mutual financial services fund annual report · 2017. 6. 24. · severe economic slowdowns. credit...

DECEMBER 31, 2011

ANNUAL REPORTAND SHAREHOLDER LETTER

SECTOR

Sign up for electronic deliveryon franklintempleton.com

Mutual Financial Services Fund

Franklin Templeton InvestmentsGain From Our Perspective®

Franklin Templeton’s distinct multi-manager structure combines thespecialized expertise of three world-class investment management groups—Franklin, Templeton and Mutual Series.

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 investingand 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, withoffices 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.

Because our management groups work independently and adhere to differentinvestment approaches, Franklin, Templeton and Mutual Series funds typicallyhave distinct portfolios. That’s why our funds can be used to build trulydiversified allocation plans covering every major asset class.

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 trustednames in financial services.

TRUE DIVERSIFICATION

RELIABILITY YOU CAN TRUST

SPECIALIZED EXPERTISE

MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS

Not part of the annual report

Not part of the annual report | 1

Contents

Shareholder Letter

Annual Report

Mutual Financial Services Fund . . . . . . . . . . . . 5

Performance Summary . . . . . . 11

Your Fund’s Expenses . . . . . . . 16

Financial Highlights and Statement of Investments . . . 18

Financial Statements . . . . . . . 27

Notes to Financial Statements . . . . . . . . . . . . . . 31

Report of Independent Registered Public Accounting Firm . . . . . . . . . . . 47

Tax Information . . . . . . . . . . . 48

Board Members and Officers . . 49

Shareholder Information . . . . 54

Shareholder Letter . . . . . . . . 1

NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE

Shareholder LetterDear Mutual Financial Services Fund Shareholder:

In 2011, volatility and uncertainty were dominant themes for investors.Concerns over sovereign credit and a pervasive political stalemate — largelyfocused on Europe but also in the U.S. — stifled the anemic economic recoveryin developed markets. A preference for perceived safety over uncertainty led tobetter relative performance in U.S. equity markets than those in Europe orAsia, albeit at low absolute levels. The 2.11% gain for the Standard & Poor’s®

500 Index (S&P 500®) over the calendar year just matched its dividend yield,while the MSCI Europe Index in local currency was down 9.34%.1 Theseuninspiring absolute returns also belie the underlying market volatilityreflected by the approximate 20 percentage point price swing in the S&P 500and 35 percentage point price swing in the MSCI Europe Index in local cur-rency over the same period.2 By contrast, one of the best performing assets in2011 was the 10-year U.S. Treasury note, which returned 16.14% as a resultof its yield falling from 3.36% to 1.89% — although one might question how“safe” it was to own 10-year bonds yielding less than 2% at year-end. Overthe course of 2011, Mutual Financial Services Fund – Class Z lost 9.26%.

The threat of the eurozone’s collapse and potential ramifications for the globaleconomy highlighted a shift in focus from corporate to sovereign balancesheets. Going back 12 years, the creation of the euro as a common currency

1. Source: © 2012 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstarand/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete ortimely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use ofthis information. The S&P 500 is a market capitalization-weighted index of 500 stocks designed to measure total U.S.equity market performance. The index is unmanaged and includes reinvested dividends. STANDARD & POOR’S®, S&P®

and S&P 500® are registered trademarks of Standard & Poor’s Financial Services LLC. Standard & Poor’s does notsponsor, endorse, sell or promote any S&P index-based product. The MSCI Europe Index is a free float-adjusted, marketcapitalization-weighted index designed to measure equity market performance of developed countries in Europe. Theindex includes reinvested daily net dividends. One cannot invest directly in an index, and an index is not representa-tive of the Fund’s portfolio.

2. Sources: S&P; MSCI, Inc.

Average Annual Total Return

Class Z 12/31/11

1-Year -9.26%

5-Year -8.45%

10-Year +2.81%

Performance data represent past

performance, which does not guar-

antee future results. Investment

return and principal value will fluc-

tuate, 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

(800) 342-5236 for most recent

month-end performance.

2 | Not part of the annual report

for a significant portion of Europe was in theory the key to a more unified andstronger economic area. A collateral effect was the convergence of interestrates among the euro members, usually through a lowering of borrowing costsin less competitive countries such as Greece, Ireland and Portugal (versusGermany, economically the strongest of the group). Those “peripheral” coun-tries responded by borrowing more and engaging in a boom of constructionand consumption. After the global slowdown in 2008-2009, the boom timesended. Now these countries are struggling with significant national debt andsevere economic slowdowns. Credit markets have concluded that these countriesmight have unsustainable debt levels, and borrowing costs rose dramaticallyin 2011. As borrowing costs rise, concerns about solvency may become self-fulfilling and require a coordinated response — a bailout or debt restructuring— to avoid a potentially uncontrolled collapse of a major financial marketparticipant, similar to Lehman Brothers in 2008, or worse.

The year became a painful exercise in watching European leaders attempt toimplement a structure for countries with debt problems to receive assistancewithout rewarding profligate spenders and unduly penalizing those who hadlived within their means. The process was understandably quite messy, withnational leaders engaging in multiple negotiations and operating within andaround the institutional structures of the European Union and their ownnational political constraints. This slow political process added to the market’snervousness and heightened uncertainty. The overall environment also discour-aged business activity and companies became reluctant to invest in the face ofa potential eurozone meltdown. Even assuming a favorable outcome to the“European problem,” Europe stood on the brink of a recession and threatenedother markets with potential contagion.

The U.S. was not a model of economic clarity or decisiveness either. The U.S.budget deficit remains significant, and political conflict over the best time-frame and approach to address this deficit led to a showdown in mid-2011between the Democratic administration and the Republican majority in theHouse of Representatives. The resulting uncertainty about the U.S. govern-ment’s ability and commitment to cut the structural deficit and restore itsbalance sheet to good order led to a much publicized U.S. long-term debtdowngrade by a major ratings agency.

Not part of the annual report | 3

Markets also seemed to reflect fear and uncertainty surrounding the continu-ing debate over China’s economy. China’s growth eventually will slow, it willhave to address its own bank solvency concerns and it must address increasingdemands for an improved standard of living from its average citizen. Thecountry is trying to address these longer term challenges, but in the short termthe key questions are whether the economic landing will be “hard” or “soft,”and what global ramifications may result.

HSBC is one of the world’s largest banking and financial organizations.3

Mutual Financial Services Fund began to purchase the stock during the latterpart of the year although it is not one of our traditional investments becauseit traded at higher multiples than many banks. However, in a world wherebanks are challenged by funding, HSBC stood out to us as a relatively safehaven among global banks, with the ability to fund its loans through its out-standing deposit franchise. HSBC also has “self-help” measures in the form ofcost savings that we believe should help improve margins. In our analysis, therobust global deposit franchise the bank has developed helps produce sustain-ably higher returns on equity than the balance sheet leverage that has beencommon in many troubled western banks. Although we expect non-performingloans to escalate with the deteriorating economy and headwinds as HSBC, likeits competitors, manages the balance sheet to meet Basel III capital require-ments, we think the bank is well positioned in this environment and thebank’s intrinsic value is well above the share price in 2011.

Distressed debt opportunities in 2011 were unexpectedly limited. Quantitativeeasing and risk aversion has pushed investors into corporate credit markets intheir search for yield. As a result, companies with high leverage, many of themparticipants in the leveraged buyout wave of 2005-2007, were successful inobtaining credit and restructuring their debts to avoid near-term maturities. Wefound some interesting opportunities but fewer than we would have expectedat the start of the year. Looking into 2012, we anticipate credit to remainavailable and opportunities to be idiosyncratic rather than widespread.

Merger and acquisition (M&A) activity remained muted. Economic uncer-tainty reduced many buyers’ willingness to commit to transactions, anddampened valuations reduced many companies’ willingness to sell. A globalrevitalization of regulation, exemplified by the Canadian government’s blockof BHP Billiton’s proposed acquisition of Potash and the U.S. Department of

3. Mutual Financial Services Fund’s holdings are based on total net assets as of 12/31/11: HSBC 1.1%.

Justice’s lawsuit to prevent AT&T from acquiring T-Mobile, also increased therisks of major transactions. The year 2011 ended with less M&A activity thananticipated, and 2012 looks to be similarly muted. We anticipate an increasein corporate restructurings via spin-offs or asset sales as alternatives to M&A.

We remain in the thick of the aftermath of the post-financial crisis recession.In the U.S., persistently high unemployment, significant budget deficits atevery level of government, and a potential rise in interest rates following theend of quantitative easing are troubling. In Europe, the sovereign debt crisis,inextricably linked to the survival of the euro as a currency and the need forongoing austerity and fiscal contraction, remains the focus of concern. InAsia, growth continues but at an uncertain pace. Chinese authorities areattempting to keep growth on track while coping with the issues of theirmajor trading partners. Beyond China, the implications of changes in devel-oped world monetary policy and exchange rates ripple through Asianmarkets. In the midst of these cross-currents, we continue to look for thecompany-specific opportunities that can provide attractive returns in a vari-ety of economic scenarios.

We thank you for your trust and your support.

Sincerely,

Peter A. LangermanChairman, President and Chief Executive OfficerFranklin Mutual Advisers, LLC

This letter reflects our analysis, opinions and portfolio holdings as of December 31, 2011, the end of the reportingperiod. The way we implement our main investment strategies and the resulting portfolio holdings may changedepending on factors such as market and economic conditions. These opinions may not be relied upon as invest-ment advice or an offer for a particular security. The information is not a complete analysis of every aspect ofany market, country, industry, security or the Fund. Statements of fact are from sources considered reliable, butthe investment manager makes no representation or warranty as to their completeness or accuracy. Althoughhistorical performance is no guarantee of future results, these insights may help you understand our investmentmanagement philosophy.

4 | Not part of the annual report

Annual Report | 5

This annual report for Mutual Financial Services Fund covers the fiscal yearended December 31, 2011.

Performance Overview

Mutual Financial Services Fund – Class Z had a -9.26% cumulative totalreturn for the 12 months under review. The Fund performed better than the -17.06% total return of its narrow benchmark, the Standard & Poor’s 500(S&P 500) Financials Index, which tracks financials stocks in the S&P 500Index.1 For the same period, the Fund underperformed the +2.11% totalreturn of its broad benchmark, the S&P 500 Index, which is a broad measureof U.S. stock performance.1 You can find the Fund’s long-term performancedata in the Performance Summary beginning on page 11.

Economic and Market Overview

Global stocks declined in 2011 as deepening sovereign debt, political paralysisand economic growth concerns led to escalating investor anxiety and severemarket volatility. This was particularly so in financial services. Stocks enteredthe year supported by positive momentum in corporate earnings and renewedeconomic stimulus measures in the developed world. However, a number of

1. Source: © 2012 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstarand/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, completeor timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from anyuse of this information. The indexes are unmanaged and include reinvested dividends. One cannot invest directly inan index, and an index is not representative of the Fund’s portfolio.

The dollar value, number of shares or principal amount, and names of all portfolio holdings are listed in the Fund’sStatement of Investments (SOI). The SOI begins on page 22.

Annual Report

Mutual Financial Services FundYour Fund’s Goals and Main Investments: Mutual Financial Services Fund seeks capital

appreciation, with income as a secondary goal, by investing at least 80% of its net assets in securities of

financial services companies that the manager believes are available at market prices less than their

intrinsic value. The Fund concentrates its investments in securities of issuers such as banks, savings

and loan organizations, credit card companies, brokerage firms, finance companies, subprime lending

institutions, investment advisors, investment companies and insurance companies.

Performance data represent past

performance, which does not guar-

antee future results. Investment

return and principal value will fluc-

tuate, 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

(800) 342-5236 for most recent

month-end performance.

events interrupted the market’s rise early in 2011, including a severe naturaldisaster and nuclear crisis in Japan and populist uprisings across the oil-and-gas-producing regions of the Middle East and North Africa. Global marketsrecovered quickly from these setbacks but soon faced more significant turmoilas Europe’s sovereign debt crisis worsened in the summer. Portugal, Greece andIreland received bailouts and had their credit ratings slashed to junk grade,while rising bond yields in the larger economies of Italy and Spain, and eventu-ally in the critical core economies of Germany and France, threatened thesurvival of the European Monetary Union. The U.S.’s sovereign debt issuesand political dysfunction, accompanied by the downgrade of its AAA creditrating to AA+, further pressured investor sentiment during the summer months.Additionally, the precarious state of the global banking system as well as emerg-ing signs of a renewed global economic slowdown and possible hard landing inChina weighed on the markets.

Despite these global challenges, corporate profits remained remarkably resilient,some signs of U.S. economic improvement emerged toward year-end, andEuropean policymakers ultimately stepped up their response to their sovereigndebt and banking crisis. Greek and Italian prime ministers were replaced withtechnocrats tasked with arresting a debt spiral, the European Central Bank cutshort-term interest rates and expanded bank lending facilities, and six key globalcentral banks agreed to lower dollar funding costs for Europe’s distressed com-mercial banks. Meanwhile, the Federal Reserve Board increased purchases oflong-dated bonds to reduce key borrowing costs and hinted at “additional pol-icy accommodation.” Chinese policymakers lowered commercial bank reserverequirements and the International Monetary Fund revamped its credit line andeased its lending terms. Commodities initially rallied due to the coordinatedmonetary stimulus, but most ultimately declined as global economic prospectsweakened. Gold and oil, however, made annual gains. In currency markets, theeuro declined with escalating weakness at year-end, while the dollar ultimatelyrose after a late surge. Amid general global market declines, perceived safe-haven currencies such as the Japanese yen and Swiss franc rallied strongly, andU.S. Treasuries posted their best one-year return since 2008.

In the financial services sector, many banks started adjusting their balancesheets in an effort to accommodate new liquidity and capital requirements.This forced some banks to repatriate liquidity to their respective home mar-kets. Although this appeared negative for credit creation and global growth, itcould create opportunities for well-funded banks to increase their loans whereoverextended banks contract their balance sheets. For the property and casu-alty industry, 2011 was the worst year for catastrophe losses due to major

6 | Annual Report

Geographic BreakdownBased on Total Net Assets as of 12/31/11

U.S.

Switzerland

South Korea

China

Japan

Hong Kong

U.K.

Norway

Bermuda

Netherlands

Other

Short-Term Investments & Other Net Assets

40.6%

15.3%

5.3%

4.8%

4.5%

4.2%

4.2%

2.8%

1.9%

1.2%

2.8%

12.4%

Annual Report | 7

events all over the globe, from the Japanese earthquake to floods in Thailandand Australia to tornados in the U.S. The property and casualty industry waswell capitalized and able to cope with the losses, but the strains brought aboutby this confluence of events and low investment returns is forcing prices higheras we head into 2012, which is positive for the industry.

Investment Strategy

We strive to provide investors with superior risk-adjusted returns over timethrough our distinctive, value investment style, which includes investments inundervalued common stocks, distressed debt and risk arbitrage. Rigorous fun-damental analysis drives our investment process. We attempt to determine eachinvestment’s intrinsic value as well as the price at which we would be willingto commit shareholder funds. While valuation remains our key consideration,we utilize numerous fundamental factors such as return on equity, financialleverage and long-term earnings power. We also consider factors such as man-agement quality and competitive position. As always, our approach to successfulinvesting is as much about assessing risk and containing losses as it is aboutachieving profits.

In addition, it is our practice to hedge the Fund’s currency exposure when wedeem it advantageous for our shareholders.

Manager’s Discussion

Despite the weak performance of global stock markets in 2011, several Fundinvestments increased in value. Three particularly strong performers wereU.S.-based White Mountains Insurance Group; Aozora Bank, a full-servicecommercial bank based in Japan; and Bermuda-based global specialty insur-ance and reinsurance provider Lancashire Holdings.

We had long thought that the market had underappreciated the value of long-time Fund holding White Mountains, and in particular its Esurance andAnswer Financial subsidiaries. In 2011, White Mountains sold those busi-nesses to Allstate at a significant premium to book value, driving WhiteMountains’ share price higher. At period-end, we believed the stock was stilltrading at a significant discount to its tangible book value, of which almosttwo-thirds is excess capital. We expect White Mountains to use this excesscapital to generate shareholder value in 2012.

What is return on equity?

Return on equity is an amount, expressed

as a percentage, earned on a company’s

common stock investment for a given

period. It is calculated by dividing com-

mon stock equity (net worth) over the

average of the accounting period into

net income for the period after preferred

stock dividends but before common

stock dividends. Return on equity tells

common shareholders how effectually

their money is being employed. Com-

paring percentages for current and prior

periods also reveals trends, and compari-

son with industry composites reveals how

well a company is holding its own against

its competitors.

8 | Annual Report

Portfolio BreakdownBased on Total Net Assets as of 12/31/11

Commercial Banks

Diversified Financial Services

Insurance

Industrial Conglomerates

Thrifts & Mortgage Finance

Real Estate Management & Development

Household Durables

Consumer Finance

Capital Markets

Trading Companies & Distributors

Short-Term Investments & Other Net Assets

Real Estate Investment Trusts

40.2%

19.7%

13.7%

3.9%

3.6%

1.3%

1.2%

1.1%

1.1%

1.1%

0.7%

12.4%

Aozora Bank’s business benefited from its strongly capitalized balance sheetand a management team focused on strengthening its deposit franchise, condi-tions that in 2011 reassured investors during a very tumultuous environmentfor most financial services companies. In addition, Aozora shares continued tomove higher toward year-end due to the company’s profit margin expansionand a reversal of conservative credit loss provisions. Based on our analysis, weexpect its management should be able to grow the company’s loan book tofurther enhance value.

Lancashire was a noticeable outperformer in the financials sector. The com-pany’s unique underwriting culture minimized its exposure to near-recordindustry losses in 2011. Catastrophe losses as a percentage of beginning share-holder equity were about one-third lower than those of its peers, helping thecompany maintain its industry-leading profitability. We believe Lancashireshares may benefit from the company’s continued focus on underwriting andimproved pricing.

During a highly volatile year for global stock markets in general, and especiallyamong the world’s financial services stocks, several holdings had a negativeeffect on the Fund. These included Symetra Financial, a holding companywhose subsidiaries offer life insurance, annuities, retirement plans, healthinsurance and employee benefit plans to some three million U.S. customers;and large U.S. banking and financial services institutions Morgan Stanley andBank of America.

Historically low interest rates and volatile capital markets pressured life insur-ance sector valuations throughout 2011, and Symetra’s share price suffered asa result. Symetra derives a larger portion of revenues from investment incomethan most of its competitors, and therefore has a relatively greater sensitivityto interest rates. During the year, Symetra’s new CEO also revealed a strategicrepositioning plan to diversify and grow the company’s portfolio of life insur-ance businesses. Although we have confidence in the management team tonavigate this transition and increase profitability over the longer term, in ouranalysis, costs associated with the expanded distribution, new products andback office support initiatives could remain a headwind to Symetra’s earningsin the near term.

Annual Report | 9

Morgan Stanley’s stock price decline was driven largely by negative sentimenttoward global investment banks, given economic and regulatory uncertainty,particularly in the U.S. and Europe. Additional fears surfaced during the sec-ond half of 2011 that Morgan Stanley held excessive sovereign exposure tocertain highly leveraged European countries in its accounts, although thisturned out to be false. Morgan Stanley also faced operating challenges in itstwo main business segments, wealth management and institutional securities,due to client risk aversion and weak capital markets activity levels. At year-end, we continued to view Morgan Stanley as an attractive investment givenits low stock valuation and strong earnings potential. We also think the com-pany has made great strides over the past few years in terms of strengtheningits balance sheet while improving funding and capital positions.

Bank of America shares declined in 2011 as investors reacted to the com-pany’s potential exposure to large mortgage-related losses. There was also agrowing concern that related losses might force the company into a dilutive,capital-raising scenario. Bank of America also faced a very difficult generaloperating environment in 2011. Low interest rates, weak lending, the impactof new consumer rules on fees, and a drop-off in capital markets activity allpressured earnings and the stock price. Like many other financial stocks,Bank of America was also impacted by contagion fears from Europe, changesin capital requirements and uncertainty over the impact of new regulations,such as Dodd-Frank. Although we still believed this holding held value, weexited our position in Bank of America and reallocated the capital proceedsto companies where we thought better risk-reward characteristics existed.

During the year, the Fund held currency forwards to hedge a significant por-tion of the currency risk of the portfolio’s non-U.S. dollar investments. Thehedges had a negligible impact on the Fund’s performance during the period.

Top 10 Equity Holdings12/31/11

Company % of TotalSector/Industry, Country Net Assets

Enstar Group Ltd. 3.3%Insurance, U.S.

ACE Ltd. 3.1%Insurance, U.S.

White Mountains Insurance Group Ltd. 3.1%Insurance, U.S.

Oslo Bors VPS Holding ASA 2.8%Diversified Financial Services, Norway

Aozora Bank Ltd. 2.8%Commercial Banks, Japan

First Pacific Co. Ltd. 2.6%Diversified Financial Services, Hong Kong

Resolution Ltd. 2.6%Insurance, U.K.

Protector Forsikring ASA 2.5%Insurance, Norway

Lancashire Holdings Ltd. 2.4%Insurance, U.K.

PartnerRe Ltd. 2.3%Insurance, Bermuda

10 | Annual Report

Thank you for your continued participation in Mutual Financial ServicesFund. We look forward to serving your future investment needs.

Andrew Sleeman, CFAPortfolio Manager

Richard CetlinAssistant Portfolio Manager


CFA® is a trademark owned by CFA Institute.

The foregoing information reflects our analysis, opinions and portfolio holdings as of December 31, 2011, the endof the reporting period. The way we implement our main investment strategies and the resulting portfolio holdingsmay change depending on factors such as market and economic conditions. These opinions may not be relied uponas investment advice or an offer for a particular security. The information is not a complete analysis of everyaspect of any market, country, industry, security or the Fund. Statements of fact are from sources consideredreliable, 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 ourinvestment management philosophy.

Andrew Sleeman has been portfolio manager for Mutual Financial Services Fund since2009. He has also been a co-portfolio manager for Mutual International Fund since 2009.Mr. Sleeman joined Franklin Templeton Investments in 2007. Previously, he was with Fox-Pitt, Kelton, a financials specialist firm, where he focused on international financial equities.Prior to that, he worked in international equities at BNP Paribas. Mr. Sleeman also workedin Australia in the fixed income division of JP Morgan Investment Management.

Richard Cetlin has been assistant portfolio manager for Mutual Financial Services Fund since2010 with primary coverage of European banks. Prior to joining Franklin Templeton Investmentsin 2010, Mr. Cetlin was a consultant for Asian Century Quest, a hedge fund focused on theAsia-Pacific region. In this role, he focused on the analysis of banking, insurance and realestate stocks in China and banking stocks in Hong Kong and Korea. Prior to that, Mr. Cetlinworked for 14 years at AllianceBernstein where he was a senior vice president and senioranalyst for U.S. banking and specialty finance.

Annual Report | 11

Performance Summary as of 12/31/11

Price and Distribution Information

Class Z (Symbol: TEFAX) Change 12/31/11 12/31/10

Net Asset Value (NAV) -$1.48 $11.53 $13.01

Distributions (1/1/11–12/31/11)

Dividend Income $0.2808

Class A (Symbol: TFSIX) Change 12/31/11 12/31/10




Class B (Symbol: TBFSX) Change 12/31/11 12/31/10




Class C (Symbol: TMFSX) Change 12/31/11 12/31/10




Your dividend income will vary depending on dividends or interest paid by securities in the Fund’sportfolio, adjusted for operating expenses of each class. Capital gain distributions are net profitsrealized from the sale of portfolio securities. The performance table and graphs do not reflect anytaxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or anyrealized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund’s dividendsand capital gain distributions, if any, and any unrealized gains or losses.

Performance Summary (continued)

12 | Annual Report

Performance

Cumulative total return excludes sales charges. Average annual total return and value of $10,000 investment include maximum sales charges. Class Z: no sales charges; Class A: 5.75% maximum initial sales charge; Class B: contingentdeferred sales charge (CDSC) declining from 4% to 1% over six years, and eliminated thereafter; Class C: 1% CDSC infirst year only.

Class Z 1-Year 5-Year 10-Year

Cumulative Total Return1 -9.26% -35.69% +31.97%

Average Annual Total Return2 -9.26% -8.45% +2.81%

Value of $10,000 Investment3 $9,074 $6,431 $13,197

Total Annual Operating Expenses4 1.28%

Class A 1-Year 5-Year 10-Year





Class B 1-Year 5-Year 10-Year





Class C 1-Year 5-Year 10-Year





Performance data represent past performance, which does not guarantee future results. Investment return and principalvalue 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, go to franklintempleton.com or call (800) 342-5236.

Annual Report | 13


Class Z 12/31/11

1-Year -9.26%

5-Year -8.45%

10-Year +2.81%


Class Z (1/1/02–12/31/11)

$6,245

$13,335$13,197

$0

$5,000

$10,000

$15,000

$20,000

$25,000

12/1112/0912/0712/0512/031/02

Mutual Financial Services Fund S&P 500 Index5 S&P 500 Financials Index5

Total Return Index Comparison for a Hypothetical $10,000 Investment

Total return represents the change in value of an investment over the periods shown. It includesany current, applicable, maximum sales charge, Fund expenses, account fees and reinvested dis-tributions. The unmanaged indexes include reinvestment of any income or distributions. Theydiffer from the Fund in composition and do not pay management fees or expenses. One cannotinvest directly in an index.


Class A 12/31/11

1-Year -14.72%

5-Year -9.78%

10-Year +1.90%

Class A (1/1/02–12/31/11)

$6,245

$13,335$12,065

$0

$5,000

$10,000

$15,000

$20,000

$25,000

12/1112/0912/0712/0512/031/02


14 | Annual Report

Class B (1/1/02–12/31/11)

$6,245

$13,335$12,126

$0

$5,000

$10,000

$15,000

$20,000

$25,000

12/1112/0912/0712/0512/031/02



Class C (1/1/02–12/31/11)

$6,245

$13,335$11,954

$0

$5,000

$10,000

$15,000

$20,000

$25,000

12/1112/0912/0712/0512/031/02



Class B 12/31/11

1-Year -13.77%

5-Year -9.66%

10-Year +1.95%


Class C 12/31/11

1-Year -11.01%

5-Year -9.35%

10-Year +1.80%

Annual Report | 15


Endnotes

All investments involve risks. Value securities may not increase in price as anticipated or may decline further in value. Investing in a single-sectorFund involves special risks, including greater sensitivity to economic, political or regulatory developments impacting the sector. In addition, theFund invests in foreign securities whose risks include currency fluctuations, and economic and political uncertainties. The Fund’s investments in smaller company stocks carry an increased risk of price fluctuation, particularly over the short term. The Fund may also invest in companiesengaged in mergers, reorganizations or liquidations, which involve special risks as pending deals may not be completed on time or on favorableterms, as well as lower-rated bonds, which entail higher credit risk. The Fund is actively managed but there is no guarantee that the manager’sinvestment decisions will produce the desired results. The Fund’s prospectus also includes a description of the main investment risks.

Class Z: Shares are available to certain eligible investors as described in the prospectus.

Class B: These shares have higher annual fees and expenses than Class A shares.

Class C: Prior to 1/1/04, these shares were offered with an initial sales charge; thus actual total returns would have differed. These shares havehigher annual fees and expenses than Class A shares.

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

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

3. These figures represent the value of a hypothetical $10,000 investment in the Fund over the periods indicated.

4. Figures are as stated in the Fund’s prospectus current as of the date of this report. In periods of market volatility, assets may decline significantly,causing total annual Fund operating expenses to become higher than the figures shown.

5. Source: © 2012 Morningstar. The S&P 500 is a market capitalization-weighted index of 500 stocks designed to measure total U.S. equity marketperformance. The S&P 500 Financials Index is market capitalization weighted and consists of all financial stocks in the S&P 500.

16 | Annual Report

Your Fund’s Expenses

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

• Transaction costs, including sales charges (loads) on Fund purchases; and

• Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and otherFund 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 understandthese costs and compare them with those of other mutual funds. The table assumes a $1,000investment 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 andexpenses. The “Ending Account Value” is derived from the Fund’s actual return, which includesthe 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 compareongoing 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 andan assumed 5% annual rate of return before expenses, which does not represent the Fund’s actualreturn. The figure under the heading “Expenses Paid During Period” shows the hypotheticalexpenses your account would have incurred under this scenario. You can compare this figure withthe 5% hypothetical examples that appear in shareholder reports of other funds.

Annual Report | 17

Your Fund’s Expenses (continued)

Please note that expenses shown in the table are meant to highlight ongoing costs and do not reflectany transaction costs, such as sales charges. Therefore, the second line for each class is useful incomparing 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 referto the Fund prospectus for additional information on operating expenses.

Beginning Account Ending Account Expenses Paid During Class Z Value 7/1/11 Value 12/31/11 Period* 7/1/11–12/31/11

Actual $1,000 $ 875.10 $ 6.10

Hypothetical (5% return before expenses) $1,000 $1,018.70 $ 6.56

Class A

Actual $1,000 $ 874.30 $ 7.51

Hypothetical (5% return before expenses) $1,000 $1,017.19 $ 8.08

Class B

Actual $1,000 $ 870.90 $10.80

Hypothetical (5% return before expenses) $1,000 $1,013.66 $11.62

Class C

Actual $1,000 $ 871.30 $10.80

Hypothetical (5% return before expenses) $1,000 $1,013.66 $11.62

*Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Z: 1.29%; A: 1.59%; B: 2.29%; and C: 2.29%),multiplied by the average account value over the period, multiplied by 184/365 to reflect the one-half year period.

Mutual Financial Services FundFinancial Highlights

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

Year Ended December 31,Class Z 2011 2010 2009 2008 2007

Per share operating performance(for a share outstanding throughout the year)

Net asset value, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . $13.01 $12.05 $10.80 $18.68 $22.59

Income from investment operationsa:

Net investment incomeb . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.28 0.26 0.15c 0.46 0.51

Net realized and unrealized gains (losses) . . . . . . . . . . . . . . . . . . . . (1.48) 1.27 1.44 (7.94) (2.41)

Total from investment operations . . . . . . . . . . . . . . . . . . . . . . . . . . . (1.20) 1.53 1.59 (7.48) (1.90)

Less distributions from:

Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (0.28) (0.57) (0.34) (0.40) (0.61)

Net realized gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — — (1.40)

Total distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (0.28) (0.57) (0.34) (0.40) (2.01)

Redemption feesd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — — —e —e

Net asset value, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11.53 $13.01 $12.05 $10.80 $18.68

Total return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9.26)% 12.84% 14.82% (40.08)% (8.71)%

Ratios to average net assets

Expenses before expense reductionf . . . . . . . . . . . . . . . . . . . . . . . . . 1.24% 1.28% 1.26% 1.19% 1.11%

Expenses net of expense reductionf . . . . . . . . . . . . . . . . . . . . . . . . . 1.24% 1.28% 1.25% 1.19%g 1.11%g

Expenses incurred in connection with securities sold short . . . . . . . . —% —% —%h 0.01% —%

Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.22% 2.07% 1.24%c 3.15% 2.25%

Supplemental data

Net assets, end of year (000’s) . . . . . . . . . . . . . . . . . . . . . . . . . . . . $80,105 $97,487 $99,610 $91,691 $164,890

Portfolio turnover rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23.58% 35.37% 81.29% 41.98% 49.87%

aThe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases ofthe Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund.bBased on average daily shares outstanding.cNet investment income per share includes approximately $(0.09) per share related to an adjustment for uncollectible interest. Excluding the effect of this adjustment, the ratio ofnet investment income to average net assets would have been 2.09%.dEffective September 1, 2008, the redemption fee was eliminated.eAmount rounds to less than $0.01 per share.fIncludes dividend expense on securities sold short and borrowing fees, if any. See below for the ratios of such expenses to average net assets for the periods presented. gBenefit of expense reduction rounds to less than 0.01%.hRounds to less than 0.01%.

Mutual Financial Services FundFinancial Highlights (continued)

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

Year Ended December 31,Class A 2011 2010 2009 2008 2007













Total returnf . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (9.49)% 12.45% 14.53% (40.23)% (8.99)%


Expenses before expense reductiong . . . . . . . . . . . . . . . . . . . . . . . . 1.54% 1.58% 1.55% 1.49% 1.40%

Expenses net of expense reductiong . . . . . . . . . . . . . . . . . . . . . . . . . 1.54% 1.58% 1.54% 1.49%h 1.40%h

Expenses incurred in connection with securities sold short . . . . . . . . —% —% —%i 0.01% —%


Supplemental data



aThe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases ofthe Fund shares in relation to income earned and/or fluctuating market value of the investments of the Fund.bBased on average daily shares outstanding.cNet investment income per share includes approximately $(0.09) per share related to an adjustment for uncollectible interest. Excluding the effect of this adjustment, the ratio ofnet investment income to average net assets would have been 1.80%. dEffective September 1, 2008, the redemption fee was eliminated.eAmount rounds to less than $0.01 per share.fTotal return does not reflect sales commissions or contingent deferred sales charges, if applicable.gIncludes dividend expense on securities sold short and borrowing fees, if any. See below for the ratios of such expenses to average net assets for the periods presented. hBenefit of expense reduction rounds to less than 0.01%.iRounds to less than 0.01%.



Year Ended December 31,Class B 2011 2010 2009 2008 2007













Total returnf . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10.20)% 11.73% 13.69% (40.66)% (9.58)%






Supplemental data






Year Ended December 31,Class C 2011 2010 2009 2008 2007













Total returnf . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10.13)% 11.69% 13.64% (40.63)% (9.60)%






Supplemental data




22 | Annual Report

Mutual Financial Services FundStatement of Investments, December 31, 2011

Country Shares/Warrants Value

Common Stocks and Other Equity Interests 84.7%Capital Markets 3.9%F&C Asset Management PLC . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 5,857,750 $ 5,939,078Morgan Stanley . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 160,390 2,426,701Sun Hung Kai & Co. Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hong Kong 2,058,497 1,081,383

a UBS AG . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Switzerland 265,929 3,168,41912,615,581

Commercial Banks 19.4%a,b AB&T Financial Corp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 226,100 175,228

Aozora Bank Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Japan 3,302,341 9,096,294Associated Banc-Corp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 315,352 3,522,482

a,c The Bankshares Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 456,903 1,633,081Barclays PLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 584,120 1,596,821

a,c Elephant Capital Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . . . Japan 5,268 —a First California Financial Group Inc. . . . . . . . . . . . . . . . . . . . . United States 906,100 2,953,886

a,c First Southern Bancorp Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . United States 110,792 1,076,898a Guaranty Bancorp . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 1,333,807 1,960,696Hana Financial Group Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . South Korea 164,600 5,047,686HSBC Holdings PLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 450,110 3,433,444KB Financial Group Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . South Korea 117,423 3,676,907Korea Exchange Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . South Korea 528,130 3,348,506

a,c NCB Warrant Holdings Ltd., A . . . . . . . . . . . . . . . . . . . . . . . . . Japan 25,741 —PNC Financial Services Group Inc. . . . . . . . . . . . . . . . . . . . . . United States 84,290 4,861,004

a Southern National Bancorp of Virginia Inc. . . . . . . . . . . . . . . . . United States 547,560 3,340,116a State Bank Financial Corp. . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 200,000 3,022,000Wells Fargo & Co. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 196,250 5,408,650

a West Coast Bancorp . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 237,760 3,709,056a,c West Coast Bancorp, wts., C, 10/23/16 . . . . . . . . . . . . . . . . . . United States 6,964 667,980

a Western Liberty Bancorp . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 556,530 1,508,196Woori Finance Holdings Co. Ltd. . . . . . . . . . . . . . . . . . . . . . . . South Korea 317,090 2,579,391

62,618,322

Consumer Finance 1.1%a Comdisco Holding Co. Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 103 607White River Capital Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 172,799 3,499,180

3,499,787

Diversified Financial Services 11.9%a,d Bond Street Holdings LLC, A, 144A . . . . . . . . . . . . . . . . . . . . United States 206,369 3,972,603

Citigroup Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 41,189 1,083,683First Pacific Co. Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hong Kong 8,141,469 8,490,961Hellenic Exchanges SA Holding Clearing Settlement and Registry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Greece 234,948 878,829

a ING Groep NV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Netherlands 526,883 3,791,612a,d North American Financial Holdings Inc., A, 144A . . . . . . . . . . . United States 42,649 639,735a,d North American Financial Holdings Inc., B, 144A, non-voting . . United States 153,021 2,295,315

NYSE Euronext . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 150,411 3,925,727Osaka Securities Exchange Co. Ltd. . . . . . . . . . . . . . . . . . . . . . Japan 750 4,307,153Oslo Bors VPS Holding ASA . . . . . . . . . . . . . . . . . . . . . . . . . . Norway 911,000 9,139,475

38,525,093

Annual Report | 23

Mutual Financial Services FundStatement of Investments, December 31, 2011 (continued)


Common Stocks and Other Equity Interests (continued)Electric Utilities 0.0%

a,c AET&D Holdings No. 1 Pty. Ltd. . . . . . . . . . . . . . . . . . . . . . . . Australia 490,308 $ —

Household Durables 1.1%a Berkeley Group Holdings PLC . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 186,924 3,694,572

Industrial Conglomerates 1.1%Shanghai Industrial Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . China 1,281,000 3,521,406

Insurance 39.4%ACE Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 144,170 10,109,200Ageas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Belgium 1,635,640 2,540,411Argo Group International Holdings Ltd. . . . . . . . . . . . . . . . . . . United States 114,242 3,308,448Aspen Insurance Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . . . United States 125,616 3,328,824AXA SA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . France 118,350 1,538,697Catlin Group Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 1,109,668 6,877,131

a CNO Financial Group Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 745,470 4,703,916a Enstar Group Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 109,749 10,777,352Hiscox Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 970,882 5,636,234

a,c Imagine Group Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . Bermuda 146,863 1,838,666Lancashire Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 690,536 7,752,036Maiden Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 402,850 3,528,966MetLife Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 133,110 4,150,370

a,c Olympus Re Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 7,480 —PartnerRe Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bermuda 116,700 7,493,307

b Protector Forsikring ASA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Norway 4,479,410 8,089,025RenaissanceRe Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . United States 46,300 3,443,331Resolution Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 2,113,787 8,272,122RSA Insurance Group PLC . . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 2,355,820 3,853,113Symetra Financial Corp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 757,254 6,868,294Transatlantic Holdings Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 63,380 3,468,787Validus Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bermuda 119,914 3,777,291White Mountains Insurance Group Ltd. . . . . . . . . . . . . . . . . . . United States 21,828 9,898,125Zurich Financial Services AG . . . . . . . . . . . . . . . . . . . . . . . . . Switzerland 26,700 6,046,518

127,300,164

Real Estate Investment Trusts (REITs) 1.3%The Link REIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Hong Kong 1,115,514 4,107,808

Real Estate Management & Development 1.2%a Dolphin Capital Investors Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . Virgin Islands (British) 3,979,650 1,375,360Franshion Properties China Ltd. . . . . . . . . . . . . . . . . . . . . . . . China 12,850,800 2,465,389

a,c Star Asia Finance Ltd., 144A . . . . . . . . . . . . . . . . . . . . . . . . . Japan 96,850 92,6083,933,357

Thrifts & Mortgage Finance 3.6%a Cape Bancorp Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 264,663 2,077,605First Clover Leaf Financial Corp. . . . . . . . . . . . . . . . . . . . . . . . United States 358,575 2,187,307

a TFS Financial Corp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 151,800 1,360,128Viewpoint Financial Group . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 227,108 2,954,675Westfield Financial Inc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 424,060 3,121,082

11,700,797

24 | Annual Report



Common Stocks and Other Equity Interests (continued)Trading Companies & Distributors 0.7%Seven Group Holdings Ltd. . . . . . . . . . . . . . . . . . . . . . . . . . . . Australia 314,146 $ 2,275,420

Total Common Stocks and Other Equity Interests(Cost $312,448,939) . . . . . . . . . . . . . . . . . . . . . . . . . . 273,792,307

Convertible Preferred Stocks 0.3%Commercial Banks 0.3%

a,c First Southern Bancorp Inc., cvt. pfd., C . . . . . . . . . . . . . . . . . United States 190 699,839a West Coast Bancorp, cvt. pfd., B . . . . . . . . . . . . . . . . . . . . . . . United States 1,224 190,944

Total Convertible Preferred Stocks(Cost $312,400) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 890,783

Preferred Stocks 1.1%Diversified Financial Services 1.1%

a,c Hightower Holding LLC, pfd., A . . . . . . . . . . . . . . . . . . . . . . . . United States 3,000,000 2,513,490a,c Hightower Holding LLC, pfd., A, Series 2 . . . . . . . . . . . . . . . . . United States 496,574 1,040,115

Total Preferred Stocks (Cost $3,603,760) . . . . . . . . . 3,553,605

Principal Amount*

Corporate Bonds and Notes 1.5%d,e Catlin Insurance Co. Ltd., pfd., junior sub. stock, 144A,

7.249%, Perpetual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bermuda 3,000,000 2,572,500e EGG Banking PLC, sub. note, 19, 7.50% to 12/09/13, FRN

thereafter, Perpetual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United Kingdom 1,740,000 GBP 2,375,509

Total Corporate Bonds and Notes (Cost $2,116,450) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,948,009

Shares

Companies in Liquidation (Cost $—) 0.0%a,c FIM Coinvestor Holdings I, LLC . . . . . . . . . . . . . . . . . . . . . . . . United States 4,357,178 —

Total Investments before Short Term Investments (Cost $318,481,549) . . . . . . . . . . . . . . . . . . . . . . . . . . 283,184,704

Principal Amount*

Short Term Investments 3.4%U.S. Government and Agency Securities 3.4%

f FHLB, 1/03/12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 700,000 700,000f U.S. Treasury Bills,

3/22/12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 4,500,000 4,499,851g 3/08/12 - 6/28/12 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . United States 6,000,000 5,999,070

Total U.S. Government and Agency Securities(Cost $11,198,865) . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,198,921

Total Investments (Cost $329,680,414) 91.0% . . . . . 294,383,625

Other Assets, less Liabilities 9.0% . . . . . . . . . . . . . . . . 29,016,830

Net Assets 100.0% . . . . . . . . . . . . . . . . . . . . . . . . . . . . $323,400,455

Annual Report | 25


*The principal amount is stated in U.S. dollars unless otherwise indicated.aNon-income producing.bSee Note 13 regarding holdings of 5% voting securities.cSee Note 10 regarding restricted securities.dSecurity 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 ina 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 December 31,2011, the aggregate value of these securities was $9,480,153, representing 2.93% of net assets.ePerpetual security with no stated maturity date.fThe security is traded on a discount basis with no stated coupon rate.gSecurity or a portion of the security has been pledged as collateral for open futures contracts. At December 31, 2011, the value of this security and/or cash pledged as collateralwas $83,997, representing 0.03% of net assets.

At December 31, 2011, the Fund had the following futures contracts outstanding. See Note 1(c).

Futures Contracts

Number of Notional Expiration Unrealized UnrealizedDescription Type Contracts Value Date Appreciation Depreciation

EUR/USD . . . . . . . . . . . . . . . Short 7 $1,134,700 3/19/12 $8,797 $— GBP/USD . . . . . . . . . . . . . . . Short 26 2,518,750 3/19/12 183 —

Unrealized appreciation (depreciation) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,980 —

Net unrealized appreciation (depreciation) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,980

At December 31, 2011, the Fund had the following forward exchange contracts outstanding. See Note 1(c).

Forward Exchange Contracts

Settlement Unrealized UnrealizedCurrency Counterparty Type Quantity Contract Amount Date Appreciation Depreciation

British Pound . . . . . . . . . . . . . BANT Sell 6,709,666 $10,353,351 1/17/12 $ — $ (66,667)British Pound . . . . . . . . . . . . . SSBT Buy 211,789 331,117 1/17/12 — (2,212)British Pound . . . . . . . . . . . . . BBU Buy 484,492 750,720 1/17/12 1,689 — British Pound . . . . . . . . . . . . . HAND Buy 484,492 750,957 1/17/12 1,452 — British Pound . . . . . . . . . . . . . BBU Sell 1,557,846 2,453,601 1/17/12 34,288 — British Pound . . . . . . . . . . . . . HSBC Sell 1,338,801 2,104,017 1/17/12 24,878 — British Pound . . . . . . . . . . . . . BANT Sell 676,904 1,069,509 1/17/12 18,286 — British Pound . . . . . . . . . . . . . DBFX Sell 130,117 209,742 1/17/12 7,672 — Euro . . . . . . . . . . . . . . . . . . . DBFX Buy 222,690 301,077 1/18/12 — (12,812)Euro . . . . . . . . . . . . . . . . . . . BANT Buy 197,353 256,384 1/18/12 — (917)Euro . . . . . . . . . . . . . . . . . . . BBU Buy 197,353 256,198 1/18/12 — (731)Euro . . . . . . . . . . . . . . . . . . . HSBC Sell 65,730 93,182 1/18/12 8,097 — Euro . . . . . . . . . . . . . . . . . . . BANT Sell 103,573 146,585 1/18/12 12,514 — Euro . . . . . . . . . . . . . . . . . . . BBU Sell 65,730 93,066 1/18/12 7,981 — Euro . . . . . . . . . . . . . . . . . . . DBFX Sell 37,843 53,680 1/18/12 4,694 — Japanese Yen . . . . . . . . . . . . . HSBC Sell 121,300,000 1,566,172 1/20/12 — (10,383)Japanese Yen . . . . . . . . . . . . . BANT Buy 24,132,676 313,972 1/20/12 — (316)Japanese Yen . . . . . . . . . . . . . SSBT Buy 107,498,700 1,387,492 1/20/12 9,685 — Japanese Yen . . . . . . . . . . . . . DBFX Sell 1,013,258,922 13,220,933 1/20/12 51,454 — South Korean Won . . . . . . . . . BANT Buy 7,318,397,320 6,344,270 2/08/12 — (49,597)South Korean Won . . . . . . . . . BANT Buy 2,100,266,700 1,801,258 2/08/12 5,216 — South Korean Won . . . . . . . . . BANT Sell 22,939,349,100 20,383,811 2/08/12 653,300 —



Forward Exchange Contracts (continued)

Settlement Unrealized UnrealizedCurrency Counterparty Type Quantity Contract Amount Date Appreciation Depreciation

Swiss Franc . . . . . . . . . . . . . . DBFX Buy 1,437,318 $ 1,868,581 2/10/12 $ — $(335,580)Swiss Franc . . . . . . . . . . . . . . BBU Buy 500,000 688,705 2/10/12 — (155,420)Swiss Franc . . . . . . . . . . . . . . BANT Buy 105,341 119,043 2/10/12 — (6,689)Swiss Franc . . . . . . . . . . . . . . SSBT Buy 271,530 295,112 2/10/12 — (5,506)Swiss Franc . . . . . . . . . . . . . . HAND Buy 36,031 40,681 2/10/12 — (2,251)Swiss Franc . . . . . . . . . . . . . . SSBT Buy 314,849 330,856 2/10/12 4,953 — Swiss Franc . . . . . . . . . . . . . . BBU Sell 2,539,865 3,275,828 2/10/12 566,882 — Swiss Franc . . . . . . . . . . . . . . DBFX Sell 2,577,896 3,318,019 2/10/12 568,511 — Swiss Franc . . . . . . . . . . . . . . HSBC Sell 128,501 141,382 2/10/12 4,327 — Swiss Franc . . . . . . . . . . . . . . BANT Sell 108,848 117,313 2/10/12 1,218 — British Pound . . . . . . . . . . . . . SSBT Buy 1,120,356 1,737,124 2/21/12 2,188 — British Pound . . . . . . . . . . . . . BANT Sell 10,224,496 16,124,030 2/21/12 250,870 — British Pound . . . . . . . . . . . . . DBFX Sell 622,121 975,710 2/21/12 9,889 — British Pound . . . . . . . . . . . . . SSBT Sell 58,884 92,398 2/21/12 983 — British Pound . . . . . . . . . . . . . HSBC Sell 58,884 92,420 2/21/12 1,004 — British Pound . . . . . . . . . . . . . BBU Sell 58,884 92,350 2/21/12 935 — Australian Dollar . . . . . . . . . . . BANT Sell 1,100,000 1,081,465 2/23/12 — (36,724)Australian Dollar . . . . . . . . . . . SSBT Sell 179,000 171,709 2/23/12 — (10,250)Australian Dollar . . . . . . . . . . . DBFX Buy 246,184 243,233 2/23/12 7,021 — Australian Dollar . . . . . . . . . . . BANT Buy 133,000 133,098 2/23/12 2,101 — Australian Dollar . . . . . . . . . . . SSBT Buy 328,823 323,492 2/23/12 10,768 — Australian Dollar . . . . . . . . . . . BANT Sell 1,238,524 1,267,010 2/23/12 8,007 — Australian Dollar . . . . . . . . . . . SSBT Sell 169,600 173,118 2/23/12 713 — Euro . . . . . . . . . . . . . . . . . . . BBU Buy 1,824,270 2,451,011 3/15/12 — (88,247)Euro . . . . . . . . . . . . . . . . . . . DBFX Buy 1,819,495 2,413,082 3/15/12 — (56,502)Euro . . . . . . . . . . . . . . . . . . . SSBT Buy 977,165 1,273,627 3/15/12 — (8,019)Euro . . . . . . . . . . . . . . . . . . . BANT Buy 579,046 757,294 3/15/12 — (7,323)Euro . . . . . . . . . . . . . . . . . . . SSBT Buy 656,570 851,359 3/15/12 3,596 — Euro . . . . . . . . . . . . . . . . . . . BANT Sell 5,995,388 8,226,155 3/15/12 461,028 — Euro . . . . . . . . . . . . . . . . . . . BBU Sell 3,056,980 4,169,599 3/15/12 210,249 — Euro . . . . . . . . . . . . . . . . . . . DBFX Sell 1,337,121 1,807,647 3/15/12 75,830 — Euro . . . . . . . . . . . . . . . . . . . SSBT Sell 1,269,094 1,725,988 3/15/12 82,279 — Euro . . . . . . . . . . . . . . . . . . . HSBC Sell 58,134 78,437 3/15/12 3,143 — British Pound . . . . . . . . . . . . . BANT Sell 8,243,627 12,991,956 3/19/12 197,590 — Norwegian Krone . . . . . . . . . . . HAND Sell 81,355,044 13,524,315 6/19/12 — (1,176)Norwegian Krone . . . . . . . . . . . SSBT Buy 2,580,000 429,005 6/19/12 5,121 — Norwegian Krone . . . . . . . . . . . HAND Sell 2,927,294 487,427 6/19/12 756 —

Unrealized appreciation (depreciation) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,321,168 (857,322)

Net unrealized appreciation (depreciation) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,463,846

See Abbreviations on page 46.


Mutual Financial Services FundFinancial Statements

Statement of Assets and LiabilitiesDecember 31, 2011

Assets:Investments in securities:Cost - Unaffiliated issuers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 317,404,492Cost - Non-controlled affiliated issuers (Note 13) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,275,922

Total cost of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 329,680,414

Value - Unaffiliated issuers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 286,119,372Value - Non-controlled affiliated issuers (Note 13) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,264,253

Total value of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294,383,625Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19,132,967Restricted cash (Note 1e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,020,000Foreign currency, at value (cost $7,846,185) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,846,163Receivables:Investment securities sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 796,367Capital shares sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 711,252Dividends and interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 523,862Unrealized appreciation on forward exchange contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,321,168Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327,735,417

Liabilities:Payables:Investment securities purchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 740,238Capital shares redeemed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 777,492Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 496,217Variation margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,013Due to brokers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,020,000Unrealized depreciation on forward exchange contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 857,322Accrued expenses and other liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 422,680

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,334,962

Net assets, at value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 323,400,455

Net assets consist of:Paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 592,204,091Undistributed net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,348,393Net unrealized appreciation (depreciation) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (32,817,122)Accumulated net realized gain (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (237,334,907)

Net assets, at value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 323,400,455


Mutual Financial Services FundFinancial Statements (continued)

Statement of Assets and Liabilities (continued)December 31, 2011

Class Z:Net assets, at value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 80,105,143

Shares outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,950,009

Net asset value and maximum offering price per share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11.53

Class A:Net assets, at value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 173,166,891


Net asset value per sharea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11.57

Maximum offering price per share (net asset value per share ÷ 94.25%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12.28

Class B:Net assets, at value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,803,939

Shares outstanding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157,480

Net asset value and maximum offering price per sharea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11.46

Class C:Net assets, at value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 68,324,482


Net asset value and maximum offering price per sharea . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11.55

aRedemption price is equal to net asset value less contingent deferred sales charges, if applicable.



Statement of Operationsfor the year ended December 31, 2011

Investment income:Dividends:Unaffiliated issuers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,952,649Non-controlled affiliated issuers (Note 13) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,186,743Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,344,188

Total investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,483,580

Expenses:Management fees (Note 3a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,120,947Administrative fees (Note 3b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297,339Distribution fees: (Note 3c)Class A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 633,201Class B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36,027Class C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 828,011Transfer agent fees (Note 3e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 938,643Custodian fees (Note 4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,483Reports to shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117,157Registration and filing fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63,869Professional fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206,941Trustees’ fees and expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,078Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,100

Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,326,796

Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,156,784

Realized and unrealized gains (losses):Net realized gain (loss) from:Investments:Unaffiliated issuers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,666,005)Non-controlled affiliated issuers (Note 13) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,316,920)Foreign currency transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,897,291)Futures contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195,212

Net realized gain (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (22,685,004)

Net change in unrealized appreciation (depreciation) on:Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (23,625,743)Translation of other assets and liabilities denominated in foreign currencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,531,209

Net change in unrealized appreciation (depreciation) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (21,094,534)

Net realized and unrealized gain (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (43,779,538)

Net increase (decrease) in net assets resulting from operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(36,622,754)



Statements of Changes in Net Assets

Year Ended December 31,

2011 2010Increase (decrease) in net assets:Operations:Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,156,784 $ 7,097,545Net realized gain (loss) from investments, written options, foreign currency transactionsand futures contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (22,685,004) (11,991,986)Net change in unrealized appreciation (depreciation) on investments and translation of other assets and liabilities denominated in foreign currencies . . . . . . . . . . . . . . . . . . . . . . (21,094,534) 53,003,388

Net increase (decrease) in net assets resulting from operations . . . . . . . . . . . . . . . . . . . (36,622,754) 48,108,947

Distributions to shareholders from:Net investment income:Class Z . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,900,993) (4,118,180)Class A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,519,262) (8,910,756)Class B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (12,119) (169,371)Class C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (829,646) (2,953,204)

Total distributions to shareholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,262,020) (16,151,511)

Capital share transactions: (Note 2)Class Z . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (7,091,180) (9,562,908)Class A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (29,822,684) (36,123,897)Class B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,179,623) (5,076,492)Class C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (12,541,997) (14,373,840)

Total capital share transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (52,635,484) (65,137,137)

Net increase (decrease) in net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (95,520,258) (33,179,701)Net assets:Beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 418,920,713 452,100,414

End of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $323,400,455 $418,920,713

Undistributed net investment income included in net assets:End of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,348,393 $ (2,564,880)

Annual Report | 31

Mutual Financial Services FundNotes to Financial Statements

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Franklin Mutual Series Funds (Trust) is registered under the Investment Company Act of 1940,as amended, (1940 Act) as an open-end investment company, consisting of seven separate funds.The Mutual Financial Services Fund (Fund) is included in this report. The financial statementsof the remaining funds in the Trust are presented separately. The Fund offers four classes ofshares: Class Z, Class A, Class B, and Class C. Each class of shares differs by its initial salesload, contingent deferred sales charges, distribution fees, voting rights on matters affecting a single class and its exchange privilege.

The following summarizes the Fund’s significant accounting policies.

a. Financial Instrument Valuation

The Fund’s investments in securities and other financial instruments are carried at fair valuedaily. Fair value is the price that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction between market participants on the measurement date. Under proce-dures approved by the Trust’s Board of Trustees, the Fund may utilize independent pricingservices, quotations from securities and financial instrument dealers, and other market sourcesto determine fair value.

Equity securities and derivative financial instruments (derivatives) listed on an exchange or onthe NASDAQ National Market System are valued at the last quoted sale price or the officialclosing price of the day, respectively. Foreign equity securities are valued as of the close of trad-ing on the foreign stock exchange on which the security is primarily traded, or the NYSE,whichever is earlier. The value is then converted into its U.S. dollar equivalent at the foreignexchange rate in effect at the close of the NYSE on the day that the value of the security is deter-mined. Over-the-counter securities are valued within the range of the most recent quoted bidand ask prices. Securities that trade in multiple markets or on multiple exchanges are valuedaccording to the broadest and most representative market. Certain equity securities are valuedbased upon fundamental characteristics or relationships to similar securities.

Debt securities generally trade in the over-the-counter market rather than on a securitiesexchange. The Fund’s pricing services use multiple valuation techniques to determine fair value.In instances where sufficient market activity exists, the pricing services may utilize a market-based approach through which quotes from market makers are used to determine fair value. Ininstances where sufficient market activity may not exist or is limited, the pricing services alsoutilize proprietary valuation models which may consider market characteristics such as bench-mark yield curves, option-adjusted spreads, credit spreads, estimated default rates, coupon rates,anticipated timing of principal repayments, underlying collateral, and other unique security fea-tures in order to estimate the relevant cash flows, which are then discounted to calculate the fairvalue. Securities denominated in a foreign currency are converted into their U.S. dollar equiva-lent at the foreign exchange rate in effect at the close of the NYSE on the date that the values ofthe foreign debt securities are determined.

32 | Annual Report

Mutual Financial Services FundNotes to Financial Statements (continued)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (continued)

a. Financial Instrument Valuation (continued)

Certain derivatives trade in the over-the-counter market. The Fund’s pricing services use varioustechniques including industry standard option pricing models and proprietary discounted cashflow models to determine the fair value of those instruments. The Fund’s net benefit or obliga-tion under the derivative contract, as measured by the fair market value of the contract, isincluded in net assets.

The Fund has procedures to determine the fair value of securities and other financial instru-ments for which market prices are not readily available or which may not be reliably priced.Under these procedures, the Fund primarily employs a market-based approach which may userelated or comparable assets or liabilities, recent transactions, market multiples, book values,and other relevant information for the investment to determine the fair value of the investment.The Fund may also use an income-based valuation approach in which the anticipated futurecash flows of the investment are discounted to calculate fair value. Discounts may also beapplied due to the nature or duration of any restrictions on the disposition of the investments.Due to the inherent uncertainty of valuations of such investments, the fair values may differ sig-nificantly from the values that would have been used had an active market existed.

Trading in securities on foreign securities stock exchanges and over-the-counter markets may becompleted before the daily close of business on the NYSE. Occasionally, events occur betweenthe time at which trading in a foreign security is completed and the close of the NYSE thatmight call into question the reliability of the value of a portfolio security held by the Fund. As aresult, differences may arise between the value of the Fund’s portfolio securities as determined atthe foreign market close and the latest indications of value at the close of the NYSE. In order tominimize the potential for these differences, the investment manager monitors price movementsfollowing the close of trading in foreign stock markets through a series of country specific mar-ket proxies (such as baskets of American Depositary Receipts, futures contracts and exchangetraded funds). These price movements are measured against established trigger thresholds foreach specific market proxy to assist in determining if an event has occurred that may call intoquestion the reliability of the values of the foreign securities held by the Fund. If such an eventoccurs, the securities may be valued using fair value procedures, which may include the use ofindependent pricing services.

b. Foreign Currency Translation

Portfolio securities and other assets and liabilities denominated in foreign currencies are translatedinto U.S. dollars based on the exchange rate of such currencies against U.S. dollars on the date ofvaluation. The Fund may enter into foreign currency exchange contracts to facilitate transactionsdenominated in a foreign currency. Purchases and sales of securities, income and expense itemsdenominated in foreign currencies are translated into U.S. dollars at the exchange rate in effect onthe transaction date. Portfolio securities and assets and liabilities denominated in foreign currenciescontain risks that those currencies will decline in value relative to the U.S. dollar. Occasionally,

Annual Report | 33



b. Foreign Currency Translation (continued)

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 fairvalue 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 changesin market prices on securities held. Such changes are included in net realized and unrealized gain orloss from investments on the Statement of Operations.

Realized foreign exchange gains or losses arise from sales of foreign currencies, currency gains orlosses realized between the trade and settlement dates on securities transactions and the differencebetween 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 gainsand losses arise from changes in foreign exchange rates on foreign denominated assets and liabili-ties other than investments in securities held at the end of the reporting period.

c. Derivative Financial Instruments

The Fund invested in derivatives in order to manage risk or gain exposure to various otherinvestments or markets. Derivatives are financial contracts based on an underlying or notionalamount, require no initial investment or an initial net investment that is smaller than wouldnormally be required to have a similar response to changes in market factors, and require orpermit net settlement. Derivatives contain various risks including the potential inability of thecounterparty to fulfill their obligations under the terms of the contract, the potential for anilliquid secondary market, and/or the potential for market movements which expose the Fundto gains or losses in excess of the amounts shown on the Statement of Assets and Liabilities.Realized gain and loss and unrealized appreciation and depreciation on these contracts for theperiod are included in the Statement of Operations.

The Fund entered into futures contracts primarily to manage exposure to certain foreign cur-rencies. A futures contract is an agreement between the Fund and a counterparty to buy orsell an asset for a specified price on a future date. Required initial margin deposits of cash orsecurities are pledged by the Fund. Subsequent payments, known as variation margin, aremade or received by the Fund, depending on fluctuations in the value of the underlying secu-rity. Such variation margin is accounted for as unrealized appreciation or depreciation untilthe contract is closed, at which time the gains or losses are realized.

The Fund entered into forward exchange contracts primarily to manage exposure to certainforeign currencies. A forward exchange contract is an agreement between the Fund and acounterparty to buy or sell a foreign currency for a specific exchange rate on a future date.Pursuant to the terms of the forward exchange contracts, cash or securities may be required tobe deposited as collateral. Unrestricted cash may be invested according to the Fund’s invest-ment objectives.

34 | Annual Report



c. Derivative Financial Instruments (continued)

The Fund purchased or wrote option contracts primarily to manage exposure to equity pricerisk. An option is a contract entitling the holder to purchase or sell a specific amount ofshares or units of an asset or notional amount of a swap (swaption), at a specified price.Options purchased are recorded as an asset while options written are recorded as a liability.Upon exercise of an option, the acquisition cost or sales proceeds of the underlying invest-ment is adjusted by any premium received or paid. Upon expiration of an option, anypremium received or paid is recorded as a realized gain or loss. Upon closing an option otherthan through expiration or exercise, the difference between the premium and the cost to closethe position is recorded as a realized gain or loss. Pursuant to the terms of the written optioncontract, cash or securities may be required to be deposited as collateral.

At December 31, 2011, the Fund holds $1,675,435 in U.S. Treasury Bills, Bonds and Notes ascollateral for derivatives.

See Note 12 regarding other derivative information.

d. Securities Lending

The Fund participates in an agency based security lending program. The Fund receives cash col-lateral against the loaned securities in an amount equal to at least 102% of the market value ofthe loaned securities. Collateral is maintained over the life of the loan in an amount not less than100% of the market value of loaned securities, as determined at the close of Fund business eachday; any additional collateral required due to changes in security values is delivered to the Fundon the next business day. The collateral is invested in a non-registered money fund managed bythe Fund’s custodian on the Fund’s behalf. The Fund receives income from the investment of cashcollateral, in addition to lending fees and rebates paid by the borrower. The Fund bears the mar-ket risk with respect to the collateral investment, securities loaned, and the risk that the agentmay default on its obligations to the Fund. The securities lending agent has agreed to indemnifythe Fund in the event of default by a third party borrower. At December 31, 2011, the Fund hadno securities on loan.

e. Restricted Cash

At December 31, 2011, the Fund held restricted cash in connection with investments in certain derivative securities. Restricted cash is held in a segregated account with the Fund’s custodian/counterparty broker and is reflected in the Statement of Assets and Liabilities.

f. Income Taxes

It is the Fund’s policy to qualify as a regulated investment company under the Internal RevenueCode. The Fund intends to distribute to shareholders substantially all of its taxable income andnet realized gains to relieve it from federal income and excise taxes. As a result, no provision forU.S. federal income taxes is required.

Annual Report | 35



f. Income Taxes (continued)

The Fund may be subject to foreign taxation related to income received, capital gains on the saleof securities and certain foreign currency transactions in the foreign jurisdictions in which itinvests. Foreign taxes, if any, are recorded based on the tax regulations and rates that exist inthe foreign markets in which the Fund invests. When a capital gain tax is determined to applythe Fund records an estimated deferred tax liability in an amount that would be payable if thesecurities were disposed of on the valuation date.

The Fund recognizes the tax benefits of uncertain tax positions only when the position is “morelikely than not” to be sustained upon examination by the tax authorities based on the technicalmerits of the tax position. As of December 31, 2011, and for all open tax years, the Fund hasdetermined that no liability for unrecognized tax benefits is required in the Fund’s financialstatements related to uncertain tax positions taken on a tax return (or expected to be taken onfuture tax returns). Open tax years are those that remain subject to examination and are basedon each tax jurisdiction statute of limitation.

g. Security Transactions, Investment Income, Expenses and Distributions

Security transactions are accounted for on trade date. Realized gains and losses on securitytransactions are determined on a specific identification basis. Interest income and estimatedexpenses are accrued daily. Amortization of premium and accretion of discount on debt securi-ties are included in interest income. Dividend income is recorded on the ex-dividend date exceptthat certain dividends from foreign securities are recognized as soon as the Fund is notified ofthe ex-dividend date. Distributions to shareholders are recorded on the ex-dividend date and aredetermined according to income tax regulations (tax basis). Distributable earnings determinedon a tax basis may differ from earnings recorded in accordance with accounting principles gen-erally accepted in the United States of America. These differences may be permanent ortemporary. Permanent differences are reclassified among capital accounts to reflect their taxcharacter. These reclassifications have no impact on net assets or the results of operations.Temporary differences are not reclassified, as they may reverse in subsequent periods.

Common expenses incurred by the Trust are allocated among the funds based on the ratio ofnet assets of each fund to the combined net assets of the Trust. Fund specific expenses arecharged directly to the fund that incurred the expense.

Realized and unrealized gains and losses and net investment income, not including class specificexpenses, are allocated daily to each class of shares based upon the relative proportion of netassets of each class. Differences in per share distributions, by class, are generally due to differ-ences in class specific expenses.

36 | Annual Report



h. Accounting Estimates

The preparation of financial statements in accordance with accounting principles generallyaccepted in the United States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities at the date of the financial statements andthe amounts of income and expenses during the reporting period. Actual results could differ fromthose estimates.

i. Guarantees and Indemnifications

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

2. SHARES OF BENEFICIAL INTEREST

At December 31, 2011, there were an unlimited number of shares authorized (without parvalue). Transactions in the Fund’s shares were as follows:

Year Ended December 31, 2011 2010

Shares Amount Shares Amount

Class Z Shares:Shares sold . . . . . . . . . . . . . . . . . . 864,842 $ 10,961,579 538,526 $ 6,731,752Shares issued in reinvestment of distributions . . . . . . . . . . . . . . . . 150,783 1,712,909 291,283 3,674,743Shares redeemed . . . . . . . . . . . . . (1,557,606) (19,765,668) (1,601,706) (19,969,403)

Net increase (decrease) . . . . . . . . (541,981) $ (7,091,180) (771,897) $ (9,562,908)

Class A Shares:Shares sold . . . . . . . . . . . . . . . . . . 3,067,655 $ 40,020,108 3,100,831 $ 38,872,693Shares issued in reinvestment of distributions . . . . . . . . . . . . . . . . 295,417 3,367,761 651,933 8,246,644Shares redeemed . . . . . . . . . . . . . (5,724,546) (73,210,553) (6,714,101) (83,243,234)

Net increase (decrease) . . . . . . . . . (2,361,474) $(29,822,684) (2,961,337) $ (36,123,897)

Class B Shares:Shares sold . . . . . . . . . . . . . . . . . . 8,517 $ 107,274 17,315 $ 210,175Shares issued in reinvestment of distributions . . . . . . . . . . . . . . . . 1,031 11,637 12,853 159,425Shares redeemed . . . . . . . . . . . . . (263,076) (3,298,534) (449,123) (5,446,092)

Net increase (decrease) . . . . . . . . . (253,528) $ (3,179,623) (418,955) $ (5,076,492)

Annual Report | 37


2. SHARES OF BENEFICIAL INTEREST (continued)

Year Ended December 31, 2011 2010

Shares Amount Shares Amount

Class C Shares:Shares sold . . . . . . . . . . . . . . . . . . 546,272 $ 7,126,309 669,208 $ 8,255,621Shares issued in reinvestment of distributions . . . . . . . . . . . . . . . . 67,422 767,348 211,885 2,670,323Shares redeemed . . . . . . . . . . . . . (1,614,317) (20,435,654) (2,048,401) (25,299,784)

Net increase (decrease) . . . . . . . . . (1,000,623) $(12,541,997) (1,167,308) $ (14,373,840)

3. TRANSACTIONS WITH AFFILIATES

Franklin Resources, Inc. is the holding company for various subsidiaries that together are referredto as Franklin Templeton Investments. Certain officers and trustees of the Fund are also officersand/or directors of the following subsidiaries:

Subsidiary AffiliationFranklin Mutual Advisers, LLC (Franklin Mutual) Investment managerFranklin Templeton Services, LLC (FT Services) Administrative managerFranklin Templeton Distributors, Inc. (Distributors) Principal underwriterFranklin Templeton Investor Services, LLC (Investor Services) Transfer agent

a. Management Fees

The Fund pays an investment management fee to Franklin Mutual based on the average dailynet assets of the Fund as follows:

Annualized Fee Rate Net Assets

0.800% Up to and including $1 billion0.770% Over $1 billion, up to and including $2 billion0.750% Over $2 billion, up to and including $5 billion0.730% In excess of $5 billion

b. Administrative Fees

The Fund pays its allocated share of an administrative fee to FT Services based on the Trust’saggregate average daily net assets as follows:

Annualized Fee Rate Net Assets

0.150% Up to and including $200 million0.135% Over $200 million, up to and including $700 million0.100% Over $700 million, up to and including $1.2 billion0.075% In excess of $1.2 billion

38 | Annual Report


3. TRANSACTIONS WITH AFFILIATES (continued)

c. Distribution Fees

The Trust’s Board of Trustees has adopted distribution plans for each share class, with the excep-tion of Class Z shares, pursuant to Rule 12b-1 under the 1940 Act. Under the Fund’s Class Areimbursement distribution plan, the Fund reimburses Distributors for costs incurred in connec-tion with the servicing, sale and distribution of the Fund’s shares up to the maximum annual planrate. Under the Class A reimbursement distribution plan, costs exceeding the maximum for thecurrent plan year cannot be reimbursed in subsequent periods.

In addition, under the Fund’s Class B and C compensation distribution plans, the Fund paysDistributors for costs incurred in connection with the servicing, sale and distribution of theFund’s shares up to the maximum annual plan rate for each class.

The maximum annual plan rates, based on the average daily net assets, for each class, are as follows:

Class A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.35%Class B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.00%Class C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.00%

The Board of Trustees has set the current rate at 0.30% per year for Class A shares until furthernotice and approval by the Board.

d. Sales Charges/Underwriting Agreements

Front-end sales charges and contingent deferred sales charges (CDSC) do not represent expensesof the Fund. These charges are deducted from the proceeds of sales of Fund shares prior toinvestment or from redemption proceeds prior to remittance, as applicable. Distributors hasadvised the Fund of the following commission transactions related to the sales and redemptionsof the Fund’s shares for the year:

Sales charges retained net of commissions paid to unaffiliated broker/dealers . . . . . . . . . . . . . . . . . . . . . . . . . . . $54,998 CDSC retained . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,304

e. Transfer Agent Fees

For the year ended December 31, 2011, the Fund paid transfer agent fees of $938,643, of which$577,663 was retained by Investor Services.

Annual Report | 39


4. EXPENSE OFFSET ARRANGEMENT

The Fund has entered into an arrangement with its custodian whereby credits realized as a resultof uninvested cash balances are used to reduce a portion of the Fund’s custodian expenses.During the year ended December 31, 2011, there were no credits earned.

5. INDEPENDENT TRUSTEES’ RETIREMENT PLAN

On January 1, 1993, the Trust adopted an Independent Trustees’ Retirement Plan (Plan). The Planis an unfunded defined benefit plan that provides benefit payments to Trustees whose length ofservice and retirement age meets the eligibility requirements of the Plan. Benefits under the Plan arebased on years of service and fees paid to each trustee at the time of retirement. Effective inDecember 1996, the Plan was closed to new participants.

During the year ended December 31, 2011, the Fund’s projected benefit obligation and benefitpayments under the Plan were as follows:

aProjected benefit obligation at December 31, 2011 . . . . . . . . . . $19,728bIncrease in projected benefit obligation . . . . . . . . . . . . . . . . . . . $ 1,992

Benefit payments made to retired trustees . . . . . . . . . . . . . . . . . $ 694

aThe projected benefit obligation is included in accrued expenses and other liabilities in the Statement of Assets and Liabilities.bThe increase in projected benefit obligation is included in trustees’ fees and expenses in the Statement of Operations.

6. INCOME TAXES

For tax purposes, capital losses may be carried over to offset future capital gains, if any. Underthe Regulated Investment Company Modernization Act of 2010, capital losses incurred by theFund in taxable years beginning after December 22, 2010 are not subject to expiration and suchlosses retain their character as either short-term or long-term, rather than being consideredshort-term as under previous law. Post-enactment capital losses must be fully utilized prior toutilizing any losses incurred in pre-enactment tax years.

At December 31, 2011, capital loss carryforwards were as follows:

Capital loss carryforwards subject to expiration:2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $105,848,5442017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73,527,7132018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,091,133

Capital loss carryforwards not subject to expiration . . . . . . . 11,798,586

$222,265,976

40 | Annual Report


6. INCOME TAXES (continued)

For tax purposes, the Fund may elect to defer any portion of a post-October capital loss to thefirst day of the following fiscal year. At December 31, 2011, the Fund deferred post-Octobercapital losses of $11,612,739.

The tax character of distributions paid during the years ended December 31, 2011 and 2010,was as follows:

2011 2010

Distributions paid from ordinary income . . . . . . . . . . . . . . . . . $6,262,020 $16,151,511

At December 31, 2011, the cost of investments, net unrealized appreciation (depreciation), andundistributed ordinary income for income tax purposes were as follows:

Cost of investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $331,875,378

Unrealized appreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 47,218,621Unrealized depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . (84,710,374)

Net unrealized appreciation (depreciation) . . . . . . . . . . . . . . $ (37,491,753)

Distributable earnings – undistributed ordinary income . . . . $ 1,102,527

Differences between income and/or capital gains as determined on a book basis and a tax basis areprimarily due to differing treatment of passive foreign investment company shares.

7. INVESTMENT TRANSACTIONS

Purchases and sales of investments (excluding short term securities) for the year endedDecember 31, 2011, aggregated $84,613,362 and $143,324,530, respectively.

8. CREDIT RISK AND DEFAULTED SECURITIES

The Fund may purchase the pre-default or defaulted debt of distressed companies. Distressedcompanies are financially troubled and are about to be or are already involved in financialrestructuring or bankruptcy. Risks associated with purchasing these securities include the possi-bility that the bankruptcy or other restructuring process takes longer than expected, or thatdistributions in restructuring are less than anticipated, either or both of which may result inunfavorable consequences to the Fund. If it becomes probable that the income on debt securi-ties, including those of distressed companies, will not be collected, the Fund discontinuesaccruing income and recognizes an adjustment for uncollectible interest. At December 31, 2011,the Fund did not hold any distressed company securities for which interest recognition has beendiscontinued.

Annual Report | 41


9. CONCENTRATION OF RISK

Investing in foreign securities may include certain risks and considerations not typically associatedwith investing in U.S. securities, such as fluctuating currency values and changing local andregional economic, political and social conditions, which may result in greater market volatility. Inaddition, certain foreign securities may not be as liquid as U.S. securities.

10. RESTRICTED SECURITIES

The Fund invests in securities that are restricted under the Securities Act of 1933 (1933 Act) orwhich are subject to legal, contractual, or other agreed upon restrictions on resale. Restrictedsecurities are often purchased in private placement transactions, and cannot be sold withoutprior registration unless the sale is pursuant to an exemption under the 1933 Act. Disposal ofthese securities may require greater effort and expense, and prompt sale at an acceptable pricemay be difficult. The Fund may have registration rights for restricted securities. The issuer gen-erally incurs all registration costs.

At December 31, 2011, the Fund held investments in restricted securities, excluding certain secu-rities exempt from registration under the 1933 Act deemed to be liquid, as follows:

AcquisitionShares/Warrants Issuer Dates Cost Value

490,308 AET&D Holdings No. 1 Pty. Ltd. . . . 10/13/10 $ — $ —456,903 The Bankshares Inc. . . . . . . . . . . . 3/22/07 4,569,030 1,633,081

5,268 Elephant Capital Holdings Ltd. . . . . 8/29/03 - 3/10/08 814,629 — 4,357,178 FIM Coinvestor Holdings I, LLC . . . . 11/20/06 - 6/02/09 — —

110,792 First Southern Bancorp Inc. . . . . . . 1/27/10 - 7/07/10 2,337,711 1,076,898 190 First Southern Bancorp Inc., cvt.

pfd., C . . . . . . . . . . . . . . . . . . . . . 1/27/10 - 7/07/10 190,000 699,839 3,000,000 Hightower Holding LLC, pfd., A . . . 3/31/08 - 1/05/10 2,362,324 2,513,490

496,574 Hightower Holding LLC, pfd., A, Series 2 . . . . . . . . . . . . . . . . . . . . 6/10/10 - 3/31/11 1,241,436 1,040,115

146,863 Imagine Group Holdings Ltd. . . . . . 8/31/04 1,504,097 1,838,666 25,741 NCB Warrant Holdings Ltd., A . . . . 12/16/05 - 3/10/08 242,386 —

7,480 Olympus Re Holdings Ltd. . . . . . . . 12/19/01 705,150 —96,850 Star Asia Finance Ltd., 144A . . . . . 2/22/07 - 5/18/07 9,836,925 92,608

6,964 aWest Coast Bancorp, wts., C, 10/23/16 . . . . . . . . . . . . . . . . . . 10/23/09 — 667,980

Total Restricted Securities (2.96% of Net Assets) . . . $23,803,688 $9,562,677

aThe Fund also invests in unrestricted securities or other investments in the issuer, valued at $3,900,000 as of December 31, 2011.


11. UNFUNDED CAPITAL COMMITMENTS

The Fund enters into certain capital commitments and may be obligated to perform on suchagreements at a future date. The Fund monitors these commitments and assesses the probabilityof required performance. For any agreements whose probability of performance is determined tobe greater than remote, the Fund assesses the fair value of the commitment. In instances wherethe probability of performance is greater than remote and the performance under the commit-ment would result in an unrealized loss, the Fund recognizes such losses on the Statement ofAssets and Liabilities and the Statement of Operations.

At December 31, 2011, the Fund had aggregate unfunded capital commitments of $1,178,564,for which no depreciation has been recognized.

12. OTHER DERIVATIVE INFORMATION

At December 31, 2011, the Fund has invested in derivative contracts which are reflected on theStatement of Assets and Liabilities as follows:

Asset Derivatives Liability Derivatives

Derivative Contracts Not Accounted for as Statement of Assets and Fair Value Statement of Assets and Fair ValueHedging Instruments Liabilities Location Amount Liabilities Location Amount

Foreign exchange contracts . . . . . . . . . . Unrealized appreciation on $3,330,148a Unrealized depreciation on $857,322

forward exchange contracts / forward exchange contractsNet assets consist of - net unrealized appreciation (depreciation)

aIncludes cumulative appreciation (depreciation) of futures contracts as reported in the Statement of Investments. Only current day’s variation margin is separately reported within the Statement of Assets and Liabilities.

For the year ended December 31, 2011, the effect of derivative contracts on the Fund’sStatement of Operations was as follows:

Realized Change in Derivative Contracts Statement of Gain (Loss) Unrealized Appreciation Not Accounted for as Operations for the (Depreciation) for Hedging Instruments Locations Year the Year

Foreign exchange contracts . . . . . . . . . Net realized gain (loss) from foreign $(5,410,515) $ 2,511,535currency transactions and futures contracts / Net change in unrealized appreciation (depreciation) on translation of other assets and liabilities denominated in foreign currencies

42 | Annual Report

Annual Report | 43


12. OTHER DERIVATIVE INFORMATION (continued)

For the year ended December 31, 2011, the average month end market value of derivatives represented 1.11% of average month end net assets. The average month end number of openderivative contracts for the year was 75.

See Note 1(c) regarding derivative financial instruments.

13. HOLDINGS OF 5% VOTING SECURITIES OF PORTFOLIO COMPANIES

The 1940 Act defines “affiliated companies” to include investments in portfolio companies inwhich a fund owns 5% or more of the outstanding voting securities. Investments in “affiliatedcompanies” for the Fund for the year ended December 31, 2011, were as shown below.

Number of Shares Number of Shares Value atHeld at Beginning Gross Gross Held at End End of Investment Realized Capital

Name of Issuer of Year Additions Reductions of Year Year Income Gain (Loss)

Non-Controlled AffiliatesAB&T Financial Corp. . . . . . . . . . 226,100 — — 226,100 $ 175,228 $ — $ —

Atlantic Banc Holdings Inc. . . . . 350,000 — 350,000 — — — (3,500,000)

Eurocastle Investment Ltd. . . . . . — 7,624,347 7,624,347 — — — (2,591,105)

First Clover Leaf Financial Corp. . . . . . . . . . . . . . . . . . . . . . 436,070 — 77,495 358,575 —a 104,657 (225,815)

Protector Forsikring ASA . . . . . . . 4,479,410 — — 4,479,410 8,089,025 1,082,086 —

Total Affiliated Securities (2.56% of Net Assets) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,264,253 $1,186,743 $(6,316,920)

aAs of December 31, 2011, no longer an affiliate.

14. CREDIT FACILITY

The Fund, together with other U.S. registered and foreign investment funds (collectively, Borrowers),managed by Franklin Templeton Investments, are borrowers in a joint syndicated senior unsecuredcredit facility totaling $750 million (Global Credit Facility) which matured on January 20, 2012.This Global Credit Facility provides a source of funds to the Borrowers for temporary and emer-gency purposes, including the ability to meet future unanticipated or unusually large redemptionrequests. Effective January 20, 2012, the Borrowers renewed the Global Credit Facility for a total of $1.5 billion, maturing January 18, 2013.

Under the terms of the Global Credit Facility, the Fund shall, in addition to interest charged on anyborrowings made by the Fund and other costs incurred by the Fund, pay its share of fees andexpenses incurred in connection with the implementation and maintenance of the Global CreditFacility, based upon its relative share of the aggregate net assets of all of the Borrowers, including anannual commitment fee of 0.08% based upon the unused portion of the Global Credit Facility,which is reflected in other expenses on the Statement of Operations. During the year endedDecember 31, 2011, the Fund did not use the Global Credit Facility.

44 | Annual Report


15. FAIR VALUE MEASUREMENTS

The Fund follows a fair value hierarchy that distinguishes between market data obtained fromindependent sources (observable inputs) and the Fund’s own market assumptions (unobservableinputs). These inputs are used in determining the value of the Fund’s investments and are sum-marized in the following fair value hierarchy:

• Level 1 – quoted prices in active markets for identical securities

• Level 2 – other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speed, credit risk, etc.)

• Level 3 – significant unobservable inputs (including the Fund’s own assumptions indetermining the fair value of investments)

The inputs or methodology used for valuing securities are not an indication of the risk associ-ated with investing in those securities.

For movements between the levels within the fair value hierarchy, the Fund has adopted a policyof recognizing the transfers as of the date of the underlying event which caused the movement.

The following is a summary of the inputs used as of December 31, 2011, in valuing the Fund’sassets and liabilities carried at fair value:

Level 1 Level 2 Level 3 TotalAssets:

Investments in Securities:

Equity Investments:a

Commercial Banks . . . . . . . . . . . . $ 59,240,363 $ 190,944 $4,077,798b $ 63,509,105

Consumer Finance . . . . . . . . . . . . 3,499,180 607 — 3,499,787

Diversified Financial Services . . . . 31,617,440 6,907,653 3,553,605 42,078,698

Insurance . . . . . . . . . . . . . . . . . . 125,461,498 — 1,838,666b 127,300,164

Real Estate Management & Development . . . . . . . . . . . . . . . 3,840,749 — 92,608 3,933,357

All Other Equity Investmentsc . . . . 37,915,584 — —b 37,915,584

Corporate Bonds and Notes . . . . . . . — 4,948,009 — 4,948,009

Companies in Liquidation . . . . . . . . . — — —b —

Short Term Investments . . . . . . . . . . 10,498,921 700,000 — 11,198,921

Total Investments in Securities . . . . $272,073,735 $12,747,213 $9,562,677 $294,383,625

Futures Contracts . . . . . . . . . . . . . . $ 8,980 $ — $ — $ 8,980

Forward Exchange Contracts . . . . . . — 3,321,168 — 3,321,168

Liabilities:

Forward Exchange Contracts . . . . . . — 857,322 — 857,322

alncludes common, convertible preferred and preferred stocks as well as other equity investments.blncludes securities determined to have no value at December 31, 2011.cFor detailed categories, see the accompanying Statement of Investments.

Annual Report | 45


15. FAIR VALUE MEASUREMENTS (continued)

At December 31, 2011, the reconciliation of assets in which significant unobservable inputs (Level 3) were used in determining fair value, is as follows:

Net Changein Unrealized

Balance Net Net Balance Appreciationat Transfers Transfers Realized Unrealized at (Depreciation)

Beginning Into Out of Cost Basis Gain Gain End of on Assets Heldof Year Purchases Sales Level 3 Level 3a Adjustmentsb (Loss) (Loss) Year at Year End

Assets:Investments in Securities:

Equity Investments:c

Commercial Banks . . . . . . . . . . . . $ 5,590,731d $ — $ — $— $(185,068) $ — $ (11,683,152) $10,355,287 $ 4,077,798d $(192,571)

Consumer Finance . . . . . . . . . . . . 2,595,254 — (2,595,254) — — — (599,008) 599,008 — —

Diversified Financial Services . . . 3,012,620 620,718 — — — — — (79,733) 3,553,605 (79,733)

Electric Utilities . . . . . . . . . . . . . . 2,477,036d — (2,331,910) — — — — (145,126) —d —

Insurance . . . . . . . . . . . . . . . . . . . 2,618,465 — (838,593) — — (2,597) 186,896 (125,505) 1,838,666d 13,501

Real Estate Management & Development . . . . . . . . . . . . . . . . 223,830 — — — — — — (131,222) 92,608 (131,222)

Corporate Bonds and Notes . . . . . . . 3,862,379 — (4,255,829) — — — (475,000) 868,450 — —

Total . . . . . . . . . . . . . . . . . . . . . . . . $20,380,315 $ 620,718 $ (10,021,586) $— $(185,068) $(2,597) $ (12,570,264) $11,341,159 $ 9,562,677 $(390,025)

aThe investment was transferred out of Level 3 as a result of the availability of a quoted price in an active market for identical securities.bMay include accretion, amortization, partnership adjustments, and/or other cost basis adjustments.cIncludes common, convertible preferred and preferred stocks as well as other equity investments.dIncludes securities determined to have no value.

16. NEW ACCOUNTING PRONOUNCEMENTS

In May 2011, the Financial Accounting Standards Board (FASB) issued Accounting StandardsUpdate (ASU) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to AchieveCommon Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. Theamendments in the ASU will improve the comparability of fair value measurements presentedand disclosed in financial statements prepared in accordance with U.S. GAAP (Generally AcceptedAccounting Principles) and IFRS (International Financial Reporting Standards) and include newguidance for certain fair value measurement principles and disclosure requirements. The ASU iseffective for interim and annual periods beginning after December 15, 2011. The Fund believes theadoption of this ASU will not have a material impact on its financial statements.

17. SUBSEQUENT EVENTS

The Fund has evaluated subsequent events through the issuance of the financial statements anddetermined that no events have occurred that require disclosure other than those already dis-closed in the financial statements.

46 | Annual Report


ABBREVIATIONS

Currency

EUR - EuroGBP - British PoundUSD - United States Dollar

Selected Portfolio

FHLB - Federal Home Loan BankFRN - Floating Rate Note

Counterparty

BANT - Bank of America N.A.BBU - Barclays Bank PLCDBFX - Deutsche Bank AGHAND - Svenska HandelsbankenHSBC - HSBC Bank USA, N.A.SSBT - State Street Bank and Trust Co., N.A.

Annual Report | 47

Mutual Financial Services FundReport of Independent Registered Public Accounting Firm

To the Board of Trustees of Franklin Mutual Series Funds and Shareholders of the Mutual Financial Services Fund:

We have audited the accompanying statement of assets and liabilities of the Mutual FinancialServices Fund (one of the Funds constituting the Franklin Mutual Series Funds) (the “Fund”),including the statement of investments, as of December 31, 2011, and the related statement ofoperations for the year then ended, the statements of changes in net assets for each of the twoyears in the period then ended, and the financial highlights for each of the five years in theperiod then ended. These financial statements and financial highlights are the responsibility ofthe Fund’s management. Our responsibility is to express an opinion on these financial state-ments and financial highlights based on our audits.

We conducted our audits in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements and financial highlights arefree of material misstatement. We were not engaged to perform an audit of the Fund’s internal con-trol over financial reporting. Our audits included consideration of internal control over financialreporting as a basis for designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of the Fund’s internal controlover financial reporting. Accordingly, we express no such opinion. An audit also includes examin-ing, on a test basis, evidence supporting the amounts and disclosures in the financial statementsand financial highlights, assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation. Our procedures includedconfirmation of securities owned as of December 31, 2011, by correspondence with the custodianand brokers, or by other appropriate auditing procedures where replies from the brokers were notreceived. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements and financial highlights referred to above present fairly,in all material respects, the financial position of the Mutual Financial Services Fund of theFranklin Mutual Series Funds at December 31, 2011, the results of its operations for the yearthen ended, the changes in its net assets for each of the two years in the period then ended, andthe financial highlights for each of the five years in the period then ended, in conformity withU.S. generally accepted accounting principles.

Boston, MassachusettsFebruary 21, 2012

48 | Annual Report

Mutual Financial Services FundTax Information (unaudited)

Under Section 854(b)(1)(A) of the Internal Revenue Code (Code), the Fund hereby reports34.60% of the ordinary income dividends as income qualifying for the dividends receiveddeduction for the fiscal year ended December 31, 2011.

Under Section 854(b)(1)(B) of the Code, the Fund hereby reports the maximum amount allow-able but no less than $8,626,491 as qualified dividends for purposes of the maximum rate underSection 1(h)(11) of the Code for the fiscal year ended December 31, 2011. Distributions, includ-ing qualified dividend income, paid during calendar year 2011 will be reported to shareholderson Form 1099-DIV by mid-February 2012. Shareholders are advised to check with their taxadvisors for information on the treatment of these amounts on their individual income taxreturns.

Under Section 871(k)(1)(C) of the Code, the Fund hereby reports the maximum amount allow-able but no less than $260,677 as interest related dividends for purposes of the tax imposedunder Section 871(a)(1)(A) of the Code for the fiscal year ended December 31, 2011.

Annual Report | 49

Number of Portfolios inName, Year of Birth Length of Fund Complex Overseen Other Directorships Heldand Address Position Time Served by Board Member* During at Least the Past 5 Years

Mutual Financial Services FundBoard Members and Officers

Independent Board Members

The name, year of birth and address of the officers and board members, as well as their affiliations, positions held withthe Fund, principal occupations during at least the past five years and number of portfolios overseen in the FranklinTempleton Investments fund complex are shown below. Generally, each board member serves until that person’s succes-sor is elected and qualified.

NoneEdward I. Altman, Ph.D. (1941)c/o Franklin Mutual Advisers, LLC101 John F. Kennedy ParkwayShort Hills, NJ 07078-2789

Trustee Since 1987 10

Principal Occupation During at Least the Past 5 Years:Max L. Heine Professor of Finance and Director of The Credit and Debt Markets Research Program, Salomon Center, Stern School ofBusiness, New York University; editor and author of numerous financial publications; financial consultant; an adviser to numerous financialpublishing organizations; and formerly, Vice Director, Salomon Center, Stern School of Business, New York University.

SLM Corporation (Sallie Mae), AresCapital Corporation (specialty financecompany) and Allied CapitalCorporation (financial services) (2003-2010).

Ann Torre Bates (1958)c/o Franklin Mutual Advisers, LLC101 John F. Kennedy ParkwayShort Hills, NJ 07078-2789


Principal Occupation During at Least the Past 5 Years:Independent strategic and financial consultant; and formerly, Executive Vice President and Chief Financial Officer, NHP Incorporated (manager of multifamily housing) (1995-1997); and Vice President and Treasurer, US Airways, Inc. (until 1995).

Franklin Templeton Emerging MarketsDebt Opportunities Fund PLC andFiduciary International IrelandLimited.

Burton J. Greenwald (1929)c/o Franklin Mutual Advisers, LLC101 John F. Kennedy ParkwayShort Hills, NJ 07078-2789


Principal Occupation During at Least the Past 5 Years:Managing Director, B.J. Greenwald Associates (management consultants to the financial services industry); and formerly, Chairman,Fiduciary Trust International Funds; Executive Vice President, L.F Rothschild Fund Management, Inc.; President and Director, Merit MutualFunds; President, Underwriting Division and Director, National Securities & Research Corporation; Governor, Investment Company Instituteand Chairman, ICI Public Information Committee.

50 | Annual Report


NoneKeith E. Mitchell (1954)c/o Franklin Mutual Advisers, LLC101 John F. Kennedy ParkwayShort Hills, NJ 07078-2789


Principal Occupation During at Least the Past 5 Years:Managing Member, Mitchell Hartley Advisers, LLC (formerly, Mitchell Advisers, LLC) (advisory firm); director of various boards of asset management firms; and formerly, Managing Director, Putman Lovell NBF.

NoneCharles Rubens II (1930) c/o Franklin Mutual Advisers, LLC101 John F. Kennedy ParkwayShort Hills, NJ 07078-2789


Principal Occupation During at Least the Past 5 Years:Private investor and president of non-profit organizations; and formerly, an executive of Time, Inc.; and Trustee of Colorado College.

Cbeyond, Inc. (business communica-tions provider), The SouthernCompany (energy company) and TheWashington Post Company (educationand media organization).

Larry D. Thompson (1945)c/o Franklin Mutual Advisers, LLC101 John F. Kennedy ParkwayShort Hills, NJ 07078-2789


Principal Occupation During at Least the Past 5 Years:John A. Sibley Professor of Corporate and Business Law, University of Georgia School of Law (2011); and formerly, Senior Vice President –Government Affairs, General Counsel and Secretary, PepsiCo, Inc. (consumer products) (2004-May 2011); Senior Fellow of The BrookingsInstitution (2003-2004); Visiting Professor, University of Georgia School of Law (2004); and Deputy Attorney General, U.S. Department ofJustice (2001-2003).

NoneJan Hopkins Trachtman (1947)c/o Franklin Mutual Advisers, LLC101 John F. Kennedy ParkwayShort Hills, NJ 07078-2789


Principal Occupation During at Least the Past 5 Years:President and Founder, The Jan Hopkins Group (communications consulting firm); President, Economic Club of New York; serves onAdvisory Board of Knight Bagehot Fellowship; and formerly, Anchor/Correspondent, CNN Financial News (until 2003); Managing Directorand Head of Client Communications, Citigroup Private Bank (until 2005); Off-Air Reporter, ABC News’ World News Tonight and Editor, CBSNetwork News.

El Oro Ltd (investments).Robert E. Wade (1946)c/o Franklin Mutual Advisers, LLC101 John F. Kennedy ParkwayShort Hills, NJ 07078-2789

Trustee andChairman ofthe Board

Trustee since1993 andChairman of theBoard since 2005

42

Principal Occupation During at Least the Past 5 Years:Attorney at law engaged in private practice (1973-2009) and member of various boards.

Annual Report | 51


Interested Board Members and Officers

None**Gregory E. Johnson (1961)One Franklin Parkway San Mateo, CA 94403-1906


Principal Occupation During at Least the Past 5 Years:Director, President and Chief Executive Officer, Franklin Resources, Inc.; officer and/or director or trustee, as the case may be, of some ofthe other subsidiaries of Franklin Resources, Inc. and of 34 of the investment companies in Franklin Templeton Investments; and Chairman,Investment Company Institute.

American International Group, Inc.(AIG) Credit Facility Trust(2010–2011).

**Peter A. Langerman (1955)c/o Franklin Mutual Advisers, LLC101 John F. Kennedy Parkway Short Hills, NJ 07078-2702

Trustee,President andChief ExecutiveOfficer –InvestmentManagement

Trustee since2007, Presidentand ChiefExecutive Officer –InvestmentManagementsince 2005

10

Principal Occupation During at Least the Past 5 Years:Chairman of the Board, Chief Executive Officer and President, Franklin Mutual Advisers, LLC; officer and/or director, as the case may be, offour of the investment companies in Franklin Templeton Investments.

Not ApplicablePhilippe Brugere-Trelat (1949)101 John F. Kennedy ParkwayShort Hills, NJ 07078-2789

Vice President Since 2005 Not Applicable

Principal Occupation During at Least the Past 5 Years:Executive Vice President, Franklin Mutual Advisers, LLC; officer of three of the investment companies in Franklin Templeton Investments;and formerly, Portfolio Manager of Eurovest SA (French registered Investment Company, Sicav).

Not ApplicableJames M. Davis (1952)One Franklin Parkway San Mateo, CA 94403-1906

ChiefComplianceOfficer andVice President– AMLCompliance

Chief ComplianceOfficer since 2004and VicePresident – AMLCompliance since2006

Not Applicable

Principal Occupation During at Least the Past 5 Years:Director, Global Compliance, Franklin Resources, Inc.; and officer of 46 of the investment companies in Franklin Templeton Investments.

Not ApplicableLaura F. Fergerson (1962)One Franklin ParkwaySan Mateo, CA 94403-1906

Chief ExecutiveOfficer –Finance andAdministration

Since 2009 Not Applicable

Principal Occupation During at Least the Past 5 Years:Senior Vice President, Franklin Templeton Services, LLC; officer of 46 of the investment companies in Franklin Templeton Investments; andformerly, Director and member of Audit and Valuation Committees, Runkel Funds, Inc. (2003-2004); Assistant Treasurer of most of theinvestment companies in Franklin Templeton Investments (1997-2003); and Vice President, Franklin Templeton Services, LLC (1997-2003).

52 | Annual Report


Not ApplicableAliya S. Gordon (1973)One Franklin ParkwaySan Mateo, CA 94403-1906


Principal Occupation During at Least the Past 5 Years:Senior Associate General Counsel, Franklin Templeton Investments; officer of 46 of the investment companies in Franklin TempletonInvestments; and formerly, Litigation Associate, Steefel, Levitt & Weiss, LLP (2000-2004).

Not ApplicableDavid P. Goss (1947)One Franklin Parkway San Mateo, CA 94403-1906


Principal Occupation During at Least the Past 5 Years:Senior Associate General Counsel, Franklin Templeton Investments; and officer and/or director, as the case may be, of some of the other subsidiaries of Franklin Resources, Inc. and of 46 of the investment companies in Franklin Templeton Investments.

Not ApplicableSteven J. Gray (1955)One Franklin Parkway San Mateo, CA 94403-1906

Secretary andVice President

Secretary since2005 and VicePresident since2009

Not Applicable

Principal Occupation During at Least the Past 5 Years:Senior Associate General Counsel, Franklin Templeton Investments; Vice President, Franklin Templeton Distributors, Inc.; and officer of 46 ofthe investment companies in Franklin Templeton Investments.

Not ApplicableMatthew T. Hinkle (1971)One Franklin ParkwaySan Mateo, CA 94403-1906

Treasurer,Chief FinancialOfficer andChiefAccountingOfficer

Since 2009 Not Applicable

Principal Occupation During at Least the Past 5 Years:Director, Fund Accounting, Franklin Templeton Investments; and officer of five of the investment companies in Franklin TempletonInvestments.

Not ApplicableRobert C. Rosselot (1960)300 S.E. 2nd StreetFort Lauderdale, FL 33301-1923


Principal Occupation During at Least the Past 5 Years:Senior Associate General Counsel, Franklin Templeton Investments; Assistant Secretary, Franklin Resources, Inc.; Vice President andSecretary, Templeton Investment Counsel, LLC; Vice President, Secretary and Trust Officer, Fiduciary Trust International of the South; andofficer of 46 of the investment companies in Franklin Templeton Investments.

Not ApplicableKaren L. Skidmore (1952)One Franklin ParkwaySan Mateo, CA 94403-1906


Principal Occupation During at Least the Past 5 Years:Senior Associate General Counsel, Franklin Templeton Investments; and officer of 46 of the investment companies in Franklin TempletonInvestments.

Annual Report | 53


Not ApplicableCraig S. Tyle (1960)One Franklin Parkway San Mateo, CA 94403-1906


Principal Occupation During at Least the 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).

Not ApplicableLori A. Weber (1964)300 S.E. 2nd StreetFort Lauderdale, FL 33301-1923

Vice President Since June 2011 Not Applicable

Principal Occupation During at Least the Past 5 Years:Associate General Counsel, Franklin Templeton Investments; Assistant Secretary, Franklin Resources, Inc.; Vice President and AssistantSecretary, Templeton Investment Counsel, LLC; and officer of 45 of the investment companies in Franklin Templeton Investments.

*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 portfolioshave a common investment manager or affiliated investment managers.

**Gregory E. Johnson is considered to be an interested person of the Fund under the federal securities laws due to his position as an officer and director of Franklin Resources,Inc., which is the parent company of the Fund’s investment manager and distributor. Peter A. Langerman is considered to be an interested person of the Fund under the federalsecurities laws due to his position as an officer of Franklin Mutual Advisers, LLC, the Fund’s investment manager.

Note 1: Officer information is current as of the date of this report. It is possible that after this date, information about officers may change.

The Fund’s Board has determined that certain of the members of the Audit Committee, including Ann Torre Bates, are audit committee financial experts, and “independent,”under those provisions of the Sarbanes-Oxley Act of 2002, and the rules and form amendments adopted by the Securities and Exchange Commission, relating to auditcommittee financial experts.

The Statement of Additional Information (SAI) includes additional information about the board members and is available, without charge, upon request. Shareholders maycall (800) DIAL BEN/342-5236 to request the SAI.

54 | Annual Report

Mutual Financial Services FundShareholder Information

Proxy Voting Policies and Procedures

The Fund’s investment manager has established Proxy Voting Policies and Procedures (Policies) thatthe Fund uses to determine how to vote proxies relating to portfolio securities. Shareholders mayview the Fund’s complete Policies online at franklintempleton.com. Alternatively, shareholders mayrequest copies of the Policies free of charge by calling the Proxy Group collect at (954) 527-7678or by sending a written request to: Franklin Templeton Companies, LLC, 300 S.E. 2nd Street, FortLauderdale, FL 33301, Attention: Proxy Group. Copies of the Fund’s proxy voting records are alsomade available online at franklintempleton.com and posted on the U.S. Securities and ExchangeCommission’s website at sec.gov and reflect the most recent 12-month period ended June 30.

Quarterly Statement of Investments

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

Householding of Reports and Prospectuses

You will receive the Fund’s financial reports every six months as well as an annual updated sum-mary prospectus (prospectus available upon request). To reduce Fund expenses, we try to identifyrelated shareholders in a household and send only one copy of the financial reports and summaryprospectus. This process, called “householding,” will continue indefinitely unless you instruct usotherwise. If you prefer not to have these documents householded, please call us at (800) 632-2301.At any time you may view current prospectuses/summary prospectuses and financial reports onour website. If you choose, you may receive these documents through electronic delivery.


GOF P-1 01/12

SUPPLEMENT DATED JANUARY 3, 2012TO THE CURRENTLY EFFECTIVE PROSPECTUS

OF EACH OF THE LISTED FUNDS

Franklin California Tax-Free Income FundFranklin California Tax-Free TrustFranklin California Insured Tax-FreeIncome FundFranklin California Intermediate-TermTax-Free Income FundFranklin California Tax-Exempt Money FundFranklin Custodian FundsFranklin DynaTech FundFranklin Growth FundFranklin Income FundFranklin U.S. Government Securities FundFranklin Utilities FundFranklin Federal Tax-Free Income FundFranklin Global TrustFranklin Global Real Estate FundFranklin International Growth FundFranklin International Small CapGrowth FundFranklin Large Cap Equity FundFranklin Templeton Emerging Market DebtOpportunities FundFranklin Gold and Precious Metals FundFranklin High Income TrustFranklin High Income FundFranklin Investors Securities TrustFranklin Adjustable U.S. GovernmentSecurities FundFranklin Balanced FundFranklin Convertible Securities FundFranklin Equity Income FundFranklin Floating Rate Daily Access FundFranklin Limited Maturity U.S. GovernmentSecurities FundFranklin Low Duration Total Return FundFranklin Real Return FundFranklin Total Return FundFranklin Managed TrustFranklin Rising Dividends FundFranklin Money FundFranklin Municipal Securities TrustFranklin California High Yield Municipal FundFranklin Tennessee Municipal Bond FundFranklin Mutual Recovery FundFranklin Mutual Series FundsMutual Beacon FundMutual Discovery FundMutual European FundMutual Financial Services FundMutual International FundMutual Quest FundMutual Shares Fund

Franklin New York Tax-Free Income FundFranklin New York Tax-Free TrustFranklin New York Intermediate-TermTax-Free IncomeFranklin Real Estate Securities TrustFranklin Real Estate Securities FundFranklin Strategic Mortgage PortfolioFranklin Strategic SeriesFranklin Biotechnology Discovery FundFranklin Flex Cap Growth FundFranklin Focused Core Equity FundFranklin Growth Opportunities FundFranklin Natural Resources FundFranklin Small-Mid Cap Growth FundFranklin Small Cap Growth FundFranklin Strategic Income FundFranklin Tax-Exempt Money FundFranklin Tax-Free TrustFranklin Alabama Tax-Free Income FundFranklin Arizona Tax-Free Income FundFranklin Colorado Tax-Free Income FundFranklin Connecticut Tax-FreeIncome FundFranklin Double Tax-Free Income FundFranklin Federal Intermediate-TermTax-Free Income FundFranklin Federal Limited-Term Tax-FreeIncome FundFranklin Florida Tax-Free Income FundFranklin Georgia Tax-Free Income FundFranklin High Yield Tax-Free Income FundFranklin Insured Tax-Free Income FundFranklin Kentucky Tax-Free Income FundFranklin Louisiana Tax-Free Income FundFranklin Maryland Tax-Free Income FundFranklin Massachusetts Tax-FreeIncome FundFranklin Michigan Tax-Free Income FundFranklin Minnesota Tax-Free Income FundFranklin Missouri Tax-Free Income FundFranklin New Jersey Tax-Free Income FundFranklin North Carolina Tax-FreeIncome FundFranklin Ohio Tax-Free Income FundFranklin Oregon Tax-Free Income FundFranklin Pennsylvania Tax-FreeIncome FundFranklin Virginia Tax-Free Income Fund

Franklin Templeton Fund Allocator SeriesFranklin Templeton 2015 RetirementTarget FundFranklin Templeton 2025 RetirementTarget FundFranklin Templeton 2035 RetirementTarget FundFranklin Templeton 2045 RetirementTarget FundFranklin Templeton ConservativeAllocation FundFranklin Templeton CorefolioAllocation FundFranklin Templeton Founding FundsAllocation FundFranklin Templeton GrowthAllocation FundFranklin Templeton ModerateAllocation FundFranklin Templeton Global TrustFranklin Templeton Hard Currency FundFranklin Templeton International TrustFranklin India Growth FundFranklin Templeton Global Allocation FundFranklin World Perspectives FundTempleton Foreign Smaller Companies FundFranklin Value Investors TrustFranklin All Cap Value FundFranklin Balance Sheet Investment FundFranklin Large Cap Value FundFranklin MicroCap Value FundFranklin MidCap Value FundFranklin Small Cap Value FundInstitutional Fiduciary TrustMoney Market PortfolioTempleton Developing Markets TrustTempleton Global Investment TrustTempleton Asian Growth FundTempleton BRIC FundTempleton Emerging MarketsBalanced FundTempleton Emerging MarketsSmall Cap FundTempleton Frontier Markets FundTempleton Global Balanced FundTempleton Global Opportunities TrustTempleton Institutional FundsEmerging Markets SeriesForeign Equity SeriesForeign Smaller Companies SeriesGlobal Equity Series

The Prospectus is amended as follows:

I. The paragraph beginning “In considering an investor’s trading patterns…” in the “Exchanging Shares – FrequentTrading Policy” section of the Fund Details is revised as follows:

In considering an investor’s trading patterns, the Fund may consider, among other factors, the investor’s trading historyboth directly and, if known, through financial intermediaries, in the Fund, in other Franklin Templeton funds, in


non-Franklin Templeton mutual funds, or in accounts under common control or ownership (see, for example, “Investmentby asset allocators” in the SAI). The transfer agent may also reject any purchase or redemption request, whether or not itrepresents part of any ongoing trading pattern, if the Fund investment manager or transfer agent reasonably concludesthat the amount of the requested transaction may disrupt or otherwise interfere with the efficient management of theFund’s portfolio. In determining what actions should be taken, the Fund’s transfer agent may consider a variety offactors, including the potential impact of such remedial actions on the Fund and its shareholders. If the Fund is a “fundof funds,” the Fund’s transfer agent may take into account the impact of the trading activity and of any proposed remedialaction on both the Fund and the underlying funds in which the Fund invests.

II. The following replaces the second paragraph of the “Selling Shares – Selling Shares in Writing” section of the Fund Details:

We also may require a signature guarantee when we receive instructions from an agent, not the registered owners; whenyou want to send your proceeds to a bank account that was added or changed on your account within the last 15 days andthe bank and fund accounts have at least one common owner; or when we believe it would protect the Fund againstpotential claims based on the instructions received.

III. The following is added to the “SELLING SHARES” table of the “Selling Shares” section as a third paragraph under “ByElectronic Funds Transfer (ACH)” in the “Selling Shares” table of the Fund Details:

If the bank and Fund accounts have at least one common owner and the bank account was added or changed within thelast 15 days, you may be required to provide written instructions signed by all fund account owners, with a signatureguarantee for each fund account owner.

IV. The paragraph beginning “If you believe there are cumulative quantity discount…” in the “Choosing a Share Class –Sales Charge Reductions and Waivers” section of the Fund Details is replaced with the following:

If you believe there are cumulative quantity discount eligible shares that can be combined with your current purchase toachieve a sales charge breakpoint (for example, shares held in a different broker-dealer’s brokerage account or with a bank or an investment advisor), it is your responsibility to specifically identify those shares to your financial advisor atthe time of your purchase (including at the time of any future purchase). It may be necessary for you to provide yourfinancial advisor with information and records (including account statements) of all relevant accounts invested in theFranklin Templeton Funds. If you have not designated a financial advisor associated with your Franklin Templeton fundshares, it is your responsibility to specifically identify any cumulative quantity discount eligible shares to the Fund’stransfer agent at the time of any purchase.

Please keep this supplement for future reference.

Franklin Templeton FundsLiterature Request. To receive a summary prospectus and/or prospectus, please call us at (800) DIAL BEN/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 a 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.

VALUEFranklin All Cap Value FundFranklin Balance Sheet Investment FundFranklin Large Cap Value FundFranklin MicroCap Value Fund1

Franklin MidCap Value FundFranklin Small Cap Value FundMutual Beacon FundMutual Quest FundMutual Recovery Fund2

Mutual Shares Fund

BLENDFranklin Focused Core Equity FundFranklin Large Cap Equity FundFranklin Rising Dividends Fund

GROWTHFranklin DynaTech FundFranklin Flex Cap Growth FundFranklin Growth FundFranklin Growth Opportunities FundFranklin Small Cap Growth FundFranklin Small-Mid Cap Growth Fund

SECTORFranklin Biotechnology Discovery FundFranklin Global Real Estate FundFranklin Gold & Precious Metals FundFranklin Natural Resources FundFranklin Real Estate Securities FundFranklin Utilities FundMutual Financial Services Fund

GLOBALFranklin World Perspectives FundMutual Global Discovery FundTempleton Global Opportunities TrustTempleton Global Smaller Companies FundTempleton Growth FundTempleton World Fund

1. The fund is closed to new investors. Existing shareholders and select retirement plans cancontinue adding to their accounts.2. The fund is a continuously offered, closed-end fund. Shares may be purchased daily; thereis no daily redemption. However, each quarter, pending board approval, the fund will authorizethe repurchase of 5%–25% of the outstanding number of shares. Investors may tender all ora portion of their shares during the tender period.3. Effective 7/1/11, Templeton Income Fund changed its name to Templeton Global BalancedFund. Additionally, the fund changed its goal and pricing structure. Under normalcircumstances, the fund will invest: at least 25% of its assets in fixed income senior securities

and at least 25% of its assets in equity securities; at least 40% of its assets in non-U.S.investments; and in issuers located in at least three different countries (including the U.S.).4. An investment in the fund is neither insured nor guaranteed by the U.S. government or byany other entity or institution.5. For investors subject to the alternative minimum tax, a small portion of fund dividends maybe taxable. Distributions of capital gains are generally taxable.6. The fund invests primarily in insured municipal securities.7. The funds of the Franklin Templeton Variable Insurance Products Trust are generally availableonly through insurance company variable contracts.

AlabamaArizonaCalifornia (4 funds)ColoradoConnecticutFloridaGeorgiaKentuckyLouisianaMarylandMassachusettsMichigan

MinnesotaMissouriNew JerseyNew York (2 funds)North CarolinaOhioOregonPennsylvaniaTennesseeVirginia

INSURANCE FUNDSFranklin Templeton Variable Insurance Products Trust7

12/11 Not part of the annual report

INTERNATIONALFranklin India Growth FundFranklin International Growth FundFranklin International Small Cap Growth FundMutual European FundMutual International FundTempleton Asian Growth FundTempleton BRIC FundTempleton China World FundTempleton Developing Markets TrustTempleton Emerging Markets Small Cap FundTempleton Foreign FundTempleton Foreign Smaller Companies FundTempleton Frontier Markets Fund

HYBRIDFranklin Balanced FundFranklin Convertible Securities FundFranklin Equity Income FundFranklin Income FundTempleton Emerging Markets Balanced FundTempleton Global Balanced Fund3

ASSET ALLOCATIONFranklin Templeton Corefolio® Allocation FundFranklin Templeton Founding Funds Allocation FundFranklin Templeton Conservative Allocation FundFranklin Templeton Growth Allocation FundFranklin Templeton Moderate Allocation FundFranklin Templeton 2015 Retirement Target FundFranklin Templeton 2025 Retirement Target FundFranklin Templeton 2035 Retirement Target FundFranklin Templeton 2045 Retirement Target FundFranklin Templeton Global Allocation FundFranklin Templeton Multi-Asset Real Return Fund

FIXED INCOMEFranklin Adjustable U.S. Government Securities Fund4

Franklin Floating Rate Daily Access FundFranklin High Income Fund

Franklin Limited Maturity U.S. GovernmentSecurities Fund4

Franklin Low Duration Total Return FundFranklin Real Return FundFranklin Strategic Income FundFranklin Strategic Mortgage PortfolioFranklin Templeton Hard Currency FundFranklin Total Return FundFranklin U.S. Government Securities Fund4

Templeton Global Bond FundTempleton Global Total Return FundTempleton International Bond Fund

TAX-FREE INCOME5

NationalDouble Tax-Free Income FundFederal Tax-Free Income FundHigh Yield Tax-Free Income FundInsured Tax-Free Income Fund6

Limited-/ Intermediate-TermCalifornia Intermediate-Term Tax-Free Income FundFederal Intermediate-Term Tax-Free Income FundFederal Limited-Term Tax-Free Income FundNew York Intermediate-Term Tax-Free Income Fund

State-Specific

< GAIN FROM OUR PERSPECTIVE® >

VALUE BLEND GROWTH SECTOR GLOBAL INTERNAT IONAL HYBRID ASSET ALLOCAT ION F IXED INCOME TAX-FREE INCOME

© 2012 Franklin Templeton Investments. All rights reserved. 479 A 02/12

Annual Report and Shareholder Letter


Investment ManagerFranklin Mutual Advisers, LLC101 John F. Kennedy ParkwayShort Hills, NJ 07078

DistributorFranklin Templeton Distributors, Inc.(800) DIAL BEN®/342-5236franklintempleton.com

Shareholder Services(800) 632-2301 - (Class A, B & C)(800) 448-FUND - (Class Z)

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

To 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.

mutual financial services fund annual report · 2017. 6. 24. · severe economic slowdowns. credit...

Documents