Franklin Mutual Quest Fund

Transcription

1 Annual Report and Shareholder Letter December 31, 2017 Franklin Mutual Quest Fund A SERIES OF FRANKLIN MUTUAL SERIES FUNDS Sign up for electronic delivery at franklintempleton.com/edelivery

2 Franklin Templeton Investments Gain From Our Perspective At Franklin Templeton Investments, we re dedicated to one goal: delivering exceptional asset management for our clients. By bringing together multiple, world-class investment teams in a single firm, we re able to offer specialized expertise across styles and asset classes, all supported by the strength and resources of one of the world s largest asset managers. This has helped us to become a trusted partner to individual and institutional investors across the globe. Dear Franklin Mutual Quest Fund Shareholder: Securities markets benefited from a confluence of positive economic, financial and political trends during The global economy entered a synchronized pace of modest and steady growth, corporate earnings strengthened in the US, Europe and Japan, and US equity market volatility remained at historically low levels. A number of political risks identified at the start of 2017, such as the success of far-right parties in Europe, Brexit negotiations and the Trump administration s ability to enact its policy agenda, also dissipated or became less immediate for investors as the year progressed. For the year ended December 31, 2017, US stocks, as measured by the Standard & Poor s 500 Index (S&P 500 ), produced a % total return. 1 Stocks in global developed markets, as measured by the MSCI World Index, returned %, and investment-grade bonds, as measured by the Bloomberg Barclays US Aggregate Bond Index, posted a +3.54% total return. 1 In many equity markets, the trend of growth stocks outpacing value stocks continued. The Russell 1000 Growth Index returned %, while the Russell 1000 Value Index returned %. 1 The difference in performance has been driven in large part by a rally in internet and software stocks, which dominated the S&P 500 Growth Index. In addition, the S&P 500 Value Index has components that we believe are facing disruption from new technology (e.g., the rapid market share shift to online retailing from traditional bricks and mortar retailers that are often labeled as value stocks). Exacerbating the disruption is the reality that many new technology companies are able to innovate without the need to show immediate profits. We do not know how long these trends will continue, but historically, periods of strong performance by growth stocks have eventually been followed by relatively weaker performance. Given that unemployment has continued to decline in most developed markets and the US Federal Reserve has taken its first steps toward monetary normalization, value-oriented stocks may become more attractive to investors, particularly within cyclical sectors of the equity markets such as industrials, consumer discretionary and financials. A stellar 2017 for equity markets also pushed up common valuation metrics, such as price-to-earnings. Valuation is a critical factor in our analysis and we always ask ourselves if current and potential investments represent an attractive balance of risk and reward. We remain committed to our long-term perspective and disciplined investment approach as we conduct a rigorous, fundamental analysis of securities with a regular emphasis on investment risk management. Although the investment landscape appears favorable as we enter 2018, it is worth remembering that securities markets are dynamic and constantly evolving. Therefore, we believe active, professional investment management serves investors well. We also recognize the important role of financial advisors in today s markets and encourage investors to continue to seek their advice. Amid changing markets and economic conditions, we are confident investors with a well-diversified portfolio and a patient, long-term outlook should be well positioned for the years ahead. 1. Source: Morningstar. Frank Russell Company is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell is a trademark of Frank Russell Company. See for additional data provider information. Not FDIC Insured May Lose Value No Bank Guarantee franklintempleton.com Not part of the annual report 1

3 On the following pages, the Fund s portfolio management team reviews investment decisions that pertain to performance during the past 12 months in light of the economic environment and other factors. Please remember all securities markets fluctuate, as do mutual fund share prices. We thank you for investing with Franklin Templeton, welcome your questions and comments, and look forward to continuing to serve your investment needs in the years ahead. Sincerely, Peter A. Langerman Chairman, President and Chief Executive Officer Franklin Mutual Advisers, LLC Contents Annual Report Franklin Mutual Quest Fund... 3 Performance Summary Your Fund's Expenses Financial Highlights and Statement of Investments Financial Statements Notes to Financial Statements Report of Independent Registered Public Accounting Firm Tax Information Board Members and Officers Shareholder Information This letter reflects our analysis and opinions as of December 31, 2017, unless otherwise indicated. The information is not a complete analysis of every aspect of any market, country, industry, security or fund. Statements of fact are from sources considered reliable. Visit franklintempleton.com for fund updates, to access your account, or to find helpful financial planning tools. 2 Not part of the annual report franklintempleton.com

4 Annual Report Franklin Mutual Quest Fund This annual report for Franklin Mutual Quest Fund covers the fiscal year ended December 31, Your Fund s Goal and Main Investments The Fund seeks capital appreciation, which may occasionally be short term, with income as a secondary goal. Under normal market conditions, the Fund invests substantially to primarily in equity securities of US and foreign companies that the investment manager believes are available at market prices less than their intrinsic value. The equity securities in which the Fund invests are primarily common stock, with a current focus on mid- and large-cap companies. To a lesser extent, the Fund also invests in merger arbitrage securities and the debt and equity of distressed companies. The Fund may invest a substantial portion, potentially up to 100% of its assets in foreign securities, which may include sovereign debt and participations in foreign government debt. The Geographic Composition bar chart on this page lists the leading countries where the Fund invests. Performance Overview The Fund s Class Z shares delivered a +7.25% cumulative total return for the 12 months ended December 31, In comparison, the Fund s benchmark, the MSCI World Index (USD), which tracks stock performance in global developed markets, generated a total return of %. 1 Also for comparison, the Fund s secondary benchmark, the Bloomberg Barclays US Corporate High Yield Index, which measures the US corporate market of non-investment grade, fixed-rate corporate bonds, defined as the middle or lower ratings of Moody s, Fitch and Standard & Poor s (Ba1/BB+/BB+), produced a +7.50% total return. 1 You can find more of the Fund s performance data in the Performance Summary beginning on page 10. Geographic Composition* Based on Total Net Assets as of 12/31/17 US UK Netherlands Israel Switzerland Other Short-Term Investments & Other Net Assets 4.0% 3.4% 2.2% 10.4% 7.6% 13.5% Performance data represent past performance, which does not guarantee future results. Investment return and principal value will fluctuate, and you may have a gain or loss when you sell your shares. Current performance may differ from figures shown. For most recent month-end performance, go to franklintempleton.com or call (800) Economic and Market Overview 58.9% *Figures are stated as a percentage of total and may not equal 100% or may be negative due to rounding, use of any derivatives, unsettled trades or other factors. The global economy grew moderately during the 12-month period under review. In this environment, global developed and emerging market stocks generated a % total return, as measured by the MSCI All Country World Index. 1 Global markets were aided by price gains in oil and other commodities, generally upbeat economic data across regions, the European Central Bank s (ECB s) extension of its monetary easing program, and investor optimism about pro-growth and pro-business policies in the US. The prospect for reforms in the European Union (EU) with Emmanuel Macron s election as 1. Source: Morningstar. The indexes are unmanaged and include reinvestment of any income or distributions. They do not reflect any fees, expenses or sales charges. One cannot invest directly in an index, and an index is not representative of the Fund s portfolio. The dollar value, number of shares or principal amount, and names of all portfolio holdings are listed in the Fund s Statement of Investments (SOI). The SOI begins on page 19. franklintempleton.com Annual Report 3

5 France s president, encouraging corporate earnings reports and the passage of the US tax reform bill also supported global stocks. However, global markets reflected investor concerns about the terms of the UK s exit from the EU, political uncertainty in the US and the EU, and geopolitical tensions in the Korean peninsula and other regions. Other concerns included the health of European banks, global oil oversupply despite a pact by major oil-producing countries to extend production cuts, and comments from key central bankers around the world about potentially raising interest rates. After strengthening in 2017 s second and third quarters, the US economy moderated in the fourth quarter. The economy grew faster in 2017 than in 2016, however, largely due to growth in consumer spending, business investment and exports. The unemployment rate decreased from 4.7% in December 2016, as reported at the beginning of the 12-month period, to 4.1% at period-end. 2 Annual inflation, as measured by the Consumer Price Index, was 2.1% in December 2016, as reported at the beginning of the 12-month period, and while it varied over the 12-month period, remained unchanged at period-end. 2 The US Federal Reserve (Fed) raised its target range for the federal funds rate 0.25% three times during the period, amid signs of a growing US economy, strengthening labor market and improving business spending. At its December meeting, the Fed confirmed that the monthly balance sheet reduction would increase from US$10 billion to US$20 billion beginning in January In Europe, the UK s economic growth moderated in 2017 compared to 2016, largely due to slower growth in the services sector. In November, the Bank of England raised its key policy rate 0.25%, its first increase in a decade. The eurozone s growth accelerated in 2017 s second and third quarters, but moderated in the fourth quarter. However, the eurozone s 2017 economic growth rate of 2.5% was the fastest in a decade. 3 The bloc s annual inflation rate, while low, ended higher than in December The ECB kept its benchmark interest rate unchanged during the period. However, at its October meeting, the ECB extended the time frame for its massive bond-buying program from December 2017 to at least September 2018, while reducing the amount of monthly bond purchases in half beginning in January In Asia, Japan s quarterly gross domestic product (GDP) grew for the seventh consecutive quarter, although third-quarter 2017 growth was lower than the previous quarter. The Bank of Japan left its benchmark interest rate unchanged during the period and continued its monetary stimulus measures. In emerging markets, Brazil s quarterly GDP grew for the third consecutive quarter, although third-quarter 2017 growth slowed from the previous quarter. The country s central bank cut its benchmark interest rate several times during the period to spur economic growth. Russia s GDP grew in 2017 s first three quarters compared to the prior-year periods, amid the Bank of Russia s continued policy support. China s GDP grew faster in 2017 than in 2016, supported by solid growth in industrial production, services, fixed-asset investment, retail sales, and imports and exports. The People s Bank of China left its benchmark interest rate unchanged during the period. Overall, emerging market stocks, as measured by the MSCI Emerging Markets Index, produced a substantial % total return during the period. 1 Investment Strategy At Franklin Mutual Series, we are committed to our distinctive value approach to investing, which we believe can generate above-average risk-adjusted returns over time for our shareholders. Our major investment strategy is investing in undervalued stocks. When selecting undervalued equities, we are attracted to what we believe are fundamentally strong companies with healthy balance sheets, high-quality assets, substantial free cash flow and shareholder-oriented management teams and whose stocks are trading at discounts to our assessment of the companies intrinsic or business value. We also look for asset-rich companies whose shares may be trading at depressed levels due to concerns over short-term earnings disappointments, litigation, management strategy or other perceived negatives. This strict value approach is not only intended to improve the likelihood of upside potential, but also reduces the risk of substantial declines, in our opinion. While the vast majority of our undervalued equity investments are made in publicly traded companies globally, we may invest occasionally in privately held companies as well. We complement this more traditional investment strategy with two others. One is distressed investing, a highly specialized field that has proven quite profitable during certain periods over the years. Distressed investing is complex and can take many forms. The most common distressed investment the Fund 2. Source: Bureau of Labor Statistics. 3. Source: Eurostat. 4 Annual Report franklintempleton.com

6 undertakes is the purchase of financially troubled or bankrupt companies debt at a substantial discount to face value. After the financially distressed company is reorganized, often in bankruptcy court, the old debt is typically replaced with new securities issued by the financially stronger company. The other piece of our investment strategy is participating in arbitrage situations, another highly specialized field. When companies announce proposed mergers or takeovers, commonly referred to as deals, the target company may trade at a discount to the bid it ultimately accepts. One form of arbitrage involves purchasing the target company s stock when it is trading below the value we believe it would receive in a deal. In keeping with our commitment to a relatively conservative investment approach, we typically focus our arbitrage efforts on announced deals, and avoid rumored deals or other situations we consider relatively risky. The current percentages of the Fund s assets devoted to these investment strategies are listed in the Asset Allocation bar chart on this page. In addition, it is our practice to hedge the Fund s currency exposure when we deem it advantageous for our shareholders. What is meant by hedge? To hedge an investment is to take a position intended to offset potential losses/gains that may be incurred by a companion financial instrument. Manager s Discussion In 2017, an improving economic and political backdrop helped drive most equity markets higher. The positive performances were broad based, spanning across most regions and sectors, and complemented by minimal volatility. Global markets were aided by generally upbeat economic data, improved corporate earnings in the US, Europe and Japan, as well as improved industrial commodity prices, most notably crude oil. In addition, the most significant political risks identified by investors heading into 2017 failed to materialize. In the US, markets began 2017 rallying as investors hoped that a Republican sweep of US elections in November 2016 would lead to a general loosening in regulations and tax reform, including lower corporate tax rates. Although the Trump administration s policy agenda was hindered by political Asset Allocation* Based on Total Net Assets as of 12/31/17 Equity & Equity-Linked Distressed Debt & Reorganization Merger Arbitrage Short-Term Investments & Other Net Assets 2.2% 13.5% 23.1% 61.2% *Figures are stated as a percentage of total and may not equal 100% or may be negative due to rounding, use of any derivatives, unsettled trades or other factors. gridlock, efforts to loosen federal regulations yielded some results and tax reform legislation was finally passed in late December. Improving economic activity and corporate earnings appeared to be the most meaningful equity market catalysts during much of However, the modest level of economic growth and low interest rates pushed investors to keep favoring growth stocks. During the period, the Russell 1000 Growth Index generated a total return of %, while the Russell 1000 Value Index posted a total return of %. 4 Within the Russell 1000 Growth Index, stocks with the largest weightings were technology firms that dominated the headlines: Apple, 5 Alphabet (a.k.a. Google), 5 Microsoft, 5 Amazon.com 5 and Facebook. 5 European equity markets started 2017 slowly, but positive political events and improved economic data fueled strong performances during the period. Elections in Europe produced outcomes generally regarded as positive economically as far-right parties largely failed to gain political power in national elections. Investors were particularly encouraged by the presidential election outcome in France. The reform-minded, centrist candidate, Emmanuel Macron, won the French presidential election in May and quickly began to push his agenda, most notably labor decrees giving employers in France greater freedom in negotiating contracts directly with workers. Amid all the positive events, the UK remained the most significant outlier. In the UK, a June 2017 snap election resulting in no party having a majority in Parliament appeared to make a hard Brexit, in which the UK leaves the European Union (EU) in March 2019 without a negotiated deal, even more likely than before. Although the UK and EU appeared to 4. Source: Morningstar. Frank Russell Company is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell is a trademark of Frank Russell Company. 5. Not a Fund holding. See for additional data provider information. franklintempleton.com Annual Report 5

7 make some progress late in the year, the snap election results left the Conservative Party in a precarious position and with the risk of another election in the near future. As value investors, we seek to invest prudently in securities that we believe represent good value, but adjust our views accordingly as the world around us changes. The media industry is a recent example of this approach. The Top 10 Sectors/Industries table on this page lists media and other leading industries in which the Fund currently invests. The media industry became a significant area of investment interest in the latter stages of the year due to significant structural changes. Since the 1980s, most Americans received their TV entertainment as part of a bundle from a cable provider. Disparate networks were combined and sold as packages, with annual price increases justified by the inclusion of more networks. Consumers rarely had the option to unbundle cable packages and most markets had no direct competition. However, the growth of fixed and mobile broadband connectivity ushered in the opportunity to bypass traditional distributors through the delivery of film and TV content over the internet and the launch of direct-to-consumer offerings by TV networks. The growing popularity of new digital options has driven cable providers to roll out lower-priced packages with fewer channels. This evolution has begun to create winners and losers among networks and new opportunities for investors. Pay TV subscription among US households peaked in 2009 at close to 100 million homes. Initially, the decline in subscribers was moderate, but has accelerated since 2015, reaching a pace of more than 2% per year in At first, media companies benefited from digital distribution by using it as an additional outlet for selling content. With the cannibalization of traditional platforms accelerating, media companies have begun to respond. The necessity for greater scale in content development and direct access to consumers is driving investment and merger decisions in the industry. From our standpoint, we are looking for networks with the most attractive content relative to the price they have been charging and may be able to charge in the future. The Fund initiated a position in Walt Disney in the latter half of We believe Disney is well positioned to benefit from the evolution toward a more direct-to-consumer distribution model. In our view, Disney has one of the best intellectual property (IP) portfolios in all of media with a stable of globally recognized proprietary characters upon which to build a strong direct-to-consumer franchise. If Disney is successful in its bid to acquire the bulk of Twenty-First Century Fox s 5 content assets, the deal would further strengthen its IP portfolio and its Top 10 Sectors/Industries Based on Equity Securities as of 12/31/17 % of Total Net Assets Pharmaceuticals 8.0% Media 7.9% Oil, Gas & Consumable Fuels 6.7% Insurance 5.1% Banks 5.0% Communications Equipment 3.1% Consumer Finance 3.0% Wireless Telecommunication Services 2.9% Software 2.7% Equity Real Estate Investment Trusts (REITs) 2.5% content development scale. As it has done with its own IP, Disney would likely be able to leverage Fox s content into attractions at its theme parks as well as consumer products. The acquisition would offer potential cost synergies that would likely offset some of the investments in the direct-to-consumer service. Under the leadership of chief executive officer Bob Iger, Disney has been effective in integrating acquired companies and navigating through a changing media landscape. Iger s commitment to remain at the helm through 2021 strengthens our belief that the company should be able to execute on this opportunity. Merger and acquisition activity remained healthy in 2017, although the pace of activity appeared to decelerate slightly compared to 2016 due to less favorable political and regulatory conditions in the US, the UK and China. In the US, several key regulatory agencies remain short of members, including the Federal Communications Commission and the Federal Trade Commission. Many large deals continued to wind their way through prolonged regulatory reviews, including AT&T s 5 acquisition of Time Warner, and Twenty-First Century Fox s offer for Sky. Credit spreads narrowed in 2017 for higher quality and high yield credit, albeit with some minor bouts of volatility. The broad-based decrease in yield differentials between bonds with the same maturity but different credit quality provided the Fund with the opportunity to exit a number of opportunities that presented themselves in early 2016, including several bond offerings related to leveraged acquisitions, as prices improved, yield premium over Treasuries shrank, and the risk-adjusted returns were no longer mispriced. As the year progressed and investors became more willing buyers of credit, mispriced risk became more difficult to find, in our opinion. In times when the credit markets fluctuate and value is difficult to identify, we believe our industry specific expertise, deep fundamental 6 Annual Report franklintempleton.com

8 analysis with a focus on cash flow, and intensive credit and covenant review combine seamlessly and provide us with different ways of looking at the same ideas others may disregard. Fund Performance Turning to Fund performance, top positive contributors included US-based companies NRG Energy and Ally Financial and Netherlands-based ASR Nederland. ASR Nederland is listed among the Fund s largest positions in the Top 10 Equity Holdings table on this page. NRG Energy is an integrated wholesale power generation and retail electricity company that includes solar and renewable energy businesses. Shares of NRG began to rally in January 2017 after hedge fund management firm Elliott Associates and private equity firm Bluescape Energy Partners announced a combined stake in NRG. In a filing with the US Securities and Exchange Commission, the two investors stated their belief in numerous opportunities to significantly increase shareholder value. Shares of NRG rose further in July 2017 in reaction to the NRG Board of Directors transformation plan. The plan includes a reduction in debt by several billion through significant cost reduction and margin improvement goals, asset sales of up to $4 billion, including renewable energy assets and contracted power plants, and restructuring that includes the bankruptcy filing of subsidiary GenOn. If successfully executed, the transformation plan could turn NRG into a more focused energy provider with a considerably stronger balance sheet, in our view. The stock price of Ally Financial, a US-based bank and auto finance company, rose steadily from the middle of 2017 due to improved financial performance, stable to improving auto prices, favorable decisions by the US Federal Reserve (Fed), as well as the passage of a major US tax reform bill. Ally s quarterly results showed improved lending spreads, positive management of expenses and credit, and a good rate of deposit growth. In June, shares of Ally rose in response to the Fed s Comprehensive Capital Analysis and Review (CCAR) results. As part of CCAR, the Fed evaluated banks capital distribution plans, including dividends and stock repurchases. Ally was approved to raise its dividend by more than investors had expected, as well as to increase its share buyback plan. In August, the Fed released Ally Bank from the capital, liquidity, and business plan commitments connected to its application for membership in the Federal Reserve System. Shares of insurer ASR Nederland steadily rose during most of the period, aided by a series of solid quarterly results. Operating results were aided by ASR Nederland s efforts to Top 10 Equity Holdings 12/31/17 Company Sector/Industry, Country % of Total Net Assets Sorenson Communications LLC 3.1% Communications Equipment, US Vodafone Group PLC 2.9% Wireless Telecommunication Services, UK Royal Dutch Shell PLC 2.5% Oil, Gas & Consumable Fuels, UK Time Warner Inc. 2.4% Media, US ASR Nederland NV 2.2% Insurance, Netherlands Novartis AG 2.2% Pharmaceuticals, Switzerland CIT Group Inc. 2.0% Banks, US Voya Financial Inc. 1.9% Diversified Financial Services, US Medtronic PLC 1.9% Health Care Equipment & Supplies, US BP PLC 1.9% Oil, Gas & Consumable Fuels, UK increase the investment risk of its portfolio by shifting invested premiums from traditional fixed income securities to equities and other assets with higher historical returns. In February 2017, ASR Nederland announced it would increase its dividend and repurchase shares on offer from the Dutch government, shares the government had acquired during the 2008 financial crisis. The company announced an additional share buyback plan in May In our view, the buybacks demonstrated ASR Nederland s strong capital position. During the period under review, Fund investments that detracted from performance included US-based companies Eastman Kodak and Avaya and Israel-based pharmaceutical services provider Teva Pharmaceuticals. Shares of Eastman Kodak, a digital commercial imaging company, retreated in March due to weak results, particularly lower revenues. Earnings guidance for full year 2017 was also met with disappointment as was Kodak s announcement in April that it would not sell its inkjet business. The stock price dropped further in November on another set of disappointing quarterly results and a downward revision to 2017 earnings guidance. Eastman Kodak has been dealing with a number of challenges, including weakness in the commercial print business and problems with vendors in its film business. Avaya is a communications company that was chiefly a hardware maker but is transitioning into a software and services franklintempleton.com Annual Report 7

9 provider. As we anticipated, the company filed for Chapter 11 bankruptcy in January 2017 to restructure and reduce its debt load. Avaya then emerged from bankruptcy in December with significantly less debt. Teva Pharmaceutical Industries experienced a challenging year. In January 2017, Teva provided lower earnings guidance and a US federal court invalidated four patents for the company s top-selling multiple sclerosis drug Copaxone. The resignations of Teva s chief executive officer (CEO) and chief financial officer in the first half of 2017 further hindered Teva s stock price. In the second half of the year, weak operating results, a dividend cut and a debt rating downgrade escalated investor concerns. The company managed to ease investor anxiety later in 2017, in our view, with the appointment of Kare Schultz, a well-regarded industry veteran as the new CEO, as well as the divestiture of certain non-core assets and amendment to certain debt instruments. We were also encouraged by the details of a restructuring plan announced by the new CEO in December. During the period, the Fund held currency forwards and futures seeking to hedge most of the currency risk of the portfolio s non-us dollar investments. The currency forwards and futures had a negative impact on the Fund s performance because of the depreciation of the US dollar versus the hedged currencies. What is a currency forward? A currency forward is an agreement between the Fund and a counterparty to buy or sell a foreign currency in exchange for another currency at a specific exchange rate on a future date. What is a future? A future is an agreement between the Fund and a counterparty made through a US or foreign futures exchange to buy or sell an underlying instrument or asset at a specific price on a future date. Thank you for your participation in Franklin Mutual Quest Fund. We look forward to continuing to serve your investment needs. Shawn M. Tumulty Co-Portfolio Manager Keith Luh, CFA Co-Portfolio Manager The foregoing information reflects our analysis, opinions and portfolio holdings as of December 31, 2017, the end of the reporting period. The way we implement our main investment strategies and the resulting portfolio holdings may change depending on factors such as market and economic conditions. These opinions may not be relied upon as investment advice or an offer for a particular security. The information is not a complete analysis of every aspect of any market, country, industry, security or the Fund. Statements of fact are from sources considered reliable, but the investment manager makes no representation or warranty as to their completeness or accuracy. Although historical performance is no guarantee of future results, these insights may help you understand our investment management philosophy. Shawn Tumulty has been a portfolio manager for Franklin Mutual Quest Fund since 2003 and a co-portfolio manager since He joined Franklin Templeton Investments in Prior to joining Franklin Templeton Investments, Mr. Tumulty was an analyst and portfolio manager at Hamilton Partners Limited. CFA is a trademark owned by CFA Institute. 8 Annual Report franklintempleton.com

10 Keith Luh has been a co-portfolio manager for Franklin Mutual Quest Fund since He is also head of cross asset investing for Franklin Mutual Series with a value and event-driven focus across equity and fixed income investments, globally. Prior to joining in 2005, Mr. Luh was a senior analyst in global investment research at Putnam Investments, where he also helped manage a best-ideas research fund. Previously, he worked in the investment banking group at Volpe Brown Whelan and Co., LLC, and the derivative products trading group at BNP. Mr. Luh is also Adjunct Professor in Finance and Economics at the Graduate School of Business, Columbia University. franklintempleton.com Annual Report 9

11 Performance Summary as of December 31, 2017 The performance table and graphs do not reflect any taxes that a shareholder would pay on Fund dividends, capital gain distributions, if any, or any realized gains on the sale of Fund shares. Total return reflects reinvestment of the Fund s dividends and capital gain distributions, if any, and any unrealized gains or losses. Your dividend income will vary depending on dividends or interest paid by securities in the Fund s portfolio, adjusted for operating expenses of each class. Capital gain distributions are net profits realized from the sale of portfolio securities. Performance as of 12/31/17 Cumulative total return excludes sales charges. Average annual total return includes maximum sales charges. Sales charges will vary depending on the size of the investment and the class of share purchased. The maximum is 5.75% and the minimum is 0%. Class A: 5.75% maximum initial sales charge. For other share classes, visit franklintempleton.com. Share Class Cumulative Total Return 1 Average Annual Total Return 2 Z 1-Year +7.25% % 3 5-Year % +8.94% 10-Year % +5.34% A 1-Year +6.95% % 5-Year % +7.36% 10-Year % +4.42% Performance data represent past performance, which does not guarantee future results. Investment return and principal value will fluctuate, and you may have a gain or loss when you sell your shares. Current performance may differ from figures shown. For most recent month-end performance, go to franklintempleton.com or call (800) See page 12 for Performance Summary footnotes. 10 Annual Report franklintempleton.com

12 PERFORMANCE SUMMARY 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 includes any applicable maximum sales charge, Fund expenses, account fees and reinvested distributions. The unmanaged indexes include reinvestment of any income or distributions. They differ from the Fund in composition and do not pay management fees or expenses. One cannot invest directly in an index. Class Z (1/1/08 12/31/17) $25,000 $20,000 $15,000 $21,653 $17,301 $16,822 $10,000 $5,000 $0 1/08 12/09 12/11 12/13 12/15 12/17 Franklin Mutual Quest Fund MSCI World Index (USD) 4 Bloomberg Barclays US High Yield Corporate Index 4 Class A (1/1/08 12/31/17) $25,000 $20,000 $15,000 $21,653 $17,301 $15,406 $10,000 $5,000 $0 1/08 12/09 12/11 12/13 12/15 12/17 Franklin Mutual Quest Fund MSCI World Index (USD) 4 Bloomberg Barclays US High Yield Corporate Index 4 See page 12 for Performance Summary footnotes. franklintempleton.com Annual Report 11

13 PERFORMANCE SUMMARY Distributions (1/1/17 12/31/17) Share Class Net Investment Income Short-Term Capital Gain Long-Term Capital Gain Total Z $ $ $ $ A $ $ $ $ C $ $ $ $ R $ $ $ $ R6 $ $ $ $ Total Annual Operating Expenses 5 Share Class Z 0.79% A 1.04% Each class of shares is available to certain eligible investors and has different annual fees and expenses, as described in the prospectus. All investments involve risks, including possible loss of principal. Value securities may not increase in price as anticipated or may decline further in value. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Because the Fund may invest its assets in companies in a specific region, including Europe, it is subject to greater risks of adverse developments in that region and/or the surrounding regions than a fund that is more broadly diversified geographically. Current political and financial uncertainty surrounding the European Union may increase market volatility and the economic risk of investing in companies in Europe. Smaller company stocks have exhibited greater price volatility than larger company stocks, particularly over the short term. The Fund s investments in companies engaged in mergers, reorganizations or liquidations also involve special risks as pending deals may not be completed on time or on favorable terms. The Fund may invest in lower rated bonds, which entail higher credit risk. The Fund is actively managed but there is no guarantee that the manager s investment decisions will produce the desired results. The Fund s prospectus also includes a description of the main investment risks. 1. 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. Return for less than one year, if any, has not been annualized. 3. Total return information is based on net asset values calculated for shareholder transactions. Certain adjustments were made to the net assets of the Fund at 12/31/17 for financial reporting purposes, and as a result, the total returns based on those net asset values differ from the adjusted total returns reported in the Financial Highlights. 4. Source: Morningstar. The MSCI World Index (USD) is a free float-adjusted, market capitalization-weighted index designed to measure equity market performance in global developed markets. The Bloomberg Barclays US Corporate High Yield Index measures the US corporate market of non-investment grade, fixed-rate corporate bonds, defined as the middle or lower ratings of Moody s, Fitch and Standard & Poor s (Ba1/BB+/BB+). 5. Figures are as stated in the Fund s current prospectus and may differ from the expense ratios disclosed in the Your Fund s Expenses and Financial Highlights sections in this report. In periods of market volatility, assets may decline significantly, causing total annual Fund operating expenses to become higher than the figures shown. See for additional data provider information. 12 Annual Report franklintempleton.com

14 Your Fund s Expenses As a Fund shareholder, you can incur two types of costs: (1) transaction costs, including sales charges (loads) on Fund purchases and redemptions; and (2) ongoing Fund costs, including management fees, distribution and service (12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs, sometimes referred to as operating expenses. The table below shows ongoing costs of investing in the Fund and can help you understand these costs and compare them with those of other mutual funds. The table assumes a $1,000 investment held for the six months indicated. Actual Fund Expenses The table below provides information about actual account values and actual expenses in the columns under the heading Actual. In these columns the Fund s actual return, which includes the effect of Fund expenses, is used to calculate the Ending Account Value for each class of shares. You can estimate the expenses you paid during the period by following these steps (of course, your account value and expenses will differ from those in this illustration): Divide your account value by $1,000 (if your account had an $8,600 value, then $8,600 $1,000 = 8.6). Then multiply the result by the number in the row for your class of shares under the headings Actual and Expenses Paid During Period (if Actual Expenses Paid During Period were $7.50, then 8.6 x $7.50 = $64.50). In this illustration, the actual expenses paid this period are $ Hypothetical Example for Comparison with Other Funds Under the heading Hypothetical in the table, information is provided about hypothetical account values and hypothetical expenses based on the Fund s actual expense ratio and an assumed rate of return of 5% per year before expenses, which is not the Fund s actual return. This information may not be used to estimate the actual ending account balance or expenses you paid for the period, but it can help you compare ongoing costs of investing in the Fund with those of other funds. To do so, compare this 5% hypothetical example for the class of shares you hold with the 5% hypothetical examples that appear in the shareholder reports of other funds. Please note that expenses shown in the table are meant to highlight ongoing costs and do not reflect any transactional costs. Therefore, information under the heading Hypothetical is useful in comparing ongoing costs only, and will not help you compare total costs of owning different funds. In addition, if transactional costs were included, your total costs would have been higher. Share Class Beginning Account Value 7/1/17 Actual (actual return after expenses) Ending Account Value 12/31/17 Expenses Paid During Period 7/1/17 12/31/17 1 Hypothetical (5% annual return before expenses) Ending Account Value 12/31/17 Expenses Paid During Period 7/1/17 12/31/17 1 Annualized Expense Ratio Z $1,000 $1, $4.12 $1, $ % A $1,000 $1, $5.40 $1, $ % C $1,000 $1, $9.24 $1, $ % R $1,000 $1, $6.68 $1, $ % R6 $1,000 $1, $3.76 $1, $ % 1. Expenses are equal to the annualized expense ratio for the six-month period as indicated above in the far right column multiplied by the simple average account value over the period indicated, and then multiplied by 184/365 to reflect the one-half year period. franklintempleton.com Annual Report 13

15 Financial Highlights Year Ended December 31, Class Z Per share operating performance (for a share outstanding throughout the year) Net asset value, beginning of year... $15.52 $14.47 $16.21 $18.18 $16.55 Income from investment operations a : Net investment income b c d 0.54 Net realized and unrealized gains (losses) (1.45) (0.16) 3.68 Total from investment operations (0.91) Less distributions from: Net investment income... (0.63) (1.01) (0.68) (0.85) (0.56) Netrealizedgains... (0.13) (0.28) (0.15) (1.74) (2.03) Totaldistributions... (0.76) (1.29) (0.83) (2.59) (2.59) Net asset value, end of year.... $15.83 $15.52 $14.47 $16.21 $18.18 Totalreturn % 16.26% (5.55)% 3.44% 25.97% Ratios to average net assets... Expenses e,f % 0.79% g 0.82% g 0.81% 0.84% Expenses incurred in connection with securities sold short... % 0.01% 0.03% 0.04% 0.07% Netinvestmentincome % 5.74% c 3.35% 4.18% d 2.93% Supplemental data Net assets, end of year (000 s).... $3,667,351 $3,683,095 $3,577,696 $4,116,651 $4,270,828 Portfolio turnover rate % 44.04% 30.51% 65.77% 63.41% athe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund s shares in relation to income earned and/or fluctuating fair value of the investments of the Fund. bbased on average daily shares outstanding. cnet investment income per share includes approximately $0.05 per share related to income received in the form of special dividends in connection with certain Fund holdings. Excluding this amount, the ratio of net investment income to average net assets would have been 5.42%. dnet investment income per share includes approximately $0.27 per share related to income received in the form of special dividends in connection with certain Fund holdings. Excluding this amount, the ratio of net investment income to average net assets would have been 2.73%. eincludes dividend and/or interest expense on securities sold short and security borrowing fees, if any. See below for the ratios of such expenses to average net assets for the periods presented. See Note 1(d). fbenefit of expense reduction rounds to less than 0.01%. g Benefit of waiver and payments by affiliates rounds to less than 0.01%. 14 Annual Report The accompanying notes are an integral part of these financial statements. franklintempleton.com

16 FINANCIAL HIGHLIGHTS Year Ended December 31, Class A Per share operating performance (for a share outstanding throughout the year) Net asset value, beginning of year... $15.32 $14.29 $16.02 $18.00 $16.41 Income from investment operations a : Net investment income b c d 0.48 Net realized and unrealized gains (losses) (1.43) (0.15) 3.65 Total from investment operations (0.94) Less distributions from: Net investment income... (0.58) (0.97) (0.64) (0.80) (0.51) Netrealizedgains... (0.13) (0.28) (0.15) (1.74) (2.03) Totaldistributions... (0.71) (1.25) (0.79) (2.54) (2.54) Net asset value, end of year.... $15.60 $15.32 $14.29 $16.02 $18.00 Total return e % 16.04% (5.85)% 3.11% 25.61% Ratios to average net assets Expenses f,g % 1.04% h 1.10% h 1.11% 1.14% Expenses incurred in connection with securities sold short... % 0.01% 0.03% 0.04% 0.07% Netinvestmentincome % 5.49% c 3.07% 3.88% d 2.63% Supplemental data Net assets, end of year (000 s).... $1,153,870 $1,216,085 $1,203,508 $1,394,138 $1,371,789 Portfolio turnover rate % 44.04% 30.51% 65.77% 63.41% athe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund s shares in relation to income earned and/or fluctuating fair value of the investments of the Fund. bbased on average daily shares outstanding. cnet investment income per share includes approximately $0.05 per share related to income received in the form of special dividends in connection with certain Fund holdings. Excluding this amount, the ratio of net investment income to average net assets would have been 5.17%. dnet investment income per share includes approximately $0.27 per share related to income received in the form of special dividends in connection with certain Fund holdings. Excluding this amount, the ratio of net investment income to average net assets would have been 2.43%. e Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. fincludes dividend and/or interest expense on securities sold short and security borrowing fees, if any. See below for the ratios of such expenses to average net assets for the periods presented. See Note 1(d). gbenefit of expense reduction rounds to less than 0.01%. h Benefit of waiver and payments by affiliates rounds to less than 0.01%. franklintempleton.com The accompanying notes are an integral part of these financial statements. Annual Report 15

17 FINANCIAL HIGHLIGHTS Year Ended December 31, Class C Per share operating performance (for a share outstanding throughout the year) Net asset value, beginning of year... $15.06 $14.08 $15.78 $17.76 $16.24 Income from investment operations a : Net investment income b c d 0.35 Net realized and unrealized gains (losses) (1.39) (0.14) 3.59 Total from investment operations (1.03) Less distributions from: Net investment income... (0.46) (0.85) (0.52) (0.67) (0.39) Netrealizedgains... (0.13) (0.28) (0.15) (1.74) (2.03) Totaldistributions... (0.59) (1.13) (0.67) (2.41) (2.42) Net asset value, end of year.... $15.35 $15.06 $14.08 $15.78 $17.76 Total return e % 15.10% (6.49)% 2.42% 24.74% Ratios to average net assets Expenses f,g % 1.79% h 1.82% h 1.81% 1.84% Expenses incurred in connection with securities sold short... % 0.01% 0.03% 0.04% 0.07% Netinvestmentincome % 4.74% c 2.35% 3.18% d 1.93% Supplemental data Net assets, end of year (000 s).... $309,160 $343,624 $337,974 $397,963 $406,304 Portfolio turnover rate % 44.04% 30.51% 65.77% 63.41% athe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund s shares in relation to income earned and/or fluctuating fair value of the investments of the Fund. bbased on average daily shares outstanding. cnet investment income per share includes approximately $0.05 per share related to income received in the form of special dividends in connection with certain Fund holdings. Excluding this amount, the ratio of net investment income to average net assets would have been 4.42%. dnet investment income per share includes approximately $0.27 per share related to income received in the form of special dividends in connection with certain Fund holdings. Excluding this amount, the ratio of net investment income to average net assets would have been 1.73%. e Total return does not reflect sales commissions or contingent deferred sales charges, if applicable. fincludes dividend and/or interest expense on securities sold short and security borrowing fees, if any. See below for the ratios of such expenses to average net assets for the periods presented. See Note 1(d). gbenefit of expense reduction rounds to less than 0.01%. h Benefit of waiver and payments by affiliates rounds to less than 0.01%. 16 Annual Report The accompanying notes are an integral part of these financial statements. franklintempleton.com

18 FINANCIAL HIGHLIGHTS Year Ended December 31, Class R Per share operating performance (for a share outstanding throughout the year) Net asset value, beginning of year... $15.14 $14.14 $15.87 $17.84 $16.33 Income from investment operations a : Net investment income b c d 0.50 Net realized and unrealized gains (losses) (1.40) (0.13) 3.56 Total from investment operations (0.96) Less distributions from: Net investment income... (0.57) (0.93) (0.62) (0.75) (0.52) Netrealizedgains... (0.13) (0.28) (0.15) (1.74) (2.03) Totaldistributions... (0.70) (1.21) (0.77) (2.49) (2.55) Net asset value, end of year.... $15.40 $15.14 $14.14 $15.87 $17.84 Totalreturn % 15.69% (6.03)% 2.94% 25.34% Ratios to average net assets Expenses e,f % 1.29% g 1.32% g 1.31% 1.34% Expenses incurred in connection with securities sold short... % 0.01% 0.03% 0.04% 0.07% Netinvestmentincome % 5.24% c 2.85% 3.68% d 2.43% Supplemental data Net assets, end of year (000 s).... $1,774 $880 $898 $675 $853 Portfolio turnover rate % 44.04% 30.51% 65.77% 63.41% athe amount shown for a share outstanding throughout the period may not correlate with the Statement of Operations for the period due to the timing of sales and repurchases of the Fund s shares in relation to income earned and/or fluctuating fair value of the investments of the Fund. bbased on average daily shares outstanding. cnet investment income per share includes approximately $0.05 per share related to income received in the form of special dividends in connection with certain Fund holdings. Excluding this amount, the ratio of net investment income to average net assets would have been 4.92%. dnet investment income per share includes approximately $0.27 per share related to income received in the form of special dividends in connection with certain Fund holdings. Excluding this amount, the ratio of net investment income to average net assets would have been 2.23%. eincludes dividend and/or interest expense on securities sold short and security borrowing fees, if any. See below for the ratios of such expenses to average net assets for the periods presented. See Note 1(d). fbenefit of expense reduction rounds to less than 0.01%. g Benefit of waiver and payments by affiliates rounds to less than 0.01%. franklintempleton.com The accompanying notes are an integral part of these financial statements. Annual Report 17