UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES

Investment Company Act file number 811-07288
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FRANKLIN STRATEGIC MORTGAGE PORTFOLIO
-------------------------------------
(Exact name of registrant as specified in charter)

ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906
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(Address of principal executive offices) (Zip code)

CRAIG S. TYLE, ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906
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(Name and address of agent for service)

Registrant's telephone number, including area code: 650
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312-2000

Date of fiscal year end: 9/30
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Date of reporting period: 9/30/07
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ITEM 1. REPORTS TO STOCKHOLDERS.

[GRAPHIC OMITTED]

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SEPTEMBER 30, 2007
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ANNUAL REPORT AND SHAREHOLDER LETTER INCOME
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WANT TO RECEIVE
THIS DOCUMENT
FRANKLIN FASTER VIA EMAIL?
STRATEGIC MORTGAGE PORTFOLIO
Eligible shareholders can
sign up for eDelivery at
franklintempleton.com.
See inside for details.
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[LOGO](R)
FRANKLIN TEMPLETON
INVESTMENTS

FRANKLIN o Templeton o Mutual Series

Franklin Templeton Investments

GAIN FROM OUR PERSPECTIVE(R)

Franklin Templeton's distinct multi-manager
structure combines the specialized expertise of
three world-class investment management groups--
Franklin, Templeton and Mutual Series.

SPECIALIZED EXPERTISE Each of our portfolio management groups operates
autonomously, relying on its own research and
staying true to the unique investment disciplines
that underlie its success.

FRANKLIN. Founded in 1947, Franklin is a
recognized leader in fixed income investing and
also brings expertise in growth- and value-style
U.S. equity investing.

TEMPLETON. Founded in 1940, Templeton pioneered
international investing and, in 1954, launched
what has become the industry's oldest global fund.
Today, with offices in over 25 countries,
Templeton offers investors a truly global
perspective.

MUTUAL SERIES. Founded in 1949, Mutual Series is
dedicated to a unique style of value investing,
searching aggressively for opportunity among what
it believes are undervalued stocks, as well as
arbitrage situations and distressed securities.

TRUE DIVERSIFICATION Because our management groups work independently
and adhere to different investment approaches,
Franklin, Templeton and Mutual Series funds
typically have distinct portfolios. That's why our
funds can be used to build truly diversified
allocation plans covering every major asset class.

RELIABILITY YOU CAN TRUST At Franklin Templeton Investments, we seek to
consistently provide investors with exceptional
risk-adjusted returns over the long term, as well
as the reliable, accurate and personal service
that has helped us become one of the most trusted
names in financial services.

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MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS
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[GRAPHIC OMITTED]

Not part of the annual report

Contents

SHAREHOLDER LETTER ........................................................ 1

ANNUAL REPORT

Franklin Strategic Mortgage Portfolio ..................................... 3

Performance Summary ....................................................... 8

Your Fund's Expenses ...................................................... 10

Financial Highlights and Statement of Investments ......................... 12

Financial Statements ...................................................... 19

Notes to Financial Statements ............................................. 22

Report of Independent Registered Public Accounting Firm ................... 31

Tax Designation ........................................................... 32

Meeting of Shareholders ................................................... 33

Board Members and Officers ................................................ 37

Shareholder Information ................................................... 42

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Annual Report

Franklin Strategic Mortgage Portfolio

YOUR FUND'S GOAL AND MAIN INVESTMENTS: Franklin Strategic Mortgage Portfolio
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 normally focuses its investments in mortgage pass-through
securities, which are securities representing interests in "pools" of mortgage
loans issued or guaranteed by the U.S. government, its agencies or
instrumentalities. Some of the Fund's investments may include securities issued
by government-sponsored entities, such as Fannie Mae and Freddie Mac. 1

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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. PLEASE VISIT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236 FOR
MOST RECENT MONTH-END PERFORMANCE.
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This annual report for Franklin Strategic Mortgage Portfolio covers the fiscal
year ended September 30, 2007.

PERFORMANCE OVERVIEW

For the year under review, Franklin Strategic Mortgage Portfolio - Class A
delivered a +3.70% cumulative total return. The Fund underperformed its
benchmark, the Citigroup Mortgage Index, which returned +5.40% for the same
period. 2 For comparison, the Lipper U.S. Mortgage Funds Classification Average
returned +4.07%, and the Lehman Brothers (LB) U.S. Treasury Index,

1. Securities owned by the Fund but not shares of the Fund are guaranteed by the
U.S. government, its agencies or instrumentalities as to the timely payment of
principal and interest. Although U.S. government-sponsored entities 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. The Fund's yield and share price are not
guaranteed and will fluctuate with market conditions.

2. Source: Standard & Poor's Micropal. The Citigroup Mortgage Index is the
mortgage component of the Citigroup U.S. Broad Investment-Grade Bond Index and
comprises 30- and 15-year GNMA, FNMA and FHLMC securities, and FNMA and FHLMC
balloon mortgages. The index is unmanaged and includes reinvestment of any
income or distributions. One cannot invest directly in an index, nor is an index
representative of the Fund's portfolio.

THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL
PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE
SOI BEGINS ON PAGE 13.

Annual Report | 3

PORTFOLIO BREAKDOWN
9/30/07

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% OF TOTAL
INVESTMENTS
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Federal National Mortgage Association (FNMA) 38.3%
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Asset-Backed Securities and Commercial Mortgage-Backed Securities 30.0%
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Federal Home Loan Mortgage Corp. (FHLMC) 25.2%
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Government National Mortgage Association (GNMA) 1.8%
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Short-Term Investments 4.7%
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a component of the LB U.S. Government Index, returned +5.62%. 3 You can find the
Fund's long-term performance data in the Performance Summary beginning on
page 8.

ECONOMIC AND MARKET OVERVIEW

The U.S. economy grew at a moderate but uneven pace for the 12-month period
ended September 30, 2007. After ending 2006 with fourth quarter gross domestic
product (GDP) growth of 2.1% annualized, the economy decelerated to a
surprisingly weak first quarter 2007 annualized growth rate of 0.6%. A surge in
exports fueled second quarter 2007 growth to 3.8% annualized. In the third
quarter, GDP growth advanced at an estimated 3.9% annualized rate, the fastest
pace in over a year. Over the reporting period, consumer spending and personal
income remained positive contributors to economic expansion, while a declining
housing market, softening employment environment and tighter credit conditions
weighed on overall economic growth.

Oil prices exhibited volatility, reaching a historical high in September. Core
inflation, which excludes food and energy costs, remained modest. For September
2007, core CPI had a 12-month increase of 2.1%. 4 The Federal Reserve Board's
(Fed's) preferred measure of inflation, core personal consumption expenditures,
reported a 12-month increase of 1.8%. 5 These current levels of inflation,
generally within the Fed's target range of 1% to 2%, lessened near-term concerns
and provided the Fed with more flexibility to respond to ongoing economic
pressures resulting from tightening credit conditions.

In August, the Fed cut the discount rate (the Fed's interest rate charged to
member banks) from 6.25% to 5.75% and followed up in September with a further
cut of 50 basis points, bringing the rate to 5.25%. After remaining on hold
since June 2006, the Fed lowered the federal funds target rate 50 basis

3. Sources: Lipper Inc.; Lehman Brothers Inc. The Lipper U.S. Mortgage Funds
Classification Average is calculated by averaging the total return for all funds
within the Lipper U.S. Mortgage Funds classification in the Lipper Open-End
underlying funds universe for the period indicated. Lipper U.S. Mortgage Funds
are defined as funds that invest primarily in mortgages/securities issued or
guaranteed as to principal and interest by the U.S. government and certain
federal agencies. For the one-year period ended 9/30/07, the Lipper U.S.
Mortgage Funds Classification Average consisted of 75 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 LB U.S. Treasury Index includes public
obligations of the U.S. Treasury with a remaining maturity of one year or more.
All issues must have at least one year to final maturity regardless of call
features, have at least $250 million par amount outstanding and be rated
investment grade (Baa3 or better). They must also be dollar denominated,
nonconvertible and publicly issued. Treasuries, if held to maturity, offer a
fixed rate of return and fixed principal value; their interest payments and
principal are guaranteed. The Fund's investment return and share price fluctuate
with market conditions. The indexes are unmanaged and include reinvestment of
any income or distributions. One cannot invest directly in an index, nor is an
index representative of the Fund's portfolio.

4. Source: Bureau of Labor Statistics.

5. Source: Bureau of Economic Analysis.

4 | Annual Report

points to 4.75% at its September meeting, citing increased uncertainty
surrounding the economic outlook due to significant dislocations in parts of the
credit markets. The committee noted that "some inflation risks remain, and it
will continue to monitor inflation developments carefully." The Fed stated it
will continue to act as necessary to restore stability as the potential of
increased distress from a housing correction threatens to "restrain economic
growth more generally."

Over the period, investors sought relative safety in short-term U.S. Treasuries,
Treasury yields declined and the yield curve steepened. Short-term, two- and
five-year yields declined substantially, with the two-year bill yielding 3.97%
at the end of September, down from 4.71% a year earlier. The 10-year U.S.
Treasury note ended September yielding 4.59%, compared with 4.64% at the
beginning of the period.

INVESTMENT STRATEGY

We invest at least 80% of the Fund's net assets in mortgage securities. Normally
we focus on mortgage pass-through securities issued or guaranteed by the
Government National Mortgage Association (Ginnie Mae), Fannie Mae and Freddie
Mac. At least 65% of total assets are invested in securities rated AAA by
Standard & Poor's Rating Group (S&P) or Fitch, or Aaa by Moody's Investors
Service (Moody's), independent credit rating agencies. For the remaining 35% of
portfolio securities, at least 20% will be rated at least BBB by S&P or Fitch,
or Baa by Moody's, and up to 15% may be invested in securities rated below BBB
by S&P or Fitch, or Baa by Moody's. If unrated, securities will be deemed of
comparable quality by the Fund's manager. We analyze securities using research
to help identify attractive investment opportunities.

MANAGER'S DISCUSSION

Continuing a trend from recent years, investors' risk appetite remained robust
at the beginning of the reporting period, due to strong global liquidity and a
continued solid economic environment. During this time, low volatility
characterized the fixed income markets. However, by June, several months of
increased delinquency and default activity in the lower-credit quality, subprime
mortgage market created a challenging environment across the fixed income
markets.

Rising defaults in the narrow subprime sector of the mortgage market began to
impact several mortgage credit-focused hedge funds. Within a few months,
structured finance markets became impaired and end buyers of structured products
began to back away from the market. This risk aversion led to increased risk
premiums across many fixed income investments such as bonds, loans and

DIVIDEND DISTRIBUTIONS*
10/1/06-9/30/07

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MONTH DIVIDEND PER SHARE
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October 4.2774 cents
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November 4.0719 cents
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December 3.7846 cents
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January 4.2729 cents
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February 3.9626 cents
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March 4.0147 cents
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April 5.4837 cents
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May 4.7763 cents
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June 4.1042 cents
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July 4.4788 cents
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August 4.2160 cents
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September 4.2794 cents
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TOTAL 51.7225 CENTS
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*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.

Annual Report | 5

mortgages that are packaged into structured finance products. Interbank lending
rates, such as the London InterBank Offered Rate (LIBOR), rose as banks began to
charge each other higher rates due to increasing concerns about each other's
balance sheet risk. In contrast to the past several years, investors exhibited a
sudden, rapid shift in risk appetite.

High credit-quality agency-issued mortgage-backed securities (MBS) provided some
insulation to investors during this market volatility. Ginnie Mae (GNMA), Fannie
Mae (FNMA) and Freddie Mac (FHLMC) agency mortgages posted positive total
returns during July, August and September. Thirty-year GNMA MBS generally
outperformed their conventional FNMA and FHLMC MBS counterparts as investors
slightly preferred the safety of U.S. government guaranteed securities. 1

For the majority of the period, we generally increased our allocation to higher
coupon conventional agency MBS, as we believed prepayment risk affecting those
coupons would continue to wane. Prepayment risk was lower due to the generally
slower U.S. housing market, elevated mortgage rates and tighter underwriting
standards instituted by mortgage originators.

Broader mortgage-related asset-backed securities (ABS) and commercial MBS (CMBS)
exhibited higher levels of volatility and detracted from the Fund's performance
during the reporting period.

Franklin Strategic Mortgage Portfolio has a broad mortgage strategy with
investment exposure to these markets. However, the majority of our overall
exposure is invested in the highest-rated securities -- those at the top of the
capital structure. Typical investments in mortgage-related ABS are primarily
short-term, AAA-rated, floating rate securities that have been protected from
the type of default problems that have been the market's chief concern. We
remained allocated to CMBS, as credit fundamentals for the sector's major
property types were generally positive. The Fund's CMBS allocations are AAA- and
AA-rated securities that are high in the capital structure and benefit from high
levels of credit protection.

6 | Annual Report

Thank you for your continued participation in Franklin Strategic Mortgage
Portfolio. We look forward to serving your future investment needs.

[PHOTO OMITTED] /s/ Roger A. Bayston, CFA

Roger A. Bayston, CFA

[PHOTO OMITTED] /s/ Paul Varunok

Paul Varunok

Portfolio Management Team
Franklin Strategic Mortgage Portfolio

THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS
AS OF SEPTEMBER 30, 2007, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT
OUR MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE
DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY
NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY.
THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET,
COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES
CONSIDERED RELIABLE, BUT THE INVESTMENT MANAGER MAKES NO REPRESENTATION OR
WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE
IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR
INVESTMENT MANAGEMENT PHILOSOPHY.

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PAUL VARUNOK is a vice president and portfolio manager in the Franklin Templeton
Fixed Income Group. Mr. Varunok specializes in the mortgage-backed securities
(MBS), asset-backed securities (ABS), commercial mortgage-backed securities
(CMBS) and collateralized mortgage obligation (CMO) markets.

Prior to joining Franklin Templeton Investments in 2001, Mr. Varunok spent eight
years as a fixed-income analyst for Prudential Securities, Inc. in New York
City. At Prudential, Mr. Varunok held research positions in both the MBS and ABS
markets. Mr. Varunok started his career at Prudential as a reverse-engineer of
both ABS and MBS transactions and subsequently moved into the structuring of
those products. From 1996-2000, Mr. Varunok concentrated his efforts in the ABS
market where he was an ABS researcher and market strategist.

Mr. Varunok earned his B.S. in finance from New York University
- --------------------------------------------------------------------------------

Annual Report | 7

Performance Summary as of 9/30/07

Your dividend income will vary depending on dividends or interest paid by
securities in the Fund's portfolio, adjusted for operating expenses. Capital
gain distributions are net profits realized from the sale of portfolio
securities. The performance table and graph do not reflect any taxes that a
shareholder would pay on Fund dividends, capital gain distributions, if any, or
any realized gains on the sale of Fund shares. Total return reflects
reinvestment of the Fund's dividends and capital gain distributions, if any, and
any unrealized gains or losses.

PRICE AND DISTRIBUTION INFORMATION

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CLASS A (SYMBOL: FSMIX) CHANGE 9/30/07 9/30/06
- ---------------------------------------------------------------------------------------------------

Net Asset Value (NAV) -$0.17 $9.42 $9.59
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DISTRIBUTIONS (10/1/06-9/30/07)
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Dividend Income $0.517225
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PERFORMANCE 1

CUMULATIVE TOTAL RETURN EXCLUDES THE SALES CHARGE. AVERAGE ANNUAL TOTAL RETURN
INCLUDES THE MAXIMUM SALES CHARGE. CLASS A: 4.25% MAXIMUM INITIAL SALES CHARGE.
THE FUND MAY CHARGE A 2% FEE ON REDEMPTIONS MADE WITHIN SEVEN DAYS OF PURCHASE.

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CLASS A 1-YEAR 5-YEAR 10-YEAR
- --------------------------------------------------------------------------------------------------

Cumulative Total Return 2 +3.70% +19.30% +73.28%
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Average Annual Total Return 3 -0.75% +2.70% +5.20%
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Distribution Rate 4 5.65%
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30-Day Standardized Yield 5 5.90%
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Total Annual Operating Expenses 6 0.57%
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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 RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND
PERFORMANCE" AT FRANKLINTEMPLETON.COM OR CALL 1-800/342-5236.

8 | Annual Report

Performance Summary (CONTINUED)

TOTAL RETURN INDEX COMPARISON FOR HYPOTHETICAL $10,000 INVESTMENT 1

Total return represents the change in value of an investment over the periods
shown. It includes the applicable maximum sales charge, Fund expenses, account
fees and reinvested distributions. The unmanaged index includes reinvestment of
any income or distributions. It differs from the Fund in composition and does
not pay management fees or expenses. One cannot invest directly in an index.

CLASS A (10/1/97-9/30/07)

[THE FOLLOWING TABLE WAS REPRESENTED BY A LINE GRAPH IN THE PRINTED MATERIAL.]

Franklin Strategic Citigroup Mortgage
Date Mortgage Portfolio Index 7
10/1/1997 $ 9,577 $10,000
10/31/1997 $ 9,670 $10,108
11/30/1997 $ 9,694 $10,142
12/31/1997 $ 9,784 $10,235
1/31/1998 $ 9,876 $10,330
2/28/1998 $ 9,899 $10,361
3/31/1998 $ 9,934 $10,402
4/30/1998 $ 9,985 $10,460
5/31/1998 $10,056 $10,533
6/30/1998 $10,114 $10,580
7/31/1998 $10,159 $10,632
8/31/1998 $10,265 $10,729
9/30/1998 $10,411 $10,857
10/31/1998 $10,413 $10,845
11/30/1998 $10,477 $10,895
12/31/1998 $10,523 $10,950
1/31/1999 $10,585 $11,025
2/28/1999 $10,533 $10,984
3/31/1999 $10,593 $11,060
4/30/1999 $10,639 $11,115
5/31/1999 $10,569 $11,040
6/30/1999 $10,541 $11,015
7/31/1999 $10,479 $10,939
8/31/1999 $10,472 $10,933
9/30/1999 $10,651 $11,119
10/31/1999 $10,697 $11,178
11/30/1999 $10,707 $11,187
12/31/1999 $10,679 $11,151
1/31/2000 $10,596 $11,065
2/29/2000 $10,715 $11,195
3/31/2000 $10,824 $11,315
4/30/2000 $10,839 $11,321
5/31/2000 $10,850 $11,330
6/30/2000 $11,075 $11,575
7/31/2000 $11,151 $11,648
8/31/2000 $11,323 $11,820
9/30/2000 $11,460 $11,947
10/31/2000 $11,546 $12,035
11/30/2000 $11,721 $12,213
12/31/2000 $11,954 $12,409
1/31/2001 $12,124 $12,602
2/28/2001 $12,195 $12,672
3/31/2001 $12,277 $12,754
4/30/2001 $12,289 $12,767
5/31/2001 $12,360 $12,846
6/30/2001 $12,412 $12,864
7/31/2001 $12,620 $13,104
8/31/2001 $12,728 $13,223
9/30/2001 $12,904 $13,418
10/31/2001 $13,071 $13,600
11/30/2001 $12,991 $13,476
12/31/2001 $12,954 $13,427
1/31/2002 $13,073 $13,559
2/28/2002 $13,202 $13,706
3/31/2002 $13,065 $13,568
4/30/2002 $13,322 $13,821
5/31/2002 $13,416 $13,922
6/30/2002 $13,532 $14,035
7/31/2002 $13,693 $14,193
8/31/2002 $13,793 $14,318
9/30/2002 $13,910 $14,422
10/31/2002 $13,956 $14,477
11/30/2002 $13,953 $14,463
12/31/2002 $14,101 $14,616
1/31/2003 $14,134 $14,657
2/28/2003 $14,220 $14,758
3/31/2003 $14,236 $14,753
4/30/2003 $14,296 $14,809
5/31/2003 $14,330 $14,816
6/30/2003 $14,342 $14,848
7/31/2003 $14,068 $14,580
8/31/2003 $14,158 $14,675
9/30/2003 $14,383 $14,926
10/31/2003 $14,317 $14,875
11/30/2003 $14,364 $14,919
12/31/2003 $14,507 $15,064
1/31/2004 $14,601 $15,160
2/29/2004 $14,738 $15,292
3/31/2004 $14,779 $15,359
4/30/2004 $14,565 $15,089
5/31/2004 $14,536 $15,040
6/30/2004 $14,642 $15,171
7/31/2004 $14,752 $15,313
8/31/2004 $14,998 $15,565
9/30/2004 $15,017 $15,587
10/31/2004 $15,124 $15,720
11/30/2004 $15,086 $15,674
12/31/2004 $15,164 $15,789
1/31/2005 $15,241 $15,869
2/28/2005 $15,196 $15,800
3/31/2005 $15,151 $15,758
4/30/2005 $15,305 $15,944
5/31/2005 $15,435 $16,073
6/30/2005 $15,470 $16,128
7/31/2005 $15,390 $16,052
8/31/2005 $15,538 $16,195
9/30/2005 $15,428 $16,106
10/31/2005 $15,333 $16,003
11/30/2005 $15,382 $16,052
12/31/2005 $15,508 $16,219
1/31/2006 $15,544 $16,259
2/28/2006 $15,609 $16,344
3/31/2006 $15,482 $16,196
4/30/2006 $15,463 $16,199
5/31/2006 $15,436 $16,156
6/30/2006 $15,455 $16,200
7/31/2006 $15,670 $16,441
8/31/2006 $15,871 $16,680
9/30/2006 $16,003 $16,790
10/31/2006 $16,108 $16,916
11/30/2006 $16,277 $17,106
12/31/2006 $16,223 $17,057
1/31/2007 $16,227 $17,071
2/28/2007 $16,413 $17,280
3/31/2007 $16,465 $17,324
4/30/2007 $16,541 $17,406
5/31/2007 $16,434 $17,294
6/30/2007 $16,332 $17,204
7/31/2007 $16,358 $17,318
8/31/2007 $16,397 $17,556
9/30/2007 $16,595 $17,698

AVERAGE ANNUAL TOTAL RETURN

- ------------------------------------
CLASS A 9/30/07
- ------------------------------------
1-Year -0.75%
- ------------------------------------
5-Year +2.70%
- ------------------------------------
10-Year +5.20%
- ------------------------------------

ENDNOTES

THE FUND'S SHARE PRICE AND YIELD WILL BE AFFECTED BY INTEREST RATE MOVEMENTS AND
MORTGAGE PREPAYMENTS. 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'S PROSPECTUS ALSO
INCLUDES A DESCRIPTION OF THE MAIN INVESTMENT RISKS.

1. Past expense reductions by the Fund's manager increased the Fund's total
returns. If the manager had not taken this action, the Fund's total returns
would have been lower.

2. Cumulative total return represents the change in value of an investment over
the periods indicated.

3. Average annual total return represents the average annual change in value of
an investment over the periods indicated.

4. Distribution rate is based on the sum of distributions per share for the 30
days of September and the maximum offering price of $9.84 on 9/30/07.

5. Yield, calculated as required by the SEC, is based on the earnings of the
Fund's portfolio for the 30 days ended 9/30/07.

6. Figures are as stated in the Fund's prospectus current as of the date of this
report.

7. Source: Standard & Poor's Micropal. The Citigroup Mortgage Index is the
mortgage component of the Citigroup U.S. Broad Investment-Grade Bond Index and
comprises 30- and 15-year GNMA, FNMA and FHLMC securities, and FNMA and FHLMC
balloon mortgages.

Annual Report | 9

Your Fund's Expenses

As a Fund shareholder, you can incur two types of costs:

o Transaction costs, including sales charges (loads) on Fund purchases and
redemption fees; and

o Ongoing Fund costs, including management fees, distribution and service
(12b-1) fees, and other Fund expenses. All mutual funds have ongoing
costs, sometimes referred to as operating expenses.

The following table shows ongoing costs of investing in the Fund and can help
you understand these costs and compare them with those of other mutual funds.
The table assumes a $1,000 investment held for the six months indicated.

ACTUAL FUND EXPENSES

The first line (Actual) for each share class listed in the table provides actual
account values and expenses. The "Ending Account Value" is derived from the
Fund's actual return, which includes the effect of Fund expenses.

You can estimate the expenses you paid during the period by following these
steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS
ILLUSTRATION:

1. Divide your account value by $1,000.

IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6.

2. Multiply the result by the number under the heading "Expenses Paid During
Period."

IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 X $7.50 = $64.50.

In this illustration, the estimated expenses paid this period are $64.50.

HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS

Information in the second line (Hypothetical) for each class in the table can
help you compare ongoing costs of investing in the Fund with those of other
mutual funds. This information may not be used to estimate the actual ending
account balance or expenses you paid during the period. The hypothetical "Ending
Account Value" is based on the actual expense ratio for each class and an
assumed 5% annual rate of return before expenses, which does not represent the
Fund's actual return. The figure under the heading "Expenses Paid During Period"
shows the hypothetical expenses your account would have incurred under this
scenario. You can compare this figure with the 5% hypothetical examples that
appear in shareholder reports of other funds.

10 | Annual Report

Your Fund's Expenses (CONTINUED)

PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING
COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES OR
REDEMPTION FEES. Therefore, the second line for each class is useful in
comparing ongoing costs only, and will not help you compare total costs of
owning different funds. In addition, if transaction costs were included, your
total costs would have been higher. Please refer to the Fund prospectus for
additional information on operating expenses.

- ----------------------------------------------------------------------------------------------------------------
BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING
CLASS A VALUE 4/1/07 VALUE 9/30/07 PERIOD* 4/1/07-9/30/07
- ----------------------------------------------------------------------------------------------------------------

Actual $1,000 $1,007.90 $ 2.77
- ----------------------------------------------------------------------------------------------------------------
Hypothetical (5% return before expenses) $1,000 $1,022.31 $ 2.79
- ----------------------------------------------------------------------------------------------------------------

* Expenses are calculated using the most recent annualized six-month expense
ratio of 0.55%, multiplied by the average account value over the period,
multiplied by 183/365 to reflect the one-half year period.

Annual Report | 11

Franklin Strategic Mortgage Portfolio

FINANCIAL HIGHLIGHTS

---------------------------------------------------------------
YEAR ENDED SEPTEMBER 30,
2007 2006 2005 2004 2003
---------------------------------------------------------------

PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net asset value, beginning of year ........................... $ 9.59 $ 9.73 $ 9.96 $ 10.06 $ 10.36
---------------------------------------------------------------
Income from investment operations a:
Net investment income b ................................... 0.476 0.418 0.391 0.328 0.285
Net realized and unrealized gains (losses) ................ (0.129) (0.069) (0.123) 0.112 0.048
---------------------------------------------------------------
Total from investment operations ............................. 0.347 0.349 0.268 0.440 0.333
---------------------------------------------------------------
Less distributions from:
Net investment income ..................................... (0.517) (0.489) (0.498) (0.540) (0.542)
Net realized gains ........................................ -- -- -- -- (0.091)
---------------------------------------------------------------
Total distributions .......................................... (0.517) (0.489) (0.498) (0.540) (0.633)
---------------------------------------------------------------
Redemption fees .............................................. -- e -- e -- e -- e --
---------------------------------------------------------------
Net asset value, end of year ................................. $ 9.42 $ 9.59 $ 9.73 $ 9.96 $ 10.06
===============================================================

Total return c ............................................... 3.70% 3.73% 2.74% 4.41% 3.40%

RATIOS TO AVERAGE NET ASSETS
Expenses ..................................................... 0.57% f 0.55% f 0.55% f 0.54% f 0.52%
Net investment income ........................................ 5.05% 4.48% 3.97% 3.29% 2.79%

SUPPLEMENTAL DATA
Net assets, end of year (000's) .............................. $243,664 $287,865 $367,759 $376,848 $421,827
Portfolio turnover rate ...................................... 326.67% 247.03% 160.36% 245.18% 288.41%
Portfolio turnover rate excluding mortgage dollar rolls d .... 30.85% 38.75% 36.26% 50.14% 125.17%

a The amount shown for a share outstanding throughout the period may not
correlate with the Statement of Operations for the period due to the timing of
sales and repurchase of the Fund shares in relation to income earned and/or
fluctuating market value of the investments of the Fund.

b Based on average daily shares outstanding for years ended September 30, 2003
through September 30, 2004.

c Total return does not reflect sales commissions or contingent deferred sales
charges, if applicable.

d See Note 1(g) regarding mortgage dollar rolls.

e Amount rounds to less than $0.001 per share.

f Benefit of expense reduction rounds to less than 0.01%.

12 | The accompanying notes are an integral part of these financial statements.
| Annual Report

Franklin Strategic Mortgage Portfolio

STATEMENT OF INVESTMENTS, SEPTEMBER 30, 2007

- ------------------------------------------------------------------------------------------------------------------------------------
PRINCIPAL
AMOUNT a VALUE
- ------------------------------------------------------------------------------------------------------------------------------------

LONG TERM INVESTMENTS 126.7%
MORTGAGE-BACKED SECURITIES 86.9%
b FEDERAL HOME LOAN MORTGAGE CORP. (FHLMC) ADJUSTABLE RATE 4.2%
FHLMC, 5.542%, 10/01/18 ....................................................................... 198,751 $ 199,843
FHLMC, 5.975%, 10/01/36 ....................................................................... 3,020,692 3,079,622
FHLMC, 6.184%, 7/01/30 ........................................................................ 572,903 581,533
FHLMC, 6.342%, 1/01/28 ........................................................................ 362,999 367,683
FHLMC, 6.836%, 4/01/24 ........................................................................ 296,205 298,590
FHLMC, 6.868%, 11/01/16 ....................................................................... 459,321 463,792
FHLMC, 6.875%, 4/01/17 ........................................................................ 65,872 66,612
FHLMC, 6.945%, 5/01/20 ........................................................................ 244,129 248,002
FHLMC, 7.007%, 4/01/30 ........................................................................ 1,714,082 1,771,588
FHLMC, 7.03%, 11/01/25 ........................................................................ 99,673 100,705
FHLMC, 7.112%, 3/01/19 ........................................................................ 230,425 234,177
FHLMC, 7.133%, 7/01/22 ........................................................................ 1,434,269 1,463,395
FHLMC, 7.154%, 11/01/19 ....................................................................... 199,643 208,456
FHLMC, 7.211%, 8/01/31 ........................................................................ 87,362 87,899
FHLMC, 7.212%, 1/01/32 ........................................................................ 144,321 145,379
FHLMC, 7.218%, 5/01/22 ........................................................................ 87,749 88,977
FHLMC, 7.374%, 1/01/31 ........................................................................ 260,478 263,730
FHLMC, 7.375%, 4/01/18 ........................................................................ 103,719 105,128
FHLMC, 7.475%, 7/01/24 ........................................................................ 183,982 185,792
FHLMC, 7.496%, 12/01/30 ....................................................................... 159,773 164,015
FHLMC, 7.658%, 4/01/31 ........................................................................ 69,743 71,177
--------------
10,196,095
--------------
FEDERAL HOME LOAN MORTGAGE CORP. (FHLMC) FIXED RATE 29.4%
FHLMC 15 Year, 6.50%, 2/01/19 ................................................................. 427,336 439,747
FHLMC 15 Year, 8.00%, 4/01/08 ................................................................. 84 85
c FHLMC 30 Year, 5.00%, 10/15/35 ................................................................ 9,688,000 9,241,441
c FHLMC 30 Year, 5.50%, 10/15/35 ................................................................ 26,860,000 26,301,822
c FHLMC 30 Year, 6.00%, 10/01/30 ................................................................ 4,400,000 4,404,814
c FHLMC 30 Year, 6.50%, 10/01/32 ................................................................ 4,250,000 4,326,368
FHLMC Gold 15 Year, 5.00%, 10/01/17 - 8/01/18 ................................................. 3,651,130 3,590,879
FHLMC Gold 15 Year, 6.50%, 3/01/09 - 4/01/11 .................................................. 2,536 2,575
FHLMC Gold 15 Year, 7.00%, 6/01/09 - 7/01/11 .................................................. 3,754 3,849
FHLMC Gold 15 Year, 7.50%, 4/01/10 ............................................................ 1,702 1,744
FHLMC Gold 15 Year, 8.00%, 1/01/10 - 12/01/12 ................................................. 21,657 22,238
FHLMC Gold 30 Year, 5.00%, 10/01/33 - 7/01/35 ................................................. 5,304,330 5,070,336
FHLMC Gold 30 Year, 5.00%, 7/01/35 ............................................................ 4,008,966 3,831,063
FHLMC Gold 30 Year, 5.00%, 7/01/35 ............................................................ 3,733,905 3,568,207
FHLMC Gold 30 Year, 5.50%, 9/01/33 ............................................................ 517,784 508,543
FHLMC Gold 30 Year, 6.00%, 7/01/28 - 6/01/34 .................................................. 669,575 672,879
FHLMC Gold 30 Year, 6.00%, 8/01/34 ............................................................ 3,797,907 3,811,230
FHLMC Gold 30 Year, 6.50%, 11/01/27 - 7/01/32 ................................................. 1,230,327 1,262,505
FHLMC Gold 30 Year, 7.50%, 10/01/25 - 8/01/32 ................................................. 895,977 934,975
FHLMC Gold 30 Year, 8.00%, 7/01/24 - 5/01/30 .................................................. 189,122 199,894
FHLMC Gold 30 Year, 8.50%, 10/01/17 - 9/01/30 ................................................. 430,334 453,671
FHLMC Gold 30 Year, 9.00%, 9/01/30 ............................................................ 270,352 293,210
FHLMC Gold 30 Year, 9.25%, 12/01/08 ........................................................... 7,618 7,742

Annual Report | 13

Franklin Strategic Mortgage Portfolio

STATEMENT OF INVESTMENTS, SEPTEMBER 30, 2007 (CONTINUED)

LONG TERM INVESTMENTS (CONTINUED)
MORTGAGE-BACKED SECURITIES (CONTINUED)
FEDERAL HOME LOAN MORTGAGE CORP. (FHLMC) FIXED RATE (CONTINUED)
FHLMC Gold 30 Year, 9.50%, 12/01/16 - 4/01/25 ................................................. 1,193,821 $ 1,300,967
FHLMC PC 15 Year, 8.50%, 5/01/17 .............................................................. 1,037,289 1,101,993
FHLMC PC 15 Year, 9.25%, 8/01/14 .............................................................. 6,711 7,175
FHLMC PC 15 Year, 9.50%, 12/01/09 - 8/01/19 ................................................... 169,830 179,603
FHLMC PC 30 Year, 8.50%, 2/01/17 .............................................................. 14,154 15,110
FHLMC PC 30 Year, 9.00%, 7/01/08 - 6/01/16 .................................................... 2,436 2,588
--------------
71,557,253
--------------
b FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA) ADJUSTABLE RATE 5.3%
FNMA, 5.408%, 10/01/19 ........................................................................ 375,765 379,819
FNMA, 5.533%, 1/01/18 ......................................................................... 2,320,215 2,329,142
FNMA, 5.917%, 5/01/21 ......................................................................... 349,739 356,791
FNMA, 5.995%, 5/01/30 ......................................................................... 196,188 202,769
FNMA, 6.245%, 1/01/17 ......................................................................... 765,770 766,815
FNMA, 6.338%, 12/01/24 ........................................................................ 122,415 125,154
FNMA, 6.353%, 7/01/31 ......................................................................... 1,072,375 1,101,369
FNMA, 6.443%, 4/01/18 ......................................................................... 202,821 207,243
FNMA, 6.479%, 7/01/17 ......................................................................... 189,666 189,644
FNMA, 6.678%, 4/01/31 ......................................................................... 100,516 102,261
FNMA, 6.723%, 6/01/17 ......................................................................... 141,790 142,517
FNMA, 6.812%, 4/01/21 ......................................................................... 37,642 37,590
FNMA, 6.823%, 12/01/31 ........................................................................ 75,618 76,983
FNMA, 6.947%, 4/01/18 ......................................................................... 39,034 40,080
FNMA, 7.00%, 11/01/28 ......................................................................... 137,889 139,998
FNMA, 7.011%, 7/01/14 ......................................................................... 430,572 431,670
FNMA, 7.02%, 7/01/27 .......................................................................... 145,233 145,778
FNMA, 7.047%, 4/01/33 ......................................................................... 1,006,168 1,025,930
FNMA, 7.075%, 12/01/22 ........................................................................ 242,249 243,634
FNMA, 7.094%, 11/01/31 ........................................................................ 535,531 543,011
FNMA, 7.104%, 7/01/31 ......................................................................... 21,198 21,418
FNMA, 7.144%, 7/01/19 - 2/01/32 ............................................................... 1,709,340 1,718,947
FNMA, 7.175%, 8/01/32 ......................................................................... 39,545 39,841
FNMA, 7.192%, 8/01/29 ......................................................................... 74,783 75,874
FNMA, 7.213%, 4/01/27 ......................................................................... 266,541 268,048
FNMA, 7.215%, 5/01/31 ......................................................................... 29,476 29,912
FNMA, 7.243%, 7/01/25 ......................................................................... 109,856 110,033
FNMA, 7.25%, 9/01/18 .......................................................................... 54,337 54,420
FNMA, 7.259%, 8/01/27 ......................................................................... 166,758 168,178
FNMA, 7.275%, 6/01/31 ......................................................................... 393,309 393,175
FNMA, 7.32%, 5/01/27 .......................................................................... 191,745 192,389
FNMA, 7.326%, 9/01/32 ......................................................................... 446,801 454,530
FNMA, 7.369%, 10/01/32 ........................................................................ 271,158 270,798
FNMA, 7.377%, 8/01/26 ......................................................................... 151,076 152,284
FNMA, 7.461%, 10/01/24 ........................................................................ 385,952 390,458
FNMA, 7.52%, 7/01/26 .......................................................................... 45,167 45,252
FNMA, 7.638%, 10/01/29 ........................................................................ 27,343 27,588
--------------
13,001,343
--------------

14 | Annual Report

Franklin Strategic Mortgage Portfolio

STATEMENT OF INVESTMENTS, SEPTEMBER 30, 2007 (CONTINUED)

LONG TERM INVESTMENTS (CONTINUED)
MORTGAGE-BACKED SECURITIES (CONTINUED)
FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA) FIXED RATE 45.7%
FNMA 7 Year, 9.00%, 11/01/11 .................................................................. 135,200 $ 141,485
FNMA 15 Year, 5.00%, 6/01/18 - 4/01/20 ........................................................ 5,173,343 5,077,950
FNMA 15 Year, 5.00%, 7/01/18 .................................................................. 4,013,478 3,949,432
FNMA 15 Year, 5.50%, 5/01/14 - 2/01/18 ........................................................ 3,960,447 3,965,568
FNMA 15 Year, 6.50%, 9/01/08 - 10/01/16 ....................................................... 346,722 355,912
FNMA 15 Year, 7.00%, 11/01/11 ................................................................. 945 974
FNMA 15 Year, 7.50%, 7/01/09 - 7/01/12 ........................................................ 27,198 28,069
FNMA 15 Year, 10.00%, 8/01/15 ................................................................. 36,641 40,614
FNMA 30 Year, 5.00%, 4/01/34 .................................................................. 1,305,083 1,248,395
c FNMA 30 Year, 5.00%, 10/25/35 ................................................................. 7,000,000 6,677,342
FNMA 30 Year, 5.00%, 6/01/37 .................................................................. 6,092,368 5,812,298
FNMA 30 Year, 5.50%, 9/01/33 - 11/01/35 ....................................................... 9,846,170 9,671,076
c FNMA 30 Year, 5.50%, 10/01/34 ................................................................. 8,100,000 7,934,201
FNMA 30 Year, 5.50%, 11/15/34 ................................................................. 16,288,053 15,989,169
FNMA 30 Year, 6.00%, 12/01/23 - 12/01/35 ...................................................... 11,836,513 11,887,499
c FNMA 30 Year, 6.00%, 10/01/28 ................................................................. 22,100,000 22,131,073
FNMA 30 Year, 6.00%, 10/01/34 ................................................................. 5,522,100 5,543,184
FNMA 30 Year, 6.50%, 12/01/27 - 8/01/32 ....................................................... 7,636,889 7,828,272
FNMA 30 Year, 7.50%, 8/01/25 - 5/01/32 ........................................................ 489,374 512,491
FNMA 30 Year, 8.00%, 1/01/25 - 7/01/31 ........................................................ 71,966 75,901
FNMA 30 Year, 8.50%, 11/01/26 - 11/01/28 ...................................................... 1,187,402 1,275,925
FNMA 30 Year, 9.00%, 8/01/09 - 9/01/26 ........................................................ 272,304 286,218
FNMA 30 Year, 9.25%, 10/01/09 ................................................................. 2,838 2,876
FNMA 30 Year, 9.50%, 11/01/15 - 4/01/30 ....................................................... 371,960 401,841
FNMA 30 Year, 10.00%, 7/01/16 - 4/01/21 ....................................................... 314,212 352,475
FNMA 30 Year, 10.50%, 1/01/16 - 5/01/30 ....................................................... 29,210 32,102
FNMA 30 Year, 11.00%, 10/01/15 ................................................................ 14,868 16,161
FNMA 30 Year, 12.00%, 4/01/15 - 5/01/16 ....................................................... 3,728 4,202
FNMA 30 Year, 12.50%, 12/01/13 ................................................................ 837 948
--------------
111,243,653
--------------
b GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) ADJUSTABLE RATE 0.1%
GNMA, 5.75%, 7/20/27 .......................................................................... 246,538 248,893
GNMA, 6.125%, 11/20/25 ........................................................................ 81,274 82,105
--------------
330,998
--------------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) FIXED RATE 2.2%
GNMA I SF 15 Year, 7.00%, 4/15/14 ............................................................. 48,540 50,266
GNMA I SF 15 Year, 8.00%, 9/15/15 ............................................................. 30,979 32,805
GNMA I SF 30 Year, 6.50%, 1/15/24 - 9/15/32 ................................................... 711,965 729,889
GNMA I SF 30 Year, 7.00%, 3/15/17 - 2/15/32 ................................................... 776,399 812,317
GNMA I SF 30 Year, 7.50%, 10/15/23 - 10/15/29 ................................................. 99,521 104,534
GNMA I SF 30 Year, 8.00%, 1/15/17 - 9/15/27 ................................................... 392,610 415,876
GNMA I SF 30 Year, 8.25%, 4/15/08 - 5/15/21 ................................................... 253,987 271,355
GNMA I SF 30 Year, 8.50%, 6/15/16 - 7/15/24 ................................................... 482,704 519,978
GNMA I SF 30 Year, 9.00%, 9/15/08 - 8/15/28 ................................................... 117,202 123,961
GNMA I SF 30 Year, 9.50%, 10/15/09 - 1/15/10 .................................................. 73,938 76,950

Annual Report | 15

Franklin Strategic Mortgage Portfolio

STATEMENT OF INVESTMENTS, SEPTEMBER 30, 2007 (CONTINUED)

LONG TERM INVESTMENTS (CONTINUED)
MORTGAGE-BACKED SECURITIES (CONTINUED)
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) FIXED RATE (CONTINUED)
GNMA I SF 30 Year, 10.00%, 10/15/18 - 2/15/19 ................................................. 9,829 $ 11,151
GNMA I SF 30 Year, 10.50%, 1/15/16 ............................................................ 1,081 1,229
GNMA II SF 30 Year, 6.50%, 1/20/26 - 2/20/34 .................................................. 1,262,134 1,291,528
GNMA II SF 30 Year, 7.50%, 11/20/22 - 7/20/32 ................................................. 664,567 694,722
GNMA II SF 30 Year, 8.00%, 1/20/17 - 8/20/26 .................................................. 183,610 193,329
GNMA II SF 30 Year, 8.50%, 7/20/16 - 8/20/16 .................................................. 80,893 86,258
GNMA II SF 30 Year, 9.00%, 11/20/19 - 3/20/25 ................................................. 8,845 9,543
GNMA II SF 30 Year, 10.50%, 6/20/20 ........................................................... 28 32
--------------
5,425,723
--------------
TOTAL MORTGAGE-BACKED SECURITIES (COST $214,283,437) .......................................... 211,755,065
--------------
ASSET-BACKED SECURITIES AND COMMERCIAL MORTGAGE-BACKED SECURITIES 39.8%
FINANCE 39.8%
b Ace Securities Corp., 2004-HE4, M9, 8.231%, 12/25/34 .......................................... 2,170,351 1,763,210
b AFC Home Equity Loan Trust, 1997-4, 2A2, 5.771%, 12/22/27 ..................................... 545,701 539,509
b Ameriquest Mortgage Securities Inc., 2003-12, M2, 6.831%, 1/25/34 ............................. 3,526,559 3,280,070
b Asset-Backed Securities Corp. Home Equity Loan Trust, 2005-HE4, A1, 5.291%, 5/25/35 ........... 455,028 453,839
b Asset-Backed Funding Certificates, 2005-HE2, A2C, 5.431%, 6/25/35 ............................. 1,097,681 1,096,034
b,d Bayview Commercial Asset Trust, 2006-CD1A, A-1, 144A, 5.153%, 7/25/23 (Canada) ................ 2,033,636 CAD 2,016,806
Bear Stearns Commercial Mortgage Securities Inc.,
2005-PW10, A4, 5.405%, 12/11/40 ............................................................. 3,000,000 2,984,414
b,d 2007-T26, B, 144A, 5.601%, 1/12/45 .......................................................... 2,650,000 2,468,196
d sub. bond, 2007-PW15, B, 144A, 5.444%, 2/11/44 .............................................. 6,250,000 5,799,808
CitiFinancial Mortgage Securities Inc., 2003-4, AF6, 4.493%, 10/25/33 ......................... 2,207,293 2,094,425
Citigroup/Deutsche Bank Commercial Mortgage Trust,
2006-CD3, A5, 5.617%, 10/15/48 .............................................................. 7,000,000 7,045,920
2007-CD4, C, 5.476%, 12/11/49 ............................................................... 6,500,000 6,029,946
b Contimortgage Home Equity Loan Trust, 1999-3, A6, 8.18%, 12/25/29 ............................. 120,035 119,640
Countrywide Asset-Backed Certificates,
2004-7, AF4, 4.774%, 8/25/32 ................................................................ 889,298 877,741
b 2006-11, 1AF1, 5.251%, 9/25/46 .............................................................. 893,612 890,972
b FHLMC, 2942, TF, 6.103%, 3/15/35 .............................................................. 1,548,546 1,537,572
b First Franklin Mortgage Loan Asset-Backed Certificates,
2004-FF3, B3, 8.651%, 5/25/34 ............................................................... 699,375 106,889
2004-FF11, 1A2, 5.481%, 1/25/35 ............................................................. 472,313 467,952
2005-FF8, A2B, 5.311%, 9/25/35 .............................................................. 415,315 415,222
2005-FF10, A2, 5.231%, 11/25/35 ............................................................. 114,343 114,126
2005-FF11, A2A, 5.231%, 11/25/35 ............................................................ 538,272 536,932
2006-FF12, A2, 5.171%, 9/25/36 .............................................................. 1,950,453 1,930,062
FNMA,
b 2007-1, NF, 5.381%, 2/25/37 ................................................................. 1,198,883 1,186,050
G93-33, K, 7.00%, 9/25/23 ................................................................... 2,163,122 2,278,753
GE Capital Commercial Mortgage Corp., 2003-C1, A4, 4.819%, 1/10/38 ............................ 1,262,683 1,238,559
Greenwich Capital Commercial Funding Corp.,
2004-GG1, A7, 5.317%, 6/10/36 ............................................................... 5,000,000 4,972,547
2007-GG9, C, 5.554%, 3/10/39 ................................................................ 3,500,000 3,273,411

16 | Annual Report

Franklin Strategic Mortgage Portfolio

STATEMENT OF INVESTMENTS, SEPTEMBER 30, 2007 (CONTINUED)

LONG TERM INVESTMENTS (CONTINUED)
ASSET-BACKED SECURITIES AND COMMERCIAL MORTGAGE-BACKED SECURITIES (CONTINUED)
b GSAMP Trust, 2006-S4, A1, 5.221%, 5/25/36 ..................................................... 1,088,805 $ 1,039,801
b HSI Asset Securitization Corp. Trust, 2006-OPT4, 2A2, 5.241%, 3/25/36 ......................... 1,750,000 1,730,041
b Ixis Real Estate Capital Trust, 2006-HE1, A1, 5.221%, 3/25/36 ................................. 174,046 174,002
JPMorgan Chase Commercial Mortgage Securities Corp.,
b 2004-CB9, A4, 5.375%, 6/12/41 ............................................................... 3,779,632 3,800,618
2004-LN2, A2, 5.115%, 7/15/41 ............................................................... 557,685 546,337
b LB-UBS Commercial Mortgage Trust, 2007-C2, C, 5.611%, 2/15/40 ................................. 6,100,000 5,725,405
b Master Asset-Backed Securities Trust,
2005-WMC1, A4, 5.321%, 3/25/35 .............................................................. 21,270 21,266
2006-AB1, A1, 5.271%, 2/25/36 ............................................................... 2,453,615 2,441,873
b Merrill Lynch Mortgage Investors Trust, 2006-RM2, A1B, 5.366%, 5/25/37 ........................ 5,868,465 5,709,496
b Morgan Stanley ABS Capital I,
2006-NC3, A2B, 5.251%, 3/25/36 .............................................................. 3,000,000 2,973,007
2006-NC4, A2A, 5.161%, 6/25/36 .............................................................. 815,504 812,585
b Morgan Stanley Capital I, 2004-IQ7, A4, 5.407%, 6/15/38 ....................................... 6,000,000 6,011,719
b Nomura Home Equity Loan Inc., 2006-HE1, A1, 5.211%, 2/25/36 ................................... 226,847 226,257
b Novastar Home Equity Loan, 2004-4, M4, 6.231%, 3/25/35 ........................................ 1,500,000 1,384,318
b Ownit Mortgage Loan Asset-Backed Certificates, 2006-6, A2B, 5.241%, 9/25/37 ................... 2,000,000 1,952,503
Residential Asset Securities Corp.,
2004-KS1, AI4, 4.213%, 4/25/32 .............................................................. 1,409,830 1,384,493
b 2005-AHL2, A2, 5.391%, 10/25/35 ............................................................. 373,295 366,530
Residential Funding Mortgage Securities II,
2004-HI2, A4, 5.24%, 9/25/18 ................................................................ 2,126,819 2,112,243
b 2006-HI1, A1, 5.241%, 2/25/36 ............................................................... 496,038 493,327
b Securitized Asset-Backed Receivables LLC, 2006-FR1, A2A, 5.201%, 11/25/35 ..................... 187,693 187,374
b Specialty Underwriting and Residential Finance, 2006-BC2, A2A, 5.191%, 2/25/37 ................ 1,138,541 1,131,643
b Structured Asset Investment Loan Trust,
2004-1, M5, 8.131%, 2/25/34 ................................................................. 434,772 148,867
2005-5, A7, 5.341%, 6/25/35 ................................................................. 9,125 9,125
b,d Structured Asset Securities Corp., 2005-SC1, 1A1, 144A, 5.401%, 5/25/31 ....................... 966,965 937,550
b Travelers Mortgage Services Inc., 1998-5A, A, 8.055%, 12/25/18 ................................ 160,094 160,094
Vanderbilt Mortgage Finance, 1998-C, 1A6, 6.75%, 10/07/28 ..................................... 100,000 103,918
--------------
TOTAL ASSET-BACKED SECURITIES AND COMMERCIAL MORTGAGE-BACKED SECURITIES
(COST $101,592,010) ......................................................................... 97,102,997
--------------
TOTAL LONG TERM INVESTMENTS (COST $315,875,447) ............................................... 308,858,062
--------------
SHORT TERM INVESTMENTS 6.3%
U.S. GOVERNMENT AND AGENCY SECURITIES (COST $248,665) 0.1%
e,f U.S. Treasury Bill, 11/23/07 .................................................................. 250,000 248,669
--------------
TOTAL INVESTMENTS BEFORE MONEY MARKET FUND AND REPURCHASE AGREEMENT
(COST $316,124,112) ......................................................................... 309,106,731
--------------

-----------
SHARES
-----------

MONEY MARKET FUND (COST $12,212,539) 5.0%
g Franklin Institutional Fiduciary Trust Money Market Portfolio, 4.95% .......................... 12,212,539 12,212,539
--------------

Annual Report | 17

Franklin Strategic Mortgage Portfolio

STATEMENT OF INVESTMENTS, SEPTEMBER 30, 2007 (CONTINUED)

SHORT TERM INVESTMENTS (CONTINUED)
REPURCHASE AGREEMENT (COST $2,834,371) 1.2%
h Joint Repurchase Agreement, 4.656%, 10/01/07 (Maturity Value $2,835,471) ...................... 2,834,371 $ 2,834,371
ABN AMRO Bank NV, New York Branch (Maturity Value $262,791)
Banc of America Securities LLC (Maturity Value $262,791)
Barclays Capital Inc. (Maturity Value $262,791)
BNP Paribas Securities Corp. (Maturity Value $262,791)
Deutsche Bank Securities Inc. (Maturity Value $262,791)
Goldman, Sachs & Co. (Maturity Value $262,791)
Greenwich Capital Markets Inc. (Maturity Value $262,791)
Lehman Brothers Inc. (Maturity Value $207,561)
Merrill Lynch Government Securities Inc. (Maturity Value $262,791)
Morgan Stanley & Co. Inc. (Maturity Value $262,791)
UBS Securities LLC (Maturity Value $262,791)
Collateralized by U.S. Government Agency Securities, 2.84% - 7.25%, 10/05/07 - 8/23/12;
e U.S. Government Agency Discount Notes, 10/01/07 - 3/05/08; e U.S. Treasury Bills,
12/06/07 - 3/27/08; and U.S. Treasury Notes, 4.125% - 4.875%, 4/30/12 - 8/31/12
--------------
TOTAL INVESTMENTS (COST $331,171,022) 133.0% .................................................. 324,153,641
OTHER ASSETS, LESS LIABILITIES (33.0)% ........................................................ (80,489,825)
--------------
NET ASSETS 100.0% ............................................................................. $ 243,663,816
==============

CURRENCY ABBREVIATIONS

CAD - Canadian Dollar

SELECTED PORTFOLIO ABBREVIATIONS

PC - Participation Certificate
SF - Single Family

a The principal amount is stated in U.S. dollars unless otherwise indicated.

b The coupon rate shown represents the rate at period end.

c See Note 1(d) regarding securities purchased on a to-be-announced basis.

d Security was purchased pursuant to Rule 144A under the Securities Act of 1933
and may be sold in transactions exempt from registration only to qualified
institutional buyers or in a public offering registered under the Securities Act
of 1933. These securities have been deemed liquid under guidelines approved by
the Trust's Board of Trustees. At September 30, 2007, the aggregate value of
these securities was $11,222,360, representing 4.61% of net assets.

e The security is traded on a discount basis with no stated coupon rate.

f On deposit with broker for initial margin on futures contracts (Note 1(e)).

g See Note 7 regarding investments in the Franklin Institutional Fiduciary Trust
Money Market Portfolio. The rate shown is the annualized seven-day yield at
period end.

h See Note 1(c) regarding joint repurchase agreement.

18 | The accompanying notes are an integral part of these financial statements.
| Annual Report

Franklin Strategic Mortgage Portfolio

FINANCIAL STATEMENTS

STATEMENT OF ASSETS AND LIABILITIES
September 30, 2007

Assets:
Investments in securities:
Cost - Unaffiliated issuers .............................................. $316,124,112
Cost - Sweep Money Fund (Note 7) ......................................... 12,212,539
Cost - Repurchase agreements ............................................. 2,834,371
-------------
Total cost of investments ................................................ $331,171,022
=============
Value - Unaffiliated issuers ............................................. $309,106,731
Value - Sweep Money Fund (Note 7) ........................................ 12,212,539
Value - Repurchase agreements ............................................ 2,834,371
-------------
Total value of investments ............................................... 324,153,641
Foreign currency at value (cost $183,913) ................................... 176,269
Receivables:
Investment securities sold ............................................... 221,669
Capital shares sold ...................................................... 140,167
Interest ................................................................. 1,005,990
Variation margin ......................................................... 2,344
-------------
Total assets .......................................................... 325,700,080
-------------
Liabilities:
Payables:
Investment securities purchased .......................................... 81,195,786
Capital shares redeemed .................................................. 433,564
Affiliates ............................................................... 90,534
Distributions to shareholders ............................................ 172,474
Accrued expenses and other liabilities ...................................... 143,906
-------------
Total liabilities ..................................................... 82,036,264
-------------
Net assets, at value ............................................... $243,663,816
=============
Net assets consist of:
Paid-in capital ............................................................. $270,655,555
Distributions in excess of net investment income ............................ (120,565)
Net unrealized appreciation (depreciation) .................................. (7,035,406)
Accumulated net realized gain (loss) ........................................ (19,835,768)
-------------
Net assets, at value ............................................... $243,663,816
=============
Shares outstanding ............................................................. 25,871,183
=============
Net asset value per share a .................................................... $ 9.42
=============
Maximum offering price per share (net asset value per share / 95.75%) .......... $ 9.84
=============

a Redemption price is equal to net asset value less contingent deferred sales
charges, if applicable, and redemption fees retained by the Fund.

Annual Report |
The accompanying notes are an integral part of these financial statements. | 19

Franklin Strategic Mortgage Portfolio

FINANCIAL STATEMENTS (CONTINUED)

STATEMENT OF OPERATIONS
for the year ended September 30, 2007

Investment income:
Dividends from Sweep Money Fund (Note 7) .................................... $ 568,303
Interest .................................................................... 14,688,284
-------------
Total investment income ............................................... 15,256,587
-------------
Expenses:
Management fees (Note 3a) ................................................... 1,044,625
Transfer agent fees (Note 3d) ............................................... 323,983
Custodian fees (Note 4) ..................................................... 6,475
Reports to shareholders ..................................................... 51,933
Registration and filing fees ................................................ 35,937
Professional fees ........................................................... 35,108
Trustees' fees and expenses ................................................. 19,589
Other ....................................................................... 20,456
-------------
Total expenses ........................................................ 1,538,106
Expense reductions (Note 4) ........................................... (1,162)
-------------
Net expenses ....................................................... 1,536,944
-------------
Net investment income ........................................... 13,719,643
-------------
Realized and unrealized (losses):
Net realized gain (loss) from:
Investments .............................................................. (886,652)
Foreign currency transactions ............................................ 7,434
Financial futures contracts .............................................. (407,092)
-------------
Net realized gain (loss) ........................................ (1,286,310)
-------------
Net change in unrealized appreciation (depreciation) on:
Investments .............................................................. (2,576,099)
Translation of assets and liabilities denominated in foreign currencies .. 17,728
-------------
Net change in unrealized appreciation (depreciation) ............ (2,558,371)
-------------
Net realized and unrealized gain (loss) ........................................ (3,844,681)
-------------
Net increase (decrease) in net assets resulting from operations ................ $ 9,874,962
=============

20 | The accompanying notes are an integral part of these financial statements.
| Annual Report

Franklin Strategic Mortgage Portfolio

FINANCIAL STATEMENTS (CONTINUED)

STATEMENTS OF CHANGES IN NET ASSETS

-----------------------------
YEAR ENDED SEPTEMBER 30,
2007 2006
-----------------------------

Increase (decrease) in net assets:
Operations:
Net investment income .............................................................. $ 13,719,643 $ 14,376,702
Net realized gain (loss) from investments, foreign currency transactions
and financial futures contracts ................................................. (1,286,310) (2,357,735)
Net change in unrealized appreciation (depreciation) on investments and
translation of assets and liabilities denominated in foreign currencies ......... (2,558,371) (1,197,977)
-----------------------------
Net increase (decrease) in net assets resulting from operations .............. 9,874,962 10,820,990
-----------------------------
Distributions to shareholders from net investment income .............................. (14,759,374) (16,436,788)
Capital share transactions (Note 2) ................................................... (39,317,503) (74,284,316)
-----------------------------
Redemption fees ....................................................................... 1,009 6,040
-----------------------------
Net increase (decrease) in net assets ........................................ (44,200,906) (79,894,074)
Net assets:
Beginning of year ..................................................................... 287,864,722 367,758,796
-----------------------------
End of year ........................................................................... $243,663,816 $287,864,722
=============================
Distributions in excess of net investment income included in net assets:
End of year ........................................................................... $ (120,565) $ (186,974)
=============================

Annual Report |
The accompanying notes are an integral part of these financial statements. | 21

Franklin Strategic Mortgage Portfolio

NOTES TO FINANCIAL STATEMENTS

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Franklin Strategic Mortgage Portfolio (the Trust) is registered under the
Investment Company Act of 1940, as amended, (the 1940 Act) as a diversified,
open-end investment company, consisting of one fund, the Franklin Strategic
Mortgage Portfolio (the Fund).

The following summarizes the Fund's significant accounting policies.

A. SECURITY VALUATION

Securities listed on a securities exchange or on the NASDAQ National Market
System are valued at the last quoted sale price or the official closing price of
the day, respectively. Over-the-counter securities and listed securities for
which there is no reported sale are valued within the range of the most recent
quoted bid and ask prices. Securities that trade in multiple markets or on
multiple exchanges are valued according to the broadest and most representative
market. Investments in open-end mutual funds are valued at the closing net asset
value.

Government securities, mortgage pass-through securities, other mortgage-backed
securities, collateralized mortgage obligations and asset-backed securities
generally trade in the over-the-counter market rather than on a securities
exchange. The Fund may utilize independent pricing services, quotations from
bond dealers, and information with respect to bond and note transactions, to
assist in determining a current market value for each security. The Fund's
pricing services may use valuation models or matrix pricing which considers
information with respect to comparable bond and note transactions, quotations
from bond dealers, or by reference to other securities that are considered
comparable in such characteristics as rating, interest rate and maturity date,
option adjusted spread models, prepayment projections, interest rate spreads and
yield curves, to determine current value.

The Trust has procedures to determine the fair value of individual securities
and other assets for which market prices are not readily available or which may
not be reliably priced. Methods for valuing these securities may include:
fundamental analysis, matrix pricing, discounts from market prices of similar
securities, or discounts applied due to the nature and duration of restrictions
on the disposition of the securities. Due to the inherent uncertainty of
valuations of such securities, the fair values may differ significantly from the
values that would have been used had a ready market for such investments
existed. Occasionally, events occur between the time at which trading in a
security is completed and the close of the NYSE that might call into question
the availability (including the reliability) of the value of a portfolio
security held by the Fund. If such an event occurs, the securities may be valued
using fair value procedures, which may include the use of independent pricing
services. All security valuation procedures are approved by the Trust's Board of
Trustees.

22 | Annual Report

Franklin Strategic Mortgage Portfolio

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

B. FOREIGN CURRENCY TRANSLATION

Portfolio securities and other assets and liabilities denominated in foreign
currencies are translated into U.S. dollars based on the exchange rate of such
currencies against U.S. dollars on the date of valuation. Purchases and sales of
securities, income and expense items denominated in foreign currencies are
translated into U.S. dollars at the exchange rate in effect on the transaction
date. Occasionally, events may impact the availability or reliability of foreign
exchange rates used to convert the U.S. dollar equivalent value. If such an
event occurs, the foreign exchange rate will be valued at fair value using
procedures established and approved by the Trust's Board of Trustees.

The Fund does not separately report the effect of changes in foreign exchange
rates from changes in market prices on securities held. Such changes are
included in net realized and unrealized gain or loss from investments on the
Statement of Operations.

Realized foreign exchange gains or losses arise from sales of foreign
currencies, currency gains or losses realized between the trade and settlement
dates on securities transactions and the difference between the recorded amounts
of dividends, interest, and foreign withholding taxes and the U.S. dollar
equivalent of the amounts actually received or paid. Net unrealized foreign
exchange gains and losses arise from changes in foreign exchange rates on
foreign denominated assets and liabilities other than investments in securities
held at the end of the reporting period.

C. JOINT REPURCHASE AGREEMENT

The Fund may enter 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 their pro-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 market value, including accrued interest, of the initial
collateralization is required to be at least 102% of the dollar amount invested
by the funds, with the value of the underlying securities marked to market daily
to maintain coverage of at least 100%. The joint repurchase agreement held by
the Fund at year end had been entered into on September 28, 2007. The joint
repurchase agreement is valued at cost.

D. SECURITIES PURCHASED ON A TBA BASIS

The Fund may purchase securities on a to-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. Although the Fund will
generally purchase these securities with the intention of holding the
securities, it may sell the securities before the settlement date. Sufficient
assets have been segregated for these securities.

Annual Report | 23

Franklin Strategic Mortgage Portfolio

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

E. FUTURES CONTRACTS

The Fund may purchase financial futures contracts to gain exposure to market
changes. A financial futures contract is an agreement between two parties to buy
or sell a security for a set price on a future date. Required initial margin
deposits of cash or securities are maintained by the Fund's custodian in
segregated accounts as disclosed in the Statement of Investments. Subsequent
payments, known as variation margin, are made or received by the fund depending
on the fluctuations in the value of the underlying securities. Such variation
margin is accounted for as unrealized gains or losses until the contract is
closed, at which time the gains or losses are reclassified to realized. Realized
and unrealized gains and losses on these contracts are included in the Statement
of Operations.

The risks of these contracts include the possibility there may be an illiquid
secondary market and/or a change in the value of the contract may not correlate
with the changes in the value of the underlying securities.

F. FOREIGN CURRENCY CONTRACTS

When the Fund purchases or sells foreign securities it may enter into foreign
exchange contracts to minimize foreign exchange risk from the trade date to the
settlement date of the transactions. A foreign exchange contract is an agreement
between two parties to exchange different currencies at an agreed upon exchange
rate at a future date. Realized and unrealized gains and losses on these
contracts are included in the Statement of Operations.

The risks of these contracts include movement in the values of the foreign
currencies relative to the U.S. dollar and the possible inability of the
counterparties to fulfill their obligations under the contracts, which may be in
excess of the amount reflected in the Statement of Assets and Liabilities.

G. MORTGAGE DOLLAR ROLLS

The Fund enters into mortgage dollar rolls, typically on a TBA basis. Dollar
rolls are agreements between the fund and a financial institution to
simultaneously sell and repurchase mortgage-backed securities at a future date.
Gains or losses are realized at the time of the sale and the difference between
the repurchase price and sale price is recorded as an unrealized gain to the
fund. The risks of mortgage dollar roll transactions include the potential
inability of the counter-party to fulfill its obligations.

H. INCOME TAXES

No provision has been made for U.S. income taxes because it is the Fund's policy
to qualify as a regulated investment company under the Internal Revenue Code and
to distribute to shareholders substantially all of its taxable income and net
realized gains.

24 | Annual Report

Franklin Strategic Mortgage Portfolio

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

I. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS

Security transactions are accounted for on trade date. Realized gains and losses
on security transactions are determined on a specific identification basis.
Interest income and estimated expenses are accrued daily. Dividends from net
investment income are normally declared daily and distributed monthly to
shareholders. Distributions to shareholders are determined according to income
tax regulations (tax basis). Distributable earnings determined on a tax basis
may differ from earnings recorded in accordance with accounting principles
generally accepted in the United States of America. These differences may be
permanent or temporary. Permanent differences are reclassified among capital
accounts to reflect their tax character. These reclassifications have no impact
on net assets or the results of operations. Temporary differences are not
reclassified, as they may reverse in subsequent periods.

J. ACCOUNTING ESTIMATES

The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the amounts of income
and expenses during the reporting period. Actual results could differ from those
estimates.

K. REDEMPTION FEES

A short term trading redemption fee will be imposed, with some exceptions, on
any fund shares that are redeemed or exchanged within seven calendar days
following their purchase date. The redemption fee is 2% of the amount redeemed.
Such fees are retained by the fund and accounted for as an addition to paid-in
capital.

L. GUARANTEES AND INDEMNIFICATIONS

Under the Trust's organizational documents, its officers and trustees are
indemnified by the Trust against certain liabilities arising out of the
performance of their duties to the Trust. Additionally, in the normal course of
business, the Trust enters into contracts with service providers that contain
general indemnification clauses. The Trust's maximum exposure under these
arrangements is unknown as this would involve future claims that may be made
against the Trust that have not yet occurred. Currently, the Trust expects the
risk of loss to be remote.

Annual Report | 25

Franklin Strategic Mortgage Portfolio

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

2. SHARES OF BENEFICIAL INTEREST

At September 30, 2007, there were an unlimited number of shares authorized
(without par value). Transactions in the Fund's shares were as follows:

-------------------------------------------------------
YEAR ENDED SEPTEMBER 30,
2007 2006
-------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT
-------------------------------------------------------

Shares sold ............................ 3,029,951 $ 28,938,366 3,601,439 $ 34,449,038
Shares issued in reinvestment
of distributions .................... 1,296,189 12,353,213 1,441,749 13,769,644
Shares redeemed ........................ (8,476,807) (80,609,082) (12,807,953) (122,502,998)
--------------------------------------------------------
Net increase (decrease) ................ (4,150,667) $(39,317,503) (7,764,765) $ (74,284,316)
========================================================

3. TRANSACTIONS WITH AFFILIATES

Franklin Resources, Inc. is the holding company for various subsidiaries that
together are referred to as Franklin Templeton Investments. Certain officers and
trustees of the Trust 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

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
- --------------------------------------------------------------------------------
0.40% First $250 million
0.38% Over $250 million, up to and including $500 million
0.36% 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 average daily net assets, and
is not an additional expense of the Fund.

26 | Annual Report

Franklin Strategic Mortgage Portfolio

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

3. TRANSACTIONS WITH AFFILIATES (CONTINUED)

C. SALES CHARGES/UNDERWRITING AGREEMENTS

Distributors has advised the Fund of the following commission transactions
related to the sales and redemptions of the Fund's shares for the year:

Sales charges retained net of commissions paid to unaffiliated
broker/dealers ................................................. $ 25,669
Contingent deferred sales charges retained ........................ $ 534

D. TRANSFER AGENT FEES

For the year ended September 30, 2007, the Fund paid transfer agent fees of
$323,983, of which $165,682 was retained by Investor Services.

E. OTHER AFFILIATED TRANSACTIONS

At September 30, 2007, Advisers owned 29.10% of the Fund's outstanding shares.

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, 2007, 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, if any. At September 30, 2007, the capital loss carryforwards were as
follows:

Capital loss carryforwards expiring in:
2012 ......................................................... $ 6,223,578
2013 ......................................................... 4,584,050
2014 ......................................................... 2,817,022
2015 ......................................................... 4,099,588
------------
$ 17,724,238
============

For tax purposes, realized capital losses occurring subsequent to October 31,
may be deferred and treated as occurring on the first day of the following
fiscal year. At September 30, 2007, the Fund deferred realized capital losses of
$2,139,763.

Annual Report | 27

Franklin Strategic Mortgage Portfolio

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

5. INCOME TAXES (CONTINUED)

The tax character of distributions paid during the years ended September 30,
2007 and 2006, was as follows:
---------------------------
2007 2006
---------------------------
Distributions paid from ordinary income .......... $ 14,759,374 $ 16,436,788
===========================

At September 30, 2007, the cost of investments, net unrealized appreciation
(depreciation), and undistributed ordinary income for income tax purposes were
as follows:

Cost of Investments ............................................ $331,333,945
=============

Unrealized appreciation ........................................ $ 613,376
Unrealized depreciation ........................................ (7,793,680)
-------------
Net unrealized appreciation (depreciation) ..................... $ (7,180,304)
=============
Distributable earnings - undistributed ordinary income ........ $ 213,575
=============

Net investment income differs for financial statement and tax purposes primarily
due to differing treatments of foreign currency transactions, mortgage dollar
roll transactions, and paydown losses.

Net realized gains (losses) differ for financial statement and tax purposes
primarily due to differing treatments of wash sales, foreign currency
transactions, mortgage dollar roll transactions, financial futures transactions,
and paydown losses.

6. INVESTMENT TRANSACTIONS

Purchases and sales of investments (excluding short term securities) for the
year ended September 30, 2007, aggregated $1,093,202,034 and $1,149,621,920,
respectively.

7. INVESTMENTS IN FRANKLIN INSTITUTIONAL FIDUCIARY TRUST MONEY MARKET PORTFOLIO

The Fund may invest in the Franklin Institutional Fiduciary Trust Money Market
Portfolio (the Sweep Money Fund), an open-end investment company managed by
Advisers. Management fees paid by the Fund are reduced on assets invested in the
Sweep Money Fund, in an amount not to exceed the management and administrative
fees paid by the Sweep Money Fund.

28 | Annual Report

Franklin Strategic Mortgage Portfolio

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

8. FINANCIAL FUTURES CONTRACTS

At September 30, 2007, the Fund had the following financial futures contracts
outstanding:

- --------------------------------------------------------------------------------------------------------------
NUMBER OF CONTRACT UNREALIZED
CONTRACTS TO SELL CONTRACTS DELIVERY DATES FACE VALUE GAIN (LOSS)
- --------------------------------------------------------------------------------------------------------------

U.S. Treasury 5 Year Note ....................... 40 12/31/07 $ 4,000,000 $ (10,625)
U.S. Treasury 2 Year Note ....................... 50 12/31/07 $ 10,000,000 $ (50,000)
U.S. Treasury Long Bond ......................... 80 12/19/07 $ 8,000,000 $ 31,133

9. CONCENTRATION OF CREDIT RISK

The Fund has 39.8% of its net assets invested in asset-backed and commercial
mortgage-backed securities. Investments in these securities may subject the Fund
to increased market volatility which can cause the Fund's net asset value per
share to fluctuate.

10. REGULATORY AND LITIGATION MATTERS

As part of various investigations by a number of federal, state, and foreign
regulators and governmental entities, including the Securities and Exchange
Commission ("SEC"), relating to certain practices in the mutual fund industry,
including late trading, market timing and marketing support payments to
securities dealers who sell fund shares ("marketing support"), Franklin
Resources, Inc. and certain of its subsidiaries (collectively, the "Company"),
entered into settlements with certain of those regulators and governmental
entities. Specifically, the Company entered into settlements with the SEC, among
others, concerning market timing and marketing support.

On June 6, 2007, the SEC posted for public comment the proposed plan of
distribution for the market timing settlement. Once the SEC approves the final
plan of distribution, disbursements of settlement monies will be made promptly
to individuals who were shareholders of the designated funds during the relevant
period, in accordance with the terms and conditions of the settlement and plan.

In addition, the Company, as well as most of the mutual funds within Franklin
Templeton Investments and certain current or former officers, Company directors,
fund directors, and employees, have been named in private lawsuits (styled as
shareholder class actions, or as derivative actions on behalf of either the
named funds or Franklin Resources, Inc.). The lawsuits relate to the industry
practices referenced above.

Annual Report | 29

Franklin Strategic Mortgage Portfolio

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

10. REGULATORY AND LITIGATION MATTERS (CONTINUED)

The Company and fund management believe that the claims made in each of the
private lawsuits referenced above are without merit and intend to defend against
them vigorously. The Company cannot predict with certainty the eventual outcome
of these lawsuits, nor whether they will have a material negative impact on the
Company. If it is determined that the Company bears responsibility for any
unlawful or inappropriate conduct that caused losses to the Trust, it is
committed to making the Trust or its shareholders whole, as appropriate.

11. NEW ACCOUNTING PRONOUNCEMENTS

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of FASB Statement No. 109" (FIN 48), which clarifies the
accounting for uncertainty in tax positions taken or expected to be taken in a
tax return. FIN 48 provides guidance on the measurement, recognition,
classification and disclosure of tax positions, along with accounting for the
related interest and penalties. FIN 48 is effective for fiscal years beginning
after December 15, 2006, and is to be applied to all open tax years as of the
date of effectiveness. On December 22, 2006, the Securities and Exchange
Commission extended the implementation date to no later than the last net asset
value calculation in the first semi-annual reporting period beginning after
December 15, 2006. The Trust believes the adoption of FIN 48 will have no
material impact on its financial statements.

In September 2006, FASB issued FASB Statement No. 157, "Fair Value Measurement"
(SFAS 157), which defines fair value, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. SFAS 157 is
effective for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. The Trust believes the adoption of SFAS 157
will have no material impact on its financial statements.

30 | Annual Report

Franklin Strategic Mortgage Portfolio

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF THE FRANKLIN STRATEGIC MORTGAGE
PORTFOLIO

In our opinion, the accompanying statement of assets and liabilities, including
the statement of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Franklin Strategic Mortgage
Portfolio (the "Fund") at September 30, 2007, the results of its operations for
the year then ended, the changes in its net assets for each of the two years in
the period then ended and the financial highlights for each of the five years in
the period then ended, in conformity with accounting principles generally
accepted in the United States of America. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at September 30, 2007 by correspondence with the
custodian and brokers, provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP

San Francisco, California
November 16, 2007

Annual Report | 31

Franklin Strategic Mortgage Portfolio

TAX DESIGNATION (UNAUDITED)

Under Section 871(k)(1)(C) of the Internal Revenue Code (Code), the Fund
designates the maximum amount allowable but no less than $14,432,976 as interest
related dividends for purposes of the tax imposed under Section 871(a)(1)(A) of
the Code for the fiscal year ended September 30, 2007.

32 | Annual Report

Franklin Strategic Mortgage Portfolio

MEETING OF SHAREHOLDERS, MARCH 21, 2007 AND RECONVENED ON APRIL 11, 2007
(UNAUDITED)

A Special Meeting of Shareholders of the Trust was held at the Trust's offices,
One Franklin Parkway, San Mateo, California on March 21, 2007 and reconvened on
April 11, 2007. The purpose of the meeting was to elect Trustees of the Trust
and to vote on the following Proposals and Sub-Proposals: to approve an Amended
and Restated Agreement and Declaration of Trust; to approve amendments to
certain of the Trust's fundamental investment restrictions (including eight
Sub-Proposals); and to approve the elimination of certain of the Trust's
fundamental investment restrictions. At the meeting, the following persons were
elected by the shareholders to serve as Independent Trustees of the Trust:
Harris J. Ashton, Robert F. Carlson, Sam Ginn, Edith E. Holiday, Frank W. T.
LaHaye, Frank A. Olson, Larry D. Thompson, John B. Wilson. Charles B. Johnson
and Gregory E. Johnson were elected by the shareholders to serve as Interested
Trustees. Shareholders also approved the Amended and Restated Agreement and
Declaration of Trust, amendments to certain of the Trust's fundamental
investment restrictions (including eight Sub-Proposals) and the elimination of
certain of the Trust's fundamental investment restrictions. No other business
for the Trust was transacted at the meeting.

The results of the voting at the meeting with respect to the Trust are as
follows:

Proposal 1. The election of Trustees:

- ----------------------------------------------------------------------------------------------------------
% OF % OF % OF % OF
OUTSTANDING VOTED OUTSTANDING VOTED
NAME FOR SHARES SHARES WITHHELD SHARES SHARES
- ----------------------------------------------------------------------------------------------------------

Harris J. Ashton ........... 21,279,796.020 71.693% 98.530% 317,584.411 1.070% 1.470%
Robert F. Carlson .......... 21,287,463.690 71.719% 98.565% 309,916.741 1.044% 1.435%
Sam Ginn ................... 21,284,034.036 71.707% 98.549% 313,346.395 1.056% 1.451%
Edith E. Holiday ........... 21,273,918.334 71.673% 98.502% 323,462.097 1.090% 1.498%
Frank W. T. LaHaye ......... 21,283,978.913 71.707% 98.549% 313,401.518 1.056% 1.451%
Frank A. Olson ............. 21,282,717.891 71.703% 98.543% 314,662.540 1.060% 1.457%
Larry D. Thompson .......... 21,299,749.688 71.760% 98.622% 297,630.743 1.003% 1.378%
John B. Wilson ............. 21,297,587.983 71.753% 98.612% 299,792.448 1.010% 1.388%
Charles B. Johnson ......... 21,253,045.550 71.603% 98.406% 344,334.881 1.160% 1.594%
Gregory E. Johnson ......... 21,282,267.362 71.701% 98.541% 315,113.069 1.062% 1.459%

Proposal 2. To approve an Amended and Restated Agreement and Declaration of
Trust:

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,587,371.803 52.515% 72.173%
Against .............................. 270,853.371 0.912% 1.254%
Abstain .............................. 944,935.257 3.184% 4.375%
Broker Non-votes ..................... 4,794,220.000 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

Annual Report | 33

Franklin Strategic Mortgage Portfolio

MEETING OF SHAREHOLDERS, MARCH 21, 2007 AND RECONVENED ON APRIL 11, 2007
(UNAUDITED) (CONTINUED)

Proposal 3. To approve amendments to certain of the Trust's fundamental
investment restrictions (includes eight Sub-Proposals):

(a) To amend the Trust's fundamental investment restriction regarding borrowing:

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,299,244.731 51.544% 70.839%
Against .............................. 544,555.873 1.835% 2.522%
Abstain .............................. 959,359.827 3.232% 4.441%
Broker Non-votes ..................... 4,794,220.000 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

(b) To amend the Trust's fundamental investment restriction regarding
underwriting:

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,388,762.625 51.846% 71.253%
Against .............................. 397,269.096 1.338% 1.839%
Abstain .............................. 1,017,128.710 3.427% 4.710%
Broker Non-votes ..................... 4,794,220.00 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,242,075.780 51.351% 70.574%
Against .............................. 557,178.871 1.878% 2.580%
Abstain .............................. 1,003,905.780 3.382% 4.648%
Broker Non-votes ..................... 4,794,220.000 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

(d) To amend the Trust's fundamental investment restriction regarding
investments in real estate:

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,397,623.875 51.875% 71.294%
Against .............................. 441,714.493 1.489% 2.045%
Abstain .............................. 963,822.063 3.247% 4.463%
Broker Non-votes ..................... 4,794,220.000 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

34 | Annual Report

Franklin Strategic Mortgage Portfolio

MEETING OF SHAREHOLDERS, MARCH 21, 2007 AND RECONVENED ON APRIL 11, 2007
(UNAUDITED) (CONTINUED)

Proposal 3. To approve amendments to certain of the Trust's fundamental
investment restrictions (includes eight Sub-Proposals) (CONTINUED):

(e) To amend the Trust's fundamental investment restriction regarding
investments in commodities:

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,100,180.867 50.873% 69.917%
Against .............................. 709,205.755 2.390% 3.283%
Abstain .............................. 993,773.809 3.348% 4.602%
Broker Non-votes ..................... 4,794,220.000 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

(f) To amend the Trust's fundamental investment restriction regarding issuing
senior securities:

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,125,005.963 50.957% 70.032%
Against .............................. 676,559.982 2.279% 3.132%
Abstain .............................. 1,001,594.486 3.375% 4.638%
Broker Non-votes ..................... 4,794,220.000 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

(g) To amend the Trust's fundamental investment restriction regarding industry
concentration:

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,319,706.698 51.613% 70.933%
Against .............................. 464,509.831 1.565% 2.151%
Abstain .............................. 1,018,943.902 3.433% 4.718%
Broker Non-votes ..................... 4,794,220.000 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

Annual Report | 35

Franklin Strategic Mortgage Portfolio

MEETING OF SHAREHOLDERS, MARCH 21, 2007 AND RECONVENED ON APRIL 11, 2007
(UNAUDITED) (CONTINUED)

Proposal 3. To approve amendments to certain of the Trust's fundamental
investment restrictions (includes eight Sub-Proposals) (CONTINUED):

(h) To amend the Trust's fundamental investment restriction regarding
diversification of investments:

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,560,983.239 52.426% 72.050%
Against .............................. 363,522.231 1.225% 1.684%
Abstain .............................. 878,654.961 2.960% 4.068%
Broker Non-votes ..................... 4,794,220.000 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

Proposal 4. To approve the elimination of certain of the Trust's fundamental
investment restrictions:

- --------------------------------------------------------------------------------
% OF % OF
OUTSTANDING VOTED
SHARES VOTED SHARES SHARES
- --------------------------------------------------------------------------------
For .................................. 15,104,611.206 50.888% 69.937%
Against .............................. 752,066.278 2.534% 3.482%
Abstain .............................. 946,482.947 3.189% 4.383%
Broker Non-votes ..................... 4,794,220.000 16.152% 22.198%
- --------------------------------------------------------------------------------
TOTAL ................................ 21,597,380.431 72.763% 100.000%

36 | Annual Report

Franklin Strategic Mortgage Portfolio

BOARD MEMBERS AND OFFICERS

The name, year of birth and address of the officers and board members, as well
as their affiliations, positions held with the Trust, principal occupations
during the past five years and number of portfolios overseen in the Franklin
Templeton Investments fund complex are shown below. Generally, each board member
serves until that person's successor is elected and qualified.

INDEPENDENT BOARD MEMBERS

- ------------------------------------------------------------------------------------------------------------------------------------
NUMBER OF PORTFOLIOS IN
NAME, YEAR OF BIRTH LENGTH OF FUND COMPLEX OVERSEEN
AND ADDRESS POSITION TIME SERVED BY BOARD MEMBER* OTHER DIRECTORSHIPS HELD
- ------------------------------------------------------------------------------------------------------------------------------------

HARRIS J. ASHTON (1932) Trustee Since 1992 139 Bar-S Foods (meat packing company).
One Franklin Parkway
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Director of various companies; and FORMERLY, 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).
- ------------------------------------------------------------------------------------------------------------------------------------

ROBERT F. CARLSON (1928) Trustee Since April 2007 120 None
One Franklin Parkway
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Vice President, senior member and past President, Board of Administration, California Public Employees Retirement Systems (CALPERS);
and FORMERLY, member and Chairman of the Board, Sutter Community Hospitals; member, Corporate Board, Blue Shield of California; and
Chief Counsel, California Department of Transportation.
- ------------------------------------------------------------------------------------------------------------------------------------

SAM GINN (1937) Trustee Since April 2007 120 Chevron Corporation (global energy
One Franklin Parkway company) and ICO Global
San Mateo, CA 94403-1906 Communications (Holdings) Limited
(satellite company).

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Private investor; and FORMERLY, Chairman of the Board, Vodafone AirTouch, PLC (wireless company); Chairman of the Board and Chief
Executive Officer, AirTouch Communications (cellular communications) (1993-1998) and Pacific Telesis Groups (telephone holding
company) (1988-1994).
- ------------------------------------------------------------------------------------------------------------------------------------

EDITH E. HOLIDAY (1952) Trustee Since 2003 139 Hess Corporation (exploration and
One Franklin Parkway refining of oil and gas), H.J. Heinz
San Mateo, CA 94403-1906 Company (processed foods and
allied products), RTI International
Metals, Inc. (manufacture and distri-
bution of titanium), Canadian
National Railway (railroad) and White
Mountains Insurance Group, Ltd.
(holding company).

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Director or Trustee of various companies and trusts; and FORMERLY, 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).
- ------------------------------------------------------------------------------------------------------------------------------------

Annual Report | 37

FRANK W.T. LAHAYE (1929) Trustee Since 1992 120 Center for Creative Land Recycling
One Franklin Parkway (brownfield redevelopment).
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
General Partner, Las Olas L.P. (Asset Management); and FORMERLY, Chairman, Peregrine Venture Management Company (venture capital).
- ------------------------------------------------------------------------------------------------------------------------------------

FRANK A. OLSON (1932) Trustee Since April 2007 139 Hess Corporation (exploration and
One Franklin Parkway refining of oil and gas) and Sentient
San Mateo, CA 94403-1906 Jet (private jet service).

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Chairman Emeritus, The Hertz Corporation (car rental) (since 2000) (Chairman of the Board (1980-2000) and Chief Executive Officer
(1977-1999)); and FORMERLY, Chairman of the Board, President and Chief Executive Officer, UAL Corporation (airlines).
- ------------------------------------------------------------------------------------------------------------------------------------

LARRY D. THOMPSON (1945) Trustee Since April 2007 139 None
One Franklin Parkway
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Senior Vice President - Government Affairs, General Counsel and Secretary, PepsiCo, Inc. (consumer products); and FORMERLY,
Director, Delta Airlines (aviation) (2003-2005) and Providian Financial Corp. (credit card provider) (1997-2001); 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).
- ------------------------------------------------------------------------------------------------------------------------------------

JOHN B. WILSON (1959) Trustee Since April 2007 120 None
One Franklin Parkway
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
President and Founder, Hyannis Port Capital, Inc. (real estate and private equity investing); serves on private and non-profit
boards; and FORMERLY, Chief Operating Officer and Executive Vice President, Gap, Inc. (retail) (1996-2000); Chief Financial Officer
and Executive Vice President - Finance and Strategy, Staples, Inc. (office supplies) (1992-1996); Executive Vice President -
Corporate Planning, Northwest Airlines, Inc. (airlines) (1990-1992); and Vice President and Partner, Bain & Company (consulting
firm) (1986-1990).
- ------------------------------------------------------------------------------------------------------------------------------------

38 | Annual Report

INTERESTED BOARD MEMBERS AND OFFICERS

**CHARLES B. JOHNSON (1933) Trustee and Trustee since 139 None
One Franklin Parkway Chairman of 1992 and
San Mateo, CA 94403-1906 the Board Chairman of the
Board since 1993

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Chairman of the Board, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Director, Templeton Worldwide, 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 42
of the investment companies in Franklin Templeton Investments.
- ------------------------------------------------------------------------------------------------------------------------------------

**GREGORY E. JOHNSON (1961) Trustee Since April 2007 91 None
One Franklin Parkway
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Director, President and Chief Executive Officer, Franklin Resources, Inc.; President, Templeton Worldwide, Inc.; Director, Templeton
Asset Management Ltd.; and officer and/or director or trustee, as the case may be, of some of the other subsidiaries of Franklin
Resources, Inc. and of 33 of the investment companies in Franklin Templeton Investments.
- ------------------------------------------------------------------------------------------------------------------------------------

JAMES M. DAVIS (1952) Chief Chief Compliance Not Applicable Not Applicable
One Franklin Parkway Compliance Officer since 2004
San Mateo, CA 94403-1906 Officer and and Vice
Vice President President - AML
- AML Compliance since
Compliance 2006

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Director, Global Compliance, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin Resources, Inc. and of
46 of the investment companies in Franklin Templeton Investments; and FORMERLY, Director of Compliance, Franklin Resources, Inc.
(1994-2001).
- ------------------------------------------------------------------------------------------------------------------------------------

LAURA FERGERSON (1962) Treasurer Since 2004 Not Applicable Not Applicable
One Franklin Parkway
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Vice President, Franklin Templeton Services, LLC; officer of 28 of the investment companies in Franklin Templeton Investments; and
FORMERLY, Director and member of Audit and Valuation Committees, Runkel Funds, Inc. (2003-2004); Assistant Treasurer of most of the
investment companies in Franklin Templeton Investments (1997-2003); and Vice President, Franklin Templeton Services, LLC
(1997-2003).
- ------------------------------------------------------------------------------------------------------------------------------------

Annual Report | 39

JIMMY D. GAMBILL (1947) Senior Vice Since 2002 Not Applicable Not Applicable
500 East Broward Blvd. President and
Suite 2100 Chief
Fort Lauderdale, FL Executive
33394-3091 Officer -
Finance and
Administration

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
President, Franklin Templeton Services, LLC; Senior Vice President, Templeton Worldwide, Inc.; and officer of some of the other
subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments.
- ------------------------------------------------------------------------------------------------------------------------------------

DAVID P. GOSS (1947) Vice President Since 2000 Not Applicable Not Applicable
One Franklin Parkway
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Senior Associate General Counsel, Franklin Templeton Investments; officer and director of one of the subsidiaries of Franklin
Resources, Inc.; and officer of 46 of the investment companies in Franklin Templeton Investments.
- ------------------------------------------------------------------------------------------------------------------------------------

RUPERT H. JOHNSON, JR. (1940) President and President since Not Applicable Not Applicable
One Franklin Parkway Chief 1993 and Chief
San Mateo, CA 94403-1906 Executive Executive Officer
Officer - Investment
- Investment Management
Management since 2002

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Vice Chairman, Member - Office of the Chairman and Director, Franklin Resources, Inc.; Director, Franklin Advisers, Inc. and
Templeton Worldwide, Inc.; Senior Vice President, Franklin Advisory Services, LLC; and officer and/or director or trustee, as the
case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 44 of the investment companies in Franklin
Templeton Investments.
- ------------------------------------------------------------------------------------------------------------------------------------

KAREN L. SKIDMORE (1952) Vice President Since 2006 Not Applicable Not Applicable
One Franklin Parkway and Secretary
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Senior Associate General Counsel, Franklin Templeton Investments; and officer of 30 of the investment companies in Franklin
Templeton Investments.
- ------------------------------------------------------------------------------------------------------------------------------------

40 | Annual Report

CRAIG S. TYLE (1960) Vice President Since 2005 Not Applicable Not Applicable
One Franklin Parkway
San Mateo, CA 94403-1906

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
General Counsel and Executive Vice President, Franklin Resources, Inc.; officer of some of the other subsidiaries of Franklin
Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments; and FORMERLY, Partner, Shearman & Sterling,
LLP (2004-2005); and General Counsel, Investment Company Institute (ICI) (1997-2004).
- ------------------------------------------------------------------------------------------------------------------------------------

GALEN G. VETTER (1951) Chief Financial Since 2004 Not Applicable Not Applicable
500 East Broward Blvd. Officer and
Suite 2100 Chief
Fort Lauderdale, FL Accounting
33394-3091 Officer

PRINCIPAL OCCUPATION DURING PAST 5 YEARS:
Senior Vice President, Franklin Templeton Services, LLC; officer of some of the other subsidiaries of Franklin Resources, Inc. and
of 46 of the investment companies in Franklin Templeton Investments; and FORMERLY, Managing Director, RSM McGladrey, Inc.
(1999-2004); and Partner, McGladrey & Pullen, LLP (1979-1987 and 1991-2004).
- ------------------------------------------------------------------------------------------------------------------------------------

* We base the number of portfolios on each separate series of the U.S.
registered investment companies within the Franklin Templeton Investments fund
complex. These portfolios have a common investment manager or affiliated
investment managers.

** Charles B. Johnson is considered to be an interested person of the Fund under
the federal securities laws due to his position as officer and director and
major shareholder of Franklin Resources, Inc. (Resources), which is the parent
company of the Fund's investment manager and distributor. 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 Resources.

Note 1: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers and the
father and uncle, respectively, of Gregory E. Johnson.

Note 2: Officer information is current as of October 17, 2007. It is possible
that information about officers may change.

Note 3: Prior to September 30, 2007, Rupert H. Johnson, Jr. ceased to be a
trustee of the Trust.

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 OF TRUSTEES HAS DETERMINED
THAT THERE IS AT LEAST ONE SUCH FINANCIAL EXPERT ON THE AUDIT COMMITTEE AND HAS
DESIGNATED JOHN B. WILSON AS ITS AUDIT COMMITTEE FINANCIAL EXPERT. THE BOARD
BELIEVES THAT MR. WILSON QUALIFIES AS SUCH AN EXPERT IN VIEW OF HIS EXTENSIVE
BUSINESS BACKGROUND AND EXPERIENCE, INCLUDING SERVICE AS CHIEF FINANCIAL OFFICER
OF STAPLES, INC. FROM 1992 TO 1996. MR. WILSON HAS BEEN A MEMBER AND CHAIRMAN OF
THE FUND'S AUDIT COMMITTEE SINCE 2006. AS A RESULT OF SUCH BACKGROUND AND
EXPERIENCE, THE BOARD OF TRUSTEES BELIEVES THAT MR. WILSON 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. MR. WILSON IS AN INDEPENDENT TRUSTEE
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 1-800/DIAL BEN (1-800/342-5236) TO REQUEST THE SAI.

Annual Report | 41

Franklin Strategic Mortgage Portfolio

SHAREHOLDER INFORMATION

PROXY VOTING POLICIES AND PROCEDURES

The Trust has established Proxy Voting Policies and Procedures (Policies) that
the Trust uses to determine how to vote proxies relating to portfolio
securities. Shareholders may view the Trust's complete Policies online at
franklintempleton.com. Alternatively, shareholders may request copies of the
Policies free of charge by calling the Proxy Group collect at 1-954/527-7678 or
by sending a written request to: Franklin Templeton Companies, LLC, 500 East
Broward Boulevard, Suite 1500, Fort Lauderdale, FL 33394, Attention: Proxy
Group. Copies of the Trust's proxy voting records are also made available online
at franklintempleton.com and posted on the U.S. Securities and Exchange
Commission's website at sec.gov and reflect the most recent 12-month period
ended June 30.

QUARTERLY STATEMENT OF INVESTMENTS

The Trust files a complete statement of investments with the U.S. Securities and
Exchange Commission for the first and third quarters for each fiscal year on
Form N-Q. Shareholders may view the filed Form N-Q by visiting the Commission's
website at sec.gov. The filed form may also be viewed and copied at the
Commission's Public Reference Room in Washington, DC. Information regarding the
operations of the Public Reference Room may be obtained by calling
1-800/SEC-0330.

42 | Annual Report

This page intentionally left blank.

Literature Request

LITERATURE REQUEST. TO RECEIVE A BROCHURE AND PROSPECTUS, PLEASE CALL US AT
1-800/DIAL BEN(R) (1-800/342-5236) OR VISIT FRANKLINTEMPLETON.COM. INVESTORS
SHOULD CAREFULLY CONSIDER A FUND'S INVESTMENT GOALS, RISKS, CHARGES AND EXPENSES
BEFORE INVESTING. THE PROSPECTUS CONTAINS THIS AND OTHER INFORMATION. PLEASE
CAREFULLY READ THE PROSPECTUS BEFORE INVESTING. To ensure the highest quality of
service, we may monitor, record and access telephone calls to or from our
service departments. These calls can be identified by the presence of a regular
beeping tone.

FRANKLIN TEMPLETON FUNDS

INTERNATIONAL

Mutual European Fund
Templeton BRIC Fund
Templeton China World Fund
Templeton Developing Markets Trust
Templeton Emerging Markets Small Cap Fund
Templeton Foreign Fund
Templeton Foreign Smaller Companies Fund 1

GLOBAL

Mutual Discovery Fund
Templeton Global Long-Short Fund
Templeton Global Opportunities Trust
Templeton Global Smaller Companies Fund 1
Templeton Growth Fund
Templeton World Fund

GROWTH

Franklin Aggressive Growth Fund
Franklin Capital Growth Fund
Franklin Flex Cap Growth Fund
Franklin Small Cap Growth Fund II 2
Franklin Small-Mid Cap Growth Fund

VALUE

Franklin Balance Sheet Investment Fund 1
Franklin Equity Income Fund
Franklin Large Cap Value Fund
Franklin MicroCap Value Fund 1
Franklin MidCap Value Fund
Franklin Small Cap Value Fund
Mutual Beacon Fund
Mutual Qualified Fund
Mutual Recovery Fund 3
Mutual Shares Fund

BLEND

Franklin Balanced Fund
Franklin Convertible Securities Fund
Franklin Growth Fund
Franklin Rising Dividends Fund

SECTOR

Franklin Biotechnology Discovery Fund
Franklin DynaTech Fund
Franklin Global Communications Fund
Franklin Global Health Care Fund
Franklin Global Real Estate Fund
Franklin Gold and Precious Metals Fund
Franklin Natural Resources Fund
Franklin Real Estate Securities Fund
Franklin Technology Fund
Franklin Utilities Fund
Mutual Financial Services Fund

ASSET ALLOCATION

Franklin Templeton Corefolio(R) Allocation Fund
Franklin Templeton Founding Funds Allocation Fund
Franklin Templeton Perspectives Allocation Fund
Franklin Templeton Conservative Target Fund
Franklin Templeton Growth Target Fund
Franklin Templeton Moderate Target Fund
Franklin Templeton 2015 Retirement Target Fund
Franklin Templeton 2025 Retirement Target Fund
Franklin Templeton 2035 Retirement Target Fund
Franklin Templeton 2045 Retirement Target Fund

INCOME

Franklin Adjustable U.S. Government
Securities Fund 4
Franklin Floating Rate Daily Access Fund
Franklin High Income Fund 5
Franklin Income Fund
Franklin Limited Maturity
U.S. Government Securities Fund 4
Franklin Low Duration Total Return Fund
Franklin Real Return Fund
Franklin Strategic Income Fund
Franklin Strategic Mortgage Portfolio
Franklin Templeton Hard Currency Fund
Franklin Total Return Fund
Franklin U.S. Government Securities Fund 4
Templeton Global Bond Fund
Templeton Income Fund

TAX-FREE INCOME 6

NATIONAL FUNDS

Double Tax-Free Income Fund
Federal Tax-Free Income Fund
High Yield Tax-Free Income Fund
Insured Tax-Free Income Fund 7

LIMITED-TERM FUNDS

California Limited-Term Tax-Free Income Fund
Federal Limited-Term Tax-Free Income Fund
New York Limited-Term Tax-Free Income Fund

INTERMEDIATE-TERM FUNDS

California Intermediate-Term Tax-Free Income Fund
Federal Intermediate-Term Tax-Free Income Fund
New York Intermediate-Term Tax-Free Income Fund

STATE-SPECIFIC

Alabama
Arizona
California 8
Colorado
Connecticut
Florida 8
Georgia
Kentucky
Louisiana
Maryland
Massachusetts 7
Michigan 7
Minnesota 7
Missouri
New Jersey
New York 8
North Carolina
Ohio 7
Oregon
Pennsylvania
Tennessee
Virginia

INSURANCE FUNDS

Franklin Templeton Variable Insurance
Products Trust 9

1. The fund is open only to existing shareholders and select retirement plans.

2. The fund is closed to new investors. Existing shareholders can continue
adding to their accounts.

3. The fund is a continuously offered, closed-end fund. Shares may be purchased
daily; there is no daily redemption. However, each quarter, pending board
approval, the fund will authorize the repurchase of 5%-25% of the outstanding
number of shares. Investors may tender all or a portion of their shares during
the tender period.

4. An investment in the fund is neither insured nor guaranteed by the U.S.
government or by any other entity or institution.

5. Effective 10/1/06, Franklin's AGE High Income Fund changed its name to
Franklin High Income Fund. The fund's investment goal and strategy remained the
same.

6. For investors subject to the alternative minimum tax, a small portion of fund
dividends may be taxable. Distributions of capital gains are generally taxable.

7. The fund invests primarily in insured municipal securities.

8. These funds are available in two or more variations, including long-term
portfolios, portfolios of insured securities, a high-yield portfolio (CA) and
limited-term, intermediate-term and money market portfolios (CA and NY).

9. The funds of the Franklin Templeton Variable Insurance Products Trust are
generally available only through insurance company variable contracts.

05/07 Not part of the annual report

[LOGO](R)
FRANKLIN TEMPLETON One Franklin Parkway
INVESTMENTS San Mateo, CA 94403-1906

o WANT TO RECEIVE THIS DOCUMENT FASTER VIA EMAIL?

Eligible shareholders can sign up for eDelivery at
franklintempleton.com. See inside for details.

ANNUAL REPORT AND SHAREHOLDER LETTER

FRANKLIN STRATEGIC
MORTGAGE PORTFOLIO

INVESTMENT MANAGER

Franklin Advisers, Inc.

DISTRIBUTOR

Franklin Templeton Distributors, Inc.
1-800/DIAL BEN(R)
franklintempleton.com

SHAREHOLDER SERVICES

1-800/632-2301

Authorized for distribution only when accompanied or preceded by a prospectus.
Investors should carefully consider a fund's investment goals, risks, charges
and expenses before investing. The prospectus contains this and other
information; please read it carefully before investing.

To ensure the highest quality of service, telephone calls to or from our service
departments may be monitored, recorded and accessed. These calls can be
identified by the presence of a regular beeping tone.

157 A2007 11/07

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.

(d) N/A

(f) Pursuant to Item 12(a)(1), the Registrant is attaching as an exhibit a copy
of its code of ethics that applies to its principal executive officers and
principal financial and accounting officer.

ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.

(a)(1) The Registrant has an audit committee financial expert serving on its
audit committee.

(2) The audit committee financial expert is John B. Wilson and he 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 $28,825 for the
fiscal year ended September 30, 2007 and $22,559 for the
fiscal year ended September 30, 2006.

(b) Audit-Related Fees
There were no fees paid to the principal accountant for
assurance and related services rendered by the principal
accountant to the registrant that are reasonably related to
the performance of the audit of the registrant's financial
statements and are not reported under paragraph (a) of Item
4.

There were no fees paid to the principal accountant for
assurance and related services rendered by the principal
accountant to the registrant's investment adviser and any
entity controlling, controlled by or under common control
with the investment adviser that provides ongoing services
to the registrant that are reasonably related to the
performance of the audit of their financial statements.

(c) Tax Fees
There were no fees paid to the principal accountant for
professional services rendered by the principal accountant
to the registrant for tax compliance, tax advice and tax
planning.

The aggregate fees paid to the principal accountant for
professional services rendered by the principal accountant
to the registrant's investment adviser and any entity
controlling, controlled by or under common control with the
investment adviser that provides ongoing services to the
registrant for tax compliance, tax advice and tax planning
were $46,000 for the fiscal year ended September 30, 2007
and $0 for the fiscal year ended September 30, 2006. The
services for which these fees were paid included tax
compliance and advice.

(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, 2007 and
$183 for the fiscal year ended September 30, 2006. 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 other than services reported in paragraphs
(a)-(c) of Item 4 were $0 for the fiscal year ended
September 30, 2007 and $175,678 for the fiscal year ended
September 30, 2006. The services for which these fees were
paid included review of materials provided to the fund Board
in connect with the investment management contract renewal
process.

(e) (1) The registrant's audit committee is directly
responsible for approving the services to be provided by the
auditors, including:

(i) pre-approval of all audit and audit related
services;

(ii) pre-approval of all non-audit related services to
be provided to the Fund by the auditors;

(iii)pre-approval of all non-audit related services to
be provided to the registrant by the auditors to the
registrant's investment adviser or to any entity that
controls, is controlled by or is under common control with
the registrant's investment adviser and that provides
ongoing services to the registrant where the non-audit
services relate directly to the operations or financial
reporting of the registrant; and

(iv) establishment by the audit committee, if deemed
necessary or appropriate, as an alternative to committee
pre-approval of services to be provided by the auditors, as
required by paragraphs (ii) and (iii) above, of policies and
procedures to permit such services to be pre-approved by
other means, such as through establishment of guidelines or
by action of a designated member or members of the
committee; provided the policies and procedures are detailed
as to the particular service and the committee is informed
of each service and such policies and procedures do not
include delegation of audit committee responsibilities, as
contemplated under the Securities Exchange Act of 1934, to
management; subject, in the case of (ii) through (iv), to
any waivers, exceptions or exemptions that may be available
under applicable law or rules.

(e) (2) None of the services provided to the registrant
described in paragraphs (b)-(d) of Item 4 were approved by
the audit committee pursuant to paragraph (c)(7)(i)(C) of
Rule 2-01 of regulation S-X.

(f) No disclosures are required by this Item 4(f).

(g) The aggregate non-audit fees paid to the principal
accountant for services rendered by the principal accountant
to the registrant and the registrant's investment adviser
and any entity controlling, controlled by or under common
control with the investment adviser that provides ongoing
services to the registrant were $46,000 for the fiscal year
ended September 30, 2007 and $175,861 for the fiscal year
ended September 30, 2006.

(h) The registrant's audit committee of the board has
considered whether the provision of non-audit services that
were rendered to the registrant's investment adviser (not
including any sub-adviser whose role is primarily portfolio
management and is subcontracted with or overseen by another
investment adviser), and any entity controlling, controlled
by, or under common control with the investment adviser that
provides ongoing services to the registrant that were not
pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01
of Regulation S-X is compatible with maintaining the
principal accountant's independence.

ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. N/A

ITEM 6. SCHEDULE OF INVESTMENTS. N/A

ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND
PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
N/A

ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT
INVESTMENT COMPANIES. N/A

ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END
MANAGEMENT INVESTMENT COMPANY AND AFFILIATED PURCHASERS. N/A

ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There have
been no changes to the procedures by which shareholders may recommend nominees
to the Registrant's Board of 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 ensure that information required to be disclosed in the
Registrant's filings under the Securities Exchange Act of 1934 and the
Investment Company Act of 1940 is recorded, processed, summarized and reported
within the periods specified in the rules and forms of the Securities and
Exchange Commission. Such information is accumulated and communicated to the
Registrant's management, including its principal executive officer and principal
financial officer, as appropriate, to allow timely decisions regarding required
disclosure. The Registrant's management, including the principal executive
officer and the principal financial officer, recognizes that any set of controls
and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives.

Within 90 days prior to the filing date of this Shareholder Report on Form
N-CSR, the Registrant had carried out an evaluation, under the supervision and
with the participation of the Registrant's management, including the
Registrant's principal executive officer and the Registrant's principal
financial officer, of the effectiveness of the design and operation of the
Registrant's disclosure controls and procedures. Based on such evaluation, the
Registrant's principal executive officer and principal financial officer
concluded that the Registrant's disclosure controls and procedures are
effective.

(B) CHANGES IN INTERNAL CONTROLS. There have been no significant changes in the
Registrant's internal controls or in other factors that could significantly
affect the internal controls subsequent to the date of their evaluation in
connection with the preparation of this Shareholder Report on Form N-CSR.

ITEM 12. EXHIBITS.

(a) (1) Code of Ethics

(a) (2) Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
of Jimmy D. Gambill, Chief Executive Officer - Finance and Administration, and
Galen G. Vetter, Chief Financial Officer

(b) Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of
Jimmy D. Gambill, Chief Executive Officer - Finance and Administration, and
Galen G. Vetter, Chief Financial Officer

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.

FRANKLIN STRATEGIC MORTGAGE PORTFOLIO

By /S/JIMMY D. GAMBILL
-------------------
Jimmy D. Gambill
Chief Executive Officer - Finance and Administration
Date November 27, 2007

Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.

By /S/JIMMY D. GAMBILL
-------------------
Jimmy D. Gambill
Chief Executive Officer - Finance and Administration
Date November 27, 2007

By /S/GALEN G. VETTER
------------------
Galen G. Vetter
Chief Financial Officer
Date November 27, 2007