Emerging Markets Series Foreign Equity Series Foreign Smaller … · 2012-10-13 · Emerging Markets Series This semiannual report for Emerging Markets Series (Fund) covers the period

Templeton Institutional Funds

JUNE 30, 2012

Emerging Markets Series

Foreign Equity Series

Foreign Smaller Companies Series

Global Equity Series

S E M I A N N U A L R E P O R T

Not part of the semiannual report

An Open Letter to U.S. Fund Shareholders Regarding the U.S. Debt by Greg Johnson, President and CEO of Franklin Resources, Inc.

August 15, 2012

Long-term perspective is essential in investing. As CEO of a global investment manager, I am struckby the deteriorating state of our nation’s finances and fear that the short-term focus of the currentpolitical debate is detracting from the development of a sound long-term plan. That is why I feel itis important to join the growing group of business leaders who are speaking out on the issue of ournation’s debt and ask for your help.

The numbers should speak for themselves. Currently standing at more than $11 trillion, the U.S.net public debt has doubled in just the last four years.1 It is projected that for the current fiscalyear ending in September, the U.S. will post a fourth straight deficit in excess of $1 trillion.2 Theratio of U.S. debt to GDP is expected to rise above 70% this year, the highest level since just afterWorld War II.3 This is simply unsustainable and unhealthy.

We’ve recently witnessed vivid examples of what can happen to nations that allow their indebted-ness to grow out of control. As with consumer credit, countries with strong balance sheets and theability to service their debt generally get charged relatively low interest rates on their borrowing.When the ability of a country to service its debts comes into question, those interest rates can sky-rocket and contribute to a painful period of economic deterioration. We need to ensure that does nothappen in the U.S. As Sir John Templeton said, “Only one thing is more important than learningfrom experience, and that is not learning from experience.”

At the end of this year, we will face what Federal Reserve Chairman Ben Bernanke has called a“fiscal cliff.” This term reflects the expiration of a number of tax reductions and the imposition oftax increases and across-the-board spending cuts, which are to begin going into effect on January 1,2013. While these measures would in theory put us on a path toward long-term debt reduction, theycould also be disruptive to the U.S. economy in the short term. Some forecasts suggest this couldreduce U.S. GDP by 2.2 percentage points next year.4

We have not fully recovered from the deepest recession we’ve experienced in decades. The simulta-neous imposition of these measures next year could throw the country into a recession and couldexacerbate the debt problem by decreasing revenues and raising unemployment in a vicious circle.

Clearly, there are no easy fixes. However, we must develop a realistic plan for reducing our debtover the long term without sabotaging the economy in the short term.

Without such a long-term plan, we are likely to face continued uncertainty, which has negative consequences for businesses, their employees, and investors. When decision-makers face heighteneduncertainty, it often hinders their ability to make longer-range plans that include investments ofcapital and the hiring of workers. Not surprisingly, this tends to weigh heavily on financial marketsas well. A plan that thoughtfully and definitively helps us get our fiscal house in order will help toimprove the economy and provide the right environment for markets to thrive.

What can you do to inspire thoughtful action?

• Contact your congressional representatives. Share your concern and expectation that theyrise to the occasion and responsibly address it. Contact details for your representatives areavailable online at websites for the United States Senate (www.senate.gov) and the UnitedStates House of Representatives (www.house.gov).

• Support the Campaign to Fix the Debt (fixthedebt.org), a non-partisan movement to putAmerica on a better fiscal and economic path.

We need to rally as a nation to resolve the debt issue, but that takes genuine debate, compromise,and sacrifice. I firmly believe that our democratic process can work toward a practical, long-termsolution. As Benjamin Franklin noted, “Energy and persistence conquer all things.”

IMPORTANT LEGAL INFORMATION

Statements of fact are from sources considered reliable, but no representation or warranty is madeas to their completeness or accuracy.

1. Source: U.S. Department of the Treasury, Bureau of the Public Debt, as of August 13, 2012.

2. Sources: U.S. Department of the Treasury, Monthly Treasury Statement for Fiscal Year 2012 through July 31, 2012. U.S. Department of the Treasury,Press Center, October 14, 2011, and October 16, 2009.

3. Source: Congressional Budget Office, The 2012 Long-Term Budget Outlook, June 2012.

4. Source: The Committee for a Responsible Federal Budget, Between a Mountain of Debt and a Fiscal Cliff, July 16, 2012.

Not part of the semiannual report

Semiannual Report | 1

Semiannual Report

Economic and Market Overview

The six months under review encompassed two different market environments.The first quarter of 2012 delivered the best annual start for global developedand emerging market stocks in more than a decade, as measured by the MSCIAll Country World Index, as signs of U.S. economic recovery and Europeanpolicy relief underpinned a rally in cyclical stocks. Yet, renewed global economic weakness and European debt concerns led the market lower in thesecond quarter, and stocks dropped sharply in the spring before additionalpolicy action prompted a rebound in June. Politics largely drove the marketsduring the first half of 2012 as investors closely monitored developments inEurope, where German-led austerity demands were met with increasingresentment from some highly indebted eurozone members. Coalition-buildingefforts in Greece collapsed amid anger over the terms of the country’s secondbailout, forcing a new election that brought some relief when the pro-europarty won. Elsewhere in the region, France’s socialist candidate clinched thepresidency on a pro-growth platform and the Dutch cabinet resigned in thewake of a contentious austerity deal.

On the economic front, global growth trends generally moderated, led byEurope, which narrowly avoided recession mainly because of German export strength. Yet, even the more resilient economies of Germany, the U.S.and China showed signs of a slowdown at period-end. The combination offlagging growth, political uncertainty and populist unrest pressured investorconfidence, and ratings agencies downgraded global banks and European sovereigns. Concerns about Italian and Spanish borrowing costs added to

NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE

ContentsSemiannual Report

Economic and Market Overview . . . . . . . . . . . . . . . . 1

Emerging Markets Series . . . . 3

Foreign Equity Series . . . . . . . 9

Foreign Smaller Companies Series . . . . . . . . . 20

Global Equity Series . . . . . . . . 26

Financial Highlights and Statements of Investments . . 35

Financial Statements . . . . . . . 58

Notes to Financial Statements . . . . . . . . . . . . . . 64

Shareholder Information . . . . 77

2 | Semiannual Report

investor anxiety as bond yields climbed. Europe’s initial policy responses —including enhanced liquidity measures and an ineffective Spanish bankingbailout — did little to address the structural imbalances of eurozone economiesor the solvency fears plaguing the region’s banking system. Yet, encouragingprogress did emerge at period-end when leaders in Brussels agreed to ease con-ditions of sovereign bond purchases and permit the region’s bailout fund todirectly recapitalize banks. Meanwhile, the U.S. Federal Reserve Board optedto extend its strategy, dubbed Operation Twist, designed to lower systemicallyimportant interest rates, and the People’s Bank of China slashed interest ratesfor the first time since the global financial crisis began. In the latter half of theperiod, commodities extended recent losses, with oil falling back below $100,while the euro dipped and traditional safe havens like U.S. Treasuries, the U.S.dollar and the Japanese yen made gains. Stellar first-quarter gains helped globaldeveloped and emerging market stocks post solid returns for the six monthsended June 30, 2012.

The foregoing information reflects our analysis and opinions as of June 30, 2012. The information is not acomplete analysis of every aspect of any market, country, industry or fund. Statements of fact are from sourcesconsidered reliable.

Emerging Markets Series

This semiannual report for Emerging Markets Series (Fund) covers the periodended June 30, 2012.

Investment Strategy

Our investment strategy employs a fundamental research, value-oriented,long-term approach. We focus on the market price of a company’s securitiesrelative to our evaluation of the company’s long-term earnings, asset valueand cash flow potential. Before we make a purchase, we make a detailedexamination of the company’s profit and loss outlook, balance sheet strength,cash flow trends and asset value in relation to the current price. The analysisconsiders the company’s corporate governance behavior as well as its positionin its sector, the economic framework and political environment.

Performance Overview

The Fund posted a +1.34% cumulative total return for the six-month periodended June 30, 2012. In comparison, the Standard & Poor’s®/InternationalFinance Corporation Investable Composite Index and the MSCI EmergingMarkets Index, which track global emerging market stock performance, generated total returns of +4.48% and +4.12% during the same period.1

Please note index performance information is provided for reference and wedo not attempt to track an index but rather undertake investments on thebasis of fundamental research. The Fund’s return reflects the effect of fees andexpenses for professional management, while an index does not have suchcosts. In addition, an index is not subject to investment flows while the Fundis subject to purchases and redemptions that could impact performance. Youcan find the Fund’s long-term performance data in the Performance Summaryon page 6.

Your Fund’s Goal and Main Investments: Emerging Markets Series seeks long-term

capital growth. Under normal market conditions, the Fund invests at least 80% of its net assets in

securities issued by “emerging market companies,” as defined in the Fund’s prospectus.


Performance data represent past

performance, which does not

guarantee future results.

Investment return and principal

value will fluctuate, and you may

have a gain or loss when you sell

your shares. Current performance

may differ from figures shown.

Please visit ftinstitutional.comor call a Franklin Templeton

Institutional Services representative

at (800) 321-8563 for mostrecent month-end performance.

Geographic BreakdownEmerging Markets SeriesBased on Total Net Assets as of 6/30/12

Asia

Europe

Middle East & Africa

North America

Australia & New Zealand

46.8%

26.5%

16.2%

6.2%

0.7%

0.6%

Short-Term Investments & Other Net Assets3.0%

Latin America & Caribbean

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. STANDARD & POOR’S®, S&P® and S&P 500® are registered trademarks of Standard & Poor’s FinancialServices LLC. The indexes are unmanaged and include reinvested dividends. One cannot invest directly in an index, andan 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 36.


Manager’s Discussion

During the six months under review, key contributors to the Fund’s absoluteperformance were Souza Cruz, a major Brazilian cigarette company; Brazil-based AmBev (Companhia de Bebidas das Americas), one of the world’slargest beer and soft drink producers; and Kasikornbank, one of Thailand’sleading commercial banks. The strong market positions of Souza Cruz andAmBev have allowed their businesses to achieve superior returns and buildmarket share as consumers become wealthier and more discerning. In ourview, the companies’ strong operations, low debt levels, good dividend yields and popular brands made them attractive investments. We believeKasikornbank is well positioned to benefit from Thailand’s potentially strongeconomic growth as the country recovers from last year’s floods and the gov-ernment’s fiscal stimulus measures, including minimum wage increases, workthrough the economy. The bank enjoyed strong earnings in the first half of2012 as it benefited from strong loan growth.

In contrast, key detractors from absolute performance during the reportingperiod included Itau Unibanco Holding, one of Brazil’s largest financialconglomerates; Luk Fook Holdings (International), a major jewelry retailchain in Hong Kong and mainland China; and Astra International, Indonesia’sleading car and motorcycle company. Itau Unibanco’s share price weakened asongoing central bank interest rate cuts threatened to hurt the bank’s profitmargins. In our long-term view, the bank could benefit from its strong marketposition as Brazil’s economy grows and consumer wealth increases. Luk Fook’ssales growth eased recently as China’s slowing economic growth led Chinesetourists to cut spending on luxury items such as jewelry. However, wemaintained a positive view of the company due to its solid market position,high return on equity, strong balance sheet and increasing presence in mainlandChina. Astra’s share price corrected largely due to investor expectations thatnew rules in Indonesia, which increased the minimum down payment requiredfor vehicle purchases, could impact sales. As a leader in the Indonesian car andmotorcycle markets, which have been enjoying strong secular growth trends,Astra could benefit from the country’s robust economic growth, higherincomes and affordable credit in the long term.

It is important to recognize the effect of currency movements on the Fund’sperformance. In general, if the value of the U.S. dollar goes up compared witha foreign currency, an investment traded in that foreign currency will go downin value because it will be worth fewer U.S. dollars. This can have a negativeeffect on Fund performance. Conversely, when the U.S. dollar weakens in

Top 10 CountriesEmerging Markets Series6/30/12

% of TotalNet Assets

Brazil 20.8%

Russia 14.1%

China 9.5%

Indonesia 8.8%

India 8.6%

Thailand 7.0%

Hong Kong 6.1%

South Africa 4.1%

Chile 4.0%

Singapore 2.4%

relation to a foreign currency, an investment traded in that foreign currencywill increase in value, which can contribute to Fund performance. For thesix months ended June 30, 2012, the U.S. dollar rose in value relative to manycurrencies in which the Fund’s investments were traded. As a result, the Fund’sperformance was negatively affected by the portfolio’s investment predomi-nantly in securities with non-U.S. currency exposure.

In the past six months, we initiated positions in Colombia and Kenya andincreased our holdings in Hong Kong, South Africa and South Korea as wecontinued to search for what we considered to be attractive investment oppor-tunities. We added to casinos and gaming, catalog retail and specialty retailcompanies. Key purchases included additional shares of SJM Holdings, one ofMacau’s largest casino operators, and the aforementioned Luk Fook, as wellas a new position in South Korea-based Samsung Electronics, one of theworld’s largest electronics manufacturers.

As certain stocks reached our sale targets, we reduced the Fund’s investmentsin Brazil, Indonesia, India and Russia to focus on stocks we considered to bemore attractively valued within our investment universe. We reduced theFund’s holdings largely in diversified metals and mining, diversified banking,and integrated oil and gas companies. Key reductions included Brazilian ironore and nickel producer Vale, Indonesia-based Bank Central Asia and Russia-based integrated oil and gas group TNK-BP Holding.

Thank you for your continued participation in Emerging Markets Series. We look forward to serving your future investment needs.

Mark MobiusExecutive ChairmanTempleton Emerging Markets Group

The foregoing information reflects our analysis, opinions and portfolio holdings as of June 30, 2012, the end of thereporting period. The way we implement our main investment strategies and the resulting portfolio holdings maychange depending on factors such as market and economic conditions. These opinions may not be relied upon asinvestment advice or an offer for a particular security. The information is not a complete analysis of every aspectof any market, country, industry, security or the Fund. Statements of fact are from sources considered reliable,but the investment manager makes no representation or warranty as to their completeness or accuracy. Althoughhistorical performance is no guarantee of future results, these insights may help you understand our investmentmanagement philosophy.


Top 10 Equity HoldingsEmerging Markets Series6/30/12

Company % of TotalSector/Industry, Country Net Assets

AmBev (Companhia de Bebidas das Americas) 10.0%

Beverages, Brazil

PT Astra International Tbk 6.1%Automobiles, Indonesia

Souza Cruz SA 5.3%Tobacco, Brazil

Tata Consultancy Services Ltd. 5.1%IT Services, India

LUKOIL Holdings, ADR 3.4%Oil, Gas & Consumable Fuels, Russia

Kasikornbank PCL, fgn. 3.3%Commercial Banks, Thailand

PetroChina Co. Ltd., H 3.1%Oil, Gas & Consumable Fuels, China

Sberbank of Russia 3.0%Commercial Banks, Russia

Vale SA, ADR, pfd., A 2.9%Metals & Mining, Brazil

Uralkali OJSC, GDR, Reg S 2.8%Chemicals, Russia


Endnotes

All investments involve risks, including possible loss of principal. The Fund invests in foreign securities, which can involve exposure to currencyfluctuations, economic instability and political developments. Emerging markets involve heightened risks related to the same factors, in additionto those associated with their relatively small size and lesser liquidity. 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.

1. Fund investment results reflect the expense reduction, without which the results would have been lower.

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

3. Average annual total return represents the average annual change in value of an investment over the periods indicated. Six-month return has notbeen annualized.

4. These figures represent the value of a hypothetical $1,000,000 investment in the Fund over the periods indicated.

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

Performance Summary as of 6/30/12Emerging Markets Series

Performance

Class A1 6-Month 1-Year 5-Year 10-Year

Cumulative Total Return2 +1.34% -11.64% -4.70% +235.32%

Average Annual Total Return3 +1.34% -11.64% -0.96% +12.86%

Value of $1,000,000 Investment4 $1,013,352 $883,583 $953,097 $3,353,459

Total Annual Operating Expenses5

Without Waiver 1.29%

With Waiver 1.25%

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, visit ftinstitutional.com or call a Franklin Templeton InstitutionalServices representative at (800) 321-8563.

The investment manager and administrator have contractually agreed to waive or assume certain expenses so that commonexpenses (excluding acquired fund fees and expenses) do not exceed 1.24% (other than certain nonroutine expenses)until 4/30/13.

Price Information

Symbol: TEEMX Change 6/30/12 12/31/11

Net Asset Value (NAV) +$0.14 $10.62 $10.48

Your dividend income will vary depending on dividends or interest paid by securities in theFund’s portfolio, adjusted for operating expenses. Capital gain distributions are net profitsrealized from the sale of portfolio securities. The performance table does not reflect any taxes thata shareholder would pay on Fund dividends, capital gain distributions, if any, or any realizedgains on the sale of Fund shares. Total return reflects reinvestment of the Fund’s dividends andcapital gain distributions, if any, and any unrealized gains or losses on the sale of Fund shares.


Your Fund’s ExpensesEmerging Markets Series

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

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

• Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, ifapplicable, and other Fund expenses. All mutual funds have ongoing costs, sometimesreferred 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) of the table provides actual account values and expenses. The “EndingAccount Value” is derived from the Fund’s actual return, which includes the effect of Fund expenses.

You can estimate the expenses you paid during the period by following these steps. Of course,your account value and expenses will differ from those in this illustration:

1. Divide your account value by $1,000. If an account had an $8,600 value, then $8,600 ÷ $1,000 = 8.6.

2. Multiply the result by the number under the heading “Expenses Paid During Period.”If Expenses Paid During Period were $7.50, then 8.6 x $7.50 = $64.50.

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

Hypothetical Example for Comparison with Other Funds

Information in the second line (Hypothetical) of the table can help you compare ongoing costsof investing in the Fund with those of other mutual funds. This information may not be usedto estimate the actual ending account balance or expenses you paid during the period. Thehypothetical “Ending Account Value” is based on the Fund’s actual expense ratio and anassumed 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 figurewith the 5% hypothetical examples that appear in shareholder reports of other funds.


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, if applicable. Therefore, the second line of the table isuseful in comparing ongoing costs only, and will not help you compare total costs of owningdifferent funds. In addition, if transaction costs were included, your total costs would have beenhigher. Please refer to the Fund prospectus for additional information on operating expenses.

Beginning Account Ending Account Expenses Paid During Value 1/1/12 Value 6/30/12 Period* 1/1/12–6/30/12

Actual $1,000 $1,013.40 $6.21

Hypothetical (5% return before expenses) $1,000 $1,018.70 $6.22

*Expenses are calculated using the most recent six-month annualized expense ratio, net of expense waivers, of 1.24%, multiplied by the averageaccount value over the period, multiplied by 182/366 to reflect the one-half year period.


This semiannual report for Foreign Equity Series (Fund) covers the periodended June 30, 2012.


For the six months under review, the Fund’s Primary shares delivered a +0.82%total return. The Fund underperformed the +3.13% total return of its bench-mark, the MSCI All Country (AC) World ex USA Index, which tracksstock market performance in global developed and emerging markets exclud-ing the U.S.1 The Fund also underperformed the +3.38% total return of itsother benchmark, the MSCI Europe, Australasia, Far East (EAFE) Index,which measures stock market performance in global developed marketsexcluding the U.S. and Canada.1 Please note index performance information

Foreign Equity Series

Your Fund’s Goal and Main Investments: Foreign Equity Series seeks long-term capital

growth. Under normal market conditions, the Fund invests at least 80% of its net assets in foreign

(non-U.S.) equity securities.

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 indexes are unmanaged and include reinvested dividends. One cannot invest directly in an index,and an index is not representative of the Fund’s portfolio.


Performance data represent

past performance, which does

not guarantee future results.






Please visit ftinstitutional.comor call a Franklin Templeton



Short-Term Investments & Other Net Assets


North America

Asia

Europe

Geographic BreakdownForeign Equity SeriesBased on Total Net Assets as of 6/30/12

Europe 65.2%

Asia 25.9%

North America 2.6%

Latin America & Caribbean 2.4%

Short-Term Investments & Other Net Assets 3.9%


is provided for reference and we do not attempt to track an index but ratherundertake investments on the basis of fundamental research. You can findthe Fund’s long-term performance data in the Performance Summary onpage 17.

Investment Strategy

We employ a bottom-up, value-oriented, long-term investment strategy.Our in-depth fundamental research evaluates a company’s potential togrow earnings, asset value and/or cash flow. We also consider a company’sprice/earnings ratio, profit margins and liquidation value.


Dramatic headlines and continued volatility buffeted international equity markets during the first six months of 2012 as investors scrutinized policypronouncements and data releases in search of better clarity on global eco-nomic growth prospects and regional leaders’ ability to address the ongoingeurozone sovereign debt and banking system woes. However, such matterswere put starkly into perspective for all of us at Templeton as we learned ofthe sudden passing of our long-time chief investment officer, Gary Motyl, in late June. A 30-year veteran at Templeton, Gary served as manager ofForeign Equity Series since 1996. He began his Templeton career in 1981 asthe third investment professional hired by Sir John Templeton, and with quietleadership and a steady hand he helped guide our organization through aperiod of tremendous growth.

Gary’s passing deeply saddened all who collaborated with him during thecourse of his long and distinguished career. I worked closely with Gary in my various roles at Templeton, communicating over the phone or in personalmost every day of the past decade. He possessed a wealth of knowledgeand experience, and a sharp intellect demonstrating insightful analysis andshrewd judgment. Gary was not one to seek the spotlight, but among his peershe was widely respected for his investment acumen and professional integrity. A mentor for many and a respected voice of reason in euphoric and tryingtimes, Gary will be deeply missed by all.

Despite the tragic circumstances, I am proud to assume responsibility for afund that Gary so capably managed during the past 16 years, and I look for-ward to continuing Templeton’s long tradition of investment excellence. My28 years of experience in the investment industry include the last 15 with the


firm, including as Director of Research, lead manager of Templeton GrowthFund and, more recently, Director of Portfolio Management and President ofTempleton Investment Counsel, LLC. Although I assume my new responsibili-ties with a heavy heart, I know how much the Templeton organization meantto Gary, and the best tribute our investment team can pay him is to remaindiligent and use our time-tested investment discipline to create long-term valuefor our clients.

Gary saw immense opportunity in this market environment and constantlyreminded us to block out the noise and focus on bottom-up fundamentalanalysis. This has admittedly been a challenge in a market environment that,since the onset of the global financial crisis, has been marked by heightenedvolatility and, in our view, delayed value recognition. Extreme risk aversionamid Europe’s recent financial uncertainty has resulted in what we consider asignificant undervaluation of companies compared to their long-term fran-chise levels. Although the Fund achieved absolute gains during the period,such adverse conditions pressured returns relative to its benchmark, theMSCI AC World ex USA Index, with isolated stock level weakness being thekey source of underperformance. Although we find underperformance unac-ceptable and remain focused on producing what we believe to be the excellentinvestment results for which we have long been known, we note that suchperiods are not unprecedented for fundamental value investors. Under SirJohn’s tenure, Templeton experienced bouts of protracted underperformancefar deeper than what we have undergone recently. Nor are such periods unex-pected. As Sir John Templeton explained in a note to clients in 1950, “Theinvestor who selects stocks on the basis of long-term intrinsic value mustexpect certain problems.”

Our ability to use the market’s apparent preoccupation with short-term uncer-tainties to uncover long-term values is the foundation upon which we havestrived to build one of the industry’s top track records. Although the market’sshort-term focus can be painful for disciplined investors, our experience leadsus to believe the recognition of distressed value will occur, and we seek to posi-tion the Fund to benefit from value recognition over time. We were encouragedas some of our value-driven stock selections began to deliver results during thesix months under review. For example, the Fund has long held an underweight-ing in the materials sector relative to the benchmark index, where our analysis suggested the record profits hailed by most investors were structurally unsus-tainable over the longer term.2 Our underweighting strongly benefited relative

2. The materials sector comprises chemicals, construction materials, and metals and mining in the SOI.


3. The financials sector comprises capital markets, commercial banks, diversified financial services, insurance, realestate management and development, and thrifts and mortgage finance in the SOI.

performance as global growth concerns, particularly in China, and a resurgentU.S. dollar extended a year-long decline in commodity prices. In addition to ourunderweighted allocation, stock selection in the sector contributed to relativeperformance. Specifically, our preference for deep-value chemicals andconstruction aggregate companies and our decision to avoid mining companieshelped drive sector outperformance during the six months under review.

Another contrarian investment move inspired by bottom-up security analysiswas our decision to increase exposure to certain financials stocks in 2011.3

At that time, valuations had plummeted to all-time lows despite the consid-erable progress companies had made repairing balance sheets, stabilizingfunding sources and refocusing on core competencies. The Fund’s financialsallocation — composed of deep-value European banks as well as a diversegroup of companies with defensive characteristics, good dividend yields andattractive growth profiles in other regions of the world — produced mixedresults in the reporting period. Stock selection in banks outside Europe comprised three of the Fund’s top performing holdings in the period:Singaporean financial services firm DBS Group Holdings, Switzerland-basedreinsurer SwissRe and Indian lender ICICI Bank.

Our European bank holdings, however, pressured returns as high-profiledowngrades, writedowns and bailouts further eroded investor confidence inthe eurozone banking system. Among this group was Italy’s UniCredit, whichundertook an ill-timed rights offering at the beginning of the period, and Swissfinancial services firm Credit Suisse Group, which the Swiss National Bank(SNB) asked to increase capital reserves. However, UniCredit, having alreadyaddressed capital adequacy concerns, was progressing with cost-cutting andprofit improvement initiatives. For Credit Suisse, the SNB is not the company’sregulator, capital ratios remained in line with Basel III targets, and we believean outright equity issuance is unlikely given the firm’s various sources ofavailable capital. Although we are aware of the continued sensitivity of thesestocks to the deeply pessimistic sentiment surrounding Europe, we remainedfavorable on these firms given their historically depressed valuations and ourassessment that regional leaders were determined to avert a monetary unioncollapse. Although risks and market pressure remained, we were encouraged bythe compromises reached at the June summit in Brussels, which could helpbreak the seemingly dysfunctional feedback loop between sovereigns andbanks by helping Europe move toward a regional banking union. Overall, weremained sanguine on our increased (though still below benchmark) financials

Portfolio BreakdownForeign Equity SeriesBased on Total Net Assets as of 6/30/12

Pharmaceuticals

Oil, Gas & Consumable Fuels

Other

Food Products

Wireless Telecommunication Services

Industrial Conglomerates

Semiconductors & Semiconductor Equipment

Aerospace & Defense


Commercial Banks

Insurance

Diversified Telecommunication Services

11.3%

11.0%

10.4%

9.0%

6.0%

7.4%

3.5%

4.2%

3.0%

2.8%

27.5%

3.9%


sector allocation, where we believe a diverse combination of value and growthopportunities left us well positioned for a range of market scenarios.

We also believe our information technology (IT) holdings offer flexibility acrossvarious market environments.4 The cyclical nature of enterprise demand is gen-erally balanced by technology’s productivity-enhancing capabilities, which areoften sought after in weaker economic environments. The Fund’s overweightedIT positions positively contributed to relative performance during the first halfof 2012, led by Samsung Electronics, the world’s biggest maker of mobile phones,memory chips and televisions. Share prices surged to a record high mainly dueto strong earnings and remarkable success in the firm’s handset unit, whereemerging market growth helped the firm surpass Apple as the global leader insmartphone sales. Although we reduced exposure to realize gains amid pricestrength during the period (shares were up more than five-fold since the stockinitially joined our bargain list in 2001), Samsung remained a core holding giventhe company’s market-share consolidation, emerging market growth exposureand what we considered to be attractive valuations.

Similarly, telecommunication services firms provide essential products and serv-ices that are not widely used in developing regions, which could allow suchcompanies to leverage global growth trends while mitigating the impact ofeconomic downturns.5 Furthermore, concerns about competition, regulatoryinterference and developed market weakness resulted in what we believe to beexcessively cheap sector valuations. International telecommunications stockstraded well below their historical average price-to-forward earnings ratios dur-ing the period and, in an era of zero-bound interest rates, offered investors a6% average dividend yield. Despite such supportive attributes, isolated weak-ness in the Fund’s overweighted telecommunications holdings resulted inrelative underperformance during the period. Specifically, China Telecom andSpain’s Telefonica pressured returns, as the former declined after missing earn-ings estimates amid increased costs associated with its iPhone offering, and thelatter fell after reducing its dividend and pursuing asset sales to reduce debt.However, our analysis found that China Telecom’s fixed-line business (thelargest in China) alone was worth its share price, offering investors consider-able promise should the company execute on its cellular network build-out.Meanwhile, Telefonica’s aggressive debt reduction, in our view, increased thelikelihood of stabilization over a long-term horizon, and concerns about the

4. The IT sector comprises communications equipment, computers and peripherals, semiconductors and semiconductorequipment, and software in the SOI.

5. The telecommunication services sector comprises diversified telecommunication services and wireless telecommu-nication services in the SOI.


company’s domestic Spanish business seemed to ignore the fact that interna-tional operations, which generated the bulk of group revenues, retainedhealthy growth profiles.

Relative underperformance was also concentrated in the energy sector, whereSpanish oil company Repsol lost nearly half of its market capitalization afterthe Argentinian government nationalized the company’s majority-ownedjoint venture, YPF.6 Although considerable uncertainty remained, ourlong-term worst-case scenario (in which we wrote off the entire YPF stakeand assumed a minority partner in the venture defaulted on a Repsol-financedloan) suggested the stock was already fully discounting for severe impairmentand assigned no value to the company’s exploration portfolio. Even withoutYPF, Repsol featured some of the most promising global assets and thepossibility of superior production growth if management proves capable ofexecuting strategically.

Dutch drilling company SBM Offshore also experienced a setback during theperiod when an internal review revealed potentially improper sales practiceswith third-party representatives. Again, we believe near-term headlines obscuredlong-term value. Similar to Repsol, the full extent of this issue remained diffi-cult to predict; however, analysis of potential outcomes suggested to us thatthe market already priced in very bad news, including a potential capital raisedue to legacy program-cost overruns. In our view, SBM’s healthy backlog andfavorable pipeline for future products could offer considerable upside over along-term investment horizon should the company resolve near-term issues.Overall, we remained modestly overweighted in energy and believe certainfirms with the technology and expertise to extract hydrocarbons stand to bene-fit as new reserves are developed in increasingly remote and difficult locations.

From a regional standpoint, the Fund’s Asian holdings outperformed, led by anoverweighted Singapore allocation and stock selection among underweightedJapanese stocks. An underweighting in Canada also contributed, while mod-est exposure to South America slightly detracted. Stock-specific losses amongthe Fund’s overweighted European holdings significantly hurt performance,with strongly performing positions in Switzerland and Germany failing to off-set weakness in Spain and the Netherlands. Although the situation in Europeremained fluid, we found recent policy pronouncements encouraging and iden-tified considerable valuation support. Restoring sustainable economic balanceto the eurozone will likely require a combination of stimulus and structuralreform to improve competitiveness and growth, spending cuts to restore fiscalsustainability and credible policy advancement toward banking and fiscal

6. The energy sector comprises energy equipment and services; and oil, gas and consumable fuels in the SOI.

Top 10 HoldingsForeign Equity Series6/30/12


Samsung Electronics Co. Ltd. 2.4%Semiconductors & Semiconductor Equipment, South Korea

Sanofi, ord. & ADR 2.4%Pharmaceuticals, France

GlaxoSmithKline PLC 2.4%Pharmaceuticals, U.K.

Taiwan Semiconductor Manufacturing Co. Ltd., ord. & ADR 2.2%

Semiconductors & Semiconductor Equipment, Taiwan

Telenor ASA 2.1%Diversified Telecommunication Services, Norway

DBS Group Holdings Ltd., ord. & ADR 2.1%Commercial Banks, Singapore

Royal Dutch Shell PLC, A, B & ADR 2.1%Oil, Gas & Consumable Fuels, U.K.

Vodafone Group PLC 2.0%Wireless Telecommunication Services, U.K.

Statoil ASA 1.8%Oil, Gas & Consumable Fuels, Norway

SAP AG 1.8%Software, Germany


union. Recently announced measures, which included direct bank recapital-izations and easier conditions for sovereign bond purchases, could potentiallyserve to break the cycle between sovereigns and banks that has challenged theregion’s private and public funding mechanisms.

Our bottom-up stock analysis indicated that European stocks at period-endtraded at their lowest price-to-book levels since March 2009, offering what webelieve were attractive entry points into some of the region’s highest qualityglobal brands. Asian and emerging market stocks also remained below theirlong-term average price-to-earnings ratios, and stood to potentially benefitshould growth in these regions exceed diminished expectations. Keep in mind,we are not pinning our hopes on economic growth. In an era of low interestrates and investor uncertainty, we believe the assets most likely to outperformover the long term are the most undervalued stocks. Such discounts often existfor a reason, and investing in deeply undervalued stocks in times of crisisrequires rigorous analysis, as well as patience and fortitude through periods ofconsiderable adversity. Our discipline in such challenging environments haspaid off in the past, and we are confident it will yet again if investors re-focuson fundamental value. We thank you for your patience and support as thisprocess unfolds.

Thank you for your continued participation in Foreign Equity Series. We lookforward to serving your future investment needs.

Cindy L. Sweeting, CFADirector of Portfolio Management – Templeton Global Equity GroupPresident – Templeton Investment Counsel, LLC

CFA® is a trademark owned by CFA Institute.



Cindy L. Sweeting assumed portfolio manager responsibilities for the Fund in June 2012.

Effective July 2012, she assumed responsibilities as President of Templeton Investment

Counsel, LLC. She is also Director of Portfolio Management for the Templeton Global

Equity Group. She has portfolio management responsibility for other retail funds and insti-

tutional separate account relationships with global and international mandates.

Ms. Sweeting has 28 years of experience in the investment industry. She joined Franklin

Templeton Investments in Templeton’s Nassau office in 1997, and has served as Director of

Research for the Templeton Global Equity Group, as well as President of Templeton Global

Advisers Limited. Prior to joining Templeton, she was the senior vice president of investments

with McDermott International Investments Co., Inc., in Nassau. At McDermott, she was

responsible for the investment department, which encompassed portfolio management

and pension administration.


Endnotes

All investments involve risks, including possible loss of principal. Special risks are associated with foreign investing, including currency fluctuations,economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in additionto those associated with these markets’ smaller size and lesser liquidity. 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.





Price Information

Primary Shares (Symbol: TFEQX) Change 6/30/12 12/31/11

Net Asset Value (NAV) +0.14% $17.18 $17.04

Service Shares (Symbol: TFESX) Change 6/30/12 12/31/11

Net Asset Value (NAV) +0.13% $17.15 $17.02

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 does not reflect any taxes thata shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gainson the sale of Fund shares. Total return reflects reinvestment of the Fund’s dividends and capitalgain distributions, if any, and any unrealized gains or losses on the sale of Fund shares.

Performance Summary as of 6/30/12Foreign Equity Series

Performance

Primary Shares 6-Month 1-Year 5-Year 10-Year




Total Annual Operating Expenses4 0.80%

Service Shares 6-Month 1-Year 5-Year Inception (9/18/06)

Cumulative Total Return1 +0.76% -15.44% -23.00% -1.36%

Average Annual Total Return2 +0.76% -15.44% -5.09% -0.24%

Value of $1,000,000 Investment3 $1,007,631 $845,581 $770,000 $986,467

Total Annual Operating Expenses4 0.95%

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, visit ftinstitutional.com or call a Franklin Templeton InstitutionalServices representative at (800) 321-8563.




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






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 notbe used to estimate the actual ending account balance or expenses you paid during the period. Thehypothetical “Ending Account Value” is based on the actual expense ratio for each class and anassumed 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.

Your Fund’s ExpensesForeign Equity Series



Please note that expenses shown in the table are meant to highlight ongoing costs and do notreflect any transaction costs, such as sales charges, if applicable. Therefore, the second line for eachclass is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would havebeen higher. Please refer to the Fund prospectus for additional information on operating expenses.

Beginning Account Ending Account Expenses Paid During Primary Shares Value 1/1/12 Value 6/30/12 Period* 1/1/12–6/30/12

Actual $1,000 $1,008.20 $3.99


Service Shares

Actual $1,000 $1,007.60 $4.74


*Expenses are calculated using the most recent six-month expense ratio, annualized for each class (Primary Shares: 0.80% and Service Shares: 0.95%),multiplied by the average account value over the period, multiplied by 182/366 to reflect the one-half year period.


We are pleased to bring you Foreign Smaller Companies Series’ (Fund’s)semiannual report for the period ended June 30, 2012.


The Fund delivered a +7.38% cumulative total return for the six-month periodended June 30, 2012. The Fund outperformed the +4.34% total return of itsbenchmark, the MSCI All Country World ex USA Small Cap Index, whichtracks global developed and emerging market small-cap equities, excluding theU.S.1 Please note index performance information is provided for reference andwe do not attempt to track the index but rather undertake investments on thebasis of fundamental research. You can find the Fund’s long-term performancedata in the Performance Summary on page 23.

Foreign Smaller Companies Series

Your Fund’s Goal and Main Investments: Foreign Smaller Companies Series seeks

long-term capital growth. Under normal market conditions, the Fund invests at least 80% of its net

assets in investments of smaller companies located outside the U.S., including emerging markets.

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 index is unmanaged and includes reinvested dividends. One cannot invest directly in an index,and an index is not representative of the Fund’s portfolio.


Performance data represent

past performance, which does

not guarantee future results.






Please call a Franklin Templeton






North America

Asia

Europe

Geographic BreakdownForeign Smaller Companies SeriesBased on Total Net Assets as of 6/30/12

Europe 41.1%

Asia 36.5%

North America 8.2%

Latin America & Caribbean 4.7%

Australia & New Zealand 2.8%

Short-Term Investments & Other Net Assets 6.7%


Investment Strategy

When choosing equity investments, we apply a bottom-up, value-oriented,long-term approach, focusing on the market price of a company’s securitiesrelative to our evaluation of the company’s long-term (typically five years)earnings, asset value and cash flow potential. We also consider a company’sprice/earnings ratio, profit margins, liquidation value and other factors.


Several holdings performed well during the six-month period under review.Hong Kong-based Techtronic Industries Co. is a brand leader in power tools recognized for its product innovation and product extension. The company continued to gain market share through better innovation than competitors, andshares benefited during the period from the announcement of solid 2011 results.With the firm’s restructuring at an end, we believe the company has the potentialto experience a sharp increase in margins, despite the prospect of higher costs.

Arcadis is a Netherlands-based global provider of infrastructure, water, environment and buildings design. The company’s continued shift towardhigher-margin environmental and water businesses benefited the share priceduring the period. At period-end, in our view Arcadis remained well posi-tioned to benefit from secular growth trends in environmental services andspecialty infrastructure.

U.K.-based Laird Group is a leading supplier of technology solutions for elec-tronic devices needing antennae or shielding from electromagnetic interferenceor heat. The company maintained a strong balance sheet and cut costs to protect margins. Furthermore, our analysis indicated cost reductions and sta-bilization in handset products could lead Laird to return to a strong growthpath. We believe measures to broaden its technical and customer base couldalso improve future performance. During the period, the company announcedprofits notably increased, a sign to us that restructuring efforts gained traction.

Although the Fund outperformed its benchmark in the period under review,certain positions declined in value, including Kloeckner & Co., the largestproducer-independent metal distributor in the combined European and NorthAmerican market. Kloeckner offers distribution and metal processing services,with earnings largely driven by steel demand. Although some fear that demandmay wane if the global economy slows, in our assessment Kloeckner offered atrack record of value-enhancing acquisitions and strong earnings growth poten-tial on even modest assumptions of future growth in steel demand, and remaineda leading company in its industry with sustainable competitive advantages.

Portfolio BreakdownForeign Smaller Companies SeriesBased on Total Net Assets as of 6/30/12

Electronic Equipment, Instruments & Components

Auto Components

Media

Specialty Retail

Commercial Services & Supplies

Communications Equipment

Leisure Equipment & Products

Energy Equipment & Services

Personal Products

Capital Markets

Household Durables

Commercial Banks

Machinery

Textiles, Apparel & Luxury Goods

4.1%

4.3%

4.5%

5.7%

4.0%

4.0%

3.7%

3.7%

3.4%

3.3%

3.0%

3.0%

Other


33.1%

6.7%

6.0%

7.5%


Top 10 Equity HoldingsForeign Smaller Companies Series6/30/12


Kobayashi Pharmaceutical Co. Ltd. 2.4%Personal Products, Japan

Asics Corp. 2.0%Textiles, Apparel & Luxury Goods, Japan

VTech Holdings Ltd. 1.9%Communications Equipment, Hong Kong

Huhtamaki OYJ 1.9%Containers & Packaging, Finland

Techtronic Industries Co. Ltd. 1.8%Household Durables, Hong Kong

Greggs PLC 1.8%Food & Staples Retailing, U.K.

Amer Sports OYJ 1.7%Leisure Equipment & Products, Finland

Steiner Leisure Ltd. 1.6%Diversified Consumer Services, Bahamas

Axis Capital Holdings Ltd. 1.6%Insurance, Bermuda

Laird PLC 1.5%Electronic Equipment, Instruments & Components, U.K.

HudBay Minerals, an integrated zinc and copper producer, held assets inNorth and Central America. Despite recent underperformance, we believethat HudBay’s stock price offered an attractive risk-to-reward ratio. In ourview, downside risk was limited by a high net cash position, which couldpotentially rise. On the upside, an increase in metal prices and announcedacquisitions could lead to a rise in production, reserves, net asset valueand earnings.

The share price of Asahi Co., Japan’s largest specialty bicycle retail chain,lagged during the period due to global economic concerns and their potentialimpact on consumers. From our long-term perspective, we believe Asahi dis-tinguishes itself from the competition, which includes general merchandisestores, home improvement stores and typical mom-and-pop bicycle shops, byproviding high-quality in-store services as well as developing competitivelypriced private-brand products.

Thank you for your continued participation in Foreign Smaller CompaniesSeries. We look forward to serving your future investment needs.

Harlan B. Hodes, CPA

Cindy L. Sweeting, CFA

Portfolio Management TeamForeign Smaller Companies Series



Performance Summary as of 6/30/12Foreign Smaller Companies Series

Price Information

Symbol: TFSCX Change 6/30/12 12/31/11

Net Asset Value (NAV) +$1.13 $16.44 $15.31

Performance1

6-Month 1-Year 5-Year Inception (10/21/02)




Total Annual Operating Expenses5

Without Waiver 1.02%

With Waiver 0.95%

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, call a Franklin Templeton Institutional Services representativeat (800) 321-8563.

The investment manager and/or administrator have contractually agreed to waive or assume certain expenses so that common expenses (excluding acquired fund fees and expenses) do not exceed 0.95% (other than certain nonroutineexpenses) until 4/30/13.

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

Endnotes

All investments involve risks, including possible loss of principal. The Fund invests in foreign securities, which can involve exposure to currencyvolatility and political, economic and regulatory uncertainty. Emerging markets involve heightened risks related to the same factors, in additionto those associated with their relatively small size and lesser liquidity. The Fund’s investments in smaller company stocks carry special risks assuch stocks have historically exhibited greater price volatility than large company stocks, particularly over the short term. Additionally, smallercompanies often have relatively small revenues, limited product lines and small market share. The Fund is actively managed but there is noguarantee that the manager’s investment decisions will produce the desired results. The Fund’s prospectus also includes a description of themain investment risks.









• Ongoing Fund costs, including management fees, distribution and service (12b-1) fees, if applicable,and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to asoperating expenses.



The first line (Actual) of the table provides actual account values and expenses. The “EndingAccount Value” is derived from the Fund’s actual return, which includes the effect of Fundexpenses.






Information in the second line (Hypothetical) of the table can help you compare ongoing costsof investing in the Fund with those of other mutual funds. This information may not be usedto estimate the actual ending account balance or expenses you paid during the period. Thehypothetical “Ending Account Value” is based on the Fund’s actual expense ratio and anassumed 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 figurewith the 5% hypothetical examples that appear in shareholder reports of other funds.

Your Fund’s ExpensesForeign Smaller Companies Series



Please note that expenses shown in the table are meant to highlight ongoing costs and do not reflectany transaction costs, such as sales charges, if applicable. Therefore, the second line of the tableis useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transaction costs were included, your total costs would have beenhigher. Please refer to the Fund prospectus for additional information on operating expenses.

Beginning Account Ending Account Expenses Paid During Value 1/1/12 Value 6/30/12 Period* 1/1/12–6/30/12

Actual $1,000 $1,073.80 $4.90


*Expenses are calculated using the most recent six-month annualized expense ratio, net of expense waivers, of 0.95%, multiplied by the averageaccount value over the period, multiplied by 182/366 to reflect the one-half year period.


We are pleased to bring you Global Equity Series’ (Fund’s) semiannual reportfor the period ended June 30, 2012.


For the six months under review, the Fund delivered a +6.70% total return.The Fund outperformed the +6.01% total return of its benchmark, theMSCI All Country World Index, which tracks stock market performance inglobal developed and emerging markets.1 Please note index performance information is provided for reference and we do not attempt to track an indexbut rather undertake investments on the basis of fundamental research. Youcan find the Fund’s long-term performance data in the Performance Summaryon page 32.

Investment Strategy

We employ a bottom-up, value-oriented, long-term investment strategy. Ourin-depth fundamental research evaluates a company’s potential to growearnings, asset value and/or cash flow. We also consider a company’sprice/earnings ratio, profit margins and liquidation value.


Although conditions remained challenging for value investors, with investordisregard for business fundamentals reflected in all-time high equity correla-tions, the Fund proved resilient and encouraging performance developmentsemerged during the review period. The outperformance of the Fund’s finan-cials holdings was particularly notable during a period when high-profiledowngrades, bailouts, scandals and trading losses further eroded investor

Global Equity Series

Your Fund’s Goal and Main Investments: Global Equity Series seeks long-term capital

growth. Under normal market conditions, the Fund invests at least 80% of its net assets in equity

securities of companies located anywhere in the world, including emerging markets.

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 index is unmanaged and includes reinvested dividends. One cannot invest directly in an index, andan index is not representative of the Fund’s portfolio.


Performance data represent past

performance, which does not

guarantee future results.






Please visit ftinstitutional.com or call a Franklin Templeton



Geographic BreakdownGlobal Equity SeriesBased on Total Net Assets as of 6/30/12

Europe

Asia

North America




40.5%

33.1%

22.3%

1.5%

0.6%

2.0%


confidence in the financials sector.2 Sector outperformance was primarilyattributable to the positions with resilient financials operations outsideEurope, led by U.S. investment bank Morgan Stanley. The company’s shareprice rose after the company reported better-than-expected results, includ-ing the only trading revenue increase among the five largest Wall Streetbanks. We sold our position to realize a profit before the share price retreatedin the latter half of the review period. Similarly, we closed our position inJapanese financial services firm Nomura Holdings after shares jumped fol-lowing an increase in profitability spurred by cost-cutting progress and thesuccessful sale of a private equity business. The divesture, which occurredprior to a ratings downgrade that erased nearly all year-to-date gains in thestock, realized a profit for the Fund. Other top contributors from the finan-cials sector included U.S. credit card company American Express, India’sICICI Bank and Thai lender Bangkok Bank.

In our view, these holdings represented the Fund’s diverse financials sectorexposure across a range of institutions and geographies, reflecting a mix ofdefensive characteristics and attractive growth profiles. The Fund’s financialsallocation included a cautious and selective exposure to the European finan-cials sector where, in our view, valuations remained among the cheapestglobally. By the end of the review period, the entire European banking sector’smarket capitalization had shrunken considerably. It was perhaps unsurprisingthat at period-end many of the main European banks traded at all-time lowvaluations that were in line with those of U.S. banks in 1932. Although wefound the risks associated with investing in the European banking sectorremained elevated and we continued to underweight this market segment, wewere also aware that these stocks traded at valuations that could be support-ive of notable upside potential if Europe moves toward a credible federalsystem of checks and balances on national fiscal policies. Consequently, wemaintained a cautious exposure to Europe in addition to higher financialsweightings in other regions, which we believe positioned us well for a rangeof different market scenarios.

The Fund’s consumer discretionary positions also offered diverse exposure toa range of industries and geographies, and notably outperformed during theperiod as retailers confounded forecasts that economic uncertainty wouldseverely curtail consumer spending.3 The share price of GAP,4 the U.S.’s largestclothing chain, hit its highest level in over a decade during the review period as

2. The financials sector comprises capital markets, commercial banks, consumer finance, diversified financialservices, insurance, real estate management and development, and thrifts and mortgage finance in the SOI.

3. The consumer discretionary sector comprises auto components, automobiles, media, multiline retail and specialtyretail in the SOI.

4. No longer held at period-end.

Portfolio BreakdownGlobal Equity SeriesBased on Total Net Assets as of 6/30/12

Other

Diversified Telecommunication Services

Insurance

Pharmaceuticals

Food & Staples Retailing

Software

Commercial Banks

Oil, Gas & Consumable Fuels

Capital Markets

Diversified Financial Services


Multiline Retail

13.7%

11.1%

7.9%

4.9%

4.2%

3.9%

3.8%

3.5%

3.3%

3.2%

38.5%

2.0%


strong sales growth demonstrated to us the success of strategic initiatives thatrecently reinvigorated the brand. Elsewhere in the retail space, shares of homeimprovement chains Kingfisher (U.K.) and Home Depot (U.S.) performed wellas resilient earnings highlighted sustained improvements from the companies’respective restructuring plans. The Fund’s media holdings also contributed toconsumer discretionary sector outperformance, led by U.S. cable providersComcast and Time Warner Cable that beat profit and sales estimates onbroadband subscriber gains. Recent results supported our long-held view thatthe cable industry’s control of the valuable broadband pipeline represents apowerful secular growth driver that can help buffer more cyclical revenuesources such as video and advertising.

The Fund’s overweighted position in the stalwart health care sector wasanother major contributor.5 Shares of U.S.-based generic drug maker WatsonPharmaceuticals rallied after the company agreed to acquire closely heldActavis Group in a deal that would create the third-largest global genericsfirm by revenue. Despite the shares’ recent strength, we think they continuedto trade near the bottom of their historical range, based on our analysisthat conservatively accounted for the synergies we believe are likely to berealized in the Actavis acquisition. Watson remained one of the best posi-tioned global generics firms, with a large portion of sales from hard-to-makedrugs resulting in high barriers to entry for competitors and providinghealthy margins. Management has, in our assessment, demonstrated gooddiscipline in capital allocation, and we believe Watson received a bargainprice in purchasing Actavis from creditors after the firm breached covenantsfollowing a poorly timed leveraged buyout in Iceland; to us, the transac-tion continued a favorable management track record. We remainedoptimistic about the pharmaceuticals industry in general, where ongoingprogress in cost cutting and research and development optimization at cer-tain firms presented what we believe are considerable performance catalystsnot currently reflected in the depressed sector valuations. We remained lesssanguine on the materials sector, where we have long believed the miningindustry’s record profits hailed by most investors were structurally unsus-tainable over the longer term.6 Our long-standing materials underweightingand stock selection contributed to relative performance during the period ascommodities extended their declines amid global growth concerns.

5. The health care sector comprises biotechnology, health care providers and services, health care equipment and supplies, and pharmaceuticals in the SOI.

6. The materials sector comprises chemicals, construction materials, containers and packaging, and metals and mining in the SOI.


7. The IT sector comprises communications equipment; computers and peripherals; electronic equipment, instru-ments and components; IT services; semiconductors and semiconductor equipment; and software in the SOI. Theindustrials sector comprises aerospace and defense, air freight and logistics, airlines, commercial services andsupplies, industrial conglomerates, machinery, professional services, and trading companies and distributors inthe SOI. The consumer staples sector comprises food and staples retailing, and household products in the SOI.

On the other hand, underperformance was concentrated primarily in under-weighted information technology (IT), industrials and consumer staplespositions.7 IT sector performance was pressured by our underweightingin the well-performing sector and isolated weakness at the stock level.U.S. computer maker Dell’s share price fell in value the most in more than adecade after the company released disappointing revenue forecasts, reportinga slowdown in enterprise sales amid continued economic uncertainty. Atperiod-end levels, Dell’s share price discounted a 15% free cash flow declinein perpetuity, an unlikely scenario for what we believe to be a strong brand facing cyclical headwinds. U.S. computer security software developerSymantec declined the most in two years after a drop in data storage con-tracts and profitability led to concerns that the company was struggling tocompete with its bigger data storage market rivals. Our analysis indicatedsuch concerns were largely priced into shares at period-end levels and thatSymantec’s attractive organic growth prospects and ample cash positionmade it compelling to us at depressed prices.

Weakness in the industrials sector, meanwhile, was primarily attributable toHong Kong-based specialty steel maker CITIC Pacific and U.S. truck makerNavistar International. CITIC Pacific’s share price retreated after its credit outlook was slashed following delays and cost overruns at a troubled iron oreproject in Australia. This once-promising project became mired in challenges,impairing our investment thesis and diminishing our confidence in manage-ment’s ability. At period-end, we were more inclined to reduce our exposureshould near-term catalysts present what looked to us like favorable exit pricingthan to hold the stock over our long-term investment horizon. Conversely, webelieve Navistar maintained its promise despite recent setbacks. Shares soldoff sharply during the period after the company reported a surprise loss andcontinued difficulty in meeting emissions targets on one of its truck engines.We viewed Navistar’s challenge of fulfilling Environmental Protection Agency(EPA) requirements as somewhat of a red herring and believed the stockwould remain attractive regardless of the EPA review outcome. The stock pricealready discounted a healthy amount of pessimism, based on our analysis, andif approval is not initially granted, Navistar would remain cash flow positiveand we believe deeply undervalued. Approval, on the other hand, could spurshort-term appreciation that we believe could still leave Navistar modestly val-ued given an ongoing recovery in U.S. freight volumes.


An underweighting in the consumer staples sector also detracted from relativeperformance. We continued to believe that increasing price competition andvolatile input costs will pressure margins for the foreseeable future. The Fund’sselection of telecommunication services stocks also detracted, with leadingChinese mobile phone operator China Telecom declining after missing earningsestimates amid increased costs associated with its iPhone offering.8 However,our analysis indicated China Telecom’s fixed line business, the largest in China,was alone worth its current share price and offered investors considerable prom-ise if the company executes on its cellular network build-out. Underweightedenergy holdings were the other notable detractors, pressured by losses at coalproducers China Coal Energy and China Shenhua Energy.9 Their stocks declinedalong with those of many coal companies as coal prices remained weak due to global growth concerns and fears that low natural gas prices could have anegative effect on coal markets.

Regionally, the Fund’s European and North American holdings outperformedas stock selection overcame a detractive overweighting in Europe and detractiveunderweighting in North America. Asian holdings also notably contributed torelative performance, led by an overweighting in Singapore and favorablestock selection among underweighted Japanese holdings. In general, weremained encouraged by the bottom-up opportunities created by investoruncertainty across the global equity landscape.

Our bottom-up analysis indicated that European stocks at period-end traded attheir lowest price-to-book levels since March 2009. U.S. and emerging marketstocks also remained below their long-term average price-to-earnings ratios,and stood to potentially benefit should growth in these regions exceed dimin-ished expectations. Keep in mind, we are not pinning our hopes on economicgrowth. In an era of low interest rates and investor uncertainty, we believe theassets most likely to outperform over the long term are the most undervaluedstocks. Such discounts often exist for a reason, and investing in deeply under-valued stocks in times of crisis requires rigorous analysis, as well as patienceand fortitude through periods of considerable adversity. Our discipline in suchchallenging environments has paid off in the past, and we are confident it willyet again if investors re-focus on fundamental value. We thank you for yourpatience and support as this process unfolds.

8. The telecommunication services sector comprises diversified telecommunication services and wireless telecommuni-cation services in the SOI.

9. The energy sector comprises energy equipment and services; and oil, gas and consumable fuels in the SOI.

Top 10 HoldingsGlobal Equity Series6/30/12


Sanofi 2.4%Pharmaceuticals, France

Royal Dutch Shell PLC, B, ADR 2.3%Oil, Gas & Consumable Fuels, U.K.

GlaxoSmithKline PLC 2.2%Pharmaceuticals, U.K.

Pfizer Inc. 2.1%Pharmaceuticals, U.S.

HSBC Holdings PLC 2.0%Commercial Banks, U.K.

Bayer AG 1.9%Pharmaceuticals, Germany

AIA Group Ltd. 1.8%Insurance, Hong Kong

Kingfisher PLC 1.7%Specialty Retail, U.K.

United Parcel Service, B 1.7%Air Freight & Logistics, U.S.

Trend Micro Inc. 1.7%Software, Japan


Thank you for your continued participation in Global Equity Series. We lookforward to serving your future investment needs.

Neil Devlin, CFA

Antonio T. Docal, CFACindy L. Sweeting, CFAPeter A. Nori, CFA

Portfolio Management TeamGlobal Equity Series


Cindy L. Sweeting assumed portfolio manager responsibilities for the Fund in June 2012.

Effective July 2012, she assumed responsibilities as President of Templeton Investment

Counsel, LLC. She is also Director of Portfolio Management for the Templeton Global Equity

Group. She has portfolio management responsibility for other retail funds and institutional

separate account relationships with global and international mandates.

Ms. Sweeting has 28 years of experience in the investment industry. She joined Franklin

Templeton Investments in Templeton’s Nassau office in 1997, and has served as Director of

Research for the Templeton Global Equity Group, as well as President of Templeton Global

Advisers Limited. Prior to joining Templeton, she was the senior vice president of investments

with McDermott International Investments Co., Inc., in Nassau. At McDermott, she was

responsible for the investment department, which encompassed portfolio management and

pension administration.


Endnotes

All investments involve risks, including possible loss of principal. Special risks are associated with foreign investing, including currency fluctuations,economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in additionto these markets’ smaller size and lesser liquidity. The Fund is actively managed but there is no guarantee that the manager’s investment decisionswill produce the desired results. The Fund’s prospectus also includes a description of the main investment risks.



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

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Emerging Markets Series Foreign Equity Series Foreign Smaller … · 2012-10-13 · Emerging Markets Series This semiannual report for Emerging Markets Series (Fund) covers the period