 $20,513 14 | Annual Report Performance Summary (CONTINUED) CLASS R (1/1/02-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] Date Mutual Discovery Fund S&P 500 6 MSCI World Index 6 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 $10,027 $10,043 4/30/2002 $10,630 $ 9,420 $ 9,705 5/31/2002 $10,708 $ 9,350 $ 9,728 6/30/2002 $10,050 $ 8,684 $ 9,140 7/31/2002 $ 9,382 $ 8,007 $ 8,370 8/31/2002 $ 9,471 $ 8,060 $ 8,388 9/30/2002 $ 8,970 $ 7,184 $ 7,467 10/31/2002 $ 9,004 $ 7,816 $ 8,020 11/30/2002 $ 9,132 $ 8,276 $ 8,454 12/31/2002 $ 9,051 $ 7,790 $ 8,046 1/31/2003 $ 8,893 $ 7,586 $ 7,803 2/28/2003 $ 8,655 $ 7,472 $ 7,669 3/31/2003 $ 8,689 $ 7,545 $ 7,648 4/30/2003 $ 9,351 $ 8,166 $ 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 $ 8,859 $ 9,151 8/31/2003 $10,454 $ 9,032 $ 9,351 9/30/2003 $10,505 $ 8,936 $ 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 $10,172 $10,941 6/30/2004 $12,316 $10,370 $11,170 7/31/2004 $12,189 $10,026 $10,808 8/31/2004 $12,258 $10,067 $10,860 9/30/2004 $12,589 $10,176 $11,069 10/31/2004 $12,838 $10,332 $11,343 11/30/2004 $13,568 $10,750 $11,944 12/31/2004 $14,076 $11,115 $12,403 1/31/2005 $13,753 $10,844 $12,126 2/28/2005 $14,341 $11,073 $12,516 3/31/2005 $14,211 $10,877 $12,279 4/30/2005 $14,100 $10,670 $12,019 5/31/2005 $14,394 $11,010 $12,242 6/30/2005 $14,699 $11,025 $12,353 7/31/2005 $15,190 $11,435 $12,788 8/31/2005 $15,243 $11,331 $12,890 9/30/2005 $15,669 $11,423 $13,228 10/31/2005 $15,178 $11,232 $12,910 11/30/2005 $15,646 $11,657 $13,347 12/31/2005 $16,207 $11,661 $13,646 1/31/2006 $16,751 $11,970 $14,258 2/28/2006 $17,152 $12,003 $14,243 3/31/2006 $17,791 $12,152 $14,563 4/30/2006 $17,935 $12,315 $15,013 5/31/2006 $17,478 $11,961 $14,513 6/30/2006 $17,510 $11,977 $14,515 7/31/2006 $17,664 $12,051 $14,609 8/31/2006 $18,123 $12,338 $14,995 9/30/2006 $18,289 $12,655 $15,179 10/31/2006 $18,870 $13,068 $15,739 11/30/2006 $19,291 $13,316 $16,132 12/31/2006 $19,898 $13,503 $16,465 1/31/2007 $20,450 $13,707 $16,662 2/28/2007 $20,297 $13,439 $16,582 3/31/2007 $20,882 $13,590 $16,893 4/30/2007 $21,726 $14,192 $17,648 5/31/2007 $22,477 $14,687 $18,160 6/30/2007 $22,408 $14,443 $18,026 7/31/2007 $21,949 $13,995 $17,631 8/31/2007 $21,656 $14,205 $17,625 9/30/2007 $22,215 $14,736 $18,469 10/31/2007 $22,667 $14,970 $19,040 11/30/2007 $22,042 $14,344 $18,270 12/31/2007 $22,040 $14,245 $18,040 AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------- CLASS R 12/31/07 - ---------------------------------------------- 1-Year +10.76% - ---------------------------------------------- 5-Year +19.48% - ---------------------------------------------- Since Inception (1/1/02) +14.09% - ---------------------------------------------- ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. THE FUND'S INVESTMENTS IN FOREIGN SECURITIES INVOLVE CERTAIN RISKS INCLUDING CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. SMALLER-COMPANY STOCKS HAVE 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'S INVESTMENTS IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS ALSO INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS. THE FUND MAY INVEST IN 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. 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. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated. 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. 5. Figures are as stated in the Fund's prospectus current as of the date of this report. 6. 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. Annual Report | 15 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 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 Fund's 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. 16 | 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 7/1/07 VALUE 12/31/07 PERIOD* 7/1/07-12/31/07 - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 986.10 $ 5.06 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,020.11 $ 5.14 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 984.30 $ 6.60 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,018.55 $ 6.72 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 981.10 $ 10.04 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,015.07 $ 10.21 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 981.00 $ 10.04 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,015.07 $ 10.21 - -------------------------------------------------------------------------------------------------------- CLASS R - -------------------------------------------------------------------------------------------------------- Actual $ 1,000 $ 983.60 $ 7.55 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $ 1,000 $ 1,017.59 $ 7.68 - --------------------------------------------------------------------------------------------------------
* Expenses are calculated using the most recent six-month expense ratio annualized for each class (Z: 1.01%; A: 1.32%; B: 2.01%; C: 2.01%; and R: 1.51%), multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period. Annual Report | 17 Mutual Discovery Fund FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2007 2006 2005 2004 2003 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................... $ 30.45 $ 26.28 $ 24.26 $ 20.81 $ 16.16 --------------------------------------------------------------------------- Income from investment operations a: Net investment income b ........................... 0.69 0.67 0.37 0.41 0.28 Net realized and unrealized gains (losses) ........ 2.76 5.36 3.43 3.58 4.80 --------------------------------------------------------------------------- Total from investment operations ..................... 3.45 6.03 3.80 3.99 5.08 --------------------------------------------------------------------------- Less distributions from: Net investment income ............................. (0.74) (0.63) (0.44) (0.54) (0.43) Net realized gains ................................ (0.71) (1.23) (1.34) -- -- --------------------------------------------------------------------------- Total distributions .................................. (1.45) (1.86) (1.78) (0.54) (0.43) --------------------------------------------------------------------------- Redemption fees ...................................... -- d -- d -- d -- d -- --------------------------------------------------------------------------- Net asset value, end of year ......................... $ 32.45 $ 30.45 $ 26.28 $ 24.26 $ 20.81 =========================================================================== Total return ......................................... 11.32% 23.43% 15.70% 19.39% 31.55% RATIOS TO AVERAGE NET ASSETS Expenses c ........................................... 1.01% e 1.05% e 1.07% e 1.07% e 1.11% Expenses - excluding dividend expense on securities sold short ........................................ 1.01% e 1.02% e 1.04% e 1.06% e 1.08% Net investment income ................................ 2.09% 2.28% 1.42% 1.87% 1.55% SUPPLEMENTAL DATA Net assets, end of year (000's) ...................... $4,720,388 $3,923,802 $3,033,756 $2,578,585 $2,168,161 Portfolio turnover rate .............................. 25.12% 22.27% 25.69% 34.34% 46.34%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. 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 rounds to less than $0.01 per share. e Benefit of expense reduction rounds to less than 0.01%. 18 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2007 2006 2005 2004 2003 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................... $ 30.14 $ 26.04 $ 24.07 $ 20.67 $ 16.06 --------------------------------------------------------------------------- Income from investment operations a: Net investment income b ........................... 0.58 0.55 0.27 0.33 0.21 Net realized and unrealized gains (losses) ........ 2.73 5.34 3.41 3.54 4.78 --------------------------------------------------------------------------- Total from investment operations ..................... 3.31 5.89 3.68 3.87 4.99 --------------------------------------------------------------------------- Less distributions from: Net investment income ............................. (0.65) (0.56) (0.37) (0.47) (0.38) Net realized gains ................................ (0.71) (1.23) (1.34) -- -- --------------------------------------------------------------------------- Total distributions .................................. (1.36) (1.79) (1.71) (0.47) (0.38) --------------------------------------------------------------------------- Redemption fees ...................................... -- e -- e -- e -- e -- --------------------------------------------------------------------------- Net asset value, end of year ......................... $ 32.09 $ 30.14 $ 26.04 $ 24.07 $ 20.67 =========================================================================== Total return c ....................................... 10.96% 23.02% 15.29% 18.98% 31.13% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................... 1.32% f 1.36% f 1.42% f 1.42% f 1.46% Expenses - excluding dividend expense on securities sold short ........................................ 1.32% f 1.33% f 1.39% f 1.41% f 1.43% Net investment income ................................ 1.78% 1.97% 1.07% 1.52% 1.20% SUPPLEMENTAL DATA Net assets, end of year (000's) ...................... $8,913,527 $6,128,353 $3,545,288 $ 2,106,695 $1,439,579 Portfolio turnover rate .............................. 25.12% 22.27% 25.69% 34.34% 46.34%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 19 Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2007 2006 2005 2004 2003 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................... $ 29.55 $ 25.57 $ 23.67 $ 20.35 $ 15.85 --------------------------------------------------------------------------- Income from investment operations a: Net investment income b ........................... 0.36 0.38 0.11 0.18 0.09 Net realized and unrealized gains (losses) ........ 2.67 5.19 3.33 3.49 4.69 --------------------------------------------------------------------------- Total from investment operations ..................... 3.03 5.57 3.44 3.67 4.78 --------------------------------------------------------------------------- Less distributions from: Net investment income ............................. (0.41) (0.36) (0.20) (0.35) (0.28) Net realized gains ................................ (0.71) (1.23) (1.34) -- -- --------------------------------------------------------------------------- Total distributions .................................. (1.12) (1.59) (1.54) (0.35) (0.28) --------------------------------------------------------------------------- Redemption fees ...................................... -- e -- e -- e -- e -- --------------------------------------------------------------------------- Net asset value, end of year ......................... $ 31.46 $ 29.55 $ 25.57 $ 23.67 $ 20.35 =========================================================================== Total return c ....................................... 10.22% 22.16% 14.59% 18.22% 30.22% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................... 2.01% f 2.05% f 2.07% f 2.07% f 2.11% Expenses - excluding dividend expense on securities sold short ........................................ 2.01% f 2.02% f 2.04% f 2.06% f 2.08% Net investment income ................................ 1.09% 1.28% 0.42% 0.87% 0.55% SUPPLEMENTAL DATA Net assets, end of year (000's) ...................... $ 276,175 $ 274,181 $225,158 $ 186,841 $ 115,801 Portfolio turnover rate .............................. 25.12% 22.27% 25.69% 34.34% 46.34%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. 20 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2007 2006 2005 2004 2003 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................... $ 29.93 $ 25.90 $ 23.97 $ 20.59 $ 16.02 --------------------------------------------------------------------------- Income from investment operations a: Net investment income b ........................... 0.36 0.36 0.11 0.19 0.10 Net realized and unrealized gains (losses) ........ 2.70 5.28 3.38 3.53 4.73 --------------------------------------------------------------------------- Total from investment operations ..................... 3.06 5.64 3.49 3.72 4.83 --------------------------------------------------------------------------- Less distributions from: Net investment income ............................. (0.44) (0.38) (0.22) (0.34) (0.26) Net realized gains ................................ (0.71) (1.23) (1.34) -- -- --------------------------------------------------------------------------- Total distributions .................................. (1.15) (1.61) (1.56) (0.34) (0.26) --------------------------------------------------------------------------- Redemption fees ...................................... -- e -- e -- e -- e -- --------------------------------------------------------------------------- Net asset value, end of year ......................... $ 31.84 $ 29.93 $ 25.90 $ 23.97 $ 20.59 =========================================================================== Total return c ....................................... 10.24% 22.17% 14.56% 18.17% 30.29% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................... 2.01% f 2.05% f 2.07% f 2.07% f 2.11% Expenses - excluding dividend expense on securities sold short ........................................ 2.01% f 2.02% f 2.04% f 2.06% f 2.08% Net investment income ................................ 1.09% 1.28% 0.42% 0.87% 0.55% SUPPLEMENTAL DATA Net assets, end of year (000's) ...................... $3,075,593 $2,242,348 $1,435,702 $ 968,934 $ 725,489 Portfolio turnover rate .............................. 25.12% 22.27% 25.69% 34.34% 46.34%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 21 Mutual Discovery Fund FINANCIAL HIGHLIGHTS (CONTINUED)
--------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS R 2007 2006 2005 2004 2003 --------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................... $ 29.93 $ 25.88 $ 23.94 $ 20.57 $ 16.01 --------------------------------------------------------------------------- Income from investment operations a: Net investment income b ........................... 0.51 0.50 0.22 0.29 0.17 Net realized and unrealized gains (losses) ........ 2.72 5.29 3.40 3.54 4.76 --------------------------------------------------------------------------- Total from investment operations ..................... 3.23 5.79 3.62 3.83 4.93 --------------------------------------------------------------------------- Less distributions from: Net investment income ............................. (0.60) (0.51) (0.34) (0.46) (0.37) Net realized gains ................................ (0.71) (1.23) (1.34) -- -- --------------------------------------------------------------------------- Total distributions .................................. (1.31) (1.74) (1.68) (0.46) (0.37) --------------------------------------------------------------------------- Redemption fees ...................................... -- e -- e -- e -- e -- --------------------------------------------------------------------------- Net asset value, end of year ......................... $ 31.85 $ 29.93 $ 25.88 $ 23.94 $ 20.57 =========================================================================== Total return c ....................................... 10.76% 22.78% 15.13% 18.84% 30.87% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................... 1.51% f 1.55% f 1.57% f 1.57% f 1.61% Expenses - excluding dividend expense on securities sold short ........................................ 1.51% f 1.52% f 1.54% f 1.56% f 1.58% Net investment income ................................ 1.59% 1.78% 0.92% 1.37% 1.05% SUPPLEMENTAL DATA Net assets, end of year (000's) ...................... $ 275,002 $ 175,790 $ 99,501 $ 46,690 $ 19,546 Portfolio turnover rate .............................. 25.12% 22.27% 25.69% 34.34% 46.34%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. 22 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS 85.9% COMMON STOCKS AND OTHER EQUITY INTERESTS 83.8% AIRLINES 0.4% a ACE Aviation Holdings Inc., A ................................. Canada 1,277,511 $ 36,445,219 a,b ACE Aviation Holdings Inc., A, 144A ........................... Canada 64,416 1,837,679 a Northwest Airlines Corp. ...................................... United States 1,754,015 25,450,758 a,c Northwest Airlines Corp., Contingent Distribution ............. United States 69,160,000 2,334,150 ------------------ 66,067,806 ------------------ AUTO COMPONENTS 0.0% d a,c Collins & Aikman Products Co., Contingent Distribution ........ United States 1,970,181 871,805 ------------------ AUTOMOBILES 0.4% Hero Honda Motors Ltd. ........................................ India 1,042,903 18,464,187 a,e,f,g,h International Automotive Components Group Brazil LLC .......... Brazil 3,204,016 22,255,512 a,e,f,g,h International Automotive Components Group Japan LLC ........... Japan 650,533 5,833,592 a,e,g,h International Automotive Components Group LLC ................. Luxembourg 13,618,870 14,448,259 a,e,g,h International Automotive Components Group NA LLC .............. United States 11,533,275 15,858,253 ------------------ 76,859,803 ------------------ BEVERAGES 4.7% Brown-Forman Corp., A ......................................... United States 143,200 10,717,088 Brown-Forman Corp., B ......................................... United States 391,650 29,025,181 Carlsberg AS, A ............................................... Denmark 113,300 12,927,664 Carlsberg AS, B ............................................... Denmark 2,348,253 283,564,361 Fomento Economico Mexicano SAB de CV, ADR ..................... Mexico 3,150,684 120,261,608 Lotte Chilsung Beverage Co. Ltd. .............................. South Korea 55,692 62,412,166 Pernod Ricard SA .............................................. France 1,303,498 300,747,266 ------------------ 819,655,334 ------------------ BUILDING PRODUCTS 0.7% a Armstrong World Industries Inc. ............................... United States 199,839 8,015,542 a,c Armstrong World Industries Inc., Contingent Distribution ...... United States 22,185,050 83,194 KCC Corp. ..................................................... South Korea 160,170 90,176,369 a Owens Corning Inc. ............................................ United States 750,622 15,177,577 ------------------ 113,452,682 ------------------ CAPITAL MARKETS 1.1% Legg Mason Inc. ............................................... United States 852,120 62,332,578 Marfin Investment Group Holdings SA ........................... Greece 14,276,740 123,758,474 ------------------ 186,091,052 ------------------ CHEMICALS 2.2% a,c Dow Corning Corp., Contingent Distribution .................... United States 11,430,153 5,829,378 Linde AG ...................................................... Germany 1,662,431 219,534,948 Sika AG ....................................................... Switzerland 85,406 160,984,130 ------------------ 386,348,456 ------------------ COMMERCIAL BANKS 8.3% a Banco Popolare SpA ............................................ Italy 7,825,844 173,136,979 Bank of Ireland ............................................... Ireland 1,707,777 25,321,202 BNP Paribas SA ................................................ France 1,957,306 212,001,594 Commerce Bancorp Inc. ......................................... United States 3,717,790 141,796,511
Annual Report | 23 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMMERCIAL BANKS (CONTINUED) Danske Bank AS ................................................ Denmark 3,875,695 $ 151,515,819 a,e,f,g FE Capital Holdings Ltd. ...................................... Japan 12,017 7,893,554 First Community Bancorp ....................................... United States 518,434 21,380,218 Intesa Sanpaolo SpA ........................................... Italy 13,008,438 102,702,701 a Investors Bancorp Inc. ........................................ United States 1,775 25,098 Mitsubishi UFJ Financial Group Inc. ........................... Japan 5,860,123 55,019,942 a,e,g NCB Warrant Holdings Ltd., A .................................. Japan 55,890 3,316,056 Royal Bank of Scotland Group PLC .............................. United Kingdom 1,101,074 9,713,739 Societe Generale, A ........................................... France 773,452 111,665,965 Sumitomo Mitsui Financial Group Inc. .......................... Japan 12,485 93,708,873 Svenska Handelsbanken AB, A ................................... Sweden 3,204,537 102,593,557 Swedbank AB, A ................................................ Sweden 2,532,015 71,664,127 Unione Di Banche Italiane SCPA ................................ Italy 1,785,203 49,004,488 U.S. Bancorp .................................................. United States 3,199,005 101,536,419 ------------------ 1,433,996,842 ------------------ COMMERCIAL SERVICES & SUPPLIES 0.1% a Comdisco Holding Co. Inc. ..................................... United States 913 8,318 a,c Comdisco Holding Co. Inc., Contingent Distribution ............ United States 41,726,153 -- Fursys Inc. ................................................... South Korea 547,260 13,622,304 ------------------ 13,630,622 ------------------ COMPUTERS & PERIPHERALS 0.3% a,e,g DecisionOne Corp. ............................................. United States 359,884 -- a,e,g DecisionOne Corp., wts., 6/08/17 .............................. United States 197,603 -- a Dell Inc. ..................................................... United States 1,871,150 45,861,887 ------------------ 45,861,887 ------------------ CONSTRUCTION MATERIALS 0.6% Ciments Francais SA ........................................... France 399,572 68,638,511 Hanil Cement Co. Ltd. ......................................... South Korea 331,250 38,396,053 ------------------ 107,034,564 ------------------ CONSUMER FINANCE 0.4% a,e,g Cerberus CG Investor I LLC .................................... United States 7,903,600 6,654,646 a,e,g Cerberus CG Investor II LLC ................................... United States 7,903,600 6,654,646 a,e,g Cerberus CG Investor III LLC .................................. United States 3,951,800 3,327,323 a,e,g Cerberus FIM Investors Auto Finance LLC ....................... United States 8,723,795 4,680,586 a,e,g Cerberus FIM Investors Commercial Finance LLC ................. United States 726,666 389,879 a,e,g Cerberus FIM Investors Commercial Mortgage LLC ................ United States 1,362,023 730,767 a,e,g Cerberus FIM Investors Insurance LLC .......................... United States 6,661,738 3,574,228 a,e,g Cerberus FIM Investors Rescap LLC ............................. United States 12,402,778 6,654,474 SLM Corp. ..................................................... United States 2,001,760 40,315,446 ------------------ 72,981,995 ------------------ DISTRIBUTORS 0.2% Compania de Distribucion Integral Logista SA .................. Spain 564,170 41,865,896 ------------------
24 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) DIVERSIFIED FINANCIAL SERVICES 5.0% Citigroup Inc. ................................................ United States 561,610 $ 16,533,798 Deutsche Boerse AG ............................................ Germany 1,405,872 278,512,742 Fortis ........................................................ Belgium 9,062,832 239,123,250 a Fortis VVPR Strip ............................................. Belgium 3,397,596 49,583 Guinness Peat Group PLC ....................................... United Kingdom 27,286,699 36,392,544 Jardine Matheson Holdings Ltd. ................................ Hong Kong 4,554,012 126,146,132 Jardine Strategic Holdings Ltd. ............................... Hong Kong 10,060,600 157,951,420 a,c Marconi Corp., Contingent Distribution ........................ United Kingdom 33,909,700 -- ------------------ 854,709,469 ------------------ DIVERSIFIED TELECOMMUNICATION SERVICES 0.9% a,e,g,h AboveNet Inc. ................................................. United States 352,895 17,644,750 a,e,h AboveNet Inc., stock grants, grant price $20.95, expiration date 9/09/13 ............................................... United States 464 19,233 a,e,g,h AboveNet Inc., wts., 9/08/08 .................................. United States 12,673 598,165 a,e,g,h AboveNet Inc., wts., 9/08/10 .................................. United States 14,911 651,312 Chunghwa Telecom Co. Ltd., ADR ................................ Taiwan 2,902,333 61,268,244 a,c,g Global Crossing Holdings Ltd., Contingent Distribution ........ United States 45,658,716 -- Koninklijke (Royal) KPN NV .................................... Netherlands 4,511,679 81,906,435 ------------------ 162,088,139 ------------------ ELECTRIC UTILITIES 0.7% E.ON AG ....................................................... Germany 597,820 127,034,327 ------------------ ELECTRONIC EQUIPMENT & INSTRUMENTS 0.2% Tyco Electronics Ltd. ......................................... United States 781,630 29,021,922 ------------------ ENERGY EQUIPMENT & SERVICES 4.2% Bourbon SA .................................................... France 1,031,595 67,474,633 a BW Offshore Ltd. .............................................. Norway 18,666,535 78,657,402 a Compagnie Generale de Geophysique SA .......................... France 580,532 165,203,873 a,f Dockwise Ltd. ................................................. Norway 12,379,100 51,252,139 Petroleum Geo-Services ASA .................................... Norway 1,796,568 52,149,895 a Seadrill Ltd. ................................................. Bermuda 9,211,447 224,586,756 a Transocean Inc. ............................................... United States 551,774 78,986,448 ------------------ 718,311,146 ------------------ FOOD & STAPLES RETAILING 2.2% Carrefour SA .................................................. France 4,298,988 334,326,961 CVS Caremark Corp. ............................................ United States 1,232,553 48,993,982 ------------------ 383,320,943 ------------------ FOOD PRODUCTS 6.1% Cadbury Schweppes PLC ......................................... United Kingdom 10,530,995 129,941,528 Cermaq ASA .................................................... Norway 3,630,328 50,435,139 f CSM NV ........................................................ Netherlands 4,036,926 136,088,747 f Farmer Brothers Co. ........................................... United States 904,637 20,797,605 Groupe Danone ................................................. France 2,686,412 240,713,495 Kraft Foods Inc., A ........................................... United States 415,186 13,547,519
Annual Report | 25 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) FOOD PRODUCTS (CONTINUED) a Lighthouse Caledonia ASA ...................................... Norway 1,401,289 $ 1,330,509 Lotte Confectionary Co. Ltd. .................................. South Korea 52,189 94,225,105 a,i Marine Harvest ................................................ Norway 164,857,626 105,870,478 Nestle SA ..................................................... Switzerland 219,229 100,599,259 Nong Shim Co. Ltd. ............................................ South Korea 210,569 43,753,721 Premier Foods PLC ............................................. United Kingdom 22,024,219 89,491,295 Rieber & Son ASA .............................................. Norway 3,605,065 34,660,897 ------------------ 1,061,455,297 ------------------ HEALTH CARE EQUIPMENT & SUPPLIES 0.2% Covidien Ltd. ................................................. United States 781,630 34,618,393 ------------------ HEALTH CARE PROVIDERS & SERVICES 1.3% a,e,g,h Kindred Healthcare Inc. ....................................... United States 1,135,557 26,947,903 a,e,g,h Kindred Healthcare Inc., stock grants: grant price $18.15, expiration date 7/17/11 ................ United States 3,928 21,922 grant price $19.87, expiration date 1/01/12 ................ United States 1,175 4,537 grant price $6.94, expiration date 1/01/13 ................. United States 1,174 19,713 grant price $19.87, expiration date 1/01/14 ................ United States 878 3,390 grant price $21.33, expiration date 1/10/15 ................ United States 489 1,174 grant price $22.08, expiration date 1/10/16 ................ United States 246 406 a MDS Inc. ...................................................... Canada 1,294,341 24,994,620 a PharMerica Inc. ............................................... United States 415,641 5,769,097 Quest Diagnostics Inc. ........................................ United States 1,302,600 68,907,540 Rhoen-Klinikum AG ............................................. Germany 3,163,170 98,878,404 ------------------ 225,548,706 ------------------ HOTELS, RESTAURANTS & LEISURE 0.0% d a,e,f,g Hancock Discovery LLC ......................................... United States 8,758,216 -- a Trump Entertainment Resorts Inc. .............................. United States 839,693 3,610,680 ------------------ 3,610,680 ------------------ HOUSEHOLD DURABLES 0.2% Hunter Douglas NV ............................................. Netherlands 323,796 23,947,905 Koninklijke Philips Electronics NV ............................ Netherlands 272,485 11,738,657 ------------------ 35,686,562 ------------------ INDEPENDENT POWER PRODUCERS & ENERGY TRADERS 0.7% Constellation Energy Group .................................... United States 1,098,560 112,635,357 ------------------ INDUSTRIAL CONGLOMERATES 4.2% Keppel Corp. Ltd. ............................................. Singapore 17,381,344 156,757,065 h Orkla ASA ..................................................... Norway 20,568,718 398,354,507 Siemens AG .................................................... Germany 1,005,019 159,016,842 Tyco International Ltd. ....................................... United States 156,030 6,186,590 ------------------ 720,315,004 ------------------ INSURANCE 5.7% a Alleghany Corp. ............................................... United States 75,045 30,168,090 Allianz SE .................................................... Germany 593,700 128,298,891 American International Group Inc. ............................. United States 500,700 29,190,810
26 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) INSURANCE (CONTINUED) Assicurazioni Generali SpA .................................... Italy 1,206,738 $ 54,592,644 a,e,f,g Augsburg Re AG ................................................ Switzerland 66,860 -- a Berkshire Hathaway Inc., A .................................... United States 853 120,784,800 a Berkshire Hathaway Inc., B .................................... United States 34,470 163,249,920 a Conseco Inc. .................................................. United States 2,684,120 33,712,547 E-L Financial Corp. Ltd. ...................................... Canada 177,619 104,471,251 Hartford Financial Services Group Inc. ........................ United States 511,000 44,554,090 a,e,f,g Imagine Group Holdings Ltd. ................................... Bermuda 4,551,501 52,069,171 Old Republic International Corp. .............................. United States 1,898,187 29,251,062 a,e,g Olympus Re Holdings Ltd. ...................................... United States 47,160 154,458 Prudential Financial Inc. ..................................... United States 421,200 39,188,448 White Mountains Insurance Group Ltd. .......................... United States 172,815 88,835,551 Zurich Financial Services AG .................................. Switzerland 237,664 69,734,628 ------------------ 988,256,361 ------------------ MACHINERY 1.5% f,j Aker Yards ASA ................................................ Norway 5,752,030 65,622,571 Kone OYJ, B ................................................... Finland 77,263 5,404,288 a,e,g Motor Coach Industries International Inc., wts., 5/27/09 ...... United States 5 -- Schindler Holding AG .......................................... Switzerland 2,263,002 145,781,103 Schindler Holding AG, Registered .............................. Switzerland 659,880 42,509,036 ------------------ 259,316,998 ------------------ MEDIA 5.7% a Adelphia Recovery Trust ....................................... United States 45,477,593 3,183,431 a,c Adelphia Recovery Trust Arahova Contingent Value Vehicle, Contingent Distribution .................................... United States 5,538,790 2,852,477 a,c Century Communications Corp., Contingent Distribution ......... United States 15,282,000 -- CJ CGV Co. Ltd. ............................................... South Korea 849,040 11,700,888 Daekyo Co. Ltd. ............................................... South Korea 367,570 34,870,163 Eutelsat Communications ....................................... France 6,644,123 197,315,647 JC Decaux SA .................................................. France 2,791,333 109,578,002 a Liberty Media Holding Corp.-Capital, A ........................ United States 212,775 24,786,160 k News Corp., A ................................................. United States 5,033,010 103,126,375 a Premiere AG ................................................... Germany 3,927,965 73,430,450 a Sun-Times Media Group Inc., A ................................. United States 880,440 1,936,968 Teleperformance ............................................... France 1,465,107 56,937,705 a Time Warner Cable Inc., A ..................................... United States 1,019,692 28,143,499 Time Warner Inc. .............................................. United States 7,333,400 121,074,434 a,g TVMAX Holdings Inc. ........................................... United States 118,432 -- a Viacom Inc., B ................................................ United States 1,719,410 75,516,487 Virgin Media Inc. ............................................. United Kingdom 5,426,163 93,004,434 WPP Group PLC ................................................. United Kingdom 3,258,420 41,888,837 ------------------ 979,345,957 ------------------ METALS & MINING 1.4% Anglo American PLC ............................................ United Kingdom 2,536,742 155,243,698 a,e,f,g Esmark Inc. ................................................... United States 3,850,425 48,965,854 a Gammon Gold Inc. .............................................. Canada 4,215,239 33,764,329 ------------------ 237,973,881 ------------------
Annual Report | 27 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MULTI-UTILITIES 1.8% Energy East Corp. ............................................. United States 1,290,320 $ 35,109,607 NorthWestern Corp. ............................................ United States 328,196 9,681,782 a,c NorthWestern Corp., Contingent Distribution ................... United States 9,839,500 697,661 RWE AG ........................................................ Germany 1,172,783 165,074,254 Suez SA ....................................................... France 1,593,344 108,286,729 ------------------ 318,850,033 ------------------ MULTILINE RETAIL 0.3% Jelmoli Holding AG ............................................ Switzerland 19,024 45,579,033 ------------------ OIL, GAS & CONSUMABLE FUELS 2.1% BP PLC ........................................................ United Kingdom 7,976,960 97,476,402 BP PLC, ADR ................................................... United Kingdom 180,900 13,236,453 Eni SpA ....................................................... Italy 847,600 30,985,473 Royal Dutch Shell PLC, A ...................................... United Kingdom 3,324,863 139,498,986 Total SA, B ................................................... France 510,684 42,353,505 Total SA, B, ADR .............................................. France 417,296 34,468,650 ------------------ 358,019,469 ------------------ PAPER & FOREST PRODUCTS 1.4% a Domtar Corp. .................................................. United States 3,018,373 23,211,288 Mondi Ltd. .................................................... United Kingdom 278,762 2,633,729 Mondi PLC ..................................................... United Kingdom 696,907 5,885,058 Weyerhaeuser Co. .............................................. United States 2,781,353 205,096,970 ------------------ 236,827,045 ------------------ PERSONAL PRODUCTS 0.3% Amorepacific Corp. ............................................ South Korea 64,004 48,547,449 ------------------ PHARMACEUTICALS 1.6% Novartis AG ................................................... Switzerland 2,508,989 137,494,014 Pfizer Inc. ................................................... United States 2,675,730 60,819,343 Sanofi-Aventis ................................................ France 860,485 79,087,056 ------------------ 277,400,413 ------------------ REAL ESTATE 2.7% a,g Canary Wharf Group PLC ........................................ United Kingdom 5,400,183 53,971,368 Great Eagle Holdings Ltd. ..................................... Hong Kong 12,726,353 47,572,253 Link REIT ..................................................... Hong Kong 84,222,231 182,309,955 Swire Pacific Ltd., A ......................................... Hong Kong 9,379,950 129,306,450 Swire Pacific Ltd., B ......................................... Hong Kong 13,605,000 36,114,374 Ventas Inc. ................................................... United States 516,500 23,371,625 ------------------ 472,646,025 ------------------ SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT 0.2% a LSI Corp. ..................................................... United States 4,963,248 26,354,847 ------------------ SOFTWARE 0.9% Microsoft Corp. ............................................... United States 4,335,680 154,350,208 ------------------
28 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) THRIFTS & MORTGAGE FINANCE 0.6% Hudson City Bancorp Inc. ...................................... United States 2,146,520 $ 32,240,730 Hypo Real Estate Holding AG ................................... Germany 1,488,952 78,854,615 ------------------ 111,095,345 ------------------ TOBACCO 11.7% Altadis SA .................................................... Spain 3,911,525 283,758,789 Altria Group Inc. ............................................. United States 1,213,908 91,747,167 British American Tobacco PLC .................................. United Kingdom 10,342,443 403,805,893 Imperial Tobacco Group PLC .................................... United Kingdom 7,506,026 404,470,370 ITC Ltd. ...................................................... India 18,037,005 96,261,443 Japan Tobacco Inc. ............................................ Japan 49,765 298,103,573 KT&G Corp. .................................................... South Korea 4,837,575 411,895,441 Reynolds American Inc. ........................................ United States 378,400 24,959,264 ------------------ 2,015,001,940 ------------------ TRADING COMPANIES & DISTRIBUTORS 0.6% f Kloeckner & Co. AG ............................................ Germany 2,796,264 111,403,867 ------------------ TRANSPORTATION INFRASTRUCTURE 0.0% d a Groupe Eurotunnel SA, wts., 12/30/11 .......................... France 200,763 67,386 ------------------ TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $10,017,156,596) ..................................... 14,474,110,946 ------------------ PREFERRED STOCKS 0.1% AUTO COMPONENTS 0.1% e,g Dana Holding Corp., 4.00%, cvt. pfd., B ....................... United States 89,831 8,983,100 ------------------ DIVERSIFIED TELECOMMUNICATION SERVICES 0.0% d e PTV Inc., 10.00%, pfd., A ..................................... United Kingdom 86,280 103,536 ------------------ TOTAL PREFERRED STOCKS (COST $9,241,940) ...................... 9,086,636 ------------------ OPTIONS PURCHASED 0.5% CALL OPTIONS 0.0% d a,e Owens Corning Inc., exercise price $37.50, expiration date 1/02/08, shares ............................................ United States 535,890 26,795 ------------------ PUT OPTIONS 0.5% a Index basket consisting of 80% Dow Jones EUROSTOXX 50 (exercise price $4,018.50), 20% S&P 500 Index (exercise price $1,362.92), expiration date 5/23/08, contracts ....... United States 4,372,000 9,546,796 a Index basket consisting of 80% Dow Jones EUROSTOXX 50 (exercise price $4,029.17), 20% S&P 500 Index (exercise price $1,368.36), expiration date 5/29/08, contracts ....... United States 4,372,000 10,501,544 a Index basket consisting of 80% Dow Jones EUROSTOXX 50 (exercise price $4,059.77), 20% S&P 500 Index (exercise price $1,379.26), expiration date 6/20/08, contracts ....... United States 4,372,000 11,984,195 a Index basket consisting of 80% Dow Jones EUROSTOXX 50 (exercise price $4,089.42), 20% S&P 500 Index (exercise price $1,380.37), expiration date 6/20/08, contracts ....... United States 4,372,000 13,190,324
Annual Report | 29 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) OPTIONS PURCHASED (CONTINUED) PUT OPTIONS (CONTINUED) a Index basket consisting of 70% Dow Jones EUROSTOXX 50 (exercise price $4,083.52), 30% S&P 500 Index (exercise price $1,393.76), expiration date 7/18/08, contracts ....... United States 4,350,300 $ 14,148,421 a Index basket consisting of 70% Dow Jones EUROSTOXX 50 (exercise price $4,083.52), 30% S&P 500 Index (exercise price $1,393.78), expiration date 7/18/08, contracts ....... United States 4,350,000 15,181,500 a Index basket consisting of 70% Dow Jones EUROSTOXX 50 (exercise price $3,919.03), 30% S&P 500 Index (exercise price $1,343.00), expiration date 8/15/08, contracts ....... United States 4,358,000 12,925,828 ------------------ 87,478,608 ------------------ TOTAL OPTIONS PURCHASED (COST $88,561,721) .................... 87,505,403 ------------------ ------------------ PRINCIPAL AMOUNT l ------------------ CORPORATE BONDS & NOTES 1.3% b ACE Aviation Holdings Inc., cvt., 144A, 4.25%, 6/01/35 ........ Canada 2,761,000 CAD 3,139,552 e,f,g Augsburg Re AG, zero cpn., 1/30/08 ............................ Switzerland 768,890 -- e,g Cerberus CG Investor I LLC, 12.00%, 7/31/14 ................... United States 7,903,600 6,654,646 e,g Cerberus CG Investor II LLC, 12.00%, 7/31/14 .................. United States 7,903,600 6,654,646 e,g Cerberus CG Investor III LLC, 12.00%, 7/31/14 ................. United States 3,951,800 3,327,323 e,g Cerberus FIM Investors Auto Finance LLC, 12.00%, 11/22/13 ..... United States 26,153,583 14,032,206 e,g Cerberus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 ................................................... United States 2,179,997 1,169,636 e,g Cerberus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 ................................................... United States 4,086,069 2,192,302 e,g Cerberus FIM Investors Insurance LLC, 12.00%, 11/22/13 ........ United States 19,985,213 10,722,685 e,g Cerberus FIM Investors Rescap LLC, 12.00%, 11/22/13 ........... United States 37,208,337 19,963,423 e,g DecisionOne Corp., 12.00%, 4/15/10 ............................................ United States 444,865 444,865 m FRN, 9.50%, 5/12/09 ........................................... United States 82,993 82,993 Groupe Eurotunnel SA, cvt., 3.00%, 6/28/09 ............................................. France 9,600 EUR 30,821 3.00%, 6/28/09 ............................................. France 11,935 GBP 52,171 3.00%, 7/28/10 ............................................. France 7,220,400 EUR 20,810,753 3.00%, 7/28/10 ............................................. France 4,866,820 GBP 19,098,505 6.00%, 7/28/10 ............................................. France 16,883,900 EUR 33,140,153 6.00%, 7/28/10 ............................................. France 12,517,564 GBP 33,452,539 sub. bond, T1, 3.00%, 7/28/08 .............................. France 9,600 EUR 34,324 sub. bond, T1, 3.00%, 7/28/08 .............................. France 11,935 GBP 58,100 e,g,h International Automotive Components Group NA LLC, 9.00%, 4/01/17 .................................................... United States 3,472,200 3,472,200 e,g,m Motor Coach Industries International Inc., FRN, 18.081%, 12/01/08 ................................................... United States 29,617,472 29,321,297 Trump Entertainment Resorts Inc., 8.50%, 5/20/15 .............. United States 17,141,134 13,134,394
30 | Annual Report Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT l VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) CORPORATE BONDS & NOTES (CONTINUED) g TVMAX Holdings Inc., PIK, 11.50%, 2/28/08 ............................................ United States 284,850 $ 199,395 14.00%, 2/28/08 ............................................ United States 728,545 509,981 ------------------ TOTAL CORPORATE BONDS & NOTES (COST $265,768,491) ............. 221,698,910 ------------------ CORPORATE BONDS & NOTES IN REORGANIZATION 0.2% b Calpine Corp., senior secured note, 144A, 8.50%, 7/15/10 ............................................. United States 6,435,000 6,917,625 9.875%, 12/01/11 ........................................... United States 2,265,000 2,378,250 8.75%, 7/15/13 ............................................. United States 3,395,000 3,666,600 n Dana Corp., 6.50%, 3/01/09 ............................................. United States 4,782,000 3,610,410 5.85%, 1/15/15 ............................................. United States 15,800,000 11,613,000 7.00%, 3/01/29 ............................................. United States 3,435,000 2,593,425 senior note, 7.00%, 3/15/28 ................................... United States 986,000 724,710 g,n Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ....... United States 40,000 200 ------------------ TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $30,175,927) ......................................... 31,504,220 ------------------ TOTAL LONG TERM INVESTMENTS (COST $10,410,904,675) ..................................... 14,823,906,115 ------------------ SHORT TERM INVESTMENTS 14.2% U.S. GOVERNMENT AND AGENCY SECURITIES 14.1% o FHLB, k 1/02/08 - 12/09/08 .......................................... United States 1,682,430,000 1,669,231,992 1/03/08 ..................................................... United States 315,510,000 315,510,000 1/08/08 ..................................................... United States 310,000,000 309,798,810 k U.S. Treasury Bills, 4/24/08 - 5/01/08 ........................ United States 149,500,000 147,951,277 ------------------ TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $2,440,452,436) ...................................... 2,442,492,079 ------------------ TOTAL INVESTMENTS BEFORE MONEY MARKET FUND (COST $12,851,357,111) ..................................... 17,266,398,194 ------------------ p INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES 0.1% MONEY MARKET FUND (COST $9,238,186) 0.1% q Bank of New York Institutional Cash Reserve Fund, 5.06% ....... United States 9,238,186 9,238,186 ------------------ TOTAL INVESTMENTS (COST $12,860,595,297) 100.1% ............... 17,275,636,380 SECURITIES SOLD SHORT (0.6)% .................................. (107,716,565) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (0.2)% ........................................... (34,130,356) OTHER ASSETS, LESS LIABILITIES 0.7% ........................... 126,895,980 ------------------ NET ASSETS 100.0% ............................................. $ 17,260,685,439 ------------------
Annual Report | 31 Mutual Discovery Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY SHARES VALUE - ------------------------------------------------------------------------------------------------------------------------------------ r SECURITIES SOLD SHORT (PROCEEDS $112,850,226) 0.6% COMMERCIAL BANKS 0.6% Toronto-Dominion Bank Canada 1,539,908 $ 107,716,565 ------------------
CURRENCY ABBREVIATIONS CAD - Canadian Dollar EUR - Euro GBP - British Pound SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FHLB - Federal Home Loan Bank FRN - Floating Rate Note PIK - Payment-In-Kind REIT - Real Estate Investment Trust a Non-income producing for the twelve months ended December 31, 2007. 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, 2007, the aggregate value of these securities was $17,939,706, representing 0.10% 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 0.1% of net assets. e See Note 10 regarding restricted securities. f See Note 12 regarding holdings of 5% voting securities. g Security has been deemed illiquid because it may not be able to be sold within seven days. At December 31, 2007, the aggregate value of these securities was $411,056,796, representing 2.38% of net assets. h See Note 13 regarding other considerations. i A portion or all of the security is on loan as of December 31, 2007. See Note 1(h). j See Note 1(c) regarding securities purchased on a when-issued or delayed delivery basis. k Security or a portion of the security has been segregated as collateral for securities sold short. At December 31, 2007, the value of securities and or cash pledged amounted to $87,536,985. l The principal amount is stated in U.S. dollars unless otherwise indicated. m The coupon rate shown represents the rate at period end. n See Note 9 regarding defaulted securities. o The security is traded on a discount basis with no stated coupon rate. p See Note 1(h) regarding securities on loan. q The rate shown is the annualized seven-day yield at period end. r See Note 1(g) regarding securities sold short. 32 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Discovery Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2007 Assets: Investments in securities: Cost - Unaffiliated issuers .............................................................................. $ 12,315,811,019 Cost - Controlled affiliated issuers (Note 12) ........................................................... 10,913,951 Cost - Non-controlled affiliated issuers (Note 12) ....................................................... 533,870,327 ------------------ Total cost of investments ................................................................................ $ 12,860,595,297 ================== Value - Unaffiliated issuers (includes securities loaned in the amount of $8,465,777) .................... $ 16,753,453,768 Value - Controlled affiliated issuer (Note 12) ........................................................... -- Value - Non-controlled affiliated issuers (Note 12) ...................................................... 522,182,612 ------------------ Total value of investments ............................................................................... 17,275,636,380 Cash on deposits with brokers for securities sold short .................................................... 111,013,795 Foreign currency, at value (cost $35,640,300) .............................................................. 35,631,450 Receivables: Capital shares sold ...................................................................................... 39,838,283 Dividends and interest ................................................................................... 25,012,795 Unrealized gain on forward exchange contracts (Note 7) ..................................................... 46,620,880 ------------------ Total assets ........................................................................................... 17,533,753,583 ------------------ Liabilities: Payables: Investment securities purchased .......................................................................... 5,671,497 Capital shares redeemed .................................................................................. 42,004,902 Affiliates ............................................................................................... 23,051,377 Funds advanced by custodian ................................................................................ 59,456 Securities sold short, at value (proceeds $112,850,226) .................................................... 107,716,565 Payable upon return of securities loaned ................................................................... 9,238,186 Unrealized loss on forward exchange contracts (Note 7) ..................................................... 80,751,236 Accrued expenses and other liabilities ..................................................................... 4,574,925 ------------------ Total liabilities ...................................................................................... 273,068,144 ------------------ Net assets, at value ................................................................................. $ 17,260,685,439 ================== Net assets consist of: Paid-in capital ............................................................................................ $ 12,799,410,054 Distributions in excess of net investment income ........................................................... (10,579,632) Net unrealized appreciation (depreciation) ................................................................. 4,386,214,251 Accumulated net realized gain (loss) ....................................................................... 85,640,766 ------------------ Net assets, at value ................................................................................. $ 17,260,685,439 ==================
Annual Report | The accompanying notes are an integral part of these financial statements. | 33 Mutual Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2007 Class Z: Net assets, at value ....................................................................................... $ 4,720,388,259 ================== Shares outstanding ......................................................................................... 145,481,590 ================== Net asset value and maximum offering price per share a ..................................................... $ 32.45 ================== Class A: Net assets, at value ....................................................................................... $ 8,913,527,320 ================== Shares outstanding ......................................................................................... 277,742,385 ================== Net asset value per share a ................................................................................ $ 32.09 ================== Maximum offering price per share (net asset value per share / 94.25%) ...................................... $ 34.05 ================== Class B: Net assets, at value ....................................................................................... $ 276,174,953 ================== Shares outstanding ......................................................................................... 8,779,388 ================== Net asset value and maximum offering price per share a ..................................................... $ 31.46 ================== Class C: Net assets, at value ....................................................................................... $ 3,075,593,403 ================== Shares outstanding ......................................................................................... 96,602,233 ================== Net asset value and maximum offering price per share a ..................................................... $ 31.84 ================== Class R: Net assets, at value ....................................................................................... $ 275,001,504 ================== Shares outstanding ......................................................................................... 8,633,163 ================== Net asset value and maximum offering price per share a ..................................................... $ 31.85 ==================
a Redemption price is equal to net asset value less contingent deferred sales charges, if applicable, and redemption fees retained by the Fund. 34 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2007 Investment income: Dividends: (net of foreign taxes of $27,212,366) Unaffiliated issuers ..................................................................................... $ 333,462,927 Non-controlled affiliated issuers (Note 12) .............................................................. 58,800,043 Interest: (net of foreign taxes of $3,083) Unaffiliated issuers ....................................................................................... 91,981,258 Non-controlled affiliated issuers (Note 12) ................................................................ 208,898 Income from securities loaned ................................................................................. 1,921,701 ------------------ Total investment income ................................................................................ 486,374,827 ------------------ Expenses: Management fees (Note 3a) .................................................................................. 118,295,055 Administrative fees (Note 3b) .............................................................................. 11,909,667 Distribution fees: (Note 3c) Class A .................................................................................................. 24,639,541 Class B .................................................................................................. 2,860,347 Class C .................................................................................................. 27,858,343 Class R .................................................................................................. 1,188,112 Transfer agent fees (Note 3e) .............................................................................. 19,601,483 Custodian fees (Note 4) .................................................................................... 4,042,361 Reports to shareholders .................................................................................... 1,246,826 Registration and filing fees ............................................................................... 836,634 Professional fees .......................................................................................... 824,088 Directors' fees and expenses ............................................................................... 246,017 Dividends on securities sold short ......................................................................... 702,876 Other ...................................................................................................... 498,976 ------------------ Total expenses ......................................................................................... 214,750,326 Expense reductions (Note 4) ............................................................................ (39,881) ------------------ Net expenses ......................................................................................... 214,710,445 ------------------ Net investment income .............................................................................. 271,664,382 ------------------ Realized and unrealized gains (losses): Net realized gain (loss) from: Investments Unaffiliated Issuers ................................................................................... 847,197,690 Non-controlled affiliated issuers (Note 12) ............................................................ 69,998,317 Written options .......................................................................................... 132,425 Foreign currency transactions ............................................................................ (432,645,702) Securities sold short .................................................................................... (11,817,133) Synthetic equity swaps ................................................................................... 4,677,013 ------------------ Net realized gain (loss) ............................................................................... 477,542,610 ------------------ Net change in unrealized appreciation (depreciation) on: Investments .............................................................................................. 701,583,732 Translation of assets and liabilities denominated in foreign currencies .................................. 15,433,556 ------------------ Net change in unrealized appreciation (depreciation) ................................................... 717,017,288 ------------------ Net realized and unrealized gain (loss) ....................................................................... 1,194,559,898 ------------------ Net increase (decrease) in net assets resulting from operations ............................................... $ 1,466,224,280 ==================
Annual Report | The accompanying notes are an integral part of these financial statements. | 35 Mutual Discovery Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
------------------------------------- YEAR ENDED DECEMBER 31, ------------------------------------- 2007 2006 ------------------------------------- Increase (decrease) in net assets: Operations: Net investment income .................................................................. $ 271,664,382 $ 203,044,400 Net realized gain (loss) from investments, written options, securities sold short, synthetic equity swaps, and foreign currency transactions ............................ 477,542,610 417,255,448 Net change in unrealized appreciation (depreciation) on investments, translation of assets and liabilities denominated in foreign currencies, and deferred taxes ......... 717,017,288 1,559,485,835 ------------------------------------- Net increase (decrease) in net assets resulting from operations .................... 1,466,224,280 2,179,785,683 ------------------------------------- Distributions to shareholders from: Net investment income: Class Z .............................................................................. (103,525,166) (79,515,700) Class A .............................................................................. (172,255,326) (104,704,715) Class B .............................................................................. (3,477,494) (3,195,315) Class C .............................................................................. (40,926,857) (26,440,918) Class R .............................................................................. (4,909,917) (2,764,923) Net realized gains: Class Z .............................................................................. (98,813,037) (152,564,620) Class A .............................................................................. (188,175,584) (226,734,020) Class B .............................................................................. (6,040,635) (11,010,320) Class C .............................................................................. (65,710,419) (85,287,764) Class R .............................................................................. (5,833,119) (6,547,343) ------------------------------------- Total distributions to shareholders ...................................................... (689,667,554) (698,765,638) ------------------------------------- Capital share transactions: (Note 2) Class Z .............................................................................. 546,678,826 386,789,430 Class A .............................................................................. 2,422,442,924 1,915,592,766 Class B .............................................................................. (16,203,793) 13,246,450 Class C .............................................................................. 697,882,683 551,191,840 Class R .............................................................................. 88,798,021 57,174,658 ------------------------------------- Total capital share transactions ......................................................... 3,739,598,661 2,923,995,144 ------------------------------------- Redemption fees .......................................................................... 56,157 54,889 ------------------------------------- Net increase (decrease) in net assets .............................................. 4,516,211,544 4,405,070,078 Net assets: Beginning of year ........................................................................ 12,744,473,895 8,339,403,817 ------------------------------------- End of year .............................................................................. $ 17,260,685,439 $ 12,744,473,895 ===================================== Distributions in excess of net investment income included in net assets: End of year .............................................................................. $ (10,579,632) $ (12,725,521) =====================================
36 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Fund Inc. (Series Fund) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of six separate funds. The Mutual Discovery Fund (Fund)included in this report is diversified. The financial statements of the remaining funds in the Series Fund are presented separately. The Fund offers five classes of shares: Class Z, Class A, Class B, Class C and Class R. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. 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. Annual Report | 37 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. 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. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. 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. 38 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. SECURITIES PURCHASED ON A WHEN-ISSUED OR DELAYED DELIVERY BASIS The Fund may purchase securities on a when-issued or delayed delivery basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Although the Fund will generally purchase these securities with the intention if holding the securities, it may sell the securities before the settlement date. Sufficient assets have been segregated for these securities. D. FOREIGN CURRENCY CONTRACTS 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. A foreign exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. Realized and unrealized gains and losses on these contracts are included in the Statement of Operations. The Fund may also enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates or to gain exposure to certain foreign currencies. These contracts are valued daily by the Fund and the unrealized gains or losses on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, are included in the Statement of Assets and Liabilities. 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 short 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 (margin account). Periodically, payments are made to recognize changes in value of the contract resulting from interest on the notional value of the contract, market value changes in the underlying security, and/or dividends paid by the issuer of the underlying security. The Fund recognizes a realized gain or loss when cash is received from, or paid to, the broker. Synthetic equity swaps are valued daily by the Fund and the unrealized gains or losses on the contracts (as measured by the difference between the contract amount plus or minus cash received or paid and the market value of the underlying securities) are recorded in the Statement Annual Report | 39 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) E. SYNTHETIC EQUITY SWAPS (CONTINUED) of Operations. The margin account and any net unrealized gains or losses on open synthetic equity swaps are included in the Statement of Assets and Liabilities. 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 or index 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. 40 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. SECURITIES LENDING The Fund may loan securities to certain brokers through a securities lending agent for which it receives initial cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of Fund business each day; any additional collateral required due to changes in security values is delivered to the Fund on the next business day. 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 it is the Fund's policy 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 on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. The Fund may be 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. 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 accounting principles generally accepted in the United States of America. 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. Annual Report | 41 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS (CONTINUED) 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. 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. Differences in per share distributions, by class, are generally due to differences in class specific expenses. 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. 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 Funds' 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. Currently, the Fund expects the risk of loss to be remote. 42 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK At December 31, 2007, there were 870 million shares authorized ($0.001 par value). Transactions in the Fund's shares were as follows:
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 -------------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT -------------------------------------------------------------------- CLASS Z SHARES: Shares sold ......................... 24,056,002 $ 798,541,198 17,002,780 $ 491,154,476 Shares issued in reinvestment of distributions ..................... 5,514,378 177,662,386 7,260,169 212,486,746 Shares redeemed ..................... (12,948,159) (429,524,758) (10,860,325) (316,851,792) -------------------------------------------------------------------- Net increase (decrease) ............. 16,622,221 $ 546,678,826 13,402,624 $ 386,789,430 ==================================================================== CLASS A SHARES: Shares sold ......................... 99,655,862 $ 3,253,322,579 79,025,862 $ 2,243,787,149 Shares issued in reinvestment of distributions ..................... 10,564,327 336,532,210 10,632,371 308,509,847 Shares redeemed ..................... (35,803,944) (1,167,411,865) (22,474,891) (636,704,230) -------------------------------------------------------------------- Net increase (decrease) ............. 74,416,245 $ 2,422,442,924 67,183,342 $ 1,915,592,766 ==================================================================== CLASS B SHARES: Shares sold ......................... 764,950 $ 24,471,455 1,015,295 $ 28,025,010 Shares issued in reinvestment of distributions ..................... 272,720 8,514,149 453,192 12,798,395 Shares redeemed ..................... (1,535,785) (49,189,397) (996,900) (27,576,955) -------------------------------------------------------------------- Net increase (decrease) ............. (498,115) $ (16,203,793) 471,587 $ 13,246,450 ==================================================================== CLASS C SHARES: Shares sold ......................... 27,970,919 $ 903,746,320 23,002,226 $ 647,945,552 Shares issued in reinvestment of distributions ..................... 2,910,663 91,972,642 3,385,090 97,115,493 Shares redeemed ..................... (9,203,919) (297,836,279) (6,905,349) (193,869,205) -------------------------------------------------------------------- Net increase (decrease) ............. 21,677,663 $ 697,882,683 19,481,967 $ 551,191,840 ==================================================================== CLASS R SHARES: Shares sold ......................... 3,907,963 $ 126,322,542 2,480,439 $ 69,654,257 Shares issued in reinvestment of distributions ..................... 333,189 10,535,932 318,277 9,168,194 Shares redeemed ..................... (1,480,501) (48,060,453) (770,653) (21,647,793) -------------------------------------------------------------------- Net increase (decrease) ............. 2,760,651 $ 88,798,021 2,028,063 $ 57,174,658 ====================================================================
Annual Report | 43 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 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 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 Transfer agent Services) 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 $4 billion 0.770% Over $4 billion, up to and including $7 billion 0.750% Over $7 billion, up to and including $10 billion 0.730% Over $10 billion, up to and including $13 billion 0.710% Over $13 billion, up to and including $16 billion 0.690%* In excess of $16 billion * Breakpoint added effective July 1, 2007. 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. 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 plans, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. 44 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) In addition, under the Fund's Class B, C and R compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ................................. 0.35% 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: Sales charges retained net of commissions paid to unaffiliated broker/dealers ........................ $9,133,439 Contingent deferred sales charges retained............ $ 482,481 E. TRANSFER AGENT FEES For the year ended December 31, 2007, the Fund paid transfer agent fees of $19,601,483, of which $8,836,745 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, 2007, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES The Fund has reviewed the tax positions taken on federal income tax returns, for each of the three open tax years and as of December 31, 2007 and has determined that no provision for income tax is required in the Fund's financial statements. 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, 2007, the Fund deferred realized currency losses of $1,763,159. 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, 2007 and 2006, was as follows: --------------------------- 2007 2006 --------------------------- Distributions paid from: Ordinary income ......................... $325,094,760 $250,153,080 Long term capital gain .................. 364,572,794 448,612,558 --------------------------- $689,667,554 $698,765,638 =========================== At December 31, 2007, 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 .................................. $ 12,884,106,281 ================= Unrealized appreciation .............................. $ 5,058,095,855 Unrealized depreciation .............................. (666,565,756) ----------------- Net unrealized appreciation (depreciation)............ $ 4,391,530,099 ================= Undistributed ordinary income ........................ $ 28,992,280 Undistributed long term capital gains ................ 46,469,216 ----------------- Distributable earnings ............................... $ 75,461,496 ================= Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares, pass-through entity income, bond discounts and premiums, synthetic equity swaps, 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, pass-through entity income, bond discounts and premiums, synthetic equity swaps, and certain dividends on securities sold short. 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the year ended December 31, 2007, aggregated $5,112,511,701 and $3,596,900,635, respectively. Transactions in options written during the year ended December 31, 2007, were as follows: -------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED -------------------------- Options outstanding at December 31, 2006 .............. 990 $ 112,825 Options written ................... 200 19,600 Options expired ................... (1,190) (132,425) Options exercised ................. -- -- Options closed .................... -- -- -------------------------- Options outstanding at December 31, 2007 .............. -- $ -- ========================== 46 | Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. FORWARD EXCHANGE CONTRACTS At December 31, 2007, the Fund had the following forward exchange contracts outstanding:
----------------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED UNREALIZED AMOUNT DATE GAIN LOSS ----------------------------------------------------------------- CONTRACTS TO BUY 94,290,140 Norwegian Krone .................... $ 17,050,000 2/19/08 $ 276,652 $ -- 677,621 Canadian Dollar .................... 664,745 3/26/08 17,718 -- 3,214,244 Danish Krone ....................... 629,009 4/23/08 394 -- CONTRACTS TO SELL 1,560,689,259 Norwegian Krone .................... 286,642,158 1/09/08 -- (466,058) 17,400,000 British Pound ...................... 34,484,364 1/10/08 -- (78,345) 298,622,049 British Pound ...................... 601,887,283 1/10/08 8,712,021 -- 304,073,640 Euro ............................... 420,971,928 1/14/08 -- (22,894,970) 820,655,565 Swedish Krona ...................... 128,564,110 1/15/08 1,618,531 -- 77,259,193 Singapore Dollar ................... 51,794,750 1/24/08 -- (1,903,335) 33,565,253 New Zealand Dollar ................. 25,795,568 2/08/08 187,930 -- 146,498,155 Euro ............................... 204,455,047 2/13/08 -- (9,475,162) 61,299,788 Euro ............................... 89,520,556 2/13/08 4,913 -- 462,188,667 Norwegian Krone .................... 84,432,260 2/19/08 -- (499,020) 771,200,000 Norwegian Krone .................... 142,335,737 2/19/08 620,874 -- 447,886,205 Euro ............................... 664,522,938 2/25/08 10,432,677 -- 466,044,975 Swiss Franc ........................ 417,005,576 3/07/08 4,130,635 -- 230,982,027 British Pound ...................... 467,320,721 3/10/08 9,243,937 -- 158,134,114 Euro ............................... 221,449,959 3/13/08 -- (9,491,056) 123,146,692 Euro ............................... 182,386,408 3/13/08 2,541,456 -- 26,174,934,744 Japanese Yen ....................... 232,882,879 3/19/08 -- (3,868,649) 167,884,085 Canadian Dollar .................... 167,910,049 3/26/08 -- (1,173,713) 4,304,450,000 Korean Won ......................... 4,600,000 3/27/08 -- (22,228) 260,701,036,075 Korean Won ......................... 285,673,500 3/27/08 5,726,079 -- 1,780,635,684 Danish Krone ....................... 338,572,110 4/23/08 -- (10,106,257) 184,379,206 Euro ............................... 260,160,894 4/24/08 -- (9,069,892) 300,000,000 Euro ............................... 426,309,363 5/19/08 -- (11,693,761) 10,500,000 Euro ............................... 15,619,433 5/19/08 289,323 -- 3,600,000 Euro ............................... 5,247,000 5/28/08 -- (8,790) 251,838,733 Euro ............................... 370,487,595 5/28/08 2,817,740 -- ---------------------------------- UNREALIZED GAIN (LOSS) ON FORWARD EXCHANGE CONTRACTS ............................. 46,620,880 (80,751,236) ---------------------------------- NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS ............................. $ (34,130,356) ================
8. 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 | 47 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. CREDIT RISK AND 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. Risks associated with purchasing these securities include the possibility that the bankruptcy or other restructuring process takes longer than expected, or that distributions in restructuring are less than anticipated, either or both of which may result in unfavorable consequences to the Fund. At December 31, 2007, the aggregate value of these securities was $18,541,745, representing 0.11% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 10. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. At December 31, 2007, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- ------------------------------------------------------------------------------------------------------------------------ PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ------------------------------------------------------------------------------------------------------------------------ 352,895 AboveNet Inc. .................................... 10/02/01 - 12/12/07 $17,427,178 $ 17,644,750 464 AboveNet Inc., stock grants, grant price $20.95, expiration date 9/09/13 ............... 4/17/06 - 9/08/06 -- 19,233 12,673 AboveNet Inc., wts., 9/08/08 ..................... 10/02/01 - 9/07/07 1,506,203 598,165 14,911 AboveNet Inc., wts., 9/08/10 ..................... 10/02/01 - 9/07/07 1,843,189 651,312 66,860 Augsburg Re AG ................................... 5/25/06 66,860 -- 768,890 Augsburg Re AG, zero cpn., 1/30/08 ............... 5/25/06 768,890 -- 7,903,600 Cerberus CG Investor I LLC ....................... 7/26/07 7,903,600 6,654,646 7,903,600 Cerberus CG Investor I LLC, 12.00%, 7/31/14 ....................................... 7/26/07 7,903,600 6,654,646 7,903,600 Cerberus CG Investor II LLC ...................... 7/26/07 7,903,600 6,654,646 7,903,600 Cerberus CG Investor II LLC, 12.00%, 7/31/14 ....................................... 7/26/07 7,903,600 6,654,646 3,951,800 Cerberus CG Investor III LLC ..................... 7/26/07 3,951,800 3,327,323
48| Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. RESTRICTED SECURITIES (CONTINUED)
- -------------------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - -------------------------------------------------------------------------------------------------------------------- 3,951,800 Cerberus CG Investor III LLC, 12.00%, 7/31/14 .................................... 7/26/07 $ 3,951,800 $ 3,327,323 8,723,795 Cerberus FIM Investors Auto Finance LLC ........................................ 11/20/06 8,723,795 4,680,586 26,153,583 Cerberus FIM Investors Auto Finance LLC, 12.00%, 11/22/13 ...................... 11/21/06 26,153,583 14,032,206 726,666 Cerberus FIM Investors Commercial Finance LLC ................................ 11/20/06 726,666 389,879 2,179,997 Cerberus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 .............. 11/20/06 2,179,997 1,169,636 1,362,023 Cerberus FIM Investors Commercial Mortgage LLC ............................... 11/20/06 1,362,023 730,767 4,086,069 Cerberus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 ............. 11/20/06 4,086,069 2,192,302 6,661,738 Cerberus FIM Investors Insurance LLC ........................................ 11/20/06 6,661,738 3,574,228 19,985,213 Cerberus FIM Investors Insurance LLC, 12.00%, 11/22/13 ........................... 11/20/06 19,985,213 10,722,685 12,402,778 Cerberus FIM Investors Rescap LLC ............. 11/20/06 12,402,779 6,654,474 37,208,337 Cerberus FIM Investors Rescap LLC, 12.00%, 11/22/13 ........................... 11/20/06 37,208,336 19,963,423 89,831 Dana Holding Corp., 4.00%, cvt., pfd., B .................................... 12/27/07 8,983,100 8,983,100 359,884 DecisionOne Corp. ............................. 9/28/99 - 7/18/00 273,004 -- 444,865 DecisionOne Corp., 12.00%, 4/15/10 .................................... 10/29/99 - 10/17/07 865,275 444,865 82,993 DecisionOne Corp., FRN, 9.50%, 5/12/09 .................................... 7/09/07 82,993 82,993 197,603 DecisionOne Corp., wts., 6/08/17 .............. 7/09/07 -- -- 3,850,425 Esmark Inc. ................................... 11/08/04 - 11/28/07 71,317,488 48,965,854 12,017 FE Capital Holdings Ltd. ...................... 8/29/03 - 3/22/07 428,176 7,893,554 8,758,216 Hancock Discovery LLC ......................... 3/06/97 - 7/20/98 10,913,951 -- 4,551,501 Imagine Group Holdings Ltd. ................... 8/31/04 46,614,197 52,069,171 3,204,016 International Automotive Components Group Brazil LLC ........................... 4/13/06 - 8/21/06 1,917,450 22,255,512 650,533 International Automotive Components Group Japan LLC ............................ 9/26/06 - 3/27/07 5,652,928 5,833,592 13,618,870 International Automotive Components Group LLC .................................. 1/12/06 - 10/16/06 13,625,552 14,448,259 11,533,275 International Automotive Components Group NA LLC ............................... 3/30/07 - 10/10/07 11,517,385 15,858,253 3,472,200 International Automotive Components Group NA LLC, 9.00%, 4/01/17 ............... 3/30/07 3,524,283 3,472,200 1,135,557 Kindred Healthcare Inc. ....................... 5/20/99 - 3/29/06 10,626,030 26,947,903
Annual Report | 49 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. RESTRICTED SECURITIES (CONTINUED)
- --------------------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - --------------------------------------------------------------------------------------------------------------------- Kindred Healthcare Inc., stock grants: 3,928 grant price $18.15, expiration date 7/17/11 ................................. 7/17/02 - 7/17/05 $ -- $ 21,922 1,175 grant price $19.87, expiration date 1/01/12 ................................. 1/01/03 - 1/01/06 -- 4,537 1,174 grant price $6.94, expiration date 1/01/13 ................................. 1/01/04 - 1/03/07 -- 19,713 878 grant price $19.87, expiration date 1/01/14 ................................. 1/01/05 - 1/03/07 -- 3,390 489 grant price $21.33, expiration date 1/10/15 ................................. 1/06/06 - 1/09/07 -- 1,174 246 grant price $22.08, expiration date 1/10/16 ................................. 1/09/07 -- 406 29,617,472 Motor Coach Industries International Inc., FRN, 18.081%, 12/01/08 ............... 5/27/04 - 11/30/07 29,617,472 29,321,297 5 Motor Coach Industries International Inc., wts., 5/27/09 ........................ 3/30/07 -- -- 55,890 NCB Warrant Holdings Ltd., A .................. 12/16/05 -- 3,316,056 47,160 Olympus Re Holdings Ltd. ...................... 12/19/01 4,716,000 154,458 535,890 a Owens Corning Inc., exercise price $37.50, expiration date 1/02/08, shares .................................. 12/20/06 56,082 26,795 86,280 PTV Inc., 10.00%, pfd., A ..................... 12/07/01 - 3/06/02 258,840 103,536 ------------- TOTAL RESTRICTED SECURITIES (2.07% of Net Assets) ............................ $356,525,416 =============
a The Fund also invests in unrestricted securities of the issuer, valued at $15,177,577 as of December 31, 2007. 11. UNFUNDED CAPITAL COMMITMENTS At December 31, 2007, the Fund had aggregate unfunded capital commitments to investments of $17,415,000. 12. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act 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 for the year ended December 31, 2007, were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF SHARES/ NUMBER OF SHARES/ PRINCIPAL AMOUNT PRINCIPAL AMOUNT REALIZED HELD AT GROSS GROSS HELD AT VALUE AT INVESTMENT CAPITAL NAME OF ISSUER BEGINNING OF YEAR ADDITIONS REDUCTIONS END OF YEAR END OF YEAR INCOME GAIN (LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ CONTROLLED AFFILIATES a Hancock Discovery LLC .... 8,758,216 -- -- 8,758,216 $ -- $ -- $ --
50| Annual Report Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 12. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF SHARES/ NUMBER OF SHARES/ PRINCIPAL AMOUNT PRINCIPAL AMOUNT REALIZED HELD AT GROSS GROSS HELD AT VALUE AT INVESTMENT CAPITAL NAME OF ISSUER BEGINNING OF YEAR ADDITIONS REDUCTIONS END OF YEAR END OF YEAR INCOME GAIN (LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ NON-CONTROLLED AFFILIATES Aker Yards ASA ............. -- 6,889,540 1,137,510 5,752,030 $ 65,622,571 $ 1,458,732 $ (3,758,879) Augsberg Re AG ............. 66,860 -- -- 66,860 -- -- -- Augsberg Re AG, zero cpn., 1/30/08 ................. 768,890 -- -- 768,890 -- -- -- CSM NV ..................... 4,036,926 -- -- 4,036,926 136,088,747 3,733,486 -- Dockwise Ltd. .............. -- 12,379,100 -- 12,379,100 51,252,139 -- -- Esmark Inc. ................ 7,661 3,884,320 41,556 3,850,425 48,965,854 183,864 -- Esmark Inc., 8.00%, cvt. pfd., A ................. 27,889 610 28,499 -- -- 1,705,437 353,037 Farmer Brothers Co. ........ 904,637 -- -- 904,637 20,797,605 402,563 -- FE Capital Holdings Ltd. ... 11,589 428 -- 12,017 7,893,554 -- -- Florida East Coast Industries Inc. ......... 2,247,600 -- 2,247,600 -- -- 48,638,064 73,404,159 Imagine Group Holdings Ltd. .................... 4,551,501 -- -- 4,551,501 52,069,171 -- -- International Automotive Components Group Brazil LLC ..................... 3,204,016 -- -- 3,204,016 22,255,512 -- -- International Automotive Components Group Japan LLC ..................... 561,502 89,031 -- 650,533 5,833,592 -- -- International Automotive Components Group NA LLC .................. -- 11,533,275 -- 11,533,275 --b -- -- International Automotive Components Group NA LLC, 9.00%, 4/01/17 ....... -- 3,472,200 -- 3,472,200 --b 208,898 -- Kloeckner & Co. AG ......... 506,310 2,289,954 -- 2,796,264 111,403,867 2,677,897 -- ---------------------------------------- TOTAL NON-CONTROLLED AFFILIATES ......................................................... $522,182,612 $59,008,941 $ 69,998,317 ---------------------------------------- TOTAL AFFILIATED SECURITIES (3.03% of Net Assets) ....................................... $522,182,612 $59,008,941 $ 69,998,317 ========================================
a Issuer in which the Fund owns 25% or more of the outstanding voting securities. b As of December 31, 2007, no longer an affiliate. 13. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of bondholders' steering committees, official creditors' committees, or boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. Annual Report | 51 Mutual Discovery Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 14. REGULATORY AND LITIGATION MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), 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 ("marketing support"), Franklin Resources, Inc. and certain of its subsidiaries (collectively, the "Company"), entered into settlements with certain of those regulators and governmental entities. Specifically, the Company entered into settlements with the SEC, among others, concerning market timing and marketing support. On June 6, 2007, the SEC posted for public comment the proposed plan of distribution for the market timing settlement. Once the SEC approves the final plan of distribution, disbursements of settlement monies will be made promptly to individuals who were shareholders of the designated funds during the relevant period, in accordance with the terms and conditions of the settlement and plan. In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, Company directors, fund directors, and 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.). The lawsuits relate to the industry practices referenced above. The Company and fund management 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. 15. NEW ACCOUNTING PRONOUNCEMENT In September 2006, Financial Accounting Standards Board (FASB) issued FASB Statement No. 157, "Fair Value Measurement" (SFAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Fund believes the adoption of SFAS 157 will have no material impact on its financial statements. 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 THE MUTUAL DISCOVERY FUND: We have audited the accompanying statement of assets and liabilities of the Mutual Discovery Fund (one of the Funds constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2007, 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, 2007, 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, 2007, 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 14, 2008 Annual Report | 53 Mutual Discovery 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 $411,042,010 as a long term capital gain dividend for the fiscal year ended December 31, 2007. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $399,011,943 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2007. In January 2008, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2007. 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)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $32,397,837 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, 2007. Under Section 854(b)(2) of the Code, the Fund designates 29.59% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2007. At December 31, 2007, more than 50% of the Mutual Discovery Fund's total assets were invested in securities of foreign issuers. In most instances, foreign taxes were withheld from income 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, pursuant to Section 853 of the Code. This designation will allow shareholders of record on December 20, 2007, 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 table provides a detailed analysis of foreign tax paid, foreign source income, and foreign qualified dividends as designated by the Fund, to Class A, Class B, Class C, Class Z and Class R shareholders of record. RECORD DATE: 12/20/2007 - ------------------------------------------------------------------------------- FOREIGN TAX FOREIGN FOREIGN PAID SOURCE INCOME QUALIFIED DIVIDENDS CLASS PER SHARE PER SHARE PER SHARE - ------------------------------------------------------------------------------- Class A ................... $ 0.0526 $ 0.4131 $ 0.3159 Class B ................... $ 0.0526 $ 0.2616 $ 0.2003 Class C ................... $ 0.0526 $ 0.2843 $ 0.2176 Class Z ................... $ 0.0526 $ 0.4705 $ 0.3601 Class R ................... $ 0.0526 $ 0.3811 $ 0.2916 54 | Annual Report Mutual Discovery Fund TAX DESIGNATION (UNAUDITED) (CONTINUED) 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 2008, shareholders will receive Form 1099-DIV which will include their share of taxes paid and foreign source income distributed during the calendar year 2007. 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 2007 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 brackets). 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 | 55 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 None c/o Franklin Mutual Advisers, LLC 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, Stern School of Business, New York University; editor and author of numerous financial publications; financial consultant; a director to numerous financial publishing organizations; and FORMERLY, Vice Director, Salomon Center, Stern School of Business, New York University. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE BATES (1958) Director Since 1994 7 SLM Corporation (Sallie Mae) c/o Franklin Mutual Advisers, LLC and Allied Capital 101 John F. Kennedy Parkway Corporation (financial Short Hills, NJ 07078-2789 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 14 Franklin Templeton Emerging c/o Franklin Mutual Advisers, LLC Markets Debt Opportunities 101 John F. Kennedy Parkway 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); and FORMERLY, Chairman, Fiduciary Trust International Funds; Executive Vice President, L.F Rothschild Fund Management, Inc.; President and Director, Merit Mutual Funds; President, Underwriting Division and Director, National Securities & Research Corporation; Governor, Investment Company Institute and Chairman, ICI Public Information Committee. - ------------------------------------------------------------------------------------------------------------------------------------ BRUCE A. MACPHERSON (1930) Director Since 1974 7 None c/o Franklin Mutual Advisers, LLC 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (1930) Director Since 1998 14 None c/o Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------ ROBERT E. WADE (1946) Director and Director 34 El Oro and Exploration Co., c/o Franklin Mutual Advisers, LLC Chairman since 1991 p.l.c. (investments) and ARC 101 John F. Kennedy Parkway of the Board and Chairman Wireless Solutions, Inc. Short Hills, NJ 07078-2789 of the Board (wireless components and since 2005 network products). 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 - ------------------------------------------------------------------------------------------------------------------------------------ **GREGORY E. JOHNSON (1961) Director Since April 92 None One Franklin Parkway 2007 San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, President and Chief Executive Officer, Franklin Resources, Inc.; President, Templeton Worldwide, Inc.; Director, Templeton Asset Management Ltd.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 33 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ **PETER A. LANGERMAN (1955) Director, Director 7 None c/o Franklin Mutual Advisers, LLC President and since April 101 John F. Kennedy Parkway Chief Executive 2007 and Short Hills, NJ 07078-2702 Officer - President and Investment Chief Management Executive Officer - Investment Management since 2005 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; officer and/or director, as the case may be, of three of the investment companies in Franklin Templeton Investments; and FORMERLY, Director, New Jersey's Division of Investment. - ------------------------------------------------------------------------------------------------------------------------------------ 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 | 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 - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (1952) Chief Chief Not Applicable Not Applicable One Franklin Parkway Compliance Compliance San Mateo, CA 94403-1906 Officer and Officer since Vice President 2004 and Vice - AML Compliance President - AML Compliance since 2006 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL J. EMBLER (1964) Senior Vice Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President and Short Hills, NJ 07078-2789 Chief Investment Officer 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. - ------------------------------------------------------------------------------------------------------------------------------------ JIMMY D. GAMBILL (1947) Senior Vice Since 2002 Not Applicable Not Applicable 500 East Broward Blvd. President and Suite 2100 Chief Executive Fort Lauderdale, FL 33394-3091 Officer - Finance and Administration PRINCIPAL OCCUPATION DURING PAST 5 YEARS: President, Franklin Templeton Services, LLC; Senior Vice President, Templeton Worldwide, Inc.; and officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ STEVEN J. GRAY (1955) Secretary Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Templeton Investments; Secretary, Franklin Advisory Services, LLC, Franklin Mutual Advisers, LLC and Franklin Templeton Distributors, Inc.; and officer of 41 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ GREGORY R. SEWARD (1956) Treasurer Since 2005 Not Applicable Not Applicable 500 East Broward Blvd. Suite 2100 Fort Lauderdale, FL 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 18 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPMorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ CRAIG S. TYLE (1960) Vice President Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 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). - ------------------------------------------------------------------------------------------------------------------------------------ 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 some of the other subsidiaries of Franklin Resources, Inc. and of 46 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 manager or affiliated investment managers. ** Gregory E. Johnson is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer and director of Franklin Resources, Inc., which is the parent company of the Fund's investment manager and distributor. Peter A. Langerman is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, which is the Fund's investment manager. Note 1: Officer information is current as of the date of this report. It is possible that after this date, information about officers may change. Note 2: Prior to December 31, 2007, William J. Lippman, Leonard Rubin and Anne M. Tatlock ceased to be directors of the Fund. THE FUND'S BOARD 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 | 59 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 1-954/527-7678 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. 60 | 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 FUNDS INTERNATIONAL Mutual European Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund 1 GLOBAL Mutual Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund 1 Templeton Growth Fund Templeton World Fund GROWTH Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Growth Opportunities Fund 2 Franklin Small Cap Growth Fund II 3 Franklin Small-Mid Cap Growth Fund VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund 1 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 1 Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Focused Core Equity Fund Franklin Growth Fund Franklin Rising Dividends Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Global Real Estate 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(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 5 Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund 5 Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 5 Templeton Global Bond Fund Templeton Income Fund Templeton International Bond Fund TAX-FREE INCOME 6 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California 8 Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts 7 Michigan 7 Minnesota 7 Missouri New Jersey New York 8 North Carolina Ohio 7 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 9 1. The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. 2. Effective 11/1/07, Franklin Aggressive Growth Fund changed its name to Franklin Growth Opportunities Fund. The fund's investment goal and strategy remained the same. 3. The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 4. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5. An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 6. For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. 7. The fund invests primarily in insured municipal securities. 8. 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). 9. The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 12/07 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 A2007 02/08 Contents SHAREHOLDER LETTER ........................................................ 1 ANNUAL REPORT Mutual Financial Services Fund ............................................ 4 Performance Summary ....................................................... 9 Your Fund's Expenses ...................................................... 14 Financial Highlights and Statement of Investments ......................... 16 Financial Statements ...................................................... 24 Notes to Financial Statements ............................................. 28 Report of Independent Registered Public Accounting Firm ................... 41 Tax Designation ........................................................... 42 Board Members and Officers ................................................ 44 Shareholder Information ................................................... 48 - -------------------------------------------------------------------------------- Shareholder Letter - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------------------- CLASS Z 12/31/07 - ------------------------------------------------------- 1-Year -8.71% - ------------------------------------------------------- 5-Year +13.44% - ------------------------------------------------------- 10-Year +12.05% - ------------------------------------------------------- Dear Shareholder: We are pleased to bring you the annual report for Mutual Financial Services Fund. Although Mutual Financial Services Fund - Class Z declined 8.71% for the year ended December 31, 2007, this compared favorably with the Standard and Poor's 500 (S&P 500) Financials Index, which fell 18.63% during the same period. 1 While our distinctive, disciplined investment style contributed to the Fund's continued relative outperformance, we were not completely immune from the financial services sector's significant underperformance relative to the broader market. The year under review was a difficult environment for financial services-specific investing, as a number of factors affected these stocks as well as the economy in general. These factors included: (1) credit problems centered around sub-prime mortgage lending; (2) declining home values in the U.S.; (3) a nearly complete evaporation of the corporate leveraged lending that fueled the leveraged buyout boom of the past several years; (4) a sharp increase in oil, mining and agricultural commodity prices; and (5) a sharp decline in the value of the U.S. dollar relative to most other currencies. 1. Source: Standard & Poor's Micropal. The S&P 500 Financials Index is market value weighted and includes all the financial stocks in the S&P 500 Index. 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. - -------------------------------------------------------------------------------- eDELIVERY DETAILS Log in at franklintempleton.com and click on eDelivery. Shareholders who are registered at franklintempleton.com can receive these reports via email. Not all accounts are eligible for eDelivery. - ----------------------------------------------------- NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE - ----------------------------------------------------- Not part of the annual report | 1 The positive factors impacting the Fund's 2007 results centered around our philosophy of investing with capital preservation as a top priority. Successful investing is at least as much about curtailing losses as it is about participating in the upside, and while we did not avoid a loss this year, we are content in knowing that our approach helped minimize losses over the Fund's fiscal year. The Fund has also served our investors well over the longer term, as Class Z shares delivered a 24.76% cumulative total return over the past three years and easily outpaced the S&P 500 Financials Index, which rose just 3.27% over the same time. 1 Specifically, our enduring strategy of investing in specialty insurance companies and attractively valued securities exchanges, especially those in Europe, continued to perform well during 2007. The past year was one in which many financial stocks with apparently inexpensive valuations became even cheaper, and those with rich valuations outperformed. This presented a problem to many value investors. We chose to navigate this course by investing in stocks that offered solid business models and balance sheets with less relative risk. The Fund's U.S. exposure continued to wane, as has been the trend for several years. We divested from many U.S. companies in 2005 and 2006, particularly those that seemed directly exposed to the risks of a U.S. housing slowdown. We took further steps in 2007 to eliminate exposure to companies where we saw significant downside potential. Also, we never allocated a significant amount of capital to U.S. investment banks, where four years of retained earnings can be (and sometimes are) wiped out within a calendar quarter or two of write-downs. Many of our investments in Europe, while outperforming their U.S. peers, still detracted from the Fund's absolute performance in 2007 in the latter half of the year. Although many of our investments in European banks had no direct and little secondary exposure to increasingly risky U.S. assets, the widespread sell-off within the financial services sector, sparked primarily by the subprime mortgage lending crisis, negatively impacted funding markets and dragged down stock prices globally. We had projected that these stocks would have performed even better than they did amid a U.S.-driven downturn but viewed the valuations at which many of these companies were trading at year-end as having substantially less risk than their underlying valuations implied. Fear and volatility can breed opportunity for patient investors. We are happy to take advantage of market stresses to buy great companies cheaply, and the extended credit crisis in particular continues to create such opportunities. We have no crystal ball telling us precisely when the U.S. housing market will turn positive, where oil prices will be a year from now, or what actions the 2 | Not part of the annual report Federal Reserve Board will take. However, we believe that if we stick to our discipline of buying good businesses at cheap valuations, we should reach our goal of limiting our downside risk while generating consistent returns over the long term. In the enclosed annual report for Mutual Financial Services Fund, the portfolio manager discusses market conditions, investment management decisions and Fund performance during the period under review. You will also find performance data and financial information. Please remember that all securities markets fluctuate, as do mutual fund share prices. If you would like more frequent updates, FRANKLINTEMPLETON.COM provides daily prices, monthly performance figures, portfolio holdings and other information. You can also access your account, buy and sell shares, read timely articles, and find helpful financial planning tools. We hope you will take advantage of these online services. As always, we thank you for your trust and support and extend our best wishes for a happy, healthy and prosperous 2008. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC /s/ Michael J. Embler Michael J. Embler Senior Vice President and Chief Investment Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF DECEMBER 31, 2007. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE. Not part of the annual report | 3 Annual Report Mutual Financial Services Fund YOUR FUND'S GOALS AND MAIN INVESTMENTS: Mutual Financial Services Fund seeks capital appreciation, with income as a secondary goal, by investing 80% of its net assets in securities of financial services companies that the manager believes are available at market prices less than their intrinsic value. The Fund concentrates its investments in securities of issuers such as banks, savings and loan organizations, credit card companies, brokerage firms, finance companies, subprime lending institutions, investment advisors, investment companies and insurance companies. - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- This annual report for Mutual Financial Services Fund covers the fiscal year ended December 31, 2007. PERFORMANCE OVERVIEW Mutual Financial Services Fund - Class Z had a cumulative total return of -8.71% for the 12 months ended December 31, 2007. The Fund - Class Z underperformed its broad benchmark, the Standard & Poor's 500 (S&P 500) Index, which returned +5.49% for the same period, but outperformed its narrow benchmark, the S&P 500 Financials Index, which returned -18.63%. 1 You can find the Fund's long-term performance data in the Performance Summary beginning on page 9. ECONOMIC AND MARKET OVERVIEW In spite of elevated energy prices and widespread fears of contagion from the deteriorating U.S. housing situation, the global economy remained resilient in 2007. Consumer and corporate demand strength, particularly in China and other developing economies, generally favorable employment and accommodative monetary policies continued to underpin the current expansionary period that began in 2002. 1. Source: Standard & Poor's Micropal. The S&P 500 Index 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 Index is one of the most widely used benchmarks of U.S. equity performance. The S&P 500 Financials Index is market value weighted and includes all the financial stocks in the S&P 500 Index. 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 20. 4 | Annual Report These factors also contributed to the strength of global equity markets during 2007. However, concerns about slower growth and declining asset quality surfaced in the first quarter. These were initially centered on the U.S. subprime mortgage market but spread in August to global capital markets. Difficulties in assessing risk and the value of collateral in the structured finance industry contributed to declining risk appetite among lenders and investors. The private equity industry, which relies on the availability of cheap credit, played a pivotal role in several large and high-profile acquisitions and helped boost merger and acquisition activity in the first half of the year. This was an important driver of equity performance, but as liquidity dried up in the second half of the year, significantly slower money flows from private equity weighed on market performance. However, global merger and acquisition activity still reached record levels. The staggering $4.5 trillion of deals announced in 2007 eclipsed the previous record from 2006 by 24%. 2 To alleviate the credit crunch and restore investor confidence, the world's major central banks infused capital into the system, and the U.S. Federal Reserve Board reduced its target interest rate by a full percentage point. However, credit and equity markets continued to face headwinds as write-downs and losses from subprime mortgage financing affected many large financial institutions toward the end of the year, and equity prices remained volatile. For the year, however, global and non-U.S. equity markets registered the fifth consecutive year of double-digit total returns, making this an exceptionally strong period for investors in global equities. Broad-based stock performance by European and Asian shares at least doubled that of U.S. stocks, while emerging market equity returns more than tripled those in developed markets. Led by the BRIC countries, Brazil, Russia, India and China, emerging market economies continued to grow at accelerated rates, supporting elevated prices for oil and other commodities. At the same time, investment inflows from developed economies continued to underpin equity prices in emerging markets. In addition, U.S. dollar weakness versus the currencies of many major trading partners enhanced equity returns for U.S.-based investors holding stocks denominated in these currencies. - -------------------------------------------------------------------------------- WHAT IS RETURN ON EQUITY? - -------------------------------------------------------------------------------- RETURN ON EQUITY IS AN AMOUNT, EXPRESSED AS A PERCENTAGE, EARNED ON A COMPANY'S COMMON STOCK INVESTMENT FOR A GIVEN PERIOD. IT IS CALCULATED BY DIVIDING COMMON STOCK EQUITY (NET WORTH) AT THE BEGINNING OF THE ACCOUNTING PERIOD INTO NET INCOME FOR THE PERIOD AFTER PREFERRED STOCK DIVIDENDS BUT BEFORE COMMON STOCK DIVIDENDS. RETURN ON EQUITY TELLS COMMON SHAREHOLDERS HOW EFFECTUALLY THEIR MONEY IS BEING EMPLOYED. COMPARING PERCENTAGES FOR CURRENT AND PRIOR PERIODS ALSO REVEALS TRENDS, AND COMPARISON WITH INDUSTRY COMPOSITES REVEALS HOW WELL A COMPANY IS HOLDING ITS OWN AGAINST ITS COMPETITORS. - -------------------------------------------------------------------------------- 2. Source: "For Deal Makers, Tale of Two Halves," THE WALL STREET JOURNAL, 1/2/08. Annual Report | 5 GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/07 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] U.S. 28.2% Germany 12.8% Norway 6.9% Sweden 6.4% Belgium 5.6% France 4.9% Switzerland 4.4% U.K. 4.2% Italy 3.9% Japan 3.3% Greece 3.1% Denmark 2.5% Other 9.7% Short-Term Investments & Other Net Assets 4.1% INVESTMENT STRATEGY We strive to provide investors with superior risk-adjusted returns over time through our distinctive, value investment style, which includes investments in undervalued common stocks, distressed debt and risk arbitrage. Rigorous fundamental analysis drives our investment process. We attempt to determine each investment's intrinsic value as well as the price at which we would be willing to commit shareholder funds. While valuation remains our key consideration, we utilize numerous fundamental factors such as return on equity, financial leverage and long-term earnings power. We also consider factors such as management quality and competitive position. As always, our approach to successful investing is as much about assessing risk and containing losses as it is about achieving profits. In addition, we will generally seek to hedge the Fund's currency exposure when we deem it advantageous for our shareholders. MANAGER'S DISCUSSION Among the Fund's top contributors to performance in 2007 were Deutsche Boerse, OMX and Hellenic Exchanges. The Fund's investment in Deutsche Boerse rose nearly 99% in local currency as cash equity trading volumes surged 63%, the company resumed its buyback of shares, and investors appeared to recognize hidden potential embedded in the business. The exchange industry grew as such quasi-monopolies benefited from higher volumes in different product classes and generally beneficial pricing trends. Deutsche Boerse also tapped into the structural potential of its business by announcing future cost cutting of over 100 millioneuros per year to enhance profitability. We believed future exchange consolidation prospects placed the company in a good position for ongoing shareholder returns. Therefore, we increased our holdings in Deutsche Boerse throughout 2007 when we found the price attractive. OMX, a company owning securities exchanges in the Nordic and Baltic regions of Europe, appreciated 115% in local currency as its acquisition by the NASDAQ-Borse Dubai group closed successfully. The cash-generative nature of exchanges has made them a Fund staple for many years, and OMX experienced many of the same positive trends that other exchanges saw in 2007. Seeing the fundamental attractions of the business, NASDAQ-Borse Dubai acquired OMX to create a transatlantic business and to leverage off of OMX's undervalued technology business. 6 | Annual Report Our investment in Hellenic Exchanges, the Greek stock exchange, appreciated 81% in local currency during 2007. The positive factors affecting securities trading were felt in markets both large and small, as the Greek stock exchange possesses a highly profitable monopoly in Greek securities and in 2007 earned an EBITDA (earnings before interest, tax, depreciation and amortization) margin in excess of 70% with potential for further cost containment. In addition to robust growth in trading volumes, Hellenic Exchanges has maintained a generous capital return program and has continually reduced its operating costs, cutting them by almost 20% since 2004. We believe many of the attractive qualities found in other European exchanges are present in Hellenic Exchanges, and it could become a sought-after acquisition target by another exchange or financial groups as the pan-European consolidation theme proceeds. In a difficult year for the financial services sector as a whole, the Fund also owned several stocks that detracted from performance. Among the leading detractors were Belgium-based Fortis, whose operations are focused in banking, insurance and investment management; Banca Popolare, an Italian financial services provider; and Eurocastle, a Guernsey-based company that operates in the German real estate industry. Fortis declined 30% in local currency as the company raised a significant amount of capital to fund its acquisition of ABN Amro's Dutch retail banking, asset management and private banking units. Fortis was part of a consortium with Royal Bank of Scotland and Banco Santander, which together acquired these businesses and by year-end had completed the largest bank acquisition in European history. Fortis' stock price also came under pressure after the company announced weak third quarter 2007 operating results for its banking and insurance businesses. The Fund's shares of Banca Popolare declined 34% in local currency during 2007. As global economic fears became more evident in the markets, Banca Popolare suffered as investors became hesitant about the bank's growth prospects for the next few years. Also, concerns developed over the potential integration of its $10 billion BPI (Banca Popolare Italiana) acquisition and lost revenue stemming from the company's Banca Italease subsidiary. At period-end, we believed Banca Popolare should be able to weather an economic downturn due to its regional focus and potential future earnings growth from merger integration. PORTFOLIO BREAKDOWN Based on Total Net Assets as of 12/31/07 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] Commercial Banks 25.4% Diversified Financial Services 18.1% Insurance 17.5% Real Estate 12.3% Capital Markets 9.4% Thrifts & Mortgage Finance 6.0% Commercial Services & Supplies 2.4% Media 1.5% Consumer Finance 1.3% Corporate Bonds 1.1% Other 5.0% Annual Report | 7 TOP 10 HOLDINGS 12/31/07 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- Fortis 4.6% DIVERSIFIED FINANCIAL SERVICES, BELGIUM - -------------------------------------------------------------------------------- Deutsche Boerse AG 3.7% DIVERSIFIED FINANCIAL SERVICES, GERMANY - -------------------------------------------------------------------------------- Acta Holding ASA 3.0% CAPITAL MARKETS, NORWAY - -------------------------------------------------------------------------------- Oslo Bors Holding ASA 3.0% DIVERSIFIED FINANCIAL SERVICES, NORWAY - -------------------------------------------------------------------------------- BNP Paribas SA 2.9% COMMERCIAL BANKS, FRANCE - -------------------------------------------------------------------------------- Danske Bank AS 2.5% COMMERCIAL BANKS, DENMARK - -------------------------------------------------------------------------------- White Mountains Insurance Group Ltd. 2.4% INSURANCE, U.S. - -------------------------------------------------------------------------------- Banque Cantonale Vaudoise 2.4% COMMERCIAL BANKS, SWITZERLAND - -------------------------------------------------------------------------------- D. Carnegie & Co. AB 2.2% CAPITAL MARKETS, SWEDEN - -------------------------------------------------------------------------------- Hellenic Exchanges SA Holding 2.1% DIVERSIFIED FINANCIAL SERVICES, GREECE - -------------------------------------------------------------------------------- Our investment in Eurocastle shares declined 53% in local currency. Investors became concerned with the functioning of global funding markets as well as with global economic weakening and its possible effects on the recovery in German office properties. In our analysis, Eurocastle stock traded at a meaningful discount to its liquidation value at period-end, which indicated the presence of significant value. Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during 2007, the Fund benefited to the extent it was not fully hedged. Thank you for your continued participation in Mutual Financial Services Fund. We look forward to serving your future investment needs. [PHOTO OMITTED] /s/ Charles M. Lahr Charles M. Lahr, CFA Portfolio Manager Mutual Financial Services Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2007, 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 INVESTMENT MANAGER MAKES NO REPRESENTATION OR WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR INVESTMENT MANAGEMENT PHILOSOPHY. - -------------------------------------------------------------------------------- CHARLES LAHR has been a portfolio manager for Mutual Financial Services Fund since 2004. He is also portfolio manager for Mutual Discovery Fund. He joined Franklin Templeton Investments in 2003. Previously, he was a senior analyst for the State of Wisconsin Investment Board and also worked for U.S. Bancorp and the Principal Financial Group. - -------------------------------------------------------------------------------- 8 | ANNUAL REPORT Performance Summary as of 12/31/07 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: TEFAX) CHANGE 12/31/07 12/31/06 - -------------------------------------------------------------------------------------- Net Asset Value (NAV) -$3.91 $18.68 $22.59 - -------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - -------------------------------------------------------------------------------------- Dividend Income $0.6144 - -------------------------------------------------------------------------------------- Short-Term Capital Gain $0.1339 - -------------------------------------------------------------------------------------- Long-Term Capital Gain $1.2614 - -------------------------------------------------------------------------------------- TOTAL $2.0097 - -------------------------------------------------------------------------------------- CLASS A (SYMBOL: TFSIX) CHANGE 12/31/07 12/31/06 - -------------------------------------------------------------------------------------- Net Asset Value (NAV) -$3.90 $18.70 $22.60 - -------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - -------------------------------------------------------------------------------------- Dividend Income $0.5418 - -------------------------------------------------------------------------------------- Short-Term Capital Gain $0.1339 - -------------------------------------------------------------------------------------- Long-Term Capital Gain $1.2614 - -------------------------------------------------------------------------------------- TOTAL $1.9371 - -------------------------------------------------------------------------------------- CLASS B (SYMBOL: TBFSX) CHANGE 12/31/07 12/31/06 - -------------------------------------------------------------------------------------- Net Asset Value (NAV) -$3.82 $18.26 $22.08 - -------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - -------------------------------------------------------------------------------------- Dividend Income $0.3594 - -------------------------------------------------------------------------------------- Short-Term Capital Gain $0.1339 - -------------------------------------------------------------------------------------- Long-Term Capital Gain $1.2614 - -------------------------------------------------------------------------------------- TOTAL $1.7547 - -------------------------------------------------------------------------------------- CLASS C (SYMBOL: TMFSX) CHANGE 12/31/07 12/31/06 - -------------------------------------------------------------------------------------- Net Asset Value (NAV) -$3.87 $18.59 $22.46 - -------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - -------------------------------------------------------------------------------------- Dividend Income $0.3757 - -------------------------------------------------------------------------------------- Short-Term Capital Gain $0.1339 - -------------------------------------------------------------------------------------- Long-Term Capital Gain $1.2614 - -------------------------------------------------------------------------------------- TOTAL $1.7710 - --------------------------------------------------------------------------------------
Annual Report | 9 Performance Summary (CONTINUED) PERFORMANCE 1 CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z: NO SALES CHARGES; 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. THE FUND MAY CHARGE A 2% FEE ON REDEMPTIONS MADE WITHIN SEVEN DAYS OF PURCHASE.
- ------------------------------------------------------------------------------------------------ CLASS Z 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------ Cumulative Total Return 2 -8.71% +87.85% +212.08% - ------------------------------------------------------------------------------------------------ Average Annual Total Return 3 -8.71% +13.44% +12.05% - ------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $ 9,129 $ 18,785 $ 31,208 - ------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 1.08% - ------------------------------------------------------------------------------------------------ CLASS A 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------ Cumulative Total Return 2 -8.99% +84.82% +202.17% - ------------------------------------------------------------------------------------------------ Average Annual Total Return 3 -14.22% +11.74% +11.03% - ------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $ 8,578 $ 17,422 $ 28,478 - ------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 1.39% - ------------------------------------------------------------------------------------------------ CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - ------------------------------------------------------------------------------------------------ Cumulative Total Return 2 -9.58% +78.77% +168.41% - ------------------------------------------------------------------------------------------------ Average Annual Total Return 3 -12.89% +12.07% +11.59% - ------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $ 8,711 $ 17,677 $ 26,841 - ------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 2.08% - ------------------------------------------------------------------------------------------------ CLASS C 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------ Cumulative Total Return 2 -9.60% +78.66% +182.94% - ------------------------------------------------------------------------------------------------ Average Annual Total Return 3 -10.43% +12.31% +10.96% - ------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $ 8,957 $ 17,866 $ 28,294 - ------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 2.08% - ------------------------------------------------------------------------------------------------
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 indexes include reinvestment of any income or distributions. They differ from the Fund in composition and do not pay management fees or expenses. One cannot invest directly in an index. CLASS Z (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY LINE GRAPH IN THE PRINTED MATERIAL.] Mutual Financial S&P 500 Financials Date Services Fund S&P 500 6 Index 6 - ------------- ---------------- --------- ------------------- 1/1/1998 $10,000 $10,000 $10,000 1/31/1998 $10,098 $10,111 $ 9,715 2/28/1998 $11,091 $10,840 $10,628 3/31/1998 $11,735 $11,395 $11,234 4/30/1998 $12,044 $11,510 $11,420 5/31/1998 $11,783 $11,312 $11,145 6/30/1998 $11,645 $11,771 $11,612 7/31/1998 $11,609 $11,646 $11,614 8/31/1998 $ 9,381 $ 9,962 $ 8,936 9/30/1998 $ 9,578 $10,600 $ 9,115 10/31/1998 $ 9,997 $11,463 $10,221 11/30/1998 $10,441 $12,157 $10,918 12/31/1998 $10,708 $12,858 $11,142 1/31/1999 $10,675 $13,396 $11,379 2/28/1999 $10,458 $12,979 $11,531 3/31/1999 $10,717 $13,498 $11,972 4/30/1999 $11,399 $14,021 $12,784 5/31/1999 $11,541 $13,690 $12,073 6/30/1999 $12,066 $14,450 $12,573 7/31/1999 $11,941 $13,999 $11,792 8/31/1999 $11,380 $13,929 $11,250 9/30/1999 $11,238 $13,548 $10,666 10/31/1999 $12,058 $14,405 $12,446 11/30/1999 $11,807 $14,698 $11,835 12/31/1999 $11,211 $15,563 $11,601 1/31/2000 $10,515 $14,781 $11,234 2/29/2000 $ 9,639 $14,502 $10,017 3/31/2000 $11,014 $15,920 $11,876 4/30/2000 $10,928 $15,441 $11,503 5/31/2000 $11,624 $15,124 $12,274 6/30/2000 $11,329 $15,497 $11,530 7/31/2000 $12,059 $15,255 $12,722 8/31/2000 $12,982 $16,203 $13,943 9/30/2000 $13,852 $15,347 $14,274 10/31/2000 $13,738 $15,282 $14,212 11/30/2000 $13,333 $14,078 $13,374 12/31/2000 $14,832 $14,146 $14,582 1/31/2001 $15,022 $14,648 $14,542 2/28/2001 $15,068 $13,313 $13,587 3/31/2001 $15,168 $12,469 $13,178 4/30/2001 $15,804 $13,438 $13,668 5/31/2001 $16,495 $13,528 $14,219 6/30/2001 $16,917 $13,199 $14,214 7/31/2001 $17,130 $13,069 $13,984 8/31/2001 $17,001 $12,251 $13,132 9/30/2001 $15,658 $11,262 $12,357 10/31/2001 $15,501 $11,476 $12,127 11/30/2001 $16,177 $12,357 $12,993 12/31/2001 $16,658 $12,465 $13,277 1/31/2002 $16,978 $12,283 $13,070 2/28/2002 $17,088 $12,046 $12,880 3/31/2002 $18,070 $12,499 $13,736 4/30/2002 $18,610 $11,741 $13,370 5/31/2002 $18,750 $11,655 $13,347 6/30/2002 $18,044 $10,825 $12,714 7/31/2002 $17,153 $ 9,981 $11,705 8/31/2002 $17,501 $10,046 $11,945 9/30/2002 $16,077 $ 8,955 $10,548 10/31/2002 $16,508 $ 9,743 $11,503 11/30/2002 $16,671 $10,316 $11,975 12/31/2002 $16,613 $ 9,710 $11,334 1/31/2003 $16,425 $ 9,456 $11,145 2/28/2003 $16,081 $ 9,314 $10,796 3/31/2003 $16,227 $ 9,404 $10,754 4/30/2003 $17,344 $10,179 $12,071 5/31/2003 $18,325 $10,715 $12,709 6/30/2003 $18,388 $10,852 $12,741 7/31/2003 $18,952 $11,043 $13,326 8/31/2003 $19,276 $11,259 $13,192 9/30/2003 $19,234 $11,139 $13,280 10/31/2003 $20,384 $11,769 $14,194 11/30/2003 $20,802 $11,873 $14,155 12/31/2003 $21,635 $12,495 $14,851 1/31/2004 $22,315 $12,725 $15,324 2/29/2004 $22,639 $12,902 $15,730 3/31/2004 $22,725 $12,707 $15,575 4/30/2004 $21,873 $12,508 $14,856 5/31/2004 $22,002 $12,679 $15,129 6/30/2004 $22,284 $12,926 $15,204 7/31/2004 $21,988 $12,498 $14,892 8/31/2004 $22,273 $12,549 $15,393 9/30/2004 $22,922 $12,684 $15,261 10/31/2004 $22,966 $12,878 $15,339 11/30/2004 $24,251 $13,399 $15,793 12/31/2004 $25,015 $13,855 $16,468 1/31/2005 $24,648 $13,518 $16,112 2/28/2005 $25,089 $13,802 $16,027 3/31/2005 $24,648 $13,558 $15,418 4/30/2005 $24,318 $13,300 $15,434 5/31/2005 $25,052 $13,724 $15,857 6/30/2005 $25,708 $13,743 $16,085 7/31/2005 $26,813 $14,254 $16,338 8/31/2005 $26,474 $14,124 $16,053 9/30/2005 $26,574 $14,239 $16,201 10/31/2005 $26,210 $14,001 $16,713 11/30/2005 $27,504 $14,531 $17,496 12/31/2005 $28,551 $14,536 $17,535 1/31/2006 $29,768 $14,921 $17,692 2/28/2006 $30,799 $14,961 $18,050 3/31/2006 $31,593 $15,147 $18,103 4/30/2006 $31,950 $15,351 $18,887 5/31/2006 $30,429 $14,909 $18,192 6/30/2006 $30,068 $14,929 $18,080 7/31/2006 $30,244 $15,021 $18,528 8/31/2006 $31,081 $15,379 $18,743 9/30/2006 $31,823 $15,775 $19,524 10/31/2006 $32,498 $16,289 $19,998 11/30/2006 $32,809 $16,599 $20,123 12/31/2006 $34,185 $16,832 $20,900 1/31/2007 $35,320 $17,086 $21,085 2/28/2007 $35,078 $16,752 $20,456 3/31/2007 $35,396 $16,939 $20,305 4/30/2007 $36,379 $17,690 $21,145 5/31/2007 $37,438 $18,307 $21,632 6/30/2007 $36,114 $18,003 $20,735 7/31/2007 $34,027 $17,445 $19,118 8/31/2007 $33,408 $17,706 $19,413 9/30/2007 $33,114 $18,368 $19,852 10/31/2007 $32,991 $18,661 $19,493 11/30/2007 $31,445 $17,880 $17,984 12/31/2007 $31,208 $17,756 $17,006 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS Z 12/31/07 - -------------------------------------------------------------------------------- 1-Year -8.71% - -------------------------------------------------------------------------------- 5-Year +13.44% - -------------------------------------------------------------------------------- 10-Year +12.05% - -------------------------------------------------------------------------------- CLASS A (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY LINE GRAPH IN THE PRINTED MATERIAL.] Mutual Financial S&P 500 Financials Date Services Fund S&P 500 6 Index 6 - ------------- ---------------- --------- ------------------- 1/1/1998 $ 9,424 $10,000 $10,000 1/31/1998 $ 9,517 $10,111 $ 9,715 2/28/1998 $10,453 $10,840 $10,628 3/31/1998 $11,067 $11,395 $11,234 4/30/1998 $11,351 $11,510 $11,420 5/31/1998 $11,105 $11,312 $11,145 6/30/1998 $10,967 $11,771 $11,612 7/31/1998 $10,936 $11,646 $11,614 8/31/1998 $ 8,837 $ 9,962 $ 8,936 9/30/1998 $ 9,015 $10,600 $ 9,115 10/31/1998 $ 9,402 $11,463 $10,221 11/30/1998 $ 9,821 $12,157 $10,918 12/31/1998 $10,066 $12,858 $11,142 1/31/1999 $10,035 $13,396 $11,379 2/28/1999 $ 9,832 $12,979 $11,531 3/31/1999 $10,066 $13,498 $11,972 4/30/1999 $10,708 $14,021 $12,784 5/31/1999 $10,841 $13,690 $12,073 6/30/1999 $11,324 $14,450 $12,573 7/31/1999 $11,206 $13,999 $11,792 8/31/1999 $10,680 $13,929 $11,250 9/30/1999 $10,538 $13,548 $10,666 10/31/1999 $11,300 $14,405 $12,446 11/30/1999 $11,065 $14,698 $11,835 12/31/1999 $10,505 $15,563 $11,601 1/31/2000 $ 9,853 $14,781 $11,234 2/29/2000 $ 9,026 $14,502 $10,017 3/31/2000 $10,312 $15,920 $11,876 4/30/2000 $10,231 $15,441 $11,503 5/31/2000 $10,874 $15,124 $12,274 6/30/2000 $10,598 $15,497 $11,530 7/31/2000 $11,280 $15,255 $12,722 8/31/2000 $12,135 $16,203 $13,943 9/30/2000 $12,940 $15,347 $14,274 10/31/2000 $12,833 $15,282 $14,212 11/30/2000 $12,447 $14,078 $13,374 12/31/2000 $13,855 $14,146 $14,582 1/31/2001 $14,025 $14,648 $14,542 2/28/2001 $14,058 $13,313 $13,587 3/31/2001 $14,152 $12,469 $13,178 4/30/2001 $14,736 $13,438 $13,668 5/31/2001 $15,380 $13,528 $14,219 6/30/2001 $15,762 $13,199 $14,214 7/31/2001 $15,960 $13,069 $13,984 8/31/2001 $15,831 $12,251 $13,132 9/30/2001 $14,579 $11,262 $12,357 10/31/2001 $14,432 $11,476 $12,127 11/30/2001 $15,054 $12,357 $12,993 12/31/2001 $15,497 $12,465 $13,277 1/31/2002 $15,794 $12,283 $13,070 2/28/2002 $15,896 $12,046 $12,880 3/31/2002 $16,799 $12,499 $13,736 4/30/2002 $17,292 $11,741 $13,370 5/31/2002 $17,422 $11,655 $13,347 6/30/2002 $16,761 $10,825 $12,714 7/31/2002 $15,934 $ 9,981 $11,705 8/31/2002 $16,248 $10,046 $11,945 9/30/2002 $14,925 $ 8,955 $10,548 10/31/2002 $15,315 $ 9,743 $11,503 11/30/2002 $15,468 $10,316 $11,975 12/31/2002 $15,408 $ 9,710 $11,334 1/31/2003 $15,225 $ 9,456 $11,145 2/28/2003 $14,906 $ 9,314 $10,796 3/31/2003 $15,032 $ 9,404 $10,754 4/30/2003 $16,065 $10,179 $12,071 5/31/2003 $16,964 $10,715 $12,709 6/30/2003 $17,027 $10,852 $12,741 7/31/2003 $17,540 $11,043 $13,326 8/31/2003 $17,840 $11,259 $13,192 9/30/2003 $17,792 $11,139 $13,280 10/31/2003 $18,846 $11,769 $14,194 11/30/2003 $19,224 $11,873 $14,155 12/31/2003 $19,999 $12,495 $14,851 1/31/2004 $20,617 $12,725 $15,324 2/29/2004 $20,906 $12,902 $15,730 3/31/2004 $20,985 $12,707 $15,575 4/30/2004 $20,188 $12,508 $14,856 5/31/2004 $20,298 $12,679 $15,129 6/30/2004 $20,552 $12,926 $15,204 7/31/2004 $20,278 $12,498 $14,892 8/31/2004 $20,532 $12,549 $15,393 9/30/2004 $21,130 $12,684 $15,261 10/31/2004 $21,160 $12,878 $15,339 11/30/2004 $22,337 $13,399 $15,793 12/31/2004 $23,034 $13,855 $16,468 1/31/2005 $22,696 $13,518 $16,112 2/28/2005 $23,101 $13,802 $16,027 3/31/2005 $22,685 $13,558 $15,418 4/30/2005 $22,370 $13,300 $15,434 5/31/2005 $23,045 $13,724 $15,857 6/30/2005 $23,642 $13,743 $16,085 7/31/2005 $24,658 $14,254 $16,338 8/31/2005 $24,334 $14,124 $16,053 9/30/2005 $24,415 $14,239 $16,201 10/31/2005 $24,080 $14,001 $16,713 11/30/2005 $25,258 $14,531 $17,496 12/31/2005 $26,217 $14,536 $17,535 1/31/2006 $27,321 $14,921 $17,692 2/28/2006 $28,267 $14,961 $18,050 3/31/2006 $28,995 $15,147 $18,103 4/30/2006 $29,310 $15,351 $18,887 5/31/2006 $27,903 $14,909 $18,192 6/30/2006 $27,566 $14,929 $18,080 7/31/2006 $27,714 $15,021 $18,528 8/31/2006 $28,482 $15,379 $18,743 9/30/2006 $29,151 $15,775 $19,524 10/31/2006 $29,758 $16,289 $19,998 11/30/2006 $30,042 $16,599 $20,123 12/31/2006 $31,289 $16,832 $20,900 1/31/2007 $32,328 $17,086 $21,085 2/28/2007 $32,092 $16,752 $20,456 3/31/2007 $32,369 $16,939 $20,305 4/30/2007 $33,255 $17,690 $21,145 5/31/2007 $34,224 $18,307 $21,632 6/30/2007 $33,018 $18,003 $20,735 7/31/2007 $31,080 $17,445 $19,118 8/31/2007 $30,515 $17,706 $19,413 9/30/2007 $30,246 $18,368 $19,852 10/31/2007 $30,119 $18,661 $19,493 11/30/2007 $28,705 $17,880 $17,984 12/31/2007 $28,478 $17,756 $17,006 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS A 12/31/07 - -------------------------------------------------------------------------------- 1-Year -14.22% - -------------------------------------------------------------------------------- 5-Year +11.74% - -------------------------------------------------------------------------------- 10-Year +11.03% - -------------------------------------------------------------------------------- Annual Report | 11 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS B 12/31/07 - -------------------------------------------------------------------------------- 1-Year -12.89% - -------------------------------------------------------------------------------- 5-Year +12.07% - -------------------------------------------------------------------------------- Since Inception (1/1/99) +11.59% - -------------------------------------------------------------------------------- CLASS B (1/1/99-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY LINE GRAPH IN THE PRINTED MATERIAL.] Mutual Financial S&P 500 Financials Date Services Fund S&P 500 6 Index 6 - ------------- ---------------- --------- ------------------- 1/1/1999 $10,000 $10,000 $10,000 1/31/1999 $ 9,961 $10,418 $10,212 2/28/1999 $ 9,759 $10,094 $10,349 3/31/1999 $ 9,984 $10,498 $10,745 4/30/1999 $10,614 $10,905 $11,473 5/31/1999 $10,738 $10,647 $10,836 6/30/1999 $11,215 $11,238 $11,285 7/31/1999 $11,090 $10,887 $10,583 8/31/1999 $10,559 $10,833 $10,097 9/30/1999 $10,419 $10,536 $ 9,573 10/31/1999 $11,168 $11,203 $11,170 11/30/1999 $10,926 $11,431 $10,622 12/31/1999 $10,369 $12,104 $10,412 1/31/2000 $ 9,722 $11,496 $10,082 2/29/2000 $ 8,901 $11,278 $ 8,991 3/31/2000 $10,161 $12,382 $10,659 4/30/2000 $10,073 $12,009 $10,324 5/31/2000 $10,711 $11,763 $11,016 6/30/2000 $10,424 $12,053 $10,348 7/31/2000 $11,092 $11,864 $11,417 8/31/2000 $11,924 $12,601 $12,514 9/30/2000 $12,714 $11,936 $12,811 10/31/2000 $12,600 $11,886 $12,755 11/30/2000 $12,217 $10,949 $12,003 12/31/2000 $13,583 $11,002 $13,088 1/31/2001 $13,751 $11,392 $13,052 2/28/2001 $13,776 $10,354 $12,194 3/31/2001 $13,851 $ 9,698 $11,827 4/30/2001 $14,421 $10,451 $12,267 5/31/2001 $15,041 $10,521 $12,762 6/30/2001 $15,414 $10,265 $12,757 7/31/2001 $15,593 $10,164 $12,550 8/31/2001 $15,457 $ 9,528 $11,786 9/30/2001 $14,228 $ 8,759 $11,090 10/31/2001 $14,074 $ 8,926 $10,884 11/30/2001 $14,672 $ 9,610 $11,661 12/31/2001 $15,099 $ 9,694 $11,916 1/31/2002 $15,384 $ 9,553 $11,730 2/28/2002 $15,466 $ 9,369 $11,560 3/31/2002 $16,346 $ 9,721 $12,328 4/30/2002 $16,814 $ 9,132 $11,999 5/31/2002 $16,924 $ 9,064 $11,979 6/30/2002 $16,277 $ 8,419 $11,410 7/31/2002 $15,461 $ 7,763 $10,506 8/31/2002 $15,761 $ 7,813 $10,720 9/30/2002 $14,467 $ 6,964 $ 9,467 10/31/2002 $14,833 $ 7,577 $10,323 11/30/2002 $14,974 $ 8,023 $10,748 12/31/2002 $14,917 $ 7,552 $10,172 1/31/2003 $14,727 $ 7,354 $10,002 2/28/2003 $14,414 $ 7,244 $ 9,689 3/31/2003 $14,528 $ 7,314 $ 9,652 4/30/2003 $15,524 $ 7,917 $10,834 5/31/2003 $16,377 $ 8,334 $11,407 6/30/2003 $16,423 $ 8,440 $11,435 7/31/2003 $16,916 $ 8,589 $11,960 8/31/2003 $17,192 $ 8,756 $11,839 9/30/2003 $17,135 $ 8,663 $11,918 10/31/2003 $18,151 $ 9,153 $12,739 11/30/2003 $18,502 $ 9,234 $12,704 12/31/2003 $19,225 $ 9,718 $13,328 1/31/2004 $19,819 $ 9,897 $13,753 2/29/2004 $20,082 $10,034 $14,117 3/31/2004 $20,150 $ 9,883 $13,978 4/30/2004 $19,381 $ 9,728 $13,333 5/31/2004 $19,478 $ 9,861 $13,578 6/30/2004 $19,707 $10,053 $13,645 7/31/2004 $19,430 $ 9,720 $13,366 8/31/2004 $19,667 $ 9,759 $13,815 9/30/2004 $20,222 $ 9,865 $13,697 10/31/2004 $20,242 $10,016 $13,767 11/30/2004 $21,362 $10,421 $14,174 12/31/2004 $22,015 $10,776 $14,780 1/31/2005 $21,675 $10,513 $14,460 2/28/2005 $22,048 $10,734 $14,384 3/31/2005 $21,631 $10,544 $13,837 4/30/2005 $21,324 $10,344 $13,852 5/31/2005 $21,960 $10,673 $14,232 6/30/2005 $22,516 $10,689 $14,436 7/31/2005 $23,472 $11,086 $14,663 8/31/2005 $23,146 $10,985 $14,407 9/30/2005 $23,213 $11,074 $14,540 10/31/2005 $22,876 $10,889 $15,000 11/30/2005 $23,989 $11,301 $15,703 12/31/2005 $24,884 $11,305 $15,737 1/31/2006 $25,918 $11,604 $15,878 2/28/2006 $26,800 $11,636 $16,200 3/31/2006 $27,458 $11,781 $16,247 4/30/2006 $27,752 $11,939 $16,951 5/31/2006 $26,400 $11,595 $16,327 6/30/2006 $26,067 $11,611 $16,226 7/31/2006 $26,199 $11,683 $16,629 8/31/2006 $26,907 $11,961 $16,821 9/30/2006 $27,518 $12,269 $17,523 10/31/2006 $28,082 $12,669 $17,948 11/30/2006 $28,334 $12,909 $18,060 12/31/2006 $29,491 $13,091 $18,757 1/31/2007 $30,470 $13,289 $18,923 2/28/2007 $30,248 $13,029 $18,359 3/31/2007 $30,508 $13,174 $18,224 4/30/2007 $31,344 $13,758 $18,977 5/31/2007 $32,256 $14,238 $19,414 6/30/2007 $31,117 $14,001 $18,609 7/31/2007 $29,291 $13,567 $17,158 8/31/2007 $28,758 $13,771 $17,423 9/30/2007 $28,504 $14,286 $17,817 10/31/2007 $28,385 $14,513 $17,494 11/30/2007 $27,053 $13,906 $16,141 12/31/2007 $26,841 $13,810 $15,263 AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS C 12/31/07 - -------------------------------------------------------------------------------- 1-Year -10.43% - -------------------------------------------------------------------------------- 5-Year +12.31% - -------------------------------------------------------------------------------- 10-Year +10.96% - -------------------------------------------------------------------------------- CLASS C (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] Mutual Financial S&P 500 Financials Date Services Fund S&P 500 6 Index 6 - ------------- ---------------- --------- ------------------- 1/1/1998 $10,000 $10,000 $10,000 1/31/1998 $10,098 $10,111 $ 9,715 2/28/1998 $11,076 $10,840 $10,628 3/31/1998 $11,711 $11,395 $11,234 4/30/1998 $12,013 $11,510 $11,420 5/31/1998 $11,744 $11,312 $11,145 6/30/1998 $11,597 $11,771 $11,612 7/31/1998 $11,549 $11,646 $11,614 8/31/1998 $ 9,330 $ 9,962 $ 8,936 9/30/1998 $ 9,519 $10,600 $ 9,115 10/31/1998 $ 9,922 $11,463 $10,221 11/30/1998 $10,357 $12,157 $10,918 12/31/1998 $10,612 $12,858 $11,142 1/31/1999 $10,571 $13,396 $11,379 2/28/1999 $10,356 $12,979 $11,531 3/31/1999 $10,596 $13,498 $11,972 4/30/1999 $11,257 $14,021 $12,784 5/31/1999 $11,397 $13,690 $12,073 6/30/1999 $11,905 $14,450 $12,573 7/31/1999 $11,764 $13,999 $11,792 8/31/1999 $11,209 $13,929 $11,250 9/30/1999 $11,052 $13,548 $10,666 10/31/1999 $11,856 $14,405 $12,446 11/30/1999 $11,599 $14,698 $11,835 12/31/1999 $11,002 $15,563 $11,601 1/31/2000 $10,311 $14,781 $11,234 2/29/2000 $ 9,442 $14,502 $10,017 3/31/2000 $10,783 $15,920 $11,876 4/30/2000 $10,690 $15,441 $11,503 5/31/2000 $11,364 $15,124 $12,274 6/30/2000 $11,066 $15,497 $11,530 7/31/2000 $11,772 $15,255 $12,722 8/31/2000 $12,658 $16,203 $13,943 9/30/2000 $13,493 $15,347 $14,274 10/31/2000 $13,372 $15,282 $14,212 11/30/2000 $12,968 $14,078 $13,374 12/31/2000 $14,421 $14,146 $14,582 1/31/2001 $14,589 $14,648 $14,542 2/28/2001 $14,625 $13,313 $13,587 3/31/2001 $14,704 $12,469 $13,178 4/30/2001 $15,305 $13,438 $13,668 5/31/2001 $15,968 $13,528 $14,219 6/30/2001 $16,356 $13,199 $14,214 7/31/2001 $16,554 $13,069 $13,984 8/31/2001 $16,410 $12,251 $13,132 9/30/2001 $15,105 $11,262 $12,357 10/31/2001 $14,943 $11,476 $12,127 11/30/2001 $15,582 $12,357 $12,993 12/31/2001 $16,030 $12,465 $13,277 1/31/2002 $16,328 $12,283 $13,070 2/28/2002 $16,415 $12,046 $12,880 3/31/2002 $17,350 $12,499 $13,736 4/30/2002 $17,851 $11,741 $13,370 5/31/2002 $17,967 $11,655 $13,347 6/30/2002 $17,285 $10,825 $12,714 7/31/2002 $16,418 $ 9,981 $11,705 8/31/2002 $16,733 $10,046 $11,945 9/30/2002 $15,363 $ 8,955 $10,548 10/31/2002 $15,748 $ 9,743 $11,503 11/30/2002 $15,895 $10,316 $11,975 12/31/2002 $15,836 $ 9,710 $11,334 1/31/2003 $15,637 $ 9,456 $11,145 2/28/2003 $15,299 $ 9,314 $10,796 3/31/2003 $15,429 $ 9,404 $10,754 4/30/2003 $16,473 $10,179 $12,071 5/31/2003 $17,388 $10,715 $12,709 6/30/2003 $17,435 $10,852 $12,741 7/31/2003 $17,953 $11,043 $13,326 8/31/2003 $18,252 $11,259 $13,192 9/30/2003 $18,192 $11,139 $13,280 10/31/2003 $19,267 $11,769 $14,194 11/30/2003 $19,646 $11,873 $14,155 12/31/2003 $20,409 $12,495 $14,851 1/31/2004 $21,041 $12,725 $15,324 2/29/2004 $21,317 $12,902 $15,730 3/31/2004 $21,388 $12,707 $15,575 4/30/2004 $20,562 $12,508 $14,856 5/31/2004 $20,664 $12,679 $15,129 6/30/2004 $20,912 $12,926 $15,204 7/31/2004 $20,622 $12,498 $14,892 8/31/2004 $20,871 $12,549 $15,393 9/30/2004 $21,462 $12,684 $15,261 10/31/2004 $21,483 $12,878 $15,339 11/30/2004 $22,666 $13,399 $15,793 12/31/2004 $23,360 $13,855 $16,468 1/31/2005 $23,004 $13,518 $16,112 2/28/2005 $23,405 $13,802 $16,027 3/31/2005 $22,959 $13,558 $15,418 4/30/2005 $22,638 $13,300 $15,434 5/31/2005 $23,314 $13,724 $15,857 6/30/2005 $23,896 $13,743 $16,085 7/31/2005 $24,907 $14,254 $16,338 8/31/2005 $24,566 $14,124 $16,053 9/30/2005 $24,636 $14,239 $16,201 10/31/2005 $24,284 $14,001 $16,713 11/30/2005 $25,459 $14,531 $17,496 12/31/2005 $26,409 $14,536 $17,535 1/31/2006 $27,502 $14,921 $17,692 2/28/2006 $28,447 $14,961 $18,050 3/31/2006 $29,147 $15,147 $18,103 4/30/2006 $29,454 $15,351 $18,887 5/31/2006 $28,018 $14,909 $18,192 6/30/2006 $27,672 $14,929 $18,080 7/31/2006 $27,810 $15,021 $18,528 8/31/2006 $28,549 $15,379 $18,743 9/30/2006 $29,213 $15,775 $19,524 10/31/2006 $29,802 $16,289 $19,998 11/30/2006 $30,078 $16,599 $20,123 12/31/2006 $31,300 $16,832 $20,900 1/31/2007 $32,317 $17,086 $21,085 2/28/2007 $32,066 $16,752 $20,456 3/31/2007 $32,331 $16,939 $20,305 4/30/2007 $33,195 $17,690 $21,145 5/31/2007 $34,143 $18,307 $21,632 6/30/2007 $32,910 $18,003 $20,735 7/31/2007 $30,961 $17,445 $19,118 8/31/2007 $30,378 $17,706 $19,413 9/30/2007 $30,093 $18,368 $19,852 10/31/2007 $29,951 $18,661 $19,493 11/30/2007 $28,528 $17,880 $17,984 12/31/2007 $28,294 $17,756 $17,006 12 | Annual Report Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. INVESTING IN A SINGLE-SECTOR FUND INVOLVES SPECIAL RISKS, INCLUDING GREATER SENSITIVITY TO ECONOMIC, POLITICAL OR REGULATORY DEVELOPMENTS IMPACTING THE SECTOR. IN ADDITION, THE FUND INVESTS IN FOREIGN SECURITIES WHOSE RISKS INCLUDE CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. THE FUND'S INVESTMENTS IN SMALLER-COMPANY STOCKS CARRY AN INCREASED RISK OF PRICE FLUCTUATION, PARTICULARLY OVER THE SHORT TERM. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, WHICH INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, 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. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated. 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. 5. Figures are as stated in the Fund's prospectus current as of the date of this report. 6. Source: Standard & Poor's Micropal. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. Each stock's weight in the index is proportionate to its market value. The S&P 500 is one of the most widely used benchmarks of U.S. equity performance. The S&P 500 Financials Index is market value weighted and includes all the financial stocks in the S&P 500. Annual Report | 13 Your Fund's Expenses As a Fund shareholder, you can incur two types of costs: o Transaction costs, including sales charges (loads) on Fund purchases and redemption fees; and o Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The following table shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. ACTUAL FUND EXPENSES The first line (Actual) for each share class listed in the table 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 7/1/07 VALUE 12/31/07 PERIOD* 7/1/07-12/31/07 - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 864.20 $ 5.26 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.56 $ 5.70 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 862.50 $ 6.62 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,018.10 $ 7.17 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 859.70 $ 9.94 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.52 $ 10.76 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 859.70 $ 9.94 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,014.52 $ 10.76 - --------------------------------------------------------------------------------------------------------
* Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 1.12%; A: 1.41%; B: 2.12%; and C: 2.12%), multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period. Annual Report | 15 Mutual Financial Services Fund FINANCIAL HIGHLIGHTS
------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2007 2006 2005 2004 2003 ------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ............................... $ 22.59 $ 21.59 $ 20.45 $ 20.06 $ 15.92 ------------------------------------------------------------- Income from investment operations a: Net investment income b ....................................... 0.51 0.40 0.44 0.34 0.23 Net realized and unrealized gains (losses) .................... (2.41) 3.76 2.40 2.70 4.58 ------------------------------------------------------------- Total from investment operations ................................. (1.90) 4.16 2.84 3.04 4.81 ------------------------------------------------------------- Less distributions from: Net investment income ......................................... (0.61) (0.57) (0.49) (0.32) (0.24) Net realized gains ............................................ (1.40) (2.59) (1.21) (2.33) (0.43) ------------------------------------------------------------- Total distributions .............................................. (2.01) (3.16) (1.70) (2.65) (0.67) ------------------------------------------------------------- Redemption fees .................................................. -- d -- d -- d -- d -- ------------------------------------------------------------- Net asset value, end of year ..................................... $ 18.68 $ 22.59 $ 21.59 $ 20.45 $ 20.06 ============================================================= Total return ..................................................... (8.71)% 19.73% 14.14% 15.62% 30.23% RATIOS TO AVERAGE NET ASSETS Expenses c ....................................................... 1.11% e 1.08% e 1.12% e 1.10% e 1.13% Expenses - excluding dividend expense on securities sold short ... 1.11% e 1.08% e 1.11% e 1.09% e 1.11% Net investment income ............................................ 2.25% 1.71% 2.10% 1.65% 1.28% SUPPLEMENTAL DATA Net assets, end of year (000's) .................................. $164,890 $213,874 $174,864 $166,175 $151,918 Portfolio turnover rate .......................................... 49.87% 62.65% 31.71% 38.40% 25.78%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Includes dividend expenses on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. d Amount rounds to less than $0.01 per share. e Benefit of expense reduction rounds to less than 0.01%. 16 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Financial Services Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2007 2006 2005 2004 2003 ------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................................ $ 22.60 $ 21.61 $ 20.47 $ 20.08 $ 15.95 ------------------------------------------------------------- Income from investment operations a: Net investment income b ........................................ 0.44 0.33 0.37 0.27 0.16 Net realized and unrealized gains (losses) ..................... (2.40) 3.76 2.41 2.70 4.58 ------------------------------------------------------------- Total from investment operations .................................. (1.96) 4.09 2.78 2.97 4.74 ------------------------------------------------------------- Less distributions from: Net investment income .......................................... (0.54) (0.51) (0.43) (0.25) (0.18) Net realized gains ............................................. (1.40) (2.59) (1.21) (2.33) (0.43) ------------------------------------------------------------- Total distributions ............................................... (1.94) (3.10) (1.64) (2.58) (0.61) ------------------------------------------------------------- Redemption fees ................................................... -- e -- e -- e -- e -- ------------------------------------------------------------- Net asset value, end of year ...................................... $ 18.70 $ 22.60 $ 21.61 $ 20.47 $ 20.08 ============================================================= Total return c .................................................... (8.99)% 19.35% 13.82% 15.17% 29.79% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................................ 1.40% f 1.39% f 1.42% f 1.44% f 1.48% Expenses - excluding dividend expense on securities sold short .... 1.40% f 1.39% f 1.41% f 1.43% f 1.46% Net investment income ............................................. 1.96% 1.40% 1.80% 1.31% 0.93% SUPPLEMENTAL DATA Net assets, end of year (000's) ................................... $441,180 $557,768 $359,058 $296,778 $264,411 Portfolio turnover rate ........................................... 49.87% 62.65% 31.71% 38.40% 25.78%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commission or contingent deferred sales charges, if applicable. d Includes dividend expenses on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 17 Mutual Financial Services Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2007 2006 2005 2004 2003 ------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................................ $ 22.08 $ 21.17 $ 20.09 $ 19.76 $ 15.73 ------------------------------------------------------------- Income from investment operations a: Net investment income b ........................................ 0.27 0.16 0.23 0.14 0.05 Net realized and unrealized gains (losses) ..................... (2.33) 3.68 2.34 2.64 4.49 ------------------------------------------------------------- Total from investment operations .................................. (2.06) 3.84 2.57 2.78 4.54 ------------------------------------------------------------- Less distributions from: Net investment income .......................................... (0.36) (0.34) (0.28) (0.12) (0.08) Net realized gains ............................................. (1.40) (2.59) (1.21) (2.33) (0.43) ------------------------------------------------------------- Total distributions ............................................... (1.76) (2.93) (1.49) (2.45) (0.51) ------------------------------------------------------------- Redemption fees ................................................... -- e -- e -- e -- e -- ------------------------------------------------------------- Net asset value, end of year ...................................... $ 18.26 $ 22.08 $ 21.17 $ 20.09 $ 19.76 ============================================================= Total return c .................................................... (9.58)% 18.51% 13.03% 14.51% 28.88% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................................ 2.11% f 2.08% f 2.12% f 2.10% f 2.12% Expenses - excluding dividend expense on securities sold short .... 2.11% f 2.08% f 2.11% f 2.09% f 2.10% Net investment income ............................................. 1.25% 0.71% 1.10% 0.65% 0.29% SUPPLEMENTAL DATA Net assets, end of year (000's) ................................... $ 30,756 $ 46,085 $ 42,526 $ 42,614 $ 34,219 Portfolio turnover rate ........................................... 49.87% 62.65% 31.71% 38.40% 25.78%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commission or contingent deferred sales charges, if applicable. d Includes dividend expenses on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. 18 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Financial Services Fund FINANCIAL HIGHLIGHTS (CONTINUED)
------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2007 2006 2005 2004 2003 ------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ................................ $ 22.46 $ 21.51 $ 20.39 $ 20.02 $ 15.92 ------------------------------------------------------------- Income from investment operations a: Net investment income b ........................................ 0.28 0.16 0.23 0.13 0.05 Net realized and unrealized gains (losses) ..................... (2.37) 3.73 2.38 2.68 4.55 ------------------------------------------------------------- Total from investment operations .................................. (2.09) 3.89 2.61 2.81 4.60 ------------------------------------------------------------- Less distributions from: Net investment income .......................................... (0.38) (0.35) (0.28) (0.11) (0.07) Net realized gains ............................................. (1.40) (2.59) (1.21) (2.33) (0.43) ------------------------------------------------------------- Total distributions ............................................... (1.78) (2.94) (1.49) (2.44) (0.50) ------------------------------------------------------------- Redemption fees ................................................... -- e -- e -- e -- e -- ------------------------------------------------------------- Net asset value, end of year ...................................... $ 18.59 $ 22.46 $ 21.51 $ 20.39 $ 20.02 ============================================================= Total return c .................................................... (9.60)% 18.52% 13.06% 14.46% 28.87% RATIOS TO AVERAGE NET ASSETS Expenses d ........................................................ 2.11% f 2.08% f 2.12% f 2.10% f 2.13% Expenses - excluding dividend expense on securities sold short .... 2.11% f 2.08% f 2.11% f 2.09% f 2.11% Net investment income ............................................. 1.25% 0.71% 1.10% 0.65% 0.28% SUPPLEMENTAL DATA Net assets, end of year (000's) ................................... $183,684 $225,305 $169,000 $155,698 $141,233 Portfolio turnover rate ........................................... 49.87% 62.65% 31.71% 38.40% 25.78%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commission or contingent deferred sales charges, if applicable. d Includes dividend expenses on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 19 Mutual Financial Services Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY SHARES VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS 96.6% COMMON STOCKS AND OTHER EQUITY INTERESTS 95.5% CAPITAL MARKETS 9.4% Acta Holding ASA .......................................... Norway 5,917,580 $ 24,717,833 D. Carnegie & Co. AB ...................................... Sweden 931,850 18,087,319 a Gottex Fund Management Holdings Ltd. ...................... Switzerland 55,916 3,424,436 Legg Mason Inc. ........................................... United States 71,542 5,233,297 Marfin Investment Group Holdings SA ....................... Greece 994,503 8,620,888 Tullett Prebon PLC ........................................ United Kingdom 1,814,894 16,921,642 ---------------- 77,005,415 ---------------- COMMERCIAL BANKS 26.1% Aareal Bank AG ............................................ Germany 297,429 13,334,108 Abington Bancorp Inc. ..................................... United States 576,850 5,422,390 a Alliance Bank & Trust Co. ................................. United States 226,100 2,159,255 a,b,c,d Atlantic Banc Holdings Inc. ............................... United States 350,000 3,500,000 a Banco Popolare SpA ........................................ Italy 458,584 10,145,596 Banque Cantonale Vaudoise ................................. Switzerland 44,100 19,497,088 BNP Paribas SA ............................................ France 220,650 23,899,253 a Centennial Bank Holdings Inc. ............................. United States 1,333,807 7,709,405 Commerce Bancorp Inc. ..................................... United States 207,100 7,898,794 Danske Bank AS ............................................ Denmark 517,029 20,212,652 a,b,c Elephant Capital Holdings Ltd. ............................ Japan 2,167 1,427,272 a,b,c First Chicago Bancorp ..................................... United States 496,868 6,956,152 First Community Bancorp ................................... United States 365,031 15,053,878 Intesa Sanpaolo SpA ....................................... Italy 1,926,362 15,208,788 Intesa Sanpaolo SpA, di Risp .............................. Italy 147,000 1,072,086 Mitsubishi UFJ Financial Group Inc. ....................... Japan 612,602 5,751,641 a,b,c NCB Warrant Holdings Ltd., A .............................. Japan 10,590 628,324 Royal Bank of Scotland Group PLC .......................... United Kingdom 78,483 692,382 Societe Generale, A ....................................... France 113,975 16,454,969 Southern National Bancorp of Virginia Inc. ................ United States 290,840 2,617,560 Sumitomo Mitsui Financial Group Inc. ...................... Japan 741 5,561,736 Svenska Handelsbanken AB, A ............................... Sweden 278,531 8,917,196 Swedbank AB, A ............................................ Sweden 219,136 6,202,250 U.S. Bancorp .............................................. United States 450,101 14,286,206 ---------------- 214,608,981 ---------------- COMMERCIAL SERVICES & SUPPLIES 2.4% a Comdisco Holding Co. Inc. ................................. United States 103 938 a,e Comdisco Holding Co. Inc., Contingent Distribution ........ United States 4,645,036 -- Intrum Justitia AB ........................................ Sweden 846,790 15,061,146 a Protection One Inc. ....................................... United States 370,533 4,405,637 ---------------- 19,467,721 ---------------- CONSUMER FINANCE 1.3% a,b,c Cerberus CG Investor I LLC ................................ United States 1,000,000 841,976 a,b,c Cerberus CG Investor II LLC ............................... United States 1,000,000 841,977 a,b,c Cerberus CG Investor III LLC .............................. United States 500,000 420,988 a,b,c Cerberus FIM Investors Auto Finance LLC ................... United States 1,255,339 673,528 a,b,c Cerberus FIM Investors Commercial Finance LLC ............. United States 104,566 56,103 a,b,c Cerberus FIM Investors Commercial Mortgage LLC ............ United States 195,993 105,156 a,b,c Cerberus FIM Investors Insurance LLC ...................... United States 958,613 514,325
20 | Annual Report Mutual Financial Services Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY SHARES VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) CONSUMER FINANCE (CONTINUED) a,b,c Cerberus FIM Investors Rescap LLC ......................... United States 1,784,739 $ 957,568 SLM Corp. ................................................. United States 173,470 3,493,686 a White River Capital Inc. .................................. United States 172,799 3,012,319 ---------------- 10,917,626 ---------------- DIVERSIFIED BANKS 0.6% a,b,c The Bankshares Inc. ....................................... United States 456,903 4,569,030 ---------------- DIVERSIFIED FINANCIAL SERVICES 18.1% Banca Italease ............................................ Italy 144,761 2,023,842 Bolsas Y Mercados Espanoles ............................... Spain 165,309 11,241,955 Citigroup Inc. ............................................ United States 188,240 5,541,785 Deutsche Boerse AG ........................................ Germany 153,979 30,504,280 Fortis .................................................... Belgium 1,429,904 37,728,084 a Fortis VVPR Strip ......................................... Belgium 439,970 6,421 Guinness Peat Group PLC ................................... United Kingdom 5,439,414 7,254,601 Hellenic Exchanges SA Holding ............................. Greece 490,500 17,179,468 KBC Ancora ................................................ Belgium 69,280 7,835,542 Osaka Securities Exchange Co. Ltd. ........................ Japan 1,023 4,797,821 Oslo Bors Holding ASA ..................................... Norway 911,000 24,306,744 ---------------- 148,420,543 ---------------- INSURANCE 17.5% Allianz SE ................................................ Germany 32,892 7,107,979 f AmTrust Financial Services Inc., 144A ..................... United States 950,031 13,081,927 a Argo Group International Holdings Ltd. .................... United States 153,230 6,455,580 Assicurazioni Generali SpA ................................ Italy 87,487 3,957,899 a,b,c Augsburg Re AG ............................................ Switzerland 10,745 -- a Berkshire Hathaway Inc., A ................................ United States 73 10,336,800 a Berkshire Hathaway Inc., B ................................ United States 254 1,202,944 a Cninsure Inc., ADR ........................................ China 250,000 3,937,500 a Conseco Inc. .............................................. United States 149,880 1,882,493 g,h Hartford Financial Services Group Inc. .................... United States 113,740 9,916,991 a,b,c Imagine Group Holdings Ltd. ............................... Bermuda 551,589 6,310,178 a Lancashire Holdings Ltd. .................................. United Kingdom 1,216,268 8,778,531 a,b,c Olympus Re Holdings Ltd. .................................. United States 7,480 24,499 a Protector Forsikring ASA .................................. Norway 4,360,410 7,935,312 Prudential Financial Inc. ................................. United States 46,220 4,300,309 Resolution PLC ............................................ United Kingdom 28,086 397,056 b,c Symetra Financial ......................................... United States 1,020,510 16,348,570 h The Travelers Cos. Inc. ................................... United States 81,913 4,406,919 a Tower Australia Group Ltd. ................................ Australia 3,567,505 8,751,874 White Mountains Insurance Group Ltd. ...................... United States 38,048 19,558,574 Zurich Financial Services AG .............................. Switzerland 29,526 8,663,427 ---------------- 143,355,362 ---------------- MEDIA 1.5% f Maiden Holdings Ltd., 144A ................................ United States 1,500,000 12,000,000 ---------------- MULTILINE RETAIL 0.3% Jelmoli Holding AG ........................................ Switzerland 1,039 2,489,309 ----------------
Annual Report | 21 Mutual Financial Services Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY SHARES VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) REAL ESTATE 12.3% a Conwert Immobilien Invest AG .............................. Austria 652,828 $ 11,470,562 DIC Asset AG .............................................. Germany 270,530 8,369,716 a Dolphin Capital Investors Ltd. ............................ Virgin Islands (British) 5,486,000 14,988,061 Eurocastle Investment Ltd. ................................ Guernsey Islands 633,467 15,484,538 a Francono Rhein-Main AG .................................... Germany 1,377,430 3,819,290 d Franconofurt AG ........................................... Germany 499,260 6,112,913 a Franconowest Ag ........................................... Germany 99,852 189,435 Gagfah SA ................................................. Luxembourg 374,530 6,449,530 JER Investors Trust Inc. .................................. United States 84,280 907,696 Link REIT ................................................. Hong Kong 2,799,102 6,059,020 Northern European Properties Ltd. ......................... Sweden 4,488,264 4,634,088 Patrizia Immobilien AG .................................... Germany 424,265 3,176,245 Redwood Trust Inc. ........................................ United States 83,300 2,852,192 b,c,f Star Asia Finance Ltd., 144A .............................. Japan 968,500 8,958,625 Vivacon AG ................................................ Germany 297,966 5,631,135 a Zueblin Immobilien Holding AG ............................. Switzerland 251,355 2,218,099 ---------------- 101,321,145 ---------------- THRIFTS & MORTGAGE FINANCE 6.0% BankUnited Financial Corp., A ............................. United States 302,070 2,084,283 Hudson City Bancorp Inc. .................................. United States 1,136,486 17,070,020 Hypo Real Estate Holding AG ............................... Germany 266,826 14,131,054 Interhyp AG ............................................... Germany 176,782 12,907,080 Sovereign Bancorp Inc. .................................... United States 168,960 1,926,144 Westfield Financial Inc. .................................. United States 160,000 1,552,000 ---------------- 49,670,581 ---------------- TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $723,117,174) ..................................... 783,825,713 ---------------- ---------------- PRINCIPAL AMOUNT ---------------- CORPORATE BONDS & NOTES 1.1% b,c Augsburg Re AG, zero cpn., 1/30/08 ........................ Switzerland $ 123,572 -- b,c Cerberus CG Investor I LLC, 12.00%, 7/31/14 ............... United States 1,000,000 841,976 b,c Cerberus CG Investor II LLC, 12.00%, 7/31/14 .............. United States 1,000,000 841,977 b,c Cerberus CG Investor III LLC, 12.00%, 7/31/14 ............. United States 500,000 420,988 b,c Cerberus FIM Investors Auto Finance LLC, 12.00%, 11/22/13 ................................................ United States 3,763,457 2,019,211 b,c Cerberus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 ................................................ United States 313,698 168,309 b,c Cerberus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 ................................................ United States 587,978 315,468 b,c Cerberus FIM Investors Insurance LLC, 12.00%, 11/22/13 .... United States 2,875,838 1,542,976 b,c Cerberus FIM Investors Rescap LLC, 12.00%, 11/22/13 ....... United States 5,354,217 2,872,703 ---------------- TOTAL CORPORATE BONDS & NOTES (COST $15,518,761 ) ......... 9,023,608 ---------------- TOTAL LONG TERM INVESTMENTS (COST $738,635,935) ........... 792,849,321 ----------------
22 | Annual Report Mutual Financial Services Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT VALUE - ------------------------------------------------------------------------------------------------------------------------------------ SHORT TERM INVESTMENTS 1.8% U.S. GOVERNMENT AND AGENCY SECURITIES 1.8% g,i FHLB, 1/02/08 - 2/15/08 ................................... United States $ 11,100,000 $ 11,081,523 i U.S. Treasury Bills, 4/24/08 - 5/01/08 .................... United States 3,500,000 3,464,031 ---------------- TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $14,531,678) ...................................... 14,545,554 ---------------- TOTAL INVESTMENTS (COST $753,167,613) 98.4% ............... 807,394,875 OPTIONS WRITTEN 0.0% j .................................... (3,040) SECURITIES SOLD SHORT (0.7)% .............................. (6,000,381) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (0.6)% ........................................ (4,940,918) OTHER ASSETS, LESS LIABILITIES 2.9% ....................... 24,058,542 ---------------- NET ASSETS 100.0% ......................................... $ 820,509,078 ================ ---------------- CONTRACTS ---------------- k OPTIONS WRITTEN 0.0% j INSURANCE 0.0% j Hartford Financial Services Group Inc., Jan. 110 Calls, 1/19/08 ................................................. United States 109 $ 1,090 The Travelers Cos. Inc., Jan. 60 Calls, 1/19/08 ........... United States 195 1,950 ---------------- TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $34,696) ......... 3,040 ---------------- ---------------- SHARES ---------------- l SECURITIES SOLD SHORT (PROCEEDS $6,284,806) COMMERCIAL BANKS 0.7% Toronto-Dominion Bank ..................................... Canada 85,781 $ 6,000,381 ----------------
SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FHLB - Federal Home Loan Bank REIT - Real Estate Investment Trust a Non-income producing for the twelve months ended December 31, 2007. b See Note 8 regarding restricted securities. c Security has been deemed illiquid because it may not be able to be sold within seven days. At December 31, 2007, the aggregate value of these securities was $62,157,879, representing 7.58% of net assets. d See Note 10 regarding holdings of 5% voting securities. e 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. 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, 2007, the aggregate value of these securities was $34,040,552, representing 4.15% of net assets. g Security or a portion of the security has been segregated as collateral for securities sold short. At December 31, 2007, the value of securities and or cash pledged amounted to $5,068,713. h A portion or all of the security is held in connection with written option contracts open at year end. i The security is traded on a discount basis with no stated coupon rate. j Rounds to less than 0.1% of net assets. k See Note 1(e) regarding written options. l See Note 1(f) regarding securities sold short. Annual Report | The accompanying notes are an integral part of these financial statements. | 23 Mutual Financial Services Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2007 Assets: Investments in securities: Cost - Unaffiliated issuers .......................................... $ 741,831,380 Cost - Non-controlled affiliated issuers (Note 10) ................... 11,336,233 ---------------- Total cost of investments ............................................ $ 753,167,613 ================ Value - Unaffiliated issuers ......................................... $ 797,781,962 Value - Non-controlled affiliated issuers (Note 10) .................. 9,612,913 ---------------- Total value of investments ........................................... 807,394,875 Cash .................................................................... 4,752 Cash on deposits with brokers for securities sold short .. .. .. . . .... 6,612,954 Foreign currency, at value (cost $18,230,883) ........................... 18,177,187 Receivables: Investment securities sold ........................................... 160,077 Capital shares sold .................................................. 3,782,098 Dividends and interest ............................................... 2,547,403 Unrealized gain on forward exchange contracts (Note 7) .................. 2,685,473 ---------------- Total assets ...................................................... 841,364,819 ---------------- Liabilities: Payables: Capital shares redeemed .............................................. 5,595,125 Affiliates ........................................................... 1,272,196 Options written, at value (premiums received $34,696) ................... 3,040 Securities sold short, at value (proceeds $6,284,806) ................... 6,000,381 Unrealized loss on forward exchange contracts (Note 7) .................. 7,626,391 Accrued expenses and other liabilities .................................. 358,608 ---------------- Total liabilities ................................................. 20,855,741 ---------------- Net assets, at value ........................................... $ 820,509,078 ---------------- Net assets consist of: Paid-in capital ......................................................... $ 769,798,870 Distributions in excess of net investment income ........................ (1,283,860) Net unrealized appreciation (depreciation) .............................. 49,563,830 Accumulated net realized gain (loss) .................................... 2,430,238 ---------------- Net assets, at value ........................................... $ 820,509,078 ================
24 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Financial Services Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2007 CLASS Z: Net assets, at value .................................................... $ 164,889,604 ================ Shares outstanding ...................................................... 8,828,487 ================ Net asset value and maximum offering price per share a .................. $ 18.68 ================ CLASS A: Net assets, at value .................................................... $ 441,179,785 ================ Shares outstanding ...................................................... 23,591,081 ================ Net asset value per share a ............................................. $ 18.70 ================ Maximum offering price per share (net asset value per share / 94.25%) ... $ 19.84 ================ CLASS B: Net assets, at value .................................................... $ 30,755,716 ================ Shares outstanding ...................................................... 1,683,930 ================ Net asset value and maximum offering price per share a .................. $ 18.26 ================ CLASS C: Net assets, at value .................................................... $ 183,683,973 ================ Shares outstanding ...................................................... 9,878,211 ================ Net asset value and maximum offering price per share a .................. $ 18.59 ================
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 | The accompanying notes are an integral part of these financial statements. | 25 Mutual Financial Services Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2007 Investment income: Dividends: (net of foreign taxes of $2,624,229) Unaffiliated issuers ................................................................... $ 29,465,350 Non-controlled affiliated issuers (Note 10) ............................................ 203,232 Interest (net of foreign taxes of $643) ................................................... 5,172,117 Income from securities loaned ............................................................. 16,615 --------------- Total investment income .......................................................... 34,857,314 --------------- Expenses: Management fees (Note 3a) ................................................................. 8,271,940 Administrative fees (Note 3b) ............................................................. 788,527 Distribution fees: (Note 3c) Class A ................................................................................ 1,627,069 Class B ................................................................................ 414,854 Class C ................................................................................ 2,237,573 Transfer agent fees (Note 3e) ............................................................. 1,799,866 Custodian fees (Note 4) ................................................................... 238,164 Reports to shareholders ................................................................... 147,772 Registration and filing fees .............................................................. 97,442 Professional fees ......................................................................... 110,751 Directors' fees and expenses .............................................................. 16,691 Other ..................................................................................... 36,102 --------------- Total expenses ................................................................... 15,786,751 Expense reductions (Note 4) ...................................................... (6,730) --------------- Net expenses ............................................................... 15,780,021 --------------- Net investment income ................................................... 19,077,293 --------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments Unaffiliated issuers ................................................................ 88,263,016 Non-controlled affiliated issuers (Note 10) ......................................... (3,902,202) Foreign currency transactions .......................................................... (36,086,384) Synthetic equity swaps ................................................................. (28,404) --------------- Net realized gain (loss) ......................................................... 48,246,026 --------------- Net change in unrealized appreciation (depreciation) on: Investments ............................................................................ (158,101,555) Translation of assets and liabilities denominated in foreign currencies ................ (440,297) --------------- Net change in unrealized appreciation (depreciation) ............................. (158,541,852) --------------- Net realized and unrealized gain (loss) ...................................................... (110,295,826) --------------- Net increase (decrease) in net assets resulting from operations .............................. $ (91,218,533) ---------------
26 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Financial Services Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
--------------------------------- YEAR ENDED DECEMBER 31, --------------------------------- 2007 2006 --------------------------------- Increase (decrease) in net assets: Operations: Net investment income .................................................................. $ 19,077,293 $ 11,544,118 Net realized gain (loss) from investments, foreign currency transactions, and synthetic equity swaps .......................................................... 48,246,026 122,729,435 Net change in unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ............. (158,541,852) 21,491,331 --------------------------------- Net increase (decrease) in net assets resulting from operations .................. (91,218,533) 155,764,884 --------------------------------- Distributions to shareholders from: Net investment income: Class Z ............................................................................. (5,237,527) (4,850,586) Class A ............................................................................. (12,467,378) (11,024,582) Class B ............................................................................. (613,237) (643,796) Class C ............................................................................. (3,628,332) (3,167,122) Net realized gains: Class Z ............................................................................. (12,010,868) (21,917,044) Class A ............................................................................. (32,373,433) (56,478,510) Class B ............................................................................. (2,369,277) (4,890,247) Class C ............................................................................. (13,398,613) (23,212,292) --------------------------------- Total distributions to shareholders ....................................................... (82,098,665) (126,184,179) --------------------------------- Capital share transactions: (Note 2) Class Z ............................................................................. (14,311,619) 30,704,932 Class A ............................................................................. (23,031,413) 186,536,002 Class B ............................................................................. (8,804,710) 1,574,660 Class C ............................................................................. (3,068,654) 49,182,992 --------------------------------- Total capital share transactions .......................................................... (49,216,396) 267,998,586 --------------------------------- Redemption fees ........................................................................... 10,203 4,102 --------------------------------- Net increase (decrease) in net assets ............................................ (222,523,391) 297,583,393 Net assets: Beginning of year ......................................................................... 1,043,032,469 745,449,076 --------------------------------- End of year ............................................................................... $ 820,509,078 $1,043,032,469 ================================= Distributions in excess of net investment income included in net assets: End of year ............................................................................... $ (1,283,860) $ (6,961,272) =================================
Annual Report | The accompanying notes are an integral part of these financial statements. | 27 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Fund Inc. (Series Fund) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of six separate funds. The Mutual Financial Services Fund (Fund) included in this report is diversified. The financial statements of the remaining funds in the Series Fund are presented separately. The Fund offers four classes of shares: Class Z, Class A, Class B and Class C. 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. 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 28 | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) (including the reliability) of the value of a portfolio security held by the Fund. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. 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. FOREIGN CURRENCY CONTRACTS 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. A foreign exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. Realized and unrealized gains and losses on these contracts are included in the Statement of Operations. Annual Report | 29 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. FOREIGN CURRENCY CONTRACTS (CONTINUED) The Fund may also enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates or to gain exposure to certain foreign currencies. These contracts are valued daily by the Fund and the unrealized gains or losses on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, are included in the Statement of Assets and Liabilities. 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. 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 short 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 (margin account). Periodically, payments are made to recognize changes in value of the contract resulting from interest on the notional value of the contract, market value changes in the underlying security, and/or dividends paid by the issuer of the underlying security. The Fund recognizes a realized gain or loss when cash is received from, or paid to, the broker. Synthetic equity swaps are valued daily by the Fund and the unrealized gains or losses on the contracts (as measured by the difference between the contract amount plus or minus cash received or paid and the market value of the underlying securities) are recorded in the Statement of Operations. The margin account and any net unrealized gains or losses on open synthetic equity swaps are included in the Statement of Assets and Liabilities. 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 or index 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 30 | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) E. OPTIONS (CONTINUED) 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. 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. SECURITIES LENDING The Fund may loan securities to certain brokers through a securities lending agent for which it receives initial cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of Fund business each day; any additional collateral required due to changes in security values is delivered to the Fund on the next business day. 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. At December 31, 2007, the fund had no securities on loan. H. INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy 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 on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. Annual Report | 31 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) I. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. 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 accounting principles generally accepted in the United States of America. 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. 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. 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. Differences in per share distributions, by class, are generally due to differences in class specific expenses. J. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. K. 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. 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. 32 | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 1. GUARANTEES AND INDEMNIFICATIONS Under the Series Funds' 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. Currently, the Fund expects the risk of loss to be remote. 2. CAPITAL STOCK At December 31, 2007, there were 500 million shares authorized ($0.001 par value). Transactions in the Fund's shares were as follows:
------------------------------------------------------------ YEAR ENDED DECEMBER 31, 2007 2006 ------------------------------------------------------------ SHARES AMOUNT SHARES AMOUNT ------------------------------------------------------------ CLASS Z SHARES Shares sold ....................... 1,142,965 $ 25,747,515 1,247,626 $ 28,944,258 Shares issued in reinvestment of distributions ................... 798,044 15,799,592 1,108,120 24,688,386 Shares redeemed ................... (2,578,954) (55,858,726) (987,955) (22,927,712) ------------------------------------------------------------ Net increase (decrease) ........... (637,945) $ (14,311,619) 1,367,791 $ 30,704,932 ============================================================ CLASS A SHARES: Shares sold ....................... 8,273,263 $ 185,555,532 10,652,294 $ 248,569,023 Shares issued in reinvestment of distributions ................... 2,082,149 41,350,983 2,801,174 62,452,788 Shares redeemed ................... (11,440,654) (249,937,928) (5,391,463) (124,485,809) ------------------------------------------------------------ Net increase (decrease) ........... (1,085,242) $ (23,031,413) 8,062,005 $ 186,536,002 ============================================================ CLASS B SHARES: Shares sold ....................... 91,173 $ 1,940,538 158,560 $ 3,562,328 Shares issued in reinvestment of distributions ................... 141,355 2,759,025 232,836 5,067,757 Shares redeemed ................... (636,193) (13,504,273) (312,782) (7,055,425) ------------------------------------------------------------ Net increase (decrease) ........... (403,665) $ (8,804,710) 78,614 $ 1,574,660 ============================================================ CLASS C SHARES: Shares sold ....................... 2,125,234 $ 47,085,730 2,318,404 $ 53,362,559 Shares issued in reinvestment of distributions ................... 769,413 15,205,291 1,051,613 23,298,391 Shares redeemed ................... (3,045,901) (65,359,675) (1,197,941) (27,477,958) ------------------------------------------------------------ Net increase (decrease) ........... (151,254) $ (3,068,654) 2,172,076 $ 49,182,992 ============================================================
Annual Report | 33 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 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 Transfer agent Services) 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. 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 plans, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B and C compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. 34 | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ............................................... 0.35% 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: Sales charges retained net of commissions paid to unaffiliated broker/dealers .................... $ 397,538 Contingent deferred sales charges retained ........ $ 77,496 E. TRANSFER AGENT FEES For the year ended December 31, 2007, the Fund paid transfer agent fees of $1,799,866, of which $963,561 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, 2007, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES The Fund has reviewed the tax positions taken on federal income tax returns, for each of the three open tax years and as of December 31, 2007 and has determined that no provision for income tax is required in the Fund's financial statements. 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, 2007, the Fund deferred realized currency losses of $42,256. The tax character of distributions paid during the years ended December 31, 2007 and 2006, was as follows: ---------------------------- 2007 2006 ---------------------------- Distributions paid from: Ordinary income .............. $ 25,584,387 $ 55,615,319 Long term capital gain ....... 56,514,278 70,568,860 ---------------------------- $ 82,098,665 $ 126,184,179 ============================ Annual Report | 35 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) At December 31, 2007, the cost of investments, net unrealized appreciation (depreciation), and undistributed long term capital gains for income tax purposes were as follows: Cost of investments ......................................... $ 756,564,985 ============= Unrealized appreciation ..................................... $ 143,601,080 Unrealized depreciation ..................................... (92,771,190) ------------- Net unrealized appreciation (depreciation) .................. $ 50,829,890 ------------- Distributable earnings - undistributed long term capital gains .................................................... $ 67,379 ============= Net investment income differs for financial statement and tax purposes primarily due to differing treatments of foreign currency transactions, passive foreign investment company shares, pass-through entity income, bond discounts and premiums, and synthetic equity swaps. Net realized gains (losses) differ for financial statement and tax purposes primarily due to differing treatments of wash sales, foreign currency transactions, passive foreign investment company shares, pass-through entity income, bond discounts and premiums, and synthetic equity swaps. 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the year ended December 31, 2007, aggregated $481,490,663 and $594,875,259, respectively. Transactions in options written during the year ended December 31, 2007, were as follows: --------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED --------------------- Options outstanding at December 31, 2006 ........... -- $ -- Options written .................................... 304 34,696 Options expired .................................... -- -- Options exercised .................................. -- -- Options closed ..................................... -- -- --------------------- Options outstanding at December 31, 2007 ........... 304 $ 34,696 ===================== 36 | Annual Report MUTUAL FINANCIAL SERVICES FUND NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. FORWARD EXCHANGE CONTRACTS At December 31, 2007, the Fund had the following forward exchange contracts outstanding:
------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED UNREALIZED AMOUNT DATE GAIN LOSS ------------------------------------------------------- CONTRACTS TO BUY 22,780,227 Swedish Krona ...... $ 3,590,863 1/15/08 $ -- $ (67,035) 22,123,100 Norwegian Krone .... 4,000,000 2/19/08 65,316 -- CONTRACTS TO SELL 941,552 British Pound ...... 1,906,495 1/10/08 36,230 -- 36,527,120 Euro ............... 50,569,767 1/14/08 -- (2,750,144) 3,896,423 Australian Dollar .. 3,511,944 1/15/08 101,008 -- 242,098,827 Swedish Krona ...... 37,925,346 1/15/08 475,560 -- 5,659,477 New Zeland Dollar .. 4,349,421 2/08/08 31,687 -- 23,692,454 Euro ............... 32,908,819 2/13/08 -- (1,689,103) 15,402,830 Euro ............... 22,493,876 2/13/08 1,234 -- 93,675,796 Norwegian Krone .... 17,110,587 2/19/08 -- (103,175) 160,000,000 Norwegian Krone .... 29,530,236 2/19/08 128,812 -- 19,000,000 Euro ............... 28,208,058 2/25/08 460,575 -- 24,909,869 Swiss Franc ........ 22,288,579 3/07/08 220,622 -- 11,137,874 British Pound ...... 22,534,860 3/10/08 446,554 -- 20,000,000 Euro ............... 27,789,000 3/13/08 -- (1,419,247) 750,615,637 Japanese Yen ....... 6,680,961 3/19/08 -- (108,283) 75,275,931 Danish Krone ....... 14,312,990 4/23/08 -- (427,301) 26,498,616 Euro ............... 37,631,214 4/24/08 -- (1,062,103) 25,621,603 Euro ............... 38,123,920 5/28/08 717,875 -- --------------------------- UNREALIZED GAIN (LOSS) ON FORWARD EXCHANGE CONTRACTS ..... 2,685,473 (7,626,391) --------------------------- NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS .. $ (4,940,918) =============
8. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. Annual Report | 37 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. RESTRICTED SECURITIES (CONTINUED) At December 31, 2007, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- ------------------------------------------------------------------------------------------------------------- PRINCIPAL ACQUISITION AMOUNT/SHARES ISSUER DATES COST VALUE - ------------------------------------------------------------------------------------------------------------- 350,000 Atlantic Banc Holdings Inc. ............ 2/01/07 $ 3,500,000 $ 3,500,000 10,745 Augsburg Re AG ......................... 5/25/06 10,745 -- 123,572 Augsburg Re AG, zero cpn., 1/30/08 .............................. 5/25/06 123,572 -- 1,000,000 Cerberus CG Investor I LLC ............. 7/26/07 1,000,000 841,976 1,000,000 Cerberus CG Investor I LLC, 12.00%, 7/31/14 .............................. 7/26/07 1,000,000 841,976 1,000,000 Cerberus CG Investor II LLC ............ 7/26/07 1,000,000 841,977 1,000,000 Cerberus CG Investor II LLC, 12.00%, 7/31/14 .............................. 7/26/07 1,000,000 841,977 500,000 Cerberus CG Investor III LLC ........... 7/26/07 500,000 420,988 500,000 Cerberus CG Investor III LLC, 12.00%, 7/31/14 .............................. 7/26/07 500,000 420,988 1,255,339 Cerebrus FIM Investors Auto Finance LLC .......................... 11/20/06 1,255,339 673,528 3,763,457 Cerebrus FIM Investors Auto Finance LLC, 12.00%, 11/22/13 ........ 11/20/06 3,763,457 2,019,211 104,566 Cerebrus FIM Investors Commercial Finance LLC .......................... 11/20/06 104,566 56,103 313,698 Cerebrus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 ........ 11/20/06 313,698 168,309 195,993 Cerebrus FIM Investors Commercial Mortgage LLC ......................... 11/20/06 195,993 105,156 587,978 Cerebrus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 ....... 11/20/06 587,978 315,468 958,613 Cerebrus FIM Investors Insurance LLC .................................. 11/20/06 958,613 514,325 2,875,838 Cerebrus FIM Investors Insurance LLC, 12.00%, 11/22/13 ................ 11/20/06 2,875,838 1,542,976 1,784,739 Cerebrus FIM Investors Rescap LLC ...... 11/20/06 1,784,739 957,568 5,354,217 Cerebrus FIM Investors Rescap LLC, 12.00%, 11/22/13 ..................... 11/20/06 5,354,217 2,872,703 2,167 Elephant Capital Holdings Ltd. ......... 8/29/03 - 3/22/07 77,220 1,427,272 496,868 First Chicago Bancorp .................. 11/16/06 6,956,152 6,956,152 551,589 Imagine Group Holdings Ltd. ............ 8/31/04 5,649,099 6,310,178 10,590 NCB Warrant Holdings Ltd., A ........... 12/16/05 -- 628,324 7,480 Olympus Re Holdings Ltd. ............... 12/19/01 748,000 24,499 968,500 Star Asia Finance Ltd., 144A ........... 2/22/07 - 5/18/07 9,836,925 8,958,625 1,020,510 Symetra Financial ...................... 7/27/04 11,730,000 16,348,570 456,903 The Bankshares Inc. .................... 3/22/07 4,569,030 4,569,030 -------------- TOTAL RESTRICTED SECURITIES (7.58% of Net Assets) .......................... $ 62,157,879 ==============
38 | Annual Report Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. UNFUNDED CAPITAL COMMITMENTS At December 31, 2007, the Fund had aggregate unfunded capital commitments to investments of $989,000. 10. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act 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 for the year ended December 31, 2007, were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF SHARES NUMBER OF SHARES VALUE AT HELD AT BEGINNING GROSS GROSS HELD AT END OF END OF INVESTMENT REALIZED CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS YEAR YEAR INCOME GAIN (LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ NON-CONTROLLED AFFILIATES Atlantic Banc Holdings ................ -- 350,000 -- 350,000 $ 3,500,000 $ -- $ -- Coast Financial Holdings Inc. ........... -- 527,780 527,780 -- -- -- (3,902,202) Franconofurt AG ......... 309,280 189,980 -- 499,260 6,112,913 203,232 -- Intergrated Alarm Systems a ............... 1,277,700 -- 1,277,700 -- -- -- -- ------------------------------------------- TOTAL NON-CONTROLLED AFFILIATES (1.17% of Net Assets) .............................. $ 9,612,913 $ 203,232 $ (3,902,202) ===========================================
a Integrated Alarm Systems merged with Protection One Inc. and is not an affiliate at December 31, 2007. 11. REGULATORY AND LITIGATION MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), 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 ("marketing support"), Franklin Resources, Inc. and certain of its subsidiaries (collectively, the "Company"), entered into settlements with certain of those regulators and governmental entities. Specifically, the Company entered into settlements with the SEC, among others, concerning market timing and marketing support. On June 6, 2007, the SEC posted for public comment the proposed plan of distribution for the market timing settlement. Once the SEC approves the final plan of distribution, disbursements of settlement monies will be made promptly to individuals who were shareholders of the designated funds during the relevant period, in accordance with the terms and conditions of the settlement and plan. In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, Company directors, fund directors, and 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.). The lawsuits relate to the industry practices referenced above. Annual Report | 39 Mutual Financial Services Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. REGULATORY AND LITIGATION MATTERS (CONTINUED) The Company and fund management 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. 12. NEW ACCOUNTING PRONOUNCEMENT In September 2006, Financial Accounting Standards Board (FASB) issued FASB Statement No. 157, "Fair Value Measurement" (SFAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Fund believes the adoption of SFAS 157 will have no material impact on its financial statements. 40 | Annual Report Mutual Financial Services Fund REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF THE MUTUAL FINANCIAL SERVICES FUND: We have audited the accompanying statement of assets and liabilities of the Mutual Financial Services Fund (one of the Funds constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2007, 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, 2007, by correspondence with the custodian and brokers. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the Mutual Financial Services Fund of the Franklin Mutual Series Fund Inc. at December 31, 2007, 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 14, 2008 Annual Report | 41 Mutual Financial Services 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 $40,819,007 as a long term capital gain dividend for the fiscal year ended December 31, 2007. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $24,713,557 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2007. In January 2008, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2007. 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)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $4,222,687 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, 2007. Under Section 854(b)(2) of the Code, the Fund designates 22.15% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2007. At December 31, 2007, more than 50% of the Mutual Financial Services Fund's total assets were invested in securities of foreign issuers. In most instances, foreign taxes were withheld from income 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, pursuant to Section 853 of the Code. This designation will allow shareholders of record on December 20, 2007, 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 table provides a detailed analysis of foreign tax paid, foreign source income, and foreign qualified dividends as designated by the Fund, to Class A, Class B, Class C and Class Z shareholders of record. RECORD DATE: 12/20/2007
- ---------------------------------------------------------------------------------------------- FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED CLASS PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - ---------------------------------------------------------------------------------------------- Class A ......................... $ 0.0635 $ 0.4162 $ 0.3262 Class B ......................... $ 0.0635 $ 0.3081 $ 0.2415 Class C ......................... $ 0.0635 $ 0.3188 $ 0.2499 Class Z ......................... $ 0.0635 $ 0.4591 $ 0.3600
42 | Annual Report Mutual Financial Services Fund TAX DESIGNATION (UNAUDITED) (CONTINUED) 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 2008, shareholders will receive Form 1099-DIV which will include their share of taxes paid and foreign source income distributed during the calendar year 2007. 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 2007 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 brackets). 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 | 43 Mutual Financial Services 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 None C/o Franklin Mutual Advisers, LLC 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, Stern School of Business, New York University; editor and author of numerous financial publications; financial consultant; a director to numerous financial publishing organizations; and FORMERLY, Vice Director, Salomon Center, Stern School of Business, New York University. - ---------------------------------------------------------------------------------------------------------------------------------- ANN TORRE BATES (1958) Director Since 1994 7 SLM Corporation (Sallie Mae) c/o Franklin Mutual Advisers, LLC and Allied Capital 101 John F. Kennedy Parkway Corporation (financial Short Hills, NJ 07078-2789 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 14 Franklin Templeton Emerging c/o Franklin Mutual Advisers, LLC Markets Debt Opportunities 101 John F. Kennedy Parkway 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); and FORMERLY, Chairman, Fiduciary Trust International Funds; Executive Vice President, L.F Rothschild Fund Management, Inc.; President and Director, Merit Mutualfunds; President, Underwriting Division and Director, National Securities & Research Corporation; Governor, Investment Company Instituteand Chairman, ICI Public Information Committee. - ---------------------------------------------------------------------------------------------------------------------------------- BRUCE A. MACPHERSON (1930) Director Since 1974 7 None C/o Franklin Mutual Advisers, LLC 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). - ----------------------------------------------------------------------------------------------------------------------------------
44 | 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 - ---------------------------------------------------------------------------------------------------------------------------------- CHARLES RUBENS II (1930) Director Since 1998 14 None c/o Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ---------------------------------------------------------------------------------------------------------------------------------- ROBERT E. WADE (1946) Director and Director Since 34 EL Oro and Exploration CO., c/o Franklin Mutual Advisers, LLC Chairman 1991 and p.l.c. (investments) and ARC 101 John F. Kennedy Parkway of the Board Chairman of the Wireless Solutions, Inc. Short Hills, NJ 07078-2789 Board since 2005 (wireless components and network products). 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 - ---------------------------------------------------------------------------------------------------------------------------------- **GREGORY E. JOHNSON (1961) Director Since April 2007 92 None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, President and Chief Executive Officer, Franklin Resources, Inc.; President, Templeton Worldwide, Inc.; Director, Templeton Asset Management Ltd.; and officer and/or Director or trustee, as the Case may be, of Some of the Other Subsidiaries of Franklin Resources, Inc. and of 33 of the investment companies in Franklin Templeton Investments. - ---------------------------------------------------------------------------------------------------------------------------------- **PETER A. LANGERMAN (1955) Director, Director Since 7 None c/o Franklin Mutual Advisers, LLC President April 2007 and 101 John F. Kennedy Parkway and chief President and Short Hills, NJ 07078-2702 Executive Chief Executive Officer - Officer - Investment Investment Management Management since 2005 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; officer and/or director, as the Case may be, of three of the investment companies in Franklin Templeton Investments; and FORMERLY, Director, New Jersey's Division of Investment. - ---------------------------------------------------------------------------------------------------------------------------------- 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 | 45
- ---------------------------------------------------------------------------------------------------------------------------------- NUMBER OF PORTFOLIOS IN NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD - ---------------------------------------------------------------------------------------------------------------------------------- JAMES M. DAVIS (1952) Chief Chief Compliance Not Applicable Not Applicable One Franklin Parkway Compliance Officer since San Mateo, CA 94403-1906 Officer and 2004 and Vice Vice President President - AML - AML Compliance since Compliance 2006 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ---------------------------------------------------------------------------------------------------------------------------------- MICHAEL J. EMBLER (1964) Senior Vice Since 2005 Not Applicable Not Applicable 101 JOhn F. Kennedy Parkway President Short Hills, NJ 07078-2789 and Chief Investment Officer 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. - ---------------------------------------------------------------------------------------------------------------------------------- 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 some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments. - ---------------------------------------------------------------------------------------------------------------------------------- STEVEN J. GRAY (1955) Secretary Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Templeton Investments; Secretary, Franklin Advisory Services, LLC, Franklin Mutual Advisers, LLC and Franklin Templeton Distributors, Inc.; and officer of 41 of the investment companies in Franklin Templeton Investments. - ---------------------------------------------------------------------------------------------------------------------------------- GREGORY R. SEWARD (1956) Treasurer Since 2005 Not Applicable Not Applicable 500 East Broward Blvd. Suite 2100 Fort Lauderdale, FL 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 18 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPMorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ----------------------------------------------------------------------------------------------------------------------------------
46 | 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 - ---------------------------------------------------------------------------------------------------------------------------------- CRAIG S. TYLE (1960) Vice President Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 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). - ---------------------------------------------------------------------------------------------------------------------------------- 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 some of the other subsidiaries of Franklin Resources, INC. and of 46 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 manager or affiliated investment managers. ** Gregory E. Johnson is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer and director of Franklin Resources, Inc., which is the parent company of the Fund's investment manager and distributor. Peter A. Langerman is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, which is the Fund's investment manager. Note 1: Officer information is current as of the date of this report. It is possible that after this date, information about officers may change. Note 2: Prior to December 31, 2007, William J. Lippman, Leonard Rubin and Anne M. Tatlock ceased to be directors of the Fund. THE FUND'S BOARD 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 | 47 Mutual Financial Services Fund SHAREHOLDER INFORMATION PROXY VOTING POLICIES AND PROCEDURES The Fund has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at 1-954/527-7678 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. 48 | Annual Report [GRAPHIC OMITTED] DECEMBER 31, 2007 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 ...................................................... 26 Notes to Financial Statements ............................................. 30 Report of Independent Registered Public Accounting Firm ................... 43 Tax Designation ........................................................... 44 Board Members and Officers ................................................ 46 Shareholder Information ................................................... 50 - -------------------------------------------------------------------------------- Shareholder Letter - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN - -------------------------------------------------------------------------------- CLASS Z 12/31/07 - -------------------------------------------------------------------------------- 1-Year +17.15% - -------------------------------------------------------------------------------- 5-Year +23.24% - -------------------------------------------------------------------------------- 10-Year +15.97% - -------------------------------------------------------------------------------- Dear Shareholder: We are pleased to bring you the annual report for Mutual European Fund. The year 2007 was a tale of two halves for the region's stock markets. European equities generally enjoyed a strong first half of the year, driven by solid economic data, ample liquidity and sustained merger and acquisition activity across a number of sectors. In the second half of the year, however, the emergence of a credit market crisis, centered on U.S. subprime mortgage lending, brought a quick end to the pervasive feeling of optimism, if not complacency, that characterized prior months. A sudden drop of confidence and liquidity led to significant turmoil in global financial markets, which was stabilized following massive interventions by the major central banks, including the European Central Bank (ECB). Although not the root of the crisis, European equities suffered from volatility brought about by uncertainty, particularly in the region's financial sector. A surge in the value of the main European currencies relative to the U.S. dollar, particularly the euro, as well as a rise in global energy and input costs, provided an added dimension to the newfound pessimism affecting European equity investors. Against this backdrop, Mutual European Fund - Class Z posted a gain of +17.15% for the 12 months ended December 31, 2007. This compared favorably with the Morgan Stanley - -------------------------------------------------------------------------------- eDELIVERY DETAILS Log in at franklintempleton.com and click on eDelivery. Shareholders who are registered at franklintempleton.com can receive these reports via email. Not all accounts are eligible for eDelivery. - ----------------------------------------------------- NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE - ----------------------------------------------------- Not part of the annual report | 1 Capital International (MSCI) All Country (AC) Europe Index, which returned +15.17% in U.S. dollar terms for the same period. 1 Despite the challenging environment, a number of positive factors contributed to Fund performance this year. Various tobacco, industrial and utility companies we owned made strong gains. One notable exception to the gloom surrounding financial equities was the Fund's investments in several European securities exchanges that performed quite well this year. Fund shareholders also benefited somewhat from the fact that we were less than fully hedged back into U.S. dollars, reflecting our cautious view regarding the dollar. The Fund's overall exposure to the European financial sector negatively impacted Fund performance during the year, although having been underweighted in the sector throughout the period relative to the benchmark index proved helpful. The spreading contagion of the credit crisis hurt valuations of most financial institutions around the world, including some well-capitalized European banks with no direct and little secondary exposure to risky U.S. assets. We believe the markets have overly penalized many stocks in the sector and, accordingly, have added selectively to certain holdings. We believe that over our longer-term horizon Fund shareholders should benefit from these positions. As we move into 2008, most companies in the European region face the combined effect on their operating margins of a strong euro, persistently high energy and commodity prices, and a less dynamic world economy dominated by an expected slowdown in U.S. economic growth. This is hardly a recipe for a strong bull market, at least in the very near term. Fear and volatility can breed opportunity for patient investors. We are happy to take advantage of market stresses to buy great companies at bargain prices. We believe the extended credit crisis has created a number of such opportunities. We have no crystal ball telling us precisely when the U.S. housing market will turn positive, where oil prices or the euro will be a year from now, or whether the ECB will become more accommodating. However, we believe that if we stick to our discipline of buying good businesses at cheap valuations, we should reach our goal of limiting our downside risk while generating consistent returns over the long term. 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. 2 | Not part of the annual report In the enclosed annual report for Mutual European Fund, the portfolio managers discuss market conditions, investment management decisions and Fund performance during the period under review. You will also find performance data and financial information. Please remember that all securities markets fluctuate, as do mutual fund share prices. If you would like more frequent updates, FRANKLINTEMPLETON.COM provides daily prices, monthly performance figures, portfolio holdings and other information. You can also access your account, buy and sell shares, read timely articles, and find helpful financial planning tools. We hope you will take advantage of these online services. As always, we thank you for your trust and support and extend our best wishes for a happy, healthy and prosperous 2008. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC /s/ Michael J. Embler Michael J. Embler Senior Vice President and Chief Investment Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF DECEMBER 31, 2007. THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY, INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED RELIABLE. Not part of the annual report | 3 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, as defined in the prospectus. - -------------------------------------------------------------------------------- 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, 2007. PERFORMANCE OVERVIEW Mutual European Fund - Class Z posted a cumulative total return of +17.15% for the 12 months ended December 31, 2007. The Fund outperformed its benchmark, the Morgan Stanley Capital International (MSCI) All Country (AC) Europe Index, which returned +15.17% (in U.S. dollars) for the same period. 1 You can find the Fund's long-term performance data in the Performance Summary beginning on page 9. ECONOMIC AND MARKET OVERVIEW In spite of elevated energy prices and widespread fears of contagion from the deteriorating U.S. housing situation, the global economy remained resilient in 2007. Consumer and corporate demand strength, particularly in China and other developing economies, generally favorable employment and accommodative monetary policies continued to underpin the current expansionary period that began in 2002. These factors also contributed to the strength of global equity markets during 2007. However, concerns about slower growth and declining asset quality surfaced in the first quarter. These were initially centered on the U.S. subprime mortgage market but spread in August to global capital markets. Difficulties in 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 assessing risk and the value of collateral in the structured finance industry contributed to declining risk appetite among lenders and investors. The private equity industry, which relies on the availability of cheap credit, played a pivotal role in several large and high-profile acquisitions and helped boost merger and acquisition activity in the first half of the year. This was an important driver of equity performance, but as liquidity dried up in the second half of the year, significantly slower money flows from private equity weighed on market performance. However, global merger and acquisition activity still reached record levels. The staggering $4.5 trillion of deals announced in 2007 eclipsed the previous record from 2006 by 24%. 2 To alleviate the credit crunch and restore investor confidence, the world's major central banks infused capital into the system, and the U.S. Federal Reserve Board reduced its target interest rate by a full percentage point. However, credit and equity markets continued to face headwinds as write-downs and losses from subprime mortgage financing affected many large financial institutions toward the end of the year, and equity prices remained volatile. For the year, however, global and non-U.S. equity markets registered the fifth consecutive year of double-digit total returns, making this an exceptionally strong period for investors in global equities. Broad-based stock performance by European and Asian shares at least doubled that of U.S. stocks, while emerging market equity returns more than tripled those in developed markets. Led by the BRIC countries, Brazil, Russia, India and China, emerging market economies continued to grow at accelerated rates, supporting elevated prices for oil and other commodities. At the same time, investment inflows from developed economies continued to underpin equity prices in emerging markets. In addition, U.S. dollar weakness versus the currencies of many major trading partners enhanced equity returns for U.S.-based investors holding stocks denominated in these currencies. 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 GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/07 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] Germany 20.7% France 17.3% U.K. 13.1% Netherlands 8.2% Switzerland 8.0% Italy 3.8% Norway 3.6% U.S. 3.6% Spain 3.5% Denmark 3.5% Sweden 3.3% Belgium 1.8% Finland 1.4% Other 1.0% Short-Term Investments & Other Net Assets 7.2% 2. Source: "For Deal Makers, Tale of Two Halves," THE WALL STREET JOURNAL, 1/2/08. Annual Report | 5 TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/07 - -------------------------------------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------------------------------------- Food Products 7.2% - -------------------------------------------------------------------------------- Commercial Banks 7.0% - -------------------------------------------------------------------------------- Tobacco 6.3% - -------------------------------------------------------------------------------- Diversified Financial Services 5.0% - -------------------------------------------------------------------------------- Industrial Conglomerates 4.9% - -------------------------------------------------------------------------------- Insurance 4.9% - -------------------------------------------------------------------------------- Oil, Gas & Consumable Fuels 4.3% - -------------------------------------------------------------------------------- Machinery 4.1% - -------------------------------------------------------------------------------- Air Freight & Logistics 4.1% - -------------------------------------------------------------------------------- Media 3.6% - -------------------------------------------------------------------------------- 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 to focus our efforts on analyzing business fundamentals and assessing the value of company assets and liabilities. MANAGER'S DISCUSSION Among the Fund's top contributors to performance in 2007 were Norwegian industrial conglomerate Orkla, German securities exchange platform provider Deutsche Boerse, and German electronics and industrial engineering firm Siemens. Orkla is one of Norway's largest conglomerates with operations in several industries including consumer goods, and metals and minerals. In 2007, Orkla was again among the top performing stocks, advancing 52% in local currency terms. Orkla shares performed well after the company reported strong operational performance, and its management pursued two transactions that we believed could create value. Orkla increased its stake in the solar energy solution company Renewable Energy Corp. (REC) from 27.5% to 40.0% in February 2007, at a discount of over 25% to REC's market price at the time. As REC's stock appreciated more than 142% in local currency during the reporting period, Orkla's ownership in REC benefited its own share price. Orkla also merged its aluminum profile business, Sapa, with Alcoa's aluminum extrusion business. The Fund's investment in Deutsche Boerse rose 97% in local currency as cash equity trading volumes surged 63%, the company resumed its buyback of shares, and investors appeared to recognize hidden potential embedded in the business. The exchange industry grew as such quasi-monopolies benefited from higher volumes in different product classes and generally beneficial pricing trends. Deutsche Boerse also tapped into the structural potential of its business by announcing future cost cutting of over 100 million euros per year to enhance profitability. We believed future exchange consolidation prospects placed the company in a good position for ongoing shareholder returns. Therefore, we increased our holdings in Deutsche Boerse throughout 2007 when we found the price attractive. Our investment in Siemens rose 47% in local currency during the year under review. Following an investigation into bribery allegations and the resignations of key executives, Dr. Gerhard Cromme was appointed chairman of the company's Supervisory Board and Peter Loescher became chief executive officer 6 | Annual Report (CEO). The new CEO set out a strategy to streamline Siemens' organizational structure and realign its divisions. Siemens also announced a substantial share buyback plan, the first in the company's 160-year history. At period-end, Siemens was still trading at a discount to its peers, which we believed was unwarranted. In our view, the "low-hanging fruit" opportunities to cut costs at Siemens are potentially significant -- from outsourcing manufacturing to low-cost countries, to global procurement and the elimination of unnecessary layers of middle management. Although the Fund performed well in 2007, some of our positions detracted from performance. Among them were Belgium-based Fortis, whose operations are focused in banking, insurance and investment management; U.K.-based cable company Virgin Media; and Banca Popolare, an Italian financial services provider. Fortis declined 30% in local currency as the company raised a significant amount of capital to fund its acquisition of ABN Amro's Dutch retail banking, asset management and private banking units. Fortis was part of a consortium with Royal Bank of Scotland and Banco Santander, which together acquired these businesses and by year-end had completed the largest bank acquisition in European history. Fortis' stock price also came under pressure after the company announced weak third quarter 2007 operating results for its banking and insurance businesses. Shares of Virgin Media, the U.K.'s largest cable company, declined 32% in local currency during 2007. First, the company was forced to pull several British Sky Broadcasting (BSkyB) channels from its offering due to a pricing dispute, which resulted in a reduction in subscribers. Second, the contraction of the leveraged corporate debt market scuttled a plan announced in June to sell the company. Finally, Virgin Media posted mediocre earnings results in 2007. The Fund's shares of Banca Popolare declined 34% in local currency during 2007. As global economic fears became more evident in the markets, Banca Popolare suffered as investors became hesitant about the bank's growth prospects for the next few years. Also, concerns developed over the potential integration of its $10 billion BPI (Banca Popolare Italiana) acquisition and lost revenue stemming from the company's Banca Italease subsidiary. At period-end, we believed Banca Popolare should be able to weather an economic downturn due to its regional focus and potential future earnings growth from merger integration. Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during 2007, the Fund benefited to the extent it was not fully hedged. TOP 10 HOLDINGS 12/31/07 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- Siemens AG 2.5% INDUSTRIAL CONGLOMERATES, GERMANY - -------------------------------------------------------------------------------- British American Tobacco PLC 2.4% TOBACCO, U.K. - -------------------------------------------------------------------------------- Imperial Tobacco Group PLC 2.4% TOBACCO, U.K. - -------------------------------------------------------------------------------- Carrefour SA 2.3% FOOD & STAPLES RETAILING, FRANCE - -------------------------------------------------------------------------------- RWE AG 2.3% MULTI-UTILITIES, GERMANY - -------------------------------------------------------------------------------- Koninklijke Philips Electronics NV 2.2% HOUSEHOLD DURABLES, NETHERLANDS - -------------------------------------------------------------------------------- DaimlerChrysler AG 2.1% AUTOMOBILES, GERMANY - -------------------------------------------------------------------------------- Nestle SA 2.1% FOOD PRODUCTS, SWITZERLAND - -------------------------------------------------------------------------------- Deutsche Boerse AG 2.0% DIVERSIFIED FINANCIAL SERVICES, GERMANY - -------------------------------------------------------------------------------- Deutsche Post AG 2.0% AIR FREIGHT & LOGISTICS, GERMANY - -------------------------------------------------------------------------------- Annual Report | 7 Thank you for your continued participation in Mutual European Fund. We look forward to serving your future investment needs. [PHOTO OMITTED] /s/ Philippe Brugere-Trelat Philippe Brugere-Trelat Portfolio Manager [PHOTO OMITTED] /s/ Katrina Dudley Katrina Dudley, CFA Assistant Portfolio Manager Mutual European Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2007, 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 INVESTMENT MANAGER 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 lead portfolio manager for Mutual European Fund since 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. KATRINA DUDLEY has been assistant portfolio manager for Mutual European Fund since 2007. She follows industrial companies (foreign and domestic) including transportation, manufacturers, machinery, electrical equipment and general industrial, as well as domestic health care companies. Prior to joining Franklin Templeton Investments in 2002, Ms. Dudley was an investment analyst at Federated Investors, Inc., responsible for the technology and health care sectors. From 1995 to 2001, Ms. Dudley was a senior manager in the corporate finance division of Ernst & Young LLP, where she specialized in valuation and litigation consulting. - -------------------------------------------------------------------------------- 8 | Annual Report Performance Summary as of 12/31/07 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 12/31/07 12/31/06 - --------------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.73 $26.32 $24.59 - --------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - --------------------------------------------------------------------------------------- Dividend Income $0.6772 - --------------------------------------------------------------------------------------- Long-Term Capital Gain $1.7898 - --------------------------------------------------------------------------------------- TOTAL $2.4670 - --------------------------------------------------------------------------------------- CLASS A (SYMBOL: TEMIX) CHANGE 12/31/07 12/31/06 - --------------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.67 $25.86 $24.19 - --------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - --------------------------------------------------------------------------------------- Dividend Income $0.6012 - --------------------------------------------------------------------------------------- Long-Term Capital Gain $1.7898 - --------------------------------------------------------------------------------------- TOTAL $2.3910 - --------------------------------------------------------------------------------------- CLASS B (SYMBOL: TEUBX) CHANGE 12/31/07 12/31/06 - --------------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.59 $25.24 $23.65 - --------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - --------------------------------------------------------------------------------------- Dividend Income $0.3998 - --------------------------------------------------------------------------------------- Long-Term Capital Gain $1.7898 - --------------------------------------------------------------------------------------- TOTAL $2.1896 - --------------------------------------------------------------------------------------- CLASS C (SYMBOL: TEURX) CHANGE 12/31/07 12/31/06 - --------------------------------------------------------------------------------------- Net Asset Value (NAV) +$1.65 $25.82 $24.17 - --------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - --------------------------------------------------------------------------------------- Dividend Income $0.4172 - --------------------------------------------------------------------------------------- Long-Term Capital Gain $1.7898 - --------------------------------------------------------------------------------------- TOTAL $2.2070 - ---------------------------------------------------------------------------------------
Annual Report | 9 Performance Summary (CONTINUED) PERFORMANCE 1 CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z: NO SALES CHARGES; 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. THE FUND MAY CHARGE A 2% FEE ON REDEMPTIONS MADE WITHIN SEVEN DAYS OF PURCHASE.
- ------------------------------------------------------------------------------------------------------ CLASS Z 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------------ Cumulative Total Return 2 +17.15% +184.30% +339.91% - ------------------------------------------------------------------------------------------------------ Average Annual Total Return 3 +17.15% +23.24% +15.97% - ------------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $11,715 $28,430 $43,991 - ------------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 1.05% - ------------------------------------------------------------------------------------------------------ CLASS A 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------------ Cumulative Total Return 2 +16.86% +179.82% +323.55% - ------------------------------------------------------------------------------------------------------ Average Annual Total Return 3 +10.13% +21.41% +14.84% - ------------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $11,013 $26,378 $39,910 - ------------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 1.34% - ------------------------------------------------------------------------------------------------------ CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - ------------------------------------------------------------------------------------------------------ Cumulative Total Return 2 +16.05% +170.52% +286.33% - ------------------------------------------------------------------------------------------------------ Average Annual Total Return 3 +12.05% +21.84% +16.20% - ------------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $11,205 $26,852 $38,633 - ------------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 2.05% - ------------------------------------------------------------------------------------------------------ CLASS C 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------------ Cumulative Total Return 2 +16.03% +170.57% +298.68% - ------------------------------------------------------------------------------------------------------ Average Annual Total Return 3 +15.03% +22.03% +14.83% - ------------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $11,503 $27,057 $39,868 - ------------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 2.05% - ------------------------------------------------------------------------------------------------------
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 (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE MUTUAL EUROPEAN FUND MSCI AC EUROPE INDEX 6 - -------------------------------------------------------------------------------- 1/1/1998 $10,000 $10,000 1/31/1998 $10,167 $10,359 2/28/1998 $10,722 $11,170 3/31/1998 $11,492 $11,968 4/30/1998 $11,786 $12,227 5/31/1998 $12,198 $12,417 6/30/1998 $11,921 $12,539 7/31/1998 $11,825 $12,809 8/31/1998 $10,479 $11,140 9/30/1998 $ 9,517 $10,695 10/31/1998 $ 9,794 $11,553 11/30/1998 $10,430 $12,183 12/31/1998 $10,474 $12,718 1/31/1999 $10,499 $12,655 2/28/1999 $10,632 $12,348 3/31/1999 $10,874 $12,492 4/30/1999 $11,509 $12,881 5/31/1999 $11,534 $12,286 6/30/1999 $11,935 $12,496 7/31/1999 $11,952 $12,633 8/31/1999 $12,062 $12,766 9/30/1999 $12,062 $12,676 10/31/1999 $12,451 $13,134 11/30/1999 $13,499 $13,502 12/31/1999 $15,376 $14,924 1/31/2000 $15,722 $13,880 2/29/2000 $17,734 $14,595 3/31/2000 $17,188 $14,946 4/30/2000 $16,715 $14,293 5/31/2000 $16,742 $14,170 6/30/2000 $16,754 $14,442 7/31/2000 $16,860 $14,214 8/31/2000 $17,282 $14,035 9/30/2000 $16,860 $13,380 10/31/2000 $17,052 $13,272 11/30/2000 $16,984 $12,708 12/31/2000 $17,600 $13,601 1/31/2001 $18,088 $13,622 2/28/2001 $17,986 $12,405 3/31/2001 $17,283 $11,484 4/30/2001 $17,804 $12,324 5/31/2001 $18,111 $11,742 6/30/2001 $17,998 $11,302 7/31/2001 $17,896 $11,315 8/31/2001 $17,725 $11,027 9/30/2001 $15,700 $ 9,918 10/31/2001 $16,212 $10,247 11/30/2001 $16,553 $10,669 12/31/2001 $16,766 $10,950 1/31/2002 $17,127 $10,397 2/28/2002 $17,383 $10,382 3/31/2002 $18,069 $10,955 4/30/2002 $18,441 $10,890 5/31/2002 $18,545 $10,868 6/30/2002 $17,837 $10,485 7/31/2002 $16,453 $ 9,324 8/31/2002 $16,477 $ 9,328 9/30/2002 $15,433 $ 8,111 10/31/2002 $15,480 $ 8,895 11/30/2002 $15,632 $ 9,335 12/31/2002 $15,474 $ 8,996 1/31/2003 $15,044 $ 8,573 2/28/2003 $14,579 $ 8,303 3/31/2003 $14,794 $ 8,177 4/30/2003 $15,975 $ 9,300 5/31/2003 $16,989 $ 9,920 6/30/2003 $17,215 $10,023 7/31/2003 $17,611 $10,223 8/31/2003 $17,983 $10,223 9/30/2003 $18,271 $10,436 10/31/2003 $19,040 $11,123 11/30/2003 $19,736 $11,593 12/31/2003 $20,555 $12,551 1/31/2004 $20,788 $12,703 2/29/2004 $21,474 $13,087 3/31/2004 $21,388 $12,709 4/30/2004 $21,217 $12,593 5/31/2004 $21,278 $12,804 6/30/2004 $21,756 $12,983 7/31/2004 $21,509 $12,629 8/31/2004 $21,571 $12,650 9/30/2004 $22,213 $13,165 10/31/2004 $22,781 $13,646 11/30/2004 $23,991 $14,638 12/31/2004 $24,991 $15,263 1/31/2005 $24,574 $14,992 2/28/2005 $25,827 $15,768 3/31/2005 $25,282 $15,353 4/30/2005 $24,953 $14,980 5/31/2005 $25,358 $15,060 6/30/2005 $25,954 $15,288 7/31/2005 $26,921 $15,867 8/31/2005 $27,366 $16,135 9/30/2005 $27,976 $16,564 10/31/2005 $27,544 $16,022 11/30/2005 $28,333 $16,322 12/31/2005 $29,498 $16,897 1/31/2006 $30,481 $18,040 2/28/2006 $31,312 $18,081 3/31/2006 $32,850 $18,757 4/30/2006 $33,251 $19,764 5/31/2006 $32,088 $19,189 6/30/2006 $32,199 $19,261 7/31/2006 $32,523 $19,585 8/31/2006 $33,693 $20,201 9/30/2006 $34,285 $20,323 10/31/2006 $35,399 $21,203 11/30/2006 $36,019 $22,005 12/31/2006 $37,552 $22,715 1/31/2007 $38,759 $22,819 2/28/2007 $38,285 $22,723 3/31/2007 $40,133 $23,574 4/30/2007 $42,164 $25,069 5/31/2007 $43,661 $25,511 6/30/2007 $43,837 $25,593 7/31/2007 $42,843 $25,125 8/31/2007 $42,552 $24,813 9/30/2007 $43,990 $26,114 10/31/2007 $45,243 $27,398 11/30/2007 $44,112 $26,556 12/31/2007 $43,991 $26,159 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------------ CLASS Z 12/31/07 - ------------------------------------------------ 1-Year +17.15% - ------------------------------------------------ 5-Year +23.24% - ------------------------------------------------ 10-Year +15.97% - ------------------------------------------------ CLASS A (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE MUTUAL EUROPEAN FUND MSCI AC EUROPE INDEX 6 - -------------------------------------------------------------------------------- 1/1/1998 $ 9,423 $10,000 1/31/1998 $ 9,580 $10,359 2/28/1998 $10,090 $11,170 3/31/1998 $10,802 $11,968 4/30/1998 $11,072 $12,227 5/31/1998 $11,462 $12,417 6/30/1998 $11,199 $12,539 7/31/1998 $11,089 $12,809 8/31/1998 $ 9,826 $11,140 9/30/1998 $ 8,917 $10,695 10/31/1998 $ 9,171 $11,553 11/30/1998 $ 9,764 $12,183 12/31/1998 $ 9,806 $12,718 1/31/1999 $ 9,830 $12,655 2/28/1999 $ 9,948 $12,348 3/31/1999 $10,168 $12,492 4/30/1999 $10,765 $12,881 5/31/1999 $10,773 $12,286 6/30/1999 $11,141 $12,496 7/31/1999 $11,157 $12,633 8/31/1999 $11,261 $12,766 9/30/1999 $11,253 $12,676 10/31/1999 $11,611 $13,134 11/30/1999 $12,581 $13,502 12/31/1999 $14,322 $14,924 1/31/2000 $14,638 $13,880 2/29/2000 $16,511 $14,595 3/31/2000 $15,998 $14,946 4/30/2000 $15,553 $14,293 5/31/2000 $15,579 $14,170 6/30/2000 $15,576 $14,442 7/31/2000 $15,675 $14,214 8/31/2000 $16,053 $14,035 9/30/2000 $15,666 $13,380 10/31/2000 $15,837 $13,272 11/30/2000 $15,774 $12,708 12/31/2000 $16,337 $13,601 1/31/2001 $16,784 $13,622 2/28/2001 $16,677 $12,405 3/31/2001 $16,028 $11,484 4/30/2001 $16,507 $12,324 5/31/2001 $16,784 $11,742 6/30/2001 $16,674 $11,302 7/31/2001 $16,567 $11,315 8/31/2001 $16,418 $11,027 9/30/2001 $14,530 $ 9,918 10/31/2001 $15,010 $10,247 11/30/2001 $15,319 $10,669 12/31/2001 $15,511 $10,950 1/31/2002 $15,837 $10,397 2/28/2002 $16,065 $10,382 3/31/2002 $16,696 $10,955 4/30/2002 $17,033 $10,890 5/31/2002 $17,131 $10,868 6/30/2002 $16,464 $10,485 7/31/2002 $15,193 $ 9,324 8/31/2002 $15,204 $ 9,328 9/30/2002 $14,239 $ 8,111 10/31/2002 $14,272 $ 8,895 11/30/2002 $14,404 $ 9,335 12/31/2002 $14,263 $ 8,996 1/31/2003 $13,863 $ 8,573 2/28/2003 $13,429 $ 8,303 3/31/2003 $13,618 $ 8,177 4/30/2003 $14,708 $ 9,300 5/31/2003 $15,630 $ 9,920 6/30/2003 $15,837 $10,023 7/31/2003 $16,195 $10,223 8/31/2003 $16,542 $10,223 9/30/2003 $16,799 $10,436 10/31/2003 $17,492 $11,123 11/30/2003 $18,130 $11,593 12/31/2003 $18,875 $12,551 1/31/2004 $19,080 $12,703 2/29/2004 $19,706 $13,087 3/31/2004 $19,627 $12,709 4/30/2004 $19,467 $12,593 5/31/2004 $19,513 $12,804 6/30/2004 $19,951 $12,983 7/31/2004 $19,711 $12,629 8/31/2004 $19,768 $12,650 9/30/2004 $20,342 $13,165 10/31/2004 $20,858 $13,646 11/30/2004 $21,971 $14,638 12/31/2004 $22,882 $15,263 1/31/2005 $22,483 $14,992 2/28/2005 $23,622 $15,768 3/31/2005 $23,117 $15,353 4/30/2005 $22,812 $14,980 5/31/2005 $23,176 $15,060 6/30/2005 $23,709 $15,288 7/31/2005 $24,581 $15,867 8/31/2005 $24,982 $16,135 9/30/2005 $25,536 $16,564 10/31/2005 $25,136 $16,022 11/30/2005 $25,855 $16,322 12/31/2005 $26,900 $16,897 1/31/2006 $27,797 $18,040 2/28/2006 $28,540 $18,081 3/31/2006 $29,937 $18,757 4/30/2006 $30,296 $19,764 5/31/2006 $29,232 $19,189 6/30/2006 $29,327 $19,261 7/31/2006 $29,627 $19,585 8/31/2006 $30,684 $20,201 9/30/2006 $31,218 $20,323 10/31/2006 $32,210 $21,203 11/30/2006 $32,771 $22,005 12/31/2006 $34,151 $22,715 1/31/2007 $35,252 $22,819 2/28/2007 $34,800 $22,723 3/31/2007 $36,480 $23,574 4/30/2007 $38,316 $25,069 5/31/2007 $39,671 $25,511 6/30/2007 $39,825 $25,593 7/31/2007 $38,921 $25,125 8/31/2007 $38,638 $24,813 9/30/2007 $39,938 $26,114 10/31/2007 $41,069 $27,398 11/30/2007 $40,023 $26,556 12/31/2007 $39,910 $26,159 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------------ CLASS A 12/31/07 - ------------------------------------------------ 1-Year +10.13% - ------------------------------------------------ 5-Year +21.41% - ------------------------------------------------ 10-Year +14.84% - ------------------------------------------------ Annual Report | 11 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------- CLASS B 12/31/07 - ------------------------------------------- 1-Year +12.05% - ------------------------------------------- 5-Year +21.84% - ------------------------------------------- Since Inception (1/1/99) +16.20% - ------------------------------------------- CLASS B (1/1/99-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE MUTUAL EUROPEAN FUND MSCI AC EUROPE INDEX 6 - ---------------------------------------------------------- 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 1/31/2006 $ 27,089 $ 14,185 2/28/2006 $ 27,802 $ 14,217 3/31/2006 $ 29,141 $ 14,748 4/30/2006 $ 29,472 $ 15,540 5/31/2006 $ 28,414 $ 15,088 6/30/2006 $ 28,491 $ 15,145 7/31/2006 $ 28,764 $ 15,399 8/31/2006 $ 29,776 $ 15,884 9/30/2006 $ 30,269 $ 15,980 10/31/2006 $ 31,229 $ 16,672 11/30/2006 $ 31,735 $ 17,302 12/31/2006 $ 33,058 $ 17,860 1/31/2007 $ 34,122 $ 17,942 2/28/2007 $ 33,686 $ 17,867 3/31/2007 $ 35,313 $ 18,536 4/30/2007 $ 37,089 $ 19,711 5/31/2007 $ 38,402 $ 20,059 6/30/2007 $ 38,552 $ 20,123 7/31/2007 $ 37,677 $ 19,756 8/31/2007 $ 37,402 $ 19,510 9/30/2007 $ 38,658 $ 20,533 10/31/2007 $ 39,752 $ 21,543 11/30/2007 $ 38,739 $ 20,881 12/31/2007 $ 38,633 $ 20,569 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------------- CLASS C 12/31/07 - ------------------------------------------- 1-Year +15.03% - ------------------------------------------- 5-Year +22.03% - ------------------------------------------- 10-Year +14.83% - ------------------------------------------- CLASS C (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE MUTUAL EUROPEAN FUND MSCI AC EUROPE INDEX 6 - ---------------------------------------------------------- 1/1/1998 $ 10,000 $ 10,000 1/31/1998 $ 10,160 $ 10,359 2/28/1998 $ 10,710 $ 11,170 3/31/1998 $ 11,468 $ 11,968 4/30/1998 $ 11,748 $ 12,227 5/31/1998 $ 12,155 $ 12,417 6/30/1998 $ 11,868 $ 12,539 7/31/1998 $ 11,757 $ 12,809 8/31/1998 $ 10,405 $ 11,140 9/30/1998 $ 9,438 $ 10,695 10/31/1998 $ 9,709 $ 11,553 11/30/1998 $ 10,331 $ 12,183 12/31/1998 $ 10,366 $ 12,718 1/31/1999 $ 10,382 $ 12,655 2/28/1999 $ 10,507 $ 12,348 3/31/1999 $ 10,740 $ 12,492 4/30/1999 $ 11,356 $ 12,881 5/31/1999 $ 11,365 $ 12,286 6/30/1999 $ 11,753 $ 12,496 7/31/1999 $ 11,761 $ 12,633 8/31/1999 $ 11,862 $ 12,766 9/30/1999 $ 11,853 $ 12,676 10/31/1999 $ 12,223 $ 13,134 11/30/1999 $ 13,241 $ 13,502 12/31/1999 $ 15,071 $ 14,924 1/31/2000 $ 15,395 $ 13,880 2/29/2000 $ 17,366 $ 14,595 3/31/2000 $ 16,817 $ 14,946 4/30/2000 $ 16,340 $ 14,293 5/31/2000 $ 16,358 $ 14,170 6/30/2000 $ 16,347 $ 14,442 7/31/2000 $ 16,442 $ 14,214 8/31/2000 $ 16,839 $ 14,035 9/30/2000 $ 16,413 $ 13,380 10/31/2000 $ 16,593 $ 13,272 11/30/2000 $ 16,508 $ 12,708 12/31/2000 $ 17,094 $ 13,601 1/31/2001 $ 17,550 $ 13,622 2/28/2001 $ 17,439 $ 12,405 3/31/2001 $ 16,739 $ 11,484 4/30/2001 $ 17,228 $ 12,324 5/31/2001 $ 17,517 $ 11,742 6/30/2001 $ 17,393 $ 11,302 7/31/2001 $ 17,270 $ 11,315 8/31/2001 $ 17,103 $ 11,027 9/30/2001 $ 15,129 $ 9,918 10/31/2001 $ 15,620 $ 10,247 11/30/2001 $ 15,932 $ 10,669 12/31/2001 $ 16,129 $ 10,950 1/31/2002 $ 16,456 $ 10,397 2/28/2002 $ 16,693 $ 10,382 3/31/2002 $ 17,325 $ 10,955 4/30/2002 $ 17,675 $ 10,890 5/31/2002 $ 17,766 $ 10,868 6/30/2002 $ 17,066 $ 10,485 7/31/2002 $ 15,734 $ 9,324 8/31/2002 $ 15,746 $ 9,328 9/30/2002 $ 14,733 $ 8,111 10/31/2002 $ 14,756 $ 8,895 11/30/2002 $ 14,893 $ 9,335 12/31/2002 $ 14,735 $ 8,996 1/31/2003 $ 14,310 $ 8,573 2/28/2003 $ 13,863 $ 8,303 3/31/2003 $ 14,047 $ 8,177 4/30/2003 $ 15,159 $ 9,300 5/31/2003 $ 16,111 $ 9,920 6/30/2003 $ 16,305 $ 10,023 7/31/2003 $ 16,663 $ 10,223 8/31/2003 $ 17,009 $ 10,223 9/30/2003 $ 17,274 $ 10,436 10/31/2003 $ 17,977 $ 11,123 11/30/2003 $ 18,623 $ 11,593 12/31/2003 $ 19,375 $ 12,551 1/31/2004 $ 19,574 $ 12,703 2/29/2004 $ 20,204 $ 13,087 3/31/2004 $ 20,111 $ 12,709 4/30/2004 $ 19,947 $ 12,593 5/31/2004 $ 19,982 $ 12,804 6/30/2004 $ 20,410 $ 12,983 7/31/2004 $ 20,163 $ 12,629 8/31/2004 $ 20,210 $ 12,650 9/30/2004 $ 20,786 $ 13,165 10/31/2004 $ 21,304 $ 13,646 11/30/2004 $ 22,421 $ 14,638 12/31/2004 $ 23,334 $ 15,263 1/31/2005 $ 22,928 $ 14,992 2/28/2005 $ 24,064 $ 15,768 3/31/2005 $ 23,538 $ 15,353 4/30/2005 $ 23,215 $ 14,980 5/31/2005 $ 23,574 $ 15,060 6/30/2005 $ 24,105 $ 15,288 7/31/2005 $ 24,982 $ 15,867 8/31/2005 $ 25,367 $ 16,135 9/30/2005 $ 25,919 $ 16,564 10/31/2005 $ 25,499 $ 16,022 11/30/2005 $ 26,208 $ 16,322 12/31/2005 $ 27,249 $ 16,897 1/31/2006 $ 28,145 $ 18,040 2/28/2006 $ 28,885 $ 18,081 3/31/2006 $ 30,288 $ 18,757 4/30/2006 $ 30,626 $ 19,764 5/31/2006 $ 29,535 $ 19,189 6/30/2006 $ 29,601 $ 19,261 7/31/2006 $ 29,891 $ 19,585 8/31/2006 $ 30,935 $ 20,201 9/30/2006 $ 31,451 $ 20,323 10/31/2006 $ 32,442 $ 21,203 11/30/2006 $ 32,983 $ 22,005 12/31/2006 $ 34,361 $ 22,715 1/31/2007 $ 35,442 $ 22,819 2/28/2007 $ 34,972 $ 22,723 3/31/2007 $ 36,636 $ 23,574 4/30/2007 $ 38,455 $ 25,069 5/31/2007 $ 39,792 $ 25,511 6/30/2007 $ 39,927 $ 25,593 7/31/2007 $ 38,988 $ 25,125 8/31/2007 $ 38,689 $ 24,813 9/30/2007 $ 39,969 $ 26,114 10/31/2007 $ 41,065 $ 27,398 11/30/2007 $ 40,012 $ 26,556 12/31/2007 $ 39,868 $ 26,159 12 | Annual Report Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. BECAUSE THE FUND INVESTS IN ISSUERS LOCATED IN EUROPE, IT MAY EXPERIENCE GREATER VOLATILITY THAN A 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, WHICH INVOLVE CERTAIN RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, 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. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated. 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. 5. Figures are as stated in the Fund's prospectus current as of the date of this report. 6. 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 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 7/1/07 VALUE 12/31/07 PERIOD* 7/1/07-12/31/07 - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,003.50 $ 5.10 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,020.11 $ 5.14 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $1,000 $1,002.10 $ 6.66 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,018.55 $ 6.72 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 998.60 $10.13 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.07 $10.21 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 998.50 $10.13 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,015.07 $10.21 - --------------------------------------------------------------------------------------------------------
* Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 1.01%; A: 1.32%; B: 2.01%; and C: 2.01%), 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, 2007 2006 2005 2004 2003 -------------------------------------------------------------- CLASS Z PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............................. $ 24.59 $ 21.30 $ 19.75 $ 16.79 $ 12.97 -------------------------------------------------------------- Income from investment operations a: Net investment income b ...................................... 0.46 0.62 0.42 0.37 0.32 Net realized and unrealized gains (losses) ................... 3.74 5.08 3.11 3.21 3.93 -------------------------------------------------------------- Total from investment operations ................................ 4.20 5.70 3.53 3.58 4.25 -------------------------------------------------------------- Less distributions from: Net investment income ........................................ (0.68) (0.66) (0.55) (0.60) (0.43) Net realized gains ........................................... (1.79) (1.75) (1.43) (0.02) -- -------------------------------------------------------------- Total distributions ............................................. (2.47) (2.41) (1.98) (0.62) (0.43) -------------------------------------------------------------- Redemption fees ................................................. -- d -- d -- d -- d -- d -------------------------------------------------------------- Net asset value, end of year .................................... $ 26.32 $ 24.59 $ 21.30 $ 19.75 $ 16.79 ============================================================== Total return .................................................... 17.15% 27.30% 18.03% 21.58% 32.84% RATIOS TO AVERAGE NET ASSETS Expenses c ...................................................... 1.04% e 1.05% e 1.05% e 1.07% e 1.08% Expenses - excluding dividend expense on securities sold short .. 1.04% e 1.04% e 1.04% e 1.07% e 1.08% Net investment income ........................................... 1.65% 2.64% 1.99% 2.10% 2.19% SUPPLEMENTAL DATA Net assets, end of year (000's) ................................. $1,250,521 $1,034,000 $788,228 $650,547 $498,667 Portfolio turnover rate ......................................... 39.60% 37.65% 29.84% 33.11% 52.33%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. 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 rounds to less than $0.01. e Benefit of expense reduction rounds to less than 0.01%. 16 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual European Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 2005 2004 2003 -------------------------------------------------------------- CLASS A PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............................. $ 24.19 $ 20.99 $ 19.50 $ 16.59 $ 12.83 -------------------------------------------------------------- Income from investment operations a: Net investment income b ...................................... 0.36 0.56 0.34 0.31 0.26 Net realized and unrealized gains (losses) ................... 3.70 4.98 3.07 3.16 3.88 -------------------------------------------------------------- Total from investment operations ................................ 4.06 5.54 3.41 3.47 4.14 -------------------------------------------------------------- Less distributions from: Net investment income ........................................ (0.60) (0.59) (0.49) (0.54) (0.38) Net realized gains ........................................... (1.79) (1.75) (1.43) (0.02) -- -------------------------------------------------------------- Total distributions ............................................. (2.39) (2.34) (1.92) (0.56) (0.38) -------------------------------------------------------------- Redemption fees ................................................. -- e -- e -- e -- e -- e -------------------------------------------------------------- Net asset value, end of year .................................... $ 25.86 $ 24.19 $ 20.99 $ 19.50 $ 16.59 ============================================================== Total return c .................................................. 16.86% 26.96% 17.56% 21.23% 32.34% RATIOS TO AVERAGE NET ASSETS Expenses d ...................................................... 1.34% f 1.34% f 1.38% f 1.42% f 1.43% Expenses - excluding dividend expense on securities sold short .. 1.34% f 1.33% f 1.37% f 1.42% f 1.43% Net investment income ........................................... 1.35% 2.35% 1.66% 1.75% 1.84% SUPPLEMENTAL DATA Net assets, end of year (000's) ................................. $1,333,176 $ 964,717 $707,995 $545,120 $417,630 Portfolio turnover rate ......................................... 39.60% 37.65% 29.84% 33.11% 52.33%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 17 Mutual European Fund FINANCIAL HIGHLIGHTS (CONTINUED) CLASS B
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 2005 2004 2003 -------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............................. $ 23.65 $ 20.58 $ 19.14 $ 16.31 $ 12.64 -------------------------------------------------------------- Income from investment operations a: Net investment income b ...................................... 0.18 0.38 0.21 0.19 0.16 Net realized and unrealized gains (losses) ................... 3.60 4.87 3.01 3.10 3.81 -------------------------------------------------------------- Total from investment operations ................................ 3.78 5.25 3.22 3.29 3.97 -------------------------------------------------------------- Less distributions from: Net investment income ........................................ (0.40) (0.43) (0.35) (0.44) (0.30) Net realized gains ........................................... (1.79) (1.75) (1.43) (0.02) -- -------------------------------------------------------------- Total distributions ............................................. (2.19) (2.18) (1.78) (0.46) (0.30) -------------------------------------------------------------- Redemption fees ................................................. -- e -- e -- e -- e -- e -------------------------------------------------------------- Net asset value, end of year .................................... $ 25.24 $ 23.65 $ 20.58 $ 19.14 $ 16.31 ============================================================== Total return c .................................................. 16.05% 26.01% 16.87% 20.41% 31.45% RATIOS TO AVERAGE NET ASSETS Expenses d ...................................................... 2.04% f 2.05% f 2.05% f 2.07% f 2.08% Expenses - excluding dividend expense on securities sold short .. 2.04% f 2.04% f 2.04% f 2.07% f 2.08% Net investment income ........................................... 0.65% 1.64% 0.99% 1.10% 1.19% SUPPLEMENTAL DATA Net assets, end of year (000's) ................................. $ 65,317 $ 63,219 $ 55,303 $ 50,216 $ 38,526 Portfolio turnover rate ......................................... 39.60% 37.65% 29.84% 33.11% 52.33%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01. f Benefit of expense reduction rounds to less than 0.01%. 18 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual European Fund FINANCIAL HIGHLIGHTS (CONTINUED) CLASS C
-------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 2005 2004 2003 -------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year .............................. $ 24.17 $ 20.98 $ 19.50 $ 16.60 $ 12.85 -------------------------------------------------------------- Income from investment operations a: Net investment income b ...................................... 0.17 0.38 0.21 0.20 0.17 Net realized and unrealized gains (losses) ................... 3.69 4.99 3.05 3.15 3.87 -------------------------------------------------------------- Total from investment operations ................................ 3.86 5.37 3.26 3.35 4.04 -------------------------------------------------------------- Less distributions from: Net investment income ........................................ (0.42) (0.43) (0.35) (0.43) (0.29) Net realized gains ........................................... (1.79) (1.75) (1.43) (0.02) -- -------------------------------------------------------------- Total distributions ............................................. (2.21) (2.18) (1.78) (0.45) (0.29) -------------------------------------------------------------- Redemption fees ................................................. -- e -- e -- e -- e -- e -------------------------------------------------------------- Net asset value, end of year .................................... $ 25.82 $ 24.17 $ 20.98 $ 19.50 $ 16.60 ============================================================== Total return c .................................................. 16.03% 26.10% 16.78% 20.43% 31.49% RATIOS TO AVERAGE NET ASSETS Expenses d ...................................................... 2.04% f 2.05% f 2.05% f 2.07% f 2.08% Expenses - excluding dividend expense on securities sold short .. 2.04% f 2.04% f 2.04% f 2.07% f 2.08% Net investment income ........................................... 0.65% 1.64% 0.99% 1.10% 1.19% SUPPLEMENTAL DATA Net assets, end of year (000's) ................................. $ 384,861 $ 303,259 $242,894 $205,197 $166,758 Portfolio turnover rate ......................................... 39.60% 37.65% 29.84% 33.11% 52.33%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 19 Mutual European Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007
- ---------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- LONG TERM INVESTMENTS 93.2% COMMON STOCKS AND OTHER EQUITY INTERESTS 90.1% AIR FREIGHT & LOGISTICS 4.1% Deutsche Post AG .................................................. Germany 1,807,249 $ 61,477,998 Geodis SA ......................................................... France 53,673 8,558,083 TNT NV ............................................................ Netherlands 1,303,263 53,729,150 ------------- 123,765,231 ------------- AUTO COMPONENTS 1.1% a Goodyear Tire & Rubber Co. ........................................ United States 1,150,310 32,461,748 ------------- AUTOMOBILES 2.1% Daimler AG ........................................................ Germany 670,054 64,743,003 ------------- BEVERAGES 2.6% Carlsberg AS, A ................................................... Denmark 28,600 3,263,294 Carlsberg AS, B ................................................... Denmark 220,105 26,578,879 Pernod Ricard SA .................................................. France 214,477 49,484,826 ------------- 79,326,999 ------------- CAPITAL MARKETS 0.6% D. Carnegie & Co. AB .............................................. Sweden 855,858 16,612,305 a Gottex Fund Management Holdings Ltd. .............................. Switzerland 9,392 575,189 ------------- 17,187,494 ------------- CHEMICALS 3.5% Koninklijke DSM NV ................................................ Netherlands 676,544 31,919,877 Lanxess ........................................................... Germany 245,850 11,821,840 Linde AG .......................................................... Germany 351,735 46,448,920 Sika AG ........................................................... Switzerland 8,141 15,345,196 ------------- 105,535,833 ------------- COMMERCIAL BANKS 7.0% Aareal Bank AG .................................................... Germany 527,029 23,627,359 a Banco Popolare SpA ................................................ Italy 944,485 20,895,546 BNP Paribas SA .................................................... France 560,850 60,747,320 Danske Bank AS .................................................... Denmark 799,196 31,243,644 Intesa Sanpaolo SpA ............................................... Italy 3,211,557 25,355,510 Royal Bank of Scotland Group PLC .................................. United Kingdom 142,089 1,253,517 a Royal Bank of Scotland Group PLC, ADR ............................. United Kingdom 1,095 9,800 Societe Generale, A ............................................... France 239,500 34,577,451 Swedbank AB, A .................................................... Sweden 383,398 10,851,390 Unione Di Banche Italiane SCPA .................................... Italy 153,175 4,204,711 ------------- 212,766,248 ------------- COMMUNICATIONS EQUIPMENT 0.8% Telefonaktiebolaget LM Ericsson, B ................................ Sweden 9,764,968 22,925,934 Telefonaktiebolaget LM Ericsson, B, ADR ........................... Sweden 67,100 1,566,785 ------------- 24,492,719 ------------- DISTRIBUTORS 0.8% Compania de Distribucion Integral Logista SA ...................... Spain 322,008 23,895,552 -------------
20 | Annual Report Mutual European Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) DIVERSIFIED FINANCIAL SERVICES 5.0% Deutsche Boerse AG ................................................ Germany 312,614 $ 61,930,945 a Fortis VVPR Strip ................................................. Belgium 442,602 6,459 Fortis ............................................................ Belgium 2,117,902 55,880,944 Guinness Peat Group PLC ........................................... United Kingdom 9,258,918 12,348,712 Investor AB, B .................................................... Sweden 589,321 13,398,424 a,b Marconi Corp., Contingent Distribution ............................ United Kingdom 28,582,000 -- Oslo Bors Holding ASA ............................................. Norway 340,000 9,071,672 ------------- 152,637,156 ------------- DIVERSIFIED TELECOMMUNICATION SERVICES 3.3% a,c,d,e AboveNet Inc. ..................................................... United States 88,848 4,442,400 a,d,e AboveNet Inc., stock grants, grant price $20.95, expiration date 9/09/13 ......................................................... United States 117 4,850 a,c,d,e AboveNet Inc., wts., 9/08/08 ...................................... United States 3,214 151,701 a,c,d,e AboveNet Inc., wts., 9/08/10 ...................................... United States 3,781 165,154 Koninklijke (Royal) KPN NV ........................................ Netherlands 2,465,171 44,753,487 Telecom Italia SpA ................................................ Italy 4,158,868 12,897,143 Telefonica SA ..................................................... Spain 1,202,001 38,976,993 ------------- 101,391,728 ------------- ELECTRIC UTILITIES 2.0% E.ON AG ........................................................... Germany 280,020 59,503,115 ------------- ENERGY EQUIPMENT & SERVICES 1.9% a Aker Drilling ASA ................................................. Norway 935,217 7,313,777 Bourbon SA ........................................................ France 373,667 24,440,835 a Compagnie Generale de Geophysique SA .............................. France 47,394 13,487,064 Petroleum Geo-Services ASA ........................................ Norway 233,063 6,765,239 a Seadrill Ltd. ..................................................... Bermuda 266,180 6,489,806 ------------- 58,496,721 ------------- FOOD & STAPLES RETAILING 2.3% Carrefour SA ...................................................... France 906,000 70,458,496 ------------- FOOD PRODUCTS 7.2% Cadbury Schweppes PLC ............................................. United Kingdom 2,622,412 32,357,837 CSM NV ............................................................ Netherlands 816,226 27,515,782 Groupe Danone ..................................................... France 646,940 57,968,468 Leroy Seafood Group ASA ........................................... Norway 348,693 7,057,913 a Lighthouse Caledonia ASA .......................................... Norway 63,111 59,923 a,f Marine Harvest .................................................... Norway 7,424,923 4,768,237 Nestle SA ......................................................... Switzerland 137,037 62,883,198 Premier Foods PLC ................................................. United Kingdom 2,866,042 11,645,626 Rieber & Son ASA .................................................. Norway 1,548,350 14,886,611 ------------- 219,143,595 ------------- HEALTH CARE PROVIDERS & SERVICES 0.9% Rhoen-Klinikum AG ................................................. Germany 859,576 26,869,723 -------------
Annual Report | 21 Mutual European Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) HOTELS, RESTAURANTS & LEISURE 0.4% Accor SA .......................................................... France 149,249 $ 11,914,017 ------------- HOUSEHOLD DURABLES 3.0% Hunter Douglas NV ................................................. Netherlands 358,046 26,481,031 Koninklijke Philips Electronics NV ................................ Netherlands 1,526,224 65,749,746 ------------- 92,230,777 ------------- INDUSTRIAL CONGLOMERATES 4.9% C.I.R. SpA ........................................................ Italy 6,718,106 24,926,842 e Orkla ASA ......................................................... Norway 2,445,205 47,356,303 Siemens AG ........................................................ Germany 485,275 76,781,531 ------------- 149,064,676 ------------- INSURANCE 4.9% Allianz SE ........................................................ Germany 155,530 33,610,117 Assicurazioni Generali SpA ........................................ Italy 313,073 14,163,375 a,c,d Augsburg Re AG .................................................... Switzerland 17,909 -- a Lancashire Holdings Ltd. .......................................... United Kingdom 1,639,810 11,835,486 a,c,d Olympus Re Holdings Ltd. .......................................... United States 16,080 52,665 Resolution PLC .................................................... United Kingdom 1,175,848 16,623,140 White Mountains Insurance Group Ltd. .............................. United States 57,372 29,492,077 Zurich Financial Services AG ...................................... Switzerland 143,320 42,052,506 ------------- 147,829,366 ------------- MACHINERY 4.1% AB SKF, B ......................................................... Sweden 2,060,828 34,901,197 Kone OYJ, B ....................................................... Finland 579,380 40,525,686 Schindler Holding AG .............................................. Switzerland 406,243 26,169,907 Schindler Holding AG, Registered .................................. Switzerland 352,315 22,695,901 ------------- 124,292,691 ------------- MARINE 1.5% A.P. Moller - Maersk AS ........................................... Denmark 4,214 44,865,760 ------------- MEDIA 3.6% Eutelsat Communications ........................................... France 1,138,898 33,822,733 JC Decaux SA ...................................................... France 557,979 21,904,310 a Premiere AG ....................................................... Germany 702,674 13,135,980 Virgin Media Inc. ................................................. United Kingdom 1,632,505 27,981,136 WPP Group PLC ..................................................... United Kingdom 990,271 12,730,495 ------------- 109,574,654 ------------- METALS & MINING 2.9% g Anglo American PLC ................................................ United Kingdom 550,500 33,689,534 a,c,d,h,i Globe Specialty Metals Inc., 144A ................................. United States 2,830,952 32,561,610 Rio Tinto PLC, ADR ................................................ United Kingdom 48,090 20,192,991 ------------- 86,444,135 -------------
22 | Annual Report Mutual European Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ---------------------------------------------------------------------------------------------------------------------------------- LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MULTI-UTILITIES 3.4% RWE AG ............................................................ Germany 489,204 $ 68,857,568 Suez SA ........................................................... France 482,571 32,796,455 ------------- 101,654,023 ------------- MULTILINE RETAIL 0.7% Jelmoli Holding AG ................................................ Switzerland 8,844 21,189,075 ------------- OIL, GAS & CONSUMABLE FUELS 4.3% BP PLC ............................................................ United Kingdom 2,260,780 27,626,151 Eni SpA ........................................................... Italy 361,200 13,204,286 a,c,d,i Euro Wagon LP ..................................................... Jersey Islands 16,127,149 20,266,754 Ganger Rolf ....................................................... Norway 321,090 12,998,399 Royal Dutch Shell PLC, A .......................................... United Kingdom 629,550 26,413,596 Total SA, B ....................................................... France 364,598 30,237,883 ------------- 130,747,069 ------------- PAPER & FOREST PRODUCTS 0.2% Ahlstrom OYJ, A ................................................... Finland 31,651 756,128 Mondi Ltd. ........................................................ South Africa 98,470 930,340 Mondi PLC ......................................................... United Kingdom 345,275 2,915,688 ------------- 4,602,156 ------------- PHARMACEUTICALS 2.7% Bristol-Myers Squibb Co. .......................................... United States 406,850 10,789,662 Novartis AG ....................................................... Switzerland 948,307 51,967,759 Sanofi-Aventis .................................................... France 203,171 18,673,418 ------------- 81,430,839 ------------- REAL ESTATE 0.1% a,c Canary Wharf Group PLC ............................................ United Kingdom 192,100 1,919,916 Patrizia Immobilien AG ............................................ Germany 248,769 1,862,401 ------------- 3,782,317 ------------- THRIFTS & MORTGAGE FINANCE 1.1% Hypo Real Estate Holding AG ....................................... Germany 628,843 33,303,406 ------------- TOBACCO 6.3% Altadis SA ........................................................ Spain 601,830 43,659,328 British American Tobacco PLC ...................................... United Kingdom 1,897,291 74,077,013 Imperial Tobacco Group PLC ........................................ United Kingdom 1,349,474 72,717,873 ------------- 190,454,214 ------------- TRADING COMPANIES & DISTRIBUTORS 0.8% Kloeckner & Co. AG ................................................ Germany 328,293 13,079,276 Wolseley PLC ...................................................... United Kingdom 789,203 11,635,354 ------------- 24,714,630 ------------- TRANSPORTATION INFRASTRUCTURE 0.0% j a Groupe Eurotunnel SA, wts., 12/30/11 .............................. France 444,134 149,074 -------------
Annual Report | 23 Mutual European Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- --------------------------------------------------------------------------------------------------------------------------------- SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - --------------------------------------------------------------------------------------------------------------------------------- LONG TERM INVESTMENTS (CONTINUED) TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $1,858,122,232) .......................................... $2,730,918,240 --------------- PREFERRED STOCKS 1.0% AUTOMOBILES 1.0% Porsche Automobile Holding SE, pfd. ............................... Germany 14,588 29,402,234 --------------- DIVERSIFIED TELECOMMUNICATION SERVICES 0.0% j d PTV Inc., 10.00%, pfd., A ......................................... United Kingdom 46,841 56,209 --------------- TOTAL PREFERRED STOCKS (COST $36,792,744) ......................... 29,458,443 --------------- OPTIONS PURCHASED 0.3% PUT OPTIONS 0.3% a Dow Jones EUROSTOXX 50, exercise price $3,900.00, expiration date 3/21/08, contracts ......................................... United States 103,530 5,567,843 a Dow Jones EUROSTOXX 50, exercise price $4,000.00, expiration date 3/20/08, contracts ......................................... United States 67,416 3,031,140 a Volkswagen AG, exercise price $160.00, expiration date 3/20/08, contracts ....................................................... Germany 558 787,445 --------------- TOTAL OPTIONS PURCHASED (COST $9,505,474) ......................... 9,386,428 --------------- ------------------- PRINCIPAL AMOUNT K ------------------- CORPORATE BONDS & NOTES 1.8% c,d Augsburg Re AG, zero cpn., 1/30/08 ................................ Switzerland 205,953 -- Groupe Eurotunnel SA, cvt., 3.00%, 6/28/09 ................................................. France 8,000 EUR 25,685 3.00%, 6/28/09 ................................................. France 9,616 GBP 42,035 3.00%, 7/28/10 ................................................. France 3,439,700 EUR 9,913,959 3.00%, 7/28/10 ................................................. France 2,751,256 GBP 10,796,552 6.00%, 7/28/10 ................................................. France 7,624,700 EUR 14,965,957 6.00%, 7/28/10 ................................................. France 7,302,720 GBP 19,516,138 sub. bond T1, 3.00%, 7/28/08 ................................... France 8,000 EUR 28,603 sub. bond T1, 3.00%, 7/28/08 ................................... France 9,616 GBP 46,812 --------------- TOTAL CORPORATE BONDS & NOTES (COST $53,136,501) .................. 55,335,741 --------------- TOTAL LONG TERM INVESTMENTS (COST $1,957,556,951) ................. 2,825,098,852 --------------- SHORT TERM INVESTMENTS 4.6% FOREIGN GOVERNMENT AND AGENCY SECURITIES (COST $41,903,555) 1.4% l Germany Treasury Bills, 1/16/08 - 3/19/08 ......................... Germany 30,000,000 EUR 43,583,048 --------------- U.S. GOVERNMENT AND AGENCY SECURITIES 3.2% l,m FHLB, 1/02/08 - 10/31/08 .......................................... United States 90,126,000 89,673,144 l U.S. Treasury Bills, 4/24/08 - 5/01/08 ............................ United States 8,750,000 8,658,879 --------------- TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $98,243,554) ............................................. 98,332,023 --------------- TOTAL INVESTMENTS BEFORE MONEY MARKET FUND (COST $2,097,704,060) .......................................... 2,967,013,923 ---------------
24 | Annual Report Mutual European Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- --------------------------------------------------------------------------------------------------------------------------------- COUNTRY SHARES VALUE - --------------------------------------------------------------------------------------------------------------------------------- SHORT TERM INVESTMENTS (CONTINUED) n INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES 0.0% j MONEY MARKET FUND (COST $416,459) 0.0% j o Bank of New York Institutional Cash Reserve Fund, 5.06% ........... United States 416,459 $ 416,459 --------------- TOTAL INVESTMENTS (COST $2,098,120,519) 97.8% ..................... 2,967,430,382 OPTIONS WRITTEN 0.0% j ............................................ (463,158) SECURITIES SOLD SHORT (0.3)% ...................................... (9,483,416) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (0.4)% .......... (11,128,736) OTHER ASSETS, LESS LIABILITIES 2.9% ............................... 87,519,284 --------------- NET ASSETS 100.0% ................................................. $3,033,874,356 =============== p OPTIONS WRITTEN (PREMIUMS RECEIVED $1,311,609) 0.0% j METALS & MINING 0.0% j Anglo American PLC, Mar. 34.00 Calls, 3/20/08 ..................... United Kingdom 180,000 463,158 --------------- q SECURITIES SOLD SHORT (PROCEEDS $10,439,921) 0.3% METALS & MINING 0.3% BHP Billiton Ltd., ADR ............................................ Australia 135,400 $ 9,483,416 ---------------
CURRENCY ABBREVIATIONS EUR - Euro GBP - British Pound SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FHLB- Federal Home Loan Bank a Non-income producing for the twelve months ended December 31, 2007. b Contingent distributions represent the right to receive additional distributions, if any, during the reorganization of the underlying company. Shares represent total underlying principal of debt securities. c Security has been deemed illiquid because it may not be able to be sold within seven days. At December 31, 2007, the aggregate value of these securities was $59,560,200, representing 1.96% of net assets. d See Note 10 regarding restricted securities. e See Note 12 regarding other considerations. f A portion or all of the security is on loan as of December 31, 2007. See Note 1(g). g A portion or all of the security is held in connection with written option contracts open at year end. h 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, 2007, the value of this security was $32,561,610, representing 1.07% of net assets. i See Note 11 regarding holdings of 5% voting securities. j Rounds to less than 0.1% of net assets. k The principal amount is stated in U.S. dollars unless otherwise indicated. l The security is traded on a discount basis with no stated coupon rate. m Security or a portion of the security has been segregated as collateral for securities sold short. At December 31, 2007, the value of securities and or cash pledged amounted to $4,931,855. n See Note 1(g) regarding securities on loan. o The rate shown is the annualized seven-day yield at period end. p See Note 1(e) regarding written options. q See Note 1(f) regarding securities sold short. Annual Report | The accompanying notes are an integral part of these financial statements. | 25 Mutual European Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2007 Assets: Investments in securities: Cost - Unaffiliated issuers ........................................................... $ 2,079,606,740 Cost - Controlled affiliated issuers (Note 11) ........................................ 6,213,779 Cost - Non-controlled affiliated issuers (Note 11) .................................... 12,300,000 ---------------- Total cost of investments ............................................................. $ 2,098,120,519 ================ Value - Unaffiliated issuers (includes securities loaned in the amount of $381,286) ... $ 2,914,602,018 Value - Controlled affiliated issuers (Note 11) ....................................... 20,266,754 Value - Non-controlled affiliated issuers (Note 11) ................................... 32,561,610 ---------------- Total value of investments ............................................................ 2,967,430,382 Cash ..................................................................................... 48,636 Cash on deposits with brokers for securities sold short .................................. 11,132,324 Foreign currency, at value (cost $50,621,169) ............................................ 50,701,105 Receivables: Investment securities sold ............................................................ 26,797,710 Capital shares sold ................................................................... 9,516,730 Dividends and interest ................................................................ 2,848,993 Unrealized gain on forward exchange contracts (Note 8) ................................... 14,793,441 Due from broker - synthetic equity swaps (Note 7) ........................................ 1,367,905 ---------------- Total assets ....................................................................... 3,084,637,226 ---------------- Liabilities: Payables: Investment securities purchased ....................................................... 4,072,520 Capital shares redeemed ............................................................... 5,945,548 Affiliates ............................................................................ 3,786,352 Options written, at value (premiums received $1,311,609) ................................. 463,158 Securities sold short, at value (proceeds $10,439,921) ................................... 9,483,416 Payable upon return of securities loaned ................................................. 416,459 Unrealized loss on forward exchange contracts (Note 8) ................................... 25,922,177 Accrued expenses and other liabilities ................................................... 673,240 ---------------- Total liabilities .................................................................. 50,762,870 ---------------- Net assets, at value ............................................................ $ 3,033,874,356 ================ Net assets consist of: Paid-in capital ....................................................................... $ 2,097,426,036 Undistributed net investment income ................................................... 1,270,818 Net unrealized appreciation (depreciation) ............................................ 859,173,222 Accumulated net realized gain (loss) .................................................. 76,004,280 ---------------- Net assets, at value ............................................................ $ 3,033,874,356 ================
26 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual European Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2007 CLASS Z: Net assets, at value .................................................... $ 1,250,520,575 ================= Shares outstanding ...................................................... 47,517,394 ================= Net asset value and maximum offering price per share a ................. $ 26.32 ================= CLASS A: Net assets, at value .................................................... $ 1,333,175,770 ================= Shares outstanding ...................................................... 51,562,303 ================= Net asset value per share a ............................................ $ 25.86 ================= Maximum offering price per share (net asset value per share / 94.25%) ... $ 27.44 ================= CLASS B: Net assets, at value .................................................... $ 65,317,335 ================= Shares outstanding ...................................................... 2,588,193 ================= Net asset value and maximum offering price per share a ................. $ 25.24 ================= CLASS C: Net assets, at value .................................................... $ 384,860,676 ================= Shares outstanding ...................................................... 14,907,676 ================= Net asset value and maximum offering price per share a ................. $ 25.82 =================
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 | The accompanying notes are an integral part of these financial statements. | 27 Mutual European Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2007 Investment income: Dividends: (net of foreign taxes of $8,113,846) Unaffiliated issuers ................................................... $ 64,775,053 Interest - Unaffiliated issuers ........................................... 10,426,939 Income from securities loaned ............................................. 60,892 -------------- Total investment income ............................................. 75,262,884 -------------- Expenses: Management fees (Note 3a) ................................................. 21,701,340 Administrative fees (Note 3b) ............................................. 2,129,808 Distribution fees: (Note 3c) Class A ................................................................ 3,570,221 Class B ................................................................ 668,051 Class C ................................................................ 3,564,351 Transfer agent fees (Note 3e) ............................................. 3,708,753 Custodian fees (Note 4) ................................................... 691,405 Reports to shareholders ................................................... 202,132 Registration and filing fees .............................................. 179,919 Professional fees ......................................................... 300,596 Directors' fees and expenses .............................................. 45,114 Dividends on securities sold short ........................................ 133,119 Other ..................................................................... 70,384 -------------- Total expenses ...................................................... 36,965,193 -------------- Expense reductions (Note 4) ......................................... (6,038) -------------- Net expenses ..................................................... 36,959,155 -------------- Net investment income ......................................... 38,303,729 -------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments - Unaffiliated issuers ..................................... 388,411,326 Written options ........................................................ 2,175,993 Foreign currency transactions .......................................... (97,696,806) Securities sold short .................................................. (1,658,657) Synthetic equity swaps ................................................. 1,130,288 -------------- Net realized gain (loss) ...................................... 292,362,144 -------------- Net change in unrealized appreciation (depreciation) on: Investments ............................................................ 68,268,634 Translation of assets and liabilities denominated in foreign currencies .......................................................... 8,378,171 -------------- Net change in unrealized appreciation (depreciation) .......... 76,646,805 -------------- Net realized and unrealized gain (loss) ...................................... 369,008,949 -------------- Net increase (decrease) in net assets resulting from operations .............. $ 407,312,678 ==============
28 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual European Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
----------------------------------- YEAR ENDED DECEMBER 31, ----------------------------------- 2007 2006 ----------------------------------- Increase (decrease) in net assets: Operations: Net investment income .......................................................... $ 38,303,729 $ 48,679,709 Net realized gain (loss) from investments, written options, securities sold short, synthetic equity swaps, and foreign currency transactions ....... 292,362,144 165,059,805 Net change in unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies ..... 76,646,805 275,194,899 ----------------------------------- Net increase (decrease) in net assets resulting from operations .......... 407,312,678 488,934,413 ----------------------------------- Distributions to shareholders from: Net investment income: Class Z ..................................................................... (29,457,929) (25,490,896) Class A ..................................................................... (28,346,985) (21,883,241) Class B ..................................................................... (963,571) (1,076,058) Class C ..................................................................... (5,742,756) (5,010,522) Net realized gains: Class Z ..................................................................... (77,736,999) (67,718,539) Class A ..................................................................... (84,839,816) (64,399,240) Class B ..................................................................... (4,299,240) (4,442,824) Class C ..................................................................... (24,673,303) (20,535,458) ----------------------------------- Total distributions to shareholders ............................................... (256,060,599) (210,556,778) ----------------------------------- Capital share transactions: (Note 2) Class Z ..................................................................... 143,919,250 120,412,634 Class A ..................................................................... 313,315,961 148,931,566 Class B ..................................................................... (2,507,612) (183,563) Class C ..................................................................... 62,682,338 23,232,387 ----------------------------------- Total capital share transactions .................................................. 517,409,937 292,393,024 ----------------------------------- Redemption fees ................................................................... 17,946 4,943 ----------------------------------- Net increase (decrease) in net assets .................................... 668,679,962 570,775,602 Net assets: Beginning of year ................................................................. 2,365,194,394 1,794,418,792 ----------------------------------- End of year ....................................................................... $ 3,033,874,356 $ 2,365,194,394 =================================== Undistributed net investment income included in net assets: End of year ....................................................................... $ 1,270,818 $ 379,335 ===================================
Annual Report | The accompanying notes are an integral part of these financial statements. | 29 Mutual European Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Fund Inc. (Series Fund) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of six separate funds. The Mutual European Fund (Fund) included in this report is diversified. The financial statements of the remaining funds in the Series Fund are presented separately. The Fund offers four classes of shares: Class Z, Class A, Class B and Class C. 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. 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. 30 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. 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. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. 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. Annual Report | 31 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. FOREIGN CURRENCY CONTRACTS 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. A foreign exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. Realized and unrealized gains and losses on these contracts are included in the Statement of Operations. The Fund may also enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates or to gain exposure to certain foreign currencies. These contracts are valued daily by the Fund and the unrealized gains or losses on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, are included in the Statement of Assets and Liabilities. 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. 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 short 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 (margin account). Periodically, payments are made to recognize changes in value of the contract resulting from interest on the notional value of the contract, market value changes in the underlying security, and/or dividends paid by the issuer of the underlying security. The Fund recognizes a realized gain or loss when cash is received from, or paid to, the broker. Synthetic equity swaps are valued daily by the fund and the unrealized gains or losses on the contracts (as measured by the difference between the contract amount plus or minus cash received or paid and the market value of the underlying securities) are recorded in the Statement of Operations. The margin account and any net unrealized gains or losses on open synthetic equity swaps are included in the Statement of Assets and Liabilities. 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. 32 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 or index 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. 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. SECURITIES LENDING The Fund may loan securities to certain brokers through a securities lending agent for which it receives initial cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of fund business each day; any additional collateral required due to changes in security values is delivered to the fund on the next business day. 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 | 33 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. INCOME TAXES No provision has been made for U.S. income taxes because it is the Fund's policy 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 on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. I. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. 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 accounting principles generally accepted in the United States of America. 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. 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. 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. Differences in per share distributions, by class, are generally due to differences in class specific expenses. J. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. 34 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. 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. 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. L. GUARANTEES AND INDEMNIFICATIONS Under the Series Funds' 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. Currently, the Fund expects the risk of loss to be remote. 2. CAPITAL STOCK At December 31, 2007, there were 500 million shares authorized ($0.001 par value). Transactions in the Fund's shares were as follows:
----------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 ----------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ----------------------------------------------------------- CLASS Z SHARES: Shares sold ....................................... 8,588,857 $ 236,306,017 5,431,574 $ 128,493,327 Shares issued in reinvestment of distributions ................................... 3,857,533 100,877,481 3,685,023 87,880,555 Shares redeemed ................................... (6,985,286) (193,264,248) (4,074,596) (95,961,248) ----------------------------------------------------------- Net increase (decrease) ........................... 5,461,104 $ 143,919,250 5,042,001 $ 120,412,634 =========================================================== CLASS A SHARES: Shares sold ....................................... 20,148,175 $ 546,548,967 13,363,218 $ 312,765,819 Shares issued in reinvestment of distributions ................................... 3,168,417 81,378,544 2,734,585 64,182,231 Shares redeemed ................................... (11,635,446) (314,611,550) (9,943,698) (228,016,484) ----------------------------------------------------------- Net increase (decrease) ........................... 11,681,146 $ 313,315,961 6,154,105 $ 148,931,566 =========================================================== CLASS B SHARES: Shares sold ....................................... 235,198 $ 6,197,833 187,205 $ 4,290,688 Shares issued in reinvestment of distributions ................................... 188,922 4,735,011 218,877 5,014,535 Shares redeemed ................................... (508,873) (13,440,456) (420,926) (9,488,786) ----------------------------------------------------------- Net increase (decrease) ........................... (84,753) $ (2,507,612) (14,844) $ (183,563) ===========================================================
Annual Report | 35 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
----------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 ----------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ----------------------------------------------------------- CLASS C SHARES: Shares sold ....................................... 3,438,611 $ 92,797,536 1,898,556 $ 44,159,577 Shares issued in reinvestment of distributions ................................... 1,035,139 26,543,890 973,872 22,793,189 Shares redeemed ................................... (2,115,360) (56,659,088) (1,898,057) (43,720,379) ----------------------------------------------------------- Net increase (decrease) ........................... 2,358,390 $ 62,682,338 974,371 $ 23,232,387 ===========================================================
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 - -------------------------------------------------------------------------------- 0.800% 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. 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 36 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. TRANSACTIONS WITH AFFILIATES (CONTINUED) 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 for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B and C compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A .................................................... 0.35% 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: Sales charges retained net of commissions paid to unaffiliated broker/dealers ............................. $ 761,460 Contingent deferred sales charges retained ................ $ 84,339 E. TRANSFER AGENT FEES For the year ended December 31, 2007, the Fund paid transfer agent fees of $3,708,753, of which $2,251,327 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, 2007, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES The Fund has reviewed the tax positions taken on federal income tax returns, for each of the three open tax years and as of December 31, 2007 and has determined that no provision for income tax is required in the Fund's financial statements. Annual Report | 37 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) The tax character of distributions paid during the years ended December 31, 2007 and 2006, was as follows: -------------------------------- 2007 2006 -------------------------------- Distributions paid from: Ordinary income ........................ $ 64,511,241 $ 67,088,310 Long term capital gain ................. 191,549,358 143,468,468 -------------------------------- $ 256,060,599 $ 210,556,778 ================================ At December 31, 2007, 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 ....................................... $ 2,099,069,037 ================= Unrealized appreciation ................................... $ 932,709,303 Unrealized depreciation ................................... (64,347,958) ----------------- Net unrealized appreciation (depreciation) ................ $ 868,361,345 ----------------- Distributable earnings - Undistributed long term capital gains ................................................... $ 66,559,277 ================= Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares, synthetic equity swaps, pass-through entity income 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, passive foreign investment company shares, synthetic equity swaps and pass-through entity income. 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the year ended December 31, 2007, aggregated $1,182,211,584 and $1,047,696,736, respectively. Transactions in options written during the year ended December 31, 2007, were as follows: --------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED --------------------------- Options outstanding at December 31, 2006 ..... -- $ -- Options written .............................. 657,111 3,606,768 Options expired .............................. (423,811) (2,112,203) Options exercised ............................ -- -- Options closed ............................... (53,300) (182,956) --------------------------- Options outstanding at December 31, 2007 ..... 180,000 $ 1,311,609 =========================== 38 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. SYNTHETIC EQUITY SWAPS As of December 31, 2007, the Fund had the following synthetic equity swaps outstanding:
- ------------------------------------------------------------------------------------------------------------------ NUMBER OF NOTIONAL UNREALIZED UNREALIZED CONTRACTS TO SELL CONTRACTS VALUE GAIN LOSS - ------------------------------------------------------------------------------------------------------------------ Fred Olson Energy ASA (229.84 - 282.66 NOK) ............ 106,858 $5,849,711 $-- $(977,256) --------------------------- NET UNREALIZED LOSS ON SYNTHETIC EQUITY SWAPS ................................... $(977,256) =============
8. FORWARD EXCHANGE CONTRACTS At December 31, 2007, the Fund had the following forward exchange contracts outstanding:
------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED UNREALIZED AMOUNT DATE GAIN LOSS ------------------------------------------------------- CONTRACTS TO BUY 42,441,773 Swedish Krona ...................... $ 6,706,523 1/15/08 $ -- $ (141,289) 3,322,720 Norwegian Krone .................... 600,000 2/19/08 10,579 -- CONTRACTS TO SELL 791,715 British Pound ...................... 1,569,367 1/10/08 -- (3,266) 84,692,310 British Pound ...................... 172,503,180 1/10/08 4,273,546 -- 98,645,162 Euro ............................... 136,642,866 1/14/08 -- (7,352,918) 1,794,361 Swedish Krona ...................... 277,318 1/15/08 -- (248) 453,689,942 Swedish Krona ...................... 71,017,289 1/15/08 836,893 -- 9,801,021 New Zealand Dollar ................. 7,532,281 2/08/08 54,875 -- 49,789,363 Euro ............................... 70,368,317 2/13/08 -- (2,338,734) 106,119,123 Norwegian Krone .................... 19,382,829 2/19/08 -- (117,504) 211,200,000 Norwegian Krone .................... 38,979,911 2/19/08 170,032 -- 178,102,638 Euro ............................... 264,249,208 2/25/08 4,149,211 -- 148,632,837 Swiss Franc ........................ 132,993,263 3/07/08 1,317,616 -- 54,164,409 British Pound ...................... 109,585,188 3/10/08 2,167,919 -- 122,734,858 Euro ............................... 174,697,394 3/13/08 -- (4,546,110) 49,446,120 Euro ............................... 73,232,176 3/13/08 1,020,451 -- 205,727,150 Danish Krone ....................... 39,130,083 4/23/08 -- (1,154,747) 188,875,253 Euro ............................... 269,064,590 4/24/08 -- (6,731,330) 99,027,504 Euro ............................... 141,047,232 5/19/08 -- (3,533,956) 12,800,000 Euro ............................... 19,040,832 5/19/08 352,699 -- 850,000 Euro ............................... 1,238,875 5/28/08 -- (2,075) 29,862,568 Euro ............................... 44,037,227 5/28/08 439,620 -- --------------------------- UNREALIZED GAIN (LOSS) ON FORWARD EXCHANGE CONTRACTS ............................ 14,793,441 (25,922,177) --------------------------- NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS ............................ $(11,128,736) =============
Annual Report | 39 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 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 SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. At December 31, 2007, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- ----------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------------------------------------------------------------------------------------------------- 88,848 AboveNet Inc. ....................... 10/02/01 - 12/12/07 $ 4,458,292 $ 4,442,400 117 AboveNet Inc., stock grants, grant price $20.95, expiration date 9/09/13 .......................... 4/17/06 - 9/08/06 -- 4,850 3,214 AboveNet Inc., wts., 9/08/08 ........ 10/02/01 - 9/07/07 365,831 151,701 3,781 AboveNet Inc., wts., 9/08/10 ........ 10/02/01 - 9/07/07 392,580 165,154 17,909 Augsburg Re AG ...................... 5/25/06 17,909 -- 205,953 Augsburg Re AG, zero cpn., 1/30/08 .. 5/25/06 205,953 -- 16,127,149 Euro Wagon LP ....................... 12/08/05 - 3/02/07 6,213,779 20,266,754 2,830,952 Globe Specialty Metals Inc., 144A ... 9/27/05 - 1/22/07 12,300,000 32,561,610 16,080 Olympus Re Holdings Ltd. ............ 12/19/01 1,608,000 52,665 46,841 PTV Inc., 10.00%, pfd., A ........... 12/07/01 - 3/06/02 140,523 56,209 ------------- TOTAL RESTRICTED SECURITIES (1.90% of Net Assets) ...................... $ 57,701,343 =============
40 | Annual Report Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act 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 for the year ended December 31, 2007, were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF SHARES/ NUMBER OF SHARES/ VALUE AT REALIZED WARRANTS HELD AT GROSS GROSS WARRANTS HELD AT END OF INVESTMENT CAPITAL NAME OF ISSUER BEGINNING OF YEAR ADDITIONS REDUCTIONS END OF YEAR YEAR INCOME GAIN (LOSS) - ------------------------------------------------------------------------------------------------------------------------------------ CONTROLLED AFFILIATESa Euro Wagon LP .................. 15,240,837 886,312 -- 16,127,149 $20,266,754 $-- $-- NON-CONTROLLED AFFILIATES Globe Speciality Metals Inc., 144A ........................ 2,050,000 780,952 -- 2,830,952 32,561,610 -- -- Globe Speciality Metals Inc., wts., 10/03/09, 144A ........ 4,100,000 -- 4,100,000 -- -- -- -- ------------------------------------ TOTAL NON-CONTROLLED AFFILIATES ........................................................... $32,561,610 $-- $-- ------------------------------------ TOTAL AFFILIATED SECURITIES (1.74% of Net Assets) ......................................... $52,828,364 $-- $-- ------------------------------------
a Issuer in which the Fund owns 25% or more of the outstanding voting securities. 12. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. 13. REGULATORY AND LITIGATION MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), 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 ("marketing support"), Franklin Resources, Inc. and certain of its subsidiaries (collectively, the "Company"), entered into settlements with certain of those regulators and governmental entities. Specifically, the Company entered into settlements with the SEC, among others, concerning market timing and marketing support. On June 6, 2007, the SEC posted for public comment the proposed plan of distribution for the market timing settlement. Once the SEC approves the final plan of distribution, disbursements of settlement monies will be made promptly to individuals who were shareholders of the designated funds during the relevant period, in accordance with the terms and conditions of the settlement and plan. Annual Report | 41 Mutual European Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY AND LITIGATION MATTERS (CONTINUED) In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, Company directors, fund directors, and 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.). The lawsuits relate to the industry practices referenced above. The Company and fund management 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. 14. NEW ACCOUNTING PRONOUNCEMENT In September 2006, Financial Accounting Standards Board (FASB) issued FASB Statement No. 157, "Fair Value Measurement" (SFAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Fund believes the adoption of SFAS 157 will have no material impact on its financial statements. 42 | Annual Report 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 Funds constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2007, 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, 2007, 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, 2007, 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 14, 2008 Annual Report | 43 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 $258,575,280 as a long term capital gain dividend for the fiscal year ended December 31, 2007. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $64,785,986 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2007. In January 2008, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2007. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their individual income tax returns. At December 31, 2007, more than 50% of the Fund's total assets were invested in securities of foreign issuers. In most instances, foreign taxes were withheld from income 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, pursuant to Section 853 of the Code. This designation will allow shareholders of record on December 20, 2007, 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 table provides a detailed analysis of foreign tax paid, foreign source income, and foreign qualified dividends as designated by the Fund, to Class Z, Class A, Class B, and Class C shareholders of record. RECORD DATE:12/20/2007 - -------------------------------------------------------------------------------- FOREIGN TAX FOREIGN SOURCE FOREIGN QUALIFIED CLASS PAID PER SHARE INCOME PER SHARE DIVIDENDS PER SHARE - -------------------------------------------------------------------------------- Class Z ........... $0.0758 $0.5257 $0.3850 Class A ........... $0.0758 $0.4565 $0.3345 Class B ........... $0.0758 $0.2704 $0.1983 Class C ........... $0.0758 $0.2883 $0.2114 44 | Annual Report Mutual European Fund TAX DESIGNATION (UNAUDITED) (CONTINUED) 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 2008, shareholders will receive Form 1099-DIV which will include their share of taxes paid and foreign source income distributed during the calendar year 2007. 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 2007 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 | 45 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 None c/o Franklin Mutual Advisers, LLC 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, Stern School of Business, New York University; editor and author of numerous financial publications; financial consultant; a director to numerous financial publishing organizations; and FORMERLY, Vice Director, Salomon Center, Stern School of Business, New York University. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE BATES (1958) Director Since 1994 7 SLM Corporation (Sallie Mae) and c/o Franklin Mutual Advisers, LLC Allied Capital Corporation 101 John F. Kennedy Parkway (financial services). Short Hills, NJ 07078-2789 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 14 Franklin Templeton Emerging c/o Franklin Mutual Advisers, LLC Markets Debt Opportunities Fund 101 John F. Kennedy Parkway PLC and Fiduciary International Short Hills, NJ 07078-2789 Ireland Limited. PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates (management consultants to the financial services industry); and FORMERLY, Chairman, Fiduciary Trust International Funds; Executive Vice President, L.F Rothschild Fund Management, Inc.; President and Director, Merit Mutual Funds; President, Underwriting Division and Director, National Securities & Research Corporation; Governor, Investment Company Institute and Chairman, ICI Public Information Committee. - ------------------------------------------------------------------------------------------------------------------------------------ BRUCE A. MACPHERSON (1930) Director Since 1974 7 None c/o Franklin Mutual Advisers, LLC 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). - ------------------------------------------------------------------------------------------------------------------------------------
46 | 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 - ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (1930) Director Since 1998 14 None c/o Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------ ROBERT E. WADE (1946) Director and Director since 34 El Oro and Exploration Co., p.l.c. c/o Franklin Mutual Advisers, LLC Chairman 1991 and (investments) and ARC Wireless 101 John F. Kennedy Parkway of the Board Chairman of the Solutions, Inc. (wireless Short Hills, NJ 07078-2789 Board since 2005 components and network products). 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 - ------------------------------------------------------------------------------------------------------------------------------------ **GREGORY E. JOHNSON (1961) Director Since April 2007 92 None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, President and Chief Executive Officer, Franklin Resources, Inc.; President, Templeton Worldwide, Inc.; Director, Templeton Asset Management Ltd.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 33 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ **PETER A. LANGERMAN (1955) Director, Director since 7 None c/o Franklin Mutual Advisers, LLC President April 2007 and 101 John F. Kennedy Parkway and Chief President and Short Hills, NJ 07078-2702 Executive Chief Executive Officer - Officer - Investment Investment Management Management since 2005 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; officer and/or director, as the case may be, of three of the investment companies in Franklin Templeton Investments; and FORMERLY, Director, New Jersey's Division of Investment. - ------------------------------------------------------------------------------------------------------------------------------------ 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 | 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 - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (1952) Chief Chief Compliance Not Applicable Not Applicable One Franklin Parkway Compliance Officer since 2004 San Mateo, CA 94403-1906 Officer and and Vice President Vice President - AML Compliance - AML since 2006 Compliance PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL J. EMBLER (1964) Senior Vice Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President Short Hills, NJ 07078-2789 and Chief Investment Officer 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. - ------------------------------------------------------------------------------------------------------------------------------------ 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 some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ STEVEN J. GRAY (1955) Secretary Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Templeton Investments; Secretary, Franklin Advisory Services, LLC, Franklin Mutual Advisers, LLC and Franklin Templeton Distributors, Inc.; and officer of 41 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ GREGORY R. SEWARD (1956) Treasurer Since 2005 Not Applicable Not Applicable 500 East Broward Blvd. Suite 2100 Fort Lauderdale, FL 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 18 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPMorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ CRAIG S. TYLE (1960) Vice President Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 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). - ------------------------------------------------------------------------------------------------------------------------------------ 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 some of the other subsidiaries of Franklin Resources, Inc. and of 46 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 manager or affiliated investment managers. ** Gregory E. Johnson is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer and director of Franklin Resources, Inc., which is the parent company of the Fund's investment manager and distributor. Peter A. Langerman is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, which is the Fund's investment manager. Note 1: Officer information is current as of the date of this report. It is possible that after this date, information about officers may change. Note 2: Prior to December 31, 2007, William J. Lippman, Leonard Rubin and Anne M. Tatlock ceased to be directors of the Fund. THE FUND'S BOARD 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 | 49 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 1-954/527-7678 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. 50 | Annual Report This page intentionally left blank. This page intentionally left blank. Literature Request LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. FRANKLIN TEMPLETON FUNDS INTERNATIONAL Mutual European Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund 1 GLOBAL Mutual Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund 1 Templeton Growth Fund Templeton World Fund GROWTH Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Growth Opportunities Fund 2 Franklin Small Cap Growth Fund II 3 Franklin Small-Mid Cap Growth Fund VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund 1 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 1 Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Focused Core Equity Fund Franklin Growth Fund Franklin Rising Dividends Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Global Real Estate 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(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 5 Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund 5 Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 5 Templeton Global Bond Fund Templeton Income Fund Templeton International Bond Fund TAX-FREE INCOME 6 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California 8 Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts 7 Michigan 7 Minnesota 7 Missouri New Jersey New York 8 North Carolina Ohio 7 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 9 1. The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. 2. Effective 11/1/07, Franklin Aggressive Growth Fund changed its name to Franklin Growth Opportunities Fund. The fund's investment goal and strategy remained the same. 3. The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 4. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5. An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 6. For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. 7. The fund invests primarily in insured municipal securities. 8. 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). 9. The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 12/07 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 A2007 02/08 [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2007 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 ..................................................... 5 Performance Summary ....................................................... 11 Your Fund's Expenses ...................................................... 16 Financial Highlights and Statement of Investments ......................... 18 Financial Statements ...................................................... 31 Notes to Financial Statements ............................................. 35 Report of Independent Registered Public Accounting Firm ................... 50 Tax Designation ........................................................... 51 Board Members and Officers ................................................ 52 Shareholder Information ................................................... 56 - -------------------------------------------------------------------------------- Shareholder Letter - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN - ---------------------------------------------------------- CLASS Z 12/31/07 - ---------------------------------------------------------- 1-Year +9.12% 5-Year +17.13% 10-Year +10.51% Dear Shareholder: The past year was a turbulent time for equities both in the U.S. and in many international markets. Several developments contributed to this volatility, including (1) credit problems centered around subprime mortgage lending; (2) declining home values in the U.S.; (3) a nearly complete evaporation of the corporate leveraged lending that fueled the leveraged buyout boom of the past several years; (4) a sharp increase in oil, agricultural and certain mining commodity prices; and (5) a sharp decline in the value of the U.S. dollar relative to most other currencies. For the year ended December 31, 2007, the Standard & Poor's (S&P) 500 Index rose 5.49% while the Morgan Stanley Capital International (MSCI) World Index gained 9.57%. 1 However, indicative of the impact of the developments noted here, the S&P 500 Financials Index declined 18.63%, the S&P Homebuilders Select Industry Index declined 48.39% and the S&P GSSI Natural Resources Index appreciated 34.44% during the year. 2 By comparison, Mutual Qualified Fund - Class Z gained 9.12% over this period. 1. Source: Standard & Poor's Micropal. The S&P 500 Index 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 Index 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. 2. Source: Standard & Poor's Micropal. The S&P 500 Financials Index is market value weighted and includes all the financial stocks in the S&P 500. The S&P Homebuilders Select Industry Index is an equal-weighted index that draws its constituents from the GICS (Global Industry Classification Standards) Homebuilding sub-industry. The S&P GSSI Natural Resources Index is a modified cap-weighted index designed to measure equity performance in the natural resources sector. The index includes companies involved in the following categories: extractive industries, energy companies, owners and operators of timber tracts, forestry services, producers of pulp and paper, and owners of plantations. 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. eDELIVERY DETAILS Log in at franklintempleton.com and click on eDelivery. Shareholders who are registered at franklintempleton.com can receive these reports via email. Not all accounts are eligible for eDelivery. - ----------------------------------------------------- NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE - ----------------------------------------------------- Not part of the annual report | 1 The markets in 2007 were particularly challenging for us as value-driven, bottom-up stock pickers in a year when a thematic approach to investing based on macroeconomic factors would likely have enhanced performance. Value investors are always faced with the task of buying and owning companies when they are out of favor, whether for company-specific reasons or because of a perception of macroeconomic fundamentals. It is these very headwinds that create opportunities to buy well-managed companies with strong industry positions at valuations that can reward investors over the long term. Despite the challenges, a number of positive factors contributed to Fund performance this year. Many of our international holdings made strong gains, particularly among the tobacco, energy and industrial companies we owned. Fund shareholders also benefited from the fact that our international holdings were less than fully hedged back into U.S. dollars, reflecting our cautious view regarding the dollar. Investments in merger arbitrage situations were also generally profitable, particularly as we took advantage in late summer of concerns that deals would fall apart because of "buyer's remorse" or unavailability of financing. In the U.S., our focus over the past several years on larger capitalization companies with strong balance sheets and leading industry positions benefited our shareholders. For example, investments in Microsoft and Altria, both part of the large-cap Dow Jones Industrial Average, generated solid returns in 2007. 3 As we have discussed in previous reports, the multi-year outperformance of small- and mid-capitalization stocks going into 2007 resulted in attractive valuations among their mega-cap counterparts. At period-end, we continued to see real value in a number of these companies. The Fund's exposure to the financial sector negatively impacted Fund performance during the year. While we had limited direct exposure to the subprime mortgage originators, the spreading contagion of the credit crisis hurt valuations of most financial institutions, including some well-capitalized domestic and European banks owned by the Fund. We were disappointed by the breakdown in risk management processes at some of the largest U.S. financial institutions and have adjusted certain positions accordingly. Nevertheless, we believe the markets have overly penalized many stocks in the sector and accordingly have added selectively to certain holdings. 3. Mutual Qualified Fund's holdings are based on total net assets as of 12/31/07: Microsoft Corp.: 1.1%; and Altria Group Inc.: 1.4%. 2 | Not part of the annual report Another difficult area for us in the latter half of the year was what we would term "event-driven" stocks. These are investments we believe are attractively valued and where we see an identifiable catalyst to unlock the value. While each investment is different, a key driver for the second half of 2007 was the abrupt absence of private equity buyers for companies (or divisions of companies) that were potential sale targets. Virgin Media, the U.K. cable company, was one example. We also believe many of these event-driven investments were held in common with some of the hedge funds that faced pressure to sell in the latter half of 2007. Again, while somewhat painful in the short term, "technical" pressures often give us a chance to take advantage of temporary market dislocations to increase ownership in attractively valued companies. Fear and volatility can breed opportunity for patient investors. We believe the extended credit crisis has created a number of such opportunities. We have no crystal ball telling us precisely when the U.S. housing market will turn positive or where oil prices will be a year from now. However, we believe that if we stick to our discipline of buying good businesses at cheap valuations, we should reach our goal of limiting our downside risk while generating consistent returns over the long term. In the enclosed annual report for Mutual Qualified Fund, the portfolio managers discuss market conditions, investment management decisions and Fund performance during the period under review. You will also find performance data and financial information. Please remember that all securities markets fluctuate, as do mutual fund share prices. If you would like more frequent updates, FRANKLINTEMPLETON.COM provides daily prices, monthly performance figures, portfolio holdings and other information. You can also access your account, buy and sell shares, read timely articles, and find helpful financial planning tools. We hope you will take advantage of these online services. Not part of the annual report | 3 As always, we thank you for your trust and support and extend our best wishes for a happy, healthy and prosperous 2008. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC /s/ Michael J. Embler Michael J. Embler Senior Vice President and Chief Investment Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF DECEMBER 31, 2007. 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 INVESTMENT MANAGER 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. 4 | Not part of the annual report Annual Report Mutual Qualified Fund YOUR FUND'S GOALS AND MAIN INVESTMENTS: Mutual Qualified Fund seeks capital appreciation, with income as a secondary goal, by investing primarily in equity securities of companies the Fund's managers believe are at prices below their intrinsic value. The Fund may invest up to 50% 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 Qualified Fund's annual report for the fiscal year ended December 31, 2007. PERFORMANCE OVERVIEW Mutual Qualified Fund - Class Z posted a cumulative total return of +9.12% for the 12 months ended December 31, 2007. The Fund outperformed its benchmark, the Standard & Poor's 500 Index (S&P 500), which returned +5.49% for the same period. 1 You can find the Fund's long-term performance data in the Performance Summary beginning on page 11. ECONOMIC AND MARKET OVERVIEW During the 12 months ended December 31, 2007, the U.S. economy advanced at a moderate but uneven pace. After slow first quarter growth, gross domestic product (GDP) advanced solidly in the second quarter, supported by federal defense spending, accelerating exports and declining imports, and greater business spending. In the third quarter, growth accelerated despite a struggling housing market and the abrupt unraveling of the subprime mortgage market. The housing downturn affected the overall economy by fourth quarter 2007 when GDP growth decelerated as credit conditions worsened and consumer spending slowed. 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. Annual Report | 5 GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/07 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] U.S. 35.8% France 10.5% U.K. 8.4% South Korea 5.6% Germany 5.4% Norway 3.6% Switzerland 2.3% Japan 2.1% Spain 2.0% Bermuda 1.8% Finland 1.6% Hong Kong 1.4% Italy 1.1% Netherlands 1.0% Other 2.8% Short-Term Investments & Other Net Assets 14.6% Consumer confidence declined through period-end largely due to rising mortgage and fuel costs, falling home prices and a weaker job market. Oil prices were volatile and established a new record high in November, nearing $99 per barrel. For the 12 months ended December 31, 2007, the core Consumer Price Index (CPI), which excludes food and energy costs, rose 2.4%, which was higher than its 10-year average rate. 2 Facing the prospect of slower economic growth, the Federal Reserve Board lowered the federal funds target rate to 4.25% from 5.25% during the period. As investors fled riskier, poorer-performing assets, U.S. Treasuries rallied and the 10-year Treasury note yield fell from 4.71% at the beginning of the period to 4.04% on December 31, 2007. The global economy remained resilient despite elevated energy prices and widespread fears of contagion from the deteriorating U.S. housing situation. Consumer and corporate demand strength, particularly in China and other developing economies, generally favorable employment and accommodative monetary policies continued to underpin the current global expansionary period that began in 2002. These factors also contributed to the strength of global equity markets during 2007. However, concerns about slower growth and declining asset quality surfaced in the first quarter. Initially centered on the U.S. subprime mortgage market, they spread in August to global capital markets. Difficulties in assessing risk and the value of collateral in the structured finance industry contributed to declining risk appetite among lenders and investors. The private equity industry, which relies on the availability of cheap credit, played a pivotal role in several large and high-profile acquisitions, helped boost merger and acquisition activity in the first half of 2007, and was an important driver of equity performance. A second-half tightening of liquidity led to slower deal activity and weighed on market performance. However, in 2007, global merger and acquisition activity still reached record levels. To alleviate the credit crunch and restore investor confidence, the world's major central banks infused capital into the system. However, credit and equity markets continued to face headwinds as write-downs and losses from subprime mortgage financing affected many large financial institutions toward the end of the year, and equity prices remained volatile. For the year, however, global and non-U.S. equity markets registered the fifth consecutive year of double-digit total returns. Broad-based stock performance by European and Asian shares at least doubled that of U.S. stocks, while emerging market equity 2. Source: Bureau of Labor Statistics. 6 | Annual Report returns more than tripled those in developed markets. In addition, U.S. dollar weakness versus the currencies of many major trading partners enhanced equity returns for U.S.-based investors holding stocks denominated in these 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 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 for our shareholders. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/07 - -------------------------------------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------------------------------------- Tobacco 14.2% - -------------------------------------------------------------------------------- Insurance 10.4% - -------------------------------------------------------------------------------- Food Products 7.3% - -------------------------------------------------------------------------------- Industrial Conglomerates 4.9% - -------------------------------------------------------------------------------- Media 4.1% - -------------------------------------------------------------------------------- Commercial Banks 4.0% - -------------------------------------------------------------------------------- Real Estate 3.9% - -------------------------------------------------------------------------------- Food & Staples Retailing 3.0% - -------------------------------------------------------------------------------- Energy Equipment & Services 2.7% - -------------------------------------------------------------------------------- Oil, Gas & Consumable Fuels 2.7% - -------------------------------------------------------------------------------- Annual Report | 7 TOP 10 HOLDINGS 12/31/07 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- KT&G Corp. 4.2% TOBACCO, SOUTH KOREA - -------------------------------------------------------------------------------- Orkla ASA 3.0% INDUSTRIAL CONGLOMERATES, NORWAY - -------------------------------------------------------------------------------- White Mountains Insurance Group Ltd. 2.8% INSURANCE, U.S. - -------------------------------------------------------------------------------- Berkshire Hathaway Inc., A & B 2.5% INSURANCE, U.S. - -------------------------------------------------------------------------------- British American Tobacco PLC 2.4% TOBACCO, U.K. - -------------------------------------------------------------------------------- Groupe Danone 2.4% FOOD PRODUCTS, FRANCE - -------------------------------------------------------------------------------- Weyerhaeuser Co. 2.3% PAPER & FOREST PRODUCTS, U.S. - -------------------------------------------------------------------------------- Groupe Eurotunnel SA 2.0% TRANSPORTATION INFRASTRUCTURE, FRANCE - -------------------------------------------------------------------------------- Altadis SA 2.0% TOBACCO, SPAIN - -------------------------------------------------------------------------------- Carrefour SA 1.8% FOOD & STAPLES RETAILING, FRANCE - -------------------------------------------------------------------------------- MANAGER'S DISCUSSION In a challenging year for investors, Mutual Qualified Fund enjoyed success within its equity portfolio, most notably with some of our long-term holdings. Three investments that performed well during 2007 were KT&G, a South Korea-based cigarette manufacturer; Berkshire Hathaway, the well-known investment conglomerate; and Transocean, a deepwater offshore oil-drilling contractor. Shares of KT&G appreciated 41% in local currency during 2007, due largely to the company's strong operating performance. Each division of KT&G reported positive news in 2007. The company's domestic tobacco sales and operating margins expanded due to increased average selling prices for a pack of cigarettes. Overseas sales and revenues registered high double-digit increases. KT&G owns a 100% stake in KGC, South Korea's leading red ginseng maker, which has a dominant position of more than 60% market share. Over the past five years, KGC's sales and earnings have grown at 20% and 27% compounded annual growth rates, respectively. We believe this trend could continue given the country's aging demographic, growing income levels, and KGC's aggressive distribution and production expansion plan. According to our analysis, not only is the outlook for earnings quite good but the company's ability to return cash to shareholders has been impressive as well. KT&G has announced that between 2006 and 2008 it will return 2.8 trillion won (the local currency, which equaled approximately $3.0 billion on December 31, 2007) to shareholders. After 2008, KT&G is expected to return an average 5% to 7% of market capitalization to shareholders annually through dividends and share buybacks. Berkshire Hathaway stock appreciated 29% as the company benefited from a lack of catastrophe losses in 2007, resulting in large insurance company profits after higher-than-average losses in 2004 and 2005 resulted in a favorable pricing environment for U.S. property insurers. Within Berkshire's non-insurance operations, the company benefited from an improving contribution from its utility business, Mid-American Energy. Most significantly for its share price value, Berkshire's cash stockpile of almost $40 billion, along with CEO Warren Buffett's willingness to wait until a bargain emerged before deploying this capital, positioned the company as a safe haven for investors who perceived 2007's subprime mortgage crisis as an investment opportunity rather than a threat. By the end of 2007 Berkshire management had successfully kept its capital mostly in reserve, for use in executing timely future transactions when the investment climate is right. 8 | Annual Report Transocean shares appreciated nearly 67% during 2007, driven by strong company fundamentals, the company's merger with GlobalSanteFe, and shareholder-friendly initiatives. Fundamentally, a continued tight supply and demand balance for offshore rig contractors resulted in higher day rates and favorable financial performance at Transocean. On the event-driven and shareholder-friendly side, the company completed a merger with GlobalSantaFe concurrently with a leveraged recapitalization that enabled a special distribution of $33.03 in late November. All of these actions were received with widespread shareholder appreciation. Although the Fund performed well in 2007, some of our positions detracted from performance. Among them were Sovereign Bancorp, U.K.-based cable company Virgin Media, and property and casualty insurance and reinsurance provider White Mountains Insurance Group. In a difficult year for finance and banking stocks in general, the Fund's shares of Sovereign Bancorp fared poorly and lost 54% in value. While the company took early steps to restructure its balance sheet in an effort to lower its risk profile at the beginning of 2007, the bank's asset quality deteriorated in the second half of the year, consistent with many other U.S. financial companies. Shares of Virgin Media, the U.K.'s largest cable company, declined 32% in local currency during 2007. First, the company was forced to pull several British Sky Broadcasting (BSkyB) channels from its offering due to a pricing dispute, which resulted in a reduction in subscribers. Second, the contraction of the leveraged corporate debt market scuttled a plan announced in June to sell the company. Finally, Virgin Media posted mediocre earnings results in 2007. Long-time Fund holding White Mountains continued to be, in our view, a collection of underappreciated assets. During the year under review, the company recapitalized and refocused on its reinsurance operations, which could benefit from minimal catastrophe losses in 2007. Furthermore, online automobile insurer Esurance, a White Mountains subsidiary, was one of the fastest growing insurance companies in the U.S. during 2007. That being said, the stock trended 10% lower for the year along with many of its industry peers including Progressive, Safeco, Old Republic, and W.R. Berkley (none of which were owned by the Fund). Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during 2007, the Fund benefited to the extent it was not fully hedged. Annual Report | 9 Thank you for your continued participation in Mutual Qualified Fund. We look forward to serving your future investment needs. [PHOTO OMITTED] /s/ Anne E. Gudefin Anne E. Gudefin, CFA Portfolio Manager [PHOTO OMITTED] /s/ Shawn M. Tumulty Shawn M. Tumulty, CFA Assistant Portfolio Manager Mutual Qualified Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2007, 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 INVESTMENT MANAGER 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 portfolio manager for Mutual Qualified Fund since 2002. She is also portfolio manager for Mutual Discovery Fund and has been a member of the management team of the Mutual Series Funds since 2000, when she joined Franklin Templeton Investments. 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. - -------------------------------------------------------------------------------- 10 | Annual Report Performance Summary as of 12/31/07 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 12/31/07 12/31/06 - ---------------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) -$0.04 $21.84 $21.88 - ---------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - ---------------------------------------------------------------------------------------------------------------- Dividend Income $0.7132 - ---------------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $1.3114 - ---------------------------------------------------------------------------------------------------------------- TOTAL $2.0246 - ---------------------------------------------------------------------------------------------------------------- CLASS A (SYMBOL: TEQIX) CHANGE 12/31/07 12/31/06 - ---------------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) -$0.05 $21.70 $21.75 - ---------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - ---------------------------------------------------------------------------------------------------------------- Dividend Income $0.6370 - ---------------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $1.3114 - ---------------------------------------------------------------------------------------------------------------- TOTAL $1.9484 - ---------------------------------------------------------------------------------------------------------------- CLASS B (SYMBOL: TEBQX) CHANGE 12/31/07 12/31/06 - ---------------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) -$0.08 $21.24 $21.32 - ---------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - ---------------------------------------------------------------------------------------------------------------- Dividend Income $0.4720 - ---------------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $1.3114 - ---------------------------------------------------------------------------------------------------------------- TOTAL $1.7834 - ---------------------------------------------------------------------------------------------------------------- CLASS C (SYMBOL: TEMQX) CHANGE 12/31/07 12/31/06 - ---------------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) -$0.08 $21.50 $21.58 - ---------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - ---------------------------------------------------------------------------------------------------------------- Dividend Income $0.4888 - ---------------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $1.3114 - ---------------------------------------------------------------------------------------------------------------- TOTAL $1.8002 - ----------------------------------------------------------------------------------------------------------------
Annual Report | 11 Performance Summary (CONTINUED) PERFORMANCE 1 CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z: NO SALES CHARGES; 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. THE FUND MAY CHARGE A 2% FEE ON REDEMPTIONS MADE WITHIN SEVEN DAYS OF PURCHASE.
- ------------------------------------------------------------------------------------------------------------ CLASS Z 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------------------ Cumulative Total Return 2 +9.12% +120.44% +171.73% - ------------------------------------------------------------------------------------------------------------ Average Annual Total Return 3 +9.12% +17.13% +10.51% - ------------------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $10,912 $22,044 $27,173 - ------------------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 0.83% - ------------------------------------------------------------------------------------------------------------ CLASS A 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------------------ Cumulative Total Return 2 +8.73% +116.64% +162.46% - ------------------------------------------------------------------------------------------------------------ Average Annual Total Return 3 +2.46% +15.34% +9.48% - ------------------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $10,246 $20,416 $24,732 - ------------------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 1.15% - ------------------------------------------------------------------------------------------------------------ CLASS B 1-YEAR 5-YEAR INCEPTION (1/1/99) - ------------------------------------------------------------------------------------------------------------ Cumulative Total Return 2 +8.04% +109.74% +148.90% - ------------------------------------------------------------------------------------------------------------ Average Annual Total Return 3 +4.05% +15.75% +10.66% - ------------------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $10,405 $20,774 $24,890 - ------------------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 1.82% - ------------------------------------------------------------------------------------------------------------ CLASS C 1-YEAR 5-YEAR 10-YEAR - ------------------------------------------------------------------------------------------------------------ Cumulative Total Return 2 +8.02% +109.63% +145.83% - ------------------------------------------------------------------------------------------------------------ Average Annual Total Return 3 +7.02% +15.95% +9.41% - ------------------------------------------------------------------------------------------------------------ Value of $10,000 Investment 4 $10,702 $20,963 $24,583 - ------------------------------------------------------------------------------------------------------------ Total Annual Operating Expenses 5 1.83% - ------------------------------------------------------------------------------------------------------------
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. 12 | 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 (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE MUTUAL QUALIFIED FUND S&P 500 6 - ---------------------------------------------------------------- 1/1/1998 $ 10,000 $ 10,000 1/31/1998 $ 9,950 $ 10,111 2/28/1998 $ 10,528 $ 10,840 3/31/1998 $ 10,941 $ 11,395 4/30/1998 $ 10,952 $ 11,510 5/31/1998 $ 10,913 $ 11,312 6/30/1998 $ 10,842 $ 11,771 7/31/1998 $ 10,522 $ 11,646 8/31/1998 $ 8,956 $ 9,962 9/30/1998 $ 8,923 $ 10,600 10/31/1998 $ 9,443 $ 11,463 11/30/1998 $ 9,913 $ 12,157 12/31/1998 $ 10,050 $ 12,858 1/31/1999 $ 10,117 $ 13,396 2/28/1999 $ 9,843 $ 12,979 3/31/1999 $ 10,343 $ 13,498 4/30/1999 $ 11,253 $ 14,021 5/31/1999 $ 11,393 $ 13,690 6/30/1999 $ 11,731 $ 14,450 7/31/1999 $ 11,510 $ 13,999 8/31/1999 $ 10,969 $ 13,929 9/30/1999 $ 10,717 $ 13,548 10/31/1999 $ 11,007 $ 14,405 11/30/1999 $ 11,328 $ 14,698 12/31/1999 $ 11,421 $ 15,563 1/31/2000 $ 11,103 $ 14,781 2/29/2000 $ 10,597 $ 14,502 3/31/2000 $ 11,752 $ 15,920 4/30/2000 $ 11,765 $ 15,441 5/31/2000 $ 12,022 $ 15,124 6/30/2000 $ 11,831 $ 15,497 7/31/2000 $ 12,189 $ 15,255 8/31/2000 $ 12,731 $ 16,203 9/30/2000 $ 12,767 $ 15,347 10/31/2000 $ 12,877 $ 15,282 11/30/2000 $ 12,475 $ 14,078 12/31/2000 $ 13,048 $ 14,146 1/31/2001 $ 13,748 $ 14,648 2/28/2001 $ 13,724 $ 13,313 3/31/2001 $ 13,426 $ 12,469 4/30/2001 $ 14,062 $ 13,438 5/31/2001 $ 14,565 $ 13,528 6/30/2001 $ 14,792 $ 13,199 7/31/2001 $ 14,857 $ 13,069 8/31/2001 $ 14,598 $ 12,251 9/30/2001 $ 13,243 $ 11,262 10/31/2001 $ 13,146 $ 11,476 11/30/2001 $ 13,703 $ 12,357 12/31/2001 $ 14,120 $ 12,465 1/31/2002 $ 14,060 $ 12,283 2/28/2002 $ 14,128 $ 12,046 3/31/2002 $ 14,616 $ 12,499 4/30/2002 $ 14,719 $ 11,741 5/31/2002 $ 14,719 $ 11,655 6/30/2002 $ 13,717 $ 10,825 7/31/2002 $ 12,750 $ 9,981 8/31/2002 $ 12,864 $ 10,046 9/30/2002 $ 12,028 $ 8,955 10/31/2002 $ 12,193 $ 9,743 11/30/2002 $ 12,498 $ 10,316 12/31/2002 $ 12,327 $ 9,710 1/31/2003 $ 12,229 $ 9,456 2/28/2003 $ 11,973 $ 9,314 3/31/2003 $ 12,000 $ 9,404 4/30/2003 $ 12,822 $ 10,179 5/31/2003 $ 13,537 $ 10,715 6/30/2003 $ 13,760 $ 10,852 7/31/2003 $ 13,965 $ 11,043 8/31/2003 $ 14,312 $ 11,259 9/30/2003 $ 14,241 $ 11,139 10/31/2003 $ 14,845 $ 11,769 11/30/2003 $ 15,343 $ 11,873 12/31/2003 $ 16,086 $ 12,495 1/31/2004 $ 16,239 $ 12,725 2/29/2004 $ 16,635 $ 12,902 3/31/2004 $ 16,635 $ 12,707 4/30/2004 $ 16,149 $ 12,508 5/31/2004 $ 16,284 $ 12,679 6/30/2004 $ 16,591 $ 12,926 7/31/2004 $ 16,338 $ 12,498 8/31/2004 $ 16,555 $ 12,549 9/30/2004 $ 16,952 $ 12,684 10/31/2004 $ 17,141 $ 12,878 11/30/2004 $ 18,205 $ 13,399 12/31/2004 $ 18,762 $ 13,855 1/31/2005 $ 18,348 $ 13,518 2/28/2005 $ 18,858 $ 13,802 3/31/2005 $ 18,704 $ 13,558 4/30/2005 $ 18,550 $ 13,300 5/31/2005 $ 19,012 $ 13,724 6/30/2005 $ 19,402 $ 13,743 7/31/2005 $ 20,036 $ 14,254 8/31/2005 $ 20,007 $ 14,124 9/30/2005 $ 20,328 $ 14,239 10/31/2005 $ 19,802 $ 14,001 11/30/2005 $ 20,397 $ 14,531 12/31/2005 $ 20,875 $ 14,536 1/31/2006 $ 21,370 $ 14,921 2/28/2006 $ 21,665 $ 14,961 3/31/2006 $ 22,476 $ 15,147 4/30/2006 $ 22,613 $ 15,351 5/31/2006 $ 22,287 $ 14,909 6/30/2006 $ 22,258 $ 14,929 7/31/2006 $ 22,397 $ 15,021 8/31/2006 $ 23,027 $ 15,379 9/30/2006 $ 23,124 $ 15,775 10/31/2006 $ 23,904 $ 16,289 11/30/2006 $ 24,449 $ 16,599 12/31/2006 $ 24,902 $ 16,832 1/31/2007 $ 25,562 $ 17,086 2/28/2007 $ 25,562 $ 16,752 3/31/2007 $ 26,211 $ 16,939 4/30/2007 $ 27,007 $ 17,690 5/31/2007 $ 27,975 $ 18,307 6/30/2007 $ 27,929 $ 18,003 7/31/2007 $ 27,255 $ 17,445 8/31/2007 $ 27,026 $ 17,706 9/30/2007 $ 27,358 $ 18,368 10/31/2007 $ 27,792 $ 18,661 11/30/2007 $ 27,392 $ 17,880 12/31/2007 $ 27,173 $ 17,756 AVERAGE ANNUAL TOTAL RETURN - ------------------------------- CLASS Z 12/31/07 - ------------------------------- 1-Year +9.12% - ------------------------------- 5-Year +17.13% - ------------------------------- 10-Year +10.51% - ------------------------------- CLASS A (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE MUTUAL QUALIFIED FUND S&P 500 6 - ---------------------------------------------------------------- 1/1/1998 $ 9,423 $ 10,000 1/31/1998 $ 9,371 $ 10,111 2/28/1998 $ 9,912 $ 10,840 3/31/1998 $ 10,296 $ 11,395 4/30/1998 $ 10,306 $ 11,510 5/31/1998 $ 10,265 $ 11,312 6/30/1998 $ 10,192 $ 11,771 7/31/1998 $ 9,894 $ 11,646 8/31/1998 $ 8,417 $ 9,962 9/30/1998 $ 8,385 $ 10,600 10/31/1998 $ 8,876 $ 11,463 11/30/1998 $ 9,308 $ 12,157 12/31/1998 $ 9,438 $ 12,858 1/31/1999 $ 9,501 $ 13,396 2/28/1999 $ 9,237 $ 12,979 3/31/1999 $ 9,708 $ 13,498 4/30/1999 $ 10,558 $ 14,021 5/31/1999 $ 10,691 $ 13,690 6/30/1999 $ 11,000 $ 14,450 7/31/1999 $ 10,787 $ 13,999 8/31/1999 $ 10,278 $ 13,929 9/30/1999 $ 10,041 $ 13,548 10/31/1999 $ 10,308 $ 14,405 11/30/1999 $ 10,604 $ 14,698 12/31/1999 $ 10,690 $ 15,563 1/31/2000 $ 10,392 $ 14,781 2/29/2000 $ 9,911 $ 14,502 3/31/2000 $ 10,988 $ 15,920 4/30/2000 $ 10,994 $ 15,441 5/31/2000 $ 11,235 $ 15,124 6/30/2000 $ 11,059 $ 15,497 7/31/2000 $ 11,388 $ 15,255 8/31/2000 $ 11,882 $ 16,203 9/30/2000 $ 11,916 $ 15,347 10/31/2000 $ 12,012 $ 15,282 11/30/2000 $ 11,635 $ 14,078 12/31/2000 $ 12,167 $ 14,146 1/31/2001 $ 12,814 $ 14,648 2/28/2001 $ 12,791 $ 13,313 3/31/2001 $ 12,505 $ 12,469 4/30/2001 $ 13,100 $ 13,438 5/31/2001 $ 13,563 $ 13,528 6/30/2001 $ 13,765 $ 13,199 7/31/2001 $ 13,825 $ 13,069 8/31/2001 $ 13,576 $ 12,251 9/30/2001 $ 12,316 $ 11,262 10/31/2001 $ 12,225 $ 11,476 11/30/2001 $ 12,738 $ 12,357 12/31/2001 $ 13,122 $ 12,465 1/31/2002 $ 13,058 $ 12,283 2/28/2002 $ 13,122 $ 12,046 3/31/2002 $ 13,569 $ 12,499 4/30/2002 $ 13,656 $ 11,741 5/31/2002 $ 13,656 $ 11,655 6/30/2002 $ 12,719 $ 10,825 7/31/2002 $ 11,826 $ 9,981 8/31/2002 $ 11,923 $ 10,046 9/30/2002 $ 11,152 $ 8,955 10/31/2002 $ 11,298 $ 9,743 11/30/2002 $ 11,574 $ 10,316 12/31/2002 $ 11,416 $ 9,710 1/31/2003 $ 11,326 $ 9,456 2/28/2003 $ 11,088 $ 9,314 3/31/2003 $ 11,096 $ 9,404 4/30/2003 $ 11,859 $ 10,179 5/31/2003 $ 12,516 $ 10,715 6/30/2003 $ 12,720 $ 10,852 7/31/2003 $ 12,902 $ 11,043 8/31/2003 $ 13,215 $ 11,259 9/30/2003 $ 13,158 $ 11,139 10/31/2003 $ 13,703 $ 11,769 11/30/2003 $ 14,165 $ 11,873 12/31/2003 $ 14,839 $ 12,495 1/31/2004 $ 14,981 $ 12,725 2/29/2004 $ 15,340 $ 12,902 3/31/2004 $ 15,340 $ 12,707 4/30/2004 $ 14,881 $ 12,508 5/31/2004 $ 15,006 $ 12,679 6/30/2004 $ 15,286 $ 12,926 7/31/2004 $ 15,044 $ 12,498 8/31/2004 $ 15,236 $ 12,549 9/30/2004 $ 15,603 $ 12,684 10/31/2004 $ 15,770 $ 12,878 11/30/2004 $ 16,747 $ 13,399 12/31/2004 $ 17,254 $ 13,855 1/31/2005 $ 16,863 $ 13,518 2/28/2005 $ 17,334 $ 13,802 3/31/2005 $ 17,183 $ 13,558 4/30/2005 $ 17,040 $ 13,300 5/31/2005 $ 17,458 $ 13,724 6/30/2005 $ 17,804 $ 13,743 7/31/2005 $ 18,380 $ 14,254 8/31/2005 $ 18,353 $ 14,124 9/30/2005 $ 18,650 $ 14,239 10/31/2005 $ 18,155 $ 14,001 11/30/2005 $ 18,695 $ 14,531 12/31/2005 $ 19,125 $ 14,536 1/31/2006 $ 19,581 $ 14,921 2/28/2006 $ 19,843 $ 14,961 3/31/2006 $ 20,571 $ 15,147 4/30/2006 $ 20,697 $ 15,351 5/31/2006 $ 20,396 $ 14,909 6/30/2006 $ 20,364 $ 14,929 7/31/2006 $ 20,492 $ 15,021 8/31/2006 $ 21,053 $ 15,379 9/30/2006 $ 21,131 $ 15,775 10/31/2006 $ 21,840 $ 16,289 11/30/2006 $ 22,331 $ 16,599 12/31/2006 $ 22,748 $ 16,832 1/31/2007 $ 23,343 $ 17,086 2/28/2007 $ 23,343 $ 16,752 3/31/2007 $ 23,929 $ 16,939 4/30/2007 $ 24,640 $ 17,690 5/31/2007 $ 25,518 $ 18,307 6/30/2007 $ 25,470 $ 18,003 7/31/2007 $ 24,841 $ 17,445 8/31/2007 $ 24,631 $ 17,706 9/30/2007 $ 24,924 $ 18,368 10/31/2007 $ 25,323 $ 18,661 11/30/2007 $ 24,945 $ 17,880 12/31/2007 $ 24,732 $ 17,756 AVERAGE ANNUAL TOTAL RETURN - ------------------------------- CLASS A 12/31/07 - ------------------------------- 1-Year +2.46% - ------------------------------- 5-Year +15.34% - ------------------------------- 10-Year +9.48% - ------------------------------- Annual Report | 13 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ------------------------------------- CLASS B 12/31/07 - ------------------------------------- 1-Year +4.05% - ------------------------------------- 5-Year +15.75% - ------------------------------------- Since Inception (1/1/99) +10.66% - ------------------------------------- CLASS B (1/1/99-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE MUTUAL QUALIFIED FUND S&P 500 6 - ---------------------------------------------------------------- 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 $ 10,833 9/30/1999 $ 10,588 $ 10,536 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 $ 11,278 3/31/2000 $ 11,550 $ 12,382 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 $ 11,864 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 $ 11,002 1/31/2001 $ 13,405 $ 11,392 2/28/2001 $ 13,366 $ 10,354 3/31/2001 $ 13,064 $ 9,698 4/30/2001 $ 13,676 $ 10,451 5/31/2001 $ 14,156 $ 10,521 6/30/2001 $ 14,358 $ 10,265 7/31/2001 $ 14,413 $ 10,164 8/31/2001 $ 14,151 $ 9,528 9/30/2001 $ 12,830 $ 8,759 10/31/2001 $ 12,719 $ 8,926 11/30/2001 $ 13,252 $ 9,610 12/31/2001 $ 13,644 $ 9,694 1/31/2002 $ 13,569 $ 9,553 2/28/2002 $ 13,628 $ 9,369 3/31/2002 $ 14,089 $ 9,721 4/30/2002 $ 14,173 $ 9,132 5/31/2002 $ 14,165 $ 9,064 6/30/2002 $ 13,184 $ 8,419 7/31/2002 $ 12,253 $ 7,763 8/31/2002 $ 12,338 $ 7,813 9/30/2002 $ 11,536 $ 6,964 10/31/2002 $ 11,681 $ 7,577 11/30/2002 $ 11,963 $ 8,023 12/31/2002 $ 11,792 $ 7,552 1/31/2003 $ 11,689 $ 7,354 2/28/2003 $ 11,439 $ 7,244 3/31/2003 $ 11,448 $ 7,314 4/30/2003 $ 12,222 $ 7,917 5/31/2003 $ 12,900 $ 8,334 6/30/2003 $ 13,099 $ 8,440 7/31/2003 $ 13,280 $ 8,589 8/31/2003 $ 13,600 $ 8,756 9/30/2003 $ 13,523 $ 8,663 10/31/2003 $ 14,076 $ 9,153 11/30/2003 $ 14,543 $ 9,234 12/31/2003 $ 15,237 $ 9,718 1/31/2004 $ 15,368 $ 9,897 2/29/2004 $ 15,733 $ 10,034 3/31/2004 $ 15,715 $ 9,883 4/30/2004 $ 15,246 $ 9,728 5/31/2004 $ 15,359 $ 9,861 6/30/2004 $ 15,634 $ 10,053 7/31/2004 $ 15,382 $ 9,720 8/31/2004 $ 15,573 $ 9,759 9/30/2004 $ 15,938 $ 9,865 10/31/2004 $ 16,104 $ 10,016 11/30/2004 $ 17,086 $ 10,421 12/31/2004 $ 17,594 $ 10,776 1/31/2005 $ 17,188 $ 10,513 2/28/2005 $ 17,658 $ 10,734 3/31/2005 $ 17,502 $ 10,544 4/30/2005 $ 17,336 $ 10,344 5/31/2005 $ 17,760 $ 10,673 6/30/2005 $ 18,100 $ 10,689 7/31/2005 $ 18,678 $ 11,086 8/31/2005 $ 18,632 $ 10,985 9/30/2005 $ 18,921 $ 11,074 10/31/2005 $ 18,408 $ 10,889 11/30/2005 $ 18,949 $ 11,301 12/31/2005 $ 19,375 $ 11,305 1/31/2006 $ 19,826 $ 11,604 2/28/2006 $ 20,086 $ 11,636 3/31/2006 $ 20,817 $ 11,781 4/30/2006 $ 20,928 $ 11,939 5/31/2006 $ 20,607 $ 11,595 6/30/2006 $ 20,562 $ 11,611 7/31/2006 $ 20,673 $ 11,683 8/31/2006 $ 21,242 $ 11,961 9/30/2006 $ 21,313 $ 12,269 10/31/2006 $ 22,004 $ 12,669 11/30/2006 $ 22,491 $ 12,909 12/31/2006 $ 22,893 $ 13,091 1/31/2007 $ 23,493 $ 13,289 2/28/2007 $ 23,493 $ 13,029 3/31/2007 $ 24,082 $ 13,174 4/30/2007 $ 24,798 $ 13,758 5/31/2007 $ 25,681 $ 14,238 6/30/2007 $ 25,632 $ 14,001 7/31/2007 $ 24,999 $ 13,567 8/31/2007 $ 24,789 $ 13,771 9/30/2007 $ 25,084 $ 14,286 10/31/2007 $ 25,485 $ 14,513 11/30/2007 $ 25,105 $ 13,906 12/31/2007 $ 24,890 $ 13,810 AVERAGE ANNUAL TOTAL RETURN - ------------------------------------- CLASS C 12/31/07 - ------------------------------------- 1-Year +7.02% - ------------------------------------- 5-Year +15.95% - ------------------------------------- 10-Year +9.41% - ------------------------------------- CLASS C (1/1/98-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE MUTUAL QUALIFIED FUND S&P 500 6 - ---------------------------------------------------------------- 1/1/1998 $ 10,000 $ 10,000 1/31/1998 $ 9,939 $ 10,111 2/28/1998 $ 10,509 $ 10,840 3/31/1998 $ 10,912 $ 11,395 4/30/1998 $ 10,912 $ 11,510 5/31/1998 $ 10,862 $ 11,312 6/30/1998 $ 10,785 $ 11,771 7/31/1998 $ 10,456 $ 11,646 8/31/1998 $ 8,891 $ 9,962 9/30/1998 $ 8,852 $ 10,600 10/31/1998 $ 9,362 $ 11,463 11/30/1998 $ 9,816 $ 12,157 12/31/1998 $ 9,942 $ 12,858 1/31/1999 $ 10,003 $ 13,396 2/28/1999 $ 9,723 $ 12,979 3/31/1999 $ 10,210 $ 13,498 4/30/1999 $ 11,098 $ 14,021 5/31/1999 $ 11,231 $ 13,690 6/30/1999 $ 11,552 $ 14,450 7/31/1999 $ 11,321 $ 13,999 8/31/1999 $ 10,789 $ 13,929 9/30/1999 $ 10,526 $ 13,548 10/31/1999 $ 10,801 $ 14,405 11/30/1999 $ 11,108 $ 14,698 12/31/1999 $ 11,189 $ 15,563 1/31/2000 $ 10,870 $ 14,781 2/29/2000 $ 10,363 $ 14,502 3/31/2000 $ 11,482 $ 15,920 4/30/2000 $ 11,489 $ 15,441 5/31/2000 $ 11,735 $ 15,124 6/30/2000 $ 11,536 $ 15,497 7/31/2000 $ 11,874 $ 15,255 8/31/2000 $ 12,392 $ 16,203 9/30/2000 $ 12,421 $ 15,347 10/31/2000 $ 12,508 $ 15,282 11/30/2000 $ 12,112 $ 14,078 12/31/2000 $ 12,657 $ 14,146 1/31/2001 $ 13,324 $ 14,648 2/28/2001 $ 13,294 $ 13,313 3/31/2001 $ 12,994 $ 12,469 4/30/2001 $ 13,593 $ 13,438 5/31/2001 $ 14,077 $ 13,528 6/30/2001 $ 14,280 $ 13,199 7/31/2001 $ 14,328 $ 13,069 8/31/2001 $ 14,068 $ 12,251 9/30/2001 $ 12,751 $ 11,262 10/31/2001 $ 12,649 $ 11,476 11/30/2001 $ 13,177 $ 12,357 12/31/2001 $ 13,562 $ 12,465 1/31/2002 $ 13,496 $ 12,283 2/28/2002 $ 13,554 $ 12,046 3/31/2002 $ 14,002 $ 12,499 4/30/2002 $ 14,085 $ 11,741 5/31/2002 $ 14,076 $ 11,655 6/30/2002 $ 13,112 $ 10,825 7/31/2002 $ 12,177 $ 9,981 8/31/2002 $ 12,269 $ 10,046 9/30/2002 $ 11,469 $ 8,955 10/31/2002 $ 11,612 $ 9,743 11/30/2002 $ 11,898 $ 10,316 12/31/2002 $ 11,727 $ 9,710 1/31/2003 $ 11,625 $ 9,456 2/28/2003 $ 11,371 $ 9,314 3/31/2003 $ 11,380 $ 9,404 4/30/2003 $ 12,150 $ 10,179 5/31/2003 $ 12,819 $ 10,715 6/30/2003 $ 13,023 $ 10,852 7/31/2003 $ 13,202 $ 11,043 8/31/2003 $ 13,517 $ 11,259 9/30/2003 $ 13,449 $ 11,139 10/31/2003 $ 14,003 $ 11,769 11/30/2003 $ 14,463 $ 11,873 12/31/2003 $ 15,147 $ 12,495 1/31/2004 $ 15,275 $ 12,725 2/29/2004 $ 15,643 $ 12,902 3/31/2004 $ 15,626 $ 12,707 4/30/2004 $ 15,155 $ 12,508 5/31/2004 $ 15,266 $ 12,679 6/30/2004 $ 15,545 $ 12,926 7/31/2004 $ 15,296 $ 12,498 8/31/2004 $ 15,485 $ 12,549 9/30/2004 $ 15,844 $ 12,684 10/31/2004 $ 16,007 $ 12,878 11/30/2004 $ 16,983 $ 13,399 12/31/2004 $ 17,497 $ 13,855 1/31/2005 $ 17,089 $ 13,518 2/28/2005 $ 17,560 $ 13,802 3/31/2005 $ 17,397 $ 13,558 4/30/2005 $ 17,234 $ 13,300 5/31/2005 $ 17,651 $ 13,724 6/30/2005 $ 17,994 $ 13,743 7/31/2005 $ 18,572 $ 14,254 8/31/2005 $ 18,526 $ 14,124 9/30/2005 $ 18,810 $ 14,239 10/31/2005 $ 18,306 $ 14,001 11/30/2005 $ 18,838 $ 14,531 12/31/2005 $ 19,261 $ 14,536 1/31/2006 $ 19,713 $ 14,921 2/28/2006 $ 19,969 $ 14,961 3/31/2006 $ 20,688 $ 15,147 4/30/2006 $ 20,806 $ 15,351 5/31/2006 $ 20,481 $ 14,909 6/30/2006 $ 20,447 $ 14,929 7/31/2006 $ 20,557 $ 15,021 8/31/2006 $ 21,115 $ 15,379 9/30/2006 $ 21,185 $ 15,775 10/31/2006 $ 21,873 $ 16,289 11/30/2006 $ 22,362 $ 16,599 12/31/2006 $ 22,758 $ 16,832 1/31/2007 $ 23,338 $ 17,086 2/28/2007 $ 23,327 $ 16,752 3/31/2007 $ 23,897 $ 16,939 4/30/2007 $ 24,593 $ 17,690 5/31/2007 $ 25,468 $ 18,307 6/30/2007 $ 25,397 $ 18,003 7/31/2007 $ 24,762 $ 17,445 8/31/2007 $ 24,530 $ 17,706 9/30/2007 $ 24,815 $ 18,368 10/31/2007 $ 25,196 $ 18,661 11/30/2007 $ 24,805 $ 17,880 12/31/2007 $ 24,583 $ 17,756 14 | Annual Report Performance Summary (CONTINUED) ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. THE FUND'S INVESTMENTS IN SMALLER-COMPANY STOCKS AND FOREIGN SECURITIES INVOLVE SPECIAL RISKS. SMALLER-COMPANY STOCKS HAVE EXHIBITED GREATER PRICE VOLATILITY THAN LARGER-COMPANY STOCKS, PARTICULARLY OVER THE SHORT TERM. FOREIGN SECURITIES RISKS INCLUDE CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, WHICH INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, 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. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated. 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. 5. Figures are as stated in the Fund's prospectus current as of the date of this report. 6. 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 | 15 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 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. 16 | 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 7/1/07 VALUE 12/31/07 PERIOD* 7/1/07-12/31/07 - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 972.90 $3.93 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,021.22 $4.02 - -------------------------------------------------------------------------------------------------------- CLASS A - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 971.00 $5.66 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,019.46 $5.80 - -------------------------------------------------------------------------------------------------------- CLASS B - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 968.20 $8.88 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,016.18 $9.10 - -------------------------------------------------------------------------------------------------------- CLASS C - -------------------------------------------------------------------------------------------------------- Actual $1,000 $ 967.90 $8.88 - -------------------------------------------------------------------------------------------------------- Hypothetical (5% return before expenses) $1,000 $1,016.18 $9.10 - --------------------------------------------------------------------------------------------------------
*Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 0.79%; A: 1.14%; B: 1.79%; and C: 1.79%), multiplied by 184/365 to reflect the one-half year period. Annual Report | 17 Mutual Qualified Fund FINANCIAL HIGHLIGHTS
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2007 2006 2005 2004 2003 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................ $ 21.88 $ 19.81 $ 19.49 $ 17.88 $ 13.95 -------------------------------------------------------------------- Income from investment operations a: Net investment income b ................................ 0.61 0.38 0.41 0.37 0.20 Net realized and unrealized gains (losses) ............. 1.37 3.39 1.77 2.56 4.04 -------------------------------------------------------------------- Total from investment operations .......................... 1.98 3.77 2.18 2.93 4.24 -------------------------------------------------------------------- Less distributions from: Net investment income .................................. (0.71) (0.40) (0.42) (0.39) (0.31) Net realized gains ..................................... (1.31) (1.30) (1.44) (0.93) -- -------------------------------------------------------------------- Total distributions ....................................... (2.02) (1.70) (1.86) (1.32) (0.31) -------------------------------------------------------------------- Redemption fees ........................................... -- d -- d -- d -- d -- -------------------------------------------------------------------- Net asset value, end of year .............................. $ 21.84 $ 21.88 $ 19.81 $ 19.49 $ 17.88 ==================================================================== Total return .............................................. 9.12% 19.29% 11.26% 16.64% 30.50% RATIOS TO AVERAGE NET ASSETS Expenses c ................................................ 0.80% e 0.83% e 0.85% e 0.82% e 0.85% Expenses - excluding dividends expense on securities sold short ............................................. 0.79% e 0.81% e 0.81% e 0.81% e 0.82% Net investment income ..................................... 2.58% 1.77% 2.04% 2.01% 1.34% SUPPLEMENTAL DATA Net assets, end of year (000's) ........................... $4,421,592 $4,200,899 $3,646,593 $3,419,744 $ 3,102,506 Portfolio turnover rate ................................... 26.25% 23.64% 20.98% 37.61% 49.70%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. 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 rounds to less than $0.01 per share. e Benefit of expense reduction rounds to less than 0.01%. 18 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Qualified Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2007 2006 2005 2004 2003 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................ $ 21.75 $ 19.71 $ 19.41 $ 17.81 $ 13.91 -------------------------------------------------------------------- Income from investment operations a: Net investment income b ................................ 0.52 0.31 0.34 0.31 0.15 Net realized and unrealized gains (losses) ............. 1.38 3.36 1.75 2.55 4.01 -------------------------------------------------------------------- Total from investment operations .......................... 1.90 3.67 2.09 2.86 4.16 -------------------------------------------------------------------- Less distributions from: Net investment income .................................. (0.64) (0.33) (0.35) (0.33) (0.26) Net realized gains ..................................... (1.31) (1.30) (1.44) (0.93) -- -------------------------------------------------------------------- Total distributions ....................................... (1.95) (1.63) (1.79) (1.26) (0.26) -------------------------------------------------------------------- Redemption fees ........................................... -- e -- e -- e -- e -- -------------------------------------------------------------------- Net asset value, end of year .............................. $ 21.70 $ 21.75 $ 19.71 $ 19.41 $ 17.81 ==================================================================== Total return c ............................................ 8.73% 18.94% 10.85% 16.27% 29.98% RATIOS TO AVERAGE NET ASSETS Expenses d ................................................ 1.14% f 1.15% f 1.20% f 1.17% f 1.20% Expenses - excluding dividend expense on securities sold short ............................................. 1.13% f 1.13% f 1.16% f 1.16% f 1.17% Net investment income ..................................... 2.24% 1.45% 1.69% 1.66% 0.99% SUPPLEMENTAL DATA Net assets, end of year (000's) ........................... $1,290,899 $ 993,364 $ 794,789 $ 692,523 $ 625,088 Portfolio turnover rate ................................... 26.25% 23.64% 20.98% 37.61% 49.70%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 19 Mutual Qualified Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2007 2006 2005 2004 2003 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................ $ 21.32 $ 19.34 $ 19.08 $ 17.54 $ 13.72 -------------------------------------------------------------------- Income from investment operations a: Net investment income b ................................ 0.36 0.16 0.20 0.19 0.05 Net realized and unrealized gains (losses) ............. 1.34 3.31 1.72 2.50 3.94 -------------------------------------------------------------------- Total from investment operations .......................... 1.70 3.47 1.92 2.69 3.99 -------------------------------------------------------------------- Less distributions from: Net investment income .................................. (0.47) (0.19) (0.22) (0.22) (0.17) Net realized gains ..................................... (1.31) (1.30) (1.44) (0.93) -- -------------------------------------------------------------------- Total distributions ....................................... (1.78) (1.49) (1.66) (1.15) (0.17) -------------------------------------------------------------------- Redemption fees ........................................... -- e -- e -- e -- e -- -------------------------------------------------------------------- Net asset value, end of year .............................. $ 21.24 $ 21.32 $ 19.34 $ 19.08 $ 17.54 ==================================================================== Total return c ............................................ 8.04% 18.16% 10.12% 15.46% 29.22% RATIOS TO AVERAGE NET ASSETS Expenses d ................................................ 1.80% f 1.82% f 1.85% f 1.82% f 1.85% Expenses - excluding dividend expense on securities sold short ............................................. 1.79% f 1.80% f 1.81% f 1.81% f 1.82% Net investment income ..................................... 1.58% 0.78% 1.04% 1.01% 0.34% SUPPLEMENTAL DATA Net assets, end of year (000's) ........................... $ 70,266 $ 74,470 $ 69,847 $ 67,714 $ 53,760 Portfolio turnover rate ................................... 26.25% 23.64% 20.98% 37.61% 49.70%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. 20 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Qualified Fund FINANCIAL HIGHLIGHTS (CONTINUED)
-------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2007 2006 2005 2004 2003 -------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ........................ $ 21.58 $ 19.58 $ 19.30 $ 17.72 $ 13.85 -------------------------------------------------------------------- Income from investment operations a: Net investment income b ................................ 0.36 0.16 0.20 0.19 0.05 Net realized and unrealized gains (losses) ............. 1.36 3.34 1.74 2.52 3.98 -------------------------------------------------------------------- Total from investment operations .......................... 1.72 3.50 1.94 2.71 4.03 -------------------------------------------------------------------- Less distributions from: Net investment income .................................. (0.49) (0.20) (0.22) (0.20) (0.16) Net realized gains ..................................... (1.31) (1.30) (1.44) (0.93) -- -------------------------------------------------------------------- Total distributions ....................................... (1.80) (1.50) (1.66) (1.13) (0.16) -------------------------------------------------------------------- Redemption fees ........................................... -- e -- e -- e -- e -- -------------------------------------------------------------------- Net asset value, end of year .............................. $ 21.50 $ 21.58 $ 19.58 $ 19.30 $ 17.72 ==================================================================== Total return c ............................................ 8.02% 18.16% 10.08% 15.52% 29.16% RATIOS TO AVERAGE NET ASSETS Expenses d ................................................ 1.80% f 1.83% f 1.85% f 1.82% f 1.85% Expenses - excluding dividend expense on securities sold short ............................................. 1.79% f 1.81% f 1.81% f 1.81% f 1.82% Net investment income ..................................... 1.58% 0.77% 1.04% 1.01% 0.34% SUPPLEMENTAL DATA Net assets, end of year (000's) ........................... $ 504,802 $ 420,806 $ 336,786 $ 311,071 $ 285,668 Portfolio turnover rate ................................... 26.25% 23.64% 20.98% 37.61% 49.70%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01 per share. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 21 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS 86.0% COMMON STOCKS AND OTHER EQUITY INTERESTS 81.2% AIRLINES 0.7% a ACE Aviation Holdings Inc., A .................................. Canada 1,159,491 $ 33,078,309 a,b ACE Aviation Holdings Inc., A, 144A ............................ Canada 58,455 1,667,622 a Northwest Airlines Corp. ....................................... United States 716,012 10,389,334 a,c Northwest Airlines Corp., Contingent Distribution .............. United States 28,232,000 952,830 ------------------ 46,088,095 ------------------ AUTO COMPONENTS 0.0% d a,c Collins & Aikman Products Co., Contingent Distribution ......... United States 1,218,896 539,362 ------------------ AUTOMOBILES 0.5% a,e,f,g International Automotive Components Group Brazil LLC ........... Brazil 1,982,308 13,769,369 a,e,f,g International Automotive Components Group Japan LLC ............ Japan 307,801 2,760,176 a,e,f,g International Automotive Components Group LLC .................. Luxembourg 8,425,843 8,938,977 a,e,f,g International Automotive Components Group NA LLC ............... United States 5,182,488 7,125,921 ------------------ 32,594,443 ------------------ BEVERAGES 2.3% Brown-Forman Corp., A .......................................... United States 79,200 5,927,328 Coca-Cola Enterprises Inc. ..................................... United States 1,570,200 40,872,306 Pernod Ricard SA ............................................... France 421,043 97,144,400 ------------------ 143,944,034 ------------------ BUILDING PRODUCTS 0.2% a Armstrong World Industries Inc. ................................ United States 141,617 5,680,258 a,c Armstrong World Industries Inc., Contingent Distribution ....... United States 15,729,675 58,986 a Owens Corning Inc. ............................................. United States 345,065 6,977,214 ------------------ 12,716,458 ------------------ CAPITAL MARKETS 0.5% Legg Mason Inc. ................................................ United States 398,890 29,178,803 ------------------ CHEMICALS 0.9% a,c Dow Corning Corp., Contingent Distribution ..................... United States 12,089,194 6,165,489 Linde AG ....................................................... Germany 302,117 39,896,537 Sika AG ........................................................ Switzerland 6,147 11,586,650 ------------------ 57,648,676 ------------------ COMMERCIAL BANKS 4.6% BNP Paribas SA ................................................. France 515,209 55,803,809 a Centennial Bank Holdings Inc. .................................. United States 1,735,639 10,031,993 Commerce Bancorp Inc. .......................................... United States 1,386,020 52,862,803 a,e,f,h Elephant Capital Holdings Ltd. ................................. Japan 11,496 7,571,181 a,e,f,h First Chicago Bancorp .......................................... United States 659,105 9,227,470 Mitsubishi UFJ Financial Group Inc. ............................ Japan 3,848,000 36,128,377 a,e,f NCB Warrant Holdings Ltd., A ................................... Japan 53,490 3,173,660 Sumitomo Mitsui Financial Group Inc. ........................... Japan 1,704 12,789,741 Svenska Handelsbanken AB, A .................................... Sweden 452,960 14,501,557 Swedbank AB, A ................................................. Sweden 877,050 24,823,322 U.S. Bancorp ................................................... United States 1,915,178 60,787,750 ------------------ 287,701,663 ------------------
22 | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) COMMERCIAL SERVICES & SUPPLIES 0.1% a Comdisco Holding Co. Inc. ...................................... United States 978 $ 8,910 a,c Comdisco Holding Co. Inc., Contingent Distribution ............. United States 44,591,246 -- a Insun ENT Co. Ltd. ............................................. South Korea 1,448,946 8,622,006 ------------------ 8,630,916 ------------------ COMPUTERS & PERIPHERALS 0.3% a,e,f,h DecisionOne Corp. .............................................. United States 1,008,199 -- a,e,f,h DecisionOne Corp., wts., 6/08/17 ............................... United States 553,576 -- a Dell Inc. ...................................................... United States 706,270 17,310,678 ------------------ 17,310,678 ------------------ CONSUMER FINANCE 0.8% a,e,f Cerberus CG Investor I LLC ..................................... United States 6,600,000 5,557,045 a,e,f Cerberus CG Investor II LLC .................................... United States 6,600,000 5,557,045 a,e,f Cerberus CG Investor III LLC ................................... United States 3,300,000 2,778,523 a,e,f Cerberus FIM Investors Auto Finance LLC ........................ United States 4,648,194 2,493,900 a,e,f Cerberus FIM Investors Commercial Finance LLC .................. United States 387,180 207,734 a,e,f Cerberus FIM Investors Commercial Mortgage LLC ................. United States 725,710 389,366 a,e,f Cerberus FIM Investors Insurance LLC ........................... United States 3,549,493 1,904,413 a,e,f Cerberus FIM Investors Rescap LLC .............................. United States 6,608,423 3,545,623 SLM Corp. ...................................................... United States 798,970 16,091,256 a,h White River Capital Inc. ....................................... United States 549,751 9,583,534 ------------------ 48,108,439 ------------------ DIVERSIFIED FINANCIAL SERVICES 0.9% Deutsche Boerse AG ............................................. Germany 66,220 13,118,629 Fortis ......................................................... Belgium 1,736,332 45,813,202 a Fortis VVPR Strip .............................................. Belgium 530,532 7,742 a,c Marconi Corp., Contingent Distribution ......................... United Kingdom 34,293,500 -- ------------------ 58,939,573 ------------------ DIVERSIFIED TELECOMMUNICATION SERVICES 0.7% a,e,f,g AboveNet Inc. .................................................. United States 387,649 19,382,450 a,e,g AboveNet Inc., stock grants, grant price $20.95, expiration date 9/09/13 ................................................ United States 510 21,140 a,e,f,g AboveNet Inc., wts., 9/08/08 ................................... United States 13,684 645,885 a,e,f,g AboveNet Inc., wts., 9/08/10 ................................... United States 16,099 703,204 Chunghwa Telecom Co. Ltd., ADR ................................. Taiwan 1,167,858 24,653,486 Embarq Corp. ................................................... United States 5,943 294,357 a,c,f Global Crossing Holdings Ltd., Contingent Distribution ......... United States 49,411,586 -- ------------------ 45,700,522 ------------------ ELECTRIC UTILITIES 0.7% E.ON AG ........................................................ Germany 198,820 42,248,444 ------------------ ELECTRONIC EQUIPMENT & INSTRUMENTS 0.1% Tyco Electronics Ltd. .......................................... United States 120,145 4,460,984 ------------------
Annual Report | 23 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) ENERGY EQUIPMENT & SERVICES 2.7% Bourbon SA ..................................................... France 579,563 $ 37,908,094 a BW Offshore Ltd. ............................................... Norway 2,813,120 11,853,979 a Seadrill Ltd. .................................................. Bermuda 3,251,262 79,269,890 a Transocean Inc. ................................................ United States 294,405 42,144,076 ------------------ 171,176,039 ------------------ FOOD & STAPLES RETAILING 3.0% Carrefour SA ................................................... France 1,494,958 116,261,028 CVS Caremark Corp. ............................................. United States 1,849,966 73,536,149 ------------------ 189,797,177 ------------------ FOOD PRODUCTS 7.3% Cadbury Schweppes PLC .......................................... United Kingdom 4,306,301 53,135,277 CSM NV ......................................................... Netherlands 1,909,144 64,359,123 Groupe Danone .................................................. France 1,681,422 150,662,283 Kraft Foods Inc., A ............................................ United States 472,085 15,404,134 a Lighthouse Caledonia ASA ....................................... Norway 416,332 395,302 Lotte Confectionary Co. Ltd. ................................... South Korea 30,405 54,894,984 a,i Marine Harvest ................................................. Norway 48,980,183 31,454,750 Nestle SA ...................................................... Switzerland 160,750 73,764,560 Nong Shim Co. Ltd. ............................................. South Korea 81,743 16,985,218 ------------------ 461,055,631 ------------------ HEALTH CARE EQUIPMENT & SUPPLIES 0.1% Covidien Ltd. .................................................. United States 120,145 5,321,222 ------------------ HEALTH CARE PROVIDERS & SERVICES 2.3% a,e,f,g Kindred Healthcare Inc. ........................................ United States 1,444,624 34,282,372 a,e,f,g Kindred Healthcare Inc., stock grants: grant price $18.15, expiration date 7/17/11 ............... United States 5,072 28,307 grant price $19.87, expiration date 1/01/12 ............... United States 1,523 5,880 grant price $6.94, expiration date 1/01/13 ................ United States 1,514 25,422 grant price $19.87, expiration date 1/01/14 ............... United States 1,129 4,359 grant price $21.33, expiration date 1/10/15 ............... United States 627 1,505 grant price $22.08, expiration date 1/10/16 ............... United States 313 517 a PharMerica Inc. ................................................ United States 528,767 7,339,286 Quest Diagnostics Inc. ......................................... United States 568,700 30,084,230 Rhoen-Klinikum AG .............................................. Germany 2,314,092 72,336,841 ------------------ 144,108,719 ------------------ HOTELS, RESTAURANTS & LEISURE 0.1% a Trump Entertainment Resorts Inc. ............................... United States 693,717 2,982,983 ------------------ INDEPENDENT POWER PRODUCERS & ENERGY TRADERS 0.3% Constellation Energy Group ..................................... United States 175,600 18,004,268 ------------------ INDUSTRIAL CONGLOMERATES 4.9% Keppel Corp. Ltd. .............................................. Singapore 5,486,488 49,480,970 g Orkla ASA ...................................................... Norway 9,599,083 185,905,508
24 | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) INDUSTRIAL CONGLOMERATES (CONTINUED) Siemens AG ..................................................... Germany 460,520 $ 72,864,728 Tyco International Ltd. ........................................ United States 23,845 945,454 ------------------ 309,196,660 ------------------ INSURANCE 10.4% a Alleghany Corp. ................................................ United States 143,797 57,806,394 Allianz SE ..................................................... Germany 59,630 12,886,075 American International Group Inc. .............................. United States 249,250 14,531,275 Assicurazioni Generali SpA ..................................... Italy 327,778 14,828,627 a Berkshire Hathaway Inc., A ..................................... United States 468 66,268,800 a Berkshire Hathaway Inc., B ..................................... United States 18,875 89,392,000 a Conseco Inc. ................................................... United States 1,264,210 15,878,478 Hartford Financial Services Group Inc. ......................... United States 482,200 42,043,018 a,e,f,h Imagine Group Holdings Ltd. .................................... Bermuda 2,814,856 32,201,953 Old Republic International Corp. ............................... United States 2,135,500 32,908,055 a,e,f Olympus Re Holdings Ltd. ....................................... United States 97,300 318,677 Prudential Financial Inc. ...................................... United States 461,000 42,891,440 e,f Symetra Financial .............................................. United States 3,434,760 55,024,855 White Mountains Insurance Group Ltd. ........................... United States 346,730 178,236,556 ------------------ 655,216,203 ------------------ MACHINERY 1.9% Kone OYJ, B .................................................... Finland 1,438,600 100,625,241 a,e,f Motor Coach Industries International Inc., wts., 5/27/09 ....... United States 5 -- NACCO Industries Inc., A ....................................... United States 172,254 17,172,001 ------------------ 117,797,242 ------------------ MEDIA 4.1% a Adelphia Recovery Trust ........................................ United States 38,254,708 2,677,830 a,c Adelphia Recovery Trust Arahova Contingent Value Vehicle, Contingent Distribution ........................................ United States 4,899,492 2,523,238 a,c Century Communications Corp., Contingent Distribution .......... United States 13,497,000 -- CJ CGV Co. Ltd. ................................................ South Korea 574,910 7,923,016 a Comcast Corp., A ............................................... United States 829,640 15,033,077 a Liberty Media Holding Corp.-Capital, A ......................... United States 307,412 35,810,424 News Corp., A .................................................. United States 1,767,710 36,220,378 a Sun-Times Media Group Inc., A .................................. United States 767,234 1,687,915 a Time Warner Cable Inc., A ...................................... United States 862,694 23,810,354 Time Warner Inc. ............................................... United States 3,504,460 57,858,635 a,f TVMAX Holdings Inc. ............................................ United States 111,391 -- a Viacom Inc., B ................................................. United States 230,350 10,116,972 Virgin Media Inc. .............................................. United Kingdom 3,655,939 62,662,794 ------------------ 256,324,633 ------------------ METALS & MINING 1.1% Anglo American PLC ............................................. United Kingdom 447,467 27,384,114 a,e,f,h Esmark Inc. .................................................... United States 3,087,162 39,259,439 ------------------ 66,643,553 ------------------
Annual Report | 25 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) MULTI-UTILITIES 0.9% Energy East Corp. .............................................. United States 256,070 $ 6,967,665 NorthWestern Corp. ............................................. United States 311,667 9,194,176 a,c NorthWestern Corp., Contingent Distribution .................... United States 9,346,450 662,741 RWE AG ......................................................... Germany 281,473 39,618,536 ------------------ 56,443,118 ------------------ MULTILINE RETAIL 0.9% Jelmoli Holding AG ............................................. Switzerland 24,399 58,456,835 ------------------ OIL, GAS & CONSUMABLE FUELS 2.7% BP PLC ......................................................... United Kingdom 1,221,600 14,927,638 BP PLC, ADR .................................................... United Kingdom 193,700 14,173,029 Eni SpA ........................................................ Italy 1,452,100 53,084,008 Royal Dutch Shell PLC, A ....................................... United Kingdom 798,053 33,483,360 Total SA, B .................................................... France 665,472 55,190,826 ------------------ 170,858,861 ------------------ PAPER & FOREST PRODUCTS 2.6% a Domtar Corp. ................................................... United States 2,118,456 16,290,927 Mondi Ltd. ..................................................... United Kingdom 49,172 464,574 Mondi PLC ...................................................... United Kingdom 122,930 1,038,087 Weyerhaeuser Co. ............................................... United States 1,952,105 143,948,223 ------------------ 161,741,811 ------------------ PHARMACEUTICALS 1.2% Pfizer Inc. .................................................... United States 1,871,640 42,542,377 Sanofi-Aventis ................................................. France 242,013 22,243,381 a Valeant Pharmaceuticals International .......................... United States 1,025,100 12,270,447 ------------------ 77,056,205 ------------------ REAL ESTATE 3.9% a Alexander's Inc. ............................................... United States 108,590 38,359,418 a,f Canary Wharf Group PLC ......................................... United Kingdom 8,298,072 82,933,911 Link REIT ...................................................... Hong Kong 12,491,769 27,040,056 Swire Pacific Ltd., A .......................................... Hong Kong 3,620,800 49,914,210 Swire Pacific Ltd., B .......................................... Hong Kong 5,292,600 14,049,168 Ventas Inc. .................................................... United States 669,525 30,296,006 ------------------ 242,592,769 ------------------ SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT 0.2% a LSI Corp. ...................................................... United States 1,879,630 9,980,835 ------------------ SOFTWARE 1.1% Microsoft Corp. ................................................ United States 1,998,000 71,128,800 ------------------ THRIFTS & MORTGAGE FINANCE 1.3% Hudson City Bancorp Inc. ....................................... United States 2,129,440 31,984,189 h Imperial Capital Bancorp Inc. .................................. United States 445,796 8,158,067 Sovereign Bancorp Inc. ......................................... United States 3,815,396 43,495,514 ------------------ 83,637,770 ------------------
26 | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) TOBACCO 14.2% Altadis SA ..................................................... Spain 1,706,907 $ 123,826,350 Altria Group Inc. .............................................. United States 1,137,077 85,940,280 British American Tobacco PLC ................................... United Kingdom 3,939,454 153,810,347 Imperial Tobacco Group PLC ..................................... United Kingdom 1,509,119 81,320,518 Japan Tobacco Inc. ............................................. Japan 12,142 72,733,318 KT&G Corp. ..................................................... South Korea 3,097,050 263,698,397 Reynolds American Inc. ......................................... United States 1,710,600 112,831,176 ------------------ 894,160,386 ------------------ TRADING COMPANIES & DISTRIBUTORS 0.7% Kloeckner & Co. AG ............................................. Germany 1,113,198 44,350,090 ------------------ TRANSPORTATION INFRASTRUCTURE 0.0% d a Groupe Eurotunnel SA, wts., 12/30/11 ........................... France 1,861,027 624,655 ------------------ TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $3,137,001,619) ....................................... 5,104,467,555 ------------------ PREFERRED STOCKS 0.1% AUTO COMPONENTS 0.1% e,f Dana Holding Corp., 4.00%, cvt. pfd., B ........................ United States 48,807 4,880,700 ------------------ DIVERSIFIED TELECOMMUNICATION SERVICES 0.0% d e PTV Inc., 10.00%, pfd., A ...................................... United Kingdom 92,938 111,526 ------------------ TOTAL PREFERRED STOCKS (COST $5,159,514) ....................... 4,992,226 ------------------ OPTIONS PURCHASED 1.0% CALL OPTIONS 0.0% d a,e Owens Corning Inc., exercise price $37.50, expiration date 1/02/08, shares ............................................. United States 249,750 12,487 ------------------ PUT OPTIONS 1.0% a Index basket consisting of 55% Dow Jones EUROSTOXX 50 (exercise price $4,026.33), 45% S&P 500 Index (exercise price $1,367.59), expiration date 5/29/08, contracts .............. United States 10,000,000 23,455,882 a Index basket consisting of 55% Dow Jones EUROSTOXX 50 (exercise price $4,091.24), 45% S&P 500 Index (exercise price $1,381.87), expiration date 6/20/08, contracts .............. United States 10,000,000 29,035,575 a Index basket consisting of 50% Dow Jones EUROSTOXX 50 (exercise price $4,083.52), 50% S&P 500 Index (exercise price $1,393.78), expiration date 7/18/08, contracts .............. United States 3,500,000 11,456,806 ------------------ 63,948,263 ------------------ TOTAL OPTIONS PURCHASED (COST $55,351,137) ..................... 63,960,750 ------------------ ------------------ PRINCIPAL AMOUNT j ------------------ CORPORATE BONDS & NOTES 3.5% b ACE Aviation Holdings Inc., cvt., 144A, 4.25%, 6/01/35 ......... Canada 2,505,000 CAD 2,848,453 e,f Cerberus CG Investor I LLC, 12.00%, 7/31/14 .................... United States 6,600,000 5,557,045 e,f Cerberus CG Investor II LLC, 12.00%, 7/31/14 ................... United States 6,600,000 5,557,045 e,f Cerberus CG Investor III LLC, 12.00%, 7/31/14 .................. United States 3,300,000 2,778,523 e,f Cerberus FIM Investors Auto Finance LLC, 12.00%, 11/22/13 ...... United States 13,935,097 7,476,610
Annual Report | 27 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT j VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) CORPORATE BONDS & NOTES (CONTINUED) e,f Cerberus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 .................................................... United States 1,161,542 $ 623,203 e,f Cerberus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 .................................................... United States 2,177,131 1,168,098 e,f Cerberus FIM Investors Insurance LLC, 12.00%, 11/22/13 ......... United States 10,648,479 5,713,238 e,f Cerberus FIM Investors Rescap LLC, 12.00%, 11/22/13 ............ United States 19,825,266 10,636,868 e,f,h DecisionOne Corp., 12.00%, 4/15/10 ........................................... United States 1,246,268 1,246,268 k FRN, 9.50%, 5/12/09 ....................................... United States 232,502 232,502 Groupe Eurotunnel SA, cvt., 3.00%, 6/28/09 ............................................ France 31,400 EUR 100,812 3.00%, 6/28/09 ............................................ France 24,416 GBP 106,728 3.00%, 7/28/10 ............................................ France 9,114,500 EUR 26,269,959 3.00%, 7/28/10 ............................................ France 5,276,020 GBP 20,704,298 6.00%, 7/28/10 ............................................ France 22,114,700 EUR 43,407,301 6.00%, 7/28/10 ............................................ France 13,086,625 GBP 34,973,324 sub. bond, T1, 3.00%, 7/28/08 ............................. France 31,400 EUR 112,268 sub. bond, T1, 3.00%, 7/28/08 ............................. France 24,416 GBP 118,856 b Indianapolis Downs LLC, senior secured note, 144A, 11.00%, 11/01/12 ............... United States 2,950,000 2,861,500 senior secured sub. note, 144A, PIK, 15.50%, 11/01/13 ..... United States 10,050,000 10,351,500 e,f,g International Automotive Components Group NA LLC, 9.00%, 4/01/17 ..................................................... United States 1,560,200 1,560,200 e,f,k Motor Coach Industries International Inc., FRN, 18.081%, 12/01/08 .................................................... United States 25,130,149 24,878,847 Trump Entertainment Resorts Inc., 8.50%, 5/20/15 ............... United States 13,553,108 10,385,069 f TVMAX Holdings Inc., PIK, 11.50%, 2/28/08 ........................................... United States 316,094 221,266 14.00%, 2/28/08 ........................................... United States 725,016 507,512 ------------------ TOTAL CORPORATE BONDS & NOTES (COST $241,975,073) .............. 220,397,293 ------------------ CORPORATE BONDS & NOTES IN REORGANIZATION 0.2% b Calpine Corp., senior secured note, 144A, 8.50%, 7/15/10 ............................................ United States 2,528,000 2,717,600 9.875%, 12/01/11 .......................................... United States 890,000 934,500 8.75%, 7/15/13 ............................................ United States 1,324,000 1,429,920 l Dana Corp., 6.50%, 3/01/09 ............................................ United States 2,058,000 1,553,790 5.85%, 1/15/15 ............................................ United States 9,145,000 6,721,575 7.00%, 3/01/29 ............................................ United States 1,972,000 1,488,860 senior note, 7.00%, 3/15/28 ............................... United States 423,000 310,905 f,l Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ........ United States 40,000 200 ------------------ TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $14,447,659) .......................................... 15,157,350 ------------------ TOTAL LONG TERM INVESTMENTS (COST $3,453,935,002) .............. 5,408,975,174 ------------------
28 | Annual Report Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ PRINCIPAL AMOUNT j COUNTRY /SHARES VALUE - ------------------------------------------------------------------------------------------------------------------------------------ SHORT TERM INVESTMENTS 14.0% U.S. GOVERNMENT AND AGENCY SECURITIES 13.9% m FHLB, n 1/02/08 - 12/04/08 ........................................ United States 615,686,000 $ 610,317,358 1/03/08 ................................................... United States 85,000,000 85,000,000 1/04/08 ................................................... United States 115,000,000 115,000,000 m U.S. Teasury Bills, 4/24/08 - 5/01/08 .......................... United States 66,500,000 65,814,185 ------------------ TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $875,294,851) ......................................... 876,131,543 ------------------ TOTAL INVESTMENTS BEFORE MONEY MARKET FUND (COST $4,329,229,853) ....................................... 6,285,106,717 ------------------ o INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES (COST $2,745,027) 0.1% MONEY MARKET FUND 0.1% p Bank of New York Institutional Cash Reserve Fund, 5.06% ........ United States 2,745,027 2,745,027 ------------------ TOTAL INVESTMENTS (COST $4,331,974,880) 100.0% ................. 6,287,851,744 SECURITIES SOLD SHORT (0.6)% ................................... (40,157,456) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (0.2)% ...................................................... (13,103,504) OTHER ASSETS, LESS LIABILITIES 0.8% ............................ 52,968,389 ------------------ NET ASSETS 100.0% .............................................. $ 6,287,559,173 ------------------ q SECURITIES SOLD SHORT (PROCEEDS $42,068,109) 0.6% COMMERCIAL BANKS 0.6% Toronto-Dominion Bank .......................................... Canada 574,088 $ 40,157,456 ------------------
CURRENCY ABBREVIATIONS CAD - Canadian Dollar EUR - Euro GBP - British Pound SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FHLB - Federal Home Loan Bank FRN - Floating Rate Note PIK - Payment-In-Kind REIT - Real Estate Investment Trust Annual Report | 29 Mutual Qualified Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- a Non-income producing for the twelve months ended December 31, 2007. 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, 2007, the aggregate value of these securities was $22,811,095, representing 0.36% 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 0.1% of net assets. e See Note 9 regarding restricted securities. f Security has been deemed illiquid because it may not be able to be sold within seven days. At December 31, 2007, the aggregate value of these securities was $412,857,264, representing 6.57% of the net assets. g See Note 12 regarding other considerations. h See Note 11 regarding holdings of 5% voting securities. i A portion or all of the security is on loan as of December 31, 2007. See Note 1(g). j The principal amount is stated in U.S. dollars unless otherwise indicated. k The coupon rate shown represents the rate at period end. l See Note 8 regarding defaulted securities. m The security is traded on a discount basis with no stated coupon rate. n Security or a portion of the security has been segregated as collateral for securities sold short. At December 31, 2007, the value of securities and or cash pledged amounted to $39,732,500. o See Note 1(g) regarding securities on loan. p The rate shown is the annualized seven-day yield at period end. q See Note 1(f) regarding securities sold short. 30 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Qualified Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2007 Assets: Investments in securities: Cost - Unaffiliated issuers .............................................................. $4,204,874,296 Cost - Non-controlled affiliated issuers (Note 11) ....................................... 127,100,584 --------------- Total cost of investments ................................................................ $4,331,974,880 =============== Value - Unaffiliated issuers (include securities loaned in the amount of $2,518,287) ..... $6,180,371,330 Value - Non-controlled affiliated issuers (Note 11) ...................................... 107,480,414 --------------- Total value of investments ............................................................... 6,287,851,744 Cash on deposits with brokers for securities sold short .................................... 41,350,677 Foreign currency, at value (cost $4,354,005) ............................................... 4,328,517 Receivables: Capital shares sold ...................................................................... 7,896,566 Dividends and interest ................................................................... 14,997,227 Unrealized gain on forward exchange contracts (Note 7) ..................................... 17,411,485 --------------- Total assets ........................................................................... 6,373,836,216 --------------- Liabilities: Payables: Capital shares redeemed .................................................................. 6,232,880 Affiliates ............................................................................... 5,530,416 Funds advanced by custodian ................................................................ 83,223 Payable upon return of securities loaned ................................................... 2,745,027 Securities sold short, at value (proceeds $42,068,109) ..................................... 40,157,456 Unrealized loss on forward exchange contracts (Note 7) ..................................... 30,514,989 Accrued expenses and other liabilities ..................................................... 1,013,052 --------------- Total liabilities ...................................................................... 86,277,043 --------------- Net assets, at value ................................................................. $6,287,559,173 =============== Net assets consist of: Paid-in capital ............................................................................ $4,316,180,314 Undistributed net investment income ........................................................ 2,003,039 Net unrealized appreciation (depreciation) ................................................. 1,944,796,963 Accumulated net realized gain (loss) ....................................................... 24,578,857 --------------- Net assets, at value ................................................................. $6,287,559,173 ===============
Annual Report | The accompanying notes are an integral part of these financial statements. | 31 Mutual Qualified Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2007 CLASS Z: Net assets, at value ....................................................................... $ 4,421,592,475 ================== Shares outstanding ......................................................................... 202,488,695 ================== Net asset value and maximum offering price per share a ..................................... $ 21.84 ================== CLASS A: Net assets, at value ....................................................................... $ 1,290,898,576 ================== Shares outstanding ......................................................................... 59,486,954 ================== Net asset value per share a ................................................................ $ 21.70 ================== Maximum offering price per share (net asset value per share / 94.25%) ...................... $ 23.02 ================== CLASS B: Net assets, at value ....................................................................... $ 70,266,233 ================== Shares outstanding ......................................................................... 3,308,704 ================== Net asset value and maximum offering price per share a ..................................... $ 21.24 ================== CLASS C: Net assets, at value ....................................................................... $ 504,801,889 ================== Shares outstanding ......................................................................... 23,478,595 ================== Net asset value and maximum offering price per share a ..................................... $ 21.50 ==================
a Redemption price is equal to net asset value less contingent deferred sales charges, if applicable, and redemption fees retained by the Fund. 32 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Qualified Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2007 Investment income: Dividends: (net of foreign taxes of $7,649,988) Unaffiliated issuers .................................................................................... $ 158,990,061 Non-controlled affiliated issuers (Note 11) ............................................................. 1,813,545 Interest income: (net of foreign taxes of $1,095) Unaffiliated issuers .................................................................................... 49,341,863 Non-controlled affiliated issuers (Note 11) ............................................................. 156,673 Income from securities loaned ............................................................................. 1,109,267 -------------- Total investment income ............................................................................... 211,411,409 -------------- Expenses: Management fees (Note 3a) ................................................................................. 37,130,347 Administrative fees (Note 3b) ............................................................................. 4,754,642 Distribution fees: (Note 3c) Class A ................................................................................................. 4,141,657 Class B ................................................................................................. 749,535 Class C ................................................................................................. 4,874,080 Transfer agent fees (Note 3e) ............................................................................. 5,244,945 Custodian fees (Note 4) ................................................................................... 1,063,419 Reports to shareholders ................................................................................... 385,649 Registration and filing fees .............................................................................. 204,582 Professional fees ......................................................................................... 739,533 Directors' fees and expenses .............................................................................. 91,546 Dividends on securities sold short ........................................................................ 414,650 Other ..................................................................................................... 150,478 -------------- Total expenses ........................................................................................ 59,945,063 Expense reductions (Note 4) ........................................................................... (33,429) -------------- Net expenses ........................................................................................ 59,911,634 -------------- Net investment income ............................................................................. 151,499,775 -------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments Unaffiliated issuers .................................................................................. 408,348,791 Non-controlled affiliated issuers (Note 11) ........................................................... 114,748,024 Foreign currency transactions ........................................................................... (128,584,213) Securities sold short ................................................................................... (1,846,753) Synthetic equity swaps .................................................................................. (340) -------------- Net realized gain (loss) ............................................................................ 392,665,509 -------------- Net change in unrealized appreciation (depreciation) on: Investments ............................................................................................. (41,488,445) Translation of assets and liabilities denominated in foreign currencies ................................. 4,807,110 -------------- Net change in unrealized appreciation (depreciation) ................................................ (36,681,335) -------------- Net realized and unrealized gain (loss) ...................................................................... 355,984,174 -------------- Net increase (decrease) in net assets resulting from operations .............................................. $ 507,483,949 ==============
Annual Report | The accompanying notes are an integral part of these financial statements. | 33 Mutual Qualified Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
------------------------------------ YEAR ENDED DECEMBER 31, ------------------------------------ 2007 2006 ------------------------------------ Increase (decrease) in net assets: Operations: Net investment income ............................................................... $ 151,499,775 $ 85,072,964 Net realized gain (loss) from investments, written options, securities sold short, synthetic equity swaps, and foreign currency transactions .................. 392,665,509 311,026,318 Net change in unrealized appreciation (depreciation) on investments, translation of assets and liabilities denominated in foreign currencies, and deferred taxes ... (36,681,335) 522,679,758 ------------------------------------ Net increase (decrease) in net assets resulting from operations ............... 507,483,949 918,779,040 ------------------------------------ Distributions to shareholders from: Net investment income: Class Z .......................................................................... (133,801,897) (72,701,378) Class A .......................................................................... (34,706,443) (14,297,690) Class B .......................................................................... (1,467,618) (624,281) Class C .......................................................................... (10,641,199) (3,637,539) Net realized gains: Class Z .......................................................................... (245,908,236) (235,676,842) Class A .......................................................................... (71,535,285) (55,482,433) Class B .......................................................................... (4,072,725) (4,356,865) Class C .......................................................................... (28,564,865) (23,788,670) ------------------------------------ Total distributions to shareholders .................................................... (530,698,268) (410,565,698) ------------------------------------ Capital share transactions: (Note 2) Class Z .......................................................................... 219,666,981 172,221,468 Class A .......................................................................... 316,804,502 114,571,705 Class B .......................................................................... (4,572,363) (2,408,287) Class C .......................................................................... 89,317,402 48,918,181 ------------------------------------ Total capital share transactions ....................................................... 621,216,522 333,303,067 ------------------------------------ Redemption fees ........................................................................ 17,800 7,653 ------------------------------------ Net increase (decrease) in net assets ......................................... 598,020,003 841,524,062 Net assets: Beginning of year ...................................................................... 5,689,539,170 4,848,015,108 ------------------------------------ End of year ............................................................................ $ 6,287,559,173 $ 5,689,539,170 ==================================== Undistributed net investment income (distributions in excess of net investment income) included in net assets: End of year ............................................................................ $ 2,003,039 $ (4,982,471) ====================================
34 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Fund Inc. (Series Fund) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of six separate funds. The Mutual Qualified Fund (Fund) included in this report is diversified. The financial statements of the remaining funds in the Series Fund are presented separately. The Fund offers four classes of shares: Class Z, Class A, Class B and Class C. 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. 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. Annual Report | 35 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. 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. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. 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. 36 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. FOREIGN CURRENCY CONTRACTS 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. A foreign exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. Realized and unrealized gains and losses on these contracts are included in the Statement of Operations. The Fund may also enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates or to gain exposure to certain foreign currencies. These contracts are valued daily by the Fund and the unrealized gains or losses on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, are included in the Statement of Assets and Liabilities. 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. 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 short 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 (margin account). Periodically, payments are made to recognize changes in value of the contract resulting from interest on the notional value of the contract, market value changes in the underlying security, and/or dividends paid by the issuer of the underlying security. The Fund recognizes a realized gain or loss when cash is received from, or paid to, the broker. Synthetic equity swaps are valued daily by the Fund and the unrealized gains or losses on the contracts (as measured by the difference between the contract amount plus or minus cash received or paid and the market value of the underlying securities) are recorded in the Statement of Operations. The margin account and any net unrealized gains or losses on open synthetic equity swaps are included in the Statement of Assets and Liabilities. The risks of entering into synthetic equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. Annual Report | 37 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 or index 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. 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. SECURITIES LENDING The Fund may loan securities to certain brokers through a securities lending agent for which it receives initial cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of Fund business each day; any additional collateral required due to changes in security values is delivered to the Fund on the next business day. 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. 38 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. INCOME AND DEFERRED TAXES No provision has been made for U.S. income taxes because it is the Fund's policy 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 on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. The Fund may be 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. I. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. 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 accounting principles generally accepted in the United States of America. 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. 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. 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. Differences in per share distributions, by class, are generally due to differences in class specific expenses. Annual Report | 39 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. K. 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. 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. L. GUARANTEES AND INDEMNIFICATIONS Under the Series Funds' 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. Currently, the Fund expects the risk of loss to be remote. 2. CAPITAL STOCK At December 31, 2007, there were 1.00 billion shares authorized ($0.001 par value). Transactions in the Fund's shares were as follows:
------------------------------------------------------------------ YEAR ENDED DECEMBER 31, 2007 2006 ------------------------------------------------------------------ SHARES AMOUNT SHARES AMOUNT ------------------------------------------------------------------ CLASS Z SHARES: Shares sold ........................ 11,498,413 $ 269,849,858 8,512,548 $ 181,803,162 Shares issued in reinvestment of distributions .................... 16,420,954 360,016,285 13,636,748 293,498,827 Shares redeemed .................... (17,456,173) (410,199,162) (14,219,750) (303,080,521) ------------------------------------------------------------------ Net increase (decrease) ............ 10,463,194 $ 219,666,981 7,929,546 $ 172,221,468 ================================================================== CLASS A SHARES: Shares sold ........................ 19,622,769 $ 459,150,297 10,807,154 $ 229,222,653 Shares issued in reinvestment of distributions .................... 4,576,592 99,690,375 3,087,615 66,093,819 Shares redeemed .................... (10,374,895) (242,036,170) (8,554,219) (180,744,767) ------------------------------------------------------------------ Net increase (decrease) ............ 13,824,466 $ 316,804,502 5,340,550 $ 114,571,705 ==================================================================
40 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
----------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 ----------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ----------------------------------------------------------- CLASS B SHARES: Shares sold ........................... 180,171 $ 4,119,296 159,945 $ 3,278,231 Shares issued in reinvestment of distributions ....................... 237,389 5,061,976 219,353 4,592,968 Shares redeemed ....................... (602,357) (13,753,635) (496,487) (10,279,486) ----------------------------------------------------------- Net increase (decrease) ............... (184,797) $ (4,572,363) (117,189) $ (2,408,287) =========================================================== CLASS C SHARES: Shares sold ........................... 5,112,901 $ 118,074,250 3,442,336 $ 72,454,321 Shares issued in reinvestment of distributions ....................... 1,634,857 35,274,002 1,177,478 24,986,482 Shares redeemed ....................... (2,772,446) (64,030,850) (2,320,964) (48,522,622) ----------------------------------------------------------- Net increase (decrease) ............... 3,975,312 $ 89,317,402 2,298,850 $ 48,918,181 ===========================================================
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 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 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 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 | 41 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 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 plans, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B and C compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ............................................................ 0.35% 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: Sales charges retained net of commissions paid to unaffiliated broker/dealers ...................................... $943,383 Contingent deferred sales charges retained ......................... $ 92,314 E. TRANSFER AGENT FEES For the year ended December 31, 2007, the Fund paid transfer agent fees of $5,244,945, of which $3,189,017 was retained by Investor Services. 42 | 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 December 31, 2007, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES The Fund has reviewed the tax positions taken on federal income tax returns, for each of the three open tax years as of December 31, 2007 and has determined that no provision for income tax is required in the Fund's financial statements. 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, 2007, the Fund deferred realized currency losses of $544,932. The tax character of distributions paid during the years ended December 31, 2007 and 2006, was as follows: --------------------------- 2007 2006 --------------------------- Distributions paid from: Ordinary income .............................. $ 180,623,450 $101,907,924 Long term capital gain ....................... 350,074,818 308,657,775 --------------------------- $ 530,698,268 $410,565,699 =========================== At December 31, 2007, 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 .......................................... $4,342,497,729 =============== Unrealized appreciation ...................................... $2,182,271,962 Unrealized depreciation ...................................... (236,917,947) --------------- Net unrealized appreciation (depreciation) ................... $1,945,354,015 =============== Undistributed ordinary income ................................ $ 12,782,493 Undistributed long term capital gains ........................ 10,528,870 --------------- Distributable earnings ....................................... $ 23,311,363 =============== Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment company shares, pass-through equity income, 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, pass-through entity income, bond discounts and premiums, and ceratin dividends on securities sold short. Annual Report | 43 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, 2007, aggregated $1,466,258,247 and $1,785,097,903, respectively. 7. FORWARD EXCHANGE CONTRACTS At December 31, 2007, the Fund had the following forward exchange contracts outstanding:
----------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED UNREALIZED AMOUNT DATE GAIN LOSS ----------------------------------------------------------- CONTRACTS TO BUY 20,461,740 Norwegian Krone ............ $ 3,700,000 2/19/08 $ 60,027 $ -- CONTRACTS TO SELL 115,915,333 Great Britian Pound ........ 233,888,193 1/10/08 3,637,256 -- 6,800,000 Great Britian Pound ........ 13,476,648 1/10/08 -- (30,617) 127,336,407 Euro ....................... 176,274,955 1/14/08 -- (9,602,439) 245,866,547 Swedish Krona .............. 38,517,306 1/15/08 484,698 -- 37,509,430 Singapore Dollar ........... 25,252,084 1/24/08 -- (818,399) 51,324,491 Euro ....................... 74,952,902 2/13/08 4,113 -- 76,452,418 Euro ....................... 106,192,409 2/13/08 -- (5,450,511) 672,000,000 Norwegian Krone ............ 124,026,991 2/19/08 541,011 -- 395,245,359 Norwegian Krone ............ 72,194,593 2/19/08 -- (435,259) 77,100,000 Euro ....................... 114,301,877 2/25/08 1,705,510 -- 113,792,932 Swiss Franc ................ 101,819,391 3/07/08 1,008,841 -- 105,461,353 Great Britian Pound ........ 213,368,664 3/10/08 4,220,800 -- 52,155,944 Euro ....................... 77,200,481 3/13/08 1,031,295 -- 78,631,558 Euro ....................... 109,854,901 3/13/08 -- (4,979,598) 8,914,308,914 Japanese Yen ............... 79,327,623 3/19/08 -- (1,301,970) 1,936,100 Canadian Dollar ............ 2,096,231 3/26/08 146,296 -- 31,811,871 Canadian Dollar ............ 31,824,601 3/26/08 -- (214,594) 141,685,647,420 South Korean Won ........... 155,242,000 3/27/08 3,096,338 -- 5,520,925,000 South Korean Won ........... 5,900,000 3/27/08 -- (28,510) 86,067,033 Euro ....................... 121,512,280 4/24/08 -- (4,162,926) 8,200,000 Euro ....................... 12,198,033 5/19/08 225,948 -- 97,508,240 Euro ....................... 138,872,880 5/19/08 -- (3,490,166) 89,532,375 Euro ....................... 131,961,395 5/28/08 1,249,352 -- ------------------------------- UNREALIZED GAIN (LOSS) ON FORWARD EXCHANGE CONTRACTS ............. 17,411,485 (30,514,989) ------------------------------- NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS ...... $ (13,103,504) ================
44 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. CREDIT RISK AND 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. Risks associated with purchasing these securities include the possibility that the bankruptcy or other restructuring process takes longer than expected, or that distributions in restructuring are less than anticipated, either or both of which may result in unfavorable consequences to the Fund. At December 31, 2007, the aggregate value of these securities was $10,075,330, representing 0.16% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 9. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. At December 31, 2007, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- ---------------------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ---------------------------------------------------------------------------------------------------------------------- 387,649 AboveNet Inc. ................................. 10/02/01 - 12/12/07 $19,435,249 $ 19,382,450 510 AboveNet Inc., stock grants, grant price $20.95, expiration date 9/09/13 ............. 4/17/06 - 9/08/06 -- 21,140 13,684 AboveNet Inc., wts., 9/08/08 .................. 10/02/01 - 9/07/07 1,564,801 645,885 16,099 AboveNet Inc., wts., 9/08/10 .................. 10/02/01 - 9/07/07 1,681,196 703,204 6,600,000 Cerberus CG Investor I LLC .................... 7/26/07 6,600,000 5,557,045
Annual Report | 45 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED)
- --------------------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ---------------------------------------------------------------------------------------------------------------------- 6,600,000 Cerberus CG Investor I LLC, 12.00%, 7/31/14 ..................................... 7/26/07 $ 6,600,000 $ 5,557,045 6,600,000 Cerberus CG Investor II LLC ................... 7/26/07 6,600,000 5,557,045 6,600,000 Cerberus CG Investor II LLC, 12.00%, 7/31/14 ..................................... 7/26/07 6,600,000 5,557,045 3,300,000 Cerberus CG Investor III LLC .................. 7/26/07 3,300,000 2,778,523 3,300,000 Cerberus CG Investor III LLC, 12.00%, 7/31/14 ..................................... 7/26/07 3,300,000 2,778,523 4,648,194 Cerberus FIM Investors Auto Finance LLC ......................................... 11/20/06 4,648,194 2,493,900 387,180 Cerberus FIM Investors Commercial Finance LLC ................................. 11/20/06 387,181 207,734 1,161,542 Cerberus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 ............... 11/20/06 1,161,542 623,203 725,710 Cerberus FIM Investors Commercial Mortgage LLC ................................ 11/20/06 725,710 389,366 2,177,131 Cerberus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 .............. 11/20/06 2,177,131 1,168,098 13,935,097 Cerberus FIM Investors I Auto Finance LLC, 12.00%, 11/22/13 ....................... 11/20/06 13,935,097 7,476,610 3,549,493 Cerberus FIM Investors Insurance LLC ......................................... 11/20/06 3,549,493 1,904,413 10,648,479 Cerberus FIM Investors Insurance, 12.00%, 11/22/13 ............................ 11/21/06 10,648,479 5,713,238 6,608,423 Cerberus FIM Investors Rescap LLC ............. 11/20/06 6,608,422 3,545,623 19,825,266 Cerberus FIM Investors Rescap LLC, 12.00%, 11/22/13 ............................ 11/20/06 19,825,267 10,636,868 48,807 Dana Holding Corp., 4.00%, cvt., pfd., B ........................................... 12/27/07 4,880,700 4,880,700 1,008,199 DecisionOne Corp. ............................. 3/12/99 - 7/18/00 700,978 -- 1,246,268 DecisionOne Corp., 12.00%, 4/15/10 ............ 3/12/99 - 10/17/07 2,328,805 1,246,268 232,502 DecisionOne Corp., FRN, 10.00%, 5/12/09 ..................................... 7/09/07 232,502 232,502 553,576 DecisionOne Corp., wts., 6/08/17 .............. 7/09/07 -- -- 11,496 Elephant Capital Holdings Ltd. ................ 8/29/03 - 3/22/07 409,627 7,571,181 3,087,162 Esmark Inc. ................................... 7/28/06 57,180,518 39,259,439 659,105 First Chicago Bancorp ......................... 11/16/06 9,227,470 9,227,470 2,814,856 Imagine Group Holdings Ltd. ................... 8/31/04 28,828,348 32,201,953 1,982,308 International Automotive Components Group Brazil LLC ............................ 4/13/06 - 8/21/06 1,186,317 13,769,369 307,801 International Automotive Components Group Japan LLC ............................. 9/26/06 - 3/27/07 2,674,756 2,760,176 8,425,843 International Automotive Components Group LLC ................................... 1/12/06 -10/16/06 8,429,977 8,938,977
46 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ---------------------------------------------------------------------------------------------------------------------- 5,182,488 International Automotive Components Group NA LLC ................................ 3/03/07 - 10/10/07 $ 5,176,082 $ 7,125,921 1,560,200 International Automotive Components Group NA LLC, 9.00%, 4/01/17 ................ 3/30/07 1,583,603 1,560,200 1,444,624 Kindred Healthcare Inc. ....................... 4/28/99 - 3/29/06 13,176,151 34,282,372 Kindred Healthcare Inc., stock grants: 5,072 grant price $18.15, expiration date 7/17/11 ................................... 7/17/02 - 7/17/05 -- 28,307 1,523 grant price $19.87, expiration date 1/01/12 ................................... 1/01/03 - 1/01/06 -- 5,880 1,514 grant price $6.94, expiration date 1/01/13 ................................... 1/01/04 - 1/03/07 -- 25,422 1,129 grant price $19.87, expiration date 1/01/14 ................................... 1/01/05 - 1/03/07 -- 4,359 627 grant price $21.33, expiration date 1/10/15 ................................... 1/06/06 - 1/09/07 -- 1,505 313 grant price $22.08, expiration date 1/10/16 ................................... 1/09/07 -- 517 25,130,149 Motor Coach Industries International Inc., FRN, 18.081%, 12/01/08 ................ 5/27/04 - 8/31/07 25,130,149 24,878,847 5 Motor Coach Industries International Inc., wts., 5/27/09 ......................... 3/30/07 -- -- 53,490 NCB Warrant Holdings Ltd., A .................. 12/16/05 -- 3,173,660 97,300 Olympus Re Holdings Ltd. ...................... 12/19/01 9,730,000 318,677 249,750 a Owens Corning Inc., exercise price $37.50, expiration date 1/02/08, shares ...................................... 12/20/06 26,137 12,487 92,938 PTV Inc., 10.00%, pfd., A ..................... 12/07/01 - 3/06/02 278,814 111,526 3,434,760 Symetra Financial ............................. 7/27/04 - 10/26/07 39,480,000 55,024,855 ------------ TOTAL RESTRICTED SECURITIES (5.24% of Net Assets) .................................. $329,339,528 ============
a The Fund also invests in unrestricted securities of the issuer, valued at $6,977,214 as of December 31, 2007. 10. UNFUNDED CAPITAL COMMITMENTS At December 31, 2007, the Fund had aggregate unfunded capital commitments to investments of $6,590,000. Annual Report | 47 Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act 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 for the year ended December 31, 2007, were as shown below.
- ----------------------------------------------------------------------------------------------------------------------------------- NUMBER OF NUMBER OF SHARES/WARRANTS/ SHARES/WARRANTS/ PRINCIPAL AMOUNT PRINCIPAL AMOUNT VALUE AT REALIZED HELD AT BEGINNING GROSS GROSS HELD AT END END OF INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS OF YEAR YEAR INCOME GAIN (LOSS) - ----------------------------------------------------------------------------------------------------------------------------------- NON-CONTROLLED AFFILIATES DecisionOne Corp. ................. 1,008,199 -- -- 1,008,199 $ -- $ -- $ -- DecisionOne Corp., 12.00%, 4/15/10 ......................... 1,173,501 72,767 -- 1,246,268 1,246,268 144,779 -- DecisionOne Corp., FRN, 9.50%, 5/12/09 ......................... -- 232,502 -- 232,502 232,502 11,894 -- DecisionOne Corp., wts., 6/08/17 .. -- 553,576 -- 553,576 -- -- -- Elephant Capital Holdings Ltd. .... 11,087 409 -- 11,496 7,571,181 -- -- Esmark Inc. ....................... 6,143 3,081,019 -- 3,087,162 39,259,439 147,430 -- Esmark Inc., 8.00%, cvt. pfd., A .. 22,360 -- 22,360 -- -- 1,380,806 283,048 First Chicago Bancorp ............. 659,105 -- -- 659,105 9,227,470 -- -- Generale de Sante ................. 3,146,068 -- 3,146,068 -- -- -- 81,509,152 Imagine Group Holdings Ltd. ....... 2,814,856 -- -- 2,814,856 32,201,953 -- -- Imperial Capital Bancorp Inc. ..... 445,796 -- -- 445,796 8,158,067 285,309 -- Insun ENT Co. Ltd. ................ 687,953 1,003,342 242,349 1,448,946 -- a -- 2,018,324 State National Bancshares Inc. .... 1,375,000 -- 1,375,000 -- -- -- 30,937,500 White River Capital Inc. .......... 549,751 -- -- 549,751 9,583,534 -- -- --------------------------------------- TOTAL AFFILIATED SECURITIES (1.71% of Net Assets) ...................................... $107,480,414 $1,970,218 $114,748,024 =======================================
a As of December 31, 2007, no longer an affiliate. 12. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of bondholders' steering committees, official creditors' committees, or boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. 13. REGULATORY AND LITIGATION MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), 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 ("marketing support"), Franklin Resources, Inc. and certain of its subsidiaries (collectively, the "Company"), entered into settlements with certain of those regulators and governmental entities. Specifically, the Company entered into settlements with the SEC, among others, concerning market timing and marketing support. 48 | Annual Report Mutual Qualified Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY AND LITIGATION MATTERS (CONTINUED) On June 6, 2007, the SEC posted for public comment the proposed plan of distribution for the market timing settlement. Once the SEC approves the final plan of distribution, disbursements of settlement monies will be made promptly to individuals who were shareholders of the designated funds during the relevant period, in accordance with the terms and conditions of the settlement and plan. In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, Company directors, fund directors, and 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.). The lawsuits relate to the industry practices referenced above. The Company and fund management 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. 14. NEW ACCOUNTING PRONOUNCEMENT In September 2006, Financial Accounting Standards Board (FASB) issued FASB Statement No. 157, "Fair Value Measurement" (SFAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Fund believes the adoption of SFAS 157 will have no material impact on its financial statements. Annual Report | 49 Mutual Qualified Fund REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF DIRECTORS OF FRANKLIN MUTUAL SERIES FUND INC. AND SHAREHOLDERS OF THE MUTUAL QUALIFIED FUND: We have audited the accompanying statement of assets and liabilities of the Mutual Qualified Fund (one of the Funds constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2007, 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, 2007, by correspondence with the custodian and brokers. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of the Mutual Qualified Fund of the Franklin Mutual Series Fund Inc. at December 31, 2007, 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 14, 2008 50 | 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 $346,372,730 as a long term capital gain dividend for the fiscal year ended December 31, 2007. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $129,341,669 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2007. In January 2008, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2007. 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)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $11,333,642 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, 2007. Under Section 854(b)(2) of the Code, the Fund designates 41.95% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2007. Annual Report | 51 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. (1941) Director Since 1987 7 None c/o Franklin Mutual Advisers, LLC 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, Stern School of Business, New York University; editor and author of numerous financial publications; financial consultant; a director to numerous financial publishing organizations; and FORMERLY, Vice Director, Salomon Center, Stern School of Business, New York University. - ---------------------------------------------------------------------------------------------------------------------------------- ANN TORRE BATES (1958) Director Since 1994 7 SLM Corporation (Sallie Mae) and c/o Franklin Mutual Advisers, LLC Allied Capital Corporation 101 John F. Kennedy Parkway (financial services). Short Hills, NJ 07078-2789 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 14 Franklin Templeton Emerging Markets c/o Franklin Mutual Advisers, LLC Debt Opportunities Fund PLC and 101 John F. Kennedy Parkway Fiduciary International Ireland Limited. Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates (management consultants to the financial services industry); and FORMERLY, Chairman, Fiduciary Trust International Funds; Executive Vice President, L.F Rothschild Fund Management, Inc.; President and Director, Merit Mutual Funds; President, Underwriting Division and Director, National Securities & Research Corporation; Governor, Investment Company Institute and Chairman, ICI Public Information Committee. - ---------------------------------------------------------------------------------------------------------------------------------- BRUCE A. MACPHERSON (1930) Director Since 1974 7 None c/o Franklin Mutual Advisers, LLC 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). - ----------------------------------------------------------------------------------------------------------------------------------
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 - ---------------------------------------------------------------------------------------------------------------------------------- CHARLES RUBENS II (1930) Director Since 1998 14 None c/o Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ---------------------------------------------------------------------------------------------------------------------------------- ROBERT E. WADE (1946) Director and Director since 34 El Oro and Exploration Co., p.l.c. c/o Franklin Mutual Advisers, LLC Chairman 1991 and (investments) and ARC Wireless 101 John F. Kennedy Parkway of the Board Chairman of the Solutions, Inc. (wireless components Short Hills, NJ 07078-2789 Board since 2005 and network products). 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 - ---------------------------------------------------------------------------------------------------------------------------------- **GREGORY E. JOHNSON (1961) Director Since April 2007 92 None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, President and Chief Executive Officer, Franklin Resources, Inc.; President, Templeton Worldwide, Inc.; Director, Templeton Asset Management Ltd.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 33 of the investment companies in Franklin Templeton Investments. - ---------------------------------------------------------------------------------------------------------------------------------- **PETER A. LANGERMAN (1955) Director, Director since 7 None c/o Franklin Mutual Advisers, LLC President April 2007 and 101 John F. Kennedy Parkway and Chief President and Short Hills, NJ 07078-2702 Executive Chief Executive Officer - Officer - Investment Investment Management Management since 2005 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; officer and/or director, as the case may be, of three of the investment companies in Franklin Templeton Investments; and FORMERLY, Director, New Jersey's Division of Investment. - ---------------------------------------------------------------------------------------------------------------------------------- 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 - ---------------------------------------------------------------------------------------------------------------------------------- JAMES M. DAVIS (1952) Chief Chief Compliance Not Applicable Not Applicable One Franklin Parkway Compliance Officer since 2004 San Mateo, CA 94403-1906 Officer and and Vice President Vice President - AML Compliance - AML since 2006 Compliance PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ---------------------------------------------------------------------------------------------------------------------------------- MICHAEL J. EMBLER (1964) Senior Vice Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President Short Hills, NJ 07078-2789 and Chief Investment Officer 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. - ---------------------------------------------------------------------------------------------------------------------------------- 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 some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments. - ---------------------------------------------------------------------------------------------------------------------------------- STEVEN J. GRAY (1955) Secretary Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Templeton Investments; Secretary, Franklin Advisory Services, LLC, Franklin Mutual Advisers, LLC and Franklin Templeton Distributors, Inc.; and officer of 41 of the investment companies in Franklin Templeton Investments. - ---------------------------------------------------------------------------------------------------------------------------------- GREGORY R. SEWARD (1956) Treasurer Since 2005 Not Applicable Not Applicable 500 East Broward Blvd. Suite 2100 Fort Lauderdale, FL 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 18 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPMorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ----------------------------------------------------------------------------------------------------------------------------------
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 - ---------------------------------------------------------------------------------------------------------------------------------- CRAIG S. TYLE (1960) Vice President Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 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). - ---------------------------------------------------------------------------------------------------------------------------------- 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 some of the other subsidiaries of Franklin Resources, Inc. and of 46 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 manager or affiliated investment managers. ** Gregory E. Johnson is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer and director of Franklin Resources, Inc., which is the parent company of the Fund's investment manager and distributor. Peter A. Langerman is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, which is the Fund's investment manager. Note 1: Officer information is current as of the date of this report. It is possible that after this date, information about officers may change. Note 2: Prior to December 31, 2007, William J. Lippman, Leonard Rubin and Anne M. Tatlock ceased to be directors of the Fund. THE FUND'S BOARD 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 | 55 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 1-954/527-7678 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. 56 | Annual Report Literature Request LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. FRANKLIN TEMPLETON FUNDS INTERNATIONAL Mutual European Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund 1 GLOBAL Mutual Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund 1 Templeton Growth Fund Templeton World Fund GROWTH Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Growth Opportunities Fund 2 Franklin Small Cap Growth Fund II 3 Franklin Small-Mid Cap Growth Fund VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund 1 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 1 Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Focused Core Equity Fund Franklin Growth Fund Franklin Rising Dividends Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Global Real Estate 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(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 5 Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund 5 Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 5 Templeton Global Bond Fund Templeton Income Fund Templeton International Bond Fund TAX-FREE INCOME 6 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California 8 Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts 7 Michigan 7 Minnesota 7 Missouri New Jersey New York 8 North Carolina Ohio 7 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 9 1. The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. 2. Effective 11/1/07, Franklin Aggressive Growth Fund changed its name to Franklin Growth Opportunities Fund. The fund's investment goal and strategy remained the same. 3. The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 4. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5. An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 6. For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. 7. The fund invests primarily in insured municipal securities. 8. 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). 9. The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 12/07 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 SHAREHOLDER SERVICES 1-800/632-2301 - (Class A, B & C) 1-800/448-FUND - (Class Z) Authorized for distribution only when accompanied or preceded by a prospectus. Investors should carefully consider a fund's investment goals, risks, charges and expenses before investing. The prospectus contains this and other information; please read it carefully before investing. To ensure the highest quality of service, telephone calls to or from our service departments may be monitored, recorded and accessed. These calls can be identified by the presence of a regular beeping tone. 475 A2007 02/08 [GRAPHIC OMITTED] - -------------------------------------------------------------------------------- DECEMBER 31, 2007 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 ........................................................ 5 Performance Summary ....................................................... 12 Your Fund's Expenses ...................................................... 17 Financial Highlights and Statement of Investments ......................... 19 Financial Statements ...................................................... 35 Notes to Financial Statements ............................................. 39 Report of Independent Registered Public Accounting Firm ................... 55 Tax Designation ........................................................... 56 Board Members and Officers ................................................ 57 Shareholder Information ................................................... 61 - -------------------------------------------------------------------------------- Shareholder Letter - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURN - --------------------------------- CLASS Z 12/31/07 - --------------------------------- 1-Year +3.30% - --------------------------------- 5-Year +14.25% - --------------------------------- 10-Year +9.26% - --------------------------------- Dear Shareholder: The past year was a turbulent time for equities both in the U.S. and in many international markets. Several developments contributed to this volatility, including (1) credit problems centered around subprime mortgage lending; (2) declining home values in the U.S.; (3) a nearly complete evaporation of the corporate leveraged lending that fueled the leveraged buyout boom of the past several years; (4) a sharp increase in oil, agricultural and certain mining commodity prices; and (5) a sharp decline in the value of the U.S. dollar relative to most other currencies. For the year ended December 31, 2007, the Standard & Poor's (S&P) 500 Index rose 5.49% while the Morgan Stanley Capital International (MSCI) World Index gained 9.57%. 1 However, indicative of the impact of the developments noted here, the S&P 500 Financials Index declined 18.63%, the S&P Homebuilders Select Industry Index declined 48.39% and the S&P GSSI Natural Resources Index appreciated 34.44% during the year. 2 By comparison, Mutual Shares Fund - Class Z gained 3.30% over this period. 1. Source: Standard & Poor's Micropal. The S&P 500 Index 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 Index 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. 2. Source: Standard & Poor's Micropal. The S&P 500 Financials Index is market value weighted and includes all the financial stocks in the S&P 500. The S&P Homebuilders Select Industry Index is an equal-weighted index that draws its constituents from the GICS (Global Industry Classification Standards) Homebuilding sub-industry. The S&P GSSI Natural Resources Index is a modified cap-weighted index designed to measure equity performance in the natural resources sector. The index includes companies involved in the following categories: extractive industries, energy companies, owners and operators of timber tracts, forestry services, producers of pulp and paper, and owners of plantations. 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. - -------------------------------------------------------------------------------- eDELIVERY DETAILS LOG IN AT FRANKLINTEMPLETON.COM AND CLICK ON EDELIVERY. SHAREHOLDERS WHO ARE REGISTERED AT FRANKLINTEMPLETON.COM CAN RECEIVE THESE REPORTS VIA EMAIL. NOT ALL ACCOUNTS ARE ELIGIBLE FOR EDELIVERY. - ----------------------------------------------------- NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE - ----------------------------------------------------- Not part of the annual report | 1 The markets in 2007 were particularly challenging for us as value-driven, bottom-up stock pickers in a year when a thematic approach to investing based on macroeconomic factors would likely have enhanced performance. Value investors are always faced with the task of buying and owning companies when they are out of favor, whether for company-specific reasons or because of a perception of macroeconomic fundamentals. It is these very headwinds that create opportunities to buy well-managed companies with strong industry positions at valuations that can reward investors over the long term. Despite the challenges, a number of positive factors contributed to Fund performance this year. Many of our international holdings made strong gains, particularly among the tobacco, energy and industrial companies we owned. Fund shareholders also benefited from the fact that our international holdings were less than fully hedged back into U.S. dollars, reflecting our cautious view regarding the dollar. Investments in merger arbitrage situations were also generally profitable, particularly as we took advantage in late summer of concerns that deals would fall apart because of "buyer's remorse" or unavailability of financing. In the U.S., our focus over the past several years on larger capitalization companies with strong balance sheets and leading industry positions benefited our shareholders. For example, investments in Microsoft, Altria and Verizon Communications, all part of the large-cap Dow Jones Industrial Average, generated solid returns in 2007. 3 As we have discussed in previous reports, the multi-year outperformance of small- and mid-capitalization stocks going into 2007 resulted in attractive valuations among their mega-cap counterparts. At period-end, we continued to see real value in a number of these companies. The Fund's exposure to the financial sector negatively impacted Fund performance during the year. While we had limited direct exposure to the subprime mortgage originators, the spreading contagion of the credit crisis hurt valuations of most financial institutions, including some well-capitalized domestic and European banks owned by the Fund. We were disappointed by the breakdown in risk management processes at some of the largest U.S. financial institutions and have adjusted certain positions accordingly. Nevertheless, we believe the markets have overly penalized many stocks in the sector and accordingly have added selectively to certain holdings. 3. Mutual Shares Fund's holdings are based on total net assets as of 12/31/07: Microsoft Corp.: 1.5%; Altria Group Inc.: 1.5%; and Verizon Communications Inc.: 0.9%. 2 | Not part of the annual report Another difficult area for us in the latter half of the year was what we would term "event-driven" stocks. These are investments we believe are attractively valued and where we see an identifiable catalyst to unlock the value. While each investment is different, a few issues dominated the second half of 2007. One key driver was the abrupt absence of private equity buyers for companies (or divisions of companies) that were potential sale targets. Virgin Media, the U.K. cable company, was one example. Another key element was direct or indirect exposure to the residential construction or financial industries, where the catalyst was overwhelmed by the economic headwinds facing the company. Temple-Inland, which sold its timber assets and split into three companies including a packaging company, a savings bank and a real estate developer in 2007, exemplified this risk. Finally, we believe many event-driven investments were held in common with some of the hedge funds that faced pressure to sell in the latter half of 2007. Again, while somewhat painful in the short term, "technical" pressures often give us a chance to take advantage of temporary market dislocations to increase ownership in attractively valued companies. Fear and volatility can breed opportunity for patient investors. We believe the extended credit crisis has created a number of such opportunities. We have no crystal ball telling us precisely when the U.S. housing market will turn positive or where oil prices will be a year from now. However, we believe that if we stick to our discipline of buying good businesses at cheap valuations, we should reach our goal of limiting our downside risk while generating consistent returns over the long term. In the enclosed annual report for Mutual Shares Fund, the portfolio managers discuss market conditions, investment management decisions and Fund performance during the period under review. You will also find performance data and financial information. Please remember that all securities markets fluctuate, as do mutual fund share prices. If you would like more frequent updates, FRANKLINTEMPLETON.COM provides daily prices, monthly performance figures, portfolio holdings and other information. You can also access your account, buy and sell shares, read timely articles, and find helpful financial planning tools. We hope you will take advantage of these online services. Not part of the annual report | 3 As always, we thank you for your trust and support and extend our best wishes for a happy, healthy and prosperous 2008. Sincerely, /s/ Peter A. Langerman Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC /s/ Michael J. Embler Michael J. Embler Senior Vice President and Chief Investment Officer Franklin Mutual Advisers, LLC THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF DECEMBER 31, 2007. 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 INVESTMENT MANAGER 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. 4 | Not part of the annual report Annual Report Mutual Shares Fund YOUR FUND'S GOALS AND MAIN INVESTMENTS: MUTUAL SHARES FUND SEEKS CAPITAL APPRECIATION, WITH INCOME AS A SECONDARY GOAL, BY INVESTING PRIMARILY IN 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. - -------------------------------------------------------------------------------- This annual report for Mutual Shares Fund covers the fiscal year ended December 31, 2007. PERFORMANCE OVERVIEW Mutual Shares Fund - Class Z posted a cumulative total return of +3.30% for the 12 months ended December 31, 2007. The Fund underperformed its benchmark, the Standard & Poor's 500 Index (S&P 500), which returned +5.49% for the same period. 1 You can find the Fund's long-term performance data in the Performance Summary beginning on page 12. ECONOMIC AND MARKET OVERVIEW During the 12 months ended December 31, 2007, the U.S. economy advanced at a moderate but uneven pace. After slow first quarter growth, gross domestic product (GDP) advanced solidly in the second quarter, supported by federal defense spending, accelerating exports and declining imports, and greater business spending. In the third quarter, growth accelerated despite a struggling housing market and the abrupt unraveling of the subprime mortgage market. The housing downturn affected the overall economy by fourth quarter 2007 when GDP growth decelerated as credit conditions worsened and consumer spending slowed. 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 24. Annual Report | 5 GEOGRAPHIC BREAKDOWN Based on Total Net Assets as of 12/31/07 [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] U.S. 57.8% U.K. 7.8% Germany 5.2% France 5.1% Netherlands 2.3% Switzerland 2.1% Norway 1.8% Spain 1.8% Denmark 1.4% Belgium 1.4% Japan 1.3% Italy 1.0% Other 3.2% Short-Term Investments & Other Net Assets 7.8% Consumer confidence declined through period-end largely due to rising mortgage and fuel costs, falling home prices and a weaker job market. Oil prices were volatile and established a new record high in November, nearing $99 per barrel. For the 12 months ended December 31, 2007, the core Consumer Price Index (CPI), which excludes food and energy costs, rose 2.4%, which was higher than its 10-year average rate. 2 Facing the prospect of slower economic growth, the Federal Reserve Board lowered the federal funds target rate to 4.25% from 5.25% during the period. As investors fled riskier, poorer-performing assets, U.S. Treasuries rallied and the 10-year Treasury note yield fell from 4.71% at the beginning of the period to 4.04% on December 31, 2007. The global economy remained resilient despite elevated energy prices and widespread fears of contagion from the deteriorating U.S. housing situation. Consumer and corporate demand strength, particularly in China and other developing economies, generally favorable employment and accommodative monetary policies continued to underpin the current global expansionary period that began in 2002. These factors also contributed to the strength of global equity markets during 2007. However, concerns about slower growth and declining asset quality surfaced in the first quarter. Initially centered on the U.S. subprime mortgage market, they spread in August to global capital markets. Difficulties in assessing risk and the value of collateral in the structured finance industry contributed to declining risk appetite among lenders and investors. The private equity industry, which relies on the availability of cheap credit, played a pivotal role in several large and high-profile acquisitions, helped boost merger and acquisition activity in the first half of 2007, and was an important driver of equity performance. A second-half tightening of liquidity led to slower deal activity and weighed on market performance. However, in 2007, global merger and acquisition activity still reached record levels. To alleviate the credit crunch and restore investor confidence, the world's major central banks infused capital into the system. However, credit and equity markets continued to face headwinds as write-downs and losses from subprime mortgage financing affected many large financial institutions toward the end of the year, and equity prices remained volatile. For the year, however, global and non-U.S. equity markets registered the fifth consecutive year of double-digit total returns. Broad-based stock performance by European and Asian shares at least doubled that of U.S. stocks, while emerging market equity 2. Source: Bureau of Labor Statistics. 6 | Annual Report returns more than tripled those in developed markets. In addition, U.S. dollar weakness versus the currencies of many major trading partners enhanced equity returns for U.S. -based investors holding stocks denominated in these 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 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 for our shareholders. TOP 10 SECTORS/INDUSTRIES Based on Equity Securities as of 12/31/07 - -------------------------------------------------------------------------------- % OF TOTAL NET ASSETS - -------------------------------------------------------------------------------- Tobacco 8.8% - -------------------------------------------------------------------------------- Insurance 8.3% - -------------------------------------------------------------------------------- Media 7.5% - -------------------------------------------------------------------------------- Commercial Banks 5.6% - -------------------------------------------------------------------------------- Industrial Conglomerates 4.1% - -------------------------------------------------------------------------------- Paper & Forest Products 3.9% - -------------------------------------------------------------------------------- Food Products 3.7% - -------------------------------------------------------------------------------- Food & Staples Retailing 3.6% - -------------------------------------------------------------------------------- Pharmaceuticals 2.7% - -------------------------------------------------------------------------------- Health Care Providers & Services 2.3% - -------------------------------------------------------------------------------- Annual Report | 7 TOP 10 HOLDINGS 12/31/07 - -------------------------------------------------------------------------------- COMPANY % OF TOTAL SECTOR/INDUSTRY, COUNTRY NET ASSETS - -------------------------------------------------------------------------------- Berkshire Hathaway Inc., A & B 3.2% INSURANCE, U.S. - -------------------------------------------------------------------------------- British American Tobacco PLC, ord. & ADR 1.9% TOBACCO, U.K. - -------------------------------------------------------------------------------- Orkla ASA 1.9% INDUSTRIAL CONGLOMERATES, NORWAY - -------------------------------------------------------------------------------- Weyerhaeuser Co. 1.8% PAPER & FOREST PRODUCTS, U.S. - -------------------------------------------------------------------------------- U.S. Bancorp 1.8% COMMERCIAL BANKS, U.S. - -------------------------------------------------------------------------------- News Corp., A 1.7% MEDIA, U.S. - -------------------------------------------------------------------------------- Altria Group Inc. 1.5% TOBACCO, U.S. - -------------------------------------------------------------------------------- Microsoft Corp. 1.5% SOFTWARE, U.S. - -------------------------------------------------------------------------------- White Mountains Insurance Group Ltd. 1.5% INSURANCE, U.S. - -------------------------------------------------------------------------------- Imperial Tobacco Group PLC 1.5% TOBACCO, U.K. - -------------------------------------------------------------------------------- MANAGER'S DISCUSSION During the year under review, the largest contributor to Fund performance was our equity portfolio, most notably some of our long-term holdings. Three investments that performed well during 2007 were Orkla, Berkshire Hathaway and British American Tobacco (BAT). Orkla is one of Norway's largest conglomerates with operations in several industries including consumer goods, and metals and minerals. In 2007, Orkla was again among the top performing stocks, advancing 52% in local currency terms. Orkla shares performed well after the company reported strong operational performance, and its management pursued two transactions that we believed could create value. Orkla increased its stake in the solar energy solution company Renewable Energy Corp. (REC) from 27.5% to 40.0% in February 2007, at a discount of over 25% to REC's market price at the time. As REC's stock appreciated more than 142% in local currency during the reporting period, Orkla's ownership in REC benefited its own share price. Orkla also merged its aluminum profile business, Sapa, with Alcoa's aluminum extrusion business. Berkshire Hathaway stock appreciated 29% as the company benefited from a lack of catastrophe losses in 2007, resulting in large insurance company profits after higher-than-average losses in 2004 and 2005 resulted in a favorable pricing environment for U.S. property insurers. Within Berkshire's non-insurance operations, the company benefited from an improving contribution from its utility business, Mid-American Energy. Most significantly for its share price value, Berkshire's cash stockpile of almost $40 billion, along with CEO Warren Buffett's willingness to wait until a bargain emerged before deploying this capital, positioned the company as a safe haven for investors who perceived 2007's subprime mortgage crisis as an investment opportunity rather than a threat. By the end of 2007 Berkshire management had successfully kept its capital mostly in reserve, for use in executing timely future transactions when the investment climate is right. Shares of U.K. -based BAT benefited from strong operations as well as tobacco's traditional role as a defensive stock, and advanced 43% in local currency for the year under review. Operationally, we believe BAT has a strong business model. During 2007, the company's topline growth was driven by increased volume and product mix improvement. As measured by volume and sales, BAT has a leadership position in the growing emerging markets, where cigarette consumption is increasing. Furthermore, BAT was able to grow its market share by refreshing all of its main brands, updating its packaging, and launching a variety of new products. BAT also continued to strengthen its distribution 8 | Annual Report channels, further contributing to its market-share gains. In Europe, cigarette pricing remained strong in 2007. At period-end, we continued to hold BAT because we believe two positive catalysts could materialize. First, BAT has indicated that a new cost-cutting program will be announced in 2008's first quarter, upon completion of its most recent five-year plan. The program's scale is expected to be significant. Second, we see potential for further corporate activity or share buybacks given BAT's balance sheet strength. Although many of our investments appreciated during the year, some of the Fund's holdings underperformed. Three positions that declined in value included financial services conglomerate Citigroup; Belgium-based Fortis, whose operations are focused in banking, insurance and investment management; and Home Depot, the world's largest home improvement chain. Shares of Citigroup declined 44% in 2007 due largely to illiquidity in the credit markets that forced the company to take meaningful mark-to-market losses on leveraged loans and securitized products remaining on the company's balance sheet. Further pressuring the company's stock price were concerns about certain off-balance sheet exposures, lower capital levels stemming from write-downs, the lingering possibility of a dividend cut, and uncertainty surrounding Citigroup's leadership. Fortis declined 30% in local currency as the company raised a significant amount of capital to fund its acquisition of ABN Amro's Dutch retail banking, asset management and private banking units. Fortis was part of a consortium with Royal Bank of Scotland and Banco Santander, which together acquired these businesses and by year-end had completed the largest bank acquisition in European history. Fortis' stock price also came under pressure after the company announced weak third quarter 2007 operating results for its banking and insurance businesses. Home Depot shares declined 31% in 2007 as the company lowered earnings guidance due to a weak housing market. In addition, the buyout purchase price for HD Supply, the company's professional services division, was negotiated downward by three private equity firms after credit markets tightened substantially. Finally, investors should note that we maintained our currency hedging posture of being generally hedged to the U.S. dollar for most of our non-U.S. holdings. Since the dollar was weaker compared with most foreign currencies during 2007, the Fund benefited to the extent it was not fully hedged. Annual Report | 9 Thank you for your continued participation in Mutual Shares Fund. We look forward to serving your future investment needs. [PHOTO OMITTED] /s/ Peter A. Langerman Peter A. Langerman Co-Portfolio Manager [PHOTO OMITTED] /s/ F. David Segal F. David Segal, CFA Co-Portfolio Manager [PHOTO OMITTED] /s/ Debbie A. Turner Debbie A. Turner, CFA Assistant Portfolio Manager Mutual Shares Fund THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS AS OF DECEMBER 31, 2007, 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 INVESTMENT MANAGER 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. 10 | Annual Report - -------------------------------------------------------------------------------- PETER LANGERMAN has been a portfolio manager for Mutual Shares Fund since 2005. He joined Franklin Templeton Investments in 1996, serving in various capacities, including President and Chief Executive Officer of Franklin Mutual Advisers and member of the management team of the Funds, including Mutual Shares Fund. From 2002 to 2005, he served 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 Fund's former manager. F. DAVID SEGAL has been a portfolio manager for Mutual Shares Fund since 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. 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 Fund's former manager. - -------------------------------------------------------------------------------- Annual Report | 11 Performance Summary as of 12/31/07 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 12/31/07 12/31/06 - ---------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) -$0.75 $25.33 $26.08 - ---------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - ---------------------------------------------------------------------------------------------------------- Dividend Income $0.7502 - ---------------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.0273 - ---------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.8426 - ---------------------------------------------------------------------------------------------------------- TOTAL $1.6201 - ---------------------------------------------------------------------------------------------------------- CLASS A (SYMBOL: TESIX) CHANGE 12/31/07 12/31/06 - ---------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) -$0.76 $25.14 $25.90 - ---------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - ---------------------------------------------------------------------------------------------------------- Dividend Income $0.6676 - ---------------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.0273 - ---------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.8426 - ---------------------------------------------------------------------------------------------------------- TOTAL $1.5375 - ---------------------------------------------------------------------------------------------------------- CLASS B (SYMBOL: FMUBX) CHANGE 12/31/07 12/31/06 - ---------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) -$0.75 $24.60 $25.35 - ---------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - ---------------------------------------------------------------------------------------------------------- Dividend Income $0.4688 - ---------------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.0273 - ---------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.8426 - ---------------------------------------------------------------------------------------------------------- TOTAL $1.3387 - ---------------------------------------------------------------------------------------------------------- CLASS C (SYMBOL: TEMTX) CHANGE 12/31/07 12/31/06 - ---------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) -$0.77 $24.86 $25.63 - ---------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - ---------------------------------------------------------------------------------------------------------- Dividend Income $0.4868 - ---------------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.0273 - ---------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.8426 - ---------------------------------------------------------------------------------------------------------- TOTAL $1.3567 - ---------------------------------------------------------------------------------------------------------- CLASS R (SYMBOL: TESRX) CHANGE 12/31/07 12/31/06 - ---------------------------------------------------------------------------------------------------------- Net Asset Value (NAV) -$0.77 $25.00 $25.77 - ---------------------------------------------------------------------------------------------------------- DISTRIBUTIONS (1/1/07-12/31/07) - ---------------------------------------------------------------------------------------------------------- Dividend Income $0.6325 - ---------------------------------------------------------------------------------------------------------- Short-Term Capital Gain $0.0273 - ---------------------------------------------------------------------------------------------------------- Long-Term Capital Gain $0.8426 - ---------------------------------------------------------------------------------------------------------- TOTAL $1.5024 - ----------------------------------------------------------------------------------------------------------
12 | Annual Report Performance Summary (CONTINUED) PERFORMANCE CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS Z/R: NO SALES CHARGES; 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. THE FUND MAY CHARGE A 2% FEE ON REDEMPTIONS MADE WITHIN SEVEN DAYS OF PURCHASE.
- ---------------------------------------------------------------------------------------------------------------- CLASS Z 1 ` 1-YEAR 5-YEAR 10-YEAR - ---------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +3.30% +94.65% +142.51% - ---------------------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +3.30% +14.25% +9.26% - ---------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $10,330 $ 19,465 $ 24,251 - ---------------------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 0.84% - ---------------------------------------------------------------------------------------------------------------- CLASS A 1 1-YEAR 5-YEAR 10-YEAR - ---------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +2.97% +91.34% +134.05% - ---------------------------------------------------------------------------------------------------------------- Average Annual Total Return 3 -2.95% +12.52% +8.23% - ---------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $ 9,705 $ 18,038 $ 22,057 - ---------------------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.18% - ---------------------------------------------------------------------------------------------------------------- CLASS B 1 1-YEAR 5-YEAR INCEPTION (1/1/99) - ---------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +2.25% +85.17% +121.47% - ---------------------------------------------------------------------------------------------------------------- Average Annual Total Return 3 -1.63% +12.87% +9.24% - ---------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $ 9,837 $ 18,317 $ 22,147 - ---------------------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.84% - ---------------------------------------------------------------------------------------------------------------- CLASS C 1 1-YEAR 5-YEAR 10-YEAR - ---------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +2.30% +85.21% +119.46% - ---------------------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +1.33% +13.12% +8.18% - ---------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $10,133 $ 18,521 $ 21,946 - ---------------------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.84% - ---------------------------------------------------------------------------------------------------------------- CLASS R 1-YEAR 5-YEAR INCEPTION (1/1/02) - ---------------------------------------------------------------------------------------------------------------- Cumulative Total Return 2 +2.77% +89.88% +68.60% - ---------------------------------------------------------------------------------------------------------------- Average Annual Total Return 3 +2.77% +13.68% +8.41% - ---------------------------------------------------------------------------------------------------------------- Value of $10,000 Investment 4 $10,277 $ 18,988 $ 16,860 - ---------------------------------------------------------------------------------------------------------------- Total Annual Operating Expenses 5 1.34% - ----------------------------------------------------------------------------------------------------------------
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 | 13 Performance Summary (CONTINUED) TOTAL RETURN INDEX COMPARISON FOR HYPOTHETICAL $10,000 INVESTMENT Total return represents the change in value of an investment over the periods shown. It includes any current, applicable, maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged index includes reinvestment of any income or distributions. It differs from the Fund in composition and does not pay management fees or expenses. One cannot invest directly in an index. AVERAGE ANNUAL TOTAL RETURN - ----------------------------------------- CLASS Z 1 12/31/07 - ----------------------------------------- 1-Year +3.30% - ----------------------------------------- 5-Year +14.25% - ----------------------------------------- 10-Year +9.26% - ----------------------------------------- CLASS Z (1/1/98-12/31/07) 1 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE Mutual Shares Fund S&P 500 6 - ------------------------------------------------------------------------------ 1/1/1998 $10,000 $10,000 1/31/1998 $ 9,930 $10,111 2/28/1998 $10,503 $10,840 3/31/1998 $10,855 $11,395 4/30/1998 $10,817 $11,510 5/31/1998 $10,719 $11,312 6/30/1998 $10,672 $11,771 7/31/1998 $10,385 $11,646 8/31/1998 $ 8,919 $ 9,962 9/30/1998 $ 8,862 $10,600 10/31/1998 $ 9,444 $11,463 11/30/1998 $ 9,950 $12,157 12/31/1998 $10,045 $12,858 1/31/1999 $10,204 $13,396 2/28/1999 $10,070 $12,979 3/31/1999 $10,538 $13,498 4/30/1999 $11,355 $14,021 5/31/1999 $11,412 $13,690 6/30/1999 $11,736 $14,450 7/31/1999 $11,412 $13,999 8/31/1999 $10,972 $13,929 9/30/1999 $10,689 $13,548 10/31/1999 $11,108 $14,405 11/30/1999 $11,317 $14,698 12/31/1999 $11,552 $15,563 1/31/2000 $11,173 $14,781 2/29/2000 $10,715 $14,502 3/31/2000 $11,823 $15,920 4/30/2000 $11,699 $15,441 5/31/2000 $11,846 $15,124 6/30/2000 $11,638 $15,497 7/31/2000 $11,962 $15,255 8/31/2000 $12,568 $16,203 9/30/2000 $12,556 $15,347 10/31/2000 $12,855 $15,282 11/30/2000 $12,452 $14,078 12/31/2000 $13,150 $14,146 1/31/2001 $13,927 $14,648 2/28/2001 $13,934 $13,313 3/31/2001 $13,581 $12,469 4/30/2001 $14,133 $13,438 5/31/2001 $14,625 $13,528 6/30/2001 $14,714 $13,199 7/31/2001 $14,707 $13,069 8/31/2001 $14,372 $12,251 9/30/2001 $13,106 $11,262 10/31/2001 $13,051 $11,476 11/30/2001 $13,599 $12,357 12/31/2001 $13,981 $12,465 1/31/2002 $13,851 $12,283 2/28/2002 $13,916 $12,046 3/31/2002 $14,333 $12,499 4/30/2002 $14,420 $11,741 5/31/2002 $14,427 $11,655 6/30/2002 $13,491 $10,825 7/31/2002 $12,681 $ 9,981 8/31/2002 $12,812 $10,046 9/30/2002 $12,118 $ 8,955 10/31/2002 $12,308 $ 9,743 11/30/2002 $12,556 $10,316 12/31/2002 $12,459 $ 9,710 1/31/2003 $12,355 $ 9,456 2/28/2003 $12,155 $ 9,314 3/31/2003 $12,185 $ 9,404 4/30/2003 $12,903 $10,179 5/31/2003 $13,561 $10,715 6/30/2003 $13,766 $10,852 7/31/2003 $13,848 $11,043 8/31/2003 $14,176 $11,259 9/30/2003 $14,117 $11,139 10/31/2003 $14,639 $11,769 11/30/2003 $15,108 $11,873 12/31/2003 $15,776 $12,495 1/31/2004 $15,904 $12,725 2/29/2004 $16,317 $12,902 3/31/2004 $16,295 $12,707 4/30/2004 $16,024 $12,508 5/31/2004 $16,047 $12,679 6/30/2004 $16,314 $12,926 7/31/2004 $16,065 $12,498 8/31/2004 $16,208 $12,549 9/30/2004 $16,420 $12,684 10/31/2004 $16,616 $12,878 11/30/2004 $17,424 $13,399 12/31/2004 $17,967 $13,855 1/31/2005 $17,616 $13,518 2/28/2005 $18,154 $13,802 3/31/2005 $18,021 $13,558 4/30/2005 $17,850 $13,300 5/31/2005 $18,232 $13,724 6/30/2005 $18,438 $13,743 7/31/2005 $18,915 $14,254 8/31/2005 $18,993 $14,124 9/30/2005 $19,282 $14,239 10/31/2005 $18,899 $14,001 11/30/2005 $19,376 $14,531 12/31/2005 $19,833 $14,536 1/31/2006 $20,330 $14,921 2/28/2006 $20,462 $14,961 3/31/2006 $21,100 $15,147 4/30/2006 $21,249 $15,351 5/31/2006 $20,901 $14,909 6/30/2006 $20,914 $14,929 7/31/2006 $20,981 $15,021 8/31/2006 $21,577 $15,379 9/30/2006 $21,736 $15,775 10/31/2006 $22,517 $16,289 11/30/2006 $22,887 $16,599 12/31/2006 $23,475 $16,832 1/31/2007 $23,997 $17,086 2/28/2007 $23,772 $16,752 3/31/2007 $24,222 $16,939 4/30/2007 $24,978 $17,690 5/31/2007 $25,860 $18,307 6/30/2007 $25,706 $18,003 7/31/2007 $24,569 $17,445 8/31/2007 $24,416 $17,706 9/30/2007 $24,831 $18,368 10/31/2007 $25,363 $18,661 11/30/2007 $24,632 $17,880 12/31/2007 $24,251 $17,756 AVERAGE ANNUAL TOTAL RETURN - ----------------------------------------- CLASS A 1 12/31/07 - ----------------------------------------- 1-Year -2.95% - ----------------------------------------- 5-Year +12.52% - ----------------------------------------- 10-Year +8.23% - ----------------------------------------- CLASS A (1/1/98-12/31/07) 1 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE Mutual Shares Fund S&P 500 6 - ------------------------------------------------------------------------------ 1/1/1998 $ 9,424 $10,000 1/31/1998 $ 9,348 $10,111 2/28/1998 $ 9,889 $10,840 3/31/1998 $10,217 $11,395 4/30/1998 $10,177 $11,510 5/31/1998 $10,080 $11,312 6/30/1998 $10,031 $11,771 7/31/1998 $ 9,758 $11,646 8/31/1998 $ 8,381 $ 9,962 9/30/1998 $ 8,322 $10,600 10/31/1998 $ 8,867 $11,463 11/30/1998 $ 9,340 $12,157 12/31/1998 $ 9,425 $12,858 1/31/1999 $ 9,575 $13,396 2/28/1999 $ 9,444 $12,979 3/31/1999 $ 9,884 $13,498 4/30/1999 $10,643 $14,021 5/31/1999 $10,692 $13,690 6/30/1999 $10,997 $14,450 7/31/1999 $10,687 $13,999 8/31/1999 $10,269 $13,929 9/30/1999 $10,003 $13,548 10/31/1999 $10,392 $14,405 11/30/1999 $10,584 $14,698 12/31/1999 $10,803 $15,563 1/31/2000 $10,443 $14,781 2/29/2000 $10,014 $14,502 3/31/2000 $11,047 $15,920 4/30/2000 $10,925 $15,441 5/31/2000 $11,063 $15,124 6/30/2000 $10,864 $15,497 7/31/2000 $11,162 $15,255 8/31/2000 $11,723 $16,203 9/30/2000 $11,706 $15,347 10/31/2000 $11,987 $15,282 11/30/2000 $11,603 $14,078 12/31/2000 $12,253 $14,146 1/31/2001 $12,973 $14,648 2/28/2001 $12,973 $13,313 3/31/2001 $12,638 $12,469 4/30/2001 $13,154 $13,438 5/31/2001 $13,607 $13,528 6/30/2001 $13,687 $13,199 7/31/2001 $13,681 $13,069 8/31/2001 $13,361 $12,251 9/30/2001 $12,178 $11,262 10/31/2001 $12,127 $11,476 11/30/2001 $12,625 $12,357 12/31/2001 $12,981 $12,465 1/31/2002 $12,860 $12,283 2/28/2002 $12,914 $12,046 3/31/2002 $13,296 $12,499 4/30/2002 $13,369 $11,741 5/31/2002 $13,376 $11,655 6/30/2002 $12,501 $10,825 7/31/2002 $11,752 $ 9,981 8/31/2002 $11,868 $10,046 9/30/2002 $11,228 $ 8,955 10/31/2002 $11,392 $ 9,743 11/30/2002 $11,623 $10,316 12/31/2002 $11,527 $ 9,710 1/31/2003 $11,431 $ 9,456 2/28/2003 $11,239 $ 9,314 3/31/2003 $11,266 $ 9,404 4/30/2003 $11,926 $10,179 5/31/2003 $12,530 $10,715 6/30/2003 $12,711 $10,852 7/31/2003 $12,787 $11,043 8/31/2003 $13,084 $11,259 9/30/2003 $13,022 $11,139 10/31/2003 $13,506 $11,769 11/30/2003 $13,928 $11,873 12/31/2003 $14,545 $12,495 1/31/2004 $14,657 $12,725 2/29/2004 $15,040 $12,902 3/31/2004 $15,012 $12,707 4/30/2004 $14,761 $12,508 5/31/2004 $14,775 $12,679 6/30/2004 $15,018 $12,926 7/31/2004 $14,781 $12,498 8/31/2004 $14,906 $12,549 9/30/2004 $15,102 $12,684 10/31/2004 $15,277 $12,878 11/30/2004 $16,011 $13,399 12/31/2004 $16,508 $13,855 1/31/2005 $16,177 $13,518 2/28/2005 $16,667 $13,802 3/31/2005 $16,537 $13,558 4/30/2005 $16,379 $13,300 5/31/2005 $16,731 $13,724 6/30/2005 $16,910 $13,743 7/31/2005 $17,343 $14,254 8/31/2005 $17,408 $14,124 9/30/2005 $17,675 $14,239 10/31/2005 $17,314 $14,001 11/30/2005 $17,747 $14,531 12/31/2005 $18,156 $14,536 1/31/2006 $18,606 $14,921 2/28/2006 $18,728 $14,961 3/31/2006 $19,300 $15,147 4/30/2006 $19,430 $15,351 5/31/2006 $19,109 $14,909 6/30/2006 $19,116 $14,929 7/31/2006 $19,170 $15,021 8/31/2006 $19,719 $15,379 9/30/2006 $19,858 $15,775 10/31/2006 $20,561 $16,289 11/30/2006 $20,894 $16,599 12/31/2006 $21,420 $16,832 1/31/2007 $21,891 $17,086 2/28/2007 $21,685 $16,752 3/31/2007 $22,081 $16,939 4/30/2007 $22,759 $17,690 5/31/2007 $23,570 $18,307 6/30/2007 $23,415 $18,003 7/31/2007 $22,379 $17,445 8/31/2007 $22,229 $17,706 9/30/2007 $22,602 $18,368 10/31/2007 $23,083 $18,661 11/30/2007 $22,412 $17,880 12/31/2007 $22,057 $17,756 14 | Annual Report Performance Summary (CONTINUED) CLASS B (1/1/99-12/31/07) 1 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE Mutual Shares Fund S&P 500 6 - ------------------------------------------------------------------------------ 1/1/1999 $10,000 $10,000 1/31/1999 $10,127 $10,418 2/28/1999 $ 9,978 $10,094 3/31/1999 $10,439 $10,498 4/30/1999 $11,232 $10,905 5/31/1999 $11,283 $10,647 6/30/1999 $11,596 $11,238 7/31/1999 $11,263 $10,887 8/31/1999 $10,815 $10,833 9/30/1999 $10,528 $10,536 10/31/1999 $10,935 $11,203 11/30/1999 $11,127 $11,431 12/31/1999 $11,352 $12,104 1/31/2000 $10,971 $11,496 2/29/2000 $10,511 $11,278 3/31/2000 $11,587 $12,382 4/30/2000 $11,458 $12,009 5/31/2000 $11,593 $11,763 6/30/2000 $11,380 $12,053 7/31/2000 $11,689 $11,864 8/31/2000 $12,270 $12,601 9/30/2000 $12,246 $11,936 10/31/2000 $12,524 $11,886 11/30/2000 $12,125 $10,949 12/31/2000 $12,792 $11,002 1/31/2001 $13,538 $11,392 2/28/2001 $13,531 $10,354 3/31/2001 $13,178 $ 9,698 4/30/2001 $13,708 $10,451 5/31/2001 $14,166 $10,521 6/30/2001 $14,241 $10,265 7/31/2001 $14,227 $10,164 8/31/2001 $13,884 $ 9,528 9/30/2001 $12,657 $ 8,759 10/31/2001 $12,590 $ 8,926 11/30/2001 $13,109 $ 9,610 12/31/2001 $13,465 $ 9,694 1/31/2002 $13,331 $ 9,553 2/28/2002 $13,380 $ 9,369 3/31/2002 $13,768 $ 9,721 4/30/2002 $13,838 $ 9,132 5/31/2002 $13,838 $ 9,064 6/30/2002 $12,929 $ 8,419 7/31/2002 $12,143 $ 7,763 8/31/2002 $12,257 $ 7,813 9/30/2002 $11,585 $ 6,964 10/31/2002 $11,749 $ 7,577 11/30/2002 $11,985 $ 8,023 12/31/2002 $11,876 $ 7,552 1/31/2003 $11,768 $ 7,354 2/28/2003 $11,574 $ 7,244 3/31/2003 $11,588 $ 7,314 4/30/2003 $12,264 $ 7,917 5/31/2003 $12,875 $ 8,334 6/30/2003 $13,059 $ 8,440 7/31/2003 $13,131 $ 8,589 8/31/2003 $13,428 $ 8,756 9/30/2003 $13,355 $ 8,663 10/31/2003 $13,848 $ 9,153 11/30/2003 $14,275 $ 9,234 12/31/2003 $14,894 $ 9,718 1/31/2004 $15,003 $ 9,897 2/29/2004 $15,387 $10,034 3/31/2004 $15,344 $ 9,883 4/30/2004 $15,075 $ 9,728 5/31/2004 $15,082 $ 9,861 6/30/2004 $15,321 $10,053 7/31/2004 $15,073 $ 9,720 8/31/2004 $15,197 $ 9,759 9/30/2004 $15,387 $ 9,865 10/31/2004 $15,554 $10,016 11/30/2004 $16,297 $10,421 12/31/2004 $16,785 $10,776 1/31/2005 $16,449 $10,513 2/28/2005 $16,934 $10,734 3/31/2005 $16,792 $10,544 4/30/2005 $16,628 $10,344 5/31/2005 $16,971 $10,673 6/30/2005 $17,147 $10,689 7/31/2005 $17,573 $11,086 8/31/2005 $17,633 $10,985 9/30/2005 $17,887 $11,074 10/31/2005 $17,513 $10,889 11/30/2005 $17,939 $11,301 12/31/2005 $18,348 $11,305 1/31/2006 $18,788 $11,604 2/28/2006 $18,906 $11,636 3/31/2006 $19,472 $11,781 4/30/2006 $19,590 $11,939 5/31/2006 $19,260 $11,595 6/30/2006 $19,255 $11,611 7/31/2006 $19,303 $11,683 8/31/2006 $19,837 $11,961 9/30/2006 $19,964 $12,269 10/31/2006 $20,665 $12,669 11/30/2006 $20,984 $12,909 12/31/2006 $21,506 $13,091 1/31/2007 $21,979 $13,289 2/28/2007 $21,773 $13,029 3/31/2007 $22,171 $13,174 4/30/2007 $22,852 $13,758 5/31/2007 $23,665 $14,238 6/30/2007 $23,509 $14,001 7/31/2007 $22,470 $13,567 8/31/2007 $22,319 $13,771 9/30/2007 $22,694 $14,286 10/31/2007 $23,178 $14,513 11/30/2007 $22,503 $13,906 12/31/2007 $22,147 $13,810 AVERAGE ANNUAL TOTAL RETURN - ----------------------------------------- CLASS B 1 12/31/07 - ----------------------------------------- 1-Year -1.63% - ----------------------------------------- 5-Year +12.87% - ----------------------------------------- Since Inception (1/1/99) +9.24% - ----------------------------------------- CLASS C (1/1/98-12/31/07) 1 [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE Mutual Shares Fund S&P 500 6 - ------------------------------------------------------------------------------ 1/1/1998 $10,000 $10,000 1/31/1998 $ 9,920 $10,111 2/28/1998 $10,487 $10,840 3/31/1998 $10,827 $11,395 4/30/1998 $10,779 $11,510 5/31/1998 $10,671 $11,312 6/30/1998 $10,614 $11,771 7/31/1998 $10,322 $11,646 8/31/1998 $ 8,855 $ 9,962 9/30/1998 $ 8,793 $10,600 10/31/1998 $ 9,363 $11,463 11/30/1998 $ 9,857 $12,157 12/31/1998 $ 9,945 $12,858 1/31/1999 $10,094 $13,396 2/28/1999 $ 9,951 $12,979 3/31/1999 $10,407 $13,498 4/30/1999 $11,201 $14,021 5/31/1999 $11,252 $13,690 6/30/1999 $11,564 $14,450 7/31/1999 $11,231 $13,999 8/31/1999 $10,788 $13,929 9/30/1999 $10,502 $13,548 10/31/1999 $10,903 $14,405 11/30/1999 $11,101 $14,698 12/31/1999 $11,325 $15,563 1/31/2000 $10,940 $14,781 2/29/2000 $10,482 $14,502 3/31/2000 $11,560 $15,920 4/30/2000 $11,431 $15,441 5/31/2000 $11,565 $15,124 6/30/2000 $11,353 $15,497 7/31/2000 $11,660 $15,255 8/31/2000 $12,239 $16,203 9/30/2000 $12,215 $15,347 10/31/2000 $12,492 $15,282 11/30/2000 $12,094 $14,078 12/31/2000 $12,761 $14,146 1/31/2001 $13,502 $14,648 2/28/2001 $13,496 $13,313 3/31/2001 $13,145 $12,469 4/30/2001 $13,671 $13,438 5/31/2001 $14,133 $13,528 6/30/2001 $14,210 $13,199 7/31/2001 $14,190 $13,069 8/31/2001 $13,855 $12,251 9/30/2001 $12,624 $11,262 10/31/2001 $12,564 $11,476 11/30/2001 $13,072 $12,357 12/31/2001 $13,432 $12,465 1/31/2002 $13,300 $12,283 2/28/2002 $13,349 $12,046 3/31/2002 $13,739 $12,499 4/30/2002 $13,809 $11,741 5/31/2002 $13,809 $11,655 6/30/2002 $12,898 $10,825 7/31/2002 $12,120 $ 9,981 8/31/2002 $12,226 $10,046 9/30/2002 $11,560 $ 8,955 10/31/2002 $11,723 $ 9,743 11/30/2002 $11,957 $10,316 12/31/2002 $11,850 $ 9,710 1/31/2003 $11,743 $ 9,456 2/28/2003 $11,544 $ 9,314 3/31/2003 $11,565 $ 9,404 4/30/2003 $12,233 $10,179 5/31/2003 $12,851 $10,715 6/30/2003 $13,031 $10,852 7/31/2003 $13,096 $11,043 8/31/2003 $13,396 $11,259 9/30/2003 $13,325 $11,139 10/31/2003 $13,811 $11,769 11/30/2003 $14,240 $11,873 12/31/2003 $14,856 $12,495 1/31/2004 $14,963 $12,725 2/29/2004 $15,350 $12,902 3/31/2004 $15,314 $12,707 4/30/2004 $15,042 $12,508 5/31/2004 $15,049 $12,679 6/30/2004 $15,291 $12,926 7/31/2004 $15,040 $12,498 8/31/2004 $15,162 $12,549 9/30/2004 $15,356 $12,684 10/31/2004 $15,521 $12,878 11/30/2004 $16,262 $13,399 12/31/2004 $16,753 $13,855 1/31/2005 $16,415 $13,518 2/28/2005 $16,900 $13,802 3/31/2005 $16,761 $13,558 4/30/2005 $16,591 $13,300 5/31/2005 $16,937 $13,724 6/30/2005 $17,111 $13,743 7/31/2005 $17,531 $14,254 8/31/2005 $17,598 $14,124 9/30/2005 $17,849 $14,239 10/31/2005 $17,472 $14,001 11/30/2005 $17,900 $14,531 12/31/2005 $18,307 $14,536 1/31/2006 $18,752 $14,921 2/28/2006 $18,861 $14,961 3/31/2006 $19,430 $15,147 4/30/2006 $19,555 $15,351 5/31/2006 $19,220 $14,909 6/30/2006 $19,211 $14,929 7/31/2006 $19,258 $15,021 8/31/2006 $19,793 $15,379 9/30/2006 $19,919 $15,775 10/31/2006 $20,618 $16,289 11/30/2006 $20,941 $16,599 12/31/2006 $21,453 $16,832 1/31/2007 $21,922 $17,086 2/28/2007 $21,696 $16,752 3/31/2007 $22,089 $16,939 4/30/2007 $22,750 $17,690 5/31/2007 $23,545 $18,307 6/30/2007 $23,377 $18,003 7/31/2007 $22,328 $17,445 8/31/2007 $22,169 $17,706 9/30/2007 $22,530 $18,368 10/31/2007 $22,991 $18,661 11/30/2007 $22,311 $17,880 12/31/2007 $21,946 $17,756 AVERAGE ANNUAL TOTAL RETURN - ----------------------------------------- CLASS C 1 12/31/07 - ----------------------------------------- 1-Year +1.33% - ----------------------------------------- 5-Year +13.12% - ----------------------------------------- 10-Year +8.18% - ----------------------------------------- Annual Report | 15 Performance Summary (CONTINUED) AVERAGE ANNUAL TOTAL RETURN - ----------------------------------------- CLASS R 12/31/07 - ----------------------------------------- 1-Year +2.77% - ----------------------------------------- 5-Year +13.68% - ----------------------------------------- Since Inception (1/1/02) +8.41% - ----------------------------------------- CLASS R (1/1/02-12/31/07) [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.] DATE Mutual Shares Fund S&P 500 6 - ------------------------------------------------------------------------------ 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 $10,027 4/30/2002 $10,315 $ 9,420 5/31/2002 $10,320 $ 9,350 6/30/2002 $ 9,643 $ 8,684 7/31/2002 $ 9,065 $ 8,007 8/31/2002 $ 9,150 $ 8,060 9/30/2002 $ 8,657 $ 7,184 10/31/2002 $ 8,782 $ 7,816 11/30/2002 $ 8,956 $ 8,276 12/31/2002 $ 8,880 $ 7,790 1/31/2003 $ 8,805 $ 7,586 2/28/2003 $ 8,662 $ 7,472 3/31/2003 $ 8,678 $ 7,545 4/30/2003 $ 9,182 $ 8,166 5/31/2003 $ 9,648 $ 8,596 6/30/2003 $ 9,792 $ 8,706 7/31/2003 $ 9,846 $ 8,859 8/31/2003 $10,076 $ 9,032 9/30/2003 $10,022 $ 8,936 10/31/2003 $10,391 $ 9,442 11/30/2003 $10,717 $ 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 $11,545 $10,194 4/30/2004 $11,351 $10,034 5/31/2004 $11,362 $10,172 6/30/2004 $11,544 $10,370 7/31/2004 $11,360 $10,026 8/31/2004 $11,457 $10,067 9/30/2004 $11,608 $10,176 10/31/2004 $11,738 $10,332 11/30/2004 $12,304 $10,750 12/31/2004 $12,680 $11,115 1/31/2005 $12,431 $10,844 2/28/2005 $12,803 $11,073 3/31/2005 $12,703 $10,877 4/30/2005 $12,581 $10,670 5/31/2005 $12,847 $11,010 6/30/2005 $12,984 $11,025 7/31/2005 $13,312 $11,435 8/31/2005 $13,362 $11,331 9/30/2005 $13,562 $11,423 10/31/2005 $13,284 $11,232 11/30/2005 $13,618 $11,657 12/31/2005 $13,934 $11,661 1/31/2006 $14,275 $11,970 2/28/2006 $14,362 $12,003 3/31/2006 $14,803 $12,152 4/30/2006 $14,898 $12,315 5/31/2006 $14,651 $11,961 6/30/2006 $14,649 $11,977 7/31/2006 $14,690 $12,051 8/31/2006 $15,106 $12,338 9/30/2006 $15,214 $12,655 10/31/2006 $15,750 $13,068 11/30/2006 $16,000 $13,316 12/31/2006 $16,405 $13,503 1/31/2007 $16,767 $13,707 2/28/2007 $16,603 $13,439 3/31/2007 $16,908 $13,590 4/30/2007 $17,423 $14,192 5/31/2007 $18,041 $14,687 6/30/2007 $17,920 $14,443 7/31/2007 $17,122 $13,995 8/31/2007 $17,007 $14,205 9/30/2007 $17,288 $14,736 10/31/2007 $17,652 $14,970 11/30/2007 $17,135 $14,344 12/31/2007 $16,860 $14,245 ENDNOTES VALUE SECURITIES MAY NOT INCREASE IN PRICE AS ANTICIPATED OR MAY DECLINE FURTHER IN VALUE. THE FUND'S INVESTMENTS IN FOREIGN SECURITIES INVOLVE SPECIAL RISKS. FOREIGN SECURITIES RISKS INCLUDE CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. THE FUND MAY ALSO INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR LIQUIDATIONS, WHICH INVOLVE SPECIAL RISKS AS PENDING DEALS MAY NOT BE COMPLETED ON TIME OR ON FAVORABLE TERMS, 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. 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. 3. Average annual total return represents the average annual change in value of an investment over the periods indicated. 4. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated. 5. Figures are as stated in the Fund's prospectus current as of the date of this report. 6. 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. 16 | 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 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 | 17 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 7/1/07 VALUE 12/31/07 PERIOD* 7/1/07-12/31/07 - ------------------------------------------------------------------------------------------------------------------------------------ Actual $1,000 $ 943.40 $3.62 - ------------------------------------------------------------------------------------------------------------------------------------ Hypothetical (5% return before expenses) $1,000 $1,021.48 $3.77 - ------------------------------------------------------------------------------------------------------------------------------------ CLASS A - ------------------------------------------------------------------------------------------------------------------------------------ Actual $1,000 $ 942.00 $5.14 - ------------------------------------------------------------------------------------------------------------------------------------ Hypothetical (5% return before expenses) $1,000 $1,019.91 $5.35 - ------------------------------------------------------------------------------------------------------------------------------------ CLASS B - ------------------------------------------------------------------------------------------------------------------------------------ Actual $1,000 $ 938.60 $8.55 - ------------------------------------------------------------------------------------------------------------------------------------ Hypothetical (5% return before expenses) $1,000 $1,016.38 $8.89 - ------------------------------------------------------------------------------------------------------------------------------------ CLASS C - ------------------------------------------------------------------------------------------------------------------------------------ Actual $1,000 $ 938.80 $8.50 - ------------------------------------------------------------------------------------------------------------------------------------ Hypothetical (5% return before expenses) $1,000 $1,016.43 $8.84 - ------------------------------------------------------------------------------------------------------------------------------------ CLASS R - ------------------------------------------------------------------------------------------------------------------------------------ Actual $1,000 $ 940.80 $6.07 - ------------------------------------------------------------------------------------------------------------------------------------ Hypothetical (5% return before expenses) $1,000 $1,018.95 $6.31 - ------------------------------------------------------------------------------------------------------------------------------------
* Expenses are calculated using the most recent expense ratio, annualized for each class (Z: 0.74%; A: 1.05%; B: 1.75%; C: 1.74%; and R: 1.24%), multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period. 18 | Annual Report Mutual Shares Fund FINANCIAL HIGHLIGHTS
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS Z 2007 2006 2005 2004 2003 ---------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ...................... $ 26.08 $ 23.95 $ 23.05 $ 20.99 $ 16.84 ---------------------------------------------------------------------- Income from investment operations a: Net investment income b .............................. 0.70 0.42 0.47 0.35 0.24 Net realized and unrealized gains (losses) ........... 0.17 3.90 1.92 2.52 4.23 ---------------------------------------------------------------------- Total from investment operations ........................ 0.87 4.32 2.39 2.87 4.47 ---------------------------------------------------------------------- Less distributions from: Net investment income ................................ (0.75) (0.52) (0.29) (0.39) (0.32) Net realized gains ................................... (0.87) (1.67) (1.20) (0.42) -- ---------------------------------------------------------------------- Total distributions ..................................... (1.62) (2.19) (1.49) (0.81) (0.32) ---------------------------------------------------------------------- Redemption fees ......................................... -- d -- d -- d -- d -- ---------------------------------------------------------------------- Net asset value, end of year ............................ $ 25.33 $ 26.08 $ 23.95 $ 23.05 $ 20.99 ====================================================================== Total return ............................................ 3.30% 18.37% 10.39% 13.89% 26.62% RATIOS TO AVERAGE NET ASSETS Expenses c .............................................. 0.75% e 0.84% e 0.81% e 0.81% e 0.84% Expenses - excluding dividend expense on securities sold short ................................ 0.74% e 0.76% e 0.76% e 0.80% e 0.81% Net investment income ................................... 2.57% 1.63% 1.99% 1.62% 1.28% SUPPLEMENTAL DATA Net assets, end of year (000's) ......................... $13,262,561 $11,577,506 $ 8,951,080 $7,240,641 $5,782,145 Portfolio turnover rate ................................. 40.57% 33.40% 21.57% 33.22% 54.65%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. 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 rounds to less than $0.01. e Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 19 Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS A 2007 2006 2005 2004 2003 ---------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ...................... $ 25.90 $ 23.82 $ 22.94 $ 20.90 $ 16.78 ---------------------------------------------------------------------- Income from investment operations a: Net investment income b .............................. 0.61 0.32 0.39 0.27 0.17 Net realized and unrealized gains (losses) ........... 0.17 3.88 1.91 2.51 4.21 ---------------------------------------------------------------------- Total from investment operations ........................ 0.78 4.20 2.30 2.78 4.38 ---------------------------------------------------------------------- Less distributions from: Net investment income ................................ (0.67) (0.45) (0.22) (0.32) (0.26) Net realized gains ................................... (0.87) (1.67) (1.20) (0.42) -- ---------------------------------------------------------------------- Total distributions ..................................... (1.54) (2.12) (1.42) (0.74) (0.26) ---------------------------------------------------------------------- Redemption fees ......................................... -- e -- e -- e -- e -- ---------------------------------------------------------------------- Net asset value, end of year ............................ $ 25.14 $ 25.90 $ 23.82 $ 22.94 $ 20.90 ====================================================================== Total return c .......................................... 2.97% 17.98% 9.98% 13.50% 26.18% RATIOS TO AVERAGE NET ASSETS Expenses d .............................................. 1.07% f 1.18% f 1.16% f 1.16% f 1.19% Expenses - excluding dividend expense on securities sold short ............................. 1.06% f 1.10% f 1.11% f 1.15% f 1.16% Net investment income ................................... 2.25% 1.29% 1.64% 1.27% 0.93% SUPPLEMENTAL DATA Net assets, end of year (000's) ......................... $ 8,469,264 $ 6,761,779 $ 4,211,238 $2,940,029 $2,257,336 Portfolio turnover rate ................................. 40.57% 33.40% 21.57% 33.22% 54.65%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01. f Benefit of expense reduction rounds to less than 0.01%. 20 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS B 2007 2006 2005 2004 2003 ---------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ...................... $ 25.35 $ 23.35 $ 22.50 $ 20.54 $ 16.53 ---------------------------------------------------------------------- Income from investment operations a: Net investment income b .............................. 0.41 0.16 0.23 0.13 0.04 Net realized and unrealized gains (losses) ........... 0.18 3.78 1.88 2.44 4.14 ---------------------------------------------------------------------- Total from investment operations ........................ 0.59 3.94 2.11 2.57 4.18 ---------------------------------------------------------------------- Less distributions from: Net investment income ................................ (0.47) (0.27) (0.06) (0.19) (0.17) Net realized gains ................................... (0.87) (1.67) (1.20) (0.42) -- ---------------------------------------------------------------------- Total distributions ..................................... (1.34) (1.94) (1.26) (0.61) (0.17) ---------------------------------------------------------------------- Redemption fees ......................................... -- e -- e -- e -- e -- ---------------------------------------------------------------------- Net asset value, end of year ............................ $ 24.60 $ 25.35 $ 23.35 $ 22.50 $ 20.54 ====================================================================== Total return c .......................................... 2.25% 17.21% 9.31% 12.70% 25.41% RATIOS TO AVERAGE NET ASSETS Expenses d .............................................. 1.75% f 1.84% f 1.81% f 1.81% f 1.84% Expenses - excluding dividend expense on securities sold short ........................................... 1.74% f 1.76% f 1.76% f 1.80% f 1.81% Net investment income 1.57% 0.63% 0.99% 0.62% 0.28% SUPPLEMENTAL DATA Net assets, end of year (000's) ......................... $ 586,289 $ 659,186 $ 612,007 $ 588,401 $ 444,671 Portfolio turnover rate ................................. 40.57% 33.40% 21.57% 33.22% 54.65%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 21 Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS C 2007 2006 2005 2004 2003 ---------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ...................... $ 25.63 $ 23.48 $ 22.76 $ 20.75 $ 16.68 ---------------------------------------------------------------------- Income from investment operations a: Net investment income b .............................. 0.42 0.16 0.23 0.13 0.05 Net realized and unrealized gains (losses) ........... 0.17 3.82 1.89 2.49 4.17 ---------------------------------------------------------------------- Total from investment operations ........................ 0.59 3.98 2.12 2.62 4.22 ---------------------------------------------------------------------- Less distributions from: Net investment income ................................ (0.49) (0.16) (0.20) (0.19) (0.15) Net realized gains ................................... (0.87) (1.67) (1.20) (0.42) -- ---------------------------------------------------------------------- Total distributions ..................................... (1.36) (1.83) (1.40) (0.61) (0.15) ---------------------------------------------------------------------- Redemption fees ......................................... -- e -- e -- e -- e -- ---------------------------------------------------------------------- Net asset value, end of year ............................ $ 24.86 $ 25.63 $ 23.48 $ 22.76 $20.75 ====================================================================== Total return c .......................................... 2.30% 17.18% 9.27% 12.77% 25.37% RATIOS TO AVERAGE NET ASSETS Expenses d .............................................. 1.75% f 1.84% f 1.81% f 1.81% f 1.84% Expenses - excluding dividend expense on securities sold short ................................ 1.74% f 1.76% f 1.76% f 1.80% f 1.81% Net investment income ................................... 1.57% 0.63% 0.99% 0.62% 0.28% SUPPLEMENTAL DATA Net assets, end of year (000's) ......................... $ 2,617,083 $ 2,387,517 $ 1,834,009 $1,551,111 $1,272,590 Portfolio turnover rate ................................. 40.57% 33.40% 21 .57% 33.22% 54.65%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01. f Benefit of expense reduction rounds to less than 0.01%. 22 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Shares Fund FINANCIAL HIGHLIGHTS (CONTINUED)
---------------------------------------------------------------------- YEAR ENDED DECEMBER 31, CLASS R 2007 2006 2005 2004 2003 ---------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE (for a share outstanding throughout the year) Net asset value, beginning of year ...................... $ 25.77 $ 23.72 $ 22.85 $ 20.83 $ 16.75 ---------------------------------------------------------------------- Income from investment operations a: Net investment income b .............................. 0.55 0.28 0.35 0.24 0.13 Net realized and unrealized gains (losses) ........... 0.18 3.86 1.91 2.50 4.21 ---------------------------------------------------------------------- Total from investment operations ........................ 0.73 4.14 2.26 2.74 4.34 ---------------------------------------------------------------------- Less distributions from: Net investment income ................................ (0.63) (0.42) (0.19) (0.30) (0.26) Net realized gains ................................... (0.87) (1.67) (1.20) (0.42) -- ---------------------------------------------------------------------- Total distributions ..................................... (1.50) (2.09) (1.39) (0.72) (0.26) ---------------------------------------------------------------------- Redemption fees ......................................... -- e -- e -- e -- e -- ---------------------------------------------------------------------- Net asset value, end of year ............................ $ 25.00 $ 25.77 $ 23.72 $ 22.85 $ 20.83 ====================================================================== Total return c .......................................... 2.77% 17.73% 9.88% 13.32% 26.02% RATIOS TO AVERAGE NET ASSETS Expenses d .............................................. 1.25% f 1.34% f 1.31% f 1.31% f 1.34% Expenses - excluding dividend expense on securities sold short ........................................... 1.24% f 1.26% f 1.26% f 1.30% f 1.31% Net investment income ................................... 2.07% 1.13% 1.49% 1.12% 0.78% SUPPLEMENTAL DATA Net assets, end of year (000's) ......................... $ 297,777 $ 188,646 $ 109,305 $ 74,763 $ 46,933 Portfolio turnover rate ................................. 40.57% 33.40% 21.57% 33.22% 54.65%
a The amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund. b Based on average daily shares outstanding. c Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. d Includes dividend expense on securities sold short which varies from period to period. See below for expense ratios that reflect only operating expenses. e Amount rounds to less than $0.01. f Benefit of expense reduction rounds to less than 0.01%. Annual Report | The accompanying notes are an integral part of these financial statements. | 23 Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS 92.6% COMMON STOCKS AND OTHER EQUITY INTERESTS 88.8% AEROSPACE & DEFENSE 0.1% a GenCorp Inc. .................................................. United States 2,073,770 $ 24,180,158 ------------------ AIR FREIGHT & LOGISTICS 1.1% Deutsche Post AG .............................................. Germany 6,618,501 225,144,510 TNT NV ........................................................ Netherlands 1,436,113 59,206,108 ------------------ 284,350,618 ------------------ AIRLINES 0.5% a ACE Aviation Holdings Inc., A ................................. Canada 2,376,693 67,803,016 a,b ACE Aviation Holdings Inc., A, 144A ........................... Canada 121,088 3,454,435 a Northwest Airlines Corp. ...................................... United States 2,823,975 40,975,877 a,c Northwest Airlines Corp., Contingent Distribution ............. United States 111,348,000 3,757,995 ------------------ 115,991,323 ------------------ AUTO COMPONENTS 0.8% a,c Collins & Aikman Products Co., Contingent Distribution ........ United States 3,850,387 1,703,796 a Goodyear Tire & Rubber Co. .................................... United States 4,294,179 121,181,731 a Lear Corp. .................................................... United States 2,563,001 70,892,608 ------------------ 193,778,135 ------------------ AUTOMOBILES 2.0% Daimler AG .................................................... Germany 1,413,460 136,573,538 General Motors Corp. .......................................... United States 7,060,014 175,723,749 Harley-Davidson Inc. .......................................... United States 1,652,699 77,197,570 a,d,e,f,g International Automotive Components Group Brazil LLC .......... Brazil 6,069,096 42,156,730 a,d,e,f,g International Automotive Components Group Japan LLC ........... Japan 1,104,272 9,902,453 a,d,e,f,g International Automotive Components Group LLC ................. Luxembourg 25,796,752 27,367,774 a,d,e,f,g International Automotive Components Group NA LLC .............. United States 19,434,979 26,723,096 ------------------ 495,644,910 ------------------ BEVERAGES 2.0% Brown-Forman Corp., A ......................................... United States 125,460 9,389,426 Brown-Forman Corp., B ......................................... United States 606,036 44,913,328 Coca-Cola Enterprises Inc. .................................... United States 8,021,543 208,800,764 Pernod Ricard SA .............................................. France 1,031,416 237,971,629 ------------------ 501,075,147 ------------------ BUILDING PRODUCTS 0.3% a Armstrong World Industries Inc. ............................... United States 408,961 16,403,426 a,c Armstrong World Industries Inc., Contingent Distribution ...... United States 45,410,075 170,288 a Owens Corning Inc. ............................................ United States 3,320,705 67,144,655 ------------------ 83,718,369 ------------------ CAPITAL MARKETS 0.2% Legg Mason Inc. ............................................... United States 762,241 55,757,929 ------------------
24 | Annual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) CHEMICALS 0.9% a,c Dow Corning Corp., Contingent Distribution .................... United States 612,630,547 $ 9,185,607 Koninklijke DSM NV ............................................ Netherlands 1,088,980 51,378,930 Linde AG ...................................................... Germany 1,240,940 163,874,289 ------------------ 224,438,826 ------------------ COMMERCIAL BANKS 6.0% a Banco Popolare SpA ............................................ Italy 4,088,405 90,450,831 a,f Centennial Bank Holdings Inc. ................................. United States 5,731,834 33,130,000 Commerce Bancorp Inc. ......................................... United States 3,284,520 125,271,593 Danske Bank AS ................................................ Denmark 5,051,544 197,484,277 a,d,e,f Elephant Capital Holdings Ltd. ................................ Japan 26,671 17,564,991 Intesa Sanpaolo SpA ........................................... Italy 20,444,175 161,408,464 Mitsubishi UFJ Financial Group Inc. ........................... Japan 5,473,223 51,387,387 a,d,e NCB Warrant Holdings Ltd., A .................................. Japan 124,040 7,359,521 Societe Generale, A ........................................... France 943,712 136,246,996 Sumitomo Mitsui Financial Group Inc. .......................... Japan 6,130 46,010,043 Swedbank AB, A ................................................ Sweden 2,629,481 74,422,727 U.S. Bancorp .................................................. United States 14,071,550 446,630,997 UnionBanCal Corp. ............................................. United States 1,002,800 49,046,948 Wachovia Corp. ................................................ United States 2,015,943 76,666,312 ------------------ 1,513,081,087 ------------------ COMMERCIAL SERVICES & SUPPLIES 0.0% h a Comdisco Holding Co. Inc. ..................................... United States 2,088 19,022 a,c Comdisco Holding Co. Inc., Contingent Distribution ............ United States 95,431,240 -- ------------------ 19,022 ------------------ COMMUNICATIONS EQUIPMENT 1.6% Motorola Inc. ................................................. United States 19,122,930 306,731,797 Telefonaktiebolaget LM Ericsson, B ............................ Sweden 36,236,735 85,075,651 Telefonaktiebolaget LM Ericsson, B, ADR ....................... Sweden 163,600 3,820,060 ------------------ 395,627,508 ------------------ COMPUTERS & PERIPHERALS 1.4% a,d,e,f DecisionOne Corp. ............................................. United States 1,879,100 -- a,d,e,f DecisionOne Corp., wts., 6/08/17 .............................. United States 1,031,766 -- a Dell Inc. ..................................................... United States 11,369,730 278,672,082 a Lexmark International Inc., A ................................. United States 2,487,110 86,700,655 ------------------ 365,372,737 ------------------ CONSUMER FINANCE 1.3% a,d,e Cerberus CG Investor I LLC .................................... United States 49,252,400 41,469,365 a,d,e Cerberus CG Investor II LLC ................................... United States 49,252,400 41,469,365 a,d,e Cerberus CG Investor III LLC .................................. United States 24,626,200 20,734,682 a,d,e Cerberus FIM Investors Auto Finance LLC ....................... United States 15,536,148 8,335,624 a,d,e Cerberus FIM Investors Commercial Finance LLC ................. United States 1,294,114 694,332 a,d,e Cerberus FIM Investors Commercial Mortgage LLC ................ United States 2,425,617 1,301,419 a,d,e Cerberus FIM Investors Insurance LLC .......................... United States 11,863,844 6,365,319
Annual Report | 25 Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) CONSUMER FINANCE (CONTINUED) a,d,e Cerberus FIM Investors Rescap LLC ............................. United States 22,088,027 $ 11,850,909 SLM Corp. ..................................................... United States 9,622,710 193,801,379 ------------------ 326,022,394 ------------------ CONTAINERS & PACKAGING 0.4% Temple-Inland Inc. ............................................ United States 4,336,720 90,420,612 ------------------ DIVERSIFIED CONSUMER SERVICES 0.3% H&R Block Inc. ................................................ United States 4,194,388 77,889,785 ------------------ DIVERSIFIED FINANCIAL SERVICES 2.0% Citigroup Inc. ................................................ United States 4,925,840 145,016,730 Fortis ........................................................ Belgium 13,066,900 344,770,772 a Fortis VVPR Strip ............................................. Belgium 5,226,760 76,277 a Guaranty Financial Group Inc. ................................. United States 1,365,873 21,853,971 a,c Marconi Corp., Contingent Distribution ........................ United Kingdom 77,739,439 -- ------------------ 511,717,750 ------------------ DIVERSIFIED TELECOMMUNICATION SERVICES 2.2% a,d,e,f,g AboveNet Inc. ................................................. United States 810,649 40,532,450 a,d,f,g AboveNet Inc., stock grants, grant price $20.95, expiration date 9/09/13 ....................................... United States 1,065 44,144 a,d,e,f,g AboveNet Inc., wts., 9/08/08 .................................. United States 29,283 1,382,158 a,d,e,f,g AboveNet Inc., wts., 9/08/10 .................................. United States 34,449 1,504,732 Embarq Corp. .................................................. United States 1,513,102 74,943,942 a,c,e Global Crossing Holdings Ltd., Contingent Distribution ........ United States 105,649,309 -- Koninklijke (Royal) KPN NV .................................... Netherlands 3,531,102 64,104,733 Telefonica SA ................................................. Spain 4,251,926 137,876,167 Verizon Communications Inc. ................................... United States 5,166,818 225,738,278 ------------------ 546,126,604 ------------------ ELECTRIC UTILITIES 0.8% E.ON AG ....................................................... Germany 684,019 145,351,265 Exelon Corp. .................................................. United States 628,000 51,269,920 ------------------ 196,621,185 ------------------ ELECTRONIC EQUIPMENT & INSTRUMENTS 0.7% Tyco Electronics Ltd. ......................................... United States 5,025,352 186,591,320 ------------------ ENERGY EQUIPMENT & SERVICES 1.0% a Seadrill Ltd. ................................................. Bermuda 5,877,230 143,294,319 a,i Transocean Inc. ............................................... United States 818,987 117,237,989 ------------------ 260,532,308 ------------------ FOOD & STAPLES RETAILING 3.6% Carrefour SA .................................................. France 2,710,739 210,810,808 CVS Caremark Corp. ............................................ United States 6,785,286 269,715,118 Kroger Co. .................................................... United States 6,275,091 167,607,681 Wal-Mart Stores Inc. .......................................... United States 5,423,910 257,798,442 ------------------ 905,932,049 ------------------
26 | Annual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) FOOD PRODUCTS 3.7% Cadbury Schweppes PLC ......................................... United Kingdom 20,153,076 $ 248,668,002 General Mills Inc. ............................................ United States 1,037,600 59,143,200 Groupe Danone ................................................. France 1,342,702 120,311,587 Kraft Foods Inc., A ........................................... United States 6,304,684 205,721,839 Nestle SA ..................................................... Switzerland 653,170 299,725,027 ------------------ 933,569,655 ------------------ HEALTH CARE EQUIPMENT & SUPPLIES 1.0% Covidien Ltd. ................................................. United States 4,006,372 177,442,216 Hillenbrand Industries Inc. ................................... United States 1,462,406 81,499,886 ------------------ 258,942,102 ------------------ HEALTH CARE PROVIDERS & SERVICES 2.3% a,f Community Health Systems Inc. ................................. United States 4,806,000 177,149,160 a,d,e,f,g Kindred Healthcare Inc. ....................................... United States 2,860,528 67,883,190 a,d,e,f,g Kindred Healthcare Inc., stock grants: grant price $18.15, expiration date 7/17/11 ................ United States 9,997 55,793 grant price $19.87, expiration date 1/01/12 ................ United States 2,999 11,579 grant price $6.94, expiration date 1/01/13 ................. United States 2,986 50,138 grant price $19.87, expiration date 1/01/14 ................ United States 2,230 8,610 grant price $21.33, expiration date 1/10/15 ................ United States 1,238 2,973 grant price $22.08, expiration date 1/10/16 ................ United States 619 1,022 a MDS Inc. ...................................................... Canada 2,178,151 42,061,603 a PharMerica Inc. ............................................... United States 1,047,022 14,532,665 Quest Diagnostics Inc. ........................................ United States 2,635,400 139,412,660 a,f Tenet Healthcare Corp. ........................................ United States 25,881,411 131,477,568 ------------------ 572,646,961 ------------------ HOTELS, RESTAURANTS & LEISURE 0.2% a Trump Entertainment Resorts Inc. .............................. United States 1,823,378 7,840,525 Wyndham Worldwide Corp. ....................................... United States 1,845,958 43,490,771 ------------------ 51,331,296 ------------------ HOUSEHOLD DURABLES 0.8% f,j Beazer Homes USA Inc. ......................................... United States 2,147,880 15,958,748 Koninklijke Philips Electronics NV ............................ Netherlands 4,391,737 189,196,077 ------------------ 205,154,825 ------------------ INDEPENDENT POWER PRODUCERS & ENERGY TRADERS 1.4% Constellation Energy Group .................................... United States 3,333,700 341,804,261 ------------------ INDUSTRIAL CONGLOMERATES 4.1% Keppel Corp. Ltd. ............................................. Singapore 16,278,934 146,814,764 g Orkla ASA ..................................................... Norway 24,350,543 471,597,138 Siemens AG .................................................... Germany 2,072,525 327,920,547 Tyco International Ltd. ....................................... United States 2,541,832 100,783,639 ------------------ 1,047,116,088 ------------------
Annual Report | 27 Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) INSURANCE 8.3% a Alleghany Corp. ............................................... United States 348,651 $ 140,157,702 Allianz SE .................................................... Germany 635,950 137,429,139 American International Group Inc. ............................. United States 2,696,200 157,188,460 a Berkshire Hathaway Inc., A .................................... United States 1,590 225,144,000 a Berkshire Hathaway Inc., B .................................... United States 121,410 574,997,760 a Conseco Inc. .................................................. United States 4,553,790 57,195,602 Hartford Financial Services Group Inc. ........................ United States 649,800 56,656,062 Old Republic International Corp. .............................. United States 6,101,302 94,021,064 a,d,e Olympus Re Holdings Ltd. ...................................... United States 202,380 662,835 Prudential Financial Inc. ..................................... United States 948,700 88,267,048 The Travelers Cos. Inc. ....................................... United States 1,385,982 74,565,832 f White Mountains Insurance Group Ltd. .......................... United States 729,457 374,977,371 Zurich Financial Services AG .................................. Switzerland 352,340 103,382,501 ------------------ 2,084,645,376 ------------------ IT SERVICES 0.6% a Alliance Data Systems Corp. ................................... United States 1,947,340 146,031,027 ------------------ LEISURE EQUIPMENT & PRODUCTS 0.8% Mattel Inc. ................................................... United States 10,209,130 194,381,835 ------------------ MACHINERY 0.2% f Federal Signal Corp. .......................................... United States 3,360,800 37,708,176 a,d,e Motor Coach Industries International Inc., wts., 5/27/09 ...... United States 12 -- ------------------ 37,708,176 ------------------ MARINE 0.6% A.P. Moller - Maersk AS ....................................... Denmark 15,130 161,086,603 ------------------ MEDIA 7.5% a Adelphia Recovery Trust ....................................... United States 99,967,609 6,997,733 a,c Adelphia Recovery Trust, Arahova Contingent Value Vehicle, Contingent Distribution ....................................... United States 12,005,115 6,182,634 a Cablevision Systems Corp., A .................................. United States 2,617,495 64,128,628 a,c Century Communications Corp., Contingent Distribution ......... United States 33,138,000 -- Clear Channel Communications Inc. ............................. United States 2,595,770 89,605,980 a Comcast Corp., A .............................................. United States 19,942,140 361,351,577 a Liberty Media Holding Corp.-Capital, A ........................ United States 1,271,417 148,107,366 News Corp., A ................................................. United States 21,263,802 435,695,303 a Sun-Times Media Group Inc., A ................................. United States 1,929,706 4,245,353 a Time Warner Cable Inc., A ..................................... United States 2,237,958 61,767,641 Time Warner Inc. .............................................. United States 15,148,228 250,097,244 a,e,f TVMAX Holdings Inc. ........................................... United States 257,217 -- a Viacom Inc., B ................................................ United States 4,820,631 211,722,114 Virgin Media Inc. ............................................. United Kingdom 9,133,425 156,546,904 WPP Group PLC ................................................. United Kingdom 7,014,952 90,181,187 ------------------ 1,886,629,664 ------------------ METALS & MINING 2.2% Alcoa Inc. .................................................... United States 3,577,590 130,760,915 i Anglo American PLC ............................................ United Kingdom 1,771,843 108,433,360
28 | Annual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) METALS & MINING (CONTINUED) ArcelorMittal ................................................. Netherlands 2,718,615 $ 210,352,114 a,d,e,f Esmark Inc. ................................................... United States 8,341,744 106,081,958 ------------------ 555,628,347 ------------------ MULTI-UTILITIES 1.4% Energy East Corp. ............................................. United States 3,668,160 99,810,634 NorthWestern Corp. ............................................ United States 723,649 21,347,645 a,c NorthWestern Corp., Contingent Distribution ................... United States 21,699,220 1,538,560 RWE AG ........................................................ Germany 1,302,182 183,287,720 Suez SA ....................................................... France 796,241 54,114,073 ------------------ 360,098,632 ------------------ MULTILINE RETAIL 0.4% a,j Sears Holdings Corp. .......................................... United States 1,068,680 109,058,794 ------------------ OIL, GAS & CONSUMABLE FUELS 2.0% a,e Apco Oil Corp. ................................................ United States 9,200 -- BP PLC ........................................................ United Kingdom 9,485,110 115,905,608 BP PLC, ADR ................................................... United Kingdom 46,400 3,395,088 Royal Dutch Shell PLC, A ...................................... United Kingdom 5,944,947 249,428,046 Total SA, B ................................................... France 1,523,752 126,372,156 ------------------ 495,100,898 ------------------ PAPER & FOREST PRODUCTS 3.9% a Domtar Corp. .................................................. United States 12,896,820 99,176,546 International Paper Co. ....................................... United States 9,480,806 306,988,498 MeadWestvaco Corp. ............................................ United States 4,116,457 128,845,104 Mondi Ltd. .................................................... South Africa 236,911 2,238,323 Mondi PLC ..................................................... United Kingdom 158,720 1,340,317 Weyerhaeuser Co. .............................................. United States 6,165,330 454,631,434 ------------------ 993,220,222 ------------------ PHARMACEUTICALS 2.7% Bristol-Myers Squibb Co. ...................................... United States 3,834,520 101,691,470 Novartis AG ................................................... Switzerland 2,427,900 133,050,291 Pfizer Inc. ................................................... United States 11,568,920 262,961,552 Sanofi-Aventis ................................................ France 1,451,967 133,450,084 a Valeant Pharmaceuticals International ......................... United States 3,520,835 42,144,395 Watson Pharmaceuticals Inc. ................................... United States 6,400 173,696 ------------------ 673,471,488 ------------------ REAL ESTATE 1.5% a,f Alexander's Inc. .............................................. United States 326,675 115,397,944 a,e Canary Wharf Group PLC ........................................ United Kingdom 14,262,931 142,548,853 Link REIT ..................................................... Hong Kong 18,210,494 39,418,979 j The St. Joe Co. ............................................... United States 1,052,935 37,389,722 Ventas Inc. ................................................... United States 1,072,765 48,542,616 ------------------ 383,298,114 ------------------
Annual Report | 29 Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED) REAL ESTATE MANAGEMENT & DEVELOPMENT 0.1% a Forestar Real Estate Group .................................... United States 1,365,873 $ 32,220,949 ------------------ SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT 1.0% a LSI Corp. ..................................................... United States 24,355,334 129,326,823 Maxim Integrated Products Inc. ................................ United States 4,365,000 115,585,200 ------------------ 244,912,023 ------------------ SOFTWARE 2.2% a BEA Systems Inc. .............................................. United States 8,200,790 129,408,466 Microsoft Corp. ............................................... United States 10,837,929 385,830,273 a NAVTEQ Corp. .................................................. United States 666,900 50,417,640 ------------------ 565,656,379 ------------------ SPECIALTY RETAIL 0.9% The Home Depot Inc. ........................................... United States 8,465,150 228,051,141 ------------------ THRIFTS & MORTGAGE FINANCE 1.0% Hudson City Bancorp Inc. ...................................... United States 11,930,969 179,203,154 Sovereign Bancorp Inc. ........................................ United States 7,375,654 84,082,456 ------------------ 263,285,610 ------------------ TOBACCO 8.8% Altadis SA .................................................... Spain 4,442,253 322,260,073 Altria Group Inc. ............................................. United States 5,137,730 388,309,633 British American Tobacco PLC .................................. United Kingdom 12,181,486 475,608,697 British American Tobacco PLC, ADR ............................. United Kingdom 70,550 5,542,408 Imperial Tobacco Group PLC .................................... United Kingdom 6,933,289 373,607,814 Japan Tobacco Inc. ............................................ Japan 30,953 185,415,451 KT&G Corp. .................................................... South Korea 2,102,036 178,977,906 Reynolds American Inc. ........................................ United States 4,494,420 296,451,943 ------------------ 2,226,173,925 ------------------ TRANSPORTATION INFRASTRUCTURE 0.0% h a Groupe Eurotunnel SA, wts., 12/30/11 .......................... France 2,855,237 958,362 ------------------ TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS (COST $18,190,596,286) ..................................... 22,407,072,529 ------------------ PREFERRED STOCKS 0.4% AUTO COMPONENTS 0.1% d,e Dana Holding Corp., 4.00%, cvt. pfd., B ....................... United States 163,322 16,332,200 ------------------ DIVERSIFIED TELECOMMUNICATION SERVICES 0.0% h d PTV Inc., 10.00%, pfd., A ..................................... United Kingdom 199,566 239,479 ------------------ THRIFTS & MORTGAGE FINANCE 0.3% a Washington Mutual Inc., 7.75%, cvt. pfd., R ................... United States 77,900 68,941,500 ------------------ TOTAL PREFERRED STOCKS (COST $92,796,401) ..................... 85,513,179 ------------------
30 | Annual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ SHARES/WARRANTS/ COUNTRY CONTRACTS VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) OPTIONS PURCHASED 0.4% CALL OPTIONS 0.0% h a,d Owens Corning Inc., exercise price $37.50, expiration date 1/02/08, shares ............................................ United States 911,589 $ 45,580 ------------------ PUT OPTIONS 0.4% a Dow Jones EUROSTOXX 50, exercise price $4,088.73, expiration date 6/20/08, contracts ......................... United States 180,000 23,924,214 a S&P 500 Index, exercise price $1,250.00, expiration date 6/21/08, contracts ......................................... United States 2,954 8,093,960 a S&P 500 Index, exercise price $1,375.00, expiration date 6/21/08, contracts ......................................... United States 11,134 59,010,200 ------------------ 91,028,374 ------------------ TOTAL OPTIONS PURCHASED (COST $73,389,888) .................... 91,073,954 ------------------ ------------------ PRINCIPAL AMOUNT k ------------------ CORPORATE BONDS & NOTES 2.8% b ACE Aviation Holdings Inc., cvt., 144A, 4.25%, 6/01/35 ........ Canada 5,190,000 CAD 5,901,585 d,e Cerberus CG Investor I LLC, 12.00%, 7/31/14 ................... United States 49,252,400 41,469,365 d,e Cerberus CG Investor II LLC, 12.00%, 7/31/14 .................. United States 49,252,400 41,469,365 d,e Cerberus CG Investor III LLC, 12.00%, 7/31/14 ................. United States 24,626,200 20,734,682 d,e Cerberus FIM Investors Auto Finance LLC, 12.00%, 11/22/13 ..... United States 46,576,742 24,989,862 d,e Cerberus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 ................................................... United States 3,882,344 2,082,997 d,e Cerberus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 ................................................... United States 7,276,853 3,904,256 d,e Cerberus FIM Investors Insurance LLC, 12.00%, 11/22/13 ........ United States 35,591,534 19,095,958 d,e Cerberus FIM Investors Rescap LLC, 12.00%, 11/22/13 ........... United States 66,264,075 35,552,725 d,e,f DecisionOne Corp., 12.00%, 4/15/10 ............................................ United States 2,322,817 2,322,817 l FRN, 9.50%, 5/12/09 ........................................ United States 433,342 433,342 Groupe Eurotunnel SA, cvt., 3.00%, 6/28/09 ............................................. France 53,400 EUR 171,444 3.00%, 6/28/09 ............................................. France 43,989 GBP 192,289 3.00%, 7/28/10 ............................................. France 18,944,500 EUR 54,602,144 3.00%, 7/28/10 ............................................. France 11,239,769 GBP 44,107,400 6.00%, 7/28/10 ............................................. France 45,720,800 EUR 89,741,961 6.00%, 7/28/10 ............................................. France 28,063,345 GBP 74,997,828 sub bond, T1, 3.00%, 7/28/08 ............................... France 53,400 EUR 190,927 sub bond, T1, 3.00%, 7/28/08 ............................... France 43,989 GBP 214,140 d,e,f,g International Automotive Components Group NA LLC, 9.00%, 4/01/17 .................................................... United States 5,851,000 5,851,000 d,e,l Motor Coach Industries International Inc., FRN, 18.081%, 12/01/08 ................................................... United States 65,739,207 65,081,814
Annual Report | 31 Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY PRINCIPAL AMOUNT k VALUE - ------------------------------------------------------------------------------------------------------------------------------------ LONG TERM INVESTMENTS (CONTINUED) CORPORATE BONDS & NOTES (CONTINUED) d,e,l Revel Entertainment Group LLC, first lien loan, FRN, 9.43%, 5/30/08 ....................... United States 52,000,000 $ 51,740,000 second lien loan, FRN, 12.43%, 5/30/08 ..................... United States 52,000,000 51,480,000 Trump Entertainment Resorts Inc., 8.50%, 5/20/15 .............. United States 36,590,212 28,037,250 e,f TVMAX Holdings Inc., PIK, 11.50%, 2/28/08 ............................................ United States 632,919 443,043 14.00%, 2/28/08 ............................................ United States 1,595,750 1,117,025 Wimar OPCO LLC/Finance Corp., senior sub. note, 9.625%, 12/15/14 ................................................... United States 76,355,000 48,867,200 ------------------ TOTAL CORPORATE BONDS & NOTES (COST $804,982,188) ............. 714,792,419 ------------------ CORPORATE BONDS & NOTES IN REORGANIZATION 0.2% b Calpine Corp., senior secured note, 144A, 8.50%, 7/15/10 ............................................. United States 9,955,000 10,701,625 9.875%, 12/01/11 ........................................... United States 3,502,000 3,677,100 8.75%, 7/15/13 ............................................. United States 5,253,000 5,673,240 m Dana Corp., 6.50%, 3/01/09 ............................................. United States 7,931,000 5,987,905 5.85%, 1/15/15 ............................................. United States 29,532,000 21,706,020 7.00%, 3/01/29 ............................................. United States 6,376,000 4,813,880 senior note, 7.00%, 3/15/28 ................................ United States 1,638,000 1,203,930 e,m Safety Kleen Services, senior sub. note, 9.25%, 6/01/08 ....... United States 85,000 425 ------------------ TOTAL CORPORATE BONDS & NOTES IN REORGANIZATION (COST $51,385,337) ......................................... 53,764,125 ------------------ COMPANIES IN LIQUIDATION 0.0% h e Peregrine Investments Holdings Ltd., 6.70%, 1/15/98 ............................................. Hong Kong 95,000,000 JPY 6,389 6.70%, 6/30/00 ............................................. Hong Kong 250,000,000 JPY 16,814 zero cpn., 1/22/98 ......................................... Hong Kong 500,000 3,750 e PIV Investment Finance (Cayman) Ltd. .......................... Hong Kong 22,710,000 454,200 ------------------ TOTAL COMPANIES IN LIQUIDATION (COST $--) ..................... 481,153 ------------------ TOTAL LONG TERM INVESTMENTS (COST $19,213,150,101) ..................................... 23,352,697,359 ------------------ SHORT TERM INVESTMENTS 8.1% U.S. GOVERNMENT AND AGENCY SECURITIES 7.6% n,o FHLB, 1/02/08 - 12/09/08 ...................................... United States 1,757,893,000 1,743,363,337 n U.S. Treasury Bill, 4/24/08 - 5/01/08 ......................... United States 170,500,000 168,728,278 ------------------ TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES (COST $1,909,992,819) ...................................... 1,912,091,615 ------------------ TOTAL INVESTMENTS BEFORE MONEY MARKET FUND (COST $21,123,142,919) ..................................... 25,264,788,974 ------------------ p INVESTMENTS FROM CASH COLLATERAL RECEIVED FOR LOANED SECURITIES 0.5% MONEY MARKET FUND (COST $136,033,986) q Bank of New York Institutional Cash Reserve Fund, 5.06% ....... United States 136,033,986 136,033,986 ------------------
32 | Annual Report Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ COUNTRY CONTRACTS/SHARES VALUE - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENTS (COST $21,259,176,906) 100.7% ............... $ 25,400,822,960 OPTIONS WRITTEN 0.0% h ........................................ (8,207,237) SECURITIES SOLD SHORT (0.4)% .................................. (95,163,478) NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS (0.2)% ........................................... (53,546,052) OTHER ASSETS, LESS LIABILITIES (0.1)% ......................... (10,932,707) ------------------ NET ASSETS 100.0% ............................................. $ 25,232,973,486 ------------------ r OPTIONS WRITTEN 0.0% h ENERGY EQUIPMENT & SERVICES 0.0% h a Transocean Inc., Feb. 120.00 Calls, 2/16/08 ................... United States 4,807 6,970,150 a Transocean Inc., Feb. 130.00 Calls, 2/16/08 ................... United States 956 682,584 ------------------ 7,652,734 ------------------ METALS & MINING 0.0% h Anglo American PLC, Mar. 34.00 Calls, 3/20/08 ................. United Kingdom 215,500 554,503 ------------------ TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $5,478,661) .......... 8,207,237 ------------------ s SECURITIES SOLD SHORT (PROCEEDS $99,183,041) COMMERCIAL BANKS 0.4% Toronto-Dominion Bank ......................................... Canada 1,360,450 $ 95,163,478 ------------------
CURRENCY ABBREVIATIONS CAD - Canadian Dollar EUR - Euro GBP - British Pound JPY - Japanese Yen SELECTED PORTFOLIO ABBREVIATIONS ADR - American Depository Receipt FHLB - Federal Home Loan Bank FRN - Floating Rate Note PIK - Payment-In-Kind REIT - Real Estate Investment Trust Annual Report | 33 Mutual Shares Fund STATEMENT OF INVESTMENTS, DECEMBER 31, 2007 (CONTINUED) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- a Non-income producing for the twelve months ended December 31, 2007. 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, 2007, the aggregate value of these securities was $29,407,985, representing 0.12% 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 9 regarding restricted securities. e Security has been deemed illiquid because it may not be able to be sold within seven days. At December 31, 2007 the aggregate value of these securities was $1,008,603,900, representing 4.00% of net assets. f See Note 11 regarding holdings of 5% voting securities. g See Note 12 regarding other considerations. h Rounds to less than 0.1% of net assets. i A portion or all of the security is held in connection with written option contracts open at year end. j A portion or all of the security is on loan as of December 31, 2007. See Note 1(g). k The principal amount is stated in U.S. dollars unless otherwise indicated. l The coupon rate shown represents the rate at period end. m See Note 8 regarding defaulted securities. n The security is traded on a discount basis with no stated coupon rate. o Security or a portion of the security has been segregated as collateral for securities sold short. At December 31, 2007, the value of securities and or cash pledged amounted to $79,513,640. p See Note 1(g) regarding securities on loan. q The rate shown is the annualized seven-day yield at period end. r See Note 1(e) regarding written options. s See Note 1(f) regarding securities sold short. 34 | THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. | ANNUAL REPORT Mutual Shares Fund FINANCIAL STATEMENTS STATEMENT OF ASSETS AND LIABILITIES December 31, 2007 Assets: Investments in securities: Cost - Unaffiliated issuers .............................................................. $20,273,762,116 Cost - Non-controlled affiliated issuers (Note 11) ....................................... 985,414,790 ================ Total cost of investments ................................................................ $21,259,176,906 ================ Value - Unaffiliated issuers (includes securities loaned in the amount of $132,421,913) .. $24,163,582,975 Value - Non-controlled affiliated issuers (Note 11) ...................................... 1,237,239,985 ---------------- Total value of investments ............................................................... 25,400,822,960 Cash ....................................................................................... 15,006,153 Cash on deposits with brokers for securities sold short .................................... 98,422,229 Foreign currency, at value (cost $48,740,963) .............................................. 49,136,557 Receivables: Investment securities sold ............................................................... 7,149,191 Capital shares sold ...................................................................... 29,711,218 Dividends and interest ................................................................... 58,637,098 Unrealized gain on forward exchange contracts (Note 7) ..................................... 43,420,582 ---------------- Total assets ......................................................................... 25,702,305,988 ---------------- Liabilities: Payables: Investment securities purchased .......................................................... 51,437,939 Capital shares redeemed .................................................................. 53,493,721 Affiliates ............................................................................... 24,373,361 Options written, at value (premiums received $5,478,661) ................................... 8,207,237 Securities sold short, at value (proceeds $99,183,041) ..................................... 95,163,478 Payable upon return of securities loaned ................................................... 136,033,986 Unrealized loss on forward exchange contracts (Note 7) ..................................... 96,966,634 Accrued expenses and other liabilities ..................................................... 3,656,146 ---------------- Total liabilities .................................................................... 469,332,502 ---------------- Net assets, at value .............................................................. $25,232,973,486 ================ Net assets consist of: Paid-in capital ............................................................................ $20,923,816,010 Undistributed net investment income ........................................................ 12,854,602 Net unrealized appreciation (depreciation) ................................................. 4,090,069,844 Accumulated net realized gain (loss) ....................................................... 206,233,030 ---------------- Net assets, at value .............................................................. $25,232,973,486 ================
ANNUAL REPORT | THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. | 35 Mutual Shares Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF ASSETS AND LIABILITIES (CONTINUED) December 31, 2007 CLASS Z: Net assets, at value ....................................................................... $13,262,560,738 ================ Shares outstanding ......................................................................... 523,558,002 ================ Net asset value and maximum offering price per share a ..................................... $ 25.33 ================ CLASS A: Net assets, at value ....................................................................... $ 8,469,263,959 ================ Shares outstanding ......................................................................... 336,849,642 ================ Net asset value per share a ................................................................ $ 25.14 ================ Maximum offering price per share (net asset value per share / 94.25%) ...................... $ 26.67 ================ CLASS B: Net assets, at value ....................................................................... $ 586,288,991 ================ Shares outstanding ......................................................................... 23,837,661 ================ Net asset value and maximum offering price per share a ..................................... $ 24.60 ================ CLASS C: Net assets, at value ....................................................................... $ 2,617,082,813 ================ Shares outstanding ......................................................................... 105,261,931 ================ Net asset value and maximum offering price per share a ..................................... $ 24.86 ================ CLASS R: Net assets, at value ....................................................................... $ 297,776,985 ================ Shares outstanding ......................................................................... 11,911,893 ================ Net asset value and maximum offering price per share a ..................................... $ 25.00 ================
a Redemption price is equal to net asset value less contingent deferred sales charges, if applicable, and redemption fees retained by the Fund. 36 | THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. | ANNUAL REPORT Mutual Shares Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENT OF OPERATIONS for the year ended December 31, 2007 Investment income: Dividends: (net of foreign taxes of $26,623,595) Unaffiliated issuers ...................................................................... $ 551,014,301 Non-controlled affiliated issuers (Note 11) ............................................... 107,008,693 Interest: (net of foreign taxes of $5,508) Unaffiliated issuers ...................................................................... 156,847,006 Non-controlled affiliated issuers (Note 11) ............................................... 909,471 Income from securities loaned ............................................................... 4,557,109 ---------------- Total investment income ................................................................. 820,336,580 ---------------- Expenses: Management fees (Note 3a) ................................................................... 136,431,266 Administrative fees (Note 3b) ............................................................... 18,791,131 Distribution fees: (Note 3c) Class A ................................................................................... 26,204,210 Class B ................................................................................... 6,453,715 Class C ................................................................................... 26,362,657 Class R ................................................................................... 1,299,161 Transfer agent fees (Note 3e) ............................................................... 21,272,810 Custodian fees (Note 4) ..................................................................... 2,435,026 Reports to shareholders ..................................................................... 1,472,358 Registration and filing fees ................................................................ 578,905 Professional fees ........................................................................... 2,681,697 Directors' fees and expenses ................................................................ 576,351 Dividends on securities sold short .......................................................... 1,360,484 Other ....................................................................................... 730,028 ---------------- Total expenses .......................................................................... 246,649,799 Expense reductions (Note 4) ............................................................. (169,199) ---------------- Net expenses .......................................................................... 246,480,600 ---------------- Net investment income ............................................................... 573,855,980 ---------------- Realized and unrealized gains (losses): Net realized gain (loss) from: Investments Unaffiliated issuers .................................................................... 1,269,577,197 Non-controlled affiliated issuers (Note 11) ............................................. 211,399,449 Written options ........................................................................... 5,898,983 Foreign currency transactions ............................................................. (381,137,541) Securities sold short ..................................................................... (38,721,279) Synthetic equity swaps .................................................................... 10,756,542 ---------------- Net realized gain (loss) .............................................................. 1,077,773,351 ---------------- Net change in unrealized appreciation (depreciation) on: Investments ............................................................................... (1,046,305,706) Translation of assets and liabilities denominated in foreign currencies ................... (7,694,377) ---------------- Net change in unrealized appreciation (depreciation) .................................. (1,054,000,083) ---------------- Net realized and unrealized gain (loss) ....................................................... 23,773,268 ---------------- Net increase (decrease) in net assets resulting from operations ............................... $ 597,629,248 ================
ANNUAL REPORT | THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS. | 37 Mutual Shares Fund FINANCIAL STATEMENTS (CONTINUED) STATEMENTS OF CHANGES IN NET ASSETS
----------------------------------- YEAR ENDED DECEMBER 31, ----------------------------------- 2007 2006 ----------------------------------- Increase (decrease) in net assets: Operations: Net investment income ................................................................. $ 573,855,980 $ 250,771,297 Net realized gain (loss) from investments, written options, securities sold short, synthetic equity swaps and foreign currency transactions ........................... 1,077,773,351 1,277,505,915 Net change in unrealized appreciation (depreciation) on investments and translation of assets and liabilities denominated in foreign currencies and deferred taxes ........ (1,054,000,083) 1,560,870,117 ----------------------------------- Net increase (decrease) in net assets resulting from operations ................. 597,629,248 3,089,147,329 ----------------------------------- Distributions to shareholders from: Net investment income: Class Z ............................................................................ (371,465,429) (213,013,305) Class A ............................................................................ (212,840,426) (102,518,920) Class B ............................................................................ (10,736,304) (6,728,719) Class C ............................................................................ (48,872,902) (14,229,042) Class R ............................................................................ (7,033,626) (2,664,653) Net realized gains: Class Z ............................................................................ (430,826,291) (688,410,621) Class A ............................................................................ (277,318,724) (398,575,406) Class B ............................................................................ (19,938,898) (41,096,225) Class C ............................................................................ (87,332,680) (145,013,204) Class R ............................................................................ (9,674,981) (11,224,212) ----------------------------------- Total distributions to shareholders ...................................................... (1,476,040,261) (1,623,474,307) ----------------------------------- Capital share transactions: (Note 2) Class Z ............................................................................ 2,129,113,775 1,805,196,748 Class A ............................................................................ 2,027,885,005 2,143,360,560 Class B ............................................................................ (59,185,727) (4,818,299) Class C ............................................................................ 316,218,501 379,010,165 Class R ............................................................................ 122,655,907 68,529,010 ----------------------------------- Total capital share transactions ......................................................... 4,536,687,461 4,391,278,184 ----------------------------------- Redemption fees .......................................................................... 62,755 44,080 ----------------------------------- Net increase (decrease) in net assets ........................................... 3,658,339,203 5,856,995,286 Net assets: Beginning of year ........................................................................ 21,574,634,283 15,717,638,997 ----------------------------------- End of year .............................................................................. $25,232,973,486 $21,574,634,283 ----------------------------------- Undistributed net investment income (distributions in excess of net investment income) included in net assets: End of year .............................................................................. $ 12,854,602 $ (1,937,133) -----------------------------------
38 | The accompanying notes are an integral part of these financial statements. | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Franklin Mutual Series Fund Inc. (Series Fund) is registered under the Investment Company Act of 1940, as amended, (1940 Act) as an open-end investment company, consisting of six separate funds. The Mutual Shares Fund (Fund) included in this report is diversified. The financial statements of the remaining funds in the Series Fund are presented separately. The Fund offers five classes of shares: Class Z, Class A, Class B, Class C and Class R. Each class of shares differs by its initial sales load, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege. 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. Annual Report | 39 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A. SECURITY VALUATION (CONTINUED) The Fund has procedures to determine the fair value of individual securities and other assets for which market prices are not readily available or which may not be reliably priced. 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. The investment manager monitors price movements following the close of trading in foreign stock markets through a series of country specific market proxies (such as baskets of American Depository Receipts, futures contracts and exchange traded funds). These price movements are measured against established trigger thresholds for each specific market proxy to assist in determining if an event has occurred. 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. 40 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) C. FOREIGN CURRENCY CONTRACTS 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. A foreign exchange contract is an agreement between two parties to exchange different currencies at an agreed upon exchange rate at a future date. Realized and unrealized gains and losses on these contracts are included in the Statement of Operations. The Fund may also enter into forward exchange contracts to hedge against fluctuations in foreign exchange rates or to gain exposure to certain foreign currencies. These contracts are valued daily by the Fund and the unrealized gains or losses on the contracts, as measured by the difference between the contractual forward foreign exchange rates and the forward rates at the reporting date, are included in the Statement of Assets and Liabilities. 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. 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 short 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 (margin account). Periodically, payments are made to recognize changes in value of the contract resulting from interest on the notional value of the contract, market value changes in the underlying security, and/or dividends paid by the issuer of the underlying security. The Fund recognizes a realized gain or loss when cash is received from, or paid to, the broker. Synthetic equity swaps are valued daily by the fund and the unrealized gains or losses on the contracts (as measured by the difference between the contract amount plus or minus cash received or paid and the market value of the underlying securities) are recorded in the Statement of Operations. The margin account and any net unrealized gains or losses on open synthetic equity swaps are included in the Statement of Assets and Liabilities. The risks of entering into synthetic equity swaps include unfavorable price movements in the underlying securities or the inability of the counterparties to fulfill their obligations under the contract. Annual Report | 41 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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 or index 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. 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. SECURITIES LENDING The Fund may loan securities to certain brokers through a securities lending agent for which it receives initial cash collateral against the loaned securities in an amount equal to at least 102% of the market value of the loaned securities. Collateral is maintained over the life of the loan in an amount not less than 100% of the market value of loaned securities, as determined at the close of fund business each day; any additional collateral required due to changes in security values is delivered to the fund on the next business day. 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. 42 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) H. INCOME AND DEFERRED TAXES No provision has been made for U.S. income taxes because it is the Fund's policy 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 on dividend and interest income received. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. The Fund may be 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. I. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. 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 accounting principles generally accepted in the United States of America. 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. 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. 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. Differences in per share distributions, by class, are generally due to differences in class specific expenses. Annual Report | 43 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) J. ACCOUNTING ESTIMATES The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. K. 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. 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. L. GUARANTEES AND INDEMNIFICATIONS Under the Series Funds' 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. Currently, the Fund expects the risk of loss to be remote. 2. CAPITAL STOCK At December 31, 2007, there were 1.9 billion shares authorized ($0.001 par value). Transactions in the Fund's shares were as follows:
---------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 ---------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ---------------------------------------------------------------- CLASS Z SHARES: Shares sold ........................................... 72,422,280 $1,980,323,230 58,989,808 $1,512,255,054 Shares issued in reinvestment of distributions ........ 29,171,280 744,740,385 32,352,206 830,332,879 Shares redeemed ....................................... (21,942,690) (595,949,840) (21,118,207) (537,391,185) ---------------------------------------------------------------- Net increase (decrease) ............................... 79,650,870 $2,129,113,775 70,223,807 $1,805,196,748 ================================================================
44 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. CAPITAL STOCK (CONTINUED)
---------------------------------------------------------------- YEAR ENDED DECEMBER 31, 2007 2006 ---------------------------------------------------------------- SHARES AMOUNT SHARES AMOUNT ---------------------------------------------------------------- CLASS A SHARES: Shares sold ........................................... 105,204,071 $ 2,849,290,589 96,505,572 $2,449,217,770 Shares issued in reinvestment of distributions ...................................... 17,844,203 452,010,160 18,089,962 461,565,811 Shares redeemed ....................................... (47,245,938) (1,273,415,744) (30,363,019) (767,423,021) ---------------------------------------------------------------- Net increase (decrease) ............................... 75,802,336 $ 2,027,885,005 84,232,515 $2,143,360,560 ================================================================ CLASS B SHARES: Shares sold ........................................... 605,798 $ 16,017,441 857,349 $ 21,132,869 Shares issued in reinvestment of distributions ...................................... 1,151,048 28,532,034 1,794,285 44,688,168 Shares redeemed ....................................... (3,923,216) (103,735,202) (2,862,654) (70,639,336) ---------------------------------------------------------------- Net increase (decrease) ............................... (2,166,370) $ (59,185,727) (211,020) $ (4,818,299) ================================================================ CLASS C SHARES: Shares sold ........................................... 20,396,970 $ 544,643,345 19,735,859 $ 494,085,976 Shares issued in reinvestment of distributions ...................................... 4,871,395 122,037,887 5,691,658 144,004,696 Shares redeemed ....................................... (13,168,608) (350,462,731) (10,380,456) (259,080,507) ---------------------------------------------------------------- Net increase (decrease) ............................... 12,099,757 $ 316,218,501 15,047,061 $ 379,010,165 ================================================================ CLASS R SHARES: Shares sold ........................................... 6,274,351 $ 169,055,165 3,617,851 $ 91,221,363 Shares issued in reinvestment of distributions ...................................... 658,955 16,589,087 542,562 13,771,339 Shares redeemed ....................................... (2,341,149) (62,988,345) (1,448,897) (36,463,692) ---------------------------------------------------------------- Net increase (decrease) ............................... 4,592,157 $ 122,655,907 2,711,516 $ 68,529,010 ================================================================
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
Annual Report | 45 Mutual Shares 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 - -------------------------------------------------------------------------------- 0.600% 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% Over $20 billion, up to and including $25 billion 0.490%* Over $25 billion, up to and including $30 billion 0.480%** Over $30 billion, up to and including $35 billion 0.470%** In excess of $35 billion * Breakpoint added effective July 1, 2007. ** Breakpoint added effective January 1, 2008. 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 for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund's Class B, C, and R compensation distribution plans, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund's shares up to the maximum annual plan rate for each class. The maximum annual plan rates, based on the average daily net assets, for each class, are as follows: Class A ................................ 0.35% Class B ................................ 1.00% Class C ................................ 1.00% Class R ................................ 0.50% 46 | Annual Report Mutual Shares 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: Sales charges retained net of commissions paid to unaffiliated broker/dealers .................................. $11,000,701 Contingent deferred sales charges retained ...................... $ 839,111 E. TRANSFER AGENT FEES For the year ended December 31, 2007, the Fund paid transfer agent fees of $21,272,810, of which $11,072,490 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, 2007, the custodian fees were reduced as noted in the Statement of Operations. 5. INCOME TAXES The Fund has reviewed the tax positions taken on federal income tax returns, for each of the three open tax years and as of December 31, 2007 and has determined that no provision for income tax is required in the Fund's financial statements. 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, 2007, the Fund deferred realized currency losses of $1,174,236. The tax character of distributions paid during the years ended December 31, 2007 and 2006, was as follows: ------------------------------- 2007 2006 ------------------------------- Distributions paid from: Ordinary income .......................... $ 676,893,393 $ 532,733,473 Long term capital gain ................... 799,146,868 1,090,740,834 ------------------------------- $1,476,040,261 $1,623,474,307 =============================== Annual Report | 47 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. INCOME TAXES (CONTINUED) At December 31, 2007, 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 ......................................... $21,284,619,856 ================ Unrealized appreciation ..................................... $ 5,782,087,662 Unrealized depreciation ..................................... (1,665,884,558) ---------------- Net unrealized appreciation (depreciation) .................. $ 4,116,203,104 ================ Undistributed ordinary income ............................... $ 164,194,654 Undistributed long term capital gains ....................... 31,487,653 ---------------- Distributable earnings ...................................... $ 195,682,307 ================ Net investment income (loss) differs for financial statement and tax purposes primarily due to differing treatments of defaulted securities, foreign currency transactions, passive foreign investment companies, bond discounts and premiums, synthetic equity swaps, pass-through entity income, 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, synthetic equity swaps, pass-through entity income, and certain dividends on securities sold short. 6. INVESTMENT TRANSACTIONS Purchases and sales of investments (excluding short term securities and securities sold short) for the year ended December 31, 2007, aggregated $12,833,815,053 and $9,252,026,093, respectively. Transactions in options written during the year ended December 31, 2007, were as follows: -------------------------- NUMBER OF PREMIUMS CONTRACTS RECEIVED -------------------------- Options outstanding at December 31, 2006 .............................. 1,764 $ 200,656 Options written ................................... 1,336,927 12,751,519 Options expired ................................... (1,112,918) (4,343,763) Options exercised ................................. -- -- Options closed .................................... (4,510) (3,129,751) -------------------------- Options outstanding at December 31, 2007 .............................. 221,263 $ 5,478,661 ========================== 48 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 7. FORWARD EXCHANGE CONTRACTS At December 31, 2007, the Fund had the following forward exchange contracts outstanding:
-------------------------------------------------------- CONTRACT SETTLEMENT UNREALIZED UNREALIZED AMOUNT DATE GAIN LOSS -------------------------------------------------------- CONTRACTS TO BUY 15,977,550 Norwegian Krone .......... $ 2,900,000 2/19/08 $ 36,017 $ -- 2,046,047,927 Japanese Yen ............. 18,031,196 3/19/08 474,653 -- CONTRACTS TO SELL 1,115,169,808 Norwegian Krone .......... 204,816,351 1/09/08 -- (333,017) 21,600,000 British Pound ............ 42,812,410 1/10/08 -- (93,021) 208,102,939 British Pound ............ 421,629,992 1/10/08 8,261,321 -- 429,971,052 Euro ..................... 595,714,928 1/14/08 -- (31,928,812) 972,640,182 Swedish Krona ............ 152,048,705 1/15/08 1,592,927 -- 111,566,807 Singapore Dollar ......... 75,109,918 1/24/08 -- (2,433,267) 177,167,427 Euro ..................... 247,587,631 2/13/08 -- (11,128,696) 142,500,322 Euro ..................... 208,103,624 2/13/08 11,421 -- 322,430,642 Norwegian Krone .......... 58,894,448 2/19/08 -- (355,052) 547,200,000 Norwegian Krone .......... 100,993,407 2/19/08 440,537 -- 412,506,504 Euro ..................... 612,300,243 2/25/08 9,878,278 -- 13,153,683 Swiss Franc .............. 11,470,502 3/07/08 -- (182,507) 342,046,056 Swiss Franc .............. 305,976,138 3/07/08 2,953,356 -- 356,277,521 British Pound ............ 720,819,383 3/10/08 14,260,248 -- 209,551,783 Euro ..................... 294,319,588 3/13/08 -- (11,712,427) 34,892,379 Euro ..................... 51,672,508 3/13/08 715,246 -- 25,415,349,672 Japanese Yen ............. 226,318,554 3/19/08 -- (3,562,978) 105,800,000 Canadian Dollar .......... 105,816,327 3/26/08 -- (739,706) 4,200,000 Canadian Dollar .......... 4,547,374 3/26/08 317,361 -- 3,602,637,500 Korean Won ............... 3,850,000 3/27/08 -- (18,604) 70,567,370,505 Korean Won ............... 77,325,500 3/27/08 1,548,458 -- 945,603,962 Danish Krone ............. 179,798,173 4/23/08 -- (5,366,961) 346,348,386 Euro ..................... 488,869,653 4/24/08 -- (16,868,763) 330,842,864 Euro ..................... 470,797,992 5/19/08 -- (12,236,035) 53,100,000 Euro ..................... 78,989,701 5/19/08 1,463,149 -- 2,780,000 Euro ..................... 4,051,850 5/28/08 -- (6,788) 143,418,347 Euro ..................... 210,850,027 5/28/08 1,467,610 -- ---------------------------- UNREALIZED GAIN (LOSS) ON FORWARD EXCHANGE CONTRACTS ............... 43,420,582 (96,966,634) ---------------------------- NET UNREALIZED LOSS ON FORWARD EXCHANGE CONTRACTS ......... $(53,546,052) =============
Annual Report | 49 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. CREDIT RISK AND 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. Risks associated with purchasing these securities include the possibility that the bankruptcy or other restructuring process takes longer than expected, or that distributions in restructuring are less than anticipated, either or both of which may result in unfavorable consequences to the Fund. At December 31, 2007, the aggregate value of these securities was $33,712,160, representing 0.13% of the Fund's net assets. For information as to specific securities, see the accompanying Statement of Investments. 9. RESTRICTED SECURITIES The Fund may invest in securities that are restricted under the Securities Act of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed upon restrictions on resale. Restricted securities are often purchased in private placement transactions, and cannot be sold without prior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal of these securities may require greater effort and expense, and prompt sale at an acceptable price may be difficult. The Fund may have registration rights for restricted securities. The issuer generally incurs all registration costs. At December 31, 2007, the Fund held investments in restricted securities, excluding 144A securities deemed to be liquid, valued in accordance with procedures approved by the Fund's Board of Directors as reflecting fair value, as follows:
- ----------------------------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------------------------------------------------------------------------------------------------------------------- 810,649 AboveNet Inc. ................................... 10/02/01 - 12/12/07 $ 40,690,364 $ 40,532,450 1,065 AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ...................... 4/17/06 - 9/08/06 -- 44,144 29,283 AboveNet Inc., wts., 9/08/08 .................... 10/02/01 - 9/07/07 3,354,118 1,382,158 34,449 AboveNet Inc., wts., 9/08/10 .................... 10/02/01 - 9/07/07 3,603,181 1,504,732 49,252,400 Cerberus CG Investor I LLC ...................... 7/26/07 49,252,400 41,469,365 49,252,400 Cerberus CG Investor I LLC, 12.00%, 7/31/14 ..... 7/26/07 49,252,400 41,469,365 49,252,400 Cerberus CG Investor II LLC ..................... 7/26/07 49,252,400 41,469,365 49,252,400 Cerberus CG Investor II LLC, 12.00%, 7/31/14 .... 7/26/07 49,252,400 41,469,365 24,626,200 Cerberus CG Investor III LLC .................... 7/26/07 24,626,200 20,734,682 24,626,200 Cerberus CG Investor III LLC, 12.00%, 7/31/14 ... 7/26/07 24,626,200 20,734,682 15,536,148 Cerberus FIM Investors Auto Finance LLC ......... 11/20/06 15,536,148 8,335,624 46,576,742 Cerberus FIM investors Auto Finance LLC, 12.00%, 11/22/13 ..................................... 11/20/06 46,576,742 24,989,862 1,294,114 Cerberus FIM Investors Commercial Finance LLC ... 11/20/06 1,294,114 694,332 3,882,344 Cerberus FIM Investors Commercial Finance LLC, 12.00%, 11/22/13 ............................. 11/20/06 3,882,344 2,082,997 2,425,617 Cerberus FIM Investors Commercial Mortgage LLC .. 11/20/06 2,425,617 1,301,419
50 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. RESTRICTED SECURITIES (CONTINUED)
- ----------------------------------------------------------------------------------------------------------------------------- PRINCIPAL AMOUNT/ SHARES/WARRANTS/ ACQUISITION CONTRACTS ISSUER DATES COST VALUE - ----------------------------------------------------------------------------------------------------------------------------- 7,276,853 Cerberus FIM Investors Commercial Mortgage LLC, 12.00%, 11/22/13 ........................ 11/20/06 $ 7,276,853 $ 3,904,256 11,863,844 Cerberus FIM Investors Insurance LLC ............ 11/20/06 11,863,844 6,365,319 35,591,534 Cerberus FIM Investors Insurance LLC, 12.00%, 11/22/13 ..................................... 11/20/06 35,591,534 19,095,958 22,088,027 Cerberus FIM Investors Rescap LLC ............... 11/20/06 22,088,025 11,850,909 66,264,075 Cerberus FIM Investors Rescap LLC, 12.00%, 11/22/13 ..................................... 11/20/06 66,264,077 35,552,725 163,322 Dana Holding Corp., 4.00%, cvt., pfd., B ........ 12/27/07 16,332,200 16,332,200 1,879,100 DecisionOne Corp. ............................... 3/12/99 - 7/18/00 1,313,384 -- 2,322,817 DecisionOne Corp., 12.00%, 4/15/10 .............. 3/12/99 - 10/17/07 4,349,337 2,322,817 433,342 DecisionOne Corp., FRN, 9.50%, 5/12/09 .......... 7/09/07 433,342 433,342 1,031,766 DecisionOne Corp., wts., 6/08/17 ................ 7/07/07 -- -- 26,671 Elephant Capital Holdings Ltd. .................. 8/29/03 - 3/22/07 950,326 17,564,991 8,341,744 Esmark Inc. ..................................... 11/08/04 - 11/28/07 154,505,847 106,081,958 6,069,096 International Automotive Components Group Brazil LLC .......................................... 4/13/06 - 8/21/06 3,634,723 42,156,730 1,104,272 International Automotive Components Group Japan LLC .......................................... 9/26/06 - 3/27/07 9,595,797 9,902,453 25,796,752 International Automotive Components Group LLC ... 1/12/06 - 10/16/06 25,809,409 27,367,774 19,434,979 International Automotive Components Group NA LLC .......................................... 3/30/07 - 10/10/07 19,402,009 26,723,096 5,851,000 International Automotive Components Group NA LLC, 9.00%, 4/01/17 .......................... 3/30/07 5,938,765 5,851,000 2,860,528 Kindred Healthcare Inc. ......................... 4/28/99 - 3/29/06 26,248,306 67,883,190 Kindred Healthcare Inc., stock grants: 9,997 grant price $18.15, expiration date 7/17/11 .. 7/17/02 - 7/17/05 -- 55,793 2,999 grant price $19.87, expiration date 1/01/12 .. 1/01/03 - 1/01/06 -- 11,579 2,986 grant price $6.94, expiration date 1/01/13 ... 1/01/04 - 1/03/07 -- 50,138 2,230 grant price $19.87, expiration date 1/01/14 .. 1/01/05 - 1/03/07 -- 8,610 1,238 grant price $21.33, expiration date 1/10/15 .. 1/06/06 - 1/09/07 -- 2,973 619 grant price $22.08, expiration date 1/10/16 .. 1/09/07 -- 1,022 65,739,207 Motor Coach Industries International Inc., FRN, 18.08%, 12/01/08 ............................. 5/27/04 - 11/30/07 65,739,206 65,081,814 12 Motor Coach Industries International Inc., wts., 5/27/09 ...................................... 3/30/07 -- -- 120,040 NCB Warrant Holdings Ltd., A .................... 12/16/05 -- 7,359,521 202,380 Olympus Re Holdings Ltd. ........................ 12/19/01 20,238,000 662,835 911,589 Owens Corning Inc., exercise price $37.50, expiration date 1/02/08, shares a ............ 12/20/06 95,400 45,580 199,566 PTV Inc., 10.00%, pfd., A ....................... 12/07/01 - 3/06/02 598,698 239,479 52,000,000 Revel Entertainment Group LLC, first lien loan, FRN, 9.43%, 5/30/08 .......................... 12/20/07 51,902,909 51,740,000 52,000,000 Revel Entertainment Group LLC, second lien loan, FRN, 12.43%, 5/30/08 ......................... 12/20/07 51,706,092 51,480,000 -------------- TOTAL RESTRICTED SECURITIES (3.43% of Net Assets) ............................................................................. $ 864,342,604 ==============
a The Fund also invests in unrestricted securities of the issuer, valued at $67,144,655 as of December 31, 2007. 10. UNFUNDED CAPITAL COMMITMENTS At December 31, 2007, the Fund had aggregate unfunded capital commitments to investments of $55,215,000. Annual Report | 51 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES The 1940 Act 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 for the year ended December 31, 2007, were as shown below.
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF NUMBER OF SHARES/ SHARES/ WARRANTS/ WARRANTS/ CONTRACTS/ CONTRACTS/ PRINCIPAL AMOUNT PRINCIPAL AMOUNT VALUE AT REALIZED HELD AT BEGINNING GROSS GROSS HELD AT END OF END OF INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS YEAR YEAR INCOME GAIN - ------------------------------------------------------------------------------------------------------------------------------------ NON-CONTROLLED AFFILIATES AboveNet Inc. ................. 763,805 46,844 -- 810,649 $ 40,532,450 $ -- $ -- AboveNet Inc., Contingent Distribution ............... 106,869,000 -- 106,869,000 -- -- -- 2,696,513 AboveNet Inc., stock grant, grant price $20.95, expiration date 9/09/13 ..... 1,065 -- -- 1,065 44,144 -- -- AboveNet Inc., wts., 9/08/08 .. 25,659 3,624 -- 29,283 1,382,158 -- -- AboveNet Inc., wts., 9/08/10 .. 30,186 4,263 -- 34,449 1,504,732 -- -- Alexander's Inc. .............. 326,675 -- -- 326,675 115,397,944 -- -- Anchor Resources LLC .......... 123,013 -- 123,013 -- -- -- 456,492 Beazer Homes USA Inc. ......... -- 2,147,880 -- 2,147,880 15,958,748 558,161 -- Centennial Bank Holdings Inc., 144A ........................ 3,845,467 1,886,367 -- 5,731,834 33,130,000 -- -- Community Health Systems Inc. ........................ -- 4,806,000 -- 4,806,000 177,149,160 -- -- DecisionOne Corp. ............. 1,879,100 -- -- 1,879,100 -- -- -- DecisionOne Corp., 12.00%, 4/15/10 .................... 2,187,193 135,624 -- 2,322,817 2,322,817 269,842 -- DecisionOne Corp., FRN, 9.50%, 5/12/09 ............. -- 433,342 -- 433,342 433,342 22,168 -- DecisionOne Corp., wts., 6/08/17 .................... -- 1,031,766 -- 1,031,766 -- -- -- Elephant Capital Holdings Ltd. ....................... 25,721 950 -- 26,671 17,564,991 -- -- Esmark Inc. ................... 16,598 8,325,146 -- 8,341,744 106,081,958 398,352 -- Esmark Inc., 8.00%, cvt., pfd., A ..................... 60,419 1,321 61,740 -- -- 3,694,676 764,824 Federal Signal Corp. .......... 3,360,800 -- -- 3,360,800 37,708,176 806,592 -- Florida East Coast Industries Inc. ............ 4,423,071 -- 4,423,071 -- -- 95,715,256 167,498,447 International Automotive Components Group Brazil LLC ........................ 6,069,096 -- -- 6,069,096 42,156,730 -- -- International Automotive Components Group Japan LLC ........................ 953,142 151,130 -- 1,104,272 9,902,453 -- -- International Automotive Components Group LLC ....... 25,796,752 -- -- 25,796,752 27,367,774 -- -- International Automotive Components Group NA LLC .... -- 19,434,979 -- 19,434,979 26,723,096 -- -- International Automotive Components Group NA LLC, 9.00%, 4/01/17 ............. -- 5,851,000 -- 5,851,000 5,851,000 352,014 --
52 | Annual Report Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 11. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES (CONTINUED)
- ------------------------------------------------------------------------------------------------------------------------------------ NUMBER OF NUMBER OF SHARES/ SHARES/ WARRANTS/ WARRANTS/ CONTRACTS/ CONTRACTS/ PRINCIPAL AMOUNT PRINCIPAL AMOUNT VALUE AT REALIZED HELD AT BEGINNING GROSS GROSS HELD AT END END OF INVESTMENT CAPITAL NAME OF ISSUER OF YEAR ADDITIONS REDUCTIONS OF YEAR YEAR INCOME GAIN - ------------------------------------------------------------------------------------------------------------------------------------ Kindred Healthcare Inc. ........ 2,860,528 -- -- 2,860,528 $ 67,883,190 $ -- $ -- Kindred Healthcare Inc., stock grants: grant price $18.15, expiration date 7/17/11 ... 7,640 2,357 -- 9,997 55,793 -- -- grant price $19.87, expiration date 1/01/12 ... 2,292 707 -- 2,999 11,579 -- -- grant price $6.94, expiration date 1/01/13 ... 1,714 1,272 -- 2,986 50,138 -- -- grant price $19.87, expiration date 1/01/14 ... 1,136 1,094 -- 2,230 8,610 -- -- grant price $21.33, expiration date 1/10/15 ... 473 765 -- 1,238 2,973 -- -- grant price $22.08, expiration date 1/10/16 ... -- 619 -- 619 1,022 -- -- OPTI Canada .................... 4,085,890 -- 4,085,890 -- -- -- 39,924,103 Tenet Healthcare Corp. ......... -- 25,881,411 -- 25,881,411 131,477,568 -- -- TVMAX Holdings Inc. ............ 257,217 -- -- 257,217 -- -- -- TVMAX Holdings Inc., PIK, 11.50%, 2/28/08 ............. 446,378 205,320 18,779 632,919 443,043 58,327 -- TVMAX Holdings Inc., PIK, 14.00%, 2/28/08 ............. 1,385,745 210,005 -- 1,595,750 1,117,025 207,120 -- White Mountains Insurance Group Ltd. .................. 729,657 -- 200 729,457 374,977,371 5,835,656 59,070 ----------------------------------------- TOTAL NON-CONTROLLED AFFILIATES (4.90% of Net Assets) ................................. $1,237,239,985 $107,918,164 $211,399,449 =========================================
12. OTHER CONSIDERATIONS Officers, directors or employees of the Fund's Investment Manager, may serve from time to time as members of boards of directors of companies in which the Fund invests. Such participation may result in the possession by the Investment Manager of material non-public information which, pursuant to the Fund's policies and the requirements of applicable securities laws, could prevent the Fund from trading in the securities of such companies for limited or extended periods of time. 13. REGULATORY AND LITIGATION MATTERS As part of various investigations by a number of federal, state, and foreign regulators and governmental entities, including the Securities and Exchange Commission ("SEC"), 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 ("marketing support"), Franklin Resources, Inc. and certain of its subsidiaries (collectively, the "Company"), entered into settlements with certain of those regulators and governmental entities. Specifically, the Company entered into settlements with the SEC, among others, concerning market timing and marketing support. Annual Report | 53 Mutual Shares Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. REGULATORY AND LITIGATION MATTERS (CONTINUED) On June 6, 2007, the SEC posted for public comment the proposed plan of distribution for the market timing settlement. Once the SEC approves the final plan of distribution, disbursements of settlement monies will be made promptly to individuals who were shareholders of the designated funds during the relevant period, in accordance with the terms and conditions of the settlement and plan. In addition, the Company, as well as most of the mutual funds within Franklin Templeton Investments and certain current or former officers, Company directors, fund directors, and 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.). The lawsuits relate to the industry practices referenced above. The Company and fund management 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. 14. NEW ACCOUNTING PRONOUNCEMENT In September 2006, Financial Accounting Standards Board (FASB) issued FASB Statement No. 157, "Fair Value Measurement" (SFAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Fund believes the adoption of SFAS 157 will have no material impact on its financial statements. 54 | Annual Report 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 Funds constituting the Franklin Mutual Series Fund Inc.) (the "Fund"), including the statement of investments, as of December 31, 2007, 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, 2007, 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, 2007, 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 14, 2008 Annual Report | 55 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 $793,654,300 as a long term capital gain dividend for the fiscal year ended December 31, 2007. Under Section 871(k)(2)(C) of the Code, the Fund designates the maximum amount allowable but no less than $180,242,809 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, 2007. Under Section 854(b)(2) of the Code, the Fund designates the maximum amount allowable but no less than $611,450,592 as qualified dividends for purposes of the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended December 31, 2007. In January 2008, shareholders will receive Form 1099-DIV which will include their share of qualified dividends distributed during the calendar year 2007. Shareholders are advised to check with their tax advisors for information on the treatment of these amounts on their individual income tax returns. Under Section 854(b)(2) of the Code, the Fund designates 59.00% of the ordinary income dividends as income qualifying for the dividends received deduction for the fiscal year ended December 31, 2007. 56 | Annual Report 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. (1941) Director Since 1987 7 None c/o Franklin Mutual Advisers, LLC 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, Stern School of Business, New York University; editor and author of numerous financial publications; financial consultant; a director to numerous financial publishing organizations; and FORMERLY, Vice Director, Salomon Center, Stern School of Business, New York University. - ------------------------------------------------------------------------------------------------------------------------------------ ANN TORRE BATES (1958) Director Since 1994 7 SLM Corporation (Sallie Mae) c/o Franklin Mutual Advisers, LLC and Allied Capital Corporation 101 John F. Kennedy Parkway (financial services). Short Hills, NJ 07078-2789 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 14 Franklin Templeton Emerging c/o Franklin Mutual Advisers, LLC Markets Debt Opportunities Fund 101 John F. Kennedy Parkway PLC and Fiduciary International Short Hills, NJ 07078-2789 Ireland Limited. PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Managing Director, B.J. Greenwald Associates (management consultants to the financial services industry); and FORMERLY, Chairman, Fiduciary Trust International Funds; Executive Vice President, L.F Rothschild Fund Management, Inc.; President and Director, Merit Mutual Funds; President, Underwriting Division and Director, National Securities & Research Corporation; Governor, Investment Company Institute and Chairman, ICI Public Information Committee. - ------------------------------------------------------------------------------------------------------------------------------------ BRUCE A. MACPHERSON (1930) Director Since 1974 7 None c/o Franklin Mutual Advisers, LLC 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). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ CHARLES RUBENS II (1930) Director Since 1998 14 None c/o Franklin Mutual Advisers, LLC 101 John F. Kennedy Parkway Short Hills, NJ 07078-2789 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Private investor. - ------------------------------------------------------------------------------------------------------------------------------------ ROBERT E. WADE (1946) Director and Director since 34 El Oro and Exploration Co., c/o Franklin Mutual Advisers, LLC Chairman 1991 and P.l.c. (investments) and ARC 101 John F. Kennedy Parkway of the Board Chairman of the Wireless Solutions, Inc. Short Hills, NJ 07078-2789 Board since 2005 (wireless components and network products). 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 - ------------------------------------------------------------------------------------------------------------------------------------ ** GREGORY E. JOHNSON (1961) Director Since April 2007 92 None One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, President and Chief Executive Officer, Franklin Resources, Inc.; President, Templeton Worldwide, Inc.; Director, Templeton Asset Management Ltd.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 33 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ ** PETER A. LANGERMAN (1955) Director, Director since 7 None c/o Franklin Mutual Advisers, LLC President April 2007 and 101 John F. Kennedy Parkway and Chief President and Short Hills, NJ 07078-2702 Executive Chief Executive Officer - Officer - Investment Investment Management Management since 2005 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; officer and/or director, as the case may be, of three of the investment companies in Franklin Templeton investments; and FORMERLY, Director, New Jersey's Division of Investment. - ------------------------------------------------------------------------------------------------------------------------------------ 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. - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ JAMES M. DAVIS (1952) Chief Chief Compliance Not Applicable Not Applicable One Franklin Parkway Compliance Officer since 2004 San Mateo, CA 94403-1906 Officer and and Vice President Vice President - AML Compliance - AML since 2006 Compliance PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Director, Global Compliance, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc. (1994-2001). - ------------------------------------------------------------------------------------------------------------------------------------ MICHAEL J. EMBLER (1964) Senior Vice Since 2005 Not Applicable Not Applicable 101 John F. Kennedy Parkway President Short Hills, NJ 07078-2789 and Chief Investment Officer 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. - ------------------------------------------------------------------------------------------------------------------------------------ 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 some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ STEVEN J. GRAY (1955) Secretary Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Senior Associate General Counsel, Franklin Templeton Investments; Secretary, Franklin Advisory Services, LLC, Franklin Mutual Advisers, LLC and Franklin Templeton Distributors, Inc.; and officer of 41 of the investment companies in Franklin Templeton Investments. - ------------------------------------------------------------------------------------------------------------------------------------ GREGORY R. SEWARD (1956) Treasurer Since 2005 Not Applicable Not Applicable 500 East Broward Blvd. Suite 2100 Fort Lauderdale, FL 33394-3091 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: Vice President, Franklin Templeton Services, LLC; officer of 18 of the investment companies in Franklin Templeton Investments; and FORMERLY, Vice President, JPmorgan Chase (2000-2004) and American General Financial Group (1991-2000). - ------------------------------------------------------------------------------------------------------------------------------------
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 - ------------------------------------------------------------------------------------------------------------------------------------ CRAIG S. TYLE (1960) Vice President Since 2005 Not Applicable Not Applicable One Franklin Parkway San Mateo, CA 94403-1906 PRINCIPAL OCCUPATION DURING PAST 5 YEARS: General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of 46 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). - ------------------------------------------------------------------------------------------------------------------------------------ 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 some of the other subsidiaries of Franklin Resources, Inc. and of 46 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 manager or affiliated investment managers. ** Gregory E. Johnson is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer and director of Franklin Resources, Inc., which is the parent company of the Fund's investment manager and distributor. Peter A. Langerman is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer of Franklin Mutual Advisers, LLC, which is the Fund's investment manager. Note 1: Officer information is current as of the date of this report. It is possible that after this date, information about officers may change. Note 2: Prior to December 31, 2007, William J. Lippman, Leonard Rubin and Anne M. Tatlock ceased to be directors of the Fund. THE FUND'S BOARD 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. 60 | Annual Report Mutual Shares Fund SHAREHOLDER INFORMATION PROXY VOTING POLICIES AND PROCEDURES The Fund has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund's complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at 1-954/527-7678 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 | 61 This page intentionally left blank. This page intentionally left blank. This page intentionally left blank. Literature Request LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT 1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. TO ENSURE THE HIGHEST QUALITY OF SERVICE, WE MAY MONITOR, RECORD AND ACCESS TELEPHONE CALLS TO OR FROM OUR SERVICE DEPARTMENTS. THESE CALLS CAN BE IDENTIFIED BY THE PRESENCE OF A REGULAR BEEPING TONE. FRANKLIN TEMPLETON FUNDS INTERNATIONAL Mutual European Fund Templeton BRIC Fund Templeton China World Fund Templeton Developing Markets Trust Templeton Emerging Markets Small Cap Fund Templeton Foreign Fund Templeton Foreign Smaller Companies Fund 1 GLOBAL Mutual Discovery Fund Templeton Global Long-Short Fund Templeton Global Opportunities Trust Templeton Global Smaller Companies Fund 1 Templeton Growth Fund Templeton World Fund GROWTH Franklin Capital Growth Fund Franklin Flex Cap Growth Fund Franklin Growth Opportunities Fund 2 Franklin Small Cap Growth Fund II 3 Franklin Small-Mid Cap Growth Fund VALUE Franklin All Cap Value Fund Franklin Balance Sheet Investment Fund 1 Franklin Equity Income Fund Franklin Large Cap Value Fund Franklin MicroCap Value Fund 1 Franklin MidCap Value Fund Franklin Small Cap Value Fund Mutual Beacon Fund Mutual Qualified Fund Mutual Recovery Fund 4 Mutual Shares Fund BLEND Franklin Balanced Fund Franklin Convertible Securities Fund Franklin Focused Core Equity Fund Franklin Growth Fund Franklin Rising Dividends Fund SECTOR Franklin Biotechnology Discovery Fund Franklin DynaTech Fund Franklin Global Communications Fund Franklin Global Health Care Fund Franklin Global Real Estate 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(R) Allocation Fund Franklin Templeton Founding Funds Allocation Fund Franklin Templeton Perspectives Allocation Fund Franklin Templeton Conservative Target Fund Franklin Templeton Growth Target Fund Franklin Templeton Moderate Target Fund Franklin Templeton 2015 Retirement Target Fund Franklin Templeton 2025 Retirement Target Fund Franklin Templeton 2035 Retirement Target Fund Franklin Templeton 2045 Retirement Target Fund INCOME Franklin Adjustable U.S. Government Securities Fund 5 Franklin Floating Rate Daily Access Fund Franklin High Income Fund Franklin Income Fund Franklin Limited Maturity U.S. Government Securities Fund 5 Franklin Low Duration Total Return Fund Franklin Real Return Fund Franklin Strategic Income Fund Franklin Strategic Mortgage Portfolio Franklin Templeton Hard Currency Fund Franklin Total Return Fund Franklin U.S. Government Securities Fund 5 Templeton Global Bond Fund Templeton Income Fund Templeton International Bond Fund TAX-FREE INCOME 6 NATIONAL FUNDS Double Tax-Free Income Fund Federal Tax-Free Income Fund High Yield Tax-Free Income Fund Insured Tax-Free Income Fund 7 LIMITED-TERM FUNDS California Limited-Term Tax-Free Income Fund Federal Limited-Term Tax-Free Income Fund New York Limited-Term Tax-Free Income Fund INTERMEDIATE-TERM FUNDS California Intermediate-Term Tax-Free Income Fund Federal Intermediate-Term Tax-Free Income Fund New York Intermediate-Term Tax-Free Income Fund STATE-SPECIFIC Alabama Arizona California 8 Colorado Connecticut Florida Georgia Kentucky Louisiana Maryland Massachusetts 7 Michigan 7 Minnesota 7 Missouri New Jersey New York 8 North Carolina Ohio 7 Oregon Pennsylvania Tennessee Virginia INSURANCE FUNDS Franklin Templeton Variable Insurance Products Trust 9 1. The fund is closed to new investors. Existing shareholders and select retirement plans can continue adding to their accounts. 2. Effective 11/1/07, Franklin Aggressive Growth Fund changed its name to Franklin Growth Opportunities Fund. The fund's investment goal and strategy remained the same. 3. The fund is closed to new investors. Existing shareholders can continue adding to their accounts. 4. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; there is no daily redemption. However, each quarter, pending board approval, the fund will authorize the repurchase of 5%-25% of the outstanding number of shares. Investors may tender all or a portion of their shares during the tender period. 5. An investment in the fund is neither insured nor guaranteed by the U.S. government or by any other entity or institution. 6. For investors subject to the alternative minimum tax, a small portion of fund dividends may be taxable. Distributions of capital gains are generally taxable. 7. The fund invests primarily in insured municipal securities. 8. 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). 9. The funds of the Franklin Templeton Variable Insurance Products Trust are generally available only through insurance company variable contracts. 12/07 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 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 A2007 02/08 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 $478,519 for the fiscal year ended December 31, 2007 and $520,429 for the fiscal year ended December 31, 2006. (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 $0 for the fiscal year ended December 31, 2007 and $33,924 for the fiscal year ended December 31, 2006. 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 not 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 other than services reported in paragraphs (a)-(c) of Item 4 were $109,538 for the fiscal year ended December 31, 2007 and $0 for the fiscal year ended December 31, 2006. The services for which these fees were paid included compiling a gap analysis for the implementation of Markets in Financial Instruments Directive. (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 $109,538 for the fiscal year ended December 31, 2007 and $33,924 for the fiscal year ended December 31, 2006. (h) The registrant's audit committee of the board 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 Galen G. Vetter, Chief Executive Officer - Finance and Administration, and Laura Fergerson, Chief Financial Officer and Chief Accounting Officer (b) Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Galen G. Vetter, Chief Executive Officer - Finance and Administration, and Laura Fergerson, Chief Financial Officer and Chief Accounting 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/GALEN G. VETTER ------------------------------- Galen G. Vetter Chief Executive Officer - Finance and Administration Date February 27, 2008 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/GALEN G. VETTER ------------------------------- Galen G. Vetter Chief Executive Officer - Finance and Administration Date February 27, 2008 By /s/LAURA FERGERSON ------------------------------- Laura Fergerson Chief Financial Officer and Chief Accounting Officer Date February 27, 2008 EX-99.CODE ETH 2 ncsr-code1205.txt CODE OF ETHICS FOR NCSR 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 fmsf302_1207.txt 302 CERTS FOR FMSF FOR NCSR Exhibit 12(a)(2) 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. 02/27/08 /s/ GALEN G. VETTER Galen G. Vetter Chief Executive Officer - Finance and Administration I, Laura F. Fergerson, 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. 02/27/08 /s/ LAURA F. FERGERSON Laura F. Fergerson Chief Financial Officer and Chief Accounting Officer EX-99.906CERT 4 fmsf906_1207.txt 906 CERTS FOR FMSF 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, Galen G. Vetter, 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 12/31/2007 (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: 02/27/08 /s/ GALEN G. VETTER Galen G. Vetter 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, Laura F. Fergerson, 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 12/31/2007 (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: 02/27/08 /s/ LAURA F. FERGERSON Laura F. Fergerson Chief Financial Officer and Chief Accounting Officer -----END PRIVACY-ENHANCED MESSAGE-----