UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORMN-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number811-07288
Franklin Strategic Mortgage Portfolio
(Exact name of registrant as specified in charter)
One Franklin Parkway, San Mateo, CA 94403-1906
(Address of principal executive offices) (Zip code)
Craig S. Tyle, One Franklin Parkway, San Mateo, CA 94403-1906
(Name and address of agent for service)
Registrant’s telephone number, including area code: 650312-2000
Date of fiscal year end: 9/30
Date of reporting period: 9/30/19
Item 1. Reports to Stockholders.
Sign up for electronic delivery at franklintempleton.com/edelivery
Internet Delivery of Fund Reports Unless You Request Paper Copies: Effective January 1, 2021, as permitted by the SEC, paper copies of the Fund’s shareholder reports will no longer be sent by mail, unless you specifically request them from the Fund or your financial intermediary. Instead, the reports will be made available on a website, and you will be notified by mail each time a report is posted and provided with a website link to access the report.
If you already elected to receive shareholder reports electronically, you will not be affected by this change and you need not take any action. If you have not signed up for electronic delivery, we would encourage you to join fellow shareholders who have. You may elect to receive shareholder reports and other communications electronically from the Fund by calling (800)632-2301 or by contacting your financial intermediary.
You may elect to continue to receive paper copies of all your future shareholder reports free of charge by contacting your financial intermediary or, if you invest directly with a Fund, calling (800)632-2301 to let the Fund know of your request. Your election to receive reports in paper will apply to all funds held in your account.
SHAREHOLDER LETTER
Dear Shareholder:
During the 12 months ended September 30, 2019, the U.S. economy continued to grow, but at a more moderate pace due to concerns about trade and geopolitical stress. The U.S. Federal Reserve (Fed) raised its federal funds rate by 0.25% at its December 2018 meeting, bringing the rate from 2.25% to 2.50%, but lowered it by 0.25% at both its July and September 2019 meetings, resulting in a rate of 2.00% byperiod-end. The Fed cited muted inflation pressures and the potential effects of global trade tensions on economic growth as rationale for easing the rate. The10-year U.S. Treasury yield began the period at 3.05% and decreased to 1.68% atperiod-end. In this environment, investment-grade bonds, as measured by the Bloomberg Barclays U.S. Aggregate Bond Index, posted a +10.30% return.1
After the reporting period, in a further effort to sustain economic expansion, while fostering a strong labor market and stable inflation, the Fed lowered the federal funds rate by 0.25%, to 1.75% at its October meeting.
We are committed to our long-term perspective and disciplined investment approach as we conduct a rigorous, fundamental analysis of securities with a regular emphasis on investment risk management.
We believe active, professional investment management serves investors well. We also recognize the important role of financial advisors in today’s markets and encourage investors to continue to seek their advice. Amid changing markets and economic conditions, we are confident investors
with a well-diversified portfolio and a patient, long-term outlook should be well positioned for the years ahead.
Franklin Strategic Mortgage Portfolio’s annual report includes more detail about prevailing conditions and a discussion about investment decisions during the period. Please remember all securities markets fluctuate, as do mutual fund share prices.
We thank you for investing with Franklin Templeton, welcome your questions and comments, and look forward to serving your investment needs in the years ahead.
Sincerely,
Sonal Desai, Ph.D.
Executive Vice President, Chief Investment Officer
Franklin Templeton Fixed Income Group
This letter reflects our analysis and opinions as of September 30, 2019, unless otherwise indicated. The information is not a complete analysis of every aspect of any market, country, industry, security or fund. Statements of fact are from sources considered reliable.
1. Source: Morningstar.
The indexes are unmanaged and include reinvestment of any income or distributions.
See www.franklintempletondatasources.com for additional data provider information.
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Not FDIC Insured | May Lose Value | No Bank Guarantee
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Franklin Strategic Mortgage Portfolio
This annual report for Franklin Strategic Mortgage Portfolio covers the fiscal year ended September 30, 2019.
Your Fund’s Goal and Main Investments
The Fund seeks high total return (a combination of high current income and capital appreciation) relative to the performance of the general mortgage securities market by investing at least 80% of its net assets in a portfolio of mortgage securities. The Fund invests substantially in mortgage securities that are issued or guaranteed by the U.S. government, its agencies or instrumentalities, which include mortgage pass-through securities representing interests in “pools” of mortgage loans issued or guaranteed by the Government National Mortgage Association (Ginnie Mae), Fannie Mae and Freddie Mac.1
Performance Overview
For the 12 months ended September 30, 2019, the Fund’s Class A shares posted a +7.08% total return. In comparison, the Fund’s primary benchmark, the Bloomberg Barclays U.S. Mortgage-Backed Securities (MBS) Fixed Rate Index, which measures the performance of investment-grade fixed-rate mortgage-backed pass-through securities of Ginnie Mae, Fannie Mae and Freddie Mac, posted a +7.80% total return.2 In comparison, the Fund’s secondary benchmark, the FTSE US Broad Investment-Grade Bond Index (USBIG®)Mortgage Index, which tracks the performance of30- and15-year Ginnie Mae, Fannie Mae and Freddie Mac securities, as well as Fannie Mae and Freddie Mac balloon mortgages, posted a +8.07% total return.2 The Lipper U.S. Mortgage Funds Classification Average, which consists of funds chosen by Lipper that invest primarily in mortgages and securities issued or guaranteed by the U.S. government and certain federal agencies, posted a +7.58% total return.3 You can find the Fund’s long-term performance data in the Performance Summary beginning on page 7.
Portfolio Composition
Performance data represent past performance, which does not guarantee future results. Investment return and principal value will fluctuate, and you may have a gain or loss when you sell your shares. Current performance may differ from figures shown. For most recentmonth-end performance, go tofranklintempleton.comor call(800)342-5236.
Economic and Market Overview
The U.S. economy expanded during the 12 months ended September 30, 2019. After moderating for two consecutive quarters, the economy grew significantly faster in 2019’s first quarter. However, the economy moderated in the second and third quarters, due partly to weakness in inventory and business investment. The manufacturing sector expanded during most of the period, but contracted in August and September 2019. The services sector continued to expand throughout the period, although the rate of expansion slowed in September. The unemployment rate decreased from 3.7%
1. Guarantees of timely payment of principal and interest do not apply to the market prices and yield of the security or to the net asset value or performance of the Fund. Ginnie Mae pass-through securities are backed by the full faith and credit of the U.S. government. Although U.S. government-sponsored entities, such as Fannie Mae and Freddie Mac, may be chartered or sponsored by acts of Congress, their securities are neither insured nor guaranteed by the U.S. Treasury. Please refer to the Fund’s prospectus for a detailed discussion regarding various levels of credit support for government agency or instrumentality securities.
2. Source: Morningstar.
3. Source: Lipper, a Thomson Reuters Company. For the 12 months ended 9/30/19, this category consisted of 126 funds. Lipper calculations do not include sales charges or subsidization by a fund’s manager. The Fund’s performance relative to the average might have differed if these or other factors had been considered.
The indexes are unmanaged and include reinvestment of any income or distributions. They do not reflect any fees, expenses or sales charges. One cannot invest directly in an index, and an index is not representative of the Fund’s portfolio.
The dollar value, number of shares or principal amount, and names of all portfolio holdings are listed in the Fund’s Statement of Investments (SOI).
The SOI begins on page 16.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
in September 2018 to 3.5% atperiod-end.4 The annual inflation rate, as measured by the Consumer Price Index, decreased from 2.3% in September 2018 to 1.7% atperiod-end.4
The U.S. Federal Reserve (Fed) raised its target range for the federal funds rate by 0.25% at its December 2018 meeting, to 2.25%–2.50%. However, at its July 2019 meeting, the Fed lowered the federal funds target rate range for the first time since December 2008, to 2.00%–2.25%, citing muted inflation pressures and the potential effects of global trade tensions on economic growth. Furthermore, the Fed ended its balance sheet normalization program earlier than previously indicated. In September, the Fed further lowered the federal funds target rate range to 1.75%–2.00%, reiterating the rationale cited at the July meeting.
The10-year Treasury yield, which moves inversely to its price, decreased during the period. The yield rose to multi-year highs in late 2018, but fell to multi-year lows in 2019’s third quarter. Political uncertainties in the U.S. (including the impeachment inquiry into President Donald Trump), geopolitical tensions in certain regions, slower domestic and global economic growth, the Fed’s more accommodative monetary policy stance and expectations of more stimulus from global central banks weighed on the Treasury yield at certain points during the period. However, several better-than-expected U.S. economic reports and periods of optimism about a potential U.S.-China trade deal supported the yield. During the period’s second half, the10-year yield fell persistently below certain short-term yields due to weaker economic data, escalating U.S. trade tensions with China and other trading partners, and the Fed’s recent monetary policy easing. Overall, the10-year Treasury yield declined from 3.05% at the beginning of the period to 1.68% atperiod-end.
Investment Strategy
Under normal market conditions, we invest at least 80% of the Fund’s net assets in mortgage securities. The Fund invests substantially in mortgage securities that are issued or guaranteed by the U.S. government, its agencies or instrumentalities, which include mortgage pass-through securities representing interests in “pools” of mortgage loans issued or guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac.1 These securities may be fixed-rate or adjustable-rate mortgage securities (ARMS). The Fund may purchase or sell mortgage securities on a delayed-delivery
or forward commitment basis through the“to-be-announced” (TBA) market. We may also invest in other types of mortgage securities that may be issued by private issuers, including, but not limited to, certain ARMS, commercial mortgage-backed securities (CMBS), credit risk transfer securities, home equity loan asset-backed securities (HELs), manufactured housing asset-backed securities (MHs) and collateralized mortgage obligations (CMOs), as well as in other mortgage-related asset-backed securities. The Fund also may invest in U.S. Treasury securities. The Fund may invest up to 15% of its net assets in foreign securities, which may includenon-U.S. dollar denominated foreign mortgage securities. In addition, the Fund may invest up to 20% of its net assets in high-yield, lower-quality securities rated, at the time of purchase, below BBB by Standard & Poor’s, or Baa by Moody’s, respectively, or, if unrated, deemed to be of comparable quality by the investment manager. The Fund may also invest up to 33% of its gross assets in mortgage dollar rolls. The Fund may invest a small portion of its assets directly in whole mortgage loans.
Dividend Distributions*
10/1/18–9/30/19
Dividend per Share (cents) | ||||||||||||||||||||
Month | Class A | Class A1 | Class C | Class R6 | Advisor Class | |||||||||||||||
October | 2.5689 | 2.7699 | 2.2486 | 2.8541 | 2.7671 | |||||||||||||||
November | 2.5604 | 2.7437 | 2.2686 | 2.8184 | 2.7397 | |||||||||||||||
December | 3.1824 | 3.3739 | 2.8960 | 3.4504 | 3.3688 | |||||||||||||||
January | 2.4847 | 2.6770 | 2.1793 | 2.7559 | 2.6731 | |||||||||||||||
February | 2.4776 | 2.6527 | 2.2011 | 2.7441 | 2.6487 | |||||||||||||||
March | 2.3148 | 2.4962 | 2.0348 | 2.5914 | 2.4925 | |||||||||||||||
April | 2.5963 | 2.7969 | 2.2779 | 2.9030 | 2.7998 | |||||||||||||||
May | 2.3936 | 2.5884 | 2.0841 | 2.6909 | 2.5847 | |||||||||||||||
June | 2.2558 | 2.4335 | 1.9749 | 2.5268 | 2.4299 | |||||||||||||||
July | 2.5971 | 2.8069 | 2.2646 | 2.9169 | 2.8025 | |||||||||||||||
August | 2.4164 | 2.6080 | 2.1123 | 2.7083 | 2.6042 | |||||||||||||||
September | 2.3166 | 2.4826 | 1.9961 | 2.6172 | 2.5188 | |||||||||||||||
Total | 30.1646 | 32.4297 | 26.5383 | 33.5774 | 32.4298 |
*The distribution amount is the sum of all net investment income distributions for the period shown. Assumes shares were purchased and held for the entire accrual period. Since dividends accrue daily, your actual distributions will vary depending on the date you purchased your shares and any account activity. All Fund distributions will vary depending upon current market conditions, and past distributions are not indicative of future trends.
4. Source: Bureau of Labor Statistics.
See www.franklintempletondatasources.com for additional data provider information.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Manager’s Discussion
For the Bloomberg Barclays indexes related to the Fund, total returns were positive, but most sectors could not keep up with the performance of Treasuries. The CMBS and ABS posted positive excess returns and outpaced Treasuries. In contrast, agency MBS Ginnie Mae, MBS, Fannie Mae and Freddie Mac markets had negative excess returns and underperformed Treasuries.
What is duration?
Duration is a measure of a bond’s price sensitivity to interest-rate changes. In general, a portfolio of securities with a lower duration can be expected to be less sensitive to interest-rate changes than a portfolio with a higher duration.
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The U.S. housing market is on solid footing as mortgage credit remains healthy. Strong mortgage credit fundamentals have been sustained as underwriting remains tight, mortgage credit availability is low from a historical perspective and mortgage delinquencies are declining. Additionally, supply and demand trends support continued home price appreciation (HPA). For 2019 we expect home prices nationally to appreciate between3-4%, but given stretched levels of housing affordability, we do expect HPA to slow over the next12-months.
The low mortgage rates that have persisted for the better part of a decade have led to a compressed stack for agency mortgages. Lower mortgage rates over the last few months have increased refinance incentive and led to higher refinance activity. We expect this dynamic to continue with about 60% of the existing universe considered to be refinance able.
With the Fed continuing to let their agency MBS wind down, the excess MBS supply is expected to be absorbed by banks, overseas investors and money managers. Spreads remain at the tighter end of their longterm historical range but are cheap more near-term. While we expect prepayments to remain elevated, underlying fundamentals continue to remain relatively supportive.
Our shorter duration positioning contributed to relative performance as interest-rate movements helped the portfolio. The Fund’s overweight exposure tonon-agency residential mortgage-backed securities (RMBS) and security selection within fixed-rate agency MBS were strong contributors to performance. Allocation to ARMS and CMBS security selection also contributed to performance relative to the benchmark
In terms of our sector allocation, we maintained our largest allocations in agency MBS, but we continued to hold an underweighted position in the sector relative to the benchmark as we believe there are better opportunities in the non-agency sectors and reduced sector exposure over the period. Within the agency MBS sector, we increased our allocation to 3.0% coupon securities and reduced our exposure to 4.0% and 3.5% MBS. The portfolio’s heaviest mortgage allocations were in 3.5%, 3.0% and 4.0% coupon securities. We were overweight in the RMBS sector relative to the benchmark and added to exposure during the reporting period. We favored post-crisis bonds over legacy positions with our largest allocations in credit risk transfer (CRT) securities, followed by re-performing loan (RPL) and prime jumbo RMBS where both fundamental and technical forces remain positive. We remained overweight in the CMBS sector relative to the benchmark, but reduced exposure over the period. We prefer to remain at the top of the capital structure as commercial real estate (CRE) prices have surpassed pre-financial crisis levels, effective rents are slowing, and vacancies are on the rise. Coupled with the slowdown, we are also observing an easing in underwriting standards, especially in multifamily originations by government-sponsored enterprises (GSEs).
In October 2019, after period-end, Roger Bayston stepped off as Portfolio Manager of the Fund, while Neil Dhruv was added as a Portfolio Manager.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Thank you for your continued participation in Franklin Strategic Mortgage Portfolio. We look forward to serving your future investment needs.
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Roger A. Bayston, CFA | ||
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Paul Varunok | ||
David Yuen, CFA, FRM | ||
Portfolio Management Team |
The foregoing information reflects our analysis, opinions and portfolio holdings as of September 30, 2019, the end of the reporting period. The way we implement our main investment strategies and the resulting portfolio holdings may change depending on factors such as market and economic conditions. These opinions may not be relied upon as investment advice or an offer for a particular security. The information is not a complete analysis of every aspect of any market, country, industry, security or the Fund. Statements of fact are from sources considered reliable, but the investment manager makes no representation or warranty as to their completeness or accuracy. Although historical performance is no guarantee of future results, these insights may help you understand our investment management philosophy.
CFA® is a trademark owned by CFA Institute.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Performance Summary as of September 30, 2019
The performance tables and graphs do not reflect any taxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund’s dividends and capital gain distributions, if any, and any unrealized gains or losses. Your dividend income will vary depending on dividends or interest paid by securities in the Fund’s portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities.
Performance as of 9/30/191
Cumulative total return excludes sales charges. Average annual total return includes maximum sales charges. Sales charges will vary depending on the size of the investment and the class of share purchased. The maximum is 3.75% and the minimum is 0%.Class A:3.75% maximum initial sales charge;Advisor Class:no sales charges. For other share classes, visitfranklintempleton.com.
Share Class | | Cumulative Total Return | 2 | | Average Annual Total Return | 3 | ||
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A4,5 | ||||||||
1-Year | +7.08% | +3.04% | ||||||
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5-Year | +12.56% | +1.61% | ||||||
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10-Year | +49.47% | +3.71% | ||||||
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Advisor6 | ||||||||
1-Year | +7.23% | +7.23% | ||||||
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5-Year | +13.85% | +2.63% | ||||||
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10-Year | +53.11% | +4.35% | ||||||
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Distribution | 30-Day Standardized Yield8 | |||||||||||||
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Share Class | Rate7 | (with fee waiver) | (without fee waiver) | |||||||||||
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A | 2.84% | 2.31% | 2.15% | |||||||||||
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Advisor | 3.21% | 2.65% | 2.48% | |||||||||||
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Performance data represent past performance, which does not guarantee future results. Investment return and principal value will fluctuate, and you may have a gain or loss when you sell your shares. Current performance may differ from figures shown. For most recentmonth-end performance, go tofranklintempleton.comor call(800)342-5236.
See page 9 for Performance Summary footnotes.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
PERFORMANCE SUMMARY
Total Return Index Comparison for a Hypothetical $10,000 Investment1
Total return represents the change in value of an investment over the periods shown. It includes any applicable maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged indexes include reinvestment of any income or distributions. They differ from the Fund in composition and do not pay management fees or expenses. One cannot invest directly in an index.
Class A(10/1/09–9/30/19)
Advisor Class(10/1/09–9/30/19)
See page 9 for Performance Summary footnotes.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
PERFORMANCE SUMMARY
Distributions(10/1/18–9/30/19)
Share Class | Net Investment Income | |||
A | $0.301646 | |||
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A1 | $0.324297 | |||
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C | $0.265383 | |||
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R6 | $0.335774 | |||
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Advisor | $0.324298 | |||
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Total Annual Operating Expenses10
Share Class | With Fee Waiver | Without Fee Waiver | ||||||
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A | 1.01% | 1.21% | ||||||
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Advisor | 0.76% | 0.96% | ||||||
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Each class of shares is available to certain eligible investors and has different annual fees and expenses, as described in the prospectus.
All investments involve risks, including possible loss of principal. The Fund’s share price and yield will be affected by interest rate movements and mortgage prepayments. During periods of declining interest rates, principal prepayments tend to increase as borrowers refinance their mortgages at lower rates; therefore the Fund may be forced to reinvest returned principal at lower interest rates, reducing income. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in the Fund adjust to a rise in interest rates, the Fund’s share price may decline. The fund may be affected by issuers that fail to make interest payments and repay principal when due. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value. The Fund is actively managed but there is no guarantee that the manager’s investment decisions will produce the desired results. The Fund’s prospectus also includes a description of the main investment risks.
1. The Fund has an expense reduction and a fee waiver associated with any investments it makes in a Franklin Templeton money fund and/or other Franklin Templeton fund, contractually guaranteed through 1/31/20. Fund investment results reflect the expense reduction and fee waiver; without these reductions, the results would have been lower.
2. Cumulative total return represents the change in value of an investment over the periods indicated.
3. Average annual total return represents the average annual change in value of an investment over the periods indicated. Return for less than one year, if any, has not been annualized.
4. Performance quotations for Class A shares reflect the following methods of calculation: (a) For periods prior to 2/1/12, a restated figure is used based on Class A1 performance and including the Class A Rule12b-1 fee, and (b) for periods after 2/1/12, actual Class A performance is used, reflecting all charges and fees applicable to that class.
5. Prior to 3/1/19, these shares were offered at a higher initial sales charge of 4.25%, thus actual returns (with sales charges) would have differed. Average annual total returns (with sales charges) have been restated to reflect the current maximum initial sales charge of 3.75%.
6. Effective 2/1/12, the Fund began offering Advisor Class shares, which do not have sales charges or a Rule12b-1 fee. Performance quotations for this class reflect the following methods of calculation: (a) For periods prior to 2/1/12, a restated figure is used based on the Fund’s oldest share class, Class A1, excluding the effect of its maximum initial sales charge; and (b) for periods after 2/1/12, actual Advisor Class performance is used, reflecting all charges and fees applicable to that class.
7. Distribution rate is based on an annualization of the sum of distributions per share for the 30 days of September and the maximum offering price (NAV for Advisor Class) on 9/30/19.
8. The Fund’s30-day standardized yield is calculated over a trailing30-day period using the yield to maturity on bonds and/or the dividends accrued on stocks. It may not equal the Fund’s actual income distribution rate, which reflects the Fund’s past dividends paid to shareholders.
9. Source: Morningstar. The Bloomberg Barclays U.S. MBS Fixed Rate Index is the fixed-rate component of the Bloomberg Barclays U.S. MBS Index and includes the agency mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA) and Freddie Mac (FHLMC). The FTSE USBIG Mortgage Index comprises30- and15-year GNMA, FNMA and FHLMC securities, as well as FNMA and FHLMC balloon mortgages, and is reconstituted each month to reflect new issuance and principalpay-downs.
10. Figures are as stated in the Fund’s current prospectus and may differ from the expense ratios disclosed in the Your Fund’s Expenses and Financial Highlights sections in this report. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the figures shown.
See www.franklintempletondatasources.com for additional data provider information.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
As a Fund shareholder, you can incur two types of costs: (1) transaction costs, including sales charges (loads) on Fund purchases and redemptions; and (2) ongoing Fund costs, including management fees, distribution and service(12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The table below shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated.
Actual Fund Expenses
The table below provides information about actual account values and actual expenses in the columns under the heading “Actual.” In these columns the Fund’s actual return, which includes the effect of Fund expenses, is used to calculate the “Ending Account Value” for each class of shares. You can estimate the expenses you paid during the period by following these steps (ofcourse, your account value and expenses will differ from those in this illustration):Divide your account value by $1,000 (ifyour account had an $8,600 value, then $8,600÷ $1,000 = 8.6). Then multiply the result by the number in the row for your class of shares under the headings “Actual” and “Expenses Paid During Period” (ifActual Expenses Paid During Period were $7.50, then 8.6 x $7.50 = $64.50). In this illustration, the actual expenses paid this period are $64.50.
Hypothetical Example for Comparison with Other Funds
Under the heading “Hypothetical” in the table, information is provided 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. This information may not be used to estimate the actual ending account balance or expenses you paid for the period, but it can help you compare ongoing costs of investing in the Fund with those of other funds. To do so, compare this 5% hypothetical example for the class of shares you hold with the 5% hypothetical examples that appear in the shareholder reports of other funds.
Please note that expenses shown in the table are meant to highlight ongoing costs and do not reflect any transactional costs. Therefore, information under the heading “Hypothetical” is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transactional costs were included, your total costs would have been higher.
Actual (actual return after expenses) | Hypothetical (5% annual return before expenses) | |||||||||||
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Share Class | Beginning Account Value 4/1/19 | Ending Account Value 9/30/19 | Expenses Period | Ending Account | Expenses Period 4/1/19–9/30/191, 2 | Net Annualized Expense Ratio2 | ||||||
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A | $1,000 | $1,030.40 | $5.09 | $1,020.05 | $5.06 | 1.00% | ||||||
A1 | $1,000 | $1,031.70 | $3.82 | $1,021.31 | $3.80 | 0.75% | ||||||
C | $1,000 | $1,028.40 | $7.12 | $1,018.05 | $7.08 | 1.40% | ||||||
R6 | $1,000 | $1,033.60 | $3.11 | $1,022.01 | $3.09 | 0.61% | ||||||
Advisor | $1,000 | $1,031.80 | $3.82 | $1,021.31 | $3.80 | 0.75% |
1. Expenses are equal to the annualized expense ratio for thesix-month period as indicated above—in the far right column—multiplied by the simple average account value over the period indicated, and then multiplied by 183/365 to reflect theone-half year period.
2. Reflects expenses after fee waivers and expense reimbursements. Does not include acquired fund fees and expenses.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Year Ended September 30, | ||||||||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||||
Class A | ||||||||||||||||||||
Per share operating performance (for a share outstanding throughout the year) | ||||||||||||||||||||
Net asset value, beginning of year | $ 8.93 | $ 9.34 | $ 9.57 | $ 9.49 | $ 9.43 | |||||||||||||||
Income from investment operationsa: | ||||||||||||||||||||
Net investment income | 0.267 | 0.243 | b | 0.147 | 0.144 | 0.185 | ||||||||||||||
Net realized and unrealized gains (losses) | 0.355 | (0.359 | ) | (0.106 | ) | 0.135 | 0.088 | |||||||||||||
Total from investment operations | 0.622 | (0.116 | ) | 0.041 | 0.279 | 0.273 | ||||||||||||||
Less distributions from: | ||||||||||||||||||||
Net investment income | (0.302 | ) | (0.294 | ) | (0.267 | ) | (0.199 | ) | (0.213 | ) | ||||||||||
Tax return of capital | — | — | (0.004) | — | — | |||||||||||||||
Total distributions | (0.302 | ) | (0.294 | ) | (0.271 | ) | (0.199 | ) | (0.213 | ) | ||||||||||
Net asset value, end of year | $ 9.25 | $ 8.93 | $ 9.34 | $ 9.57 | $ 9.49 | |||||||||||||||
Total returnc | 7.08% | (1.25)% | 0.45% | 2.98% | 2.91% | |||||||||||||||
Ratios to average net assets | ||||||||||||||||||||
Expenses before waiver and payments by affiliates | 1.24% | 1.21% | 1.17% | 1.00% | 1.01% | |||||||||||||||
Expenses net of waiver and payments by affiliates | 1.00% | d | 1.06% | d | 1.16% | d | 0.99% | d | 1.01% | e | ||||||||||
Net investment income | 2.93% | 2.67% | 1.82% | 1.47% | 1.84% | |||||||||||||||
Supplemental data | ||||||||||||||||||||
Net assets, end of year (000’s) | $18,313 | $16,303 | $21,143 | $34,191 | $26,328 | |||||||||||||||
Portfolio turnover rate | 223.36% | 243.65% | 244.09% | 551.77% | 614.11% | |||||||||||||||
Portfolio turnover rate excluding mortgage dollar rollsf | 139.83% | 153.69% | 111.62% | 185.40% | 172.54% |
aThe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund’s shares in relation to income earned and/or fluctuating fair value of the investments of the Fund.
bBased on average daily shares outstanding.
cTotal return does not reflect sales commissions or contingent deferred sales charges, if applicable.
dBenefit of expense reduction rounds to less than 0.01%.
eBenefit of waiver and payments by affiliates and expense reduction rounds to less than 0.01%.
fSee Note 1(e) regarding mortgage dollar rolls.
franklintempleton.com | The accompanying notes are an integral part of these financial statements. | Annual Report | 11 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
FINANCIAL HIGHLIGHTS
Year Ended September 30, | ||||||||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||||
Class A1 | ||||||||||||||||||||
Per share operating performance (for a share outstanding throughout the year) | ||||||||||||||||||||
Net asset value, beginning of year | $ 8.94 | $ 9.35 | $ 9.58 | $ 9.49 | $ 9.44 | |||||||||||||||
Income from investment operationsa: | ||||||||||||||||||||
Net investment income | 0.285 | 0.268 | b | 0.177 | 0.160 | 0.197 | ||||||||||||||
Net realized and unrealized gains (losses) | 0.349 | (0.360 | ) | (0.113 | ) | 0.153 | 0.090 | |||||||||||||
Total from investment operations | 0.634 | (0.092 | ) | 0.064 | 0.313 | 0.287 | ||||||||||||||
Less distributions from: | ||||||||||||||||||||
Net investment income | (0.324 | ) | (0.318 | ) | (0.289 | ) | (0.223 | ) | (0.237 | ) | ||||||||||
Tax return of capital | — | — | (0.005 | ) | — | — | ||||||||||||||
Total distributions | (0.324 | ) | (0.318 | ) | (0.294 | ) | (0.223 | ) | (0.237 | ) | ||||||||||
Net asset value, end of year | $9.25 | $8.94 | $9.35 | $9.58 | $9.49 | |||||||||||||||
Total returnc | 7.22% | (1.00)% | 0.70% | 3.34% | 3.06% | |||||||||||||||
Ratios to average net assets | ||||||||||||||||||||
Expenses before waiver and payments by affiliates | 0.99% | 0.96% | 0.92% | 0.75% | 0.76% | |||||||||||||||
Expenses net of waiver and payments by affiliates | 0.75% | d | 0.81% | d | 0.91% | d | 0.74% | d | 0.76% | e | ||||||||||
Net investment income | 3.18% | 2.92% | 2.07% | 1.72% | 2.09% | |||||||||||||||
Supplemental data | ||||||||||||||||||||
Net assets, end of year (000’s) | $29,286 | $32,802 | $40,844 | $53,432 | $59,352 | |||||||||||||||
Portfolio turnover rate | 223.36% | 243.65% | 244.09% | 551.77% | 614.11% | |||||||||||||||
Portfolio turnover rate excluding mortgage dollar rollsf | 139.83% | 153.69% | 111.62% | 185.40% | 172.54% |
aThe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund’s shares in relation to income earned and/or fluctuating fair value of the investments of the Fund.
bBased on average daily shares outstanding.
cTotal return does not reflect sales commissions or contingent deferred sales charges, if applicable.
dBenefit of expense reduction rounds to less than 0.01%.
eBenefit of waiver and payments by affiliates and expense reduction rounds to less than 0.01%.
fSee Note 1(e) regarding mortgage dollar rolls.
12 | Annual Report | The accompanying notes are an integral part of these financial statements. | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
FINANCIAL HIGHLIGHTS
Year Ended September 30, | ||||||||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||||
Class C | ||||||||||||||||||||
Per share operating performance | ||||||||||||||||||||
(for a share outstanding throughout the year) | ||||||||||||||||||||
Net asset value, beginning of year | $ 8.93 | $ 9.34 | $ 9.57 | $ 9.49 | $ 9.43 | |||||||||||||||
Income from investment operationsa: | ||||||||||||||||||||
Net investment income | 0.230 | 0.207 | b | 0.112 | 0.112 | 0.142 | ||||||||||||||
Net realized and unrealized gains (losses) | 0.355 | (0.359 | ) | (0.109 | ) | 0.130 | 0.093 | |||||||||||||
Total from investment operations | 0.585 | (0.152 | ) | 0.003 | 0.242 | 0.235 | ||||||||||||||
Less distributions from: | ||||||||||||||||||||
Net investment income | (0.265 | ) | (0.258 | ) | (0.229 | ) | (0.162 | ) | (0.175 | ) | ||||||||||
Tax return of capital | — | — | (0.004 | ) | — | — | ||||||||||||||
Total distributions | (0.265 | ) | (0.258 | ) | (0.233 | ) | (0.162 | ) | (0.175 | ) | ||||||||||
Net asset value, end of year | $9.25 | $8.93 | $9.34 | $9.57 | $9.49 | |||||||||||||||
Total returnc | 6.65% | (1.64)% | 0.06% | 2.57% | 2.51% | |||||||||||||||
Ratios to average net assets | ||||||||||||||||||||
Expenses before waiver and payments by affiliates | 1.64% | 1.61% | 1.57% | 1.40% | 1.41% | |||||||||||||||
Expenses net of waiver and payments by affiliates | 1.40% | d | 1.46% | d | 1.56% | d | 1.39% | d | 1.41% | e | ||||||||||
Net investment income | 2.53% | 2.27% | 1.42% | 1.07% | 1.44% | |||||||||||||||
Supplemental data | ||||||||||||||||||||
Net assets, end of year (000’s) | $3,843 | $4,513 | $6,308 | $9,468 | $4,067 | |||||||||||||||
Portfolio turnover rate | 223.36% | 243.65% | 244.09% | 551.77% | 614.11% | |||||||||||||||
Portfolio turnover rate excluding mortgage dollar rollsf | 139.83% | 153.69% | 111.62% | 185.40% | 172.54% |
aThe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund’s shares in relation to income earned and/or fluctuating fair value of the investments of the Fund.
bBased on average daily shares outstanding.
cTotal return does not reflect sales commissions or contingent deferred sales charges, if applicable.
dBenefit of expense reduction rounds to less than 0.01%.
eBenefit of waiver and payments by affiliates and expense reduction rounds to less than 0.01%.
fSee Note 1(e) regarding mortgage dollar rolls.
franklintempleton.com | The accompanying notes are an integral part of these financial statements. | Annual Report | 13 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
FINANCIAL HIGHLIGHTS
Year Ended September 30, | ||||||||||||
2019 | 2018 | 2017a | ||||||||||
Class R6 | ||||||||||||
Per share operating performance | ||||||||||||
(for a share outstanding throughout the year) | ||||||||||||
Net asset value, beginning of year | $ 8.92 | $ 9.33 | $ 9.38 | |||||||||
Income from investment operationsb: | ||||||||||||
Net investment income | 0.296 | 0.282 | c | 0.003 | ||||||||
Net realized and unrealized gains (losses) | 0.360 | (0.363 | ) | (0.002 | ) | |||||||
Total from investment operations | 0.656 | (0.081 | ) | 0.001 | ||||||||
Less distributions from: | ||||||||||||
Net investment income | (0.336 | ) | (0.329 | ) | (0.050 | ) | ||||||
Tax return of capital | — | — | (0.001 | ) | ||||||||
Total distributions | (0.336 | ) | (0.329 | ) | (0.051 | ) | ||||||
Net asset value, end of year | $ 9.24 | $ 8.92 | $ 9.33 | |||||||||
Total returnd | 7.49% | (0.87)% | 0.01% | |||||||||
Ratios to average net assetse | ||||||||||||
Expenses before waiver and payments by affiliates | 1.00% | 1.01% | 1.83% | |||||||||
Expenses net of waiver and payments by affiliates | 0.62% | f | 0.69% | f | 0.75% | f | ||||||
Net investment income | 3.31% | 3.04% | 2.23% | |||||||||
Supplemental data | ||||||||||||
Net assets, end of year (000’s) | $383 | $432 | $5 | |||||||||
Portfolio turnover rate | 223.36% | 243.65% | 244.09% | |||||||||
Portfolio turnover rate excluding mortgage dollar rollsg | 139.83% | 153.69% | 111.62% |
aFor the period August 1, 2017 (effective date) to September 30, 2017.
bThe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund’s shares in relation to income earned and/or fluctuating fair value of the investments of the Fund.
cBased on average daily shares outstanding.
dTotal return is not annualized for periods less than one year.
eRatios are annualized for periods less than one year, except fornon-recurring expenses, if any.
fBenefit of expense reduction rounds to less than 0.01%.
gSee Note 1(e) regarding mortgage dollar rolls.
14 | Annual Report | The accompanying notes are an integral part of these financial statements. | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
FINANCIAL HIGHLIGHTS
Year Ended September 30, | ||||||||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||||
Advisor Class | ||||||||||||||||||||
Per share operating performance | ||||||||||||||||||||
(for a share outstanding throughout the year) | ||||||||||||||||||||
Net asset value, beginning of year | $ 8.93 | $ 9.33 | $ 9.57 | $ 9.48 | $ 9.43 | |||||||||||||||
Income from investment operationsa: | ||||||||||||||||||||
Net investment income | 0.284 | 0.268 | b | 0.187 | 0.146 | 0.199 | ||||||||||||||
Net realized and unrealized gains (losses) | 0.350 | (0.351 | ) | (0.133 | ) | 0.166 | 0.087 | |||||||||||||
Total from investment operations | 0.634 | (0.083 | ) | 0.054 | 0.312 | 0.286 | ||||||||||||||
Less distributions from: | ||||||||||||||||||||
Net investment income | (0.324 | ) | (0.317 | ) | (0.289 | ) | (0.222 | ) | (0.236 | ) | ||||||||||
Tax return of capital | — | — | (0.005 | ) | — | — | ||||||||||||||
Total distributions | (0.324 | ) | (0.317 | ) | (0.294 | ) | (0.222 | ) | (0.236 | ) | ||||||||||
Net asset value, end of year | $ 9.24 | $ 8.93 | $ 9.33 | $ 9.57 | $ 9.48 | |||||||||||||||
Total return | 7.23% | (1.00)% | 0.70% | 3.34% | 3.06% | |||||||||||||||
Ratios to average net assets | ||||||||||||||||||||
Expenses before waiver and payments by affiliates | 0.99% | 0.96% | 0.92% | 0.75% | 0.76% | |||||||||||||||
Expenses net of waiver and payments by affiliates | 0.75% | c | 0.81% | c | 0.91% | c | 0.74% | c | 0.76% | d | ||||||||||
Net investment income | 3.18% | 2.92% | 2.07% | 1.72% | 2.09% | |||||||||||||||
Supplemental data | ||||||||||||||||||||
Net assets, end of year (000’s) | $10,907 | $6,574 | $7,632 | $8,264 | $12,651 | |||||||||||||||
Portfolio turnover rate | 223.36% | 243.65% | 244.09% | 551.77% | 614.11% | |||||||||||||||
Portfolio turnover rate excluding mortgage dollar rollse | 139.83% | 153.69% | 111.62% | 185.40% | 172.54% |
aThe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund’s shares in relation to income earned and/or fluctuating fair value of the investments of the Fund.
bBased on average daily shares outstanding.
cBenefit of expense reduction rounds to less than 0.01%.
dBenefit of waiver and payments by affiliates and expense reduction rounds to less than 0.01%.
eSee Note 1(e) regarding mortgage dollar rolls.
franklintempleton.com | The accompanying notes are an integral part of these financial statements. | Annual Report | 15 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Statement of Investments, September 30, 2019
Principal Amount* | Value | |||||||
Corporate Bonds 0.2% | ||||||||
Insurance Brokers 0.0%† | ||||||||
aAmbac Assurance Corp., Subordinated Note, 144A, 5.10%, 6/07/20 | $ | 236 | $ | 345 | ||||
a,bAmbac LSNI LLC, senior note, first lien, 144A, FRN, 7.104%,(3-month USD LIBOR + 5.00%), 2/12/23 | 1,016 | 1,029 | ||||||
|
| |||||||
Real Estate Services 0.2% | ||||||||
American Homes 4 Rent LP, senior bond, 4.25%, 2/15/28 | 100,000 | 107,986 | ||||||
|
| |||||||
Total Corporate Bonds (Cost $100,792) | 109,360 | |||||||
|
| |||||||
U.S. Government and Agency Securities 0.8% | ||||||||
U.S. Treasury Bond, | ||||||||
4.75%, 2/15/37 | 225,000 | 322,704 | ||||||
4.25%, 11/15/40 | 131,000 | 181,977 | ||||||
|
| |||||||
Total U.S. Government and Agency Securities (Cost $474,646) | 504,681 | |||||||
|
| |||||||
Asset-Backed Securities and Commercial Mortgage-Backed Securities 27.2% | ||||||||
Finance 27.2% | ||||||||
cAmerican Home Mortgage Investment Trust,2005-1, 6A, FRN, 4.043%,(6-month USD LIBOR + 2.00%), 6/25/45 | 85,967 | 88,243 | ||||||
aAmerican Homes 4 Rent, 2015-SFR1, A, 144A, 3.467%, 4/17/52 | 147,997 | 154,166 | ||||||
a,d,eAnthracite Ltd., 2004-HY1A, E, 144A, 7.147%, 6/20/41 | 1,598,000 | 24 | ||||||
f,gBank, 2018-BN13, XA, IO, FRN, 0.665%, 8/15/61 | 2,485,066 | 84,902 | ||||||
cBear StearnsALT-A Trust,2004-13, A2, FRN, 2.898%,(1-month USD LIBOR + 0.88%), 11/25/34 | 3,634 | 3,641 | ||||||
a,cBellemeade Re Ltd.,2018-1A, M1B, 144A, FRN, 3.618%,(1-month USD LIBOR + 1.60%), 4/25/28 | 159,843 | 160,088 | ||||||
aBRAVO Residential Funding Trust,2019-1, A1C, 144A, 3.50%, 3/25/58 | 136,711 | 139,857 | ||||||
a,fBX Commercial Mortgage Trust,2018-IND, A, 144A, FRN, 2.778%, 11/15/35 | 109,939 | 110,045 | ||||||
aCenterline REIT Inc.,2004-RR3, B, 144A, 5.04%, 9/21/45 | 20,066 | 19,949 | ||||||
a,fCIM Trust, | ||||||||
2018-INV1, A4, 144A, FRN, 4.00%, 8/25/48 | 153,458 | 160,485 | ||||||
2019-INV1, A1, 144A, FRN, 4.00%, 2/25/49 | 184,463 | 189,926 | ||||||
2019-INV2, A3, 144A, FRN, 4.00%, 5/25/49 | 278,283 | 290,796 | ||||||
a,fCitigroup Mortgage Loan Trust,2013-A, A, 144A, FRN, 3.00%, 5/25/42 | 18,204 | 17,939 | ||||||
fCommercial Mortgage Trust, | ||||||||
2006-GG7, AJ, FRN, 5.825%, 7/10/38 | 90,000 | 83,399 | ||||||
2006-GG7, AM, FRN, 5.825%, 7/10/38 | 35,845 | 36,089 | ||||||
fConseco Finance Securitizations Corp.,2002-2, M1, FRN, 7.424%, 3/01/33 | 269,540 | 292,355 | ||||||
fConseco Financial Corp.,1998-6, A8, FRN, 6.66%, 6/01/30 | 75,533 | 78,259 | ||||||
aCore Industrial Trust, 2015-CALW, A, 144A, 3.04%, 2/10/34 | 355,752 | 363,514 | ||||||
CSAIL Commercial Mortgage Trust,2015-C1, A4, 3.505%, 4/15/50 | 430,000 | 456,365 | ||||||
a,fCSMC,2009-15R, 3A1, 144A, FRN, 5.154%, 3/26/36 | 10,272 | 10,325 | ||||||
a,fCSMC Trust, 2014-OAK1, 1A1, 144A, FRN, 3.00%, 11/25/29 | 111,279 | 111,785 | ||||||
cCWABS Inc. Asset-Backed Certificates,2004-1, M1, FRN, 2.768%,(1-month USD LIBOR + 0.75%), 3/25/34 | 54,638 | 55,045 | ||||||
FHLMC Structured Agency Credit Risk Debt Notes, | ||||||||
c2013-DN2, M2, FRN, 6.268%,(1-month USD LIBOR + 4.25%), 11/25/23 | 204,968 | 220,724 | ||||||
c2014-DN3, M3, FRN, 6.018%,(1-month USD LIBOR + 4.00%), 8/25/24 | 174,392 | 184,432 | ||||||
c2014-DN4, M3, FRN, 6.568%,(1-month USD LIBOR + 4.55%), 10/25/24 | 160,676 | 172,249 | ||||||
c2014-HQ1, M3, FRN, 6.118%,(1-month USD LIBOR + 4.10%), 8/25/24 | 217,073 | 230,247 | ||||||
c2014-HQ3, M3, FRN, 6.768%,(1-month USD LIBOR + 4.75%), 10/25/24 | 174,070 | 184,995 |
16 | Annual Report | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
STATEMENT OF INVESTMENTS
Principal Amount* | Value | |||||||
Asset-Backed Securities and Commercial Mortgage-Backed Securities (continued) | ||||||||
Finance(continued) | ||||||||
FHLMC Structured Agency Credit Risk Debt Notes, (continued) | ||||||||
c2015-DN1, M3, FRN, 6.168%,(1-month USD LIBOR + 4.15%), 1/25/25 | $ | 155,313 | $ | 161,210 | ||||
c2015-HQ1, M3, FRN, 5.818%,(1-month USD LIBOR + 3.80%), 3/25/25 | 397,615 | 409,375 | ||||||
c2015-HQ2, M3, FRN, 5.268%,(1-month USD LIBOR + 3.25%), 5/25/25 | 250,000 | 262,786 | ||||||
c2016-DNA2, M3, FRN, 6.668%,(1-month USD LIBOR + 4.65%), 10/25/28 | 250,000 | 268,170 | ||||||
c2016-HQA2, M2, FRN, 4.268%,(1-month USD LIBOR + 2.25%), 11/25/28 | 101,507 | 102,000 | ||||||
c2016-HQA2, M3, FRN, 7.168%,(1-month USD LIBOR + 5.15%), 11/25/28 | 250,000 | 272,153 | ||||||
f2017-DNA1, M2, FRN, 5.268%, 7/25/29 | 250,000 | 262,380 | ||||||
c2017-DNA3, M2, FRN, 4.518%,(1-month USD LIBOR + 2.50%), 3/25/30 | 250,000 | 255,618 | ||||||
f2017-HQA1, M2, FRN, 5.568%, 8/25/29 | 250,000 | 262,831 | ||||||
a,fFlagstar Mortgage Trust,2018-6RR, 1A3, 144A, FRN, 4.00%, 10/25/48 | 144,983 | 148,669 | ||||||
cFNMA,2007-1, NF, FRN, 2.268%,(1-month USD LIBOR + 0.25%), 2/25/37 | 77,054 | 77,076 | ||||||
FNMA Connecticut Avenue Securities, | ||||||||
c2013-C01, M2, FRN, 7.268%,(1-month USD LIBOR + 5.25%), 10/25/23 | 178,996 | 198,034 | ||||||
c2014-C01, M2, FRN, 6.418%,(1-month USD LIBOR + 4.40%), 1/25/24 | 248,135 | 269,730 | ||||||
c2014-C02, 1M2, FRN, 4.618%,(1-month USD LIBOR + 2.60%), 5/25/24 | 144,192 | 150,456 | ||||||
c2014-C02, 2M2, FRN, 4.618%,(1-month USD LIBOR + 2.60%), 5/25/24 | 289,544 | 300,317 | ||||||
c2014-C03, 1M2, FRN, 5.018%,(1-month USD LIBOR + 3.00%), 7/25/24 | 198,268 | 208,326 | ||||||
c2014-C03, 2M2, FRN, 4.918%,(1-month USD LIBOR + 2.90%), 7/25/24 | 149,659 | 155,999 | ||||||
c2014-C04, 1M1, FRN, 6.918%,(1-month USD LIBOR + 4.90%), 11/25/24 | 229,164 | 250,322 | ||||||
c2015-C01, 1M2, FRN, 6.318%,(1-month USD LIBOR + 4.30%), 2/25/25 | 159,551 | 169,166 | ||||||
c2015-C01, 2M2, FRN, 6.568%,(1-month USD LIBOR + 4.55%), 2/25/25 | 133,789 | 138,918 | ||||||
c2016-C03, 1M1, FRN, 4.018%,(1-month USD LIBOR + 2.00%), 10/25/28 | 109,311 | 109,647 | ||||||
f2016-C04, 1M2, FRN, 6.268%, 1/25/29 | 115,571 | 122,220 | ||||||
f2016-C05, 2M2, FRN, 6.468%, 1/25/29 | 184,592 | 194,579 | ||||||
c2016-C06, 1M1, FRN, 3.318%,(1-month USD LIBOR + 1.30%), 4/25/29 | 109,888 | 110,184 | ||||||
c2017-C01, 1B1, FRN, 7.768%,(1-month USD LIBOR + 5.75%), 7/25/29 | 280,000 | 330,465 | ||||||
c2017-C01, 1M1, FRN, 3.318%,(1-month USD LIBOR + 1.30%), 7/25/29 | 206,270 | 206,728 | ||||||
f2017-C02, 2M1, FRN, 3.168%, 9/25/29 | 214,751 | 215,124 | ||||||
f2017-C02, 2M2, FRN, 5.668%, 9/25/29 | 250,000 | 263,101 | ||||||
f2017-C05, 1M2, FRN, 4.218%, 1/25/30 | 250,000 | 253,465 | ||||||
f2017-C06, 1M2, FRN, 4.668%, 2/25/30 | 250,000 | 255,864 | ||||||
f2017-C07, 1M1, FRN, 2.668%, 5/25/30 | 262,043 | 262,149 | ||||||
c2018-C02, 2M1, FRN, 2.668%,(1-month USD LIBOR + 0.65%), 8/25/30 | 20,837 | 20,839 | ||||||
a,fFREMF Mortgage Trust, | ||||||||
2011-K11, B, 144A, FRN, 4.567%, 12/25/48 | 170,000 | 173,833 | ||||||
2018-K72, B, 144A, FRN, 4.117%, 12/25/50 | 210,000 | 226,412 | ||||||
fGE Capital Commercial Mortgage Corp. Trust,2007-C1, AM, FRN, 5.606%, 12/10/49 | 97,540 | 85,116 | ||||||
fGreen Tree Financial Corp.,1998-4, A7, FRN, 6.87%, 4/01/30 | 38,167 | 39,926 | ||||||
f,gGS Mortgage Securities Trust,2017-GS5, XA, IO, FRN, 0.962%, 3/10/50 | 3,226,581 | 169,331 | ||||||
cGSAA Home Equity Trust,2005-6, A3, FRN, 2.388%,(1-month USD LIBOR + 0.37%), 6/25/35 | 16,031 | 16,086 | ||||||
cGSAMP Trust,2005-HE3, M2, FRN, 3.023%,(1-month USD LIBOR + 1.005%), 6/25/35 | 11,185 | 11,217 | ||||||
a,fInvitation Homes Trust, 2018-SFR4, A, 144A, FRN, 3.125%, 1/17/38 | 187,943 | 188,733 | ||||||
a,fJP Morgan Mortgage Trust,2013-3, A3, 144A, FRN, 3.392%, 7/25/43 | 196,582 | 199,731 | ||||||
fJPMBB Commercial Mortgage Securities Trust,2014-C24, AS, FRN, 3.914%, 11/15/47 | 250,000 | 265,084 | ||||||
cMerrill Lynch Mortgage Investors Trust,2003-A, 1A, FRN, 2.758%,(1-month USD LIBOR + 0.74%), 3/25/28 | 92,613 | 92,381 |
franklintempleton.com | Annual Report | 17 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
STATEMENT OF INVESTMENTS
Principal Amount* | Value | |||||||
Asset-Backed Securities and Commercial Mortgage-Backed Securities (continued) | ||||||||
Finance(continued) | ||||||||
a,fMill City Mortgage Loan Trust, | ||||||||
2016-1, A, 144A, FRN, 2.50%, 4/25/57 | $ | 80,792 | $ | 81,117 | ||||
2018-1, A1, 144A, FRN, 3.25%, 5/25/62 | 132,139 | 135,266 | ||||||
2018-2, A1, 144A, FRN, 3.50%, 5/25/58 | 192,383 | 196,472 | ||||||
2018-4, A1B, 144A, FRN, 3.50%, 4/25/66 | 190,000 | 195,978 | ||||||
cMorgan Stanley ABS Capital I Inc. Trust,2005-WMC, M2, FRN, 2.753%,(1-month USD LIBOR + 0.735%), 1/25/35 | 17,111 | 17,365 | ||||||
aOBP Depositor LLC Trust,2010-OBP, A, 144A, 4.646%, 7/15/45 | 250,000 | 251,691 | ||||||
a,cOBX Trust,2018-1, A2, 144A, FRN, 2.668%,(1-month USD LIBOR + 0.65%), 6/25/57 | 104,676 | 104,500 | ||||||
aOne Market Plaza Trust, 2017-1MKT, B, 144A, 3.845%, 2/10/32 | 350,000 | 361,795 | ||||||
aProgress Residential Trust, 2018-SFR2, A, 144A, 3.712%, 8/17/35 | 100,000 | 102,168 | ||||||
a,cRadnor RE Ltd.,2018-1, M1, 144A, FRN, 3.418%,(1-month USD LIBOR + 1.40%), 3/25/28 | 105,959 | 106,130 | ||||||
fResidential Asset Securities Corp.,2004-KS8, AI6, FRN, 4.79%, 9/25/34 | 1,329 | 1,341 | ||||||
a,fSequoia Mortgage Trust,2016-2, A4, 144A, FRN, 3.50%, 8/25/46 | 326,675 | 333,482 | ||||||
aTowd Point Mortgage Trust, | ||||||||
f2015-1, 144A, FRN, 2.75%, 11/25/60 | 219,006 | 219,805 | ||||||
f2015-3, A1B, 144A, FRN, 3.00%, 3/25/54 | 85,609 | 86,056 | ||||||
f2016-3, A1, 144A, FRN, 2.25%, 4/25/56 | 161,686 | 161,434 | ||||||
f2016-4, A1, 144A, FRN, 2.25%, 7/25/56 | 172,441 | 171,847 | ||||||
f2016-5, A1, 144A, FRN, 2.50%, 10/25/56 | 322,177 | 322,648 | ||||||
f2017-1, A1, 144A, FRN, 2.75%, 10/25/56 | 260,151 | 263,171 | ||||||
f2017-1, A2, 144A, FRN, 3.50%, 10/25/56 | 165,000 | 171,860 | ||||||
f2017-2, A1, 144A, FRN, 2.75%, 4/25/57 | 67,392 | 67,988 | ||||||
f2017-4, A1, 144A, FRN, 2.75%, 6/25/57 | 277,756 | 280,593 | ||||||
c2017-5, A1, 144A, FRN, 2.618%,(1-month USD LIBOR + 0.60%), 2/25/57 | 77,823 | 77,719 | ||||||
f2018-1, A1, 144A, FRN, 3.00%, 1/25/58 | 73,462 | 74,591 | ||||||
f2018-2, A1, 144A, FRN, 3.25%, 3/25/58 | 158,801 | 162,261 | ||||||
f2018-5, A1A, 144A, FRN, 3.25%, 7/25/58 | 84,733 | 86,192 | ||||||
f2018-6, A1A, 144A, FRN, 3.75%, 3/25/58 | 137,965 | 142,219 | ||||||
f2019-1, A1, 144A, FRN, 3.75%, 3/25/58 | 269,736 | 283,232 | ||||||
cWaMu Mortgage Pass-Through Certificates, | ||||||||
2005-AR19, A1A1, FRN, 2.288%,(1-month USD LIBOR + 0.27%), 12/25/45 | 160,558 | 160,054 | ||||||
2005-AR8, 1A1A, FRN, 2.598%,(1-month USD LIBOR + 0.58%), 7/25/45 | 86,530 | 86,338 | ||||||
a,fWells Fargo Mortgage Backed Securities,2018-1, A3, 144A, FRN, 3.50%, 7/25/47 | 114,579 | 117,121 | ||||||
fWells Fargo Mortgage Backed Securities Trust, | ||||||||
2004-W, A9, FRN, 4.843%, 11/25/34 | 54,077 | 56,501 | ||||||
2005-AR10, 2A3, FRN, 4.968%, 6/25/35 | 51,128 | 52,429 | ||||||
2005-AR9, 2A2, FRN, 4.658%, 10/25/33 | 88,937 | 90,063 | ||||||
|
| |||||||
Total Asset-Backed Securities and Commercial Mortgage-Backed Securities | 17,057,022 | |||||||
|
| |||||||
Mortgage-Backed Securities 73.0% | ||||||||
Federal Home Loan Mortgage Corp. (FHLMC) Fixed Rate 24.8% | ||||||||
hFHLMC 30 Year, 2.50%, 10/01/49 | 1,400,000 | 1,393,749 | ||||||
hFHLMC 30 Year, 3.00%, 10/01/49 | 2,620,000 | 2,660,119 | ||||||
FHLMC 30 Year, 3.50%, 10/01/47 | 1,387,308 | 1,437,833 | ||||||
FHLMC 30 Year, 4.50%, 8/01/48 | 721,582 | 771,552 | ||||||
FHLMC Gold 30 Year, 3.50%, 12/01/47 | 4,040,616 | 4,185,860 |
18 | Annual Report | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
STATEMENT OF INVESTMENTS
Principal Amount* | Value | |||||||
Mortgage-Backed Securities(continued) | ||||||||
Federal Home Loan Mortgage Corp. (FHLMC) Fixed Rate (continued) | ||||||||
FHLMC Gold 30 Year, 4.00%, 4/01/48 | $ | 602,498 | $ | 632,147 | ||||
FHLMC Gold 30 Year, 4.00%, 5/01/48 | 3,145,718 | 3,297,689 | ||||||
FHLMC Gold 30 Year, 4.50%, 4/01/40 | 439,146 | 476,369 | ||||||
FHLMC Gold 30 Year, 5.00%, 10/01/33 - 2/01/39 | 293,936 | 323,161 | ||||||
FHLMC Gold 30 Year, 5.50%, 9/01/33 | 34,487 | 39,015 | ||||||
FHLMC Gold 30 Year, 6.00%, 7/01/28 - 11/01/36 | 85,315 | 96,394 | ||||||
FHLMC Gold 30 Year, 6.50%, 11/01/27 - 7/01/32 | 47,241 | 52,699 | ||||||
FHLMC Gold 30 Year, 7.50%, 1/01/26 - 3/01/32 | 60,169 | 62,906 | ||||||
FHLMC Gold 30 Year, 8.00%, 7/01/24 - 5/01/30 | 87,856 | 91,748 | ||||||
FHLMC Gold 30 Year, 8.50%, 6/01/21 | 20 | 20 | ||||||
FHLMC Gold 30 Year, 9.00%, 9/01/30 | 15,108 | 15,281 | ||||||
FHLMC Gold 30 Year, 9.50%, 3/01/21 - 12/01/22 | 480 | 484 | ||||||
|
| |||||||
15,537,026 | ||||||||
|
| |||||||
iFederal National Mortgage Association (FNMA) Adjustable Rate 1.4% | ||||||||
FNMA, 3.547% - 4.75%,(6-month USD LIBOR +/- MBS Margin), 10/01/20 - 4/01/37 | 605,972 | 621,344 | ||||||
FNMA, 4.75% - 5.25%,(6-month USD LIBOR +/- MBS Margin), 1/01/22 - 7/01/38 | 270,368 | 275,762 | ||||||
|
| |||||||
897,106 | ||||||||
|
| |||||||
Federal National Mortgage Association (FNMA) Fixed Rate 38.1% | ||||||||
FNMA 30 Year, 3.00%, 9/01/48 | 3,337,853 | 3,420,349 | ||||||
FNMA 30 Year, 3.00%, 11/01/48 | 4,149,194 | 4,248,803 | ||||||
FNMA 30 Year, 3.00%, 5/01/49 | 193,558 | 196,615 | ||||||
FNMA 30 Year, 3.50%, 4/01/48 | 5,572,181 | 5,766,221 | ||||||
FNMA 30 Year, 3.50%, 6/01/49 | 203,512 | 209,250 | ||||||
FNMA 30 Year, 3.50%, 8/01/49 | 1,090,448 | 1,133,662 | ||||||
FNMA 30 Year, 3.50%, 7/01/56 | 983,191 | 1,035,432 | ||||||
FNMA 30 Year, 4.00%, 10/01/47 | 1,839,593 | 1,929,219 | ||||||
FNMA 30 Year, 4.50%, 11/01/47 | 1,549,076 | 1,660,567 | ||||||
FNMA 30 Year, 4.50%, 5/01/48 | 1,396,023 | 1,493,116 | ||||||
FNMA 30 Year, 5.00%, 4/01/34 | 84,991 | 91,873 | ||||||
FNMA 30 Year, 5.50%, 9/01/33 - 11/01/33 | 525,670 | 578,201 | ||||||
FNMA 30 Year, 5.50%, 11/01/34 - 11/01/35 | 389,483 | 438,404 | ||||||
FNMA 30 Year, 6.00%, 12/01/23 -10/01/34 | 292,455 | 334,980 | ||||||
FNMA 30 Year, 6.00%, 10/01/34 - 7/01/35 | 527,092 | 594,640 | ||||||
FNMA 30 Year, 6.00%, 8/01/35 | 65,232 | 72,339 | ||||||
FNMA 30 Year, 6.50%, 12/01/27 - 8/01/32 | 456,266 | 510,141 | ||||||
FNMA 30 Year, 7.50%, 8/01/25 - 5/01/32 | 18,376 | 21,292 | ||||||
FNMA 30 Year, 8.00%, 1/01/25 - 7/01/31 | 22,311 | 25,486 | ||||||
FNMA 30 Year, 8.50%, 11/01/26 - 11/01/28 | 120,064 | 127,063 | ||||||
FNMA 30 Year, 9.00%, 8/01/24 - 4/01/25 | 974 | 1,054 | ||||||
FNMA 30 Year, 9.50%, 11/01/21 - 4/01/30 | 29,021 | 29,908 | ||||||
FNMA 30 Year, 10.00%, 4/01/21 | 1,969 | 1,981 | ||||||
|
| |||||||
23,920,596 | ||||||||
|
| |||||||
Government National Mortgage Association (GNMA) Fixed Rate 8.7% | ||||||||
GNMA I SF 30 Year, 6.50%, 1/15/24 - 9/15/32 | 75,346 | 83,433 | ||||||
GNMA I SF 30 Year, 7.00%, 6/15/23 - 2/15/32 | 20,746 | 21,611 | ||||||
GNMA I SF 30 Year, 7.50%, 10/15/23 - 10/15/29 | 24,650 | 25,821 |
franklintempleton.com | Annual Report | 19 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
STATEMENT OF INVESTMENTS
Principal Amount* | Value | |||||||
Mortgage-Backed Securities(continued) | ||||||||
Government National Mortgage Association (GNMA) Fixed Rate(continued) | ||||||||
GNMA I SF 30 Year, 8.00%, 1/15/22 - 9/15/27 | $ | 21,649 | $ | 22,982 | ||||
GNMA I SF 30 Year, 8.25%, 3/15/21 - 5/15/21 | 6,285 | 6,298 | ||||||
GNMA I SF 30 Year, 8.50%, 10/15/21 - 7/15/24 | 14,640 | 14,677 | ||||||
hGNMA II SF 30 Year, 3.50%, 10/01/49 | 4,900,000 | 5,077,434 | ||||||
GNMA II SF 30 Year, 6.50%, 1/20/26 - 1/20/33 | 123,886 | 140,532 | ||||||
GNMA II SF 30 Year, 7.50%, 11/20/22 - 7/20/32 | 74,877 | 85,597 | ||||||
GNMA II SF 30 Year, 8.00%, 8/20/26 | 66 | 75 | ||||||
GNMA II SF 30 Year, 9.00%, 4/20/20 - 3/20/25 | 467 | 477 | ||||||
GNMA II SF 30 Year, 10.50%, 6/20/20 | 2 | 2 | ||||||
|
| |||||||
5,478,939 | ||||||||
|
| |||||||
Total Mortgage-Backed Securities (Cost $44,779,396) | 45,833,667 | |||||||
|
| |||||||
Total Investments before Short Term Investments (Cost $62,325,903) | 63,504,730 | |||||||
|
| |||||||
Shares | ||||||||
Short Term Investments 13.3% | ||||||||
Money Market Funds (Cost $3,132,672) 5.0% | ||||||||
j,kInstitutional Fiduciary Trust Money Market Portfolio, 1.71% | 3,132,672 | 3,132,672 | ||||||
|
| |||||||
Principal Amount* | ||||||||
Repurchase Agreements (Cost $5,217,627) 8.3% | ||||||||
lJoint Repurchase Agreement, 2.343%, 10/01/19 (Maturity Value $5,217,967) | ||||||||
BNP Paribas Securities Corp. (Maturity Value $2,572,718) | ||||||||
Deutsche Bank Securities Inc. (Maturity Value $930,103) | ||||||||
HSBC Securities (USA) Inc. (Maturity Value $1,715,146) | ||||||||
Collateralized bymU.S. Treasury Bills, 11/19/19; U.S. Treasury Notes, 1.375% - 3.125%, 1/31/20 - 7/31/26; and U.S. Treasury Strips, 2/15/24 - 5/15/35 (valued at $5,323,967) | $ | 5,217,627 | 5,217,627 | |||||
|
| |||||||
Total Investments (Cost $70,676,202) 114.5% | 71,855,029 | |||||||
Other Assets, less Liabilities (14.5)% | (9,122,736 | ) | ||||||
|
| |||||||
Net Assets 100.0% | $ | 62,732,293 | ||||||
|
|
20 | Annual Report | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
STATEMENT OF INVESTMENTS
†Rounds to less than 0.1% of net assets.
*The principal amount is stated in U.S. dollars unless otherwise indicated.
aSecurity was purchased pursuant to Rule 144A under the Securities Act of 1933 and may be sold in transactions exempt from registration only to qualified institutional buyers or in a public offering registered under the Securities Act of 1933. These securities have been deemed liquid under guidelines approved by the Fund’s Board of Trustees. At September 30, 2019, the aggregate value of these securities was $7,224,987, representing 11.5% of net assets.
bThe coupon rate shown represents the rate at period end.
cThe coupon rate shown represents the rate inclusive of any caps or floors, if applicable, in effect at period end.
dFair valued using significant unobservable inputs. See Note 10 regarding fair value measurements.
eSee Note 7 regarding defaulted securities.
fAdjustable rate security with an interest rate that is not based on a published reference index and spread. The rate is based on the structure of the agreement and current market conditions. The coupon rate shown represents the rate at period end.
gInvestment in an interest-only security entitles holders to receive only the interest payment on the underlying instruments. The principal amount shown is the notional amount of the underlying instruments.
hSecurity purchased on ato-be-announced (TBA) basis. See Note 1(c).
iAdjustable Rate Mortgage-Backed Security (ARM); the rate shown is the effective rate at period end. ARM rates are not based on a published reference rate and spread, but instead pass-through weighted average interest income inclusive of any caps or floors, if applicable, from the underlying mortgage loans in which the majority of mortgages pay interest based on the index shown at their designated reset dates plus a spread, less the applicable servicing and guaranty fee (MBS margin).
jSee Note 3(f) regarding investments in affiliated management investment companies.
kThe rate shown is the annualizedseven-day effective yield at period end.
lSee Note 1(b) regarding joint repurchase agreement.
mThe security was issued on a discount basis with no stated coupon rate.
At September 30, 2019, the Fund had the following futures contracts outstanding. See Note 1(d).
Futures Contracts
Description | Type | Number of Contracts | Notional Amount* | Expiration Date | Value/ Unrealized Appreciation (Depreciation) | |||||||||||||||
| ||||||||||||||||||||
Interest Rate Contracts | ||||||||||||||||||||
CME Ultra Long Term U.S. Treasury Bond | Short | 1 | $ 191,906 | 12/19/19 | $ 6,373 | |||||||||||||||
U.S. Treasury 2 Yr. Note | Long | 21 | 4,525,500 | 12/31/19 | (12,099 | ) | ||||||||||||||
U.S. Treasury 5 Yr. Note | Long | 13 | 1,548,929 | 12/31/19 | 6,585 | |||||||||||||||
U.S. Treasury 30 Yr. Bond | Long | 2 | 324,625 | 12/19/19 | (5,456 | ) | ||||||||||||||
Ultra 10 Yr. U.S. Treasury Note | Long | 11 | 1,566,469 | 12/19/19 | (2,796 | ) | ||||||||||||||
|
| |||||||||||||||||||
Total Futures Contracts | $ (7,393 | ) | ||||||||||||||||||
|
|
*As of period end.
See Abbreviations on page 34.
franklintempleton.com | The accompanying notes are an integral part of these financial statements. | Annual Report | 21 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Statement of Assets and Liabilities
September 30, 2019
Assets: | ||||
Investments in securities: | ||||
Cost - Unaffiliated issuers | $ | 62,325,903 | ||
Cost -Non-controlled affiliates (Note 3f) | 3,132,672 | |||
Cost - Unaffiliated repurchase agreements | 5,217,627 | |||
|
| |||
Value - Unaffiliated issuers | $ | 63,504,730 | ||
Value -Non-controlled affiliates (Note 3f) | 3,132,672 | |||
Value - Unaffiliated repurchase agreements | 5,217,627 | |||
Receivables: | ||||
Investment securities sold | 4,510 | |||
Capital shares sold | 11,796 | |||
Interest | 159,585 | |||
Deposits with brokers for: | ||||
Futures contracts | 45,826 | |||
Other assets | 24 | |||
|
| |||
Total assets |
|
72,076,770 |
| |
|
| |||
Liabilities: | ||||
Payables: | ||||
Investment securities purchased | 9,140,015 | |||
Capital shares redeemed | 55,121 | |||
Management fees | 20,603 | |||
Distribution fees | 11,837 | |||
Transfer agent fees | 11,870 | |||
Distributions to shareholders | 7,716 | |||
Variation margin on futures contracts | 1,104 | |||
Accrued expenses and other liabilities | 96,211 | |||
|
| |||
Total liabilities |
|
9,344,477 |
| |
|
| |||
Net assets, at value |
$ |
62,732,293 |
| |
|
| |||
Net assets consist of: | ||||
Paid-in capital | $ | 65,512,744 | ||
Total distributable earnings (loss) | (2,780,451 | ) | ||
|
| |||
Net assets, at value |
$ |
62,732,293 |
| |
|
|
22 | Annual Report | The accompanying notes are an integral part of these financial statements. | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
FINANCIAL STATEMENTS
Statement of Assets and Liabilities(continued)
September 30, 2019
Class A: | ||||
Net assets, at value | $18,312,604 | |||
|
| |||
Shares outstanding | 1,980,025 | |||
|
| |||
Net asset value per sharea | $9.25 | |||
|
| |||
Maximum offering price per share (net asset value per share ÷ 96.25%) | $9.61 | |||
|
| |||
Class A1: | ||||
Net assets, at value | $29,285,990 | |||
|
| |||
Shares outstanding | 3,164,679 | |||
|
| |||
Net asset value per sharea | $9.25 | |||
|
| |||
Maximum offering price per share (net asset value per share ÷ 96.25%) | $9.61 | |||
|
| |||
Class C: | ||||
Net assets, at value | $ 3,843,461 | |||
|
| |||
Shares outstanding | 415,528 | |||
|
| |||
Net asset value and maximum offering price per sharea | $9.25 | |||
|
| |||
Class R6: | ||||
Net assets, at value | $ 382,772 | |||
|
| |||
Shares outstanding | 41,444 | |||
|
| |||
Net asset value and maximum offering price per share | $9.24 | |||
|
| |||
Advisor Class: | ||||
Net assets, at value | $10,907,466 | |||
|
| |||
Shares outstanding | 1,180,427 | |||
|
| |||
Net asset value and maximum offering price per share | $9.24 | |||
|
|
aRedemption price is equal to net asset value less contingent deferred sales charges, if applicable.
franklintempleton.com | The accompanying notes are an integral part of these financial statements. | Annual Report | 23 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
FINANCIAL STATEMENTS
Statement of Operations
for the year ended September 30, 2019
Investment income: | ||||
Dividends: | ||||
Unaffiliated issuers | $ | 5,768 | ||
Non-controlled affiliates (Note 3f) | 39,216 | |||
Interest: | ||||
Unaffiliated issuers: | ||||
Paydown gain (loss) | (86,964 | ) | ||
Paid in cash | 2,439,104 | |||
|
| |||
Total investment income | 2,397,124 | |||
|
| |||
Expenses: | ||||
Management fees (Note 3a) | 244,054 | |||
Distribution fees: (Note 3c) | ||||
Class A | 42,666 | |||
Class C | 25,354 | |||
Transfer agent fees: (Note 3e) | ||||
Class A | 27,788 | |||
Class A1 | 49,671 | |||
Class C | 6,375 | |||
Class R6 | 732 | |||
Advisor Class | 14,813 | |||
Custodian fees (Note 4) | 2,201 | |||
Reports to shareholders | 25,218 | |||
Registration and filing fees | 89,139 | |||
Professional fees | 86,499 | |||
Trustees’ fees and expenses | 877 | |||
Pricing fees | 52,648 | |||
Other | 5,184 | |||
|
| |||
Total expenses |
|
673,219 |
| |
Expense reductions (Note 4) | (163 | ) | ||
Expenses waived/paid by affiliates (Note 3f and 3g) | (147,377 | ) | ||
|
| |||
Net expenses |
|
525,679 |
| |
|
| |||
Net investment income | 1,871,445 | |||
|
| |||
Realized and unrealized gains (losses): | ||||
Net realized gain (loss) from: | ||||
Investments: | ||||
Unaffiliated issuers | 65,676 | |||
Futures contracts | 525,037 | |||
|
| |||
Net realized gain (loss) | 590,713 | |||
|
| |||
Net change in unrealized appreciation (depreciation) on: | ||||
Investments: | ||||
Unaffiliated issuers | 1,686,040 | |||
Futures contracts | 71,935 | |||
|
| |||
Net change in unrealized appreciation (depreciation) | 1,757,975 | |||
|
| |||
Net realized and unrealized gain (loss) | 2,348,688 | |||
|
| |||
Net increase (decrease) in net assets resulting from operations | $ | 4,220,133 | ||
|
|
24 | Annual Report | The accompanying notes are an integral part of these financial statements. | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
FINANCIAL STATEMENTS
Statements of Changes in Net Assets
Year Ended September 30, | ||||||||
2019 | 2018 | |||||||
Increase (decrease) in net assets: | ||||||||
Operations: | ||||||||
Net investment income | $ | 1,871,445 | $ | 1,922,043 | ||||
Net realized gain (loss) | 590,713 | (1,332,463 | ) | |||||
Net change in unrealized appreciation (depreciation) | 1,757,975 | (1,374,965 | ) | |||||
|
| |||||||
Net increase (decrease) in net assets resulting from operations | 4,220,133 | (785,385 | ) | |||||
|
| |||||||
Distributions to shareholders: | ||||||||
Class A | (566,480 | ) | (602,559 | ) | ||||
Class A1 | (1,093,394 | ) | (1,294,005 | ) | ||||
Class C | (114,658 | ) | (154,034 | ) | ||||
Class R6 | (15,777 | ) | (14,606 | ) | ||||
Advisor Class | (321,953 | ) | (234,563 | ) | ||||
|
| |||||||
Total distributions to shareholders | (2,112,262 | ) | (2,299,767 | ) | ||||
|
| |||||||
Capital share transactions: (Note 2) | ||||||||
Class A | 1,414,591 | (3,988,857 | ) | |||||
Class A1 | (4,557,614 | ) | (6,372,489 | ) | ||||
Class C | (798,773 | ) | (1,549,778 | ) | ||||
Class R6 | (64,182 | ) | 445,374 | |||||
Advisor Class | 4,005,201 | (755,598 | ) | |||||
|
| |||||||
Total capital share transactions | (777 | ) | (12,221,348 | ) | ||||
|
| |||||||
Net increase (decrease) in net assets | 2,107,094 | (15,306,500 | ) | |||||
Net assets: | ||||||||
Beginning of year | 60,625,199 | 75,931,699 | ||||||
|
| |||||||
End of year | $ | 62,732,293 | $ | 60,625,199 | ||||
|
|
franklintempleton.com | The accompanying notes are an integral part of these financial statements. | Annual Report | 25 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
1. Organization and Significant Accounting Policies
Franklin Strategic Mortgage Portfolio (Trust) is registered under the Investment Company Act of 1940 (1940 Act) as anopen-end management investment company, consisting of one fund, Franklin Strategic Mortgage Portfolio (Fund) and applies the specialized accounting and reporting guidance in U.S. Generally Accepted Accounting Principles (U.S. GAAP). The Fund offers five classes of shares: Class A, Class A1, Class C, Class R6 and Advisor Class. Beginning on October 19, 2018, Class C shares automatically convert to Class A shares after they have been held for 10 years. Each class of shares may differ by its initial sales load, contingent deferred sales charges, voting rights on matters affecting a single class, its exchange privilege and fees due to differing arrangements for distribution and transfer agent fees.
The following summarizes the Fund’s significant accounting policies.
a. Financial Instrument Valuation
The Fund’s investments in financial instruments are carried at fair value daily. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. The Fund calculates the net asset value (NAV) per share each business day as of 4 p.m. Eastern time or the regularly scheduled close of the New York Stock Exchange (NYSE), whichever is earlier. Under compliance policies and procedures approved by the Fund’s Board of Trustees (the Board), the Fund’s administrator has responsibility for oversight of valuation, including leading the cross-functional Valuation Committee (VC). The Fund may utilize independent pricing services, quotations from securities and financial instrument dealers, and other market sources to determine fair value.
Debt securities generally trade in theover-the-counter (OTC) market rather than on a securities exchange. The Fund’s pricing services use multiple valuation techniques to determine fair value. In instances where sufficient market activity exists, the pricing services may utilize a market-based approach through which quotes from market makers are used to determine fair value. In instances where sufficient market activity may not exist or is limited, the pricing services also utilize proprietary valuation models which may consider market characteristics such as benchmark yield curves, credit spreads, estimated default rates, anticipated market interest rate volatility, coupon rates, anticipated timing of principal
repayments, underlying collateral, and other unique security features in order to estimate the relevant cash flows, which are then discounted to calculate the fair value. Derivative financial instruments listed on an exchange are valued at the official closing price of the day.
Investments inopen-end mutual funds are valued at the closing NAV. Investments in repurchase agreements are valued at cost, which approximates fair value.
The Fund has procedures to determine the fair value of financial instruments for which market prices are not reliable or readily available. Under these procedures, the Fund primarily employs a market-based approach which may use related or comparable assets or liabilities, recent transactions, market multiples, book values, and other relevant information for the investment to determine the fair value of the investment. An income-based valuation approach may also be used in which the anticipated future cash flows of the investment are discounted to calculate fair value. Discounts may also be applied due to the nature or duration of any restrictions on the disposition of the investments. Due to the inherent uncertainty of valuations of such investments, the fair values may differ significantly from the values that would have been used had an active market existed.
b. Joint Repurchase Agreement
The Fund enters into a joint repurchase agreement whereby its uninvested cash balance is deposited into a joint cash account with other funds managed by the investment manager or an affiliate of the investment manager and is used to invest in one or more repurchase agreements. The value and face amount of the joint repurchase agreement are allocated to the funds based on theirpro-rata interest. A repurchase agreement is accounted for as a loan by the Fund to the seller, collateralized by securities which are delivered to the Fund’s custodian. The fair value, including accrued interest, of the initial collateralization is required to be at least 102% of the dollar amount invested by the funds, with the value of the underlying securities marked to market daily to maintain coverage of at least 100%. Repurchase agreements are subject to the terms of Master Repurchase Agreements (MRAs) with approved counterparties (sellers). The MRAs contain various provisions, including but not limited to events of default and maintenance of collateral for repurchase agreements. In the event of default by either the seller or the Fund, certain MRAs may permit thenon-defaulting party to net andclose-out all transactions, if any, traded under such
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
agreements. The Fund may sell securities it holds as collateral and apply the proceeds towards the repurchase price and any other amounts owed by the seller to the Fund in the event of default by the seller. This could involve costs or delays in addition to a loss on the securities if their value falls below the repurchase price owed by the seller. The joint repurchase agreement held by the Fund at year end, as indicated in the Statement of Investments, had been entered into on September 30, 2019.
c. Securities Purchased on a TBA Basis
The Fund purchases securities on ato-be-announced (TBA) basis, with payment and delivery scheduled for a future date. These transactions are subject to market fluctuations and are subject to the risk that the value at delivery may be more or less than the trade date purchase price. Sufficient assets have been segregated for these securities.
d. Derivative Financial Instruments
The Fund invested in derivative financial instruments in order to manage risk or gain exposure to various other investments or markets. Derivatives are financial contracts based on an underlying or notional amount, require no initial investment or an initial net investment that is smaller than would normally be required to have a similar response to changes in market factors, and require or permit net settlement. Derivatives contain various risks including the potential inability of the counterparty to fulfill their obligations under the terms of the contract, the potential for an illiquid secondary market, and/or the potential for market movements which expose the Fund to gains or losses in excess of the amounts shown in the Statement of Assets and Liabilities. Realized gain and loss and unrealized appreciation and depreciation on these contracts for the period are included in the Statement of Operations.
Collateral requirements differ by type of derivative. Collateral or initial margin requirements are set by the broker or exchange clearing house for exchange traded and centrally cleared derivatives. Initial margin deposited is held at the exchange and can be in the form of cash and/or securities.
The Fund entered into exchange traded futures contracts primarily to manage and/or gain exposure to interest rate risk.
A futures contract is an agreement between the Fund and a counterparty to buy or sell an asset at a specified price on a future date. Required initial margins are pledged by the Fund,
and the daily change in fair value is accounted for as a variation margin payable or receivable in the Statement of Assets and Liabilities.
See Note 8 regarding other derivative information.
e. Mortgage Dollar Rolls
The Fund enters into mortgage dollar rolls, typically on a TBA basis. Mortgage dollar rolls are agreements between the Fund and a financial institution where the Fund sells (or buys) mortgage-backed securities for delivery on a specified date and simultaneously contracts to repurchase (or sell) substantially similar (same type, coupon, and maturity) securities at a future date and at a predetermined price. Gains or losses are realized on the initial sale, and the difference between the repurchase price and the sale price is recorded as an unrealized gain or loss to the Fund upon entering into the mortgage dollar roll. In addition, the Fund may invest the cash proceeds that are received from the initial sale. During the period between the sale and repurchase, the Fund is not entitled to principal and interest paid on the mortgage backed securities. Transactions in mortgage dollar rolls are accounted for as purchases and sales and may result in an increase to the Fund’s portfolio turnover rate. The risks of mortgage dollar roll transactions include the potential inability of the counterparty to fulfill its obligations.
f. Income and Deferred Taxes
It is the Fund’s policy to qualify as a regulated investment company under the Internal Revenue Code. The Fund intends to distribute to shareholders substantially all of its taxable income and net realized gains to relieve it from federal income and excise taxes. As a result, no provision for U.S. federal income taxes is required.
The Fund may be subject to foreign taxation related to income received, capital gains on the sale of securities and certain foreign currency transactions in the foreign jurisdictions in which it invests. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist in the foreign markets in which the Fund invests. When a capital gain tax is determined to apply, the Fund records an estimated deferred tax liability in an amount that would be payable if the securities were disposed of on the valuation date.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
1. Organization and Significant Accounting
Policies(continued)
f. Income and Deferred Taxes(continued)
The Fund may recognize an income tax liability related to its uncertain tax positions under U.S. GAAP when the uncertain tax position has a less than 50% probability that it will be sustained upon examination by the tax authorities based on its technical merits. As of September 30, 2019, the Fund has determined that no tax liability is required in its financial statements related to uncertain tax positions for any open tax years (or expected to be taken in future tax years). Open tax years are those that remain subject to examination and are based on the statute of limitations in each jurisdiction in which the Fund invests.
g. Security Transactions, Investment Income, Expenses and Distributions
Security transactions are accounted for on trade date. Realized gains and losses on security transactions are determined on a specific identification basis. Interest income and estimated expenses are accrued daily. Amortization of premium and accretion of discount on debt securities are included in interest income. Paydown gains and losses are recorded separately on the Statement of Operations. Dividend income is recorded on theex-dividend date. Dividends from net investment income are normally declared daily; these dividends may be reinvested or paid monthly to shareholders. Distributions from realized capital gains and other distributions, if any, are recorded on theex-dividend date. Distributable earnings are determined according to income tax regulations (tax basis) and may differ from earnings recorded in accordance with U.S. GAAP. These differences may be permanent or temporary. Permanent differences are reclassified among capital accounts to reflect
their tax character. These reclassifications have no impact on net assets or the results of operations. Temporary differences are not reclassified, as they may reverse in subsequent periods.
Net investment income, excluding class specific expenses, is allocated daily to each class of shares based upon the relative value of the settled shares of each class. Realized and unrealized gains and losses are allocated daily to each class of shares based upon the relative proportion of net assets of each class. Differences in per share distributions by class are generally due to differences in class specific expenses.
h. Accounting Estimates
The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the amounts of income and expenses during the reporting period. Actual results could differ from those estimates.
i. Guarantees and Indemnifications
Under the Fund’s organizational documents, its officers and trustees are indemnified by the Fund against certain liabilities arising out of the performance of their duties to the Fund. Additionally, in the normal course of business, the Fund, enters into contracts with service providers that contain general indemnification clauses. The Fund’s maximum exposure under these arrangements is unknown as this would involve future claims that may be made against the Fund that have not yet occurred. Currently, the Fund expects the risk of loss to be remote.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
2. Shares of Beneficial Interest
At September 30, 2019, there were an unlimited number of shares authorized (without par value). Transactions in the Fund’s shares were as follows:
Year Ended September 30, | ||||||||||||||||
2019 | 2018 | |||||||||||||||
Shares | Amount | Shares | Amount | |||||||||||||
Class A Shares: | ||||||||||||||||
Shares solda | 589,470 | $ | 5,341,820 | 618,223 | $ | 5,675,089 | ||||||||||
Shares issued in reinvestment of distributions | 58,246 | 529,369 | 60,586 | 552,130 | ||||||||||||
Shares redeemed | (492,653 | ) | (4,456,598 | ) | (1,117,552 | ) | (10,216,076 | ) | ||||||||
Net increase (decrease) | 155,063 | $ | 1,414,591 | (438,743 | ) | $ | (3,988,857 | ) | ||||||||
Class A1 Shares: | ||||||||||||||||
Shares sold | 74,450 | $ | 676,501 | 168,419 | $ | 1,536,070 | ||||||||||
Shares issued in reinvestment of distributions | 113,202 | 1,028,209 | 133,959 | 1,220,695 | ||||||||||||
Shares redeemed | (692,676 | ) | (6,262,324 | ) | (1,002,795 | ) | (9,129,254 | ) | ||||||||
Net increase (decrease) | (505,024 | ) | $ | (4,557,614 | ) | (700,417 | ) | $ | (6,372,489 | ) | ||||||
Class C Shares: | ||||||||||||||||
Shares sold | 86,691 | $ | 788,921 | 55,909 | $ | 508,693 | ||||||||||
Shares issued in reinvestment of distributions | 11,907 | 108,113 | 15,537 | 141,601 | ||||||||||||
Shares redeemeda | (188,273 | ) | (1,695,807 | ) | (241,517 | ) | (2,200,072 | ) | ||||||||
Net increase (decrease) | (89,675 | ) | $ | (798,773 | ) | (170,071 | ) | $ | (1,549,778 | ) | ||||||
Class R6 Shares: | ||||||||||||||||
Shares sold | 8,136 | $ | 73,528 | 64,115 | $ | 592,593 | ||||||||||
Shares issued in reinvestment of distributions | 1,645 | 14,920 | 1,601 | 14,527 | ||||||||||||
Shares redeemed | (16,801 | ) | (152,630 | ) | (17,785 | ) | (161,746 | ) | ||||||||
Net increase (decrease) | (7,020 | ) | $ | (64,182 | ) | 47,931 | $ | 445,374 | ||||||||
Advisor Class Shares: | ||||||||||||||||
Shares sold | 660,524 | $ | 5,970,032 | 217,283 | $ | 1,982,625 | ||||||||||
Shares issued in reinvestment of distributions | 35,333 | 321,562 | 20,198 | 183,021 | ||||||||||||
Shares redeemed | (251,980 | ) | (2,286,393 | ) | (318,593 | ) | (2,921,244 | ) | ||||||||
Net increase (decrease) | 443,877 | $ | 4,005,201 | (81,112 | ) | $ | (755,598 | ) |
aMay include a portion of Class C shares that were automatically converted to Class A.
3. Transactions with Affiliates
Franklin Resources, Inc. is the holding company for various subsidiaries that together are referred to as Franklin Templeton. Certain officers and trustees of the Fund are also officers and/or directors of the following subsidiaries:
Subsidiary | Affiliation | |
Franklin Advisers, Inc. (Advisers) | Investment manager | |
Franklin Templeton Services, LLC (FT Services) | Administrative manager | |
Franklin Templeton Distributors, Inc. (Distributors) | Principal underwriter | |
Franklin Templeton Investor Services, LLC (Investor Services) | Transfer agent |
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
3. Transactions with Affiliates(continued)
a. Management Fees
The Fund pays an investment management fee to Advisers based on the average daily net assets of the Fund as follows:
Annualized Fee Rate | Net Assets | |
0.400% | First $250 million | |
0.380% | Over $250 million, up to and including $500 million | |
0.360% | In excess of $500 million |
b. Administrative Fees
Under an agreement with Advisers, FT Services provides administrative services to the Fund. The fee is paid by Advisers based on the Fund’s average daily net assets, and is not an additional expense of the Fund.
c. Distribution Fees
The Board has adopted distribution plans for Class A and Class C shares, pursuant to Rule12b-1 under the 1940 Act. Under the Fund’s Class A reimbursement distribution plan, the Fund reimburses Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund’s shares up to the maximum annual plan rate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for the current plan year cannot be reimbursed in subsequent periods. In addition, under the Fund’s Class C compensation distribution plan, the Fund pays Distributors for costs incurred in connection with the servicing, sale and distribution of the Fund’s shares up to the maximum annual plan rate. The plan year, for purposes of monitoring compliance with the maximum annual plan rate, is February 1 through January 31.
The maximum annual plan rates, based on the average daily net assets, for each class, are as follows:
Class A | 0.25 | % | ||
Class C | 0.65 | % |
d. Sales Charges/Underwriting Agreements
Front-end sales charges and contingent deferred sales charges (CDSC) do not represent expenses of the Fund. These charges are deducted from the proceeds of sales of Fund shares prior to investment or from redemption proceeds prior to remittance, as applicable. Distributors has advised the Fund of the following commission transactions related to the sales and redemptions of the Fund’s shares for the year:
Sales charges retained net of commissions paid to unaffiliated brokers/dealers | $ | 933 | ||
CDSC retained | $ | 219 |
Effective March 1, 2019, certainfront-end sales charges on Class A and A1 shares were lowered. Further details are disclosed in the Fund’s Prospectus.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
e. Transfer Agent Fees
Each class of shares pays transfer agent fees to Investor Services for its performance of shareholder servicing obligations.The fees are based on an annualized asset based fee of 0.02% plus a transaction based fee. In addition, each class reimburses Investor Services for out of pocket expenses incurred and, except for Class R6, reimburses shareholder servicing fees paid to third parties. These fees are allocated daily based upon their relative proportion of such classes’ aggregate net assets. Class R6 pays Investor Services transfer agent fees specific to that class.
For the year ended September 30, 2019, the Fund paid transfer agent fees of $99,379, of which $55,661 was retained by Investor Services.
f. Investments in Affiliated Management Investment Companies
The Fund invests in one or more affiliated management investment companies for purposes other than exercising a controlling influence over the management or policies. Management fees paid by the Fund are waived on assets invested in the affiliated management investment companies, as noted in the Statement of Operations, in an amount not to exceed the management and administrative fees paid directly or indirectly by each affiliate. During the year ended September 30, 2019, the Fund held investments in affiliated management investment companies as follows:
Value at Beginning of Year | Purchases | Sales | Realized Gain (Loss) | Net Change in Unrealized Appreciation (Depreciation) | Value at End of Year | Number of Shares Held at End of Year | Dividend Income | |||||||||||||||||||||||||
Non-Controlled Affiliates | ||||||||||||||||||||||||||||||||
Institutional Fiduciary Trust Money Market Portfolio, 1.71% | $ | 3,027,312 | $ | 17,412,912 | $ | (17,307,552 | ) | $ — | $ — | $ | 3,132,672 | 3,132,672 | $39,216 | |||||||||||||||||||
|
|
|
|
g. Waiver and Expense Reimbursements
Advisers has contractually agreed in advance to waive or limit its fees and to assume as its own expense certain expenses otherwise payable by the Fund so that the expenses (excluding distribution fees, acquired fund fees and expenses, and certainnon-routine expenses or costs, including those relating to litigation, indemnification, reorganizations, and liquidations) for Class A, Class A1, Class C and Advisor Class of the Fund do not exceed 0.75%, and for Class R6 do not exceed 0.61% based on the average net assets of each class until January 31, 2020. Total expenses waived or paid are not subject to recapture subsequent to the Fund’s fiscal year end.
Prior to February 1, 2019, expenses for Class R6 were limited to 0.64% based on the average net assets of the class.
Investor Services has voluntarily agreed in advance to waive or limit its fees so that the Class R6 transfer agent fees do not exceed 0.03% based on the average net assets of the class. Investor Services may discontinue this waiver in the future.
4. Expense Offset Arrangement
The Fund has entered into an arrangement with its custodian whereby credits realized as a result of uninvested cash balances are used to reduce a portion of the Fund’s custodian expenses. During the year ended September 30, 2019, the custodian fees were reduced as noted in the Statement of Operations.
5. Income Taxes
For tax purposes, capital losses may be carried over to offset future capital gains. Capital loss carryforwards with no expiration, if any, must be fully utilized before those losses with expiration dates.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
5. Income Taxes(continued)
At September 30, 2019, the capital loss carryforwards were as follows:
Capital loss carryforwards not subject to expiration: | ||||
Short term | $ | 2,473,340 | ||
Long term | 1,463,451 | |||
|
|
| ||
Total capital loss carryforwards | $ | 3,936,791 | ||
|
|
|
During the year ended September 30, 2019, the Fund utilized $480,373 of capital loss carryforwards.
On September 30, 2019, the Fund had expired capital loss carryforwards of $8,155,073, which were reclassified topaid-in capital.
The tax character of distributions paid during the years ended September 30, 2019 and 2018, was as follows:
2019 | 2018 | |||||||
|
|
| ||||||
Distributions paid from ordinary income | $ | 2,112,262 | $ | 2,299,767 | ||||
|
|
|
At September 30, 2019, the cost of investments, net unrealized appreciation (depreciation), undistributed ordinary income and undistributed long term capital gains for income tax purposes were as follows:
Cost of investments | $ | 70,690,286 | ||
|
|
| ||
Unrealized appreciation | $ | 1,476,148 | ||
Unrealized depreciation | (318,737 | ) | ||
|
|
| ||
Net unrealized appreciation (depreciation) | $ | 1,157,411 | ||
|
|
| ||
Distributable earnings: | ||||
Undistributed ordinary income | $ | 6,620 | ||
|
|
|
Differences between income and/or capital gains as determined on a book basis and a tax basis are primarily due to differing treatment of foreign currency transactions and paydown losses.
6. Investment Transactions
Purchases and sales of investments (excluding short term securities) for the year ended September 30, 2019, aggregated $143,184,831 and $147,336,200, respectively.
7. Defaulted Securities
The Fund held a defaulted security and/or other securities for which the income has been deemed uncollectible. At September 30, 2019, the value of this security represents less than 0.1% of the Fund’s net assets. The Fund discontinues accruing income on securities for which income has been deemed uncollectible and provides an estimate for losses on interest receivable. The security has been identified in the accompanying Statement of Investments.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
8. Other Derivative Information
At September 30, 2019, investments in derivative contracts are reflected in the Statement of Assets and Liabilities as follows:
Asset Derivatives | Liability Derivatives | |||||||||||||||
Derivative Contracts Not Accounted for as Hedging Instruments | Statement of Assets and Liabilities Location | Fair Value | Statement of Assets and Liabilities Location | Fair Value | ||||||||||||
| ||||||||||||||||
Interest rate contracts | Variation margin on futures contracts | $ | 12,958 | a | Variation margin on futures contracts | $ | 20,351 | a | ||||||||
|
|
|
|
aThis amount reflects the cumulative appreciation (depreciation) of futures contracts as reported in the Statement of Investments. Only the variation margin receivable/ payable at year end is separately reported within the Statement of Assets and Liabilities. Prior variation margin movements were recorded to cash upon receipt or payment.
For the year ended September 30, 2019, the effect of derivative contracts in the Statement of Operations was as follows:
Derivative Contracts Not Accounted for as Hedging Instruments | Statement of Operations Location | Net Realized Gain (Loss) for the Year | Statement of Operations Location | Net Change in Unrealized Appreciation (Depreciation) for the Year | ||||||||
Net realized gain (loss) from: | Net change in unrealized appreciation (depreciation) on: | |||||||||||
Interest rate contracts | Futures contracts | $525,037 | Futures contracts | $71,935 |
For the year ended September 30, 2019, the average month end notional amount of futures contracts represented $7,588,810.
See Note 1(d) regarding derivative financial instruments.
9. Credit Facility
The Fund, together with other U.S. registered and foreign investment funds (collectively, Borrowers), managed by Franklin Templeton, are borrowers in a joint syndicated senior unsecured credit facility totaling $2 billion (Global Credit Facility) which matures on February 7, 2020. This Global Credit Facility provides a source of funds to the Borrowers for temporary and emergency purposes, including the ability to meet future unanticipated or unusually large redemption requests.
Under the terms of the Global Credit Facility, the Fund shall, in addition to interest charged on any borrowings made by the Fund and other costs incurred by the Fund, pay its share of fees and expenses incurred in connection with the implementation and maintenance of the Global Credit Facility, based upon its relative share of the aggregate net assets of all of the Borrowers, including an annual commitment fee of 0.15% based upon the unused portion of the Global Credit Facility. These fees are reflected in other expenses in the Statement of Operations. During the year ended September 30, 2019, the Fund did not use the Global Credit Facility.
10. Fair Value Measurements
The Fund follows a fair value hierarchy that distinguishes between market data obtained from independent sources (observable inputs) and the Fund’s own market assumptions (unobservable inputs). These inputs are used in determining the value of the Fund’s financial instruments and are summarized in the following fair value hierarchy:
• | Level 1 – quoted prices in active markets for identical financial instruments |
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
NOTES TO FINANCIAL STATEMENTS
10. Fair Value Measurements(continued)
• | Level 2 – other significant observable inputs (including quoted prices for similar financial instruments, interest rates, prepayment speed, credit risk, etc.) |
• | Level 3 – significant unobservable inputs (including the Fund’s own assumptions in determining the fair value of financial instruments) |
The input levels are not necessarily an indication of the risk or liquidity associated with financial instruments at that level.
A summary of inputs used as of September 30, 2019, in valuing the Fund’s assets and liabilities carried at fair value, is as follows:
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Assets: | ||||||||||||||||
Investments in Securities:a | ||||||||||||||||
Corporate Bonds | $ | — | $ | 109,360 | $ | — | $ | 109,360 | ||||||||
U.S. Government and Agency Securities | — | 504,681 | — | 504,681 | ||||||||||||
Asset-Backed Securities and Commercial Mortgage-Backed Securities | — | 17,056,998 | 24 | 17,057,022 | ||||||||||||
Mortgage-Backed Securities | — | 45,833,667 | — | 45,833,667 | ||||||||||||
Short Term Investments | 3,132,672 | 5,217,627 | — | 8,350,299 | ||||||||||||
Total Investments in Securities | $ | 3,132,672 | $ | 68,722,333 | $ | 24 | $ | 71,855,029 | ||||||||
Other Financial Instruments: | ||||||||||||||||
Futures Contracts | $ | 12,958 | $ | — | $ | — | $ | 12,958 | ||||||||
Liabilities: | ||||||||||||||||
Other Financial Instruments: | ||||||||||||||||
Futures Contracts | $ | 20,351 | $ | — | $ | — | $ | 20,351 |
aFor detailed categories, see the accompanying Statement of Investments.
A reconciliation of assets in which Level 3 inputs are used in determining fair value is presented when there are significant Level 3 financial instruments at the beginning and/or end of the year.
11. Subsequent Events
The Fund has evaluated subsequent events through the issuance of the financial statements and determined that no events have occurred that require disclosure.
Abbreviations
Counterparty | Currency | Selected Portfolio | ||||||||||
CME | Chicago Mercantile Exchange | USD | United States Dollar | FRN | Floating Rate Note | |||||||
IO | Interest Only | |||||||||||
LIBOR | London InterBank Offered Rate | |||||||||||
REIT | Real Estate Investment Trust | |||||||||||
SF | Single Family |
34 | Annual Report | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Report of Independent Registered Public Accounting Firm
To the Board of Trustees and Shareholders of Franklin Strategic Mortgage Portfolio
Opinion on the Financial Statements
We have audited the accompanying statement of assets and liabilities, including the statement of investments, of Franklin Strategic Mortgage Portfolio (the “Fund”) as of September 30, 2019, the related statement of operations for the year ended September 30, 2019, the statement of changes in net assets for each of the two years in the period ended September 30, 2019, including the related notes, and the financial highlights for each of the periods indicated therein (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Fund as of September 30, 2019, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period ended September 30, 2019 and the financial highlights for each of the periods indicated therein in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Fund’s management. Our responsibility is to express an opinion on the Fund’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Fund in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits of these financial statements in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our procedures included confirmation of securities owned as of September 30, 2019 by correspondence with the custodian, transfer agent, and brokers; when replies were not received from brokers, we performed other auditing procedures. We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
San Francisco, California
November 14, 2019
We have served as the auditor of one or more investment companies in the Franklin Templeton Group of Funds since 1948.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Under Section 871(k)(1)(C) of the Internal Revenue Code, the Fund hereby reports the maximum amount allowable but no less than $2,020,261 as interest related dividends for purposes of the tax imposed under Section 871(a)(1)(A) of the Internal Revenue Code for the fiscal year ended September 30, 2019.
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
The name, year of birth and address of the officers and board members, as well as their affiliations, positions held with the Trust, principal occupations during at least the past five years and number of U.S. registered portfolios overseen in the Franklin Templeton fund complex, are shown below. Generally, each board member serves until that person’s successor is elected and qualified.
Independent Board Members
Name, Year of Birth and Address
| Position
| Length of Time Served
| Number of Portfolios in by Board Member*
| Other Directorships Held During at Least the Past 5 Years
| ||||
Harris J. Ashton (1932) One Franklin Parkway San Mateo, CA 94403-1906 | Trustee | Since 1992 | 135 | Bar-S Foods (meat packing company) (1981-2010). | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Director of various companies; andformerly, Director, RBC Holdings, Inc. (bank holding company) (until 2002); and President, Chief Executive Officer and Chairman of the Board, General Host Corporation (nursery and craft centers) (until 1998).
| ||||||||
Terrence J. Checki (1945) One Franklin Parkway San Mateo, CA 94403-1906 | Trustee | Since 2017 | 114 | Hess Corporation (exploration of oil and gas) (2014-present). | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Member of the Council on Foreign Relations (1996-present); Member of the National Committee on U.S.-China Relations (1999-present); member of the Board of Trustees of the Economic Club of New York (2013-present); member of the Board of Trustees of the Foreign Policy Association (2005-present) and member of various other boards of trustees and advisory boards; andformerly, Executive Vice President of the Federal Reserve Bank of New York and Head of its Emerging Markets and Internal Affairs Group and Member of Management Committee (1995-2014); and Visiting Fellow at the Council on Foreign Relations (2014).
| ||||||||
Mary C. Choksi (1950) One Franklin Parkway San Mateo, CA 94403-1906 | Trustee | Since 2014 | 135 | Avis Budget Group Inc. (car rental) (2007-present), Omnicom Group Inc. (advertising and marketing communications services)(2011-present) and White Mountains Insurance Group, Ltd. (holding company) (2017-present). | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Director of various companies; andformerly, Founder and Senior Advisor, Strategic Investment Group (investment management group) (2015-2017); Founding Partner and Senior Managing Director, Strategic Investment Group (1987–2015); Founding Partner and Managing Director, Emerging Markets Management LLC (investment management firm) (1987-2011); and Loan Officer/Senior Loan Officer/Senior Pension Investment Officer, World Bank Group (international financial institution) (1977-1987).
| ||||||||
Edith E. Holiday (1952) One Franklin Parkway San Mateo, CA 94403-1906 | Lead Independent Trustee | Trustee since 2003 and Lead Independent Trustee since March 2019 | 135 | Hess Corporation (exploration of oil and gas) (1993-present), Canadian National Railway (railroad) (2001-present), White Mountains Insurance Group, Ltd. (holding company) (2004-present), Santander Consumer USA Holdings, Inc. (consumer finance) (2016-present), RTI International Metals, Inc. (manufacture and distribution of titanium) (1999-2015) and H.J. Heinz Company (processed foods and allied products) (1994-2013). |
Principal Occupation During at Least the Past 5 Years:
Director or Trustee of various companies and trusts; andformerly,Assistant to the President of the United States and Secretary of the Cabinet(1990-1993); General Counsel to the United States Treasury Department (1989-1990); and Counselor to the Secretary and Assistant Secretary for Public Affairs and Public Liaison-United States Treasury Department (1988-1989).
franklintempleton.com | Annual Report | 37 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Independent Board Members(continued)
Name, Year of Birth and Address
| Position
| Length of Time Served
| Number of Portfolios in by Board Member*
| Other Directorships Held During at Least the Past 5 Years
| ||||
J. Michael Luttig (1954) One Franklin Parkway San Mateo, CA 94403-1906 | Trustee | Since 2009 | 135 | Boeing Capital Corporation (aircraft financing) (2006-2013). | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Executive Vice President, Counselor and Senior Advisor to Boeing Chairman and Board of Directors, The Boeing Company (aerospace company) (May 2019); andformerly, General Counsel and member of the Executive Council, The Boeing Company (2006-2019) and Federal Appeals Court Judge, U.S. Court of Appeals for the Fourth Circuit (1991-2006).
| ||||||||
Larry D. Thompson (1945) One Franklin Parkway San Mateo, CA 94403-1906 | Trustee | Since 2007 | 135 | The Southern Company (energy company) (2014-present; previously 2010-2012), Graham Holdings Company (education and media organization) (2011-present) and Cbeyond, Inc. (business communications provider) (2010-2012). | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Director of various companies; Counsel, Finch McCranie, LLP (law firm) (2015-present); Independent Compliance Monitor and Auditor, Volkswagen AG (manufacturer of automobiles and commercial vehicles) (2017-present); John A. Sibley Professor of Corporate and Business Law, University of Georgia School of Law (2015-present; previously 2011-2012); andformerly, Executive Vice President - Government Affairs, General Counsel and Corporate Secretary, PepsiCo, Inc. (consumer products) (2012-2014); Senior Vice President - Government Affairs, General Counsel and Secretary, PepsiCo, Inc. (2004-2011); Senior Fellow of The Brookings Institution (2003-2004); Visiting Professor, University of Georgia School of Law (2004); and Deputy Attorney General, U.S. Department of Justice (2001-2003).
| ||||||||
Interested Board Members and Officers | ||||||||
Name, Year of Birth
and Address | Position
| Length of Time Served
| Number of Portfolios in
| Other Directorships Held During at Least the Past 5 Years
| ||||
**Gregory E. Johnson (1961) One Franklin Parkway San Mateo, CA 94403-1906 | Trustee | Since 2007 | 147 | None | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Chairman of the Board, Member - Office of the Chairman, Director, and Chief Executive Officer, Franklin Resources, Inc.; officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 42 of the investment companies in Franklin Templeton; Vice Chairman, Investment Company Institute; andformerly, President, Franklin Resources, Inc. (1994-2015).
| ||||||||
**Rupert H. Johnson, Jr. (1940)One Franklin Parkway San Mateo, CA 94403-1906 | Chairman of the Board and Trustee | Since 2013 | 135 | None | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Director, Franklin Advisers, Inc.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 40 of the investment companies in Franklin Templeton.
| ||||||||
Alison E. Baur (1964) One Franklin Parkway San Mateo, CA 94403-1906 | Vice President | Since 2012 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Deputy General Counsel, Franklin Templeton; and officer of some of the other subsidiaries of Franklin Resources, Inc. and of 44 of the investment companies in Franklin Templeton. |
38 | Annual Report | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Interested Board Members and Officers(continued)
Name, Year of Birth and Address
| Position
| Length of Time Served
| Number of Portfolios in by Board Member*
| Other Directorships Held During at Least the Past 5 Years
| ||||
Sonal Desai, Ph.D. (1963) One Franklin Parkway San Mateo, CA 94403-1906 | President and Chief Executive Officer – Investment Management | Since December 2018 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Director and Executive Vice President, Franklin Advisers, Inc.; Executive Vice President, Franklin Templeton Institutional, LLC; and officer of 18 of the investment companies in Franklin Templeton.
| ||||||||
Gaston Gardey (1967) One Franklin Parkway San Mateo, CA 94403-1906 | Treasurer, Chief Financial Officer and Chief Accounting Officer | Since 2009 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Treasurer, U.S. Fund Administration & Reporting and officer of 26 of the investment companies in Franklin Templeton.
| ||||||||
Aliya S. Gordon (1973) One Franklin Parkway San Mateo, CA 94403-1906 | Vice President | Since 2009 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Senior Associate General Counsel, Franklin Templeton; Vice President and Secretary, Franklin Resources, Inc.; and officer of 44 of the investment companies in Franklin Templeton.
| ||||||||
Steven J. Gray (1955) One Franklin Parkway San Mateo, CA 94403-1906 | Vice President and Co- Secretary | Vice President since 2009 andCo-Secretary since January 2019 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Senior Associate General Counsel, Franklin Templeton; Vice President, Franklin Templeton Distributors, Inc. and FASA, LLC; and officer of 44 of the investment companies in Franklin Templeton.
| ||||||||
Matthew T. Hinkle (1971) One Franklin Parkway San Mateo, CA 94403-1906 | Chief Executive Officer – Finance and Administration | Since 2017 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Senior Vice President, Franklin Templeton Services, LLC; officer of 44 of the investment companies in Franklin Templeton; andformerly,Vice President, Global Tax (2012-April 2017) and Treasurer/Assistant Treasurer, Franklin Templeton (2009-2017).
| ||||||||
Robert Lim (1948) One Franklin Parkway San Mateo, CA 94403-1906 | Vice President – AML Compliance | Since 2016 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Vice President, Franklin Templeton Companies, LLC; Chief Compliance Officer, Franklin Templeton Distributors, Inc. and Franklin Templeton Investor Services, LLC; and officer of 44 of the investment companies in Franklin Templeton.
|
franklintempleton.com | Annual Report | 39 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Interested Board Members and Officers(continued)
Name, Year of Birth and Address
| Position
| Length of Time Served
| Number of Portfolios in by Board Member*
| Other Directorships Held During at Least the Past 5 Years
| ||||
Kimberly H. Novotny (1972) 300 S.E. 2nd Street Fort Lauderdale, FL 33301-1923 | Vice President | Since 2013 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Senior Associate General Counsel, Franklin Templeton; Vice President and Corporate Secretary, Fiduciary Trust International of the South; Vice President, Templeton Investment Counsel, LLC; Assistant Secretary, Franklin Resources, Inc.; and officer of 44 of the investment companies in Franklin Templeton.
| ||||||||
Robert C. Rosselot (1960) 300 S.E. 2nd Street | Chief Compliance Officer | Since 2013 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Director, Global Compliance, Franklin Templeton; Vice President, Franklin Templeton Companies, LLC; officer of 44 of the investment companies in Franklin Templeton; andformerly, Senior Associate General Counsel, Franklin Templeton (2007-2013); and Secretary and Vice President, Templeton Group of Funds (2004-2013).
| ||||||||
Navid J. Tofigh (1972) One Franklin Parkway San Mateo, CA 94403-1906 | Vice President | Since 2015 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Associate General Counsel and officer of 44 of the investment companies in Franklin Templeton.
| ||||||||
Craig S. Tyle (1960) One Franklin Parkway San Mateo, CA 94403-1906 | Vice President | Since 2005 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
General Counsel and Executive Vice President, Franklin Resources, Inc.; and officer of some of the other subsidiaries of Franklin Resources, Inc. and of 44 of the investment companies in Franklin Templeton.
| ||||||||
Lori A. Weber (1964) 300 S.E. 2nd Street | Vice President and Co- Secretary | Vice President since 2011 andCo-Secretary since January 2019 | Not Applicable | Not Applicable | ||||
Principal Occupation During at Least the Past 5 Years: | ||||||||
Senior Associate General Counsel, Franklin Templeton; Assistant Secretary, Franklin Resources, Inc.; Vice President and Secretary, Templeton Investment Counsel, LLC; and officer of 44 of the investment companies in Franklin Templeton.
|
40 | Annual Report | franklintempleton.com |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
*We base the number of portfolios on each separate series of the U.S. registered investment companies within the Franklin Templeton fund complex. These portfolios have a common investment manager or affiliated investment managers.
**Gregory E. Johnson is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer and director of Franklin Resources, Inc. (Resources), which is the parent company of the Fund’s investment manager and distributor. Rupert H. Johnson, Jr. is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer and director and major shareholder of Resources.
Note 1: Rupert H. Johnson, Jr. is the uncle of Gregory E. Johnson.
Note 2: Effective March 12, 2019, John B. Wilson ceased to be a trustee of the Trust.
Note 3: Officer information is current as of the date of this report. It is possible that after this date, information about officers may change.
The Sarbanes-Oxley Act of 2002 and Rules adopted by the Securities and Exchange Commission require the Fund to disclose whether the Fund’s Audit Committee includes at least one member who is an audit committee financial expert within the meaning of such Act and Rules. The Fund’s Board has determined that there is at least one such financial expert on the Audit Committee and has designated Mary C. Choksi as its audit committee financial expert. The Board believes that Ms. Choksi qualifies as such an expert in view of her extensive business background and experience. She currently serves as a director of Avis Budget Group, Inc. (2007-present) and formerly, Founder and Senior Advisor, Strategic Investment Group (1987 to 2017). Ms. Choksi has been a Member of the Fund’s Audit Committee since 2014. As a result of such background and experience, the Board believes that Ms. Choksi has acquired an understanding of generally accepted accounting principles and financial statements, the general application of such principles in connection with the accounting estimates, accruals and reserves, and analyzing and evaluating financial statements that present a breadth and level of complexity of accounting issues generally comparable to those of the Fund, as well as an understanding of internal controls and procedures for financial reporting and an understanding of audit committee functions. Ms. Choksi is an independent Board member as that term is defined under the relevant Securities and Exchange Commission Rules and Releases.
The Statement of Additional Information (SAI) includes additional information about the board members and is available, without charge, upon request. Shareholders may call (800) DIALBEN/342-5236 to request the SAI.
franklintempleton.com | Annual Report | 41 |
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
Proxy Voting Policies and Procedures
The Fund’s investment manager has established Proxy Voting Policies and Procedures (Policies) that the Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders may view the Fund’s complete Policies online at franklintempleton.com. Alternatively, shareholders may request copies of the Policies free of charge by calling the Proxy Group collect at (954)527-7678 or by sending a written request to: Franklin Templeton Companies, LLC, 300 S.E. 2nd Street, Fort Lauderdale, FL 33301, Attention: Proxy Group. Copies of the Fund’s proxy voting records are also made available online at franklintempleton.com and posted on the U.S. Securities and Exchange Commission’s website at sec.gov and reflect the most recent12-month period ended June 30.
Quarterly Statement of Investments
The Fund files a complete statement of investments with the U.S. Securities and Exchange Commission for the first and third quarters for each fiscal year as an exhibit to its report on FormN-PORT. Shareholders may view the filed FormN-PORT by visiting the Commission’s website at sec.gov. The filed form may also be viewed and copied at the Commission’s Public Reference Room in Washington, DC. Information regarding the operations of the Public Reference Room may be obtained by calling(800) SEC-0330.
Householding of Reports and Prospectuses
You will receive the Fund’s financial reports every six months as well as an annual updated summary prospectus (prospectus available upon request). To reduce Fund expenses, we try to identify related shareholders in a household and send only one copy of the financial reports and summary prospectus. This process, called “householding,” will continue indefinitely unless you instruct us otherwise. If you prefer not to have these documents householded, please call us at (800)632-2301. At any time you may view current prospectuses/summary prospectuses and financial reports on our website. If you choose, you may receive these documents through electronic delivery.
42 | Annual Report | franklintempleton.com |
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Authorized for distribution only when accompanied or preceded by a summary prospectus and/or prospectus. Investors should carefully consider a fund’s investment goals, risks, charges and expenses before investing. A prospectus contains this and other information; please read it carefully before investing.
To help ensure we provide you with quality service, all calls to and from our service areas are monitored and/or recorded.
Annual Report and Shareholder Letter Franklin Strategic Mortgage Portfolio
| ||||||
Investment Manager | Distributor | Shareholder Services | ||||
Franklin Advisers, Inc. | Franklin Templeton Distributors, Inc. | (800)632-2301 | ||||
(800) DIAL BEN®/342-5236 | ||||||
franklintempleton.com |
© 2019 Franklin Templeton Investments. All rights reserved. | 357 A 11/19 |
Item 2. Code of Ethics.
(a) The Registrant has adopted a code of ethics that applies to its principal executive officers and principal financial and accounting officer.
(c) N/A
(d) N/A
(f) Pursuant to Item 13(a)(1), the Registrant is attaching as an exhibit a copy of its code of ethics that applies to its principal executive officers and principal financial and accounting officer.
Item 3. Audit Committee Financial Expert.
(a)(1) The Registrant has an audit committee financial expert serving on its audit committee.
(2) The audit committee financial expert is Mary C. Choksi and she is “independent” as defined under the relevant Securities and Exchange Commission Rules and Releases.
Item 4. Principal Accountant Fees and Services.
(a) Audit Fees
The aggregate fees paid to the principal accountant for professional services rendered by the principal accountant for the audit of the registrant’s annual financial statements or for services that are normally provided by the principal accountant in connection with statutory and regulatory filings or engagements were $39,536 for the fiscal year ended September 30, 2019 and $39,367 for the fiscal year ended September 30, 2018.
(b) Audit-Related Fees
There were no fees paid to the principal accountant for assurance and related services rendered by the principal accountant to the registrant that are reasonably related to the performance of the audit of the registrant’s financial statements and are not reported under paragraph (a) of Item 4.
There were no fees paid to the principal accountant for assurance and related services rendered by the principal accountant to the registrant’s investment adviser and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant that are reasonably related to the performance of the audit of their financial statements.
(c) Tax Fees
There were no fees paid to the principal accountant for professional services rendered by the principal accountant to the registrant for tax compliance, tax advice and tax planning.
The aggregate fees paid to the principal accountant for professional services rendered by the principal accountant to the registrant’s
investment adviser and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant for tax compliance, tax advice and tax planning were $20,000 for the fiscal year ended September 30, 2019 and $5,000 for the fiscal year ended September 30, 2018. The services for which these fees were paid included professional fees in connection with tax treatment of equipment lease transactions, professional fees in connection with an Indonesia withholding tax refund claim and tax consulting services related to the operating agreement and term sheet for the launch of a new fund.
(d) All Other Fees
The aggregate fees paid to the principal accountant for products and services rendered by the principal accountant to the registrant not reported in paragraphs (a)-(c) of Item 4 were $0 for the fiscal year ended September 30, 2019 and $27 for the fiscal year ended September 30, 2018. The services for which these fees were paid included review of materials provided to the fund Board in connection with the investment management contract renewal process.
The aggregate fees paid to the principal accountant for products and services rendered by the principal accountant to the registrant’s investment adviser and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant not reported in paragraphs (a)-(c) of Item 4 were $114,908 for the fiscal year ended September 30, 2019 and $16,500 for the fiscal year ended September 30, 2018. The services for which these fees were paid included valuation services related to fair value engagement, the issuance of an Auditor’s Certificate for South Korean regulatory shareholders disclosures, benchmarking services in connection with the ICI TA Survey and assets under management certification.
(e) (1) The registrant’s audit committee is directly responsible for approving the services to be provided by the auditors, including:
(i)pre-approval of all audit and audit related services;
(ii)pre-approval of allnon-audit related services to be provided to the Fund by the auditors;
(iii)pre-approval of allnon-audit related services to be provided to the registrant by the auditors to the registrant’s investment adviser or to any entity that controls, is controlled by or is under common control with the registrant’s investment adviser and that provides ongoing services to the registrant where thenon-audit services relate directly to the operations or financial reporting of the registrant; and
(iv) establishment by the audit committee, if deemed necessary or appropriate, as an alternative to committeepre-approval of services to be provided by the auditors, as required by paragraphs (ii) and (iii) above, of policies and procedures to permit such services to bepre-approved by other means, such as through establishment of guidelines or by action of a designated member or members of the committee; provided the policies and procedures are detailed as to the particular service and the committee is informed of each service and
such policies and procedures do not include delegation of audit committee responsibilities, as contemplated under the Securities Exchange Act of 1934, to management; subject, in the case of (ii) through (iv), to any waivers, exceptions or exemptions that may be available under applicable law or rules.
(e) (2) None of the services provided to the registrant described in paragraphs (b)-(d) of Item 4 were approved by the audit committee pursuant to paragraph (c)(7)(i)(C) of Rule2-01 of regulationS-X.
(f) No disclosures are required by this Item 4(f).
(g) The aggregatenon-audit fees paid to the principal accountant for services rendered by the principal accountant to the registrant and the registrant’s investment adviser and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant were $134,908 for the fiscal year ended September 30, 2019 and $21,527 for the fiscal year ended September 30, 2018.
(h) The registrant’s audit committee of the board has considered whether the provision ofnon-audit services that were rendered to the registrant’s investment adviser (not including anysub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant that were notpre-approved pursuant to paragraph (c)(7)(ii) of Rule2-01 of RegulationS-X is compatible with maintaining the principal accountant’s independence.
Item 5. Audit Committee of Listed Registrants. N/A
Item 6. Schedule of Investments. N/A
Item 7. Disclosure of Proxy Voting Policies and Procedures forClosed-End Management Investment Companies. N/A
Item 8. Portfolio Managers ofClosed-End Management Investment Companies. N/A
Item 9. Purchases of Equity Securities byClosed-End Management Investment Company and Affiliated Purchasers. N/A
Item 10. Submission of Matters to a Vote of Security Holders.
There have been no changes to the procedures by which shareholders may recommend nominees to the Registrant’s Board of Trustees that would require disclosure herein.
Item 11. Controls and Procedures.
(a)Evaluation of Disclosure Controls and Procedures. The Registrant maintains disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in the Registrant’s filings under the Securities Exchange Act of 1934, as amended, and the Investment Company Act of 1940 is recorded, processed, summarized and reported within the periods specified in the rules and forms of the Securities and Exchange Commission. Such information is accumulated and communicated to the Registrant’s management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. The Registrant’s management, including the principal executive officer and the principal financial officer, recognizes that any set of controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.
Within 90 days prior to the filing date of this Shareholder Report on FormN-CSR, the Registrant had carried out an evaluation, under the supervision and with the participation of the Registrant’s management, including the Registrant’s principal executive officer and the Registrant’s principal financial officer, of the effectiveness of the design and operation of the Registrant’s disclosure controls and procedures. Based on such evaluation, the Registrant’s principal executive officer and principal financial officer concluded that the Registrant’s disclosure controls and procedures are effective.
(b)Changes in Internal Controls. There have been no changes in the Registrant’s internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect the internal control over financial reporting.
Item 12. Disclosure of Securities Lending Activities forClosed-End Management Investment Company. N/A
Item 13. Exhibits.
(a) (1) Code of Ethics
(a) (2) Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 of Matthew T. Hinkle, Chief Executive Officer - Finance and Administration, and Gaston Gardey, Chief Financial Officer and Chief Accounting Officer
(b) Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of Matthew T. Hinkle, Chief Executive Officer - Finance and Administration, and Gaston Gardey, Chief Financial Officer and Chief Accounting Officer
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FRANKLIN STRATEGIC MORTGAGE PORTFOLIO |
By | /S/ MATTHEW T. HINKLE | |
Matthew T. Hinkle | ||
Chief Executive Officer - Finance and Administration | ||
Date | November 29, 2019 |
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/ MATTHEW T. HINKLE | |
Matthew T. Hinkle | ||
Chief Executive Officer - Finance and Administration | ||
Date | November 29, 2019 | |
By | /S/ GASTON GARDEY | |
Gaston Gardey | ||
Chief Financial Officer and Chief Accounting Officer | ||
Date | November 29, 2019 |