UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF
REGISTERED MANAGEMENT INVESTMENT COMPANIES
REGISTERED MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number: 811-05029
Name of Fund: Legg Mason Income Trust, Inc.
Address of Principal Executive Offices: 100 Light Street, Baltimore, MD 21202
Name and address of agent for service:
Richard M. Wachterman, Esq.
Legg Mason & Co., LLC
100 Light Street
Baltimore, MD 21202
Legg Mason & Co., LLC
100 Light Street
Baltimore, MD 21202
Registrant’s telephone number, including area code: (410) 539-0000
Date of fiscal year end: December 31, 2006
Date of reporting period: December 31, 2006
Item 1. Report to Shareholders
Annual Report to Shareholders
Legg Mason Income Trust, Inc. December 31, 2006 |
Annual Report to Shareholders 1
To Our Shareholders,
We are pleased to provide you with Legg Mason Income Trust’s annual report for the year ended December 31, 2006, combining reports for the Legg Mason Core Bond Fund, High Yield Portfolio, Investment Grade Income Portfolio and Limited Duration Bond Portfolio.
The following table summarizes key statistics for the Primary Class of each portfolio, as of December 31, 2006:
Net Asset Value | ||||||||||||
SEC YieldA | Average Life | Per Share | ||||||||||
Core Bond | 4.07% | 8.56 years | $ | 9.75 | ||||||||
High Yield | 6.46% | 7.61 years | $ | 9.41 | ||||||||
Investment Grade | 5.14% | 10.33 years | $ | 10.49 | ||||||||
Limited Duration | 4.39% | 2.83 years | $ | 10.22 |
For the year ended December 31, 2006, total returns for the Primary Class of shares of the Core Bond, High Yield, Investment Grade and Limited Duration Portfolios were +4.71%, +13.35%, 6.01% and +4.46%, respectively. Total returns for the Institutional Class of shares of the High Yield, Investment Grade and Limited Duration Portfolios were +14.05%, +6.34%, and +4.98%, respectively.
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information for the Primary Class please visit www.leggmasonfunds.com; for the Institutional Class please call 1-888-425-6432. The investment return and principal value of the Funds will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
PricewaterhouseCoopers LLP, the Funds’ independent registered public accounting firm, has completed its annual audit examination, and audited financial statements for the fiscal year ended December 31, 2006, are included in this report.
At a special meeting of shareholders of Legg Mason Income Trust, Inc., shareholders approved a plan of reorganization with respect to the Legg Mason High Yield Portfolio whereby the Portfolio would transfer all of its assets and liabilities to Legg Mason Partners High Income Fund, a series of Legg Mason Partners Income Funds. Details of the shareholder meeting results can be found in the notes to financial statements.
A SEC yields are for the 30 days ended December 31, 2006. Yields are subject to change at any time.
2 Annual Report to Shareholders
Many of our shareholders regularly add to their Primary Class Fund holdings by authorizing automatic, monthly transfers from their bank checking or brokerage accounts. Dollar cost averaging is a convenient and sensible way to invest, as it encourages continued purchases over time regardless of fluctuating price levels. Of course, it does not ensure a profit nor protect against declines in the value of your investment. Your financial advisor will be happy to help you establish a dollar cost averaging plan should you wish to do so.
Sincerely,
John F. Curley, Jr. Chairman | Mark R. Fetting President |
January 19, 2007
Annual Report to Shareholders 3
Management’s Discussion of Fund Performance
Core Bond Fund
The average annual total return for the Core Bond Fund (“Fund”) for the period from its inception to December 31, 2006, is presented below, along with the total return of its benchmark:
Since | ||||||||
One Year | InceptionA | |||||||
Core Bond Fund | ||||||||
Primary Class | +4.71% | +2.65% | ||||||
Lehman Aggregate Bond IndexB | +4.33% | +3.22% |
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information please visit www.leggmasonfunds.com. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
The Core Bond Fund was generally well-positioned for a market dominated by moderately rising interest rates and narrowing mortgage-backed and credit spreads. The total return (appreciation or depreciation in the Fund’s net asset value per share, plus dividends and any capital gain distributions) of the Fund’s primary share class exceeded the performance of its primary benchmark, the Lehman Bros. Aggregate Bond Index, delivering 4.71% versus 4.33%. The Fund’s tactical duration strategy, which allowed duration to drift up and down with interest rates, contributed to returns as rates oscillated throughout the year, but its emphasis on the front end of the yield curve suffered as the yield curve flattened. An underweight exposure to the credit sector detracted from performance as spreads widened, but an emphasis on BBB-rated bonds benefited since they outperformed higher quality bonds. Overweight exposure to mortgage-backed securities for most of the period benefited as spreads narrowed and volatility trended down. A modest exposure to Treasury Inflation-Protected SecuritiesC detracted somewhat from performance as a significant decline in inflation in the latter part of the period caused them to underperform treasuries.
Western Asset Management Company
January 19, 2007
A The inception date of the Primary Class is February 27, 2004. Index returns are for periods beginning February 29, 2004.
B A market value-weighted index that tracks the daily price, coupon, pay-downs, and total return performance of fixed rate, publicly placed, dollar-denominated, and nonconvertible investment grade debt issues with at least $100 million par amount outstanding and with at least one year to final maturity. An investor cannot invest directly in an index.
C Security whose principal value is adjusted daily or monthly in accordance with changes to the Consumer Price Index for All Urban Consumers. Interest is calculated on the basis of the current adjusted principal value.
4 Annual Report to Shareholders
Expense Example
Core Bond Fund
As a shareholder of the Fund, you incur ongoing costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. These examples are intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds. Each example is based on an investment of $1,000 invested on July 1, 2006, and held through December 31, 2006.
Actual Expenses
The first line in the table below provides information about actual account values and actual expenses for the Fund. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled “Expenses Paid During the Period” to estimate the expenses you paid on your account during this period.
Hypothetical Example for Comparison Purposes
The second line in the table below provides information about hypothetical account values and hypothetical expenses based on the Fund’s actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund’s actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Fund and other funds. To do so, compare these 5% hypothetical examples with the 5% hypothetical examples that appear in the shareholder reports of other funds.
Beginning | Ending | Expenses PaidA | ||||||||||
Account | Account | During the | ||||||||||
Value | Value | Period | ||||||||||
7/1/06 | 12/31/06 | 7/1/06 to 12/31/06 | ||||||||||
Primary Class: | ||||||||||||
Actual | $ | 1,000.00 | $ | 1,060.00 | $ | 5.19 | ||||||
Hypothetical (5% return before expenses) | 1,000.00 | 1,020.16 | 5.09 |
A These calculations are based on expenses incurred in the most recent fiscal half-year. The dollar amounts shown as “Expenses Paid” are equal to the annualized expense ratio of 1.00% multiplied by the average value over the period, multiplied by the number of days in the most recent fiscal half-year (184), and divided by 365.
Annual Report to Shareholders 5
Performance Information
Core Bond Fund
The graph on the following page compares the Fund’s total returns to that of a closely matched broad-based securities market index. The graph illustrates the cumulative total return of an initial $10,000 investment in the Fund’s Primary Class shares, for the periods indicated. The line for the Fund represents the total return after deducting all Fund investment management and other administrative expenses and the transaction costs of buying and selling securities. The line representing the securities market index does not include any transaction costs associated with buying and selling securities in the index or other administrative expenses. Both the Fund’s and the index’s results assume reinvestment of all dividends and distributions.
Total return measures investment performance in terms of appreciation or depreciation in a fund’s net asset value per share, plus dividends and any capital gain distributions. It assumes that dividends and distributions were reinvested at the time they were paid. Average annual returns tend to smooth out variations in a fund’s return, so that they differ from actual year-to-year results.
6 Annual Report to Shareholders
Performance Information — Continued
Growth of a $10,000 Investment — Primary Class
Periods Ended December 31, 2006
Cumulative | Average Annual | |||||||||
Total Return | Total Return | |||||||||
One Year | +4.71% | +4.71% | ||||||||
Life of Class* | +7.72% | +2.65% | ||||||||
* Inception date: February 27, 2004 | ||||||||||
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information please visit www.leggmasonfunds.com. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares.
A A market value-weighted index that tracks the daily price, coupon, pay-downs, and total return performance of fixed rate, publicly placed, dollar-denominated, and nonconvertible investment grade debt issues with at least $100 million par amount outstanding and with at least one year to final maturity. Index returns are for the periods beginning February 29, 2004.
Annual Report to Shareholders 7
Portfolio Composition (as of December 31, 2006)B
Standard & Poor’s Debt RatingsC (as a percentage of the portfolio)
Maturity Schedule (as a percentage of the portfolio)
B The Fund is actively managed. As a result, the composition of its portfolio holdings and sectors is subject to change at any time.
C Standard & Poor’s Ratings Services provide capital markets with credit ratings for the evaluation and assessment of credit risk.
D Preferred Stocks do not have a defined maturity date.
8 Annual Report to Shareholders
Portfolio of Investments
Legg Mason Core Bond Fund
December 31, 2006
(Amounts in Thousands)
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Long-Term Securities — 115.4% | ||||||||||||
Corporate Bonds and Notes — 19.0% | ||||||||||||
Aerospace and Defense — N.M. | ||||||||||||
United Technologies Corp. | 5.400% | 5/1/35 | $ | 20 | $ | 19 | ||||||
Airlines — 0.8% | ||||||||||||
JetBlue Airways Corp. | 5.749% | 8/15/16 | 282 | 282 | A | |||||||
JetBlue Airways Corp. | 5.824% | 11/15/16 | 300 | 294 | A | |||||||
576 | ||||||||||||
Automobiles — 2.3% | ||||||||||||
DaimlerChrysler NA Holding Corp. | 4.050% | 6/4/08 | 95 | 93 | ||||||||
DaimlerChrysler NA Holding Corp. | 7.200% | 9/1/09 | 50 | 52 | ||||||||
Ford Motor Co. | 7.450% | 7/16/31 | 720 | 565 | ||||||||
General Motors Corp. | 8.250% | 7/15/23 | 1,000 | 930 | ||||||||
1,640 | ||||||||||||
Capital Markets — 0.6% | ||||||||||||
Goldman Sachs Group LP | 4.500% | 6/15/10 | 70 | 69 | ||||||||
Lehman Brothers Holdings Inc. | 4.000% | 1/22/08 | 115 | 113 | ||||||||
Morgan Stanley | 3.625% | 4/1/08 | 30 | 29 | ||||||||
Morgan Stanley | 5.625% | 1/9/12 | 110 | 112 | ||||||||
Morgan Stanley | 5.824% | 10/18/16 | 40 | 40 | A | |||||||
The Goldman Sachs Group Inc. | 5.000% | 1/15/11 | 40 | 40 | ||||||||
403 | ||||||||||||
Commercial Banks — 1.0% | ||||||||||||
Bank One Corp. | 2.625% | 6/30/08 | 335 | 322 | ||||||||
Rabobank Capital Funding Trust II | 5.260% | 12/31/49 | 10 | 10 | B,C | |||||||
Rabobank Capital Funding Trust III | 5.254% | 10/21/49 | 20 | 19 | B,C | |||||||
SunTrust Capital VIII | 6.100% | 12/1/66 | 190 | 185 | C | |||||||
Wachovia Capital Trust III | 5.800% | 3/15/42 | 100 | 101 | C | |||||||
Wells Fargo Capital X | 5.950% | 12/15/86 | 100 | 98 | ||||||||
735 | ||||||||||||
Annual Report to Shareholders 9
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Commercial Services and Supplies — 0.1% | ||||||||||||
Waste Management Inc. | 6.375% | 11/15/12 | $ | 85 | $ | 89 | ||||||
Consumer Finance — 3.2% | ||||||||||||
Ford Motor Credit Co. | 4.950% | 1/15/08 | 40 | 39 | ||||||||
Ford Motor Credit Co. | 6.625% | 6/16/08 | 190 | 190 | ||||||||
Ford Motor Credit Co. | 7.375% | 10/28/09 | 590 | 591 | ||||||||
Ford Motor Credit Co. | 7.375% | 2/1/11 | 230 | 228 | ||||||||
Ford Motor Credit Co. | 7.250% | 10/25/11 | 210 | 206 | ||||||||
GMAC LLC | 6.125% | 8/28/07 | 230 | 230 | ||||||||
GMAC LLC | 5.625% | 5/15/09 | 685 | 680 | ||||||||
GMAC LLC | 7.750% | 1/19/10 | 110 | 115 | ||||||||
2,279 | ||||||||||||
Diversified Financial Services — 1.8% | ||||||||||||
Bank of America Corp. | 5.375% | 8/15/11 | 160 | 161 | ||||||||
CIT Group Inc. | 4.000% | 5/8/08 | 5 | 5 | ||||||||
Citigroup Inc. | 5.100% | 9/29/11 | 230 | 229 | ||||||||
General Electric Capital Corp. | 4.250% | 1/15/08 | 70 | 69 | ||||||||
General Electric Capital Corp. | 4.125% | 9/1/09 | 90 | 88 | ||||||||
HSBC Finance Corp. | 4.125% | 11/16/09 | 225 | 219 | ||||||||
ILFC E-Capital Trust II | 6.250% | 2/21/65 | 20 | 20 | B,C | |||||||
Lilacs Repackaging 05-I | 5.138% | 1/15/64 | 490 | 475 | B | |||||||
Residential Capital Corp. | 6.125% | 11/21/08 | 50 | 50 | ||||||||
1,316 | ||||||||||||
Diversified Telecommunication Services — 0.2% | ||||||||||||
AT&T Inc. | 5.100% | 9/15/14 | 90 | 87 | ||||||||
BellSouth Corp. | 4.750% | 11/15/12 | 10 | 10 | ||||||||
Verizon Global Funding Corp. | 7.375% | 9/1/12 | 35 | 38 | ||||||||
135 | ||||||||||||
10 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Core Bond Fund — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Electric Utilities — 1.1% | ||||||||||||
Duke Energy Corp. | 6.250% | 1/15/12 | $ | 50 | $ | 52 | ||||||
Duke Energy Corp. | 5.625% | 11/30/12 | 90 | 92 | ||||||||
FirstEnergy Corp. | 7.375% | 11/15/31 | 145 | 165 | ||||||||
Pacific Gas and Electric Co. | 6.050% | 3/1/34 | 135 | 136 | ||||||||
The Cleveland Electric Illuminating Co. | 5.650% | 12/15/13 | 20 | 20 | ||||||||
TXU Energy Co. | 7.000% | 3/15/13 | 320 | 335 | ||||||||
800 | ||||||||||||
Food and Staples Retailing — 0.8% | ||||||||||||
CVS Lease Pass-Through Trust | 6.036% | 12/10/28 | 400 | 399 | B | |||||||
Wal-Mart Stores Inc. | 3.375% | 10/1/08 | 190 | 182 | ||||||||
581 | ||||||||||||
Food Products — 0.1% | ||||||||||||
Kraft Foods Inc. | 5.625% | 11/1/11 | 65 | 66 | ||||||||
Health Care Providers and Services — 0.8% | ||||||||||||
HCA Inc. | 5.750% | 3/15/14 | 700 | 581 | ||||||||
Independent Power Producers and Energy Traders — 0.4% | ||||||||||||
TXU Corp. | 5.550% | 11/15/14 | 30 | 28 | ||||||||
TXU Corp. | 6.550% | 11/15/34 | 300 | 281 | ||||||||
309 | ||||||||||||
Insurance — 0.2% | ||||||||||||
ASIF Global Financing XIX | 4.900% | 1/17/13 | 20 | 19 | B | |||||||
MetLife Inc. | 6.400% | 12/15/66 | 150 | 151 | C | |||||||
170 | ||||||||||||
IT Services — N.M. | ||||||||||||
Electronic Data Systems Corp. | 7.125% | 10/15/09 | 10 | 10 | ||||||||
Annual Report to Shareholders 11
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Leisure Equipment and Products — 0.7% | ||||||||||||
Eastman Kodak Co. | 7.250% | 11/15/13 | $ | 540 | $ | 537 | ||||||
Media — 0.9% | ||||||||||||
Clear Channel Communications Inc. | 4.625% | 1/15/08 | 30 | 30 | ||||||||
Clear Channel Communications Inc. | 4.250% | 5/15/09 | 50 | 48 | ||||||||
Clear Channel Communications Inc. | 6.250% | 3/15/11 | 40 | 39 | ||||||||
Clear Channel Communications Inc. | 5.500% | 9/15/14 | 15 | 13 | ||||||||
Comcast Corp. | 6.500% | 1/15/15 | 170 | 177 | ||||||||
Comcast Corp. | 6.500% | 1/15/17 | 70 | 73 | ||||||||
Cox Communications Inc. | 3.875% | 10/1/08 | 70 | 68 | ||||||||
Time Warner Inc. | 6.875% | 5/1/12 | 75 | 79 | ||||||||
Time Warner Inc. | 7.700% | 5/1/32 | 75 | 85 | ||||||||
Viacom Inc. | 5.750% | 4/30/11 | 60 | 60 | ||||||||
672 | ||||||||||||
Multi-Utilities — 0.2% | ||||||||||||
Dominion Resources Inc. | 4.750% | 12/15/10 | 30 | 29 | ||||||||
Dominion Resources Inc. | 5.700% | 9/17/12 | 95 | 96 | ||||||||
125 | ||||||||||||
Multiline Retail — 0.2% | ||||||||||||
Target Corp. | 5.400% | 10/1/08 | 155 | 156 | ||||||||
Oil, Gas and Consumable Fuels — 2.2% | ||||||||||||
Anadarko Petroleum Corp. | 5.760% | 9/15/09 | 160 | 161 | A | |||||||
Anadarko Petroleum Corp. | 5.950% | 9/15/16 | 10 | 10 | ||||||||
Anadarko Petroleum Corp. | 6.450% | 9/15/36 | 60 | 61 | ||||||||
Apache Corp. | 6.250% | 4/15/12 | 35 | 36 | ||||||||
Conoco Inc. | 6.950% | 4/15/29 | 225 | 256 | ||||||||
ConocoPhillips | 4.750% | 10/15/12 | 60 | 59 | ||||||||
Devon Energy Corp. | 7.950% | 4/15/32 | 60 | 73 | ||||||||
Hess Corp. | 7.300% | 8/15/31 | 245 | 273 |
12 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Core Bond Fund — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Oil, Gas and Consumable Fuels — Continued | ||||||||||||
Kerr-McGee Corp. | 6.875% | 9/15/11 | $ | 300 | $ | 316 | ||||||
Kinder Morgan Energy Partners LP | 7.125% | 3/15/12 | 65 | 69 | ||||||||
Kinder Morgan Energy Partners LP | 5.000% | 12/15/13 | 35 | 33 | ||||||||
Pemex Project Funding Master Trust | 6.625% | 6/15/35 | 50 | 51 | ||||||||
XTO Energy Inc. | 7.500% | 4/15/12 | 145 | 158 | ||||||||
1,556 | ||||||||||||
Paper and Forest Products — 0.1% | ||||||||||||
Weyerhaeuser Co. | 6.750% | 3/15/12 | 45 | 47 | ||||||||
Tobacco — 0.2% | ||||||||||||
Altria Group Inc. | 7.000% | 11/4/13 | 155 | 168 | ||||||||
Wireless Telecommunication Services — 1.1% | ||||||||||||
Sprint Capital Corp. | 8.375% | 3/15/12 | 540 | 600 | ||||||||
Sprint Capital Corp. | 8.750% | 3/15/32 | 40 | 48 | ||||||||
Sprint Nextel Corp. | 6.000% | 12/1/16 | 110 | 108 | ||||||||
756 | ||||||||||||
Total Corporate Bonds and Notes (Cost — $13,938) | 13,726 | |||||||||||
Asset-Backed Securities — 2.0% | ||||||||||||
Fixed Rate Securities — 0.3% | ||||||||||||
Bank One Issuance Trust 2003-C1 | 4.540% | 9/15/10 | 200 | 198 | ||||||||
Indexed SecuritiesA — 1.7% | ||||||||||||
Ace Securities Corp. Home Equity Loan Trust, Series 2006-SL3 | 5.450% | 6/25/36 | 445 | 445 | ||||||||
Bayview Financial Acquisition Trust 2004-C | 5.770% | 5/28/44 | 308 | 308 | ||||||||
Brazos Texas Higher Education Authority Inc. 2005-1 | 5.418% | 6/15/42 | 344 | 341 |
Annual Report to Shareholders 13
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Asset-Backed Securities — Continued | ||||||||||||
Indexed Securities — Continued | ||||||||||||
Credit-Based Asset Servicing and Securitization 2005-RP1 | 5.530% | 1/25/35 | $ | 66 | $ | 67 | B | |||||
EQCC Trust 2002-1 | 5.650% | 11/25/31 | 3 | 3 | ||||||||
MSDWCC Heloc Trust 2005-1 | 5.540% | 7/25/17 | 41 | 41 | ||||||||
Wachovia Asset Securitization Inc. 2002-HE1 | 5.690% | 9/27/32 | 77 | 78 | ||||||||
1,283 | ||||||||||||
Total Asset-Backed Securities (Cost — $1,487) | 1,481 | |||||||||||
Mortgage-Backed Securities — 21.1% | ||||||||||||
Fixed Rate Securities — 5.7% | ||||||||||||
Asset Securitization Corp. 1996-D2 | 6.920% | 2/14/29 | 3 | 3 | ||||||||
Banc of America Commercial Mortgage Inc. 2005-3 A4 | 4.668% | 7/10/43 | 500 | 478 | ||||||||
Banc of America Commercial Mortgage Inc. 2006-3 A4 | 5.889% | 7/10/44 | 370 | 385 | ||||||||
Countrywide Alternative Loan Trust 2004-2 CB | 4.250% | 3/25/34 | 210 | 205 | ||||||||
GS Mortgage Securities Corp. II 2005-GG4 | 4.680% | 7/10/39 | 200 | 194 | ||||||||
LB-UBS Commercial Mortgage Trust 2005-C3 A5 | 4.739% | 7/15/30 | 140 | 135 | ||||||||
LB-UBS Commercial Mortgage Trust 2005-C3 AAB | 4.664% | 7/15/30 | 200 | 194 | ||||||||
LB-UBS Commercial Mortgage Trust 2006-C7 A3 | 5.347% | 11/15/38 | 370 | 370 | ||||||||
MASTR Reperforming Loan Trust 2005-1 | 7.000% | 8/25/34 | 244 | 251 | B | |||||||
Morgan Stanley Capital I, Series 2005-HQ6 | 4.989% | 8/13/42 | 240 | 235 | ||||||||
Prime Mortgage Trust 2006 — DR1 2A1 | 5.500% | 5/25/35 | 979 | 972 | B |
14 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Core Bond Fund — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Mortgage-Backed Securities — Continued | ||||||||||||
Fixed Rate Securities — Continued | ||||||||||||
Prime Mortgage Trust 2006 — DR1 2A2 | 6.000% | 11/25/36 | $ | 588 | $ | 586 | B | |||||
Washington Mutual MSC Mortgage Pass-Through Certificates, Series 2004-RA1 | 7.000% | 3/25/34 | 74 | 75 | ||||||||
4,083 | ||||||||||||
Indexed SecuritiesA — 13.9% | ||||||||||||
ABFS Mortgage Loan Trust 2003-2 | 5.850% | 4/25/34 | 70 | 70 | B | |||||||
Banc of America Funding Corp. 2005-E | 5.812% | 6/20/35 | 355 | 357 | ||||||||
Countrywide Alternative Loan Trust 2005-17 1A1 | 5.610% | 7/25/35 | 348 | 349 | ||||||||
Countrywide Alternative Loan Trust 2005-38 A3 | 5.670% | 9/25/35 | 349 | 350 | ||||||||
Countrywide Home Loans 2005-03 1A2 | 5.640% | 4/25/35 | 286 | 287 | ||||||||
Countrywide Home Loans 2005-09 1A1 | 5.650% | 5/25/35 | 299 | 300 | ||||||||
Countrywide Home Loans 2005-11 3A3 | 6.024% | 4/25/35 | 290 | 294 | ||||||||
Countrywide Home Loans 2005-11 6A1 | 5.650% | 3/25/35 | 242 | 242 | ||||||||
DSLA Mortgage Loan Trust 2006-AR1 1A1A | 5.747% | 4/19/36 | 552 | 552 | ||||||||
Greenpoint Mortgage Funding Trust 2005-AR1 | 5.570% | 6/25/45 | 269 | 270 | ||||||||
Greenpoint Mortgage Funding Trust 2005-AR4 | 5.610% | 10/25/45 | 145 | 145 | ||||||||
GSMPS Mortgage Loan Trust 2005-RP2 | 5.700% | 3/25/35 | 276 | 276 | B | |||||||
Harborview Mortgage Loan Trust 2005-7 | 6.232% | 6/19/45 | 417 | 419 |
Annual Report to Shareholders 15
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Mortgage-Backed Securities — Continued | ||||||||||||
Indexed Securities — Continued | ||||||||||||
Harborview Mortgage Loan Trust 2005-9 | 5.690% | 6/20/35 | $ | 314 | $ | 315 | ||||||
Impac CMB Trust 2003-7 | 5.960% | 8/25/33 | 88 | 88 | ||||||||
IXIS Real Estate Capital Trust 2006-HE2 | 5.410% | 8/25/36 | 421 | 421 | ||||||||
Lehman XS Trust 2005-7N 1A1B | 5.650% | 12/25/35 | 290 | 291 | ||||||||
Lehman XS Trust 2006-GP2 1A1A | 5.420% | 6/25/46 | 607 | 607 | ||||||||
Structured Asset Mortgage Investments Inc. 2006-AR7 A1A | 5.560% | 8/25/36 | 580 | 581 | ||||||||
Thornburg Mortgage Securities Trust 2005-2 A1 | 5.570% | 7/25/45 | 157 | 157 | ||||||||
Thornburg Mortgage Securities Trust 2005-2 A2 | 5.580% | 7/25/45 | 338 | 338 | ||||||||
Thornburg Mortgage Securities Trust 2005-4 A4 | 5.550% | 12/25/35 | 565 | 565 | ||||||||
WaMu Mortgage Pass-Through Certificates, Series 2005-AR06 2A1A | 5.580% | 4/25/45 | 299 | 300 | ||||||||
WaMu Mortgage Pass-Through Certificates, Series 2005-AR08 1A1A | 5.620% | 7/25/45 | 264 | 265 | ||||||||
WaMu Mortgage Pass-Through Certificates, Series 2005-AR11 A1A | 5.670% | 8/25/45 | 827 | 829 | ||||||||
WaMu Mortgage Pass-Through Certificates, Series 2005-AR13 A1A1 | 5.640% | 10/25/45 | 378 | 378 | ||||||||
WaMu Mortgage Pass-Through Certificates, Series 2005-AR19 A1A2 | 5.610% | 12/25/45 | 514 | 516 | ||||||||
Zuni Mortgage Loan Trust 2006-0A1 | 5.450% | 8/25/36 | 499 | 498 | ||||||||
10,060 | ||||||||||||
16 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Core Bond Fund — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Mortgage-Backed Securities — Continued | ||||||||||||
Stripped Securities — 0.6% | ||||||||||||
GE Capital Commercial Mortgage Corp. 2005-C4 | 5.334% | 11/10/45 | $ | 360 | $ | 362 | D1 | |||||
Mach One Trust, Commercial Mortgage-Backed Securities 2004-1A | 1.604% | 5/28/40 | 1,284 | 52 | D1,E | |||||||
414 | ||||||||||||
Variable Rate SecuritiesF — 0.9% | ||||||||||||
Bear Stearns ARM Trust, Mortgage Pass-Through Certificates, Series 2004-4 | 3.517% | 6/25/34 | 200 | 195 | ||||||||
Credit-Based Asset Servicing and Securitization 1999-3 | 6.576% | 1/3/29 | 57 | 55 | B | |||||||
IndyMac INDX Mortgage Loan Trust 2005-AR15 | 5.099% | 9/25/35 | 132 | 128 | ||||||||
JPMorgan Chase Commercial Mortgage Securities Corp., Series 2005-CB13 | 5.294% | 1/12/43 | 100 | 100 | ||||||||
JPMorgan Chase Commercial Mortgage Securities Corp., Series 2005-LDP4 | 4.918% | 10/15/42 | 200 | 194 | ||||||||
672 | ||||||||||||
Total Mortgage-Backed Securities (Cost — $15,297) | 15,229 | |||||||||||
U.S. Government and Agency Obligations — 19.9% | ||||||||||||
Fixed Rate Securities — 13.9% | ||||||||||||
Fannie Mae | 5.400% | 4/13/09 | 30 | 30 | ||||||||
Fannie Mae | 6.625% | 9/15/09 | 160 | 167 | ||||||||
Fannie Mae | 5.200% | 11/8/10 | 170 | 169 | ||||||||
Fannie Mae | 5.625% | 5/19/11 | 290 | 293 | ||||||||
Fannie Mae | 4.610% | 10/10/13 | 560 | 539 | ||||||||
Federal Home Loan Bank | 3.875% | 8/22/08 | 120 | 118 | ||||||||
Federal Home Loan Bank | 5.400% | 1/2/09 | 130 | 130 | ||||||||
Freddie Mac | 5.550% | 12/11/08 | 100 | 100 |
Annual Report to Shareholders 17
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
U.S. Government and Agency Obligations — Continued | ||||||||||||
Fixed Rate Securities — Continued | ||||||||||||
Freddie Mac | 4.750% | 1/18/11 | $ | 110 | $ | 109 | ||||||
Freddie Mac | 5.250% | 2/24/11 | 160 | 160 | ||||||||
Freddie Mac | 5.625% | 3/15/11 | 40 | 41 | ||||||||
Freddie Mac | 4.650% | 10/10/13 | 600 | 578 | ||||||||
Freddie Mac | 5.450% | 11/21/13 | 180 | 180 | ||||||||
Freddie Mac | 5.300% | 5/12/20 | 690 | 659 | ||||||||
Freddie Mac | 5.625% | 11/23/35 | 210 | 202 | ||||||||
United States Treasury Bonds | 4.500% | 2/15/36 | 1,970 | 1,873 | ||||||||
United States Treasury Notes | 3.750% | 5/15/08 | 40 | 39 | ||||||||
United States Treasury Notes | 4.500% | 2/15/09 | 60 | 60 | ||||||||
United States Treasury Notes | 4.125% | 8/15/10 | 100 | 98 | ||||||||
United States Treasury Notes | 4.625% | 10/31/11 | 2,600 | 2,591 | ||||||||
United States Treasury Notes | 3.875% | 2/15/13 | 800 | 766 | ||||||||
United States Treasury Notes | 5.125% | 5/15/16 | 830 | 855 | ||||||||
United States Treasury Notes | 4.875% | 8/15/16 | 190 | 192 | ||||||||
United States Treasury Notes | 4.625% | 11/15/16 | 110 | 109 | ||||||||
10,058 | ||||||||||||
Stripped Securities — 0.3% | ||||||||||||
United States Treasury Bonds | 0.000% | 11/15/21 | 420 | 202 | D2 | |||||||
Treasury Inflation-Protected SecuritiesG — 5.7% | ||||||||||||
United States Treasury Inflation-Protected Security | 3.875% | 1/15/09 | 25 | 25 | ||||||||
United States Treasury Inflation-Protected Security | 0.875% | 4/15/10 | 394 | 374 | ||||||||
United States Treasury Inflation-Protected Security | 2.375% | 4/15/11 | 1,800 | 1,793 | ||||||||
United States Treasury Inflation-Protected Security | 3.375% | 1/15/12 | 80 | 83 | ||||||||
United States Treasury Inflation-Protected Security | 2.000% | 1/15/14 | 71 | 69 |
18 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Core Bond Fund — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
U.S. Government and Agency Obligations — Continued | ||||||||||||
Treasury Inflation-Protected Securities — Continued | ||||||||||||
United States Treasury Inflation-Protected Security | 1.875% | 7/15/15 | $ | 52 | $ | 50 | ||||||
United States Treasury Inflation-Protected Security | 2.000% | 1/15/16 | 386 | 373 | ||||||||
United States Treasury Inflation-Protected Security | 2.500% | 7/15/16 | 290 | 292 | ||||||||
United States Treasury Inflation-Protected Security | 2.375% | 1/15/25 | 701 | 698 | ||||||||
United States Treasury Inflation-Protected Security | 2.000% | 1/15/26 | 41 | 38 | ||||||||
United States Treasury Inflation-Protected Security | 3.875% | 4/15/29 | 270 | 340 | ||||||||
4,135 | ||||||||||||
Total U.S. Government and Agency Obligations (Cost — $14,440) | 14,395 | |||||||||||
U.S. Government Agency Mortgage-Backed Securities — 45.9% | ||||||||||||
Fixed Rate Securities — 45.9% | ||||||||||||
Fannie Mae | 5.500% | 12/1/17 to 9/1/35 | 1,144 | 1,132 | ||||||||
Fannie Mae | 5.000% | 10/1/20 to 3/1/36 | 2,082 | 2,035 | ||||||||
Fannie Mae | 6.000% | 8/1/21 to 9/1/36 | 4,093 | 4,124 | ||||||||
Fannie Mae | 4.500% | 9/1/35 | 93 | 87 | ||||||||
Fannie Mae | 5.000% | 12/1/36 | 10,600 | 10,232 | H | |||||||
Fannie Mae | 5.500% | 12/1/36 | 1,650 | 1,635 | H | |||||||
Fannie Mae | 6.000% | 12/1/36 | 2,300 | 2,315 | H | |||||||
Fannie Mae | 6.500% | 12/1/36 | 4,790 | 4,880 | H | |||||||
Freddie Mac | 4.500% | 4/1/19 | 274 | 265 | ||||||||
Freddie Mac | 5.000% | 7/1/20 to 9/1/35 | 1,343 | 1,316 |
Annual Report to Shareholders 19
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
U.S. Government Agency Mortgage-Backed Securities — Continued | ||||||||||||
Fixed Rate Securities — Continued | ||||||||||||
Government National Mortgage Association | 6.000% | 11/15/28 to 12/15/33 | $ | 695 | $ | 707 | ||||||
Government National Mortgage Association | 6.500% | 2/15/32 | 264 | 271 | ||||||||
Government National Mortgage Association | 5.000% | 8/15/33 to 5/15/34 | 900 | 877 | ||||||||
Government National Mortgage Association | 5.500% | 2/15/35 | 2,630 | 2,618 | ||||||||
Government National Mortgage Association | 6.500% | 12/1/36 | 700 | 718 | H | |||||||
Total U.S. Government Agency Mortgage-Backed Securities (Cost — $33,512) | 33,212 | |||||||||||
Yankee BondsI — 7.2% | ||||||||||||
Commercial Banks — 2.4% | ||||||||||||
BNP Paribas NY | 6.875% | 3/1/09 | 110 | 114 | ||||||||
Eksportfinans ASA | 5.500% | 5/25/16 | 160 | 165 | ||||||||
Glitnir Banki Hf | 6.330% | 7/28/11 | 130 | 133 | B | |||||||
Glitnir Banki Hf | 6.693% | 6/15/16 | 120 | 124 | B,C | |||||||
Kaupthing Bank Hf | 6.061% | 4/12/11 | 270 | 272 | A,B | |||||||
Kaupthing Bank Hf | 7.125% | 5/19/16 | 440 | 466 | B | |||||||
Landsbanki Islands Hf | 6.100% | 8/25/11 | 230 | 234 | B | |||||||
Resona Preferred Global Securities | 7.191% | 7/30/49 | 140 | 146 | B,C | |||||||
Shinsei Finance Cayman Ltd. | 6.418% | 7/20/49 | 100 | 100 | B,C | |||||||
1,754 | ||||||||||||
20 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Core Bond Fund — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Yankee Bonds — Continued | ||||||||||||
Diversified Financial Services — 0.9% | ||||||||||||
Banagricola DPR Funding Ltd. | 6.370% | 3/15/10 | $ | 163 | $ | 164 | A,B | |||||
MUFG Capital Finance 1 Ltd. | 6.346% | 7/25/49 | 100 | 102 | C | |||||||
SMFG Preferred Capital | 6.078% | 1/25/49 | 250 | 246 | B,C | |||||||
TNK-BP Finance SA | 7.500% | 7/18/16 | 140 | 149 | B | |||||||
661 | ||||||||||||
Diversified Telecommunication Services — 0.5% | ||||||||||||
British Telecommunications PLC | 8.625% | 12/15/10 | 100 | 111 | F | |||||||
Deutsche Telekom International Finance BV | 5.750% | 3/23/16 | 75 | 74 | ||||||||
Koninklijke (Royal) KPN NV | 8.000% | 10/1/10 | 80 | 86 | ||||||||
Telecom Italia Capital SpA | 4.950% | 9/30/14 | 70 | 65 | ||||||||
Telecom Italia Capital SpA | 5.250% | 10/1/15 | 20 | 19 | ||||||||
355 | ||||||||||||
Foreign Government Obligations — 1.6% | ||||||||||||
Russian Federation | 5.000% | 3/31/30 | 620 | 700 | B,C | |||||||
United Mexican States | 5.625% | 1/15/17 | 4 | 4 | ||||||||
United Mexican States | 8.300% | 8/15/31 | 100 | 128 | ||||||||
United Mexican States | 7.500% | 4/8/33 | 293 | 345 | ||||||||
1,177 | ||||||||||||
Industrial Conglomerates — 0.7% | ||||||||||||
Tyco International Group SA | 6.375% | 10/15/11 | 45 | 47 | ||||||||
Tyco International Group SA | 6.000% | 11/15/13 | 100 | 104 | ||||||||
Tyco International Group SA | 6.875% | 1/15/29 | 310 | 352 | ||||||||
503 | ||||||||||||
Media — 0.1% | ||||||||||||
Rogers Cable Inc. | 5.500% | 3/15/14 | 90 | 86 | ||||||||
Metals and Mining — 0.3% | ||||||||||||
Vale Overseas Ltd. | 6.875% | 11/21/36 | 170 | 174 | ||||||||
Annual Report to Shareholders 21
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Yankee Bonds — Continued | ||||||||||||
Oil, Gas and Consumable Fuels — 0.7% | ||||||||||||
Apache Finance Canada Corp. | 4.375% | 5/15/15 | $ | 60 | $ | 55 | ||||||
ChevronTexaco Capital Co. | 3.500% | 9/17/07 | 140 | 139 | ||||||||
Conoco Funding Co. | 6.350% | 10/15/11 | 10 | 11 | ||||||||
Gazprom Capital | 6.212% | 11/22/16 | 170 | 171 | B | |||||||
Petrobras International Finance Co. | 6.125% | 10/6/16 | 130 | 131 | ||||||||
507 | ||||||||||||
Total Yankee Bonds (Cost — $5,024) | 5,217 | |||||||||||
Preferred Stocks — 0.3% | ||||||||||||
Fannie Mae | 5.375% | — | Jshs | 100 | K | |||||||
General Motors Corp. | 5.250% | 7 | 140 | K | ||||||||
Total Preferred Stocks (Cost — $213) | 240 | |||||||||||
Total Long-Term Securities (Cost — $83,911) | 83,500 | |||||||||||
Short-Term Securities — 12.3% | ||||||||||||
U.S. Government and Agency Obligations — 0.2% | ||||||||||||
Fannie Mae | 0.000% | 6/25/07 | $ | 161 | 157 | L,M | ||||||
Options PurchasedN — 0.2% | ||||||||||||
Eurodollar Futures Call, July 2007, Strike Price $94.00 | 24 | O | 46 | |||||||||
Eurodollar Futures Call, March 2007, Strike Price $94.00 | 14 | O | 24 | |||||||||
Eurodollar Futures Call, 2007, Strike Price $94.75 | 24 | O | 2 | |||||||||
Eurodollar Futures Call, September 2007, Strike Price $95.00 | 11 | O | 5 | |||||||||
Eurodollar Futures Put, April 2007, Strike Price $93.00 | 2 | O | — | P | ||||||||
Eurodollar Futures Put, April 2007, Strike Price $95.50 | 6 | O | 12 |
22 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Core Bond Fund — Continued
Par/ | ||||||||||||
Shares | Value | |||||||||||
Short-Term Securities — Continued | ||||||||||||
Options Purchased — Continued | ||||||||||||
U.S. Treasury Note Futures Call, March 2007, Strike Price $102.00 | 7 | O | $ | 22 | ||||||||
U.S. Treasury Note Futures Call, March 2007, Strike Price $102.50 | 21 | O | 54 | |||||||||
165 | ||||||||||||
Repurchase Agreements — 11.9% | ||||||||||||
Lehman Brothers Inc. 5.2%, dated 12/29/06 to be repurchased at $4,296 on 1/2/07 (Collateral: $17,880 Federal Home Loan Bank zero-coupon bonds, due 9/29/28, value $4,380) | $ | 4,294 | 4,294 | |||||||||
Merrill Lynch Government Securities Inc. 5.21%, dated 12/29/06, to be repurchased at $4,295 on 1/2/07 (Collateral: $4,325 Freddie Mac notes, 5.125%, due 10/15/08, value $4,379) | 4,293 | 4,293 | ||||||||||
8,587 | ||||||||||||
Total Short-Term Securities (Cost — $8,929) | 8,909 | |||||||||||
Total Investments — 127.7% (Cost — $92,840) | 92,409 | |||||||||||
Other Assets Less Liabilities — (27.7)% | (20,059 | ) | ||||||||||
Net Assets — 100.0% | $ | 72,350 | ||||||||||
Annual Report to Shareholders 23
Actual | Appreciation/ | |||||||
Expiration | Contracts | (Depreciation) | ||||||
Futures Contracts PurchasedN | ||||||||
Eurodollar Futures | March 2007 | 18 | $ | (1 | ) | |||
Eurodollar Futures | June 2007 | 6 | (1 | ) | ||||
Eurodollar Futures | September 2007 | 28 | (12 | ) | ||||
Eurodollar Futures | March 2008 | 4 | 2 | |||||
U.S. Treasury Bond Futures | March 2007 | 25 | (44 | ) | ||||
U.S. Treasury Note Futures | March 2007 | 139 | (69 | ) | ||||
$ | (125 | ) | ||||||
Futures Contracts WrittenN | ||||||||
U.S. Treasury Note Futures | March 2007 | 84 | $ | 84 | ||||
Options WrittenN | ||||||||
Eurodollar Futures Call, Strike Price $95.125 | March 2007 | 2 | $ | — | P | |||
Eurodollar Futures Put, Strike Price $94.50 | April 2007 | 5 | 1 | |||||
Eurodollar Futures Put, Strike Price $94.625 | March 2007 | 5 | 1 | |||||
U.S. Treasury Bond Futures Call, Strike Price $114.00 | March 2007 | 12 | 7 | |||||
U.S. Treasury Bond Futures Call, Strike Price $115.00 | March 2007 | 13 | 8 | |||||
U.S. Treasury Bond Futures Call, Strike Price $116.00 | March 2007 | 7 | 4 | |||||
U.S. Treasury Bond Futures Put, Strike Price $109.00 | March 2007 | 17 | 5 | |||||
U.S. Treasury Bond Futures Put, Strike Price $111.00 | March 2007 | 2 | (1 | ) | ||||
U.S. Treasury Bond Futures Put, Strike Price $113.00 | March 2007 | 9 | (13 | ) | ||||
U.S. Treasury Note Futures Call, Strike Price $109.00 | March 2007 | 27 | 10 | |||||
U.S. Treasury Note Futures Call, Strike Price $110.00 | March 2007 | 86 | 35 |
24 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Core Bond Fund — Continued
Actual | Appreciation/ | |||||||
Expiration | Contracts | (Depreciation) | ||||||
Options Written — Continued | ||||||||
U.S. Treasury Note Futures Call, Strike Price $111.00 | March 2007 | 8 | $ | 2 | ||||
U.S. Treasury Note Futures Put, Strike Price $104.00 | March 2007 | 6 | 1 | |||||
U.S. Treasury Note Futures Put, Strike Price $106.00 | March 2007 | 24 | 5 | |||||
U.S. Treasury Note Futures Put, Strike Price $107.00 | March 2007 | 4 | (1 | ) | ||||
U.S. Treasury Note Futures Put, Strike Price $108.00 | March 2007 | 5 | (2 | ) | ||||
$ | 62 | |||||||
A | Indexed Security — The rates of interest earned on these securities are tied to the London Interbank Offered Rate (“LIBOR”), the Consumer Price Index (“CPI”), and the one-year Treasury Bill Rate. The coupon rates are the rates as of December 31, 2006. |
B | Rule 144A Security — A security purchased pursuant to Rule 144A under the Securities Act of 1933 which may not be resold subject to that rule except to qualified institutional buyers. These securities, which the Fund’s investment adviser has determined to be liquid, represent 8.46% of net assets. |
C | Stepped Coupon Security — A security with a predetermined schedule of interest or dividend rate changes at which time it begins to accrue interest or pay dividends according to the predetermined schedule. |
D | Stripped Security — Security with interest-only or principal-only payment streams, denoted by a 1 or 2, respectively. For interest-only securities, the amount shown as principal is the notional balance used to calculate the amount of interest due. |
E | Private placement. |
F | The coupon rates shown on variable rate securities are the rates at December 31, 2006. |
G | Inflation-Protected Securities — Security whose principal value is adjusted daily or monthly in accordance with changes to the Consumer Price Index for All Urban Consumers. Interest is calculated on the basis of the current adjusted principal value. |
H | When-issued Security — Security purchased on a delayed delivery basis. Final settlement amount and maturity date have not yet been announced. |
I | Yankee Bond — A dollar-denominated bond issued in the U.S. by a foreign entity. |
J | Amount represents less than 0.05. |
K | Convertible Security — Security may be converted into the issuer’s common stock. |
L | Zero coupon bond — A bond with no periodic interest payments which is sold at such a discount as to produce a current yield to maturity. |
M | Collateral to cover futures and options contracts. |
N | Options and futures are described in more detail in the notes to financial statements. |
O | Par represents actual number of contracts. |
P | Amount represents less than 1. |
N.M. — | Not Meaningful. |
See notes to financial statements.
Annual Report to Shareholders 25
Statement of Assets and Liabilities
Core Bond Fund
December 31, 2006
(Amounts in Thousands)
Assets: | ||||||||
Investment securities at market value (Cost – $83,911) | $ | 83,500 | ||||||
Short-term securities at value (Cost – $8,929) | 8,909 | |||||||
Receivable for fund shares sold | 350 | |||||||
Interest and dividends receivable | 556 | |||||||
Total assets | 93,315 | |||||||
Liabilities: | ||||||||
Payable for securities purchased | $ | 20,079 | ||||||
Payable for fund shares repurchased | 705 | |||||||
Accrued management fee | 3 | |||||||
Accrued distribution and service fees | 31 | |||||||
Income distribution payable | 9 | |||||||
Futures variation margin payable | 4 | |||||||
Options written (Proceeds – $118) | 56 | |||||||
Accrued expenses | 78 | |||||||
Total liabilities | 20,965 | |||||||
Net Assets | $ | 72,350 | ||||||
Net assets consist of: | ||||||||
Accumulated paid-in capital applicable to: | ||||||||
7,420 Primary Class shares outstanding | $ | 73,636 | ||||||
Undistributed net investment income | 34 | |||||||
Accumulated net realized loss on investments, options, and futures | (910 | ) | ||||||
Unrealized appreciation/(depreciation) of investments, options and futures | (410 | ) | ||||||
Net Assets | $ | 72,350 | ||||||
Net Asset Value Per Share: | ||||||||
Primary Class | $9.75 | |||||||
See notes to financial statements.
26 Annual Report to Shareholders
Statement of Operations
Core Bond Fund
For the Year Ended December 31, 2006
(Amounts in Thousands)
Investment Income: | ||||||||
Interest | $ | 3,690 | ||||||
Dividends | 16 | |||||||
Total income | $ | 3,706 | ||||||
Expenses: | ||||||||
Management fees | 321 | |||||||
Distribution and service fees | 357 | |||||||
Audit and legal fees | 58 | |||||||
Custodian fees | 98 | |||||||
Directors’ fees and expenses | 28 | |||||||
Registration fees | 37 | |||||||
Reports to shareholders | 30 | |||||||
Transfer agent and shareholder servicing expense | 56 | |||||||
Other expenses | 46 | |||||||
1,031 | ||||||||
Less: Fees waived | (306 | ) | ||||||
Compensating balance credits | (11 | )A | ||||||
Total expenses, net of waivers and compensating balance credits | 714 | |||||||
Net Investment Income | 2,992 | |||||||
Net Realized and Unrealized Gain/(Loss) on Investments: | ||||||||
Realized gain/(loss) on: | ||||||||
Investments | 234 | |||||||
Options | 172 | |||||||
Futures | (547 | ) | ||||||
(141 | ) | |||||||
Change in unrealized appreciation/(depreciation) of investments, options and futures | 402 | |||||||
Net Realized and Unrealized Gain on Investments | 261 | |||||||
Change in Net Assets Resulting From Operations | $ | 3,253 | ||||||
A See note 1, Compensating Balance Credits, in the notes to financial statements.
See notes to financial statements.
Annual Report to Shareholders 27
Statement of Changes in Net Assets
Core Bond Fund
(Amounts in Thousands)
For the Years Ended | ||||||||
12/31/06 | 12/31/05 | |||||||
Change in Net Assets: | ||||||||
Net investment income | $ | 2,992 | $ | 2,333 | ||||
Net realized loss on investments, options and futures | (141 | ) | (663 | ) | ||||
Change in unrealized appreciation/(depreciation) of investments, options and futures | 402 | (1,045 | ) | |||||
Change in net assets resulting from operations | 3,253 | 625 | ||||||
Distributions to shareholders from: | ||||||||
Net investment income: | ||||||||
Primary Class | (2,992 | ) | (2,400 | ) | ||||
Net realized gain on investments: | ||||||||
Primary Class | — | (11 | ) | |||||
Change in net assets from Fund share transactions: | ||||||||
Primary Class | 264 | 9,838 | ||||||
Change in net assets | 525 | 8,052 | ||||||
Net Assets: | ||||||||
Beginning of year | 71,825 | 63,773 | ||||||
End of year | $ | 72,350 | $ | 71,825 | ||||
Undistributed net investment income | $ | 34 | $ | — | A | |||
A | Amount less than $1. |
See notes to financial statements.
28 Annual Report to Shareholders
Financial Highlights
Core Bond Fund
Contained below is per share operating performance data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements.
Primary Class:
Years Ended December 31, | ||||||||||||
2006 | 2005 | 2004A | ||||||||||
Net asset value, beginning of year | $9.71 | $9.95 | $10.00 | |||||||||
Investment operations: | ||||||||||||
Net investment income | .40 | B | .32 | .18 | ||||||||
Net realized and unrealized gain/(loss) on investments | .04 | (.23 | ) | .004 | ||||||||
Total from investment operations | .44 | .09 | .18 | |||||||||
Distributions from: | ||||||||||||
Net investment income | (.40 | ) | (.33 | ) | (.21 | ) | ||||||
Net realized gain on investments | — | (.002 | ) | (.02 | ) | |||||||
Total distributions | (.40 | ) | (.33 | ) | (.23 | ) | ||||||
Net asset value, end of year | $9.75 | $9.71 | $9.95 | |||||||||
Total return | 4.71 | % | .94 | % | 1.90 | %C | ||||||
Ratios to Average Net Assets:D | ||||||||||||
Total expenses | 1.44 | % | 1.38 | % | 1.56 | %E | ||||||
Expenses net of waivers, if any | 1.02 | % | 1.00 | % | 1.00 | %E | ||||||
Expenses net of all reductions | 1.00 | % | 1.00 | % | 1.00 | %E | ||||||
Net investment income | 4.19 | % | 3.29 | % | 2.50 | %E | ||||||
Supplemental Data: | ||||||||||||
Portfolio turnover rate | 428.1 | % | 435.7 | % | 233.8 | %C | ||||||
Net assets, end of year (in thousands) | $72,350 | $71,825 | $63,773 | |||||||||
A | For the period February 27, 2004 (commencement of operations) to December 31, 2004. |
B | Computed using average daily shares outstanding. |
C | Not annualized. |
D | Total expenses reflects operating expenses prior to any voluntary expense waivers and/or compensating balance credits. Expenses net of waivers reflects total expenses before compensating balance credits but net of any voluntary expense waivers. Expenses net of all reductions reflects expenses less any compensating balance credits and/or voluntary expense waivers. |
E Annualized.
See notes to financial statements.
Annual Report to Shareholders 29
Management’s Discussion of Fund Performance
High Yield Portfolio
Average annual total returns for the High Yield Portfolio (“Fund”) and its benchmark for various periods ended December 31, 2006, are presented below:
Average Annual Total Returns Through December 31, 2006 | ||||||||||||||||
One | Five | Ten | Since | |||||||||||||
Year | Years | Years | InceptionA | |||||||||||||
High Yield | ||||||||||||||||
Primary Class | +13.35% | +8.37% | +4.44% | +5.65% | ||||||||||||
Institutional Class | +14.05% | +8.90% | N/A | +3.12% | ||||||||||||
Lehman High Yield Index 2% Issuer ConstrainedB | +10.76% | +10.20% | +6.63% | +7.17% | ||||||||||||
Lehman High Yield IndexC | +11.85% | +10.18% | +6.59% | +7.13% | ||||||||||||
Lipper High Current Yield FundsD | +10.05% | +8.83% | +5.31% | +7.44% |
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information for the Primary Class please visit www.leggmasonfunds.com; for the Institutional Class please call 1-888-425-6432. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
The Fund’s Primary Class returned 13.35% for the 12-month period ending, December 31, 2006. This compares favorably to the Fund’s benchmark, the Lehman High Yield 2% Issuer Constrained Index, which returned 10.76%, and the 10.05% total return for the Lipper High Current Yield Funds. Credit spreads in general narrowed during the period helping the asset class outperform U.S. treasuries. The index generated 843 basis pointsE of excess return versus
A The inception date of the Primary Class is February 1, 1994. The inception date of the Institutional Class is May 5, 1998. Index returns are for periods beginning January 31, 1994.
B A market value-weighted index that tracks the daily price, coupon, and total return performance of non-investment grade, fixed rate, publicly placed, dollar-denominated, and non-convertible debt registered with the U.S. Securities and Exchange Commission. The index limits the maximum exposure to any one issuer to 2%. An investor cannot invest directly in an index.
C A market value-weighted index that tracks the daily price, coupon, and total return performance of non-investment grade, fixed rate, publicly placed, dollar-denominated, and non-convertible debt registered with the U.S. Securities and Exchange Commission.
D Average of 490 funds comprising the Lipper universe of funds that aim at high (relative) current yield from fixed income securities, have no quality or maturity restrictions, and tend to invest in low-grade debt issues.
E 100 basis points = 1%.
30 Annual Report to Shareholders
similar duration treasuries. The portfolio’s outperformance versus its benchmark was due to industry allocation and issue selection. Overweights to the consumer cyclicals and transportation subsectors, which returned 12.5% and 11.9%, respectively, helped relative performance. Three of the Fund’s five largest overweights returned between 17% and 24% for the period, aiding performance. The Fund’s issuer underweights also helped performance as nine of the Fund’s 10 largest underweights underperformed the broad market.
Western Asset Management Company
January 19, 2007
Annual Report to Shareholders 31
Expense Example
High Yield Portfolio
As a shareholder of the Fund, you incur ongoing costs, including management fees, distribution and service (12b-1) fees on Primary Class shares; and other Fund expenses. These examples are intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds. Each example is based on an investment of $1,000 invested on July 1, 2006, and held through December 31, 2006.
Actual Expenses
The first line for each class in the table below provides information about actual account values and actual expenses for each class. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled “Expenses Paid During the Period” to estimate the expenses you paid on your account during this period.
Hypothetical Example for Comparison Purposes
The second line for each class in the table below provides information about hypothetical account values and hypothetical expenses based on the relevant class’s actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the class’s actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Fund and other funds. To do so, compare these 5% hypothetical examples with the 5% hypothetical examples for the relevant class that appear in the shareholder reports of other funds.
Beginning | Ending | Expenses PaidA | ||||||||||
Account | Account | During the | ||||||||||
Value | Value | Period | ||||||||||
7/1/06 | 12/31/06 | 7/1/06 to 12/31/06 | ||||||||||
Primary Class: | ||||||||||||
Actual | $ | 1,000.00 | $ | 1,092.30 | $ | 7.59 | ||||||
Hypothetical (5% return before expenses) | 1,000.00 | 1,017.95 | 7.32 | |||||||||
Institutional Class: | ||||||||||||
Actual | $ | 1,000.00 | $ | 1,095.80 | $ | 4.97 | ||||||
Hypothetical (5% return before expenses) | 1,000.00 | 1,020.47 | 4.79 |
A These calculations are based on expenses incurred in the most recent fiscal half-year. The dollar amounts shown as “Expenses Paid” are equal to the annualized expense ratios of 1.44% and 0.94% for the Primary Class and Institutional Class, respectively, multiplied by the average values over the period, multiplied by the number of days in the most recent fiscal half-year (184), and divided by 365.
32 Annual Report to Shareholders
Performance Information
High Yield Portfolio
The graphs on the following pages compare the Fund’s total returns to that of two closely matched broad-based securities market indices. The graphs illustrate the cumulative total return of an initial $10,000 investment in the Primary Class and an initial $1,000,000 investment in the Institutional Class of the Fund, for the periods indicated. The lines for the Fund represent the total return after deducting all Fund investment management and other administrative expenses and the transaction costs of buying and selling securities. The line representing each securities market index does not include any transaction costs associated with buying and selling securities in the index or other administrative expenses. Both the Fund’s and the indices’ results assume reinvestment of all dividends and distributions.
Total return measures investment performance in terms of appreciation or depreciation in a fund’s net asset value per share, plus dividends and any capital gain distributions. It assumes that dividends and distributions were reinvested at the time they were paid. Average annual returns tend to smooth out variations in a fund’s return, so that they differ from actual year-to-year results.
Annual Report to Shareholders 33
Growth of a $10,000 Investment — Primary Class
Periods Ended December 31, 2006
Cumulative | Average Annual | |||||||||
Total Return | Total Return | |||||||||
One Year | +13.35% | +13.35% | ||||||||
Five Years | +49.46% | +8.37% | ||||||||
Ten Years | +54.46% | +4.44% | ||||||||
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information please visit www.leggmasonfunds.com. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares.
A A market value-weighted index that tracks the daily price, coupon, and total return performance of non-investment grade, fixed rate, publicly placed, dollar-denominated, and non-convertible debt registered with the U.S. Securities and Exchange Commission. The index limits the maximum exposure to any one issuer to 2%.
B A market value-weighted index that tracks the daily price, coupon, and total return performance of non-investment grade, fixed rate, publicly placed, dollar-denominated, and non-convertible debt registered with the U.S. Securities and Exchange Commission.
34 Annual Report to Shareholders
Performance Information — Continued
Growth of a $1,000,000 Investment — Institutional Class
Periods Ended December 31, 2006
Cumulative | Average Annual | |||||||||
Total Return | Total Return | |||||||||
One Year | +14.05% | +14.05% | ||||||||
Five Years | +53.14% | +8.90% | ||||||||
Life of Class* | +30.49% | +3.12% | ||||||||
* Inception date: May 5, 1998 | ||||||||||
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information please call 1-888-425-6432. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares.
C Index returns are for periods beginning April 30, 1998.
Annual Report to Shareholders 35
Portfolio Composition (as of December 31, 2006)D
Standard & Poor’s Debt RatingsE (as a percentage of the portfolio)
Maturity Schedule (as a percentage of the portfolio)
D The Fund is actively managed. As a result, the composition of its portfolio holdings and sectors is subject to change at any time.
E Standard & Poor’s Ratings Services provide capital markets with credit ratings for the evaluation and assessment of credit risk.
F Common Stocks, Preferred Stocks and Warrants do not have a defined maturity date.
36 Annual Report to Shareholders
Portfolio of Investments
High Yield Portfolio
December 31, 2006
(Amounts in Thousands)
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Long-Term Securities — 97.3% | ||||||||||||
Corporate Bonds and Notes — 84.1% | ||||||||||||
Aerospace and Defense — 1.5% | ||||||||||||
Alliant Techsystems Inc. | 6.750% | 4/1/16 | $ | 490 | $ | 490 | ||||||
DRS Technologies Inc. | 6.625% | 2/1/16 | 340 | 343 | ||||||||
DRS Technologies Inc. | 7.625% | 2/1/18 | 470 | 484 | ||||||||
L-3 Communications Corp. | 6.375% | 10/15/15 | 1,085 | 1,074 | ||||||||
2,391 | ||||||||||||
Airlines — 1.4% | ||||||||||||
Continental Airlines Inc. | 8.750% | 12/1/11 | 370 | 373 | ||||||||
United Air Lines Inc. | 7.032% | 10/1/10 | 474 | 483 | ||||||||
United Air Lines Inc. | 7.186% | 10/1/12 | 1,247 | 1,272 | ||||||||
2,128 | ||||||||||||
Auto Components — 1.3% | ||||||||||||
Keystone Automotive Operations Inc. | 9.750% | 11/1/13 | 810 | 802 | ||||||||
Visteon Corp. | 8.250% | 8/1/10 | 564 | 550 | ||||||||
Visteon Corp. | 7.000% | 3/10/14 | 690 | 604 | ||||||||
1,956 | ||||||||||||
Automobiles — 2.2% | ||||||||||||
Ford Motor Co. | 8.875% | 1/15/22 | 875 | 761 | ||||||||
Ford Motor Co. | 7.450% | 7/16/31 | 275 | 216 | ||||||||
Ford Motor Co. | 4.250% | 12/15/36 | 200 | 214 | A | |||||||
General Motors Corp. | 7.200% | 1/15/11 | 405 | 393 | ||||||||
General Motors Corp. | 8.375% | 7/15/33 | 2,030 | 1,877 | ||||||||
3,461 | ||||||||||||
Building Products — 2.1% | ||||||||||||
Associated Materials Inc. | 9.750% | 4/15/12 | 265 | 273 | ||||||||
Associated Materials Inc. | 11.250% | 3/1/14 | 830 | 560 | B | |||||||
Jacuzzi Brands Inc. | 9.625% | 7/1/10 | 902 | 959 | ||||||||
Nortek Inc. | 8.500% | 9/1/14 | 490 | 480 | ||||||||
NTK Holdings Inc. | 0.000% | 3/1/14 | 1,340 | 938 | B | |||||||
3,210 | ||||||||||||
Annual Report to Shareholders 37
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Capital Markets — 0.5% | ||||||||||||
E*Trade Financial Corp. | 7.375% | 9/15/13 | $ | 450 | $ | 468 | ||||||
E*Trade Financial Corp. | 7.875% | 12/1/15 | 332 | 353 | ||||||||
821 | ||||||||||||
Chemicals — 1.3% | ||||||||||||
Chemtura Corp. | 6.875% | 6/1/16 | 105 | 101 | ||||||||
Georgia Gulf Corp. | 9.500% | 10/15/14 | 800 | 780 | C | |||||||
Huntsman International LLC | 7.875% | 11/15/14 | 235 | 237 | C | |||||||
Lyondell Chemical Co. | 8.000% | 9/15/14 | 210 | 218 | ||||||||
Lyondell Chemical Co. | 8.250% | 9/15/16 | 175 | 183 | ||||||||
Westlake Chemical Corp. | 6.625% | 1/15/16 | 525 | 508 | ||||||||
2,027 | ||||||||||||
Commercial Services and Supplies — 0.4% | ||||||||||||
Allied Security Escrow Corp. | 11.375% | 7/15/11 | 105 | 108 | ||||||||
Rental Service Corp. | 9.500% | 12/1/14 | 450 | 464 | C | |||||||
572 | ||||||||||||
Consumer Finance — 4.4% | ||||||||||||
Ford Motor Credit Co. | 7.375% | 2/1/11 | 825 | 817 | ||||||||
Ford Motor Credit Co. | 9.875% | 8/10/11 | 1,730 | 1,850 | ||||||||
Ford Motor Credit Co. | 8.110% | 1/13/12 | 270 | 267 | D | |||||||
GMAC LLC | 6.875% | 8/28/12 | 640 | 657 | ||||||||
GMAC LLC | 8.000% | 11/1/31 | 2,800 | 3,215 | ||||||||
6,806 | ||||||||||||
Containers and Packaging — 1.8% | ||||||||||||
Berry Plastics Holding Corp. | 8.875% | 9/15/14 | 335 | 340 | C | |||||||
Graham Packaging Co. Inc. | 9.875% | 10/15/14 | 756 | 763 | ||||||||
Graphic Packaging International Corp. | 8.500% | 8/15/11 | 135 | 140 | ||||||||
Graphic Packaging International Corp. | 9.500% | 8/15/13 | 619 | 653 | ||||||||
Plastipak Holdings Inc. | 8.500% | 12/15/15 | 840 | 874 | C | |||||||
2,770 | ||||||||||||
38 Annual Report to Shareholders
Portfolio of Investments — Continued
High Yield Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Diversified Consumer Services — 0.4% | ||||||||||||
Education Management LLC | 8.750% | 6/1/14 | $ | 390 | $ | 403 | C | |||||
Service Corp. International | 7.875% | 2/1/13 | 90 | 95 | ||||||||
Service Corp. International | 7.625% | 10/1/18 | 45 | 48 | ||||||||
546 | ||||||||||||
Diversified Financial Services — 5.3% | ||||||||||||
AAC Group Holding Corp. | 10.250% | 10/1/12 | 1,220 | 1,068 | B | |||||||
CCM Merger Inc. | 8.000% | 8/1/13 | 385 | 376 | C | |||||||
DI Finance LLC | 9.500% | 2/15/13 | 1,460 | 1,548 | ||||||||
GrafTech Finance Inc. | 10.250% | 2/15/12 | 435 | 458 | ||||||||
Milacron Escrow Corp. | 11.500% | 5/15/11 | 1,665 | 1,582 | ||||||||
Standard Aero Holdings Inc. | 8.250% | 9/1/14 | 1,005 | 1,015 | ||||||||
UGS Corp. | 10.000% | 6/1/12 | 600 | 654 | ||||||||
Vanguard Health Holding Co. I LLC | 11.250% | 10/1/15 | 285 | 219 | B | |||||||
Vanguard Health Holding Co. II LLC | 9.000% | 10/1/14 | 1,285 | 1,301 | ||||||||
8,221 | ||||||||||||
Diversified Telecommunication Services — 4.3% | ||||||||||||
Cincinnati Bell Inc. | 7.000% | 2/15/15 | 649 | 650 | ||||||||
Cincinnati Bell Inc. | 6.300% | 12/1/28 | 380 | 342 | ||||||||
Citizens Communications Co. | 7.875% | 1/15/27 | 165 | 167 | C | |||||||
Citizens Communications Co. | 9.000% | 8/15/31 | 465 | 505 | ||||||||
Hawaiian Telcom Communications Inc. | 10.889% | 5/1/13 | 40 | 40 | D | |||||||
Hawaiian Telcom Communications Inc. | 12.500% | 5/1/15 | 1,420 | 1,487 | ||||||||
Level 3 Communications Inc. | 11.500% | 3/1/10 | 270 | 286 | ||||||||
Level 3 Financing Inc. | 11.800% | 3/15/11 | 190 | 201 | D | |||||||
Level 3 Financing Inc. | 9.250% | 11/1/14 | 320 | 326 | C | |||||||
Qwest Communications International Inc. | 7.250% | 2/15/11 | 703 | 719 |
Annual Report to Shareholders 39
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Diversified Telecommunication Services — Continued | ||||||||||||
Qwest Communications International Inc. | 7.500% | 2/15/14 | $ | 620 | $ | 639 | ||||||
Qwest Corp. | 7.500% | 10/1/14 | 525 | 556 | ||||||||
Windstream Corp. | 8.625% | 8/1/16 | 725 | 794 | C | |||||||
6,712 | ||||||||||||
Electric Utilities — 1.7% | ||||||||||||
Edison Mission Energy | 7.500% | 6/15/13 | 95 | 99 | ||||||||
IPALCO Enterprises Inc. | 8.625% | 11/14/11 | 720 | 783 | ||||||||
Midwest Generation LLC | 8.560% | 1/2/16 | 396 | 436 | ||||||||
Orion Power Holdings Inc. | 12.000% | 5/1/10 | 375 | 426 | ||||||||
Sierra Pacific Resources | 6.750% | 8/15/17 | 980 | 961 | ||||||||
2,705 | ||||||||||||
Energy Equipment and Services — 1.3% | ||||||||||||
Geokinetics Inc. | 11.860% | 12/15/12 | 160 | 161 | C,D | |||||||
Gulfmark Offshore Inc. | 7.750% | 7/15/14 | 820 | 836 | ||||||||
Pride International Inc. | 7.375% | 7/15/14 | 940 | 971 | ||||||||
1,968 | ||||||||||||
Food and Staples Retailing — 0.8% | ||||||||||||
Delhaize America Inc. | 8.125% | 4/15/11 | 464 | 501 | ||||||||
Delhaize America Inc. | 9.000% | 4/15/31 | 630 | 748 | ||||||||
1,249 | ||||||||||||
Food Products — 0.4% | ||||||||||||
Dole Food Co. Inc. | 7.250% | 6/15/10 | 715 | 681 | ||||||||
Gas Utilities — 1.0% | ||||||||||||
Southern Natural Gas Co. | 8.000% | 3/1/32 | 415 | 485 | ||||||||
Suburban Propane Partners LP | 6.875% | 12/15/13 | 1,110 | 1,088 | ||||||||
1,573 | ||||||||||||
40 Annual Report to Shareholders
Portfolio of Investments — Continued
High Yield Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Health Care Equipment and Supplies — 0.2% | ||||||||||||
Fresenius Medical Care Capital Trust II | 7.875% | 2/1/08 | $ | 100 | $ | 102 | E | |||||
Fresenius Medical Care Capital Trust IV | 7.875% | 6/15/11 | 170 | 178 | ||||||||
280 | ||||||||||||
Health Care Providers and Services — 3.9% | ||||||||||||
DaVita Inc. | 7.250% | 3/15/15 | 1,160 | 1,183 | ||||||||
HCA Inc. | 6.300% | 10/1/12 | 220 | 201 | ||||||||
HCA Inc. | 9.000% | 12/15/14 | 270 | 262 | ||||||||
HCA Inc. | 6.500% | 2/15/16 | 220 | 185 | ||||||||
HCA Inc. | 9.250% | 11/15/16 | 480 | 514 | C | |||||||
HCA Inc. | 9.625% | 11/15/16 | 440 | 473 | C | |||||||
HCA Inc. | 7.690% | 6/15/25 | 280 | 232 | ||||||||
HCA Inc. | 7.500% | 11/15/95 | 855 | 643 | ||||||||
Tenet Healthcare Corp. | 9.875% | 7/1/14 | 1,757 | 1,788 | ||||||||
Tenet Healthcare Corp. | 9.250% | 2/1/15 | 300 | 300 | ||||||||
Triad Hospitals Inc. | 7.000% | 11/15/13 | 270 | 272 | ||||||||
6,053 | ||||||||||||
Hotels, Restaurants and Leisure — 5.5% | ||||||||||||
Boyd Gaming Corp. | 8.750% | 4/15/12 | 340 | 355 | ||||||||
Boyd Gaming Corp. | 6.750% | 4/15/14 | 180 | 180 | ||||||||
Denny’s Holdings Inc. | 10.000% | 10/1/12 | 350 | 369 | ||||||||
Domino’s Inc. | 8.250% | 7/1/11 | 814 | 844 | ||||||||
El Pollo Loco Inc. | 11.750% | 11/15/13 | 570 | 619 | ||||||||
Inn of the Mountain Gods Resort and Casino | 12.000% | 11/15/10 | 1,460 | 1,577 | ||||||||
Isle of Capri Casinos Inc. | 7.000% | 3/1/14 | 170 | 169 | ||||||||
MGM MIRAGE | 8.375% | 2/1/11 | 465 | 482 | ||||||||
MGM MIRAGE | 7.625% | 1/15/17 | 705 | 707 | ||||||||
Pinnacle Entertainment Inc. | 8.250% | 3/15/12 | 800 | 808 | ||||||||
River Rock Entertainment Authority | 9.750% | 11/1/11 | 1,290 | 1,367 | ||||||||
Station Casinos Inc. | 7.750% | 8/15/16 | 670 | 675 |
Annual Report to Shareholders 41
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Hotels, Restaurants and Leisure — Continued | ||||||||||||
Turning Stone Casino Resort Enterprise | 9.125% | 9/15/14 | $ | 235 | $ | 240 | C | |||||
Wimar Opco LLC | 9.625% | 12/15/14 | 60 | 59 | C | |||||||
8,451 | ||||||||||||
Household Durables — 2.4% | ||||||||||||
Beazer Homes USA Inc. | 8.625% | 5/15/11 | 265 | 273 | ||||||||
Beazer Homes USA Inc. | 8.375% | 4/15/12 | 230 | 237 | ||||||||
Beazer Homes USA Inc. | 8.125% | 6/15/16 | 255 | 270 | ||||||||
Interface Inc. | 10.375% | 2/1/10 | 943 | 1,042 | ||||||||
K Hovnanian Enterprises Inc. | 6.250% | 1/15/16 | 820 | 775 | ||||||||
K Hovnanian Enterprises Inc. | 8.625% | 1/15/17 | 90 | 96 | ||||||||
Norcraft Cos LP | 9.000% | 11/1/11 | 890 | 921 | ||||||||
Norcraft Holdings LP | 0.000% | 9/1/12 | 160 | 135 | B | |||||||
3,749 | ||||||||||||
Household Products — 0.6% | ||||||||||||
Nutro Products Inc. | 9.400% | 10/15/13 | 90 | 93 | C,D | |||||||
Nutro Products Inc. | 10.750% | 4/15/14 | 235 | 257 | C | |||||||
Spectrum Brands Inc. | 8.500% | 10/1/13 | 222 | 208 | ||||||||
Spectrum Brands Inc. | 7.375% | 2/1/15 | 100 | 86 | ||||||||
Visant Holding Corp. | 8.750% | 12/1/13 | 330 | 340 | ||||||||
984 | ||||||||||||
Independent Power Producers and Energy Traders — 2.5% | ||||||||||||
Mirant Americas Generation LLC | 8.300% | 5/1/11 | 950 | 974 | ||||||||
NRG Energy Inc. | 7.375% | 2/1/16 | 2,170 | 2,181 | ||||||||
The AES Corp. | 7.750% | 3/1/14 | 755 | 796 | ||||||||
3,951 | ||||||||||||
Insurance — 0.4% | ||||||||||||
Crum and Forster Holdings Corp. | 10.375% | 6/15/13 | 500 | 541 | ||||||||
42 Annual Report to Shareholders
Portfolio of Investments — Continued
High Yield Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Internet and Catalog Retail — 0.8% | ||||||||||||
Brookstone Co. Inc. | 12.000% | 10/15/12 | $ | 810 | $ | 792 | ||||||
FTD Inc. | 7.750% | 2/15/14 | 425 | 425 | ||||||||
1,217 | ||||||||||||
IT Services — 1.1% | ||||||||||||
SunGard Data Systems Inc. | 10.250% | 8/15/15 | 1,620 | 1,729 | ||||||||
Machinery — 0.4% | ||||||||||||
Mueller Group Inc. | 10.000% | 5/1/12 | 350 | 381 | ||||||||
Mueller Holdings Inc. | 14.750% | 4/15/14 | 315 | 283 | B | |||||||
664 | ||||||||||||
Marine — 0.4% | ||||||||||||
American Commercial Lines LLC | 9.500% | 2/15/15 | 500 | 556 | ||||||||
Media — 9.6% | ||||||||||||
Affinion Group Inc. | 10.125% | 10/15/13 | 790 | 837 | ||||||||
Affinion Group Inc. | 11.500% | 10/15/15 | 30 | 32 | ||||||||
AMC Entertainment Inc. | 11.000% | 2/1/16 | 1,070 | 1,201 | ||||||||
CCH I Holdings LLC | 11.750% | 5/15/14 | 630 | 569 | ||||||||
CCH I Holdings LLC | 11.000% | 10/1/15 | 910 | 934 | ||||||||
CCH I Holdings LLC | 11.000% | 10/1/15 | 67 | 69 | C | |||||||
CCH II Holdings LLC | 10.250% | 10/1/13 | 1,136 | 1,209 | C | |||||||
Charter Communications Holdings LLC | 9.920% | 4/1/11 | 50 | 46 | ||||||||
Charter Communications Holdings LLC | 11.750% | 5/15/11 | 180 | 173 | ||||||||
Charter Communications Holdings LLC | 12.125% | 1/15/12 | 195 | 182 | B | |||||||
CMP Susquehanna Corp. | 9.875% | 5/15/14 | 490 | 488 | C | |||||||
CSC Holdings Inc. | 8.125% | 7/15/09 | 100 | 104 | ||||||||
CSC Holdings Inc. | 8.125% | 8/15/09 | 45 | 47 | ||||||||
CSC Holdings Inc. | 6.750% | 4/15/12 | 965 | 941 | C | |||||||
EchoStar DBS Corp. | 7.000% | 10/1/13 | 755 | 754 | ||||||||
EchoStar DBS Corp. | 6.625% | 10/1/14 | 950 | 926 |
Annual Report to Shareholders 43
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Media — Continued | ||||||||||||
EchoStar DBS Corp. | 7.125% | 2/1/16 | $ | 330 | $ | 330 | ||||||
Idearc Inc. | 8.000% | 11/15/16 | 460 | 467 | C | |||||||
LIN Television Corp. | 6.500% | 5/15/13 | 435 | 414 | ||||||||
LIN Television Corp. | 6.500% | 5/15/13 | 250 | 238 | ||||||||
LodgeNet Entertainment Corp. | 9.500% | 6/15/13 | 332 | 358 | ||||||||
PRIMEDIA Inc. | 8.875% | 5/15/11 | 1,270 | 1,295 | ||||||||
R.H. Donnelley Corp. | 6.875% | 1/15/13 | 525 | 503 | ||||||||
R.H. Donnelley Corp. | 6.875% | 1/15/13 | 960 | 920 | ||||||||
Rainbow National Services LLC | 8.750% | 9/1/12 | 510 | 536 | C | |||||||
Rainbow National Services LLC | 10.375% | 9/1/14 | 360 | 400 | C | |||||||
WMG Acquisition Corp. | 7.375% | 4/15/14 | 420 | 416 | ||||||||
XM Satellite Radio Inc. | 9.871% | 5/1/13 | 170 | 165 | D | |||||||
XM Satellite Radio Inc. | 9.750% | 5/1/14 | 365 | 365 | ||||||||
14,919 | ||||||||||||
Metals and Mining — 2.5% | ||||||||||||
Aleris International Inc. | 10.000% | 12/15/16 | 115 | 116 | C | |||||||
Chaparral Steel Co. | 10.000% | 7/15/13 | 790 | 882 | ||||||||
CitiSteel USA Inc. | 12.949% | 9/1/10 | 520 | 538 | D | |||||||
CitiSteel USA Inc. | 15.000% | 10/1/10 | 155 | 175 | C,F | |||||||
Metals USA Holdings Corp. | 11.365% | 1/15/12 | 720 | 691 | C,D | |||||||
Metals USA Inc. | 11.125% | 12/1/15 | 600 | 659 | ||||||||
RathGibson Inc. | 11.250% | 2/15/14 | 835 | 885 | ||||||||
3,946 | ||||||||||||
Multiline Retail — 0.8% | ||||||||||||
The Neiman-Marcus Group Inc. | 9.000% | 10/15/15 | 1,090 | 1,189 | ||||||||
Oil, Gas and Consumable Fuels — 10.8% | ||||||||||||
ANR Pipeline Inc. | 9.625% | 11/1/21 | 282 | 374 | ||||||||
Belden and Blake Corp. | 8.750% | 7/15/12 | 2,055 | 2,107 | ||||||||
Chesapeake Energy Corp. | 6.375% | 6/15/15 | 375 | 371 | ||||||||
Chesapeake Energy Corp. | 6.500% | 8/15/17 | 565 | 552 | ||||||||
Chesapeake Energy Corp. | 6.250% | 1/15/18 | 810 | 780 | ||||||||
Colorado Interstate Gas Co. | 6.800% | 11/15/15 | 500 | 520 | ||||||||
Complete Production Services Inc. | 8.000% | 12/15/16 | 450 | 461 | C |
44 Annual Report to Shareholders
Portfolio of Investments — Continued
High Yield Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Oil, Gas and Consumable Fuels — Continued | ||||||||||||
El Paso Corp. | 7.750% | 6/15/10 | $ | 230 | $ | 243 | ||||||
El Paso Corp. | 8.050% | 10/15/30 | 950 | 1,054 | ||||||||
El Paso Corp. | 7.800% | 8/1/31 | 1,150 | 1,256 | ||||||||
Encore Acquisition Co. | 6.250% | 4/15/14 | 160 | 150 | ||||||||
Encore Acquisition Co. | 6.000% | 7/15/15 | 310 | 283 | ||||||||
Encore Acquisition Co. | 7.250% | 12/1/17 | 400 | 387 | ||||||||
Enterprise Products Operating LP | 8.375% | 8/1/66 | 370 | 401 | B | |||||||
Exco Resources Inc. | 7.250% | 1/15/11 | 810 | 822 | ||||||||
International Coal Group Inc. | 10.250% | 7/15/14 | 560 | 560 | ||||||||
Mariner Energy Inc. | 7.500% | 4/15/13 | 295 | 286 | ||||||||
Petrohawk Energy Corp. | 9.125% | 7/15/13 | 390 | 410 | ||||||||
Pogo Producing Co. | 6.875% | 10/1/17 | 910 | 869 | ||||||||
SemGroup LP | 8.750% | 11/15/15 | 865 | 869 | C | |||||||
SESI LLC | 6.875% | 6/1/14 | 30 | 30 | ||||||||
Stone Energy Corp. | 8.250% | 12/15/11 | 230 | 226 | ||||||||
Stone Energy Corp. | 6.750% | 12/15/14 | 285 | 272 | ||||||||
The Williams Cos. Inc. | 7.500% | 1/15/31 | 440 | 457 | ||||||||
The Williams Cos. Inc. | 8.750% | 3/15/32 | 1,896 | 2,143 | ||||||||
Whiting Petroleum Corp. | 7.000% | 2/1/14 | 820 | 818 | ||||||||
16,701 | ||||||||||||
Paper and Forest Products — 1.6% | ||||||||||||
Appleton Papers Inc. | 9.750% | 6/15/14 | 830 | 855 | ||||||||
NewPage Corp. | 11.621% | 5/1/12 | 320 | 346 | D | |||||||
NewPage Corp. | 12.000% | 5/1/13 | 725 | 767 | ||||||||
Verso Paper Holdings LLC | 9.125% | 8/1/14 | 120 | 125 | C | |||||||
Verso Paper Holdings LLC | 11.375% | 8/1/16 | 310 | 325 | C | |||||||
2,418 | ||||||||||||
Pharmaceuticals — 0.5% | ||||||||||||
Leiner Health Products Inc. | 11.000% | 6/1/12 | 790 | 818 | ||||||||
Real Estate Investment Trusts — 1.1% | ||||||||||||
Host Marriott LP | 6.750% | 6/1/16 | 420 | 420 | ||||||||
Kimball Hill Inc. | 10.500% | 12/15/12 | 490 | 458 |
Annual Report to Shareholders 45
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Real Estate Investment Trusts — Continued | ||||||||||||
Ventas Inc. | 8.750% | 5/1/09 | $ | 475 | $ | 505 | ||||||
Ventas Inc. | 6.750% | 6/1/10 | 200 | 206 | ||||||||
Ventas Inc. | 9.000% | 5/1/12 | 158 | 179 | ||||||||
1,768 | ||||||||||||
Real Estate Management and Development — 0.6% | ||||||||||||
Ashton Woods USA LLC | 9.500% | 10/1/15 | 110 | 100 | ||||||||
Forest City Enterprises Inc. | 6.500% | 2/1/17 | 830 | 813 | ||||||||
913 | ||||||||||||
Road and Rail — 1.7% | ||||||||||||
Hertz Corp. | 8.875% | 1/1/14 | 470 | 493 | C | |||||||
Hertz Corp. | 10.500% | 1/1/16 | 1,290 | 1,419 | C | |||||||
Kansas City Southern Railway | 7.500% | 6/15/09 | 710 | 716 | ||||||||
2,628 | ||||||||||||
Semiconductors and Semiconductor Equipment — 0.5% | ||||||||||||
Freescale Semiconductor Inc. | 8.875% | 12/15/14 | 750 | 747 | C | |||||||
Software — 0.2% | ||||||||||||
Activant Solutions Inc. | 9.500% | 5/1/16 | 335 | 312 | C | |||||||
Specialty Retail — 0.4% | ||||||||||||
Blockbuster Inc. | 9.000% | 9/1/12 | 440 | 425 | ||||||||
Linens ’n Things Inc. | 10.999% | 1/15/14 | 205 | 199 | D | |||||||
Michaels Stores Inc. | 13.000% | 11/1/16 | 125 | 68 | B,C | |||||||
692 | ||||||||||||
46 Annual Report to Shareholders
Portfolio of Investments — Continued
High Yield Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Textiles, Apparel and Luxury Goods — 1.0% | ||||||||||||
Levi Strauss and Co. | 9.750% | 1/15/15 | $ | 750 | $ | 808 | ||||||
Levi Strauss and Co. | 8.875% | 4/1/16 | 50 | 52 | ||||||||
Oxford Industries Inc. | 8.875% | 6/1/11 | 691 | 714 | ||||||||
1,574 | ||||||||||||
Tobacco — 0.5% | ||||||||||||
Alliance One International Inc. | 11.000% | 5/15/12 | 130 | 139 | ||||||||
Reynolds American Inc. | 6.500% | 7/15/10 | 580 | 588 | ||||||||
727 | ||||||||||||
Trading Companies and Distributors — 0.9% | ||||||||||||
Ashtead Capital Inc. | 9.000% | 8/15/16 | 327 | 350 | C | |||||||
H&E Equipment Services Inc. | 8.375% | 7/15/16 | 245 | 257 | ||||||||
Penhall International Corp. | 12.000% | 8/1/14 | 680 | 734 | C | |||||||
1,341 | ||||||||||||
Transportation Infrastructure — 0.6% | ||||||||||||
H-Lines Finance Holding Corp. | 11.000% | 4/1/13 | 994 | 924 | B | |||||||
Wireless Telecommunication Services — 0.5% | ||||||||||||
Rural Cellular Corp. | 9.875% | 2/1/10 | 760 | 808 | ||||||||
Total Corporate Bonds and Notes (Cost — $126,974) | 130,397 | |||||||||||
Annual Report to Shareholders 47
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Mortgage-Backed Securities — 0.3% | ||||||||||||
Fixed Rate Securities — 0.3% | ||||||||||||
BlackRock Capital Finance LP 1996-R1 | 9.532% | 9/25/26 | $ | 502 | $ | 391 | ||||||
BlackRock Capital Finance LP 1997-R1 | 7.750% | 3/25/37 | 408 | 82 | C | |||||||
Ocwen Residential Mortgage Corp. 1998-R1 | 7.000% | 10/25/40 | 146 | 14 | ||||||||
Total Mortgage-Backed Securities (Cost — $736) | 487 | |||||||||||
Yankee BondsG — 11.8% | ||||||||||||
Chemicals — 0.5% | ||||||||||||
Montell Finance Co. BV | 8.100% | 3/15/27 | 850 | 807 | C | |||||||
Commercial Services and Supplies — 0.2% | ||||||||||||
Quebecor World Capital Corp. | 8.750% | 3/15/16 | 340 | 326 | C | |||||||
Diversified Financial Services — 0.3% | ||||||||||||
Basell AF SCA | 8.375% | 8/15/15 | 500 | 514 | C | |||||||
Diversified Telecommunication Services — 2.6% | ||||||||||||
Inmarsat Finance PLC | 7.625% | 6/30/12 | 200 | 206 | ||||||||
Intelsat Bermuda Ltd. | 9.250% | 6/15/16 | 135 | 145 | C | |||||||
Intelsat Bermuda Ltd. | 11.250% | 6/15/16 | 1,145 | 1,257 | C | |||||||
Intelsat Ltd. | 7.625% | 4/15/12 | 500 | 466 | ||||||||
Nordic Telephone Co. Holdings ApS | 8.875% | 5/1/16 | 380 | 407 | C | |||||||
NTL Cable PLC | 9.125% | 8/15/16 | 550 | 581 | ||||||||
Wind Acquisition Finance SA | 10.750% | 12/1/15 | 790 | 899 | C | |||||||
3,961 | ||||||||||||
48 Annual Report to Shareholders
Portfolio of Investments — Continued
High Yield Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Yankee Bonds — Continued | ||||||||||||
Energy Equipment and Services — 0.5% | ||||||||||||
Compagnie Generale de Geophysique SA | 7.500% | 5/15/15 | $ | 780 | $ | 784 | ||||||
Foreign Government Obligations — 1.7% | ||||||||||||
Federative Republic of Brazil | 8.000% | 1/15/18 | 190 | 211 | ||||||||
Federative Republic of Brazil | 11.000% | 8/17/40 | 470 | 623 | ||||||||
Republic of Panama | 9.375% | 4/1/29 | 93 | 124 | ||||||||
Russian Federation | 5.000% | 3/31/30 | 1,450 | 1,637 | B,C | |||||||
2,595 | ||||||||||||
Independent Power Producers and Energy Traders — 0.6% | ||||||||||||
AES China Generating Co. Ltd. | 8.250% | 6/26/10 | 995 | 995 | ||||||||
Media — 2.0% | ||||||||||||
Kabel Deutschland GmbH | 10.625% | 7/1/14 | 705 | 782 | ||||||||
Quebecor Media Inc. | 7.750% | 3/15/16 | 1,325 | 1,353 | ||||||||
Rogers Cable Inc. | 5.500% | 3/15/14 | 400 | 382 | ||||||||
Rogers Cable Inc. | 6.750% | 3/15/15 | 530 | 546 | ||||||||
3,063 | ||||||||||||
Oil, Gas and Consumable Fuels — 1.5% | ||||||||||||
OMI Corp. | 7.625% | 12/1/13 | 666 | 681 | ||||||||
OPTI Canada Inc. | 8.250% | 12/15/14 | 375 | 385 | C | |||||||
Utilicorp Canada Finance Corp. | 7.750% | 6/15/11 | 510 | 538 | ||||||||
Western Oil Sands Inc. | 8.375% | 5/1/12 | 640 | 711 | ||||||||
2,315 | ||||||||||||
Paper and Forest Products — 0.3% | ||||||||||||
Domtar Inc. | 7.875% | 10/15/11 | 450 | 467 | ||||||||
Road and Rail — 0.3% | ||||||||||||
Grupo Transportacion Ferroviaria Mexicana SA de CV | 9.375% | 5/1/12 | 370 | 395 | ||||||||
Annual Report to Shareholders 49
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Yankee Bonds — Continued | ||||||||||||
Semiconductors and Semiconductor Equipment — 0.3% | ||||||||||||
NXP BV/NXP Funding LLC | 7.875% | 10/15/14 | $ | 365 | $ | 377 | C | |||||
NXP BV/NXP Funding LLC | 9.500% | 10/15/15 | 115 | 118 | C | |||||||
495 | ||||||||||||
Wireless Telecommunication Services — 1.0% | ||||||||||||
Rogers Wireless Inc. | 7.250% | 12/15/12 | 330 | 350 | ||||||||
Rogers Wireless Inc. | 8.000% | 12/15/12 | 155 | 165 | ||||||||
True Move Co. Ltd. | 10.750% | 12/16/13 | 1,030 | 1,007 | C | |||||||
1,522 | ||||||||||||
Total Yankee Bonds (Cost — $17,722) | 18,239 | |||||||||||
Common Stocks and Equity Interests — N.M. | ||||||||||||
Washington Group International Inc. | 0.3 | shs | 20 | H | ||||||||
Total Common Stocks and Equity Interests (Cost — $ — )I | 20 | |||||||||||
Preferred Stocks — 1.1% | ||||||||||||
Chesapeake Energy Corp. | 6.250% | 1 | 240 | A | ||||||||
ION Media Networks Inc. | 14.250% | 0.2 | 1,413 | F | ||||||||
Total Preferred Stocks (Cost — $1,769) | 1,653 | |||||||||||
50 Annual Report to Shareholders
Portfolio of Investments — Continued
High Yield Portfolio — Continued
Par/ | ||||||||||||
Shares | Value | |||||||||||
Warrants — N.M. | ||||||||||||
Next Generation Network Inc. | 16 | wts | $ | — | H,I | |||||||
Total Warrants (Cost — $237) | — | I | ||||||||||
Total Long-Term Securities (Cost — $147,438) | 150,796 | |||||||||||
Short-Term Securities — 0.2% | ||||||||||||
Repurchase Agreements — 0.2% | ||||||||||||
Lehman Brothers Inc. 5.2%, dated 12/29/06, to be repurchased at $181 on 1/2/07 (Collateral: $180 Fannie Mae notes, 6.03%, due 8/15/16, value $185) | $ | 181 | 181 | |||||||||
Merrill Lynch Government Securities Inc. 5.2%, dated 12/29/06, to be repurchased at $181 on 1/2/07 (Collateral: $185 Freddie Mac notes, 5.125%, due 10/15/08, value $187) | 181 | 181 | ||||||||||
Total Short-Term Securities (Cost — $362) | 362 | |||||||||||
Total Investments — 97.5% (Cost — $147,800) | 151,158 | |||||||||||
Other Assets Less Liabilities — 2.5% | 3,895 | |||||||||||
Net Assets — 100.0% | $ | 155,053 | ||||||||||
A | Convertible Security — Security may be converted into the issuer’s common stock. |
B | Stepped Coupon Security — A security with a predetermined schedule of interest or dividend rate changes at which time it begins to accrue interest or pay dividends according to the predetermined schedule. |
C | Rule 144A Security — A security purchased pursuant to Rule 144A under the Securities Act of 1933 which may not be resold subject to that rule except to qualified institutional buyers. These securities, which the Fund investment adviser has determined to be liquid, represent 16.46% of net assets. |
D | Indexed Security — The rates of interest earned on these securities are tied to the London Interbank Offered Rate (“LIBOR”), the Euro Interbank Offered Rate (“EURIBOR”) Index, the Consumer Price Index (“CPI”), and the one-year Treasury Bill Rate. The coupon rates are the rates as of December 31, 2006. |
E | Unit — A security which consists of a bond and warrants to purchase the common stock of the issuer. |
F | Pay-in-Kind (“PIK”) security — A security in which interest or dividends during the initial few years is paid in additional PIK securities rather than in cash. |
G | Yankee Bond — A dollar-denominated bond issued in the U.S. by a foreign entity. |
H | Non-income producing. |
I | Amount represents less than 1. |
N.M. — Not meaningful.
See notes to financial statements.
Annual Report to Shareholders 51
Statement of Assets and Liabilities
High Yield Portfolio
December 31, 2006
(Amounts in Thousands)
Assets: | ||||||||
Investment securities at market value (Cost – $147,438) | $ | 150,796 | ||||||
Short-term securities at value (Cost – $362) | 362 | |||||||
Cash | 1 | |||||||
Receivable for securities sold | 1,345 | |||||||
Receivable for fund shares sold | 290 | |||||||
Interest receivable | 3,236 | |||||||
Total assets | 156,030 | |||||||
Liabilities: | ||||||||
Payable for fund shares repurchased | $ | 632 | ||||||
Accrued management fee | 85 | |||||||
Accrued distribution and service fees | 64 | |||||||
Income distribution payable | 107 | |||||||
Accrued expenses | 89 | |||||||
Total liabilities | 977 | |||||||
Net Assets | $ | 155,053 | ||||||
Net assets consist of: | ||||||||
Accumulated paid-in capital applicable to: | ||||||||
15,918 Primary Class shares outstanding | $ | 298,022 | ||||||
554 Institutional Class shares outstanding | 5,183 | |||||||
Overdistributions of net investment income | (24 | ) | ||||||
Accumulated net realized loss on investments | (151,486 | ) | ||||||
Unrealized appreciation/(depreciation) of investments | 3,358 | |||||||
Net Assets | $ | 155,053 | ||||||
Net Asset Value Per Share: | ||||||||
Primary Class | $ | 9.41 | ||||||
Institutional Class | $ | 9.39 | ||||||
See notes to financial statements.
52 Annual Report to Shareholders
Statement of Operations
High Yield Portfolio
For the Year Ended December 31, 2006
(Amounts in Thousands)
Investment Income: | ||||||||
Interest | $ | 13,927 | ||||||
Dividends | 122 | |||||||
Total income | $ | 14,049 | ||||||
Expenses: | ||||||||
Management fees | 1,051 | |||||||
Distribution and service fees | 755 | |||||||
Audit and legal fees | 59 | |||||||
Custodian fees | 83 | |||||||
Directors’ fees and expenses | 29 | |||||||
Registration fees | 48 | |||||||
Reports to shareholders | 61 | |||||||
Transfer agent and shareholder servicing expense: | ||||||||
Primary Class | 138 | |||||||
Institutional Class | 14 | |||||||
Other expenses | 47 | |||||||
2,285 | ||||||||
Less: Compensating balance credits | (5 | )A | ||||||
Total expenses, net of compensating balance credits | 2,280 | |||||||
Net Investment Income | 11,769 | |||||||
Net Realized and Unrealized Gain/(Loss) on Investments: | ||||||||
Realized gain on investments | 3,400 | |||||||
Change in unrealized appreciation/(depreciation) of investments | 5,070 | |||||||
Net Realized and Unrealized Gain on Investments | 8,470 | |||||||
Change in Net Assets Resulting From Operations | $ | 20,239 | ||||||
A | See note 1, Compensating Balance Credits, in the notes to financial statements. |
See notes to financial statements.
Annual Report to Shareholders 53
Statement of Changes in Net Assets
High Yield Portfolio
(Amounts in Thousands)
For the Years Ended | ||||||||
12/31/06 | 12/31/05 | |||||||
Change in Net Assets: | ||||||||
Net investment income | $ | 11,769 | $ | 14,117 | ||||
Net realized gain on investments | 3,400 | 765 | ||||||
Change in unrealized appreciation/(depreciation) on investments | 5,070 | (10,653 | ) | |||||
Change in net assets resulting from operations | 20,239 | 4,229 | ||||||
Distributions to shareholders from: | ||||||||
Net investment income: | ||||||||
Primary Class | (10,957 | ) | (13,197 | ) | ||||
Institutional Class | (828 | ) | (861 | ) | ||||
Change in net assets from Fund share transactions: | ||||||||
Primary Class | (15,670 | ) | (38,618 | ) | ||||
Institutional Class | (7,519 | ) | 4,174 | |||||
Change in net assets | (14,735 | ) | (44,273 | ) | ||||
Net Assets: | ||||||||
Beginning of year | 169,788 | 214,061 | ||||||
End of year | $ | 155,053 | $ | 169,788 | ||||
Under/(over) distributions of net investment income | $ | (24 | ) | $ | 1 | |||
See notes to financial statements.
54 Annual Report to Shareholders
Financial Highlights
High Yield Portfolio
Contained below is per share operating performance data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements.
Primary Class:
Years Ended December 31, | ||||||||||||||||||||
2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
Net asset value, beginning of year | $8.93 | $9.39 | $9.10 | $7.96 | $9.22 | |||||||||||||||
Investment operations: | ||||||||||||||||||||
Net investment income | .66 | .67 | .62 | .63 | .77 | |||||||||||||||
Net realized and unrealized gain/(loss) on investments | .48 | (.46 | ) | .29 | 1.15 | (1.26 | ) | |||||||||||||
Total from investment operations | 1.14 | .21 | .91 | 1.78 | (.49 | ) | ||||||||||||||
Distributions from: | ||||||||||||||||||||
Net investment income | (.66 | ) | (.67 | ) | (.62 | ) | (.64 | ) | (.77 | ) | ||||||||||
Total distributions | (.66 | ) | (.67 | ) | (.62 | ) | (.64 | ) | (.77 | ) | ||||||||||
Net asset value, end of year | $9.41 | $8.93 | $9.39 | $9.10 | $7.96 | |||||||||||||||
Total return | 13.35 | % | 2.39 | % | 10.51 | % | 23.03 | % | (5.28 | )% | ||||||||||
Ratios to Average Net Assets:A | ||||||||||||||||||||
Total expenses | 1.45 | % | 1.40 | % | 1.36 | % | 1.41 | % | 1.36 | % | ||||||||||
Expenses net of waivers, if any | 1.45 | % | 1.40 | % | 1.36 | % | 1.41 | % | 1.36 | % | ||||||||||
Expenses net of all reductions | 1.44 | % | 1.40 | % | 1.36 | % | 1.41 | % | 1.36 | % | ||||||||||
Net investment income | 7.24 | % | 7.28 | % | 6.79 | % | 7.26 | % | 9.06 | % | ||||||||||
Supplemental Data: | ||||||||||||||||||||
Portfolio turnover rate | 88.3 | % | 134.0 | % | 109.1 | % | 122.3 | % | 96.6 | % | ||||||||||
Net assets, end of year (in thousands) | $149,846 | $157,399 | $205,314 | $223,773 | $162,175 | |||||||||||||||
A | Total expenses reflects operating expenses prior to any voluntary expense waivers and/or compensating balance credits. Expenses net of waivers reflects total expenses before compensating balance credits but net of any voluntary expense waivers. Expenses net of all reductions reflects expenses less any compensating balance credits and/or voluntary expense waivers. |
See notes to financial statements.
Annual Report to Shareholders 55
Institutional Class:
Years Ended December 31, | ||||||||||||||||||||
2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
Net asset value, beginning of year | $8.96 | $9.41 | $9.11 | $7.96 | $9.20 | |||||||||||||||
Investment operations: | ||||||||||||||||||||
Net investment income | .77 | .71 | .66 | .66 | .78 | |||||||||||||||
Net realized and unrealized gain/(loss) on investments | .43 | (.45 | ) | .31 | 1.15 | (1.24 | ) | |||||||||||||
Total from investment operations | 1.20 | .26 | .97 | 1.81 | (.46 | ) | ||||||||||||||
Distributions from: | ||||||||||||||||||||
Net investment income | (.77 | ) | (.71 | ) | (.67 | ) | (.66 | ) | (.78 | ) | ||||||||||
Total distributions | (.77 | ) | (.71 | ) | (.67 | ) | (.66 | ) | (.78 | ) | ||||||||||
Net asset value, end of year | $9.39 | $8.96 | $9.41 | $9.11 | $7.96 | |||||||||||||||
Total return | 14.05 | % | 2.94 | % | 11.15 | % | 23.54 | % | (5.00 | )% | ||||||||||
Ratios to Average Net Assets:A | ||||||||||||||||||||
Total expenses | .94 | % | .85 | % | .80 | % | .85 | % | .82 | % | ||||||||||
Expenses net of waivers, if any | .94 | % | .85 | % | .80 | % | .85 | % | .82 | % | ||||||||||
Expenses net of all reductions | .94 | % | .84 | % | .80 | % | .85 | % | .82 | % | ||||||||||
Net investment income | 7.82 | % | 7.93 | % | 7.38 | % | 7.78 | % | 9.63 | % | ||||||||||
Supplemental Data: | ||||||||||||||||||||
Portfolio turnover rate | 88.3 | % | 134.0 | % | 109.1 | % | 122.3 | % | 96.6 | % | ||||||||||
Net assets, end of year (in thousands) | $5,207 | $12,389 | $8,747 | $6,434 | $2,704 | |||||||||||||||
See notes to financial statements.
56 Annual Report to Shareholders
Management’s Discussion of Fund Performance
Investment Grade Income Portfolio
Average annual total returns for the Investment Grade Income Portfolio (“Fund”) and its benchmark for various periods ended December 31, 2006, are presented below:
Average Annual Total Returns Through December 31, 2006 | ||||||||||||||||
Since | ||||||||||||||||
One Year | Five Years | Ten Years | InceptionA | |||||||||||||
Investment Grade | ||||||||||||||||
Primary Class | +6.01% | +6.56% | +6.55% | +7.53% | ||||||||||||
Institutional Class | +6.45% | +7.10% | +7.11% | +6.93% | ||||||||||||
Lehman Credit Bond IndexB | +4.26% | +5.90% | +6.56% | +8.10% | ||||||||||||
Lipper Corporate Debt Funds | ||||||||||||||||
BBB Rates AverageC | +4.62% | +5.77% | +5.91% | +5.61% |
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information for the Primary Class please visit www.leggmasonfunds.com; for the Institutional Class please call 1-888-425-6432. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods. Performance figures for periods shorter than one year represent cumulative figures and are not annualized.
The Fund returned 6.01% for the 12-month period ending, December 31, 2006. This compares favorably to the Fund’s benchmark, the Lehman Credit Bond Index, which returned 4.26%, and the 4.62% total return of the Lipper Corporate Debt Funds BBB Rates Average. Credit spreads in general narrowed during the period helping the asset class outperform U.S. treasuries. The Credit Index generated 119 basis pointsD of excess return versus similar duration treasuries. The Fund’s outperformance versus the benchmark is attributable to industry allocation, issue selection and an overweight to lower rated issuers. The Fund
A The inception date of the Primary Class is August 7, 1987. The inception date of the Institutional Class is December 1, 1995. Index returns are for periods beginning July 31, 1987.
B This index includes all publicly issued, fixed rate, non-convertible, investment grade, and domestic corporate debt. It also includes Yankee bonds, which are dollar-denominated, SEC-registered public, non-convertible debt issued or guaranteed by foreign sovereign governments, municipalities, governmental agencies, and international agencies. An investor cannot invest directly in an index.
C Average of the 176 funds comprising the Lipper universe of funds that invest at least 65% of assets in corporate and government debt issues rated in the top four grades.
D 100 basis points = 1%.
Annual Report to Shareholders 57
benefited from overweights to media cable and financial institutions, which returned 5.84% and 4.86%, respectively. The decision to maintain exposure to both GM and Ford greatly benefited the Fund as they each returned over 20% for the period. Finally, the Fund’s overweight to BBB-rated issues benefited relative performance as the returns for BBB-rated issues on average exceeded index returns.
Western Asset Management Company
January 19, 2007
58 Annual Report to Shareholders
Expense Example
Investment Grade Income Portfolio
As a shareholder of the Fund, you incur ongoing costs, including management fees, distribution and service (12b-1) fees on Primary Class shares; and other Fund expenses. These examples are intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds. Each example is based on an investment of $1,000 invested on July 1, 2006, and held through December 31, 2006.
Actual Expenses
The first line for each class in the table below provides information about actual account values and actual expenses for each class. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled “Expenses Paid During the Period” to estimate the expenses you paid on your account during this period.
Hypothetical Example for Comparison Purposes
The second line for each class in the table below provides information about hypothetical account values and hypothetical expenses based on the relevant class’s actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the class’s actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Fund and other funds. To do so, compare these 5% hypothetical examples with the 5% hypothetical examples for the relevant class that appear in the shareholder reports of other funds.
Beginning | Ending | Expenses PaidA | ||||||||||
Account | Account | During the | ||||||||||
Value | Value | Period | ||||||||||
7/1/06 | 12/31/06 | 7/1/06 to 12/31/06 | ||||||||||
Primary Class: | ||||||||||||
Actual | $ | 1,000.00 | $ | 1,072.50 | $ | 5.22 | ||||||
Hypothetical (5% return before expenses) | 1,000.00 | 1,020.16 | 5.09 | |||||||||
Institutional Class: | ||||||||||||
Actual | $ | 1,000.00 | $ | 1,074.20 | $ | 2.61 | ||||||
Hypothetical (5% return before expenses) | 1,000.00 | 1,022.68 | 2.55 |
A These calculations are based on expenses incurred in the most recent fiscal half-year. The dollar amounts shown as “Expenses Paid” are equal to the annualized expense ratios of 1.00% and 0.50% for the Primary Class and Institutional Class, respectively, multiplied by the average values over the period, multiplied by the number of days in the most recent fiscal half-year (184), and divided by 365.
Annual Report to Shareholders 59
Performance Information
Investment Grade Income Portfolio
The graphs on the following pages compare the Fund’s total returns to that of a closely matched broad-based securities market index. The graphs illustrate the cumulative total return of an initial $10,000 investment in Primary Class shares and an initial $1,000,000 investment in Institutional Class shares of the Fund, for the periods indicated. The lines for the Fund represent the total return after deducting all Fund investment management and other administrative expenses and the transaction costs of buying and selling securities. The line representing the securities market index does not include any transaction costs associated with buying and selling securities in the index or other administrative expenses. Both the Fund’s and the index’s results assume reinvestment of all dividends and distributions.
Total return measures investment performance in terms of appreciation or depreciation in a fund’s net asset value per share, plus dividends and any capital gain distributions. It assumes that dividends and distributions were reinvested at the time they were paid. Average annual returns tend to smooth out variations in a fund’s return, so that they differ from actual year-to-year results.
60 Annual Report to Shareholders
Performance Information — Continued
Growth of a $10,000 Investment — Primary Class
Periods Ended December 31, 2006
Cumulative | Average Annual | |||||||||
Total Return | Total Return | |||||||||
One Year | +6.01% | +6.01% | ||||||||
Five Years | +37.39% | +6.56% | ||||||||
Ten Years | +88.56% | +6.55% | ||||||||
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information please visit www.leggmasonfunds.com. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares.
A This index includes all publicly issued, fixed rate, non-convertible, investment grade, domestic corporate debt. It also includes Yankee bonds, which are dollar-denominated, SEC-registered public, non-convertible debt issued or guaranteed by foreign sovereign governments, municipalities, governmental agencies, and international agencies.
Annual Report to Shareholders 61
Growth of a $1,000,000 Investment — Institutional Class
Periods Ended December 31, 2006
Cumulative | Average Annual | |||||||||
Total Return | Total Return | |||||||||
One Year | +6.45% | +6.45% | ||||||||
Five Years | +40.88% | +7.10% | ||||||||
Ten Years | +98.70% | +7.11% | ||||||||
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information please call 1-888-425-6432. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares.
62 Annual Report to Shareholders
Performance Information — Continued
Portfolio Composition (as of December 31, 2006)B
Standard & Poor’s Debt RatingsC (as a percentage of the portfolio)
Maturity Schedule (as a percentage of the portfolio)
B The Fund is actively managed. As a result, the composition of its portfolio holdings and sectors is subject to change at any time.
C Standard & Poor’s Ratings Services provide capital markets with credit ratings for the evaluation and assessment of credit risk.
Annual Report to Shareholders 63
Portfolio of Investments
Legg Mason Investment Grade Income Portfolio
December 31, 2006
(Amounts in Thousands)
Rate | Maturity Date | Par | Value | |||||||||
Long-Term Securities — 96.1% | ||||||||||||
Corporate Bonds and Notes — 70.3% | ||||||||||||
Aerospace and Defense — 0.3% | ||||||||||||
L-3 Communications Corp. | 7.625% | 6/15/12 | $ | 1,000 | $ | 1,035 | ||||||
Airlines — 0.2% | ||||||||||||
Continental Airlines Inc. | 6.545% | 8/2/20 | 160 | 165 | ||||||||
Continental Airlines Inc. | 7.256% | 9/15/21 | 502 | 528 | ||||||||
693 | ||||||||||||
Automobiles — 1.7% | ||||||||||||
DaimlerChrysler NA Holding Corp. | 4.050% | 6/4/08 | 160 | 157 | ||||||||
DaimlerChrysler NA Holding Corp. | 7.200% | 9/1/09 | 260 | 270 | ||||||||
DaimlerChrysler NA Holding Corp. | 5.875% | 3/15/11 | 300 | 301 | ||||||||
DaimlerChrysler NA Holding Corp. | 7.300% | 1/15/12 | 735 | 780 | ||||||||
DaimlerChrysler NA Holding Corp. | 6.500% | 11/15/13 | 290 | 298 | ||||||||
DaimlerChrysler NA Holding Corp. | 8.500% | 1/18/31 | 850 | 1,012 | ||||||||
Ford Motor Co. | 7.450% | 7/16/31 | 1,975 | 1,550 | ||||||||
Ford Motor Co. | 8.900% | 1/15/32 | 370 | 332 | ||||||||
General Motors Corp. | 8.250% | 7/15/23 | 650 | 604 | ||||||||
General Motors Corp. | 8.375% | 7/15/33 | 1,990 | 1,841 | ||||||||
7,145 | ||||||||||||
64 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Investment Grade Income Portfolio — Continued
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Beverages — 0.2% | ||||||||||||
Foster’s Finance Corp. | 4.875% | 10/1/14 | $ | 840 | $ | 788 | A | |||||
Building Products — N.M. | ||||||||||||
American Standard Inc. | 8.250% | 6/1/09 | 37 | 39 | ||||||||
American Standard Inc. | 7.625% | 2/15/10 | 5 | 5 | ||||||||
44 | ||||||||||||
Capital Markets — 2.5% | ||||||||||||
BankAmerica Capital III | 5.944% | 1/15/27 | 585 | 567 | B | |||||||
Lehman Brothers Holdings Inc. | 5.750% | 1/3/17 | 3,980 | 4,031 | ||||||||
Merrill Lynch and Co. Inc. | 6.000% | 2/17/09 | 800 | 813 | ||||||||
Morgan Stanley | 5.050% | 1/21/11 | 900 | 894 | ||||||||
Morgan Stanley | 4.750% | 4/1/14 | 65 | 62 | ||||||||
The Bear Stearns Cos. Inc. | 5.500% | 8/15/11 | 1,650 | 1,666 | ||||||||
The Bear Stearns Cos. Inc. | 5.550% | 1/22/17 | 320 | 320 | ||||||||
The Goldman Sachs Group Inc. | 6.345% | 2/15/34 | 2,025 | 2,050 | ||||||||
10,403 | ||||||||||||
Chemicals — 0.7% | ||||||||||||
E.I. du Pont de Nemours and Co. | 4.875% | 4/30/14 | 1,100 | 1,064 | ||||||||
The Dow Chemical Co. | 6.000% | 10/1/12 | 750 | 771 | ||||||||
The Dow Chemical Co. | 7.375% | 11/1/29 | 800 | 925 | ||||||||
2,760 | ||||||||||||
Commercial Banks — 4.5% | ||||||||||||
CBA Capital Trust I | 5.805% | 6/30/49 | 3,510 | 3,525 | A | |||||||
Comerica Bank | 5.750% | 11/21/16 | 990 | 989 | ||||||||
KeyBank NA | 5.800% | 7/1/14 | 5 | 5 | ||||||||
Rabobank Capital Funding Trust II | 5.260% | 12/31/49 | 320 | 313 | A,C | |||||||
Rabobank Capital Funding Trust III | 5.254% | 10/21/49 | 3,120 | 3,008 | A,C | |||||||
RBS Capital Trust III | 5.512% | 9/30/49 | 4,020 | 3,974 | C |
Annual Report to Shareholders 65
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Commercial Banks — Continued | ||||||||||||
SunTrust Bank | 5.000% | 9/1/15 | $ | 770 | $ | 747 | ||||||
SunTrust Capital VIII | 6.100% | 12/1/66 | 1,070 | 1,041 | C | |||||||
UnionBanCal Corp. | 5.250% | 12/16/13 | 785 | 771 | ||||||||
Wachovia Capital Trust III | 5.800% | 3/15/42 | 520 | 524 | C | |||||||
Wachovia Corp. | 5.625% | 10/15/16 | 2,300 | 2,320 | ||||||||
Wells Fargo Capital X | 5.950% | 12/15/36 | 1,740 | 1,705 | C | |||||||
18,922 | ||||||||||||
Commercial Services and Supplies — 0.3% | ||||||||||||
Waste Management Inc. | 6.375% | 11/15/12 | 310 | 325 | ||||||||
Waste Management Inc. | 7.375% | 5/15/29 | 690 | 779 | ||||||||
1,104 | ||||||||||||
Communications Equipment — N.M. | ||||||||||||
Motorola Inc. | 7.625% | 11/15/10 | 135 | 145 | ||||||||
Computers and Peripherals — 0.4% | ||||||||||||
International Business Machines Corp. | 4.750% | 11/29/12 | 1,750 | 1,708 | ||||||||
Consumer Finance — 5.7% | ||||||||||||
American Express Co. | 6.800% | 9/1/66 | 2,760 | 2,943 | C | |||||||
Capital One Financial Corp. | 7.125% | 8/1/08 | 340 | 349 | ||||||||
Caterpillar Financial Services Corp. | 4.500% | 6/15/09 | 1,040 | 1,023 | ||||||||
Ford Motor Credit Co. | 7.375% | 10/28/09 | 2,970 | 2,976 | ||||||||
Ford Motor Credit Co. | 7.375% | 2/1/11 | 2,390 | 2,366 | ||||||||
Ford Motor Credit Co. | 10.610% | 6/15/11 | 6,828 | 7,288 | A,B | |||||||
Ford Motor Credit Co. | 7.250% | 10/25/11 | 2,410 | 2,360 | ||||||||
GMAC LLC | 6.125% | 8/28/07 | 2,680 | 2,681 | ||||||||
GMAC LLC | 6.311% | 11/30/07 | 320 | 318 | ||||||||
GMAC LLC | 5.625% | 5/15/09 | 590 | 585 |
66 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Investment Grade Income Portfolio — Continued
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Consumer Finance — Continued | ||||||||||||
GMAC LLC | 6.875% | 9/15/11 | $ | 750 | $ | 769 | ||||||
GMAC LLC | 0.000% | 6/15/15 | 40 | 22 | D | |||||||
John Deere Capital Corp. | 4.500% | 8/22/07 | 5 | 5 | ||||||||
23,685 | ||||||||||||
Diversified Financial Services — 13.7% | ||||||||||||
AIG SunAmerica Global Financing VI | 6.300% | 5/10/11 | 5,170 | 5,380 | A | |||||||
American Express Travel Related Services Co. Inc. | 5.250% | 11/21/11 | 830 | 829 | A | |||||||
American General Finance Corp. | 5.750% | 9/15/16 | 830 | 842 | ||||||||
Associates Corp. of North America | 8.150% | 8/1/09 | 775 | 829 | ||||||||
Bank of America Corp. | 4.750% | 8/15/13 | 110 | 106 | ||||||||
Bank of America Corp. | 5.420% | 3/15/17 | 3,100 | 3,066 | A | |||||||
Beaver Valley II Funding | 9.000% | 6/1/17 | 1,100 | 1,235 | ||||||||
Boeing Capital Corp. | 6.500% | 2/15/12 | 1,000 | 1,054 | ||||||||
Boeing Capital Corp. | 5.800% | 1/15/13 | 530 | 544 | ||||||||
Capital One Bank | 4.875% | 5/15/08 | 150 | 149 | ||||||||
Capital One Bank | 5.750% | 9/15/10 | 870 | 884 | ||||||||
Capital One Bank | 6.500% | 6/13/13 | 690 | 727 | ||||||||
Chase Capital II | 5.871% | 2/1/27 | 1,980 | 1,896 | B | |||||||
Citigroup Inc. | 6.125% | 8/25/36 | 1,530 | 1,593 | ||||||||
Countrywide Home Loans Inc. | 3.250% | 5/21/08 | 1,200 | 1,167 | ||||||||
Deutsche Bank Capital Funding Trust | 5.628% | 1/19/49 | 1,760 | 1,730 | A,C | |||||||
General Electric Capital Corp. | 4.000% | 6/15/09 | 3,640 | 3,544 | ||||||||
General Electric Capital Corp. | 3.750% | 12/15/09 | 4,900 | 4,717 | ||||||||
General Electric Capital Corp. | 6.000% | 6/15/12 | 960 | 994 | ||||||||
General Electric Capital Corp. | 6.750% | 3/15/32 | 5 | 6 | ||||||||
HSBC Finance Capital Trust IX | 5.911% | 11/30/35 | 2,500 | 2,512 | C | |||||||
HSBC Finance Corp. | 5.700% | 6/1/11 | 1,280 | 1,302 | ||||||||
HSBC Finance Corp. | 5.500% | 1/19/16 | 1,610 | 1,618 | ||||||||
ILFC E-Capital Trust II | 6.250% | 12/21/65 | 2,320 | 2,357 | A,C |
Annual Report to Shareholders 67
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Diversified Financial Services — Continued | ||||||||||||
JPMorgan Chase and Co. | 5.125% | 9/15/14 | $ | 5 | $ | 5 | ||||||
JPMorgan Chase and Co. | 4.891% | 9/1/15 | 1,035 | 1,014 | C | |||||||
Mizuho Preferred Capital Co. LLC | 8.790% | 12/29/49 | 1,520 | 1,590 | A,C | |||||||
National Rural Utilities Cooperative Finance Corp. | 7.250% | 3/1/12 | 1,700 | 1,847 | ||||||||
Residential Capital Corp. | 6.125% | 11/21/08 | 1,340 | 1,347 | ||||||||
Residential Capital Corp. | 6.000% | 2/22/11 | 2,400 | 2,396 | ||||||||
SB Treasury Co. LLC | 9.400% | 6/30/49 | 840 | 884 | A,C | |||||||
UBS Preferred Funding Trust V | 6.243% | 5/15/49 | 3,030 | 3,138 | C | |||||||
Unilever Capital Corp. | 7.125% | 11/1/10 | 480 | 510 | ||||||||
ZFS Finance USA Trust II | 6.450% | 12/15/65 | 4,990 | 5,089 | A,C | |||||||
56,901 | ||||||||||||
Diversified Telecommunication Services — 3.8% | ||||||||||||
AT&T Corp. | 8.000% | 11/15/31 | 1,200 | 1,489 | ||||||||
AT&T Inc. | 5.100% | 9/15/14 | 1,910 | 1,854 | ||||||||
BellSouth Corp. | 4.750% | 11/15/12 | 830 | 801 | ||||||||
Embarq Corp. | 7.082% | 6/1/16 | 1,500 | 1,527 | ||||||||
Qwest Corp. | 5.625% | 11/15/08 | 550 | 551 | ||||||||
TCI Communications Financing III | 9.650% | 3/31/27 | 3,350 | 3,535 | ||||||||
Verizon Global Funding Corp. | 6.875% | 6/15/12 | 1,030 | 1,100 | ||||||||
Verizon Global Funding Corp. | 7.750% | 6/15/32 | 375 | 440 | ||||||||
Verizon Global Funding Corp. | 5.850% | 9/15/35 | 1,580 | 1,513 | ||||||||
Verizon New York Inc. | 6.875% | 4/1/12 | 2,810 | 2,913 | ||||||||
15,723 | ||||||||||||
Electric Utilities — 4.3% | ||||||||||||
Alabama Power Co. | 3.125% | 5/1/08 | 920 | 894 | ||||||||
Duke Energy Corp. | 5.625% | 11/30/12 | 270 | 275 | ||||||||
Exelon Corp. | 6.750% | 5/1/11 | 1,370 | 1,431 | ||||||||
FirstEnergy Corp. | 6.450% | 11/15/11 | 2,285 | 2,383 |
68 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Investment Grade Income Portfolio — Continued
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Electric Utilities — Continued | ||||||||||||
FirstEnergy Corp. | 7.375% | 11/15/31 | $ | 4,440 | $ | 5,056 | ||||||
Niagara Mohawk Power Corp. | 7.750% | 10/1/08 | 1,010 | 1,046 | ||||||||
Pacific Gas and Electric Co. | 6.050% | 3/1/34 | 2,380 | 2,400 | ||||||||
Tampa Electric Co. | 6.375% | 8/15/12 | 380 | 397 | ||||||||
The Cleveland Electric Illuminating Co. | 5.650% | 12/15/13 | 940 | 937 | ||||||||
The Cleveland Electric Illuminating Co. | 7.880% | 11/1/17 | 850 | 994 | ||||||||
The Detroit Edison Co. | 5.200% | 10/15/12 | 1,260 | 1,241 | ||||||||
TXU Energy Co. | 7.000% | 3/15/13 | 930 | 973 | ||||||||
18,027 | ||||||||||||
Energy Equipment and Services — 0.5% | ||||||||||||
CenterPoint Energy Resources Corp. | 7.875% | 4/1/13 | 1,010 | 1,121 | ||||||||
Pride International Inc. | 7.375% | 7/15/14 | 800 | 826 | ||||||||
1,947 | ||||||||||||
Food and Staples Retailing — 0.9% | ||||||||||||
CVS Corp. | 5.750% | 8/15/11 | 820 | 830 | ||||||||
Safeway Inc. | 7.500% | 9/15/09 | 600 | 630 | ||||||||
Safeway Inc. | 5.800% | 8/15/12 | 750 | 751 | ||||||||
The Kroger Co. | 8.000% | 9/15/29 | 1,000 | 1,154 | ||||||||
Wal-Mart Stores Inc. | 6.875% | 8/10/09 | 475 | 495 | ||||||||
3,860 | ||||||||||||
Food Products — 1.0% | ||||||||||||
Ahold Finance USA Inc. | 8.250% | 7/15/10 | 960 | 1,040 | ||||||||
Kellogg Co. | 6.600% | 4/1/11 | 1,000 | 1,049 |
Annual Report to Shareholders 69
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Food Products — Continued | ||||||||||||
Kellogg Co. | 7.450% | 4/1/31 | $ | 650 | $ | 776 | ||||||
Kraft Foods Inc. | 6.250% | 6/1/12 | 1,360 | 1,413 | ||||||||
4,278 | ||||||||||||
Gas Utilities — 0.3% | ||||||||||||
Panhandle Eastern Pipe Line Co. | 4.800% | 8/15/08 | 1,170 | 1,153 | ||||||||
Health Care Equipment and Supplies — 0.4% | ||||||||||||
Baxter International Inc. | 5.900% | 9/1/16 | 1,430 | 1,469 | ||||||||
Health Care Providers and Services — 4.1% | ||||||||||||
Aetna Inc. | 5.750% | 6/15/11 | 1,490 | 1,513 | ||||||||
Cardinal Health Inc. | 5.800% | 10/15/16 | 1,100 | 1,097 | A | |||||||
Coventry Health Care Inc. | 5.875% | 1/15/12 | 1,050 | 1,037 | ||||||||
HCA Inc. | 6.300% | 10/1/12 | 1,790 | 1,638 | ||||||||
HCA Inc. | 6.250% | 2/15/13 | 2,130 | 1,885 | ||||||||
HCA Inc. | 5.750% | 3/15/14 | 150 | 124 | ||||||||
HCA Inc. | 9.125% | 11/15/14 | 1,100 | 1,176 | A | |||||||
HCA Inc. | 9.250% | 11/15/16 | 1,380 | 1,478 | A | |||||||
Humana Inc. | 6.450% | 6/1/16 | 600 | 617 | ||||||||
Quest Diagnostics Inc. | 5.125% | 11/1/10 | 790 | 778 | ||||||||
Tenet Healthcare Corp. | 9.875% | 7/1/14 | 2,310 | 2,350 | ||||||||
Tenet Healthcare Corp. | 6.875% | 11/15/31 | 750 | 602 | ||||||||
Universal Health Services Inc. | 7.125% | 6/30/16 | 1,450 | 1,514 | ||||||||
WellPoint Inc. | 5.000% | 12/15/14 | 1,330 | 1,288 | ||||||||
17,097 | ||||||||||||
70 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Investment Grade Income Portfolio — Continued
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Hotels, Restaurants and Leisure — 0.6% | ||||||||||||
Harrah’s Operating Co. Inc. | 5.500% | 7/1/10 | $ | 770 | $ | 754 | ||||||
Harrah’s Operating Co. Inc. | 5.750% | 10/1/17 | 2,110 | 1,768 | ||||||||
2,522 | ||||||||||||
Household Durables — 0.5% | ||||||||||||
Centex Corp. | 5.125% | 10/1/13 | 420 | 402 | ||||||||
DR Horton Inc. | 5.250% | 2/15/15 | 610 | 569 | ||||||||
Pulte Homes Inc. | 6.250% | 2/15/13 | 385 | 391 | ||||||||
The Black and Decker Corp. | 5.750% | 11/15/16 | 810 | 803 | ||||||||
2,165 | ||||||||||||
Household Products — 0.1% | ||||||||||||
The Clorox Co. | 5.000% | 1/15/15 | 350 | 339 | ||||||||
The Procter and Gamble Co. | 4.300% | 8/15/08 | 200 | 197 | ||||||||
536 | ||||||||||||
Independent Power Producers and Energy Traders — 1.0% | ||||||||||||
Dynegy Holdings Inc. | 8.750% | 2/15/12 | 1,690 | 1,792 | ||||||||
TXU Corp. | 6.550% | 11/15/34 | 2,730 | 2,553 | ||||||||
4,345 | ||||||||||||
Insurance — 1.7% | ||||||||||||
ASIF Global Financing XIX | 4.900% | 1/17/13 | 90 | 88 | A | |||||||
Liberty Mutual Group | 5.750% | 3/15/14 | 720 | 717 | A | |||||||
Liberty Mutual Group | 7.500% | 8/15/36 | 900 | 985 | A | |||||||
MetLife Inc. | 6.400% | 12/15/36 | 2,060 | 2,069 | C | |||||||
Prudential Financial Inc. | 5.700% | 12/14/36 | 920 | 895 | ||||||||
The St. Paul Travelers Cos. Inc. | 6.250% | 6/20/16 | 780 | 819 |
Annual Report to Shareholders 71
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Insurance — Continued | ||||||||||||
Willis North America Inc. | 5.125% | 7/15/10 | $ | 760 | $ | 741 | ||||||
Willis North America Inc. | 5.625% | 7/15/15 | 660 | 632 | ||||||||
6,946 | ||||||||||||
IT Services — 0.4% | ||||||||||||
Electronic Data Systems Corp. | 7.125% | 10/15/09 | 530 | 553 | ||||||||
Electronic Data Systems Corp. | 6.500% | 8/1/13 | 500 | 503 | E | |||||||
Electronic Data Systems Corp. | 7.450% | 10/15/29 | 570 | 624 | ||||||||
1,680 | ||||||||||||
Leisure Equipment and Products — 0.3% | ||||||||||||
Eastman Kodak Co. | 3.625% | 5/15/08 | 975 | 940 | ||||||||
Eastman Kodak Co. | 7.250% | 11/15/13 | 500 | 497 | ||||||||
1,437 | ||||||||||||
Media — 4.7% | ||||||||||||
Clear Channel Communications Inc. | 4.400% | 5/15/11 | 1,210 | 1,091 | ||||||||
Clear Channel Communications Inc. | 5.500% | 9/15/14 | 500 | 422 | ||||||||
Comcast Cable Communications Inc. | 6.750% | 1/30/11 | 960 | 1,006 | ||||||||
Comcast Cable Holdings LLC | 7.125% | 2/15/28 | 180 | 192 | ||||||||
Comcast Corp. | 7.050% | 3/15/33 | 1800 | 1925 | ||||||||
Comcast Corp. | 6.450% | 3/15/37 | 1,100 | 1,101 | ||||||||
COX Communications Inc. | 4.625% | 1/15/10 | 1,410 | 1,380 | ||||||||
CSC Holdings Inc. | 7.625% | 7/15/18 | 1,500 | 1,461 | ||||||||
Liberty Media LLC | 7.875% | 7/15/09 | 1,000 | 1,043 | ||||||||
Liberty Media LLC | 8.500% | 7/15/29 | 340 | 342 | ||||||||
Liberty Media LLC | 8.250% | 2/1/30 | 120 | 118 |
72 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Investment Grade Income Portfolio — Continued
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Media — Continued | ||||||||||||
News America Inc. | 6.550% | 3/15/33 | $ | 1,495 | $ | 1,502 | ||||||
News America Inc. | 6.200% | 12/15/34 | 115 | 111 | ||||||||
The Walt Disney Co. | 6.200% | 6/20/14 | 1,220 | 1,277 | ||||||||
Time Warner Entertainment Co. LP | 8.375% | 7/15/33 | 505 | 610 | ||||||||
Time Warner Inc. | 6.875% | 5/1/12 | 1,350 | 1,427 | ||||||||
Time Warner Inc. | 9.125% | 1/15/13 | 1,130 | 1,316 | ||||||||
Time Warner Inc. | 7.700% | 5/1/32 | 1,015 | 1,145 | ||||||||
Viacom Inc. | 7.700% | 7/30/10 | 90 | 96 | ||||||||
Viacom Inc. | 5.750% | 4/30/11 | 990 | 990 | ||||||||
Viacom Inc. | 5.625% | 8/15/12 | 1,095 | 1,080 | ||||||||
19,635 | ||||||||||||
Multi-Utilities — 1.0% | ||||||||||||
Dominion Resources Inc | 5.150% | 7/15/15 | 1,140 | 1,104 | ||||||||
DTE Energy Co. | 6.375% | 4/15/33 | 350 | 360 | ||||||||
Sempra Energy | 5.845% | 5/21/08 | 1,685 | 1,686 | B | |||||||
Xcel Energy Inc. | 7.000% | 12/1/10 | 900 | 949 | ||||||||
4,099 | ||||||||||||
Multiline Retail — 0.6% | ||||||||||||
May Department Stores Co. | 5.750% | 7/15/14 | 1,070 | 1,047 | ||||||||
May Department Stores Co. | 6.700% | 7/15/34 | 490 | 483 | ||||||||
Target Corp. | 5.875% | 3/1/12 | 860 | 884 | ||||||||
2,414 | ||||||||||||
Oil, Gas and Consumable Fuels — 6.6% | ||||||||||||
Anadarko Petroleum Corp. | 5.950% | 9/15/16 | 430 | 431 | ||||||||
Apache Corp. | 6.250% | 4/15/12 | 1,010 | 1,049 | ||||||||
Conoco Inc. | 6.950% | 4/15/29 | 740 | 841 | ||||||||
ConocoPhillips | 4.750% | 10/15/12 | 2,290 | 2,233 |
Annual Report to Shareholders 73
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Oil, Gas and Consumable Fuels — Continued | ||||||||||||
Devon Financing Corp. U.L.C. | 7.875% | 9/30/31 | $ | 560 | $ | 674 | ||||||
Duke Capital LLC | 6.250% | 2/15/13 | 340 | 350 | ||||||||
El Paso Corp. | 7.800% | 8/1/31 | 1,660 | 1,814 | ||||||||
El Paso Corp. | 7.750% | 1/15/32 | 340 | 372 | ||||||||
Hess Corp. | 7.875% | 10/1/29 | 3,770 | 4,401 | ||||||||
Kerr-McGee Corp. | 6.950% | 7/1/24 | 220 | 234 | ||||||||
Kerr-McGee Corp. | 7.875% | 9/15/31 | 4,700 | 5,607 | ||||||||
Kinder Morgan Energy Partners LP | 7.125% | 3/15/12 | 1,430 | 1,518 | ||||||||
Ocean Energy Inc. | 4.375% | 10/1/07 | 965 | 957 | ||||||||
Pemex Project Funding Master Trust | 5.970% | 12/3/12 | 107 | 107 | A,B | |||||||
Pemex Project Funding Master Trust | 6.625% | 6/15/35 | 2,900 | 2,967 | ||||||||
Tennessee Gas Pipeline Co. | 8.375% | 6/15/32 | 1,000 | 1,215 | ||||||||
The Williams Cos. Inc. | 7.625% | 7/15/19 | 2,000 | 2,140 | ||||||||
Valero Energy Corp. | 6.875% | 4/15/12 | 565 | 597 | ||||||||
27,507 | ||||||||||||
Paper and Forest Products — 0.3% | ||||||||||||
Weyerhaeuser Co. | 6.750% | 3/15/12 | 1,120 | 1,175 | ||||||||
Pharmaceuticals — 0.5% | ||||||||||||
Wyeth | 6.950% | 3/15/11 | 2,000 | 2,124 | E | |||||||
Real Estate Investment Trusts — 1.6% | ||||||||||||
EOP Operating LP | 6.750% | 2/15/12 | 1,500 | 1,620 | ||||||||
Health Care REIT Inc. | 5.875% | 5/15/15 | 1,440 | 1,422 | ||||||||
iStar Financial Inc. | 5.375% | 4/15/10 | 10 | 10 | ||||||||
iStar Financial Inc. | 5.950% | 10/15/13 | 3,610 | 3,628 | A | |||||||
6,680 | ||||||||||||
74 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Investment Grade Income Portfolio — Continued
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Road and Rail — 0.6% | ||||||||||||
Burlington Northern Rail Road Co. | 6.960% | 3/22/09 | $ | 131 | $ | 133 | ||||||
Burlington Northern Rail Road Co. | 7.330% | 6/23/10 | 105 | 109 | ||||||||
CSX Transportation Inc. | 7.875% | 5/15/43 | 252 | 313 | ||||||||
Norfolk Southern Corp. | 7.875% | 5/15/43 | 348 | 436 | ||||||||
Union Pacific Corp. | 4.875% | 1/15/15 | 1,740 | 1,668 | ||||||||
2,659 | ||||||||||||
Thrifts and Mortgage Finance — 0.9% | ||||||||||||
BB&T Capital Trust II | 6.750% | 6/7/36 | 1,750 | 1,911 | ||||||||
Countrywide Home Loans Inc. | 4.125% | 9/15/09 | 340 | 330 | ||||||||
Washington Mutual Inc. | 4.200% | 1/15/10 | 700 | 678 | ||||||||
Washington Mutual Inc. | 4.625% | 4/1/14 | 1,000 | 936 | ||||||||
3,855 | ||||||||||||
Tobacco — 0.6% | ||||||||||||
Altria Group Inc. | 7.000% | 11/4/13 | 1,385 | 1,505 | ||||||||
Reynolds American Inc. | 7.875% | 5/15/09 | 860 | 896 | ||||||||
2,401 | ||||||||||||
Wireless Telecommunication Services — 2.8% | ||||||||||||
New Cingular Wireless Services Inc. | 7.500% | 5/1/07 | 1,500 | 1,509 | ||||||||
New Cingular Wireless Services Inc. | 8.125% | 5/1/12 | 570 | 641 | ||||||||
New Cingular Wireless Services Inc. | 8.750% | 3/1/31 | 980 | 1,274 | ||||||||
Nextel Communications Inc. | 5.950% | 3/15/14 | 469 | 457 | ||||||||
Nextel Communications Inc. | 7.375% | 8/1/15 | 1,600 | 1,641 | ||||||||
Sprint Capital Corp. | 8.375% | 3/15/12 | 1,860 | 2,067 |
Annual Report to Shareholders 75
Rate | Maturity Date | Par | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Wireless Telecommunication Services — Continued | ||||||||||||
Sprint Capital Corp. | 8.750% | 3/15/32 | $ | 2,650 | $ | 3,189 | ||||||
Sprint Nextel Corp. | 6.000% | 12/1/16 | 990 | 965 | ||||||||
11,743 | ||||||||||||
Total Corporate Bonds and Notes (Cost — $291,097) | 292,810 | |||||||||||
U.S. Government and Agency Obligations — 3.6% | ||||||||||||
Fixed Rate Securities — 3.6% | ||||||||||||
Tennessee Valley Authority | 5.375% | 11/13/08 | 150 | 151 | ||||||||
United States Treasury Bonds | 6.250% | 5/15/30 | 40 | 48 | ||||||||
United States Treasury Bonds | 4.500% | 2/15/36 | 1,925 | 1,831 | ||||||||
United States Treasury Notes | 4.500% | 2/15/09 | 2,035 | 2,023 | ||||||||
United States Treasury Notes | 4.875% | 7/31/11 | 6,000 | 6,042 | ||||||||
United States Treasury Notes | 4.500% | 9/30/11 | 3,260 | 3,231 | ||||||||
United States Treasury Notes | 4.625% | 10/31/11 | 180 | 179 | ||||||||
United States Treasury Notes | 3.625% | 5/15/13 | 950 | 895 | ||||||||
United States Treasury Notes | 4.625% | 11/15/16 | 730 | 725 | ||||||||
Total U.S. Government and Agency Obligations (Cost — $15,133) | 15,125 | |||||||||||
U.S. Government Agency Mortgage-Backed Securities — N.M. | ||||||||||||
Indexed SecuritiesB — N.M. | ||||||||||||
Freddie Mac | 6.939% | 9/1/24 | 65 | 67 | ||||||||
Total U.S. Government Agency Mortgage-Backed Securities (Cost — $65) | 67 | |||||||||||
Yankee BondsF — 22.2% | ||||||||||||
Automobiles — 0.3% | ||||||||||||
General Motors Nova Scotia Finance Co. | 6.850% | 10/15/08 | 1,160 | 1,154 | ||||||||
Beverages — 0.3% | ||||||||||||
Molson Coors Capital Finance | 4.850% | 9/22/10 | 1,305 | 1,279 | ||||||||
76 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Investment Grade Income Portfolio — Continued
Rate | Maturity Date | Par | Value | |||||||||
Yankee Bonds — Continued | ||||||||||||
Commercial Banks — 8.8% | ||||||||||||
AES El Salvador Trust | 6.750% | 2/1/16 | $ | 2,080 | $ | 2,069 | A | |||||
Banco Mercantil del Norte SA | 6.135% | 10/13/16 | 2,030 | 2,031 | A,C | |||||||
BOI Capital Funding | 5.571% | 2/1/49 | 2,000 | 1,953 | A,C | |||||||
Corp. Andina de Fomento | 5.730% | 1/26/07 | 1,260 | 1,260 | B | |||||||
Glitnir Banki Hf | 6.330% | 7/28/11 | 1,100 | 1,129 | A | |||||||
Glitnir Banki Hf | 6.693% | 6/15/16 | 1,900 | 1,961 | A,C | |||||||
Glitnir Banki Hf | 7.451% | 9/14/49 | 560 | 590 | A,C | |||||||
HBOS Capital Funding LP | 6.071% | 6/30/49 | 1,490 | 1,511 | A,C | |||||||
HBOS Treasury Services PLC | 4.000% | 9/15/09 | 1,080 | 1,047 | A | |||||||
HSBC Capital Funding LP | 4.610% | 6/27/49 | 760 | 708 | A,C | |||||||
Kaupthing Bank Hf | 6.061% | 4/12/11 | 1,440 | 1,450 | A,B | |||||||
Kaupthing Bank Hf | 5.750% | 10/4/11 | 1,340 | 1,339 | A | |||||||
Kaupthing Bank Hf | 7.125% | 5/19/16 | 3,585 | 3,803 | A | |||||||
Mizuho Financial Group | 5.790% | 4/15/14 | 3,565 | 3,586 | A | |||||||
Resona Preferred Global Securities | 7.191% | 7/30/49 | 2,880 | 3,005 | A,C | |||||||
RSHB Capital SA | 7.175% | 5/16/13 | 3,690 | 3,888 | A | |||||||
Shinsei Finance Cayman Ltd. | 6.418% | 7/20/49 | 3,055 | 3,051 | A,C | |||||||
Sumitomo Mitsui Banking Corp. | 5.625% | 10/15/49 | 730 | 714 | A,C | |||||||
VTB Capital SA for Vneshtorgbank | 5.970% | 8/1/08 | 1,560 | 1,561 | A,B | |||||||
36,656 | ||||||||||||
Consumer Finance — 0.2% | ||||||||||||
HSBC Holdings PLC | 5.250% | 12/12/12 | 830 | 827 | ||||||||
Diversified Financial Services — 1.1% | ||||||||||||
AIFUL CORP. | 5.000% | 8/10/10 | 2,685 | 2,606 | A | |||||||
SMFG Preferred Capital | 6.078% | 1/25/49 | 230 | 226 | A,C | |||||||
TNK-BP Finance SA | 7.500% | 7/18/16 | 870 | 925 | A | |||||||
UFJ Finance Aruba AEC | 6.750% | 7/15/13 | 920 | 982 | ||||||||
4,739 | ||||||||||||
Annual Report to Shareholders 77
Rate | Maturity Date | Par | Value | |||||||||
Yankee Bonds — Continued | ||||||||||||
Diversified Telecommunication Services — 4.0% | ||||||||||||
British Telecommunications PLC | 8.625% | 12/15/10 | $ | 900 | $ | 1,004 | E | |||||
British Telecommunications PLC | 9.125% | 12/15/30 | 420 | 575 | E | |||||||
Deutsche Telekom International Finance BV | 8.250% | 6/15/30 | 1,400 | 1,721 | ||||||||
Deutsche Telekom International Finance BV | 9.250% | 6/1/32 | 670 | 876 | ||||||||
France Telecom SA | 7.750% | 3/1/11 | 3,000 | 3,268 | ||||||||
France Telecom SA | 8.500% | 3/1/31 | 340 | 446 | ||||||||
Intelsat Ltd. | 7.625% | 4/15/12 | 32 | 30 | ||||||||
Intelsat Ltd. | 6.500% | 11/1/13 | 1,333 | 1,133 | ||||||||
Koninklijke (Royal) KPN NV | 8.000% | 10/1/10 | 990 | 1,068 | ||||||||
Koninklijke (Royal) KPN NV | 8.375% | 10/1/30 | 655 | 750 | ||||||||
Tele Norte Leste Participacoes SA | 8.000% | 12/18/13 | 1,080 | 1,148 | ||||||||
Telecom Italia Capital | 7.200% | 7/18/36 | 2,070 | 2,163 | ||||||||
Telefonica Emisiones S.A.U | 7.045% | 6/20/36 | 800 | 850 | ||||||||
Telefonica Europe BV | 7.750% | 9/15/10 | 800 | 859 | ||||||||
Telus Corp. | 7.500% | 6/1/07 | 700 | 705 | ||||||||
16,596 | ||||||||||||
Electric Utilities — 1.0% | ||||||||||||
Enersis SA | 7.375% | 1/15/14 | 850 | 915 | ||||||||
Enersis SA/Cayman Island | 7.400% | 12/1/16 | 1,211 | 1,331 | ||||||||
Hydro Quebec | 7.500% | 4/1/16 | 1,625 | 1,887 | ||||||||
4,133 | ||||||||||||
Foreign Government Obligations — 2.6% | ||||||||||||
Federative Republic of Brazil | 8.875% | 4/15/24 | 240 | 299 | ||||||||
Federative Republic of Brazil | 10.125% | 5/15/27 | 740 | 1,040 | ||||||||
Federative Republic of Brazil | 7.125% | 1/20/37 | 340 | 365 | ||||||||
Province of Nova Scotia | 5.750% | 2/27/12 | 1,000 | 1,030 | ||||||||
Republic of Colombia | 7.375% | 9/18/37 | 177 | 190 |
78 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Investment Grade Income Portfolio — Continued
Rate | Maturity Date | Par | Value | |||||||||
Yankee Bonds — Continued | ||||||||||||
Foreign Government Obligations — Continued | ||||||||||||
Republic of Panama | 7.125% | 1/29/26 | $ | 500 | $ | 540 | ||||||
Republic of Panama | 6.700% | 1/26/36 | 353 | 367 | ||||||||
Russian Federation | 5.000% | 3/31/30 | 980 | 1,106 | A,C | |||||||
United Mexican States | 11.500% | 5/15/26 | 160 | 259 | ||||||||
United Mexican States | 8.300% | 8/15/31 | 820 | 1,048 | ||||||||
United Mexican States | 7.500% | 4/8/33 | 3,762 | 4,439 | ||||||||
10,683 | ||||||||||||
Industrial Conglomerates — 0.8% | ||||||||||||
Tyco International Group SA | 6.375% | 10/15/11 | 250 | 262 | ||||||||
Tyco International Group SA | 7.000% | 6/15/28 | 554 | 636 | ||||||||
Tyco International Group SA | 6.875% | 1/15/29 | 2,051 | 2,331 | ||||||||
3,229 | ||||||||||||
Insurance — 0.5% | ||||||||||||
Axa | 8.600% | 12/15/30 | 1,630 | 2,113 | ||||||||
XL Capital Ltd. | 5.250% | 9/15/14 | 20 | 20 | ||||||||
2,133 | ||||||||||||
Media — 0.2% | ||||||||||||
British Sky Broadcasting Group PLC | 6.875% | 2/23/09 | 870 | 896 | ||||||||
Metals and Mining — 0.8% | ||||||||||||
Vale Overseas Ltd. | 6.250% | 1/23/17 | 1,474 | 1,481 | ||||||||
Vale Overseas Ltd. | 6.875% | 11/21/36 | 1,800 | 1,846 | ||||||||
3,327 | ||||||||||||
Annual Report to Shareholders 79
Rate | Maturity Date | Par | Value | |||||||||
Yankee Bonds — Continued | ||||||||||||
Oil, Gas and Consumable Fuels — 1.4% | ||||||||||||
Anadarko Finance Co. | 6.750% | 5/1/11 | $ | 10 | $ | 10 | ||||||
Conoco Funding Co. | 6.350% | 10/15/11 | 520 | 544 | ||||||||
Gazprom Capital | 6.212% | 11/22/16 | 1,180 | 1,188 | A | |||||||
Petrobras International Finance Co. | 6.125% | 10/6/16 | 2,186 | 2,208 | ||||||||
Petroliam Nasional Bhd | 7.625% | 10/15/26 | 610 | 747 | A | |||||||
Petronas Capital Ltd. | 7.875% | 5/22/22 | 770 | 948 | A | |||||||
5,645 | ||||||||||||
Wireless Telecommunication Services — 0.2% | ||||||||||||
Rogers Wireless Inc. | 6.375% | 3/1/14 | 1,000 | 1,012 | ||||||||
Total Yankee Bonds (Cost — $89,182) | 92,309 | |||||||||||
Total Long-Term Securities (Cost — $395,477) | 400,311 | |||||||||||
80 Annual Report to Shareholders
Portfolio of Investments — Continued
Legg Mason Investment Grade Income Portfolio — Continued
Rate | Maturity Date | Par | Value | |||||||||
Short-Term Securities — 2.2% | ||||||||||||
U.S. Government and Agency Obligations — 0.1% | ||||||||||||
Fannie Mae | 0.000% | 6/25/07 | $ | 255 | $ | 249 | D,G | |||||
Fannie Mae | 0.000% | 6/28/07 | 46 | 42 | D,G | |||||||
291 | ||||||||||||
Repurchase Agreements — 2.1% | ||||||||||||
Lehman Brothers Inc. 5.2%, dated 12/29/06, to be repurchased at $4,458 on 1/2/07 (Collateral: $4,420 Fannie Mae notes, 6.03%, due 8/15/16, value $4,544) | 4,455 | 4,455 | ||||||||||
Merrill Lynch Government Securities Inc. 5.21%, dated 12/29/06, to be repurchased at $4,458 on 1/2/07 (Collateral: $4,490 Freddie Mac notes, 5.125%, due 10/15/08, value $4,546) | 4,455 | 4,455 | ||||||||||
8,910 | ||||||||||||
Total Short-Term Securities (Cost — $9,204) | 9,201 | |||||||||||
Total Investments — 98.3% (Cost — $404,681) | 409,512 | |||||||||||
Other Assets Less Liabilities — 1.7% | 7,246 | |||||||||||
Net Assets — 100.0% | $ | 416,758 | ||||||||||
Annual Report to Shareholders 81
Actual | Appreciation/ | |||||||||
Expiration | Contracts | (Depreciation) | ||||||||
Futures Contracts PurchasedH | ||||||||||
Eurodollar Futures | March 2007 | 140 | $ | (8 | ) | |||||
Eurodollar Futures | September 2007 | 557 | (253 | ) | ||||||
U.S. Treasury Note Futures | March 2007 | 207 | (123 | ) | ||||||
$ | (384 | ) | ||||||||
Futures Contracts WrittenH | ||||||||||
U.S. Treasury Bond Futures | March 2007 | 20 | $ | 59 | ||||||
U.S. Treasury Note Futures | March 2007 | 355 | 315 | |||||||
$ | 374 | |||||||||
A | Rule 144A Security — A security purchased pursuant to Rule 144A under the Securities Act of 1933 which may not be resold subject to that rule except to qualified institutional buyers. These securities, which the Fund’s investment adviser has determined to be liquid, represent 21.18% of net assets. |
B | Indexed Security — The rates of interest earned on these securities are tied to the London Interbank Offered Rate (“LIBOR”), the Consumer Price Index (“CPI”), and the one-year Treasury Bill Rate. The coupon rates are the rates as of December 31, 2006. |
C | Stepped Coupon Security — A security with a predetermined schedule of interest or dividend rate changes at which time it begins to accrue interest or pay dividends according to the predetermined schedule. |
D | Zero coupon bond — A bond with no periodic interest payments which is sold at such a discount as to produce a current yield to maturity. |
E | The coupon rates shown on variable rate securities are the rates at December 31, 2006. |
F | Yankee Bond — A dollar-denominated bond issued in the U.S. by a foreign entity. |
G | Collateral to cover futures contracts. |
H | Futures are described in more detail in the notes to financial statements. |
N.M. — Not Meaningful.
See notes to financial statements.
82 Annual Report to Shareholders
Statement of Assets and Liabilities
Investment Grade Income Portfolio
December 31, 2006
(Amounts in Thousands)
Assets: | ||||||||
Investment securities at market value (Cost – $395,477) | $ | 400,311 | ||||||
Short-term securities at value (Cost – $9,204) | 9,201 | |||||||
Cash | 676 | |||||||
Receivable for fund shares sold | 1,816 | |||||||
Interest receivable | 6,263 | |||||||
Futures variation margin receivable | 5 | |||||||
Other assets | 1 | |||||||
Total assets | 418,273 | |||||||
Liabilities: | ||||||||
Payable for fund shares repurchased | $ | 1,016 | ||||||
Accrued management fee | 125 | |||||||
Accrued distribution and service fees | 142 | |||||||
Income distribution payable | 86 | |||||||
Accrued expenses | 146 | |||||||
Total liabilities | 1,515 | |||||||
Net Assets | $ | 416,758 | ||||||
Net assets consist of: | ||||||||
Accumulated paid-in capital applicable to: | ||||||||
38,597 Primary Class shares outstanding | $ | 398,577 | ||||||
1,133 Institutional Class shares outstanding | 12,341 | |||||||
Overdistributions of net investment income | (116 | ) | ||||||
Undistributed net realized gain on investments and futures | 1,133 | |||||||
Unrealized appreciation/(depreciation) of investments and futures | 4,823 | |||||||
Net Assets | $ | 416,758 | ||||||
Net Asset Value Per Share: | ||||||||
Primary Class | $10.49 | |||||||
Institutional Class | $10.49 | |||||||
See notes to financial statements.
Annual Report to Shareholders 83
Statement of Operations
Investment Grade Income Portfolio
For the Year Ended December 31, 2006
(Amounts in Thousands)
Investment Income: | ||||||||
Interest | $ | 23,909 | ||||||
Total income | $ | 23,909 | ||||||
Expenses: | ||||||||
Management fees | 2,400 | |||||||
Distribution and service fees | 1,907 | |||||||
Audit and legal fees | 73 | |||||||
Custodian fees | 133 | |||||||
Directors’ fees and expenses | 55 | |||||||
Registration fees | 100 | |||||||
Reports to shareholders | 103 | |||||||
Transfer agent and shareholder servicing expense: | ||||||||
Primary Class | 360 | |||||||
Institutional Class | 1 | |||||||
Other expenses | 74 | |||||||
5,206 | ||||||||
Less: Fees waived | (1,294 | ) | ||||||
Compensating balance credits | (5 | )A | ||||||
Total expenses, net of waivers and compensating balance credits | 3,907 | |||||||
Net Investment Income | 20,002 | |||||||
Net Realized and Unrealized Gain/(Loss) on Investments: | ||||||||
Realized gain/(loss) on: | ||||||||
Investments | 519 | |||||||
Futures | 802 | |||||||
1,321 | ||||||||
Change in unrealized appreciation/(depreciation) of investments and futures | 2,783 | |||||||
Net Realized and Unrealized Gain on Investments | 4,104 | |||||||
Change in Net Assets Resulting From Operations | $ | 24,106 | ||||||
A | See note 1, Compensating Balance Credits, in the notes to financial statements. |
See notes to financial statements.
84 Annual Report to Shareholders
Statement of Changes in Net Assets
Investment Grade Income Portfolio
(Amounts in Thousands)
For the Years Ended | ||||||||
12/31/06 | 12/31/05 | |||||||
Change in Net Assets: | ||||||||
Net investment income | $ | 20,002 | $ | 18,980 | ||||
Net realized gain on investments and futures | 1,321 | 2,302 | ||||||
Change in unrealized appreciation/(depreciation) of investments and futures | 2,783 | (14,161 | ) | |||||
Change in net assets resulting from operations | 24,106 | 7,121 | ||||||
Distributions to shareholders from: | ||||||||
Net investment income: | ||||||||
Primary Class | (18,986 | ) | (18,146 | ) | ||||
Institutional Class | (1,013 | ) | (836 | ) | ||||
Net realized gain on investments: | ||||||||
Primary Class | (15 | ) | (3,431 | ) | ||||
Institutional Class | (1 | ) | (157 | ) | ||||
Change in net assets from Fund share transactions: | ||||||||
Primary Class | 34,481 | (22,272 | ) | |||||
Institutional Class | (8,584 | ) | 10,914 | |||||
Change in net assets | 29,988 | (26,807 | ) | |||||
Net Assets: | ||||||||
Beginning of year | 386,770 | 413,577 | ||||||
End of year | $ | 416,758 | $ | 386,770 | ||||
Overdistributions of net investment income | $ | (116 | ) | $ | (118 | ) | ||
See notes to financial statements.
Annual Report to Shareholders 85
Financial Highlights
Investment Grade Income Portfolio
Contained below is per share operating performance data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements.
Primary Class:
Years Ended December 31, | ||||||||||||||||||||
2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
Net asset value, beginning of year | $10.40 | $10.81 | $10.88 | $10.42 | $10.10 | |||||||||||||||
Investment operations: | ||||||||||||||||||||
Net investment income | .51 | A | .49 | .49 | .50 | .54 | ||||||||||||||
Net realized and unrealized gain/(loss) on investments, options and futures | .09 | (.31 | ) | .18 | .53 | .32 | ||||||||||||||
Total from investment operations | .60 | .18 | .67 | 1.03 | .86 | |||||||||||||||
Distributions from: | ||||||||||||||||||||
Net investment income | (.51 | ) | (.49 | ) | (.49 | ) | (.50 | ) | (.54 | ) | ||||||||||
Net realized gain on investments | —B | (.10 | ) | (.25 | ) | (.07 | ) | — | ||||||||||||
Total distributions | (.51 | ) | (.59 | ) | (.74 | ) | (.57 | ) | (.54 | ) | ||||||||||
Net asset value, end of year | $10.49 | $10.40 | $10.81 | $10.88 | $10.42 | |||||||||||||||
Total return | 6.01 | % | 1.69 | % | 6.29 | % | 10.16 | % | 8.82 | % | ||||||||||
Ratios to Average Net Assets:C | ||||||||||||||||||||
Total expenses | 1.33 | % | 1.30 | % | 1.27 | % | 1.28 | % | 1.30 | % | ||||||||||
Expenses net of waivers, if any | 1.00 | % | 1.00 | % | 1.00 | % | 1.00 | % | 1.00 | % | ||||||||||
Expenses net of all reductions | 1.00 | % | 1.00 | % | 1.00 | % | 1.00 | % | 1.00 | % | ||||||||||
Net investment income | 4.98 | % | 4.64 | % | 4.47 | % | 4.62 | % | 5.32 | % | ||||||||||
Supplemental Data: | ||||||||||||||||||||
Portfolio turnover rate | 65.7 | % | 51.1 | % | 74.9 | % | 78.2 | % | 131.0 | % | ||||||||||
Net assets, end of year (in thousands) | $404,864 | $366,329 | $403,361 | $408,685 | $334,763 | |||||||||||||||
A Computed using average daily shares outstanding.
B Amount represents less than $0.01 per share.
C | Total expenses reflects operating expenses prior to any voluntary expense waivers and/or compensating balance credits. Expenses net of waivers reflects total expenses before compensating balance credits but net of any voluntary expense waivers. Expenses net of all reductions reflects expenses less any compensating balance credits and/or voluntary expense waivers. |
See notes to financial statements.
86 Annual Report to Shareholders
Financial Highlights — Continued
Investment Grade Income Portfolio — Continued
Institutional Class:
Years Ended December 31, | ||||||||||||||||||||
2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
Net asset value, beginning of year | $10.41 | $10.82 | $10.89 | $10.43 | $10.11 | |||||||||||||||
Investment operations: | ||||||||||||||||||||
Net investment income | .56 | A | .55 | .54 | .55 | .59 | ||||||||||||||
Net realized and unrealized gain/(loss) on investments, options and futures | .08 | (.31 | ) | .17 | .53 | .31 | ||||||||||||||
Total from investment operations | .64 | .24 | .71 | 1.08 | .90 | |||||||||||||||
Distributions from: | ||||||||||||||||||||
Net investment income | (.56 | ) | (.55 | ) | (.53 | ) | (.55 | ) | (.58 | ) | ||||||||||
Net realized gain on investments | —B | (.10 | ) | (.25 | ) | (.07 | ) | — | ||||||||||||
Total distributions | (.56 | ) | (.65 | ) | (.78 | ) | (.62 | ) | (.58 | ) | ||||||||||
Net asset value, end of year | $10.49 | $10.41 | $10.82 | $10.89 | $10.43 | |||||||||||||||
Total return | 6.45 | % | 2.27 | % | 6.85 | % | 10.71 | % | 9.38 | % | ||||||||||
Ratios to Average Net Assets:C | ||||||||||||||||||||
Total expenses | .74 | % | .74 | % | .74 | % | .78 | % | .78 | % | ||||||||||
Expenses net of waivers, if any | .50 | % | .44 | % | .47 | % | .50 | % | .48 | % | ||||||||||
Expenses net of all reductions | .50 | % | .44 | % | .47 | % | .50 | % | .48 | % | ||||||||||
Net investment income | 5.47 | % | 5.26 | % | 5.02 | % | 5.13 | % | 5.85 | % | ||||||||||
Supplemental Data: | ||||||||||||||||||||
Portfolio turnover rate | 65.7 | % | 51.1 | % | 74.9 | % | 78.2 | % | 131.0 | % | ||||||||||
Net assets, end of year (in thousands) | $11,894 | $20,441 | $10,216 | $5,895 | $2,836 | |||||||||||||||
See notes to financial statements.
Annual Report to Shareholders 87
Management’s Discussion of Fund Performance
Limited Duration Bond Portfolio
Average annual total returns for the Limited Duration Bond Portfolio (“Fund”) and its benchmark for various periods ended December 31, 2006, are presented below:
Average Annual Total Returns Through December 31, 2006 | ||||||||||||||||
One | Five | Ten | Since | |||||||||||||
Year | Years | Years | InceptionA | |||||||||||||
Limited Duration Bond PortfolioB | ||||||||||||||||
Primary Class | +4.46% | +3.39% | +4.54% | +6.10% | ||||||||||||
Institutional Class | +4.98% | +3.92% | +5.08% | +5.84% | ||||||||||||
Merrill Lynch 1-3 Year Treasury IndexC | +3.96% | +2.82% | +4.69% | +5.98% | ||||||||||||
Lehman Intermediate U.S. Government Bond IndexD | +3.84% | +3.92% | +5.48% | +6.76% |
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information for the Primary Class please visit www.leggmasonfunds.com; for the Institutional Class please call 1-888-425-6432. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods. Performance figures for periods shorter than one year represent cumulative figures and are not annualized.
The Limited Duration Bond Portfolio was generally well-positioned for a market dominated by moderately rising interest rates and narrowing mortgage-backed and credit spreads. The total return (appreciation or depreciation in the Fund’s net asset value per share, plus dividends and any capital gain distributions) of the various share classes for the year ending December 31, 2006, exceeded the performance of its primary benchmark, the Merrill Lynch U.S. Treasury 1-3 Year Index, delivering 4.46% versus 3.96%. The Fund’s tactical duration strategy, which allowed duration to drift up and down with interest rates, contributed to
A The inception date of the Primary Class is August 7, 1987. The inception date of the Institutional Class is December 1, 1994. Index returns are for periods beginning July 31, 1987.
B Prior to August 31, 2004, the Fund was known as Legg Mason U.S. Government Intermediate-Term Portfolio and followed a policy of investing at least 80% of its assets in securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities, or repurchase agreements secured by such investments, with a dollar-weighted average portfolio maturity between three and ten years. The fund’s performance prior to such change might have been better or worse had the fund been managed in accordance with its current objective, policies and strategies.
C A total rate of return index based on daily closing prices and consisting of Treasury bills with a maturity of 1 to 3 years.
D A total return index consisting of investment grade corporate debt issues as well as U.S. government securities. The debt issues all maintain maturities within a range of 1 to 10 years.
88 Annual Report to Shareholders
returns as rates oscillated throughout the year, but its emphasis on the front end of the yield curve suffered as the yield curve flattened. Overweight exposure to short- and intermediate-maturity mortgage-backed securities and asset-backed securities contributed to performance, as their higher yields and stable to tighter spreads resulted in excess returns relative to treasuries. A modest exposure to BBB-rated corporate bonds also contributed to performance, as credit spreads generally tightened.
Western Asset Management Company
January 19, 2007
Annual Report to Shareholders 89
Expense Example
Limited Duration Bond Portfolio
As a shareholder of the Fund, you incur ongoing costs, including management fees, distribution and service (12b-1) fees on Primary Class shares; and other Fund expenses. These examples are intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds. Each example is based on an investment of $1,000 invested on July 1, 2006, and held through December 31, 2006.
Actual Expenses
The first line for each class in the table below provides information about actual account values and actual expenses for each class. You may use the information in this line, together with the amount you invested, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number in the first line under the heading entitled “Expenses Paid During the Period” to estimate the expenses you paid on your account during this period.
Hypothetical Example for Comparison Purposes
The second line for each class in the table below provides information about hypothetical account values and hypothetical expenses based on the relevant class’s actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the class’s actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use this information to compare the ongoing costs of investing in the Fund and other funds. To do so, compare these 5% hypothetical examples with the 5% hypothetical examples for the relevant class that appear in the shareholder reports of other funds.
Beginning | Ending | Expenses PaidA | ||||||||||
Account | Account | During the | ||||||||||
Value | Value | Period | ||||||||||
7/1/06 | 12/31/06 | 7/1/06 to 12/31/06 | ||||||||||
Primary Class: | ||||||||||||
Actual | $ | 1,000.00 | $ | 1,032.70 | $ | 5.12 | ||||||
Hypothetical (5% return before expenses) | 1,000.00 | 1,020.16 | 5.09 | |||||||||
Institutional Class: | ||||||||||||
Actual | $ | 1,000.00 | $ | 1,035.30 | $ | 2.57 | ||||||
Hypothetical (5% return before expenses) | 1,000.00 | 1,022.68 | 2.55 |
A These calculations are based on expenses incurred in the most recent fiscal half-year. The dollar amounts shown as “Expenses Paid” are equal to the annualized expense ratios of 1.00% and 0.50% for the Primary Class and Institutional Class respectively, multiplied by the average values over the period, multiplied by the number of days in the most recent fiscal half-year (184), and divided by 365.
90 Annual Report to Shareholders
Performance Information
Limited Duration Bond Portfolio
The graphs on the following pages compare the Fund’s total returns to those of two closely matched broad-based securities market indices. The lines illustrate the cumulative total return of an initial $10,000 investment in Primary Class shares and an initial $1,000,000 investment in Institutional Class shares of the Fund, for the periods indicated. The lines for the Fund represent the total return after deducting all Fund investment management and other administrative expenses and the transaction costs of buying and selling securities. The lines representing each securities market index do not include any transaction costs associated with buying and selling securities in the index or other administrative expenses. Both the Fund’s and the indices’ results assume reinvestment of all dividends and distributions.
Total return measures investment performance in terms of appreciation or depreciation in a fund’s net asset value per share, plus dividends and any capital gain distributions. It assumes that dividends and distributions were reinvested at the time they were paid. Average annual returns tend to smooth out variations in a fund’s return, so that they differ from actual year-to-year results.
Prior to August 31, 2004, the Fund was known as the Legg Mason U.S. Government Intermediate-Term Portfolio and followed a policy of investing at least 80% of its assets in securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities, or repurchase agreements secured by such investments, with a dollar-weighted average portfolio maturity between three and ten years. The Fund’s performance prior to such change might have been better or worse had the Fund been managed in accordance with its current objective, policies and strategies.
Annual Report to Shareholders 91
Growth of a $10,000 Investment — Primary Class
Periods Ended December 31, 2006
Cumulative | Average Annual | |||||||||
Total Return | Total Return | |||||||||
One Year | +4.46% | +4.46% | ||||||||
Five Years | +18.13% | +3.39% | ||||||||
Ten Years | +55.93% | +4.54% | ||||||||
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information please visit www.leggmasonfunds.com. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares.
A A total rate of return index based on daily closing prices and consisting of Treasury bills with a maturity of 1-3 years.
B A total return index consisting of investment grade corporate debt issues as well as U.S. government securities. The debt issues all maintain maturities within a range of 1 to 10 years.
92 Annual Report to Shareholders
Performance Information — Continued
Growth of a $1,000,000 Investment — Institutional Class
Periods Ended December 31, 2006
Cumulative | Average Annual | |||||||||
Total Return | Total Return | |||||||||
One Year | +4.98% | +4.98% | ||||||||
Five Years | +21.20% | +3.92% | ||||||||
Ten Years | +64.18% | +5.08% | ||||||||
The performance data quoted represents past performance and does not guarantee future results. The performance stated may have been due to extraordinary market conditions, which may not be duplicated in the future. Current performance may be lower or higher than the performance data quoted. To obtain the most recent month-end performance information please call 1-888-425-6432. The investment return and principal value of the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Calculations assume reinvestment of dividends and capital gain distributions. Performance would have been lower if fees had not been waived in various periods.
The graph and table do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares.
Annual Report to Shareholders 93
Portfolio Composition (as of December 31, 2006)C
Standard & Poor’s Debt RatingsD (as a percentage of the portfolio)
Maturity Schedule (as a percentage of the portfolio)
C The Fund is actively managed. As a result, the composition of its portfolio holdings and sectors is subject to change at any time.
D Standard & Poor’s Ratings Services provide capital markets with credit ratings for the evaluation and assessment of credit risk.
E Preferred Stocks do not have a defined maturity date.
94 Annual Report to Shareholders
Portfolio of Investments
Limited Duration Bond Portfolio
December 31, 2006
(Amounts in Thousands)
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Long-Term Securities — 98.0% | ||||||||||||
Corporate Bonds and Notes — 27.1% | ||||||||||||
Auto Components — 0.2% | ||||||||||||
Johnson Controls Inc. | 5.604% | 1/17/08 | $ | 430 | $ | 431 | A | |||||
Automobiles — 0.3% | ||||||||||||
DaimlerChrysler NA Holding Corp. | 5.875% | 3/15/11 | 700 | 703 | ||||||||
Capital Markets — 0.4% | ||||||||||||
Lehman Brothers Holdings E-Capital Trust I | 6.155% | 8/19/65 | 30 | 30 | A | |||||||
Morgan Stanley | 5.625% | 1/9/12 | 830 | 844 | ||||||||
874 | ||||||||||||
Chemicals — 0.4% | ||||||||||||
The Dow Chemical Co. | 5.750% | 12/15/08 | 560 | 564 | ||||||||
The Dow Chemical Co. | 5.970% | 1/15/09 | 330 | 334 | ||||||||
898 | ||||||||||||
Commercial Banks — 1.0% | ||||||||||||
SunTrust Capital VIII | 6.100% | 12/1/66 | 120 | 117 | B | |||||||
Wachovia Capital Trust III | 5.800% | 3/15/42 | 1,570 | 1,583 | B | |||||||
Wells Fargo Capital X | 5.950% | 12/15/36 | 300 | 294 | ||||||||
1,994 | ||||||||||||
Commercial Services and Supplies — 0.6% | ||||||||||||
Waste Management Inc. | 7.375% | 8/1/10 | 1,150 | 1,223 | ||||||||
Communications Equipment — 0.7% | ||||||||||||
Motorola Inc. | 4.608% | 11/16/07 | 1,500 | 1,490 | ||||||||
Annual Report to Shareholders 95
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Consumer Finance — 4.9% | ||||||||||||
Ford Motor Credit Co. | 6.193% | 9/28/07 | $ | 1,020 | $ | 1,018 | A | |||||
Ford Motor Credit Co. | 6.625% | 6/16/08 | 4,810 | 4,807 | ||||||||
GMAC LLC | 6.516% | 9/23/08 | 4,000 | 4,023 | A | |||||||
9,848 | ||||||||||||
Diversified Financial Services — 2.2% | ||||||||||||
International Lease Finance Corp. | 5.000% | 4/15/10 | 650 | 643 | ||||||||
Residential Capital Corp. | 6.739% | 6/29/07 | 1,630 | 1,638 | A | |||||||
Residential Capital Corp. | 6.474% | 4/17/09 | 200 | 202 | A | |||||||
Residential Capital LLC | 6.675% | 11/21/08 | 2,000 | 2,025 | A | |||||||
4,508 | ||||||||||||
Diversified Telecommunication Services — 0.9% | ||||||||||||
AT&T Inc. | 5.300% | 11/15/10 | 940 | 940 | ||||||||
Verizon Global Funding Corp. | 7.250% | 12/1/10 | 800 | 853 | ||||||||
1,793 | ||||||||||||
Electric Utilities — 3.4% | ||||||||||||
Alabama Power Co. | 5.560% | 8/25/09 | 1,000 | 1,003 | A | |||||||
Appalachian Power Co. | 3.600% | 5/15/08 | 1,700 | 1,660 | ||||||||
Commonwealth Edison Co. | 3.700% | 2/1/08 | 580 | 568 | ||||||||
Duke Energy Corp. | 3.750% | 3/5/08 | 1,500 | 1,472 | ||||||||
FirstEnergy Corp. | 6.450% | 11/15/11 | 370 | 386 | ||||||||
Niagara Mohawk Power Corp. | 7.750% | 10/1/08 | 460 | 477 | ||||||||
Ohio Edison Co. | 4.000% | 5/1/08 | 440 | 432 | ||||||||
Pacific Gas and Electric Co. | 3.600% | 3/1/09 | 1,000 | 966 | ||||||||
6,964 | ||||||||||||
Hotels, Restaurants and Leisure — 0.2% | ||||||||||||
Caesars Entertainment Inc. | 7.500% | 9/1/09 | 330 | 343 | ||||||||
Harrah’s Operating Co. Inc. | 5.975% | 2/8/08 | 150 | 150 | A,C | |||||||
493 | ||||||||||||
96 Annual Report to Shareholders
Portfolio of Investments — Continued
Limited Duration Bond Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Independent Power Producers and Energy Traders — 0.6% | ||||||||||||
TXU Corp. | 4.800% | 11/15/09 | $ | 1,160 | $ | 1,132 | ||||||
IT Services — 0.5% | ||||||||||||
Electronic Data Systems Corp. | 7.125% | 10/15/09 | 1,000 | 1,042 | ||||||||
Leisure Equipment and Products — 0.1% | ||||||||||||
Eastman Kodak Co. | 7.250% | 11/15/13 | 110 | 109 | ||||||||
Media — 2.3% | ||||||||||||
Clear Channel Communications Inc. | 6.625% | 6/15/08 | 140 | 142 | ||||||||
Clear Channel Communications Inc. | 4.250% | 5/15/09 | 790 | 765 | ||||||||
Comcast Cable Communications Inc. | 6.875% | 6/15/09 | 1,100 | 1,138 | ||||||||
Comcast MO of Delaware Inc. | 9.000% | 9/1/08 | 300 | 317 | ||||||||
Liberty Media LLC | 7.875% | 7/15/09 | 1,120 | 1,168 | ||||||||
The Walt Disney Co. | 5.453% | 9/10/09 | 10 | 10 | A | |||||||
Time Warner Inc. | 5.500% | 11/15/11 | 1,030 | 1,027 | ||||||||
4,567 | ||||||||||||
Multi-Utilities — 1.2% | ||||||||||||
CenterPoint Energy Inc. | 5.875% | 6/1/08 | 440 | 441 | ||||||||
Sempra Energy | 5.845% | 5/21/08 | 2,000 | 2,001 | A | |||||||
2,442 | ||||||||||||
Multiline Retail — 0.1% | ||||||||||||
May Department Stores Co. | 5.750% | 7/15/14 | 110 | 107 | ||||||||
Annual Report to Shareholders 97
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Corporate Bonds and Notes — Continued | ||||||||||||
Oil, Gas and Consumable Fuels — 3.4% | ||||||||||||
Devon Financing Corp. ULC | 6.875% | 9/30/11 | $ | 440 | $ | 465 | ||||||
Hess Corp. | 6.650% | 8/15/11 | 1,710 | 1,781 | ||||||||
Kinder Morgan Energy Partners LP | 6.750% | 3/15/11 | 410 | 427 | ||||||||
Pemex Project Funding Master Trust | 5.970% | 12/3/12 | 3,490 | 3,500 | A,C | |||||||
XTO Energy Inc. | 5.650% | 4/1/16 | 640 | 633 | ||||||||
6,806 | ||||||||||||
Paper and Forest Products — 0.1% | ||||||||||||
Weyerhaeuser Co. | 5.950% | 11/1/08 | 170 | 171 | ||||||||
Real Estate Investment Trusts — 1.3% | ||||||||||||
iStar Financial Inc. | 5.700% | 9/15/09 | 1,330 | 1,331 | A,C | |||||||
iStar Financial Inc. | 5.650% | 9/15/11 | 1,400 | 1,397 | ||||||||
2,728 | ||||||||||||
Tobacco — 1.5% | ||||||||||||
Altria Group Inc. | 5.625% | 11/4/08 | 3,000 | 3,010 | ||||||||
Wireless Telecommunication Services — 0.8% | ||||||||||||
New Cingular Wireless Services Inc. | 8.125% | 5/1/12 | 390 | 439 | ||||||||
Sprint Capital Corp. | 6.125% | 11/15/08 | 1,150 | 1,163 | ||||||||
Sprint Capital Corp. | 6.375% | 5/1/09 | 30 | 31 | ||||||||
1,633 | ||||||||||||
Total Corporate Bonds and Notes (Cost — $54,974) | 54,966 | |||||||||||
98 Annual Report to Shareholders
Portfolio of Investments — Continued
Limited Duration Bond Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Asset-Backed Securities — 9.3% | ||||||||||||
Fixed Rate Securities — 2.8% | ||||||||||||
AmeriCredit Automobile Receivables Trust 2003-BX | 2.720% | 1/6/10 | $ | 1,315 | $ | 1,303 | ||||||
MBNA Practice Solutions Owner Trust 2005-2 | 4.100% | 5/15/09 | 2,592 | 2,572 | C | |||||||
Prestige Auto Receivables Trust 2005-1A | 4.370% | 6/15/12 | 1,300 | 1,284 | C | |||||||
Structured Asset Securities Corp. 2003-AL1 | 3.357% | 4/25/31 | 655 | 582 | C | |||||||
5,741 | ||||||||||||
Indexed SecuritiesA — 6.3% | ||||||||||||
Asset Backed Funding Certificates 2002-WF2 | 6.070% | 5/25/32 | 221 | 221 | ||||||||
Bear Stearns Asset Backed Securities Inc. 2004-1 | 5.840% | 6/25/34 | 2,740 | 2,759 | ||||||||
CHEC Loan Trust 2004-2 | 5.650% | 2/25/31 | 1,076 | 1,076 | ||||||||
Citibank Credit Card Issuance Trust 2002-B1 | 5.696% | 6/25/09 | 1,675 | 1,678 | ||||||||
Countrywide Home Equity Loan Trust 2004-O | 5.630% | 2/15/34 | 702 | 704 | ||||||||
RAAC Series 2005-RP1 | 5.660% | 7/25/37 | 745 | 746 | C | |||||||
Rental Car Finance Corp. 2003-1A | 5.720% | 5/25/08 | 2,500 | 2,502 | C | |||||||
Rental Car Finance Corp. 2004-1A | 5.550% | 6/25/09 | 3,000 | 3,004 | C | |||||||
12,690 | ||||||||||||
Stripped Securities — 0.2% | ||||||||||||
HSI Asset Securitization Corp. Trust, Series 2006-OPT4 | 1.500% | 3/25/36 | 26,414 | 331 | D1 | |||||||
Total Asset-Backed Securities (Cost — $19,000) | 18,762 | |||||||||||
Annual Report to Shareholders 99
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Mortgage-Backed Securities — 18.6% | ||||||||||||
Fixed Rate Securities — 2.1% | ||||||||||||
BlackRock Capital Finance LP 1997-R3 | 7.220% | 11/25/28 | $ | 74 | $ | 74 | C | |||||
Residential Asset Mortgage Products Inc. 2005-SL1 | 8.000% | 5/25/32 | 1,490 | 1,572 | ||||||||
Washington Mutual MSC Mortgage Pass-Through Certificates, Series 2004-RA1 | 7.000% | 3/25/34 | 2,477 | 2,503 | ||||||||
4,149 | ||||||||||||
Indexed SecuritiesA — 14.8% | ||||||||||||
Banc of America Mortgage Securities 2005-F | 5.018% | 7/25/35 | 2,200 | 2,178 | ||||||||
Bear Stearns ARM Trust 2004-10 | 4.501% | 1/25/35 | 774 | 770 | ||||||||
Countrywide Alternative Loan Trust 2005-59 1A1 | 5.650% | 11/20/35 | 1,868 | 1,874 | ||||||||
Countrywide Alternative Loan Trust 2006-OA2 A5 | 5.580% | 5/20/46 | 2,267 | 2,269 | ||||||||
Harborview Mortgage Loan Trust 2004-8 | 5.750% | 11/19/34 | 716 | 718 | ||||||||
HomeBanc Mortgage Trust 2004-2 | 5.690% | 12/25/34 | 1,437 | 1,439 | ||||||||
HomeBanc Mortgage Trust 2005-1 | 5.570% | 3/25/35 | 1,841 | 1,841 | ||||||||
Impac CMB Trust 2004-2 | 5.840% | 4/25/34 | 448 | 448 | ||||||||
Impac CMB Trust 2004-6 | 5.710% | 10/25/34 | 525 | 526 | ||||||||
JPMorgan Mortgage Trust 2003-A1 | 4.345% | 10/25/33 | 2,223 | 2,173 | ||||||||
Lehman XS Trust 2005-5N 3A1A | 5.620% | 11/25/35 | 2,141 | 2,143 | ||||||||
MASTR Adjustable Rate Mortgages Trust 2004-13 | 3.786% | 11/21/34 | 3,000 | 2,913 | ||||||||
MASTR Specialized Loan Trust 2006-01 A | 5.620% | 1/25/36 | 874 | 874 | C | |||||||
Provident Funding Mortgage Loan Trust 2005-1 1A1 | 4.148% | 5/25/35 | 1,840 | 1,827 | ||||||||
Sequoia Mortgage Trust 2003-2 A2 | 5.747% | 6/20/33 | 554 | 554 | ||||||||
Sequoia Mortgage Trust 2003-7 A1 | 5.670% | 1/20/34 | 534 | 534 |
100 Annual Report to Shareholders
Portfolio of Investments — Continued
Limited Duration Bond Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Mortgage-Backed Securities — Continued | ||||||||||||
Indexed Securities — Continued | ||||||||||||
Thornburg Mortgage Securities Trust 2005-4 | 5.530% | 12/25/35 | $ | 2,119 | $ | 2,117 | ||||||
WaMu Alternative Mortgage Pass-Through Certificates 2006-AR01 | 5.640% | 2/25/36 | 1,678 | 1,679 | ||||||||
WaMu Mortgage Pass-Through Certificates 2003-AR10 | 4.062% | 10/25/33 | 2,100 | 2,073 | ||||||||
WaMu Mortgage Pass-Through Certificates 2004-AR08 | 5.795% | 6/25/44 | 1,073 | 1,077 | ||||||||
30,027 | ||||||||||||
Stripped Securities — N.M. | ||||||||||||
Nomura Asset Acceptance Corp. Series 2006-AP1 | 4.500% | 1/25/36 | 288 | 8 | D1 | |||||||
Variable Rate SecuritiesE — 1.7% | ||||||||||||
Banc of America Funding Corp. 2004-B | 4.182% | 12/20/34 | 977 | 999 | ||||||||
Countrywide Alternative Loan Trust 2004-33, 1A1 | 4.992% | 12/25/34 | 696 | 702 | ||||||||
Countrywide Alternative Loan Trust 2004-33, 2A1 | 4.933% | 12/25/34 | 367 | 365 | ||||||||
Prime Mortgage Trust 2005-2 | 7.408% | 10/25/32 | 1,387 | 1,421 | ||||||||
3,487 | ||||||||||||
Total Mortgage-Backed Securities (Cost — $37,839) | 37,671 | |||||||||||
U.S. Government and Agency Obligations — 3.9% | ||||||||||||
Fixed Rate Securities — 0.4% | ||||||||||||
United States Treasury Bonds | 5.375% | 2/15/31 | 190 | 203 | ||||||||
United States Treasury Notes | 4.625% | 10/31/11 | 570 | 568 | ||||||||
771 | ||||||||||||
Annual Report to Shareholders 101
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
U.S. Government and Agency Obligations — Continued | ||||||||||||
Treasury Inflation-Protected SecuritiesF — 3.5% | ||||||||||||
United States Treasury Inflation-Protected Security | 2.375% | 4/15/11 | $ | 1,627 | $ | 1,621 | ||||||
United States Treasury Inflation-Protected Security | 3.000% | 7/15/12 | 2,329 | 2,397 | ||||||||
United States Treasury Inflation-Protected Security | 2.500% | 7/15/16 | 1,299 | 1,309 | ||||||||
United States Treasury Inflation-Protected Security | 2.375% | 1/15/25 | 1,852 | 1,844 | ||||||||
7,171 | ||||||||||||
Total U.S. Government and Agency Obligations (Cost — $8,114) | 7,942 | |||||||||||
U.S. Government Agency Mortgage-Backed Securities — 27.7% | ||||||||||||
Fixed Rate Securities — 17.4% | ||||||||||||
Fannie Mae | 8.500% | 6/1/10 to | ||||||||||
8/1/11 | 15 | 15 | ||||||||||
Fannie Mae | 7.000% | 1/1/13 to | ||||||||||
1/1/33 | 4,468 | 4,600 | ||||||||||
Fannie Mae | 6.500% | 7/1/13 to | ||||||||||
10/1/32 | 1,431 | 1,461 | ||||||||||
Fannie Mae | 9.500% | 7/1/14 | 27 | 28 | ||||||||
Fannie Mae | 11.000% | 12/1/15 | 45 | 46 | ||||||||
Fannie Mae | 12.500% | 1/1/18 to | ||||||||||
4/1/18 | 43 | 46 | ||||||||||
Fannie Mae | 9.000% | 11/1/21 | 93 | 99 | ||||||||
Fannie Mae | 6.000% | 11/1/27 | 0.3 | — | G | |||||||
Fannie Mae | 5.000% | 12/1/36 | 18,850 | 18,196 | H | |||||||
Fannie Mae | 5.500% | 12/1/36 | 3,200 | 3,162 | H | |||||||
Fannie Mae | 6.000% | 12/1/36 | 1,200 | 1,208 | H | |||||||
Freddie Mac | 8.250% | 2/1/08 | 2 | 3 | ||||||||
Freddie Mac | 8.500% | 12/1/08 to | ||||||||||
6/1/21 | 27 | 27 | ||||||||||
Freddie Mac | 9.750% | 11/1/09 to | ||||||||||
11/1/14 | 16 | 16 |
102 Annual Report to Shareholders
Portfolio of Investments — Continued
Limited Duration Bond Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
U.S. Government Agency Mortgage-Backed Securities — Continued | ||||||||||||
Fixed Rate Securities — Continued | ||||||||||||
Freddie Mac | 9.000% | 1/1/17 to | ||||||||||
1/1/21 | $ | 122 | $ | 127 | ||||||||
Freddie Mac | 8.000% | 2/1/31 | 226 | 237 | ||||||||
Freddie Mac | 7.000% | 4/1/32 | 1,715 | 1,765 | ||||||||
Freddie Mac | 5.000% | 12/1/36 | 200 | 193 | H | |||||||
Government National Mortgage Association | 6.000% | 5/15/14 to | ||||||||||
11/15/28 | 240 | 244 | ||||||||||
Government National Mortgage Association | 9.000% | 6/15/22 to | ||||||||||
9/15/22 | 2 | 2 | ||||||||||
Government National Mortgage Association | 5.500% | 12/1/36 | 3,750 | 3,731 | H | |||||||
Government National Mortgage Association | 6.000% | 12/1/36 | 100 | 101 | H | |||||||
35,307 | ||||||||||||
Indexed SecuritiesA — 10.2% | ||||||||||||
Fannie Mae | 4.324% | 10/1/34 | 1,077 | 1,060 | ||||||||
Fannie Mae | 4.215% | 12/1/34 | 1,332 | 1,306 | ||||||||
Fannie Mae | 4.330% | 1/1/35 | 1,124 | 1,106 | ||||||||
Fannie Mae | 4.860% | 1/1/35 | 1,958 | 1,951 | ||||||||
Fannie Mae | 4.784% | 2/1/35 | 4,189 | 4,177 | ||||||||
Fannie Mae | 4.546% | 3/1/35 | 2,391 | 2,362 | ||||||||
Fannie Mae | 4.954% | 3/1/35 | 4,454 | 4,452 | ||||||||
Freddie Mac | 4.346% | 12/1/34 | 484 | 476 | ||||||||
Freddie Mac | 4.459% | 12/1/34 | 2,521 | 2,494 | ||||||||
Freddie Mac | 4.082% | 1/1/35 | 452 | 442 | ||||||||
Freddie Mac | 4.111% | 1/1/35 | 803 | 785 | ||||||||
20,611 | ||||||||||||
Annual Report to Shareholders 103
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
U.S. Government Agency Mortgage-Backed Securities — Continued | ||||||||||||
Stripped Securities — 0.1% | ||||||||||||
Government National Mortgage Association | 3.125% | 6/16/26 | $ | 1,892 | $ | 131 | D1 | |||||
Government National Mortgage Association | 3.175% | 8/16/26 | 1,395 | 141 | D1 | |||||||
272 | ||||||||||||
Total U.S. Government Agency Mortgage-Backed Securities (Cost — $58,025) | 56,190 | |||||||||||
Yankee BondsI — 11.3% | ||||||||||||
Commercial Banks — 2.7% | ||||||||||||
Glitnir Banki Hf | 5.800% | 1/21/11 | 1,550 | 1,550 | A,C | |||||||
Kaupthing Bank Hf | 6.061% | 4/12/11 | 1,000 | 1,007 | A,C | |||||||
Kaupthing Bank Hf | 5.750% | 10/4/11 | 420 | 420 | C | |||||||
Landsbanki Islands Hf | 6.100% | 8/25/11 | 620 | 630 | C | |||||||
Resona Preferred Global Securities | 7.191% | 7/30/49 | 830 | 866 | C,E | |||||||
VTB Capital SA for Vneshtorgbank | 5.970% | 8/1/08 | 1,040 | 1,041 | A,C | |||||||
5,514 | ||||||||||||
Diversified Financial Services — 1.5% | ||||||||||||
Aiful Corp. | 5.000% | 8/10/10 | 1,280 | 1,242 | C | |||||||
MUFG Capital Finance 1 Ltd. | 6.346% | 7/25/49 | 600 | 609 | B | |||||||
TNK-BP Finance SA | 6.875% | 7/18/11 | 1,090 | 1,127 | C | |||||||
2,978 | ||||||||||||
Diversified Telecommunication Services — 2.9% | ||||||||||||
British Telecommunications PLC | 8.625% | 12/15/10 | 1,520 | 1,696 | E | |||||||
Deutsche Telekom International Finance BV | 8.000% | 6/15/10 | 650 | 704 | E | |||||||
France Telecom SA | 7.750% | 3/1/11 | 770 | 839 | E | |||||||
Koninklijke (Royal) KPN NV | 8.000% | 10/1/10 | 900 | 971 |
104 Annual Report to Shareholders
Portfolio of Investments — Continued
Limited Duration Bond Portfolio — Continued
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Yankee Bonds — Continued | ||||||||||||
Diversified Telecommunication Services — Continued | ||||||||||||
Telecom Italia Capital | 5.851% | 2/1/11 | $ | 1,040 | $ | 1,034 | A | |||||
Telefonica Emisones S.A.U. | 5.665% | 6/19/09 | 600 | 601 | A | |||||||
5,845 | ||||||||||||
Energy Equipment and Services — 0.5% | ||||||||||||
SP PowerAssets Ltd. | 3.800% | 10/22/08 | 1,000 | 975 | C | |||||||
Foreign Government Obligations — 0.9% | ||||||||||||
Russian Federation | 3.000% | 5/14/08 | 1,940 | 1,873 | ||||||||
Health Care Equipment and Supplies — 0.2% | ||||||||||||
Baxter FinCo BV | 4.750% | 10/15/10 | 430 | 422 | ||||||||
Industrial Conglomerates — 0.8% | ||||||||||||
Tyco International Group SA | 6.375% | 10/15/11 | 1,480 | 1,549 | ||||||||
Metals and Mining — 0.5% | ||||||||||||
Vale Overseas Ltd. | 6.250% | 1/23/17 | 1,130 | 1,135 | ||||||||
Oil, Gas and Consumable Fuels — 1.0% | ||||||||||||
Anadarko Finance Co. | 6.750% | 5/1/11 | 1,870 | 1,960 | ||||||||
Wireless Telecommunication Services — 0.3% | ||||||||||||
Vodafone Group PLC | 3.950% | 1/30/08 | 730 | 719 | ||||||||
Total Yankee Bonds (Cost — $22,900) | 22,970 | |||||||||||
Common Stocks and Equity Interests — N.M. | ||||||||||||
Dynegy Inc. | 1shs | 5 | J | |||||||||
Total Common Stocks and Equity Interests (Cost — $ — )G | 5 | |||||||||||
Annual Report to Shareholders 105
Par/ | ||||||||||||
Rate | Maturity Date | Shares | Value | |||||||||
Preferred Stocks — 0.1% | ||||||||||||
Home Ownership Funding Corp. | 13.331% | 5shs | $ | 74 | B,C | |||||||
Home Ownership Funding Corp. II | 13.338% | 14 | 206 | B,C | ||||||||
Total Preferred Stocks (Cost — $1,537) | 280 | |||||||||||
Total Long-Term Securities (Cost — $202,389) | 198,786 | |||||||||||
Short-Term Securities — 14.9% | ||||||||||||
U.S. Government and Agency Obligations — 1.5% | ||||||||||||
Fannie Mae | 0.000% | 6/25/07 | $ | 417 | 407 | K | ||||||
Fannie Mae | 0.000% | 2/9/07 | 2,650 | 2,635 | K | |||||||
3,042 | ||||||||||||
Options PurchasedL — N.M. | ||||||||||||
Eurodollar Futures Call, April 2007, Strike Price $94.625 | 189 | M | 35 | |||||||||
Repurchase Agreements — 13.4% | ||||||||||||
Lehman Brothers Inc. 5.2%, dated 12/29/06, to be repurchased at $13,625 on 1/2/07 (Collateral: $13,505 Fannie Mae notes, 6.03%, due 8/15/16, value $13,889) | 13,617 | 13,617 | ||||||||||
Merrill Lynch Government Securities Inc. 5.21%, dated 12/29/06, to be repurchased at $13,625 on 1/2/07 (Collateral: $13,720 Freddie Mac notes, 5.125%, due 10/15/08, value $13,892) | 13,617 | 13,617 | ||||||||||
27,234 | ||||||||||||
Total Short-Term Securities (Cost — $30,317) | 30,311 | |||||||||||
Total Investments — 112.9% (Cost — $232,706) | 229,097 | |||||||||||
Other Assets Less Liabilities — (12.9)% | (26,162 | ) | ||||||||||
Net Assets — 100.0% | $ | 202,935 | ||||||||||
106 Annual Report to Shareholders
Portfolio of Investments — Continued
Limited Duration Bond Portfolio — Continued
Actual | Appreciation/ | |||||||||
Expiration | Contracts | (Depreciation) | ||||||||
Futures Contracts PurchasedL | ||||||||||
U.S. Treasury Note Futures | March 2007 | 561 | $ | (298 | ) | |||||
Futures Contracts WrittenL | ||||||||||
U.S. Treasury Note Futures | March 2007 | 276 | $ | 164 | ||||||
U.S. Treasury Note Futures | March 2007 | 344 | 160 | |||||||
$ | 324 | |||||||||
Options WrittenL | ||||||||||
U.S. Treasury Note Futures Call, Strike Price $110.00 | March 2007 | 151 | $ | 58 | ||||||
U.S. Treasury Note Futures Put, Strike Price $107.00 | March 2007 | 270 | (68 | ) | ||||||
U.S. Treasury Note Futures Put, Strike Price $108.00 | March 2007 | 76 | (46 | ) | ||||||
$ | (56 | ) | ||||||||
A | Indexed Security — The rates of interest earned on these securities are tied to the London Interbank Offered Rate (“LIBOR”), the Consumer Price Index (“CPI”), and the one-year Treasury Bill Rate. The coupon rates are the rates as of December 31, 2006. |
B | Stepped Coupon Security — A security with a predetermined schedule of interest or dividend rate changes at which time it begins to accrue interest or pay dividends according to the predetermined schedule. |
C | Rule 144A Security — A security purchased pursuant to Rule 144A under the Securities Act of 1933 which may not be resold subject to that rule except to qualified institutional buyers. These securities, which the Fund’s investment adviser has determined to be liquid, represent 12.69% of net assets. |
D | Stripped Security — Security with interest-only or principal-only payment streams, denoted by a 1 or 2, respectively. For interest-only securities, the amount shown as principal is the notional balance used to calculate the amount of interest due. |
E | The coupon rates shown on variable rate securities are the rates at December 31, 2006. |
F | Inflation-Protected Securities — Security whose principal value is adjusted daily or monthly in accordance with changes to the Consumer Price Index for All Urban Consumers. Interest is calculated on the basis of the current adjusted principal value. |
G | Amount represents less than 1. |
H | When-issued Security — Security purchased on a delayed delivery basis. Final settlement amount and maturity date have not yet been announced. |
I | Yankee Bond — A dollar-denominated bond issued in the U.S. by a foreign entity. |
J | Non-income producing. |
K | Zero coupon bond — A bond with no periodic interest payments which is sold at such a discount as to produce a current yield to maturity. |
L | Options and futures are described in more detail in the notes to financial statements. |
M | Par represents actual number of contracts. |
N.M. — Not meaningful.
See notes to financial statements.
Annual Report to Shareholders 107
Statement of Assets and Liabilities
Limited Duration Bond Portfolio
December 31, 2006
(Amounts in Thousands)
Assets: | ||||||||
Investment securities at market value (Cost – $202,389) | $ | 198,786 | ||||||
Short-term securities at value (Cost – $30,317) | 30,311 | |||||||
Cash | 1 | |||||||
Receivable for fund shares sold | 216 | |||||||
Interest and dividends receivable | 1,414 | |||||||
Futures variation margin receivable | 12 | |||||||
Other assets | 11 | |||||||
Total assets | 230,751 | |||||||
Liabilities: | ||||||||
Payable for securities purchases | $ | 26,838 | ||||||
Payable for fund shares repurchased | 503 | |||||||
Accrued management fee | 58 | |||||||
Accrued distribution and service fees | 70 | |||||||
Income distribution payable | 27 | |||||||
Options written (Proceeds – $163) | 219 | |||||||
Accrued expenses | 101 | |||||||
Total liabilities | 27,816 | |||||||
Net Assets | $ | 202,935 | ||||||
Net assets consist of: | ||||||||
Accumulated paid-in capital applicable to: | ||||||||
18,777 Primary Class shares outstanding | $ | 205,983 | ||||||
1,081 Institutional Class shares outstanding | 11,218 | |||||||
Overdistributions of net investment income | (65 | ) | ||||||
Accumulated net realized loss on investments, options and futures | (10,562 | ) | ||||||
Unrealized appreciation/(depreciation) of investments, options and futures | (3,639 | ) | ||||||
Net Assets | $ | 202,935 | ||||||
Net Asset Value Per Share: | ||||||||
Primary Class | $10.22 | |||||||
Institutional Class | $10.22 | |||||||
See notes to financial statements.
108 Annual Report to Shareholders
Statement of Operations
Limited Duration Bond Portfolio
For the Year Ended December 31, 2006
(Amounts in Thousands)
Investment Income: | ||||||||
Interest | $ | 10,886 | ||||||
Dividends | 253 | |||||||
Total income | $ | 11,139 | ||||||
Expenses: | ||||||||
Management fees | 984 | |||||||
Distribution and service fees | 1,017 | |||||||
Audit and legal fees | 53 | |||||||
Custodian fees | 108 | |||||||
Directors’ fees and expenses | 65 | |||||||
Registration fees | 59 | |||||||
Reports to shareholders | 52 | |||||||
Transfer agent and shareholder servicing expense: | ||||||||
Primary Class | 166 | |||||||
Institutional Class | 1 | |||||||
Other expenses | 59 | |||||||
2,564 | ||||||||
Less: Fees waived | (449 | ) | ||||||
Compensating balance credits | (4 | )A | ||||||
Total expenses, net of waivers and compensating balance credits | 2,111 | |||||||
Net Investment Income | 9,028 | |||||||
Net Realized and Unrealized Gain/(Loss) on Investments: | ||||||||
Realized gain/(loss) on: | ||||||||
Investments | 22 | |||||||
Options | 26 | |||||||
Futures | (432 | ) | ||||||
(384 | ) | |||||||
Change in unrealized appreciation/(depreciation) of investments, options and futures | 886 | |||||||
Net Realized and Unrealized Gain on Investments | 502 | |||||||
Change in Net Assets Resulting From Operations | $9,530 | |||||||
A | See note 1, Compensating Balance Credits, in the notes to financial statements. |
See notes to financial statements.
Annual Report to Shareholders 109
Statement of Changes in Net Assets
Limited Duration Bond Portfolio
(Amounts in Thousands)
For the Years Ended | ||||||||
12/31/06 | 12/31/05 | |||||||
Change in Net Assets: | ||||||||
Net investment income | $ | 9,028 | $ | 8,707 | ||||
Net realized loss on investments, options and futures | (384 | ) | (1,274 | ) | ||||
Change in unrealized appreciation/(depreciation) of investments, options and futures | 886 | (2,592 | ) | |||||
Change in net assets resulting from operations | 9,530 | 4,841 | ||||||
Distributions to shareholders from: | ||||||||
Net investment income: | ||||||||
Primary Class | (8,477 | ) | (8,515 | ) | ||||
Institutional Class | (703 | ) | (574 | ) | ||||
Change in net assets from Fund share transactions: | ||||||||
Primary Class | (27,940 | ) | (51,090 | ) | ||||
Institutional Class | (7,185 | ) | 8,896 | |||||
Change in net assets | (34,775 | ) | (46,442 | ) | ||||
Net Assets: | ||||||||
Beginning of year | 237,710 | 284,152 | ||||||
End of year | $ | 202,935 | $ | 237,710 | ||||
Overdistributions of net investment income | $ | (65 | ) | $ | (97 | ) | ||
See notes to financial statements.
110 Annual Report to Shareholders
Financial Highlights
Limited Duration Bond Portfolio
Contained below is per share operating performance data for a share of common stock outstanding, total investment return, ratios to average net assets and other supplemental data. This information has been derived from information provided in the financial statements.
Primary Class:
Years Ended December 31, | ||||||||||||||||||||
2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
Net asset value, beginning of year | $10.20 | $10.36 | $10.54 | $10.70 | $10.32 | |||||||||||||||
Investment operations: | ||||||||||||||||||||
Net investment income | .42 | A | .33 | .29 | .26 | .41 | ||||||||||||||
Net realized and unrealized gain/(loss) on investments, options and futures | .02 | (.14 | ) | (.09 | ) | (.14 | ) | .38 | ||||||||||||
Total from investment operations | .44 | .19 | .20 | .12 | .79 | |||||||||||||||
Distributions from: | ||||||||||||||||||||
Net investment income | (.42 | ) | (.35 | ) | (.37 | ) | (.28 | ) | (.41 | ) | ||||||||||
Net realized gain on investments | — | — | (.01 | ) | — | — | ||||||||||||||
Total distributions | (.42 | ) | (.35 | ) | (.38 | ) | (.28 | ) | (.41 | ) | ||||||||||
Net asset value, end of year | $10.22 | $10.20 | $10.36 | $10.54 | $10.70 | |||||||||||||||
Total return | 4.46 | % | 1.83 | % | 1.89 | % | 1.11 | % | 7.79 | % | ||||||||||
Ratios to Average Net Assets:B | ||||||||||||||||||||
Total expenses | 1.21 | % | 1.15 | % | 1.21 | % | 1.21 | % | 1.19 | % | ||||||||||
Expenses net of waivers, if any | 1.00 | % | 1.00 | % | 1.00 | % | 1.00 | % | 1.00 | % | ||||||||||
Expenses net of all reductions | 1.00 | % | 1.00 | % | 1.00 | % | 1.00 | % | 1.00 | % | ||||||||||
Net investment income | 4.10 | % | 3.21 | % | 2.81 | % | 2.48 | % | 3.85 | % | ||||||||||
Supplemental Data: | ||||||||||||||||||||
Portfolio turnover rate | 237.2 | % | 81.6 | % | 238.0 | % | 487.3 | % | 204.1 | % | ||||||||||
Net assets, end of year (in thousands) | $191,883 | $219,497 | $274,606 | $326,844 | $379,793 | |||||||||||||||
A Computed using average daily shares outstanding.
B | Total expenses reflects operating expenses prior to any voluntary expense waivers and/or compensating balance credits. Expenses net of waivers reflects total expenses before compensating balance credits but net of any voluntary expense waivers. Expenses net of all reductions reflects expenses less any compensating balance credits and/or voluntary expense waivers. |
See notes to financial statements.
Annual Report to Shareholders 111
Institutional Class:
Years Ended December 31, | ||||||||||||||||||||
2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||||||
Net asset value, beginning of year | $10.20 | $10.37 | $10.55 | $10.70 | $10.32 | |||||||||||||||
Investment operations: | ||||||||||||||||||||
Net investment income | .47 | A | .40 | .35 | .32 | .46 | ||||||||||||||
Net realized and unrealized gain/(loss) on investments, options and futures | .03 | (.17 | ) | (.10 | ) | (.14 | ) | .38 | ||||||||||||
Total from investment operations | .50 | .23 | .25 | .18 | .84 | |||||||||||||||
Distributions from: | ||||||||||||||||||||
Net investment income | (.48 | ) | (.40 | ) | (.42 | ) | (.33 | ) | (.46 | ) | ||||||||||
Net realized gain on investments | — | — | (.01 | ) | — | — | ||||||||||||||
Total distributions | (.48 | ) | (.40 | ) | (.43 | ) | (.33 | ) | (.46 | ) | ||||||||||
Net asset value, end of year | $10.22 | $10.20 | $10.37 | $10.55 | $10.70 | |||||||||||||||
Total return | 4.98 | % | 2.29 | % | 2.41 | % | 1.71 | % | 8.35 | % | ||||||||||
Ratios to Average Net Assets:B | ||||||||||||||||||||
Total expenses | .64 | % | .62 | % | .70 | % | .68 | % | .66 | % | ||||||||||
Expenses net of waivers, if any | .50 | % | .46 | % | .48 | % | .46 | % | .47 | % | ||||||||||
Expenses net of all reductions | .50 | % | .46 | % | .48 | % | .46 | % | .47 | % | ||||||||||
Net investment income | 4.58 | % | 3.85 | % | 3.22 | % | 3.03 | % | 4.38 | % | ||||||||||
Supplemental Data: | ||||||||||||||||||||
Portfolio turnover rate | 237.2 | % | 81.6 | % | 238.0 | % | 487.3 | % | 204.1 | % | ||||||||||
Net assets, end of year (in thousands) | $11,052 | $18,213 | $9,546 | $7,740 | $9,485 | |||||||||||||||
See notes to financial statements.
112 Annual Report to Shareholders
Notes to Financial Statements
Legg Mason Income Trust, Inc.
(Amounts in Thousands)
1. Organization and Significant Accounting Policies:
The Legg Mason Income Trust, Inc. (“Corporation”), consisting of the Core Bond Fund (“Core Bond”), the High Yield Portfolio (“High Yield”), the Investment Grade Income Portfolio (“Investment Grade”), and the Limited Duration Bond Portfolio, (“Limited Duration”) (each a “Fund”), is registered under the Investment Company Act of 1940 (“1940 Act”), as amended, as an open-end, diversified investment company.
The High Yield, Investment Grade and Limited Duration Portfolios consist of two classes of shares: Primary Class and Institutional Class. The income and expenses of each of these Funds are allocated proportionately to the two classes of shares based on daily net assets, except for Rule 12b-1 distribution fees, which are charged only on Primary Class shares, and transfer agent and shareholder servicing expenses, which are determined separately for each class.
Preparation of the 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 and disclosures in the financial statements. Actual results could differ from those estimates. The following is a summary of significant accounting policies followed by the Funds in the preparation of their financial statements:
Security Valuation
Securities owned by the Funds for which market quotations are readily available are valued at current market value. Securities for which market quotations are not readily available are fair valued pursuant to procedures approved by and under the general oversight of the Board of Directors. In determining fair value, all relevant qualitative and quantitative factors available are considered. These factors are subject to change over time and are reviewed periodically. The values assigned to fair value investments are based on available information and do not necessarily represent amounts that might ultimately be realized, since such amounts depend on future developments inherent in long-term investments. Further, because of the inherent uncertainty of valuation, those estimated values may differ significantly from quoted or published values or from the values that would have been used had a ready market of the investments existed, and the differences could be material.
With respect to High Yield, where a security is traded on more than one market, which may include foreign markets, the securities are generally valued on the market considered by the Fund’s adviser to be the primary market. The Fund will value its foreign securities in U.S. dollars on the basis of the then-prevailing exchange rates.
Annual Report to Shareholders 113
Foreign Currency Translation
Assets and liabilities initially expressed in non-U.S. currencies are translated into U.S. dollars using currency exchange rates determined prior to the close of trading on the New York Stock Exchange, usually at 2:00 p.m. Eastern time. Purchases and sales of securities and income and expenses are translated into U.S. dollars at the prevailing market rates on the dates of such transactions. The effects of changes in non-U.S. currency exchange rates on investment securities and other assets and liabilities are included with the net realized and unrealized gain or loss on investment securities.
Security Transactions
Security transactions are accounted for as of the trade date. Realized gains and losses from security transactions are reported on an identified cost basis for both financial reporting and federal income tax purposes.
For the year ended December 31, 2006, investment transactions (excluding short-term investments) were as follows:
Purchases | Proceeds From Sales | |||||||||||||||
U.S. Gov’t. Securities | Other | U.S. Gov’t. Securities | Other | |||||||||||||
Core Bond | $ | 352,966 | $ | 13,409 | $ | 350,548 | $ | 16,733 | ||||||||
High Yield | — | 139,521 | — | 160,527 | ||||||||||||
Investment Grade | 94,405 | 180,123 | 92,599 | 163,588 | ||||||||||||
Limited Duration | 457,173 | 58,924 | 456,535 | 91,454 |
Repurchase Agreements
The Funds may engage in repurchase agreement transactions. Under the terms of a typical repurchase agreement, a fund takes possession of an underlying debt obligation subject to an obligation of the seller to repurchase, and a fund to resell, the obligation at an agreed-upon price and time, thereby determining the yield during a fund’s holding period. This arrangement results in a fixed rate of return that is not subject to market fluctuations during the fund’s holding period. The value of the collateral is at all times at least equal to the total amount of the repurchase obligation, including interest. In the event of counterparty default, a fund has the right to use the collateral to satisfy the terms of the repurchase agreement. However, there could be potential loss to the fund in the event the fund is delayed or prevented from exercising its right to dispose of the collateral securities, including the risk of a possible decline in the value of the collateral securities during the period in which the fund seeks to assert its rights. The Funds’ investment adviser reviews the value of the collateral and the creditworthiness of those banks and dealers with which the Funds enter into repurchase agreements to evaluate potential risks.
114 Annual Report to Shareholders
Notes to Financial Statements — Continued
Legg Mason Income Trust, Inc. — Continued
Options and Futures
The current market value of a traded option is the last sale price or, in the absence of a sale, the mean between the closing bid and asked price. Futures contracts are valued daily at the settlement price established by the board of trade or exchange on which they are traded. Futures contracts are marked-to-market on a daily basis. As a contract’s value fluctuates, payments known as variation margin are made or received by a Fund each day, depending on the daily fluctuation in the value of the contract. The daily changes in the contract value are recorded as unrealized gains or losses, and the Fund recognizes a gain or loss when the contract is closed.
Investment Income and Distributions to Shareholders
Interest income and expenses are recorded on the accrual basis. Bond premiums and discounts are amortized for financial reporting and federal income tax purposes. Dividend income and distributions to shareholders are allocated at the class level and are recorded on the ex-dividend date. Dividends from net investment income are declared daily and paid monthly for each Fund except High Yield, which declares and pays dividends monthly. Net capital gain distributions, which are calculated at the Fund level, are declared and paid after the end of the tax year in which the gain is realized. An additional distribution may be made in December, to the extent necessary in order to comply with federal excise tax regulations. Distributions are determined in accordance with federal income tax regulations, which may differ from those determined in accordance with accounting principles generally accepted in the United States of America; accordingly, periodic reclassifications are made within the Funds’ capital accounts to reflect income and gains available for distribution under federal income tax regulations.
Compensating Balance Credits
The Funds have an arrangement with their custodian bank, whereby a portion of the custodian’s fee is paid indirectly by credits earned on each Fund’s cash on deposit with the bank. This deposit arrangement is an alternative to purchasing overnight investments.
Other
In the normal course of business, the Funds enter into contracts that provide general indemnifications. The Funds’ maximum exposure under these arrangements is dependent upon claims that may be made against the Funds in the future and, therefore, cannot be estimated; however, based on experience, the risk of material loss from such claims is considered remote.
2. Federal Income Taxes:
No provision for federal income or excise taxes is required since each Fund intends to continue to qualify as a regulated investment company and distribute substantially all of its
Annual Report to Shareholders 115
taxable income and capital gain to its shareholders. Because federal income tax regulations differ from accounting principles generally accepted in the United States of America, income and capital gain distributions determined in accordance with tax regulations may differ from net investment income and realized gains recognized for financial reporting purposes. Accordingly, the character of distributions and composition of net assets for tax purposes differ from those reflected in the accompanying financial statements.
Distributions during the years ended December 31, 2006 and 2005, were characterized as follows for tax purposes:
Core Bond | High Yield | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Ordinary income | $ | 2,992 | $ | 2,411 | $ | 11,785 | $ | 14,058 | ||||||||
Long-term capital gains | — | — | — | — | ||||||||||||
Total Distributions | $ | 2,992 | $ | 2,411 | $ | 11,785 | $ | 14,058 |
Investment Grade | Limited Duration | |||||||||||||||
2006 | 2005 | 2006 | 2005 | |||||||||||||
Ordinary income | $ | 19,999 | $ | 19,613 | $ | 9,180 | $ | 9,089 | ||||||||
Long-term capital gains | 16 | 2,957 | — | — | ||||||||||||
Total Distributions | $ | 20,015 | $ | 22,570 | $ | 9,180 | $ | 9,089 |
Pursuant to federal income tax regulations applicable to investment companies, the Funds have elected to treat net capital losses realized between November 1 and December 31 of each year (“post-October loss”) as occurring on the first day of the following tax year. For the year ended December 31, 2006, realized capital losses reflected in the accompanying financial statements, as shown in the table on the next page, will not be recognized for federal income tax purposes until 2007.
116 Annual Report to Shareholders
Notes to Financial Statements — Continued
Legg Mason Income Trust, Inc. — Continued
The tax basis components of net assets at December 31, 2006, were:
Investment | Limited | |||||||||||||||
Core Bond | High Yield | Grade | Duration | |||||||||||||
Unrealized appreciation | $ | 657 | $ | 5,092 | $ | 10,498 | $ | 961 | ||||||||
Unrealized depreciation | (1,074 | ) | (2,055 | ) | (5,781 | ) | (4,596 | ) | ||||||||
Net unrealized appreciation/depreciation | (417 | ) | 3,037 | 4,717 | (3,635 | ) | ||||||||||
Undistributed ordinary income | 60 | 1 | — | 17 | ||||||||||||
Undistributed long-term capital gains | — | — | 1,243 | — | ||||||||||||
Capital loss carryforwards | (830 | ) | (151,165 | ) | — | (10,342 | ) | |||||||||
Post-October loss deferrals | (74 | ) | — | — | (255 | ) | ||||||||||
Other temporary differences | (25 | ) | (25 | ) | (120 | ) | (51 | ) | ||||||||
Paid-in capital | 73,636 | 303,205 | 410,918 | 217,201 | ||||||||||||
Net assets | $ | 72,350 | $ | 155,053 | $ | 416,758 | $ | 202,935 | ||||||||
The Funds intend to retain realized capital gains that may be offset against available capital loss carryforwards for federal income tax purposes. At December 31, 2006, the Funds had capital loss carryforwards as follows:
Limited | ||||||||||||||
Expiration Date | Core Bond | High Yield | Duration | |||||||||||
2008 | $ | — | $ | (32,313 | ) | $ | (3,833 | ) | ||||||
2009 | — | (83,723 | ) | — | ||||||||||
2010 | — | (32,488 | ) | — | ||||||||||
2011 | — | (2,556 | ) | — | ||||||||||
2012 | — | — | (4,536 | ) | ||||||||||
2013 | (582 | ) | (85 | ) | (555 | ) | ||||||||
2014 | (248 | ) | — | (1,418 | ) |
For financial reporting purposes, capital accounts and distributions to shareholders are adjusted to reflect the tax character of permanent book/tax differences. For the year ended December 31, 2006, the Funds recorded the following permanent reclassifications, which
Annual Report to Shareholders 117
relate primarily to reclassifications of gains/losses on paydown securities.
Investment | Limited | |||||||||||||||
Core Bond | High Yield | Grade | Duration | |||||||||||||
Undistributed net investment income | $ | 34 | $ | (9 | ) | $ | (1 | ) | $ | 184 | ||||||
Accumulated realized gain/(loss) | (34 | ) | (8 | ) | 1 | (199 | ) | |||||||||
Paid-in capital | — | 17 | — | 15 |
At December 31, 2006, the cost of investments for federal income tax purposes was $92,825 for Core Bond, $148,121 for High Yield, $404,795 for Investment Grade, and $232,732 for Limited Duration.
3. Financial Instruments:
Options and Futures
As part of their investment programs, the Funds may utilize options and futures. Options may be written (sold) or purchased by the Funds. When a Fund purchases a put or call option, the premium paid is recorded as an investment and its value is marked-to-market daily. When a Fund writes a put or call option, an amount equal to the premium received by the Fund is recorded as a liability and its value is marked-to-market daily.
When options, whether written or purchased, expire, are exercised or are closed (by entering into a closing purchase or sale transaction), the Fund realizes a gain or loss as described in the chart below:
Purchased option: | Impact on the Fund: | |
The option expires | Realize a loss in the amount of the cost of the option. | |
The option is closed through a closing sale transaction | Realize a gain or loss depending on whether the proceeds from the closing sale transaction are greater or less than the cost of the option. | |
The Fund exercises a call option | The cost of the security purchased through the exercise of the option will be increased by the premium originally paid to purchase the option. | |
The Fund exercises a put option | Realize a gain or loss from the sale of the underlying security. The proceeds of that sale will be reduced by the premium originally paid to purchase the put option. | |
118 Annual Report to Shareholders
Notes to Financial Statements — Continued
Legg Mason Income Trust, Inc. — Continued
Written option: | Impact on the Fund: | |
The option expires | Realize a gain equal to the amount of the premium received. | |
The option is closed through a closing purchase transaction | Realize a gain or loss without regard to any unrealized gain or loss on the underlying security and eliminate the option liability. The Fund will realize a loss in this transaction if the cost of the closing purchase exceeds the premium received when the option was written. | |
A written call option is exercised by the option purchaser | Realize a gain or loss from the sale of the underlying security. The proceeds of that sale will be increased by the premium originally received when the option was written. | |
A written put option is exercised by the option purchaser | The amount of the premium originally received will reduce the cost of the security that the Fund purchased when the option was exercised. | |
The risk associated with purchasing options is limited to the premium originally paid. Options written by a Fund involve, to varying degrees, risk of loss in excess of the option value reflected in the statement of net assets. The risk in writing a covered call option is that a Fund may forgo the opportunity of profit if the market price of the underlying security increases and the option is exercised. The risk in writing a put option is that a Fund may incur a loss if the market price of the underlying security decreases and the option is exercised. In addition, there is the risk a Fund may not be able to enter into a closing transaction because of an illiquid secondary market or, for over-the-counter options, because of the counterparty’s inability to perform.
Activity in written call and put options during the year ended December 31, 2006, was as follows:
Core Bond Fund:
Calls | Puts | |||||||||||||||
Actual | Actual | |||||||||||||||
Contracts | Premiums | Contracts | Premiums | |||||||||||||
Options outstanding at December 31, 2005 | 104 | $ | 58 | 68 | $ | 43 | ||||||||||
Options written | 700 | 339 | 262 | 123 | ||||||||||||
Options closed | (174 | ) | (107 | ) | (94 | ) | (52 | ) | ||||||||
Options expired | (413 | ) | (180 | ) | (134 | ) | (69 | ) | ||||||||
Options exercised | (62 | ) | (25 | ) | (25 | ) | (12 | ) | ||||||||
Options outstanding at December 31, 2006 | 155 | $ | 85 | 77 | $ | 33 | ||||||||||
Annual Report to Shareholders 119
Limited Duration Bond:
Calls | Puts | |||||||||||||||
Actual | Actual | |||||||||||||||
Contracts | Premiums | Contracts | Premiums | |||||||||||||
Options outstanding at December 31, 2005 | — | $ | — | — | $ | — | ||||||||||
Options written | 241 | 135 | 482 | 139 | ||||||||||||
Options closed | (90 | ) | (65 | ) | (136 | ) | (46 | ) | ||||||||
Options expired | — | — | — | — | ||||||||||||
Options exercised | — | — | — | — | ||||||||||||
Options outstanding at December 31, 2006 | 151 | $ | 70 | 346 | $ | 93 | ||||||||||
Upon entering into a futures contract, the Fund is required to deposit with the broker cash or cash equivalents in an amount equal to a certain percentage of the contract amount. This is known as the “initial margin.” Subsequent payments (“variation margin”) are made or received by the Fund each day, depending on the daily fluctuation in the value of the contract. The daily changes in contract value are recorded as unrealized gains or losses and the Fund recognizes a realized gain or loss when the contract is closed. Futures contracts are valued daily at the settlement price established by the board of trade or exchange on which they are traded.
The Funds enter into futures contracts as a hedge against anticipated changes in interest rates. There are several risks in connection with the use of futures contracts as a hedging device. Futures contracts involve, to varying degrees, risk of loss in excess of the amounts reflected in the financial statements. The change in the value of futures contracts primarily corresponds with the value of their underlying instruments, which may not correlate with the change in the value of the hedged instruments. In addition, there is the risk that a Fund may not be able to enter into a closing transaction because of an illiquid secondary market.
The open futures positions and related appreciation or depreciation at December 31, 2006, are listed at the end of each Fund’s portfolio of investments.
Forward Currency Exchange Contracts
As part of its investment program, High Yield may utilize forward currency exchange contracts. The nature and risks of these financial instruments and the reasons for using them are set forth more fully in the Corporation’s prospectus and statement of additional information.
Forward foreign currency contracts are marked-to-market daily using forward foreign currency exchange rates supplied by an independent pricing service. The change in a contract’s market value is recorded by High Yield as an unrealized gain or loss. When the contract is closed or delivery is taken, the Fund records a realized gain or loss equal to the difference
120 Annual Report to Shareholders
Notes to Financial Statements — Continued
Legg Mason Income Trust, Inc. — Continued
between the value of the contract at the time it was opened and the value at the time it was closed.
The use of forward foreign currency contracts does not eliminate fluctuations in the underlying prices of the Fund’s securities, but it does establish a rate of exchange that can be achieved in the future. These forward foreign currency contracts involve market risk in excess of amounts reflected in the financial statements. Although forward foreign currency contracts used for hedging purposes limit the risk of loss due to a decline in the value of the hedged currency, they also limit any potential gain that might result should the value of the currency increase. In addition, the Fund could be exposed to risks if the counterparties to the contracts are unable to meet the terms of their contracts. The Fund’s adviser will enter into forward foreign currency contracts only with parties approved by the Board of Directors because there is a risk of loss to the Fund if the counterparties do not complete the transaction.
At December 31, 2006, High Yield had no open forward currency exchange contracts.
Swap Agreements
The use of swaps involves risks that are different from those associated with ordinary portfolio securities transactions. Swap agreements may be considered to be illiquid. Although a Fund will not enter into any swap agreement unless the adviser believes that the other party to the transaction is creditworthy, a Fund does bear the risk of loss of the amount expected to be received under a swap agreement in the event of the default or bankruptcy of the agreement counterparty. The nature and risks of these financial instruments and the reasons for using them are set forth more fully in the Corporation’s prospectus and statement of additional information.
The Funds may invest in different types of swap agreements. Credit default swap contracts represent the exchange of commitments to provide a level of credit protection for a commitment to receive interest at a fixed rate based on the potential risk of default of the relevant underlying issuer. Interest rate swap contracts involve the exchange of commitments to pay and receive interest based on a notional principal amount. Total return swap contracts involve the exchange of commitments to pay and receive interest based on the total return of an index over a specified period.
At December 31, 2006, there were no swap contracts outstanding for any fund.
4. Transactions With Affiliates:
Each Fund has a management agreement with Legg Mason Fund Adviser, Inc. (“LMFA”). Pursuant to their respective agreements, LMFA provides the Funds with management and administrative services for which each Fund pays a fee, computed daily and payable monthly, at annual rates of each Fund’s average daily net assets. LMFA has contractually agreed to waive its fees to the extent Core Bond and Limited Duration’s expenses (exclusive of taxes, interest, brokerage and extraordinary expenses) exceed during any month certain annual rates. These
Annual Report to Shareholders 121
contractual expense limitations are due to expire on April 30, 2007. LMFA has voluntarily agreed to waive fees to the extent that Investment Grade’s expense (exclusive of taxes, interest, brokerage and extraordinary expenses) exceed during any month certain annual rates. This voluntary waiver is currently expected to continue until April 30, 2007, but may be terminated at any time. Pursuant to an agreement approved by the Board, Core Bond and Limited Duration have agreed to repay LMFA for waived fees and reimbursed expenses provided that payment does not cause operating expenses to exceed 1.00% of the Primary Class’s average net assets and 0.50% of the Institutional Class’s average net assets and the payment is made within three years after the year in which LMFA earned the fee or incurred the expense. At December 31, 2006, High Yield has no expense limitation. The following chart shows annual rates of management fees, expense limits, and management fees waived, for each Fund:
Year Ended | Maximum | |||||||||||||
December 31, 2006 | Amount | |||||||||||||
Expense | Management Fees | Subject to | ||||||||||||
Fund | Management Fee | Limitation | Waived | Recapture | ||||||||||
Core Bond | 0.45% | 1.00% | $ | (299 | ) | $ | (669 | ) | ||||||
High Yield | ||||||||||||||
— Primary Class | 0.65% | None | — | — | ||||||||||
— Institutional Class | 0.65% | None | — | — | ||||||||||
Investment Grade | ||||||||||||||
— Primary Class | 0.60% | 1.00% | (912 | ) | (3,142 | ) | ||||||||
— Institutional Class | 0.60% | 0.50% | (45 | ) | (114 | ) | ||||||||
Limited Duration | ||||||||||||||
— Primary Class | 0.45% | 1.00% | (280 | ) | (1,305 | ) | ||||||||
— Institutional Class | 0.45% | 0.50% | (21 | ) | (62 | ) |
Western Asset Management Company (“Adviser”) serves as investment adviser to the Funds. The Adviser is responsible for the actual investment activity of each Fund. LMFA pays the Adviser a fee, computed daily and payable monthly, at an annual rate of 40% of the management fee received by LMFA for Core Bond; 77% of the management fee received by LMFA for High Yield; and 40% of the management fee received by LMFA for Investment Grade. For Limited Duration, LMFA pays the Adviser a fee, computed daily and payable monthly, of 0.20% of its average daily net assets, not to exceed the fee received by LMFA.
Legg Mason Investor Services, LLC (“LMIS”) serves as distributor of the Funds. LMIS receives an annual distribution fee and an annual service fee based on each Fund’s Primary Class’s average daily net assets, computed daily and payable monthly as shown in the table below. For the year ended December 31, 2006, LMIS waived $7, $337 and $148 of the distribution and service fees for Core Bond, Investment Grade and Limited Duration, respectively.
122 Annual Report to Shareholders
Notes to Financial Statements — Continued
Legg Mason Income Trust, Inc. — Continued
Distribution | Service | |||||||
Fee | Fee | |||||||
Core Bond | 0.25% | 0.25% | ||||||
High Yield | 0.25% | 0.25% | ||||||
Investment Grade | 0.25% | 0.25% | ||||||
Limited Duration | 0.25% | 0.25% |
LM Fund Services, Inc. (“LMFS”), a registered transfer agent, has an agreement with the Funds’ transfer agent to assist it with some of its duties. For this assistance, the transfer agent paid LMFS the following amounts during the year ended December 31, 2006: Core Bond, $5; High Yield, $12; Investment Grade, $21; and Limited Duration, $13.
LMFA, the Adviser, LMIS and LMFS are corporate affiliates and wholly owned subsidiaries of Legg Mason, Inc.
Under a Deferred Compensation Plan (“Plan”), directors may elect to defer receipt of all or a specified portion of their compensation. A participating director may select one or more funds in which his or her deferred director’s fees will be deemed to be invested. Deferred amounts remain in the fund until distributed in accordance with the Plan.
5. Line of Credit:
The Funds, along with certain other Legg Mason Funds, participate in a $400 million line of credit (“Credit Agreement”) to be used for temporary or emergency purposes. Pursuant to the Credit Agreement, each participating Fund is liable only for principal and interest payments related to borrowings made by that Fund. Borrowings under the Credit Agreement bear interest at a rate equal to the federal funds rate plus the federal funds rate margin. For the year ended December 31, 2006, the Funds had no borrowings under the credit agreement.
Annual Report to Shareholders 123
6. Fund Share Transactions:
At December 31, 2006, there were 1,000,000 shares authorized at $.001 par value for all classes of each portfolio of the Corporation. Share transactions for the Funds were as follows:
Core Bond | ||||||||
Years Ended | ||||||||
12/31/06 | 12/31/05 | |||||||
Shares | ||||||||
Sold | 2,116 | 3,168 | ||||||
Reinvestment of Distributions | 285 | 226 | ||||||
Repurchased | (2,379 | ) | (2,404 | ) | ||||
Net Change | 22 | 990 | ||||||
Amount | ||||||||
Sold | $ | 20,412 | $ | 31,295 | ||||
Reinvestment of Distributions | 2,738 | 2,215 | ||||||
Repurchased | (22,886 | ) | (23,672 | ) | ||||
Net Change | $ | 264 | $ | 9,838 | ||||
High Yield | ||||||||||||||||
Primary Class | Institutional Class | |||||||||||||||
Years Ended | Years Ended | |||||||||||||||
12/31/06 | 12/31/05 | 12/31/06 | 12/31/05 | |||||||||||||
Shares | ||||||||||||||||
Sold | 2,822 | 2,693 | 426 | 855 | ||||||||||||
Reinvestment of Distributions | 891 | 1,090 | 91 | 94 | ||||||||||||
Repurchased | (5,428 | ) | (8,012 | ) | (1,346 | ) | (495 | ) | ||||||||
Net Change | (1,715 | ) | (4,229 | ) | (829 | ) | 454 | |||||||||
Amount | ||||||||||||||||
Sold | $ | 25,600 | $ | 24,689 | $ | 3,869 | $ | 7,866 | ||||||||
Reinvestment of Distributions | 8,075 | 9,912 | 822 | 857 | ||||||||||||
Repurchased | (49,345 | ) | (73,219 | ) | (12,210 | ) | (4,549 | ) | ||||||||
Net Change | $ | (15,670 | ) | $ | (38,618 | ) | $ | (7,519 | ) | $ | 4,174 | |||||
124 Annual Report to Shareholders
Notes to Financial Statements — Continued
Legg Mason Income Trust, Inc. — Continued
Investment Grade | ||||||||||||||||
Primary Class | Institutional Class | |||||||||||||||
Years Ended | Years Ended | |||||||||||||||
12/31/06 | 12/31/05 | 12/31/06 | 12/31/05 | |||||||||||||
Shares | ||||||||||||||||
Sold | 11,858 | 6,762 | 945 | 1,449 | ||||||||||||
Reinvestment of Distributions | 1,643 | 1,834 | 92 | 92 | ||||||||||||
Repurchased | (10,116 | ) | (10,700 | ) | (1,868 | ) | (521 | ) | ||||||||
Net Change | 3,385 | (2,104 | ) | (831 | ) | 1,020 | ||||||||||
Amount | ||||||||||||||||
Sold | $ | 122,001 | $ | 72,007 | $ | 9,714 | $ | 15,490 | ||||||||
Reinvestment of Distributions | 16,875 | 19,415 | 939 | 970 | ||||||||||||
Repurchased | (104,395 | ) | (113,694 | ) | (19,237 | ) | (5,546 | ) | ||||||||
Net Change | $ | 34,481 | $ | (22,272 | ) | $ | (8,584 | ) | $ | 10,914 | ||||||
Limited Duration | ||||||||||||||||
Primary Class | Institutional Class | |||||||||||||||
Years Ended | Years Ended | |||||||||||||||
12/31/06 | 12/31/05 | 12/31/06 | 12/31/05 | |||||||||||||
Shares | ||||||||||||||||
Sold | 2,693 | 3,474 | 491 | 1,392 | ||||||||||||
Reinvestment of Distributions | 761 | 743 | 54 | 49 | ||||||||||||
Repurchased | (6,199 | ) | (9,200 | ) | (1,249 | ) | (577 | ) | ||||||||
Net Change | (2,745 | ) | (4,983 | ) | (704 | ) | 864 | |||||||||
Amount | ||||||||||||||||
Sold | $ | 27,414 | $ | 35,740 | $ | 4,987 | $ | 14,310 | ||||||||
Reinvestment of Distributions | 7,746 | 7,624 | 545 | 510 | ||||||||||||
Repurchased | (63,100 | ) | (94,454 | ) | (12,717 | ) | (5,924 | ) | ||||||||
Net Change | $ | (27,940 | ) | $ | (51,090 | ) | $ | (7,185 | ) | $ | 8,896 | |||||
Annual Report to Shareholders 125
7. Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation 48 (“FIN 48” or the “Interpretation”), Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement 109. FIN 48 supplements FASB Statement 109, Accounting for Income Taxes and establishes financial reporting rules regarding recognition, measurement, presentation, and disclosure in its financial statements of tax positions that a fund has taken or expects to take on a tax return. Management has evaluated the impact of FIN 48 on the Funds and has determined that the adoption of FIN 48 will not have a material impact on the Funds’ financial statements. FIN 48 is effective for fiscal periods beginning after June 1, 2007.
On September 20, 2006, the FASB released Statement of Financial Accounting Standards No. 157 “Fair Value Measurements” (“FAS 157”). FAS 157 establishes an authoritative definition of fair value, sets out a framework for measuring fair value, and requires additional disclosures about fair-value measurements. The application of FAS 157 is required for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. At this time, management is evaluating the implications of FAS 157 and its impact on the financial statements has not yet been determined.
126 Annual Report to Shareholders
Shareholder Meeting Results: (Unaudited)
A Special Meeting of Shareholders was held on October 19, 2006, to approve a plan of reorganization of Legg Mason Income Trust, Inc. with respect to its series Legg Mason High Yield Portfolio whereby the Portfolio would transfer all of its assets and liabilities to Legg Mason Partners High Income Fund, a series of Legg Mason Partners Income Funds. It is anticipated that the proposed reorganization will be effected by March 31, 2007.
Shareholder Meeting Results (share amounts are not in thousands):
Affirmative | 8,896,973.124 shares | 50.284 | % of shares outstanding | |||||
Against | 248,815.486 shares | 1.406 | % of shares outstanding | |||||
Abstain | 321,374.088 shares | 1.816 | % of shares outstanding |
Annual Report to Shareholders 127
Report of Independent Registered Public Accounting Firm
To the Shareholders of Core Bond Fund, High Yield Portfolio, Investment Grade Income Portfolio, and Limited Duration Bond Portfolio and to the Directors of Legg Mason Income Trust, Inc.:
In our opinion, the accompanying statements of assets and liabilities, including the portfolios of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial positions of Core Bond Fund, High Yield Portfolio, Investment Grade Income Portfolio and Limited Duration Bond Portfolio (comprising Legg Mason Income Trust, Inc., hereafter referred to as the “Funds”) at December 31, 2006, and the results of each of their operations, the changes in each of their net assets and the financial highlights for each of the fiscal periods presented, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of the Funds’ management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with 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 are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at December 31, 2006 by correspondence with the custodian and brokers, provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Baltimore, Maryland
February 23, 2007
128 Annual Report to Shareholders
Directors and Officers
The table below provides information about each of the Corporation’s directors and officers, including biographical information about their business experience and information about their relationships with Legg Mason, Inc. and its affiliates. The mailing address of each director and officer is 100 Light Street, c/o Legal and Compliance Department, 23rd Floor, Baltimore, Maryland 21202.
Term of | ||||||||||||
Name, | Office and | |||||||||||
(Year of Birth) and | Length of | Number of Funds in | ||||||||||
Position with | Time | Fund Complex | Other Directorships | Principal Occupation(s) | ||||||||
Corporation | ServedA | Overseen | Held | During the Past Years | ||||||||
INDEPENDENT DIRECTORS:B | ||||||||||||
Hearn, Ruby P. (1940) Director | Since 2004 | Director/Trustee of all Legg Mason funds consisting of 21 portfolios. | None | Senior Vice President Emerita of The Robert Wood Johnson Foundation (non-profit) since 2001. Formerly: Senior Vice President of The Robert Wood Johnson Foundation (1996-2001). | ||||||||
Lehman, Arnold L. (1944) Lead Independent Director | Since 1987 | Director/Trustee of all Legg Mason funds consisting of 21 portfolios. | None | Director of the Brooklyn Museum since 1997; Trustee of American Federation of Arts since 1998. Formerly: Director of The Baltimore Museum of Art (1979-1997). | ||||||||
Masters, Robin J.W. (1955) Director | Since 2002 | Director/Trustee of all Legg Mason funds consisting of 21 portfolios. | Chairman of the Board of Directors of Cap-a-Laige Ltd. (management company for charitable trust); Director of Cheyne Capital International Limited (investment advisory firm); Director of Cheyne Property Holdings Limited (real estate). | Retired. Director of Bermuda SMARTRISK (non-profit) since 2001. Formerly: Chief Investment Officer of ACE Limited (insurance) (1986-2000). | ||||||||
McGovern, Jill E. (1944) Director | Since 1989 | Director/Trustee of all Legg Mason funds consisting of 21 portfolios. | None | Chief Executive Officer of The Marrow Foundation (non-profit) since 1993. Formerly: Executive Director of the Baltimore International Festival (1991-1993); Senior Assistant to the President of The Johns Hopkins University (1986-1990). | ||||||||
Annual Report to Shareholders 129
Term of | ||||||||||||
Name, | Office and | |||||||||||
(Year of Birth) and | Length of | Number of Funds in | ||||||||||
Position with | Time | Fund Complex | Other Directorships | Principal Occupation(s) | ||||||||
Corporation | ServedA | Overseen | Held | During the Past Years | ||||||||
Mehlman, Arthur S. (1942) Director | Since 2002 | Director/Trustee of all Legg Mason funds consisting of 21 portfolios; Director/Trustee of the Royce Family of Funds consisting of 25 portfolios. | Director of Municipal Mortgage & Equity, LLC. | Retired. Formerly: Partner, KPMG LLP (international accounting firm) (1972-2002). | ||||||||
O’Brien, G. Peter (1945) Director | Since 2002 | Director/Trustee of all Legg Mason funds consisting of 21 portfolios; Director/Trustee of the Royce Family of Funds consisting of 25 portfolios. | Director of Technology Investment Capital Corp. | Retired. Trustee Emeritus of Colgate University; Board Member, Hill House, Inc. (residential home care). Formerly: Managing Director, Equity Capital Markets Group of Merrill Lynch & Co. (1971-1999). | ||||||||
Rowan, S. Ford (1943) Director | Since 2002 | Director/Trustee of all Legg Mason funds consisting of 21 portfolios. | None | Consultant, Rowan & Blewitt Inc. (management consulting); Chairman, National Center for Critical Incident Analysis, National Defense University, since 2004; Director of Santa Fe Institute (scientific research institute) since 1999. | ||||||||
Tarola, Robert M. (1950) Director | Since 2004 | Director/Trustee of all Legg Mason funds consisting of 21 portfolios. | None | Senior Vice President and Chief Financial Officer of W. R. Grace & Co. (specialty chemicals) since 1999; Member of PCAOB standing advisory group (since 2006). Formerly: Chief Financial Officer of MedStar Health, Inc. (healthcare) (1996-1999); Partner, Price Waterhouse, LLP (accounting and auditing) (1984-1996). | ||||||||
INTERESTED DIRECTORS:C | ||||||||||||
Curley Jr., John F. (1939) Chairman and Director | Since 1987 | Chairman and Director/Trustee of all Legg Mason funds consisting of 21 portfolios. | None | Chairman of the Board of all Legg Mason Funds. Formerly: Vice Chairman and Director of Legg Mason, Inc. and Legg Mason Wood Walker, Incorporated (1982-1998); Director of Legg Mason Fund Adviser, Inc. (1982-1998) and Western Asset Management Company (1986-1998) (each a registered investment adviser). | ||||||||
130 Annual Report to Shareholders
Directors and Officers — Continued
Term of | ||||||||||||
Name, | Office and | |||||||||||
(Year of Birth) and | Length of | Number of Funds in | ||||||||||
Position with | Time | Fund Complex | Other Directorships | Principal Occupation(s) | ||||||||
Corporation | ServedA | Overseen | Held | During the Past Years | ||||||||
Fetting, Mark R. (1954) President and Director | President since 2001 and Director since 2002 | President and Director/Trustee of all Legg Mason funds consisting of 21 portfolios; Director/Trustee of the Royce Family of Funds consisting of 25 portfolios. | None | Senior Executive Vice President of Legg Mason, Inc., Director and/or officer of various Legg Mason, Inc. affiliates since 2000. Formerly: Division President and Senior Officer of Prudential Financial Group, Inc. and related companies, including fund boards and consulting services to subsidiary companies (1991- 2000); Partner, Greenwich Associates (financial consulting); Vice President, T. Rowe Price Group, Inc. | ||||||||
EXECUTIVE OFFICERS:D | ||||||||||||
Karpinski, Marie K. (1949) Vice President and Chief Financial Officer | Since 1987 | Vice President and Chief Financial Officer of all Legg Mason funds consisting of 21 portfolios. | None | Vice President and Chief Financial Officer of all Legg Mason Funds. Vice President and Treasurer of Legg Mason Fund Adviser, Inc. Vice President and Principal Financial and Accounting Officer of Western Asset Funds, Inc., Western Asset Income Fund, Western Asset Premier Bond Fund; Treasurer and Principal Financial and Accounting Officer of Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund (2003-present), and Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund 2 (2004-present). | ||||||||
Merz, Gregory T. (1958) Vice President and Chief Legal Officer | Since 2003 | Vice President and Chief Legal Officer of all Legg Mason funds consisting of 21 portfolios. | None | Vice President and Deputy General Counsel of Legg Mason, Inc. since 2003. Formerly: Associate General Counsel, Fidelity Investments (1993-2002). | ||||||||
Olmert, Amy M. (1963) Vice President and Chief Compliance Officer | Since 2004 | Vice President and Chief Compliance Officer of all Legg Mason funds consisting of 21 portfolios. | None | Senior Vice President of Legg Mason, Inc. since 2004. Chief Compliance Officer of Western Asset Funds, Inc., Western Asset Income Fund, Western Asset Premier Bond Fund, Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund, and Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund 2 since 2004. Formerly: Managing Director, Deutsche Asset Management (1997-2004). | ||||||||
Wachterman, Richard M. (1947) Secretary | Since 2004 | Secretary of all Legg Mason funds consisting of 21 portfolios. | None | Associate General Counsel of Legg Mason, Inc. since 2004. Formerly: Managing Director, Victory Capital Management, Inc. (investment management) (1993-2003). | ||||||||
Annual Report to Shareholders 131
Term of | ||||||||||||
Name, | Office and | |||||||||||
(Year of Birth) and | Length of | Number of Funds in | ||||||||||
Position with | Time | Fund Complex | Other Directorships | Principal Occupation(s) | ||||||||
Corporation | ServedA | Overseen | Held | During the Past Years | ||||||||
Morris, Erin K. (1966) Treasurer | Since 2006 | Treasurer of Legg Mason Fixed Income funds consisting of 7 portfolios. | None | Assistant Vice President of Legg Mason & Co., LLC and Manager, Funds Accounting, LMIS since 2005. Treasurer of Western Asset Income Fund, Western Asset Premier Bond Fund and Western Asset Funds, Inc., Assistant Treasurer of Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund and Western Asset/Claymore U.S. Treasury Inflation Protected Securities Fund 2. Formerly: Assistant Treasurer on above, Assistant Vice President of Legg Mason Wood Walker, Incorporated (2002-2005) and Manager, Funds Accounting, Legg Mason Wood Walker, Incorporated (2000-2005). | ||||||||
ADDITIONAL INFORMATION ABOUT THE CORPORATION’S
DIRECTORS AND OFFICERS IS CONTAINED IN THE STATEMENT OF
ADDITIONAL INFORMATION, AVAILABLE WITHOUT CHARGE UPON
REQUEST BY CALLING 1-800-822-5544 OR ON THE SECURITIES AND
EXCHANGE COMMISSION WEBSITE (http://www.sec.gov).
DIRECTORS AND OFFICERS IS CONTAINED IN THE STATEMENT OF
ADDITIONAL INFORMATION, AVAILABLE WITHOUT CHARGE UPON
REQUEST BY CALLING 1-800-822-5544 OR ON THE SECURITIES AND
EXCHANGE COMMISSION WEBSITE (http://www.sec.gov).
A | Directors of the Funds serve a term of indefinite length until their resignation or removal and stand for re-election by shareholders only as and when required by the 1940 Act. Officers of the Funds are elected annually to serve until their successors are elected and qualified. |
B | Each of the Independent Directors serves on the standing committees of the Board of Directors, which include the Audit Committee (chair: Arthur Mehlman), the Nominating Committee (co-chairs: Peter O’Brien and Jill McGovern), and the Independent Directors Committee (chair: Arnold Lehman). |
C | Mr. Curley and Mr. Fetting are considered to be interested persons, as defined in the 1940 Act, of the Corporation on the basis of their employment with the fund’s adviser or its affiliated entities (including the fund’s principal underwriter) and Legg Mason, Inc., the parent holding company of those entities, as well as their ownership of Legg Mason, Inc. stock. |
D | Officers of the Funds are interested persons (as defined in the 1940 Act). |
132 Annual Report to Shareholders
Board Consideration of Legg Mason Income Trust’s
Investment Advisory Agreement and Management Agreement
Investment Advisory Agreement and Management Agreement
At its November 2006 meeting, the Board of Directors, including all of the Independent Directors, approved the continuation of the Management Agreements between Legg Mason Fund Adviser, Inc. (the “Manager”) and Income Trust on behalf of each of its separate series and the Investment Advisory Agreements between the Manager and Western Asset Management Company (the “Adviser”) for each separate series of Income Trust (each an “Agreement”). In voting to approve the continuation of each Agreement, the Board considered whether continuance would be in the best interests of each series of Income Trust and its shareholders, an evaluation largely based on the nature and quality of the services provided under each Agreement and the overall fairness of each Agreement to each series of Income Trust. In considering each Agreement, the Board did not identify any single factor or item of information as all-important or controlling. Based on its evaluation of all material factors, including those described below, the Board concluded that the terms of each Agreement are reasonable and fair and that the continuation of each Agreement is in the best interests of each series of Income Trust and its shareholders.
Prior to the Board action, the Independent Directors met as a committee to consider its recommendation as to continuance of each Agreement. As part of the process to consider each Agreement, legal counsel to Income Trust requested certain information from the Manager and the Adviser on behalf of the Independent Directors, and in response, the Manager and the Adviser provided extensive reports that addressed specific factors designed to inform the Board’s consideration of each Agreement. Counsel also provided the Independent Directors and the Board with a memorandum detailing their responsibilities pertaining to the continuance of each Agreement.
In addition to the November meeting, the Independent Directors meeting as a committee held an additional meeting in October 2006 at which materials relating to each Agreement were reviewed and analyzed. The Independent Directors also retained an independent consultant to assist them in their review and analysis of each Agreement. The Board meets at least another three times per year in order to oversee the Legg Mason Funds, including meetings at which the portfolio managers of each series of Income Trust or others submit or make presentations and discuss performance, compliance and other applicable issues. The Board also drew upon its long association with the Manager, the Adviser and their personnel, and the Board members’ familiarity with their culture, and the manner in which the management entities have sought to strengthen and enhance themselves.
With respect to the nature, scope and quality of the services provided, the Board considered the experience and commitment of the Manager’s and the Adviser’s personnel and their efforts to build and support a strong service team. The Board also considered the nature and quality of the Adviser’s investment process. In assessing performance, the Board compared the returns of each series of Income Trust to the average of an appropriate Lipper category and a peer group of investment companies pursuing similar strategies, all over multiple time periods. The Board
Annual Report to Shareholders 133
also considered the performance of each series of Income Trust in the context of the risk undertaken by the portfolio manager. The Board noted the performance record of each series of Income Trust and the measures that the Manager and the Adviser were taking in an effort to maintain or achieve attractive long-term performance. The Board also considered the level of service provided by the Manager to Income Trust, including oversight of the transfer agent, the custodian, fund legal counsel, and investment adviser and fund compliance, and preparation of regulatory filings. The Board considered the Adviser’s procedures for executing portfolio transactions for each series of Income Trust. The Board also reviewed the Adviser’s report on its policies and procedures for the selection of brokers and dealers.
In determining whether the terms of each Agreement are reasonable and fair, the Board considered the terms and fee structure of each Agreement. In that connection, the Board considered the costs to the Manager and the Adviser in providing services to each series of Income Trust and profitability for the Manager and its affiliates from their overall association with each series of Income Trust. The Board reviewed information about the advisory fee schedule and overall expense ratio of each series of Income Trust and comparable fee schedules and expense ratios of a peer group of funds. Although Limited Duration Bond Portfolio, Investment Grade Income Portfolio, High Yield Portfolio and Core Bond Fund had not yet grown to a size where any potential economies of scale might become apparent, the Board satisfied itself that the fees paid by each of these series at its current asset level are appropriate and noted the Manager’s agreement to waive fees for Limited Duration Bond Portfolio, Investment Grade Income Portfolio and Core Bond Fund. The Board also considered the Manager’s proposal to merge High Yield Portfolio into the Legg Mason Partners Fund family. The Board also compared the advisory fee schedule for each series of Income Trust to the advisory fees charged by the Adviser to its other accounts managed in a similar style. In that connection, the Board considered the differences in the level of services provided and the differences in responsibility of the Adviser to each series of Income Trust and to the other accounts. Finally, the Board considered the benefits accruing to the Manager, the Adviser and their affiliates by virtue of their relationship to each series of Income Trust.
Fund Information
Investment Manager
Legg Mason Fund Adviser, Inc.
Baltimore, MD
Baltimore, MD
Investment Adviser
Western Asset Management Company
Pasadena, CA
Pasadena, CA
Board of Directors
John F. Curley, Jr., Chairman
Mark R. Fetting, President
Dr. Ruby P. Hearn
Arnold L. Lehman
Robin J.W. Masters
Dr. Jill E. McGovern
Arthur S. Mehlman
G. Peter O’Brien
S. Ford Rowan
Robert M. Tarola
Officers
Marie K. Karpinski, Vice President and Chief Financial Officer
Gregory T. Merz, Vice President and Chief Legal Officer
Amy M. Olmert, Vice President and Chief Compliance Officer
Erin K. Morris, Treasurer
Richard M. Wachterman, Secretary
Peter J. Ciliberti, Assistant Secretary
Transfer and Shareholder Servicing Agent
Boston Financial Data Services
Braintree, MA
Custodian
State Street Bank & Trust Company
Boston, MA
Counsel
Kirkpatrick & Lockhart Preston Gates Ellis LLP
Washington, DC
Independent Registered Public Accounting Firm
PricewaterhouseCoopers LLP
Baltimore, MD
About the Legg Mason Funds
Equity Funds American Leading Companies Trust Classic Valuation Fund Growth Trust Special Investment Trust U.S. Small-Capitalization Value Trust Value Trust Specialty Funds Balanced Trust Financial Services Fund Opportunity Trust Global Funds Emerging Markets Trust Global Income Trust International Equity Trust Taxable Bond Funds Core Bond Fund High Yield Portfolio Investment Grade Income Portfolio Limited Duration Bond Portfolio Tax-Free Bond Funds Maryland Tax-Free Income Trust Pennsylvania Tax-Free Income Trust Tax-Free Intermediate-Term Income Trust | Legg Mason, Inc., based in Baltimore, Maryland, has built its reputation, at least in part, on the success of the Legg Mason Funds, introduced in 1979. The primary purpose of our funds is to enable investors to diversify their portfolios across various asset classes and, consequently, enjoy the stability and growth prospects generally associated with diversification. The success of our funds is contingent on the experience, discipline, and acumen of our fund managers. We believe the quality of our managers is crucial to investment success. Unlike many firms, which focus on a particular asset class or the fluctuations of the market, at Legg Mason we focus on providing a collection of top-notch managers in all the major asset classes. Information about the policies and procedures that each Fund uses to determine how to vote proxies relating to its portfolio securities is contained in the Statement of Additional Information, available without charge upon request by calling 1-800-822-5544 or on the Securities and Exchange Commission’s (“SEC”) website (http://www.sec.gov). Information regarding how each Fund voted proxies relating to portfolio securities during the most recent twelve-month period ended June 30 is also available on the SEC’s website or through the Legg Mason Funds’ website at www.leggmason.com/funds/about/aboutlmf.asp#Results. Each Fund files its complete schedule of portfolio holdings with the SEC for the first and third quarters of each fiscal year on Form N-Q. You may obtain a free copy of each Fund’s portfolio holdings as filed on Form N-Q, by contacting each Fund at the appropriate phone number, address or website listed below. Additionally, each Fund’s Form N-Q is available on the SEC’s website (http://www.sec.gov) or may be reviewed and copied at the SEC’s Public Reference Room in Washington, D.C. Information about the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330. |
This report must be preceded or accompanied by a free prospectus. Investors should consider each Fund’s investment objectives, risks, charges and expenses carefully before investing. The prospectus contains this and other important information about each Fund. Please read the prospectus carefully before investing.
Legg Mason Funds For Primary Class Shareholders c/o BFDS P.O. Box 55214 Boston, MA 02205-8504 800-822-5544 www.leggmasonfunds.com | Legg Mason Investor Services — Institutional For FI and I Class Shareholders c/o BFDS P.O. Box 8037 Boston, MA 02206-8037 888-425-6432 www.lminstitutionalfunds.com |
Legg Mason Investor Services, LLC, Distributor
A Legg Mason, Inc. subsidiary
LMF-056 (2/07)/A 07-0063
Item 2. Code of Ethics Applicable to Registrant’s Principal Executive Officer and Principal Financial Officer
(a) | Legg Mason Income Trust, Inc. (“Registrant”) has adopted a Code of Ethics, as defined in the instructions to Form N-CSR that applies to the Registrant’s President and Treasurer, which is designed to deter wrongdoing and to promote: |
• | Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; |
• | Full, fair, accurate, timely and understandable disclosure in reports and documents the Registrant files with, or submits to, the SEC or in other public communications made by the Registrant; | ||
• | Compliance with applicable governmental laws, rules and regulations; | ||
• | Prompt internal reporting of violations of the Code of Ethics to an appropriate person or persons identified in the Code of Ethics; and | ||
• | Accountability for adherence to the Code of Ethics. |
(b) | No response required. | ||
(c) | Not applicable. | ||
(d) | The Registrant has not granted a waiver, including an implicit waiver, from a provision of the Code of Ethics to the Registrant’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions during the period covered by this report. | ||
(e) | Not applicable. | ||
(f) | A copy of the Code of Ethics is attached as Exhibit 12(a)(1) to this Form N-CSR. |
Item 3. Audit Committee Financial Expert
(a) | (1 | ) | The Registrant’s Board of Directors have determined that the Registrant has at least one Audit Committee financial expert serving on its Audit Committee. | |||||
(a) | (2 | ) | The Audit Committee’s financial experts are Mr. Arthur S. Mehlman and Mr. Robert M. Tarola. They are “independent” as defined in Form N-CSR Item 3(a)(2). |
Item 4. Principal Accounting Fees and Services
(a) | Audit Fees |
PricewaterhouseCoopers LLP Fiscal Year End December 31, 2005 — $162,725 Fiscal Year End December 31, 2006 — $148,390 |
(b) | Audit-Related Fees | ||
There were no additional fees billed to the Registrant during either of the last two fiscal years in addition to those disclosed in Item 4(a). | |||
There were no fees billed to the Registrant for assurance and related services that required preapproval by the Audit Committee pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X during the Registrant’s last two fiscal years. | |||
(c) | Tax Fees | ||
PricewaterhouseCoopers LLP Fiscal Year End December 31, 2005 — $5,250 Fiscal Year End December 31, 2006 — $4,400 | |||
Services include preparation of federal and state income tax returns and preparation of excise tax returns. | |||
There were no fees billed to the Registrant for tax services that required preapproval by the Audit Committee pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X during the Registrant’s last two fiscal years. | |||
(d) | All Other Fees | ||
There were no fees billed to the Registrant during either of the last two fiscal years in addition to those disclosed in Item 4(a) through Item 4(c) above. There were no fees billed to the Registrant for services not included in Items 4(a) through 4(c) above that required preapproval by the Audit Committee pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X during the Registrant’s last two fiscal years. |
(e) | (1 | ) | The Audit Committee’s policy is to delegate to its chairperson the authority to preapprove items prior to the next meeting of the Committee. Such preapprovals are reported at the next quarterly meeting of the Audit Committee. | |||||
(2 | ) | There were no services provided to the Registrant that were approved by the Audit Committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X. |
There were no fees billed to the Registrant for services where pre-approval by the Audit Committee pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X during the Registrant’s last two fiscal years. |
(f) | The percentage of hours expended by the principal accountant’s engagement to audit the Registrant’s financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountants’ full-time, permanent employees was zero. | ||
(g) | Non-Audit Fees for services rendered to Registrant or Registrant’s investment manager and any entity controlling, controlled by, or under common control with the investment manager. | ||
PricewaterhouseCoopers LLP Fiscal Year End December 31, 2005 — $279,508 Fiscal Year End December 31, 2006 — $327,554 | |||
(h) | The members of the Registrant’s Audit Committee have considered whether the non-audit services that were rendered by the Registrant’s 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 were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X are compatible with maintaining the principal accountant’s independence. |
Item 5. Audit Committee of Listed Registrants
The Registrant is not a listed issuer as defined in Rule 10A-3 under the Securities Exchange Act of 1934.
Item 6. Schedule of Investments
The schedule of investments in securities of unaffiliated issuers is included in the annual report.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies
Not applicable.
Item 8. Portfolio Managers of Closed-End Management Investment Companies
Not applicable.
Item 9. Purchases of Equity Securities by Closed-End Management Investment Companies and Affiliated Purchasers
Not applicable.
Item 10. Submission of Matters to a Vote of Security Holders
The Nominating Committee will accept recommendations for nominations from shareholders. Shareholders may forward recommendations to the Fund Secretary at 100 Light Street, 23rd Floor, Baltimore, Maryland 21202, Attn.: Fund Secretary.
Item 11. Controls and Procedures
(a) | The Registrant’s principal executive and principal financial officers have concluded, based on their evaluation of the effectiveness of the design and operation of the Registrant’s disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) as of a date within 90 days of the filing date of this report, that the Registrant’s disclosure controls and procedures are reasonably designed to ensure that information required to be disclosed by the Registrant on Form N-CSR is recorded, processed, summarized and reported within the time periods specified in the SEC’s rule and forms and that information required to be disclosed by the Registrant in the reports that it files or submits on Form N-CSR is accumulated and communicated to the Registrant’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. | ||
(b) | There were no changes in the Registrant’s internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) during the Registrant’s second fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Registrant’s internal control over financial reporting. |
Item 12. Exhibits
(a) | File the exhibits listed below as part of this Form. |
(1) | The Registrant’s Code of Ethics applicable to Registrant’s principal executive officer and principal financial officer is attached hereto. | ||
(2) | Separate certifications for the Registrant’s chief executive officer and chief financial officer as required by Rule 30a-2(a) under the Investment Company Act of 1940 are attached hereto. |
(b) | Separate certifications for the Registrant’s chief executive officer and chief financial officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto. |
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.
Legg Mason Income Trust, Inc.
By: /s/ Mark R. Fetting
Mark R. Fetting
President, Legg Mason Income Trust, Inc.
Mark R. Fetting
President, Legg Mason Income Trust, Inc.
Date: February 27, 2007
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/ Mark R. Fetting
Mark R. Fetting
President, Legg Mason Income Trust, Inc.
Mark R. Fetting
President, Legg Mason Income Trust, Inc.
Date: February 27, 2007
By: /s/ Marie K. Karpinski
Marie K. Karpinski
Vice President and Chief Financial Officer, Legg Mason Income Trust, Inc.
Marie K. Karpinski
Vice President and Chief Financial Officer, Legg Mason Income Trust, Inc.
Date: February 26, 2007