N-CSR 1 dncsr.htm LMP EQUITY TRUST -- LMP CAPITAL AND INCOME FUND LMP Equity Trust -- LMP Capital and Income Fund

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM N-CSR

 

CERTIFIED SHAREHOLDER REPORT OF REGISTERED

MANAGEMENT INVESTMENT COMPANIES

 

Investment Company Act file number

    811-06444

 

 

 

 

 

 

 

Legg Mason Partners Equity Trust

(Exact name of registrant as specified in charter)

 

55 Water Street, New York, NY   10041
(Address of principal executive offices)   (Zip code)

 

 

Robert I. Frenkel, Esq.

Legg Mason & Co., LLC

100 First Stamford Place, 4th Floor

Stamford, CT 06902

(Name and address of agent for service)

 

Registrant’s telephone number, including area code: (800) 451-2010

 

Date of fiscal year end: December 31

 

Date of reporting period: December 31, 2008

ITEM 1. REPORT TO STOCKHOLDERS.

The Annual Report to Stockholders is filed herewith.

LOGO

ANNUAL REPORT / DECEMBER 31, 2008

Legg Mason Partners

Capital and Income Fund

 

Managed by   CLEARBRIDGE ADVISORS
 
  WESTERN ASSET

 

INVESTMENT PRODUCTS: NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE

 

Fund objective

The Fund seeks total return (that is, a combination of income and long-term capital appreciation).

 

What’s inside

 

Letter from chairman   I
Fund overview   1
Fund at a glance   7
Fund expenses   8
Fund performance   10
Historical performance   11
Schedule of investments   12
Statement of assets and liabilities   43
Statement of operations   45
Statements of changes in net assets   46
Financial highlights   47
Notes to financial Statements   52
Report of independent registered public accounting firm   72
Board approval of management and subadvisory agreements   73
Additional information   78
Important tax information   85

Legg Mason Partners Fund Advisor, LLC (“LMPFA”) is the Fund’s investment manager. ClearBridge Advisors, LLC (“ClearBridge”), Western Asset Management Company (“Western Asset”) and Western Asset Management Company Limited (“Western Asset Limited”) are the Fund’s subadvisers. LMPFA, ClearBridge, Western Asset and Western Asset Limited are wholly-owned subsidiaries of Legg Mason, Inc.

Letter from the chairman

LOGO

R. Jay Gerken, CFA

Chairman, President and Chief Executive Officer

 

Dear Shareholder,

The U.S. economy weakened significantly during the 12-month reporting period ended December 31, 2008. Looking back, U.S. gross domestic product (“GDP”)i contracted 0.2% in the fourth quarter of 2007. This was due to continued weakness in the housing market, an ongoing credit crunch and soaring oil and food prices. The economy then expanded 0.9% and 2.8% during the first and second quarters of 2008, respectively. Contributing to this rebound were rising exports that were buoyed by a weakening U.S. dollar. In addition, consumer spending accelerated, aided by the government’s tax rebate program. However, the dollar’s rally and the end of the rebate program, combined with other strains on the economy, caused GDP to take a step backward during the second half of 2008. According to the U.S. Department of Commerce, third quarter 2008 GDP declined 0.5% and its advance estimate for fourth quarter GDP decline was 3.8%, the latter being the worst quarterly reading since 1982.

While there were increasing signs that the U.S. was headed for a recession, the speculation ended in December 2008. At that time, the National Bureau of Economic Research (“NBER”) — which has the final say on when one begins and ends — announced that a recession had begun in December 2007. The NBER determined that a recession had already started using its definition, which is based on “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income and other indicators.”

Regardless of how one defines a recession, it felt like we were in the midst of an economic contraction for much of 2008. Consumer spending, which represents approximately two-thirds of GDP, has been disappointing. According to the International Council of Shopping Centers, retail sales rose a tepid 1% in 2008, the weakest level in at least 38 years. In terms of the job market, the U.S. Department of Labor reported that payroll employment declined in each of the 12 months of 2008. During 2008 as a whole, 2.6 million jobs were lost, the largest annual decline since World War II ended in 1945. In addition, at the end of 2008, the unemployment rate had risen to 7.2%, its highest level since January 1993.

 

Legg Mason Partners Capital and Income Fund   I

Letter from the chairman continued

 

Ongoing issues related to the housing and subprime mortgage markets and seizing credit markets prompted the Federal Reserve Board (“Fed”)ii to take aggressive and, in some cases, unprecedented actions. When 2008 began, the federal funds rateiii was 4.25%. This was quickly brought down to 3.00% by the end of January 2008, on the back of two Fed rate cuts. The Fed continued to lower the federal funds rate to 2.00% by the end of April 2008, but then left rates on hold for several months. This was due to growing inflationary pressures as a result of soaring oil and commodity prices, coupled with the sagging U.S. dollar. However, as inflation receded along with oil prices and the global financial crisis escalated, the Fed cut rates twice in October to 1.00%. Then, in mid-December 2008, it reduced the federal funds rate to a range of zero to 0.25%, an historic low. In conjunction with its December meeting, the Fed stated that it “will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”

In addition to the interest rate cuts, the Fed took several actions to improve liquidity in the credit markets. In March 2008, it established a new lending program allowing certain brokerage firms, known as primary dealers, to also borrow from its discount window. Also in March, the Fed played a major role in facilitating the purchase of Bear Stearns by JPMorgan Chase. In mid-September 2008, it announced an $85 billion rescue plan for ailing AIG and pumped $70 billion into the financial system as Lehman Brothers’ bankruptcy and mounting troubles at other financial firms roiled the markets.

The U.S. Department of the Treasury has also taken an active role in attempting to stabilize the financial system, as it orchestrated the government’s takeover of mortgage giants Fannie Mae and Freddie Mac in September 2008. In addition, on October 3, 2008, the Treasury’s $700 billion Troubled Asset Relief Program (“TARP”) was approved by Congress and signed into law by President Bush. As part of TARP, the Treasury had planned to purchase bad loans and other troubled financial assets. However, in November 2008, Treasury Secretary Paulson said, “Our assessment at this time is that this is not the most effective way to use TARP funds, but we will continue to examine whether targeted forms of asset purchase can play a useful role, relative to other potential uses of TARP resources, in helping to strengthen our financial system and support lending.”

The U.S. stock market was extremely volatile and generated very poor results during the 12 months ended December 31, 2008. Stock prices declined during each of the first three months of the reporting period. This was due, in part, to the credit crunch, weakening corporate profits, rising inflation and fears of an impending recession. The market then reversed course and posted positive returns in April and May 2008. The market’s

 

II   Legg Mason Partners Capital and Income Fund

 

gains were largely attributed to hopes that the U.S. would skirt a recession and that corporate profits would rebound as the year progressed. However, given the escalating credit crisis and the mounting turmoil in the financial markets, stock prices moved lower during five of the last seven months of the reporting period, including S&P 500 Indexiv (the “Index”) returns of -8.91%, -16.79% and -7.18% in September, October and November 2008, respectively. While the Index rallied approximately 20% from its low on November 20, 2008 through the end of the year, it was too little, too late. All told, the Index returned -37.00% in 2008, its third worst year ever and the biggest calendar year loss since 1937.

Turning to the fixed-income markets, both short- and long-term Treasury yields experienced periods of extreme volatility during the 12-month reporting period ended December 31, 2008. Investors were initially focused on the subprime segment of the mortgage-backed market. These concerns broadened, however, to include a wide range of financial institutions and markets. As a result, other fixed-income instruments also experienced increased price volatility. This unrest triggered several “flights to quality,” causing Treasury yields to move lower (and their prices higher), while riskier segments of the market saw their yields move higher (and their prices lower). This was particularly true toward the end of the reporting period, as the turmoil in the financial markets and sharply falling stock prices caused investors to flee securities that were perceived to be risky, even high-quality corporate bonds and high-grade municipal bonds. On several occasions, the yield available from short-term Treasuries fell to nearly zero, as investors were essentially willing to forgo any return potential in order to access the relative safety of government-backed securities. During the 12 months ended December 31, 2008, two-year Treasury yields fell from 3.05% to 0.76%. Over the same time frame, 10-year Treasury yields moved from 4.04% to 2.25%. Looking at the 12-month period as a whole, the overall bond market, as measured by the Barclays Capital U.S. Aggregate Indexv, returned 5.24%.

A special note regarding increased market volatility

In recent months, we have experienced a series of events that have impacted the financial markets and created concerns among both novice and seasoned investors alike. In particular, we have witnessed the failure and consolidation of several storied financial institutions, periods of heightened market volatility, and aggressive actions by the U.S. federal government to steady the financial markets and restore investor confidence. While we hope that the worst is over in terms of the issues surrounding the credit and housing crises, it is likely that the fallout will continue to impact the financial markets and the U.S. economy well into 2009.

Like all asset management firms, Legg Mason has not been immune to these difficult and, in some ways, unprecedented times. However, today’s

 

Legg Mason Partners Capital and Income Fund   III

Letter from the chairman continued

 

challenges have only strengthened our resolve to do everything we can to help you reach your financial goals. Now, as always, we remain committed to providing you with excellent service and a full spectrum of investment choices. And rest assured, we will continue to work hard to ensure that our investment managers make every effort to deliver strong long-term results.

We also remain committed to supplementing the support you receive from your financial advisor. One way we accomplish this is through our enhanced website, www.leggmason.com/individualinvestors. Here you can gain immediate access to many special features to help guide you through difficult times, including:

 

•  

Fund prices and performance,

 

•  

Market insights and commentaries from our portfolio managers, and

 

•  

A host of educational resources.

During periods of market unrest, it is especially important to work closely with your financial advisor and remember that reaching one’s investment goals unfolds over time and through multiple market cycles. Time and again, history has shown that, over the long run, the markets have eventually recovered and grown.

Information about your fund

As you may be aware, several issues in the mutual fund industry have come under the scrutiny of federal and state regulators. Affiliates of the Fund’s manager have, in recent years, received requests for information from various government regulators regarding market timing, late trading, fees, and other mutual fund issues in connection with various investigations. The regulators appear to be examining, among other things, the Fund’s response to market timing and shareholder exchange activity, including compliance with prospectus disclosure related to these subjects. The Fund is not in a position to predict the outcome of these requests and investigations.

Please read on for a more detailed look at prevailing economic and market conditions during the Fund’s reporting period and to learn how those conditions have affected Fund performance.

Important information with regard to recent regulatory developments that may affect the Fund is contained in the Notes to Financial Statements included in this report.

 

IV   Legg Mason Partners Capital and Income Fund

 

As always, thank you for your confidence in our stewardship of your assets. We look forward to helping you meet your financial goals.

Sincerely,

LOGO

R. Jay Gerken, CFA

Chairman, President and Chief Executive Officer

January 30, 2009

 

All index performance reflects no deduction for fees, expenses or taxes. Please note that an investor cannot invest directly in an index.

 

i

Gross domestic product (“GDP”) is the market value of all final goods and services produced within a country in a given period of time.

 

ii

The Federal Reserve Board (“Fed”) is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

 

iii

The federal funds rate is the rate charged by one depository institution on an overnight sale of immediately available funds (balances at the Federal Reserve) to another depository institution; the rate may vary from depository institution to depository institution and from day to day.

 

iv

The S&P 500 Index is an unmanaged index of 500 stocks and is generally representative of the performance of larger companies in the U.S.

 

v

The Barclays Capital (formerly Lehman Brothers) U.S. Aggregate Index is a broad-based bond index comprised of government, corporate, mortgage- and asset-backed issues, rated investment grade or higher, and having at least one year to maturity.

 

Legg Mason Partners Capital and Income Fund   V

Fund overview

 

Q. What is the Fund’s investment strategy?

A. The Fund seeks total return (a combination of income and long-term capital appreciation) by investing in both equities and fixed-income securities of both U.S. and foreign issuers. The Fund seeks to generate income and appreciation by allocating Fund assets to income and non-income producing equity and equity-related securities, including common stocks, real estate investment trusts (“REITs”)i and convertible securities. To generate income and enhance exposure to the equity markets, the Fund may purchase investment grade and high-yield fixed-income securities or unrated securities of equivalent quality along with options on securities indexes. Fixed-income securities may be of any maturity.

By investing in a combination of equity and fixed-income securities, the Fund seeks to produce a pattern of total return that moves with the S&P 500 Indexii (the “Index”), while generating high income. In addition, the Fund may use options, futures and options on futures to increase exposure to part or all of the market or to hedge against adverse changes in the market value of the Fund’s securities.

Mr. Gendelman, the Fund’s lead portfolio manager at ClearBridge Advisors, LLC, one of the Fund’s subadvisers, oversees the Fund’s allocation between equity and fixed-income securities, as well as the Fund’s equity investments in general. He manages the equity side of the Fund with a “bottom-up” approach focused on the risk and reward of each investment opportunity. A portfolio management team at Western Asset Management Company, one of the Fund’s subadvisers, manages the fixed-income portion of the Fund. Their focus is on portfolio structure, including allocation, durationiii weighting and term-structure decisions.

Q. What were the overall market conditions during the Fund’s reporting period?

A. During the fiscal year, the stock market experienced periods of heightened volatility. The overall stock market, as measured by the Index, fell 37% in 2008, its worst calendar year performance since 1937. Stock prices stumbled out of the gate in 2008, due to concerns over the economy and the outlook for corporate profits. By the end of the first quarter of 2008, the Index had fallen 9.44%. After rallying in April and May, stock prices again weakened and continued to fall during much of the last seven months of the year. Frozen credit markets, the ongoing bursting of the housing bubble, upheaval in the financial markets and expectations for a deep and prolonged recession were some of the factors driving stock prices sharply lower.

Economic numbers deteriorated significantly in the fourth quarter of the year. The unemployment rate rose to 7.2% and threatened to move far higher. During the Christmas season, retail sales fell 2.6%, the worst since 1970. Auto sales collapsed to a 10.5 million seasonally adjusted annual rate,

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   1

Fund overview continued

 

the lowest level since the early 1980s. Chrysler and GM are teetering on the edge of bankruptcy. Housing starts and permits hit new lows. Home prices fell sharply and have not yet stabilized, while inventories remain elevated.

The stock market in September and in the fourth quarter reeled from blow after blow to the U.S. financial system. On Monday, September 14, 2008, the Department of the U.S. Treasury and the Federal Reserve Board (“Fed”)iv decided to allow Lehman Brothers to declare bankruptcy, without interfering to protect creditors as they had with Bear Stearns in March. Their lack of action led to panic in the U.S. credit markets. The U.S. Congress compounded what we believe was the Treasury’s mistake by fumbling its first attempt to pass a $700 billion bailout package.

Only in November, when the Fed announced a plan to purchase mortgage-backed securities, did the markets start to settle. Since early November, numerous signs of credit improvement appeared. Mortgage rates fell below 5%, London Interbank Offered Rate (“LIBOR”)v fell back to pre-crisis levels and high-quality bond spreads fell enough that several large companies issued debt in late December. The stock market responded to the signs of credit easing by rallying more than 20% between the bottom on November 20th and the end of the year.

In terms of the bond market, changing perceptions regarding the economy, inflation and future Fed monetary policy caused bond prices to fluctuate. Two- and 10-year Treasury yields began the reporting period at 3.05% and 4.04%, respectively. Treasury yields moved lower — and their prices moved higher — during the first quarter of 2008, as concerns regarding the subprime mortgage market and a severe credit crunch caused a “flight to quality.” During this period, investors were drawn to the relative safety of Treasuries, while increased risk aversion caused other segments of the bond market to falter. Treasury yields then moved higher in April, May and early June 2008, as the economy performed better than expected and inflation moved higher. Over this period, riskier fixed-income asset classes, such as high-yield bonds and emerging market debt, rallied. However, the credit crunch resumed in mid-June, resulting in another flight to quality. Investors’ risk aversion then intensified from September through November given the severe disruptions in the global financial markets. During this time, virtually every asset class, with the exception of short-term Treasuries, performed poorly. At the end of the fiscal year, two- and 10-year Treasury yields were 0.76% and 2.25%, respectively. Aided by the strong performance in the Treasury market, the overall U.S. bond market, as measured by the Barclays Capital U.S. Aggregate Indexvi, gained 5.24% during the 12 months ended December 31, 2008.

Q. How did we respond to these changing market conditions?

A. We entered the fiscal year concerned about the health of the overall financial system and positioned the equity side of the portfolio with what we

 

2   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

felt was an appropriately defensive posture. During the fiscal year, we made two strategic changes to the portfolio. First, we increased its allocation to fixed-income from a low 20% to a high 20% range. Second, within the fixed-income portion of the portfolio, we increased exposure to high-yield fixed-income securities as credit spreads expanded and, therefore, made high-yield securities a more attractive investment in our view.

Performance review

For the 12 months ended December 31, 2008, Class A shares of Legg Mason Partners Capital and Income Fund, excluding sales charges, returned -35.59%. The Fund’s unmanaged benchmarks, the S&P 500 Index and the Barclays Capital U.S. Aggregate Index, returned -37.00% and 5.24%, respectively, for the same period. The Lipper Mixed-Asset Target Allocation Growth Funds Category Average1 returned -29.85% over the same time frame.

 

PERFORMANCE SNAPSHOT as of December 31, 2008 (excluding sales charges) (unaudited)
     6 MONTHS   12 MONTHS
Capital and Income Fund — Class A Shares   -31.26%   -35.59%
S&P 500 Index   -28.48%   -37.00%
Barclays Capital U.S. Aggregate Index   4.07%   5.24%
Lipper Mixed-Asset Target Allocation Growth Funds Category Average1   -24.04%   -29.85%
   
The performance shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown above. Principal value and investment returns will fluctuate and investors’ shares, when redeemed, may be worth more or less than their original cost. To obtain performance data current to the most recent month-end, please visit our website at www.leggmason.com/individualinvestors.
Excluding sales charges, Class B shares returned -31.46%, Class C shares returned -31.52%, Class R shares returned -31.26% and Class I shares returned -31.12% over the six months ended December 31, 2008. Excluding sales charges, Class B shares returned -35.96%, Class C shares returned -36.09% and Class I shares returned -35.37% over the 12 months ended December 31, 2008. All share class returns assume the reinvestment of all distributions, including returns of capital, if any, at net asset value and the deduction of all Fund expenses. Returns have not been adjusted to include sales charges that may apply when shares are purchased or the deduction of taxes that a shareholder would pay on Fund distributions.
Performance figures reflect expense reimbursements and/or fee waivers, without which the performance would have been lower.
Performance information for the 12-month period is not provided for Class R shares as this share class commenced operations on April 30, 2008.
TOTAL ANNUAL OPERATING EXPENSES (unaudited)
As of the Fund’s most current prospectus dated April 28, 2008, the gross total operating expense ratios for Class A, Class B, Class C, Class R and Class I shares were 1.07%, 1.64%, 1.82%, 1.42% and 0.77%, respectively.

 

1

Lipper, Inc., a wholly-owned subsidiary of Reuters, provides independent insight on global collective investments. Returns are based on the period ended December 31, 2008, including the reinvestment of all distributions, including returns of capital, if any, calculated among the 702 funds for the six-month period and among the 689 funds for the 12-month period in the Fund’s Lipper category, and excluding sales charges.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   3

Fund overview continued

 

Q. What were the leading contributors to performance?

A. For the equity portion of the portfolio, overall sector allocation contributed to performance relative to the Index. In particular, an overweight to the Energy sector and underweights to the Financials, Information Technology (“IT”) and Health Care sectors, as well as our use of derivatives, helped relative performance. Stock selection in the Materials and IT sectors also contributed to relative performance for the year. In terms of individual holdings, leading contributors to performance for the year included positions in Newmont Mining Corp. and Barrick Gold Corp., both in the Materials sector, Fidelity National Financial Inc. in the Financials sector, QUALCOMM Inc. in the IT sector and Schlumberger Ltd. in the Energy sector, as well as several derivatives and exchange-traded-fund positions.

In the fixed-income portion of the portfolio, our tactically-driven duration and yield curvevii positioning were contributors to performance as interest rates fell during the 12-month reporting period.

Q. What were the leading detractors from performance?

A. For the equity portion of the portfolio, overall stock selection detracted from relative performance for the period, specifically in the Energy, Consumer Discretionary, Financials, Utilities, Industrials and Health Care sectors. The Fund’s overweights to the Industrials and Consumer Discretionary sectors and underweights to the Consumer Staples, Materials and Telecommunication Services (“Telecom”) sectors also hurt relative performance for the year. In terms of individual Fund holdings, leading detractors from performance for the year included positions in Crosstex Energy Inc. and El Paso Corp., both in the Energy sector, General Electric Co. in the Industrials sector, American International Group Inc., Och-Ziff Capital Management Group and Invesco Ltd., all in the Financials sector, Lamar Advertising Co. (Class A Shares) and Liberty Media Corp. Series A Liberty Entertainment, both in the Consumer Discretionary sector.

In the fixed-income portion on the portfolio, our high-yield positions significantly underperformed over the past year. In particular, our high-yield Industrials issues and bank loans, especially those of lower-rated quality, were hit hard by the credit crisis and declining commodity prices. Our investment grade Financials suffered from a series of bankruptcies, government conservatorships and mergers. Non-agency mortgage-backed securities reached new lows amid all the market turmoil and the ongoing fallout from the housing slowdown.

Q. Were there any significant changes to the Fund during the reporting period?

A. On the equity side of the Fund’s portfolio, at the start of the period we held overweight positions in the Financials, Energy and Consumer

 

4   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

Discretionary sectors, with no holdings in the Materials sector. The balance of the equity portfolio was focused in, what we believed to be, high-quality companies with relatively defensive fundamental business characteristics. Over the course of the year, we reduced our overweight positions in Financials, Energy and Consumer Discretionary to underweights, while increasing our allocations to the Materials, Industrials, Consumer Staples and Health Care sectors.

During the fiscal year, we established a number of new positions, including those in Total SA (ADR) and El Paso Corp., both in the Energy sector, Consumer Staples sector holdings Kimberly-Clark Corp., Kraft Foods Inc. (Class A Shares) and Procter & Gamble Co., Health Care sector holdings HLTH Corp. (which we consider to be an IT holding), Wyeth and Novartis AG (ADR), as well as L-3 Communications Holdings Inc. in the Industrials sector. We also closed a number of existing positions, including Altria Group, Inc. in the Consumer Staples sector, Bank of America Corp., American International Group Inc., American Express Co. and UBS AG, all in the Financials sector, Dover Corp. in the Industrials sector, Liberty Media Corp. in the Consumer Discretionary sector, as well as SBA Communications Corp. and Crown Castle International Corp., both in the Telecom sector.

As of the close of the fiscal year, we maintained a preference for the existing holdings in the Energy sector and other, what we believed to be, high-quality companies, even though they may have not performed significantly better than the overall market in the recent difficult economic environment.

In terms of the fixed-income portion of the portfolio, in addition to the previously discussed changes, we gradually reduced our positions in agency mortgage-backed securities and added to the investment grade credit sector.

Thank you for your investment in Legg Mason Partners Capital and Income Fund. As always, we appreciate that you have chosen us to manage your assets and we remain focused on achieving the Fund’s investment goals.

Sincerely,

 

LOGO   

Robert Gendelman

Lead Portfolio Manager

ClearBridge Advisors, LLC

(Fund Allocation and Equity Portion)

    Western Asset Management Company
   (Fixed-Income Portion)
  

January 20, 2009

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   5

Fund overview continued

 

The information provided is not intended to be a forecast of future events, a guarantee of future results or investment advice. Views expressed may differ from those of the firm as a whole.

Portfolio holdings and breakdowns are as of December 31, 2008 and are subject to change and may not be representative of the portfolio managers’ current or future investments. The Fund’s top 10 holdings (as a percentage of net assets) as of this date were: Covanta Holding Corp. (3.4%), Total SA, ADR (2.7%), General Electric Co. (2.4%), Assa Abloy AB (2.3%), Time Warner Inc. (2.3%), United Technologies Corp. (2.1%), Kimberly-Clark Corp. (2.1%), EI Paso Corp. (1.9%), Kraft Foods Inc., Class A Shares (1.8%) and HLTH Corp. (1.7%). Please refer to pages 12 through 42 for a list and percentage breakdown of the Fund’s holdings.

The mention of sector breakdowns is for informational purposes only and should not be construed as a recommendation to purchase or sell any securities. The information provided regarding such sectors is not a sufficient basis upon which to make an investment decision. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies discussed should consult their financial professional. The Fund’s top five sector holdings (as a percentage of net assets) as of December 31, 2008 were: Industrials (16.2%), Energy (11.2%), Financials (11.2%), Health Care (10.1%) and Materials (7.9%). The Fund’s portfolio composition is subject to change at any time.

RISKS: Stock and bond prices are subject to fluctuation. As interest rates rise, bond prices fall, reducing the value of the Fund’s share price. High-yield securities are rated below investment grade and involve greater credit and liquidity risk than higher-rated securities. The Fund may use derivatives, such as options and futures, which can be illiquid, may disproportionately increase losses, and have a potentially large impact on Fund performance. The Fund is subject to certain risks of overseas investing not associated with domestic investing, including currency fluctuations and changes in political and economic conditions. Please see the Fund’s prospectus for more information on these and other risks.

All index performance reflects no deduction for fees, expenses or taxes. Please note that an investor cannot invest directly in an index.

 

i

Real estate investment trusts (“REITs”) invest in real estate or loans secured by real estate and issue shares in such investments, which can be illiquid.

 

ii

The S&P 500 Index is an unmanaged index of 500 stocks and is generally representative of the performance of larger companies in the U.S.

 

iii

Duration is the measure of the price sensitivity of a fixed-income security to an interest rate change of 100 basis points. Calculation is based on the weighted average of the present values for all cash flows.

 

iv

The Federal Reserve Board (“Fed”) is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices and a sustainable pattern of international trade and payments.

 

v

The London Interbank Offered Rate (“LIBOR”) is the interest rate offered by a specific group of London banks for U.S. dollar deposits of a stated maturity. LIBOR is used as a base index for setting rates of some adjustable rate financial instruments, including Adjustable Rate Mortgages (“ARMs”).

 

vi

The Barclays Capital (formerly Lehman Brothers) U.S. Aggregate Index is a broad-based bond index comprised of government, corporate, mortgage- and asset-backed issues, rated investment grade or higher, and having at least one year to maturity.

 

vii

The yield curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

 

6   Legg Mason Partners Capital and Income Fund 2008 Annual Report

Fund at a glance (unaudited)

 

INVESTMENT BREAKDOWN (%) As a percent of total investments — December 31, 2008

LOGO

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   7

Fund expenses (unaudited)

 

Example

As a shareholder of the Fund, you may incur two types of costs: (1) transaction costs, including front-end and back-end sales charges (loads) on purchase payments, and (2) ongoing costs, including management fees; distribution and/or service (12b-1) fees; and other Fund expenses. This example is intended to help you understand your ongoing costs (in dollars) of investing in the Fund and to compare these costs with the ongoing costs of investing in other mutual funds.

This example is based on an investment of $1,000 invested on July 1, 2008 and held for the six months ended December 31, 2008.

Actual expenses

The table below titled “Based on Actual Total Return” provides information about actual account values and actual expenses. You may use the information provided in this table, together with the amount you invested, to estimate the expenses that you paid over the period. To estimate the expenses you paid on your account, divide your ending account value by $1,000 (for example, an $8,600 ending account value divided by $1,000 = 8.6), then multiply the result by the number under the heading entitled “Expenses Paid During the Period”.

 

BASED ON ACTUAL TOTAL RETURN1
     ACTUAL TOTAL
RETURN
WITHOUT
SALES
CHARGES2		     BEGINNING
ACCOUNT
VALUE		   ENDING
ACCOUNT
VALUE		   ANNUALIZED
EXPENSE
RATIO3		    

EXPENSES

PAID DURING

THE PERIOD4

Class A   (31.26 )%   $ 1,000.00   $ 687.40   1.13 %   $ 4.79
Class B   (31.46 )     1,000.00     685.40   1.71       7.24
Class C   (31.52 )     1,000.00     684.80   1.94       8.22
Class R   (31.26 )     1,000.00     687.40   1.31       5.56
Class I   (31.12 )     1,000.00     688.80   0.78       3.31

 

1

For the six months ended December 31, 2008.

 

2

Assumes the reinvestment of all distributions, including returns of capital, if any, at net asset value and does not reflect the deduction of the applicable sales charge with respect to Class A shares or the applicable contingent deferred sales charges (“CDSC”) with respect to Class B and Class C shares. Total return is not annualized, as it may not be representative of the total return for the year. Performance figures may reflect fee waivers and/or expense reimbursements. In the absence of fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results.

 

3

The expense ratios include dividend expense related to securities sold short and not subject to a contractual expense limitation.

 

4

Expenses (net of fee waivers and/or expense reimbursements) are equal to each class’ respective annualized expense ratio multiplied by the average account value over the period, multiplied by the number of days in the most recent fiscal half-year, then divided by 366.

 

8   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

Hypothetical example for comparison purposes

The table below titled “Based on Hypothetical Total Return” provides information about hypothetical account values and hypothetical expenses based on the actual expense ratio and an assumed rate of return of 5.00% per year before expenses, which is not the Fund’s actual return. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period. You may use the information provided in this table to compare the ongoing costs of investing in the Fund and other funds. To do so, compare the 5.00% hypothetical example relating to the Fund with the 5.00% hypothetical examples that appear in the shareholder reports of the other funds.

Please note that the expenses shown in the table below are meant to highlight your ongoing costs only and do not reflect any transactional costs, such as front-end or back-end sales charges (loads). Therefore, the table is useful in comparing ongoing costs only, and will not help you determine the relative total costs of owning different funds. In addition, if these transaction costs were included, your costs would have been higher.

 

BASED ON HYPOTHETICAL TOTAL RETURN1          
     HYPOTHETICAL
ANNUALIZED
TOTAL
RETURN		     BEGINNING
ACCOUNT
VALUE		   ENDING
ACCOUNT
VALUE		   ANNUALIZED
EXPENSE
RATIO2		     EXPENSES
PAID DURING
THE PERIOD3
Class A   5.00 %   $ 1,000.00   $ 1,019.46   1.13 %   $ 5.74
Class B   5.00       1,000.00     1,016.54   1.71       8.67
Class C   5.00       1,000.00     1,015.38   1.94       9.83
Class R   5.00       1,000.00     1,018.55   1.31       6.65
Class I   5.00       1,000.00     1,021.22   0.78       3.96

 

1

For the six months ended December 31, 2008.

 

2

The expense ratios include dividend expense related to securities sold short and not subject to a contractual expense limitation.

 

3

Expenses (net of fee waivers and/or expense reimbursements) are equal to each class’ respective annualized expense ratio multiplied by the average account value over the period, multiplied by the number of days in the most recent fiscal half-year, then divided by 366.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   9

Fund performance (unaudited)

 

AVERAGE ANNUAL TOTAL RETURNS1        
     WITHOUT SALES CHARGES2  
     CLASS A     CLASS B     CLASS C     CLASS R     CLASS I  
Twelve Months Ended 12/31/08   (35.59 )%   (35.96 )%   (36.09 )%   N/A     (35.37 )%
Five Years Ended 12/31/08   (2.02 )   (2.56 )   (2.77 )   N/A     (1.65 )
Ten Years Ended 12/31/08   1.43     0.90     0.66     N/A     1.80  
Inception* through 12/31/08   6.37     7.97     0.66     (32.82 )%†   5.00  
     WITH SALES CHARGES3  
     CLASS A     CLASS B     CLASS C     CLASS R     CLASS I  
Twelve Months Ended 12/31/08   (39.30 )%   (39.03 )%   (36.70 )%   N/A     (35.37 )%
Five Years Ended 12/31/08   (3.18 )   (2.70 )   (2.77 )   N/A     (1.65 )
Ten Years Ended 12/31/08   0.84     0.90     0.66     N/A     1.80  
Inception* through 12/31/08   5.98     7.97     0.66     (32.82 )%†   5.00  
         
CUMULATIVE TOTAL RETURNS1              
     WITHOUT SALES CHARGES2  
Class A (12/31/98 through 12/31/08)   15.30 %
Class B (12/31/98 through 12/31/08)   9.38  
Class C (12/31/98 through 12/31/08)   6.81  
Class R (Inception date of 4/30/08 through 12/31/08)   (32.82 )
Class I (12/31/98 through 12/31/08)   19.49  

 

1

All figures represent past performance and are not a guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. The returns shown do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Performance figures may reflect fee waivers and/or expense reimbursements. In the absence of fee waivers and/or expense reimbursements, the total return would have been lower.

 

2

Assumes the reinvestment of all distributions, including returns of capital, if any, at net asset value and does not reflect the deduction of the applicable sales charge with respect to Class A shares or the applicable CDSC with respect to Class B and Class C shares.

 

3

Assumes the reinvestment of all distributions, including returns of capital, if any, at net asset value. In addition, Class A shares reflect the deduction of the maximum initial sales charge of 5.75%; Class B shares reflect the deduction of a 5.00% CDSC, which applies if shares are redeemed within one year from purchase payment and declines thereafter by 1.00% per year until no CDSC is incurred; Class C shares also reflect the deduction of a 1.00% CDSC, which applies if shares are redeemed within one year from purchase payment.

 

* Inception dates for Class A, Class B, Class C, Class R and Class I shares are November 6, 1992, September 16, 1985, June 15, 1998, April 30, 2008 and February 7, 1996, respectively.

 

†

Not annualized.

 

10   Legg Mason Partners Capital and Income Fund 2008 Annual Report

Historical performance (unaudited)

 

VALUE OF $10,000 INVESTED IN CLASS B SHARES OF LEGG MASON PARTNERS CAPITAL AND INCOME
FUND VS. S&P 500 INDEX AND BARCLAYS CAPITAL U.S. AGGREGATE INDEX† —
December 1998 - December 2008

LOGO

 

†

Hypothetical illustration of $10,000 invested in Class B shares of Legg Mason Partners Capital and Income Fund on December 31, 1998, assuming the reinvestment of all distributions, including returns of capital, if any, at net asset value through December 31, 2008. The S&P 500 Index is an unmanaged index of 500 stocks and is generally representative of the performance of larger companies in the U.S. The Barclays Capital (formerly Lehman Brothers) U.S. Aggregate Index is a broad-based bond index comprised of government, corporate, mortgage- and asset-backed issues, rated investment grade or higher, and having at least one year to maturity. The Indexes are unmanaged and are not subject to the same management and trading expenses as a mutual fund. Please note that an investor cannot invest directly in an index. The performance of the Fund’s other classes may be greater or less than the Class B shares’ performance indicated on this chart, depending on whether higher or lower sales charges and fees were incurred by shareholders investing in the other classes.

All figures represent past performance and are not a guarantee of future results. Investment return and principal value of an investment, which will fluctuate so that an investor’s share, when redeemed, may be worth more or less than their original cost. The returns shown do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Performance figures may reflect fee waivers and/or expense reimbursements. In the absence of fee waivers and/or expense reimbursements, the total return would have been lower.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   11

Schedule of investments

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
SHARES    SECURITY    VALUE
     
COMMON STOCKS — 60.3%       
CONSUMER DISCRETIONARY — 4.0%       
     Household Durables — 0.0%       
2,330,496    Home Interiors & Gifts Inc.(a)(b)*    $ 2
     Media — 4.0%       
857,110    Lamar Advertising Co., Class A Shares*      10,765,302
404,600    Thomson Reuters PLC(a)      8,948,708
3,956,720    Time Warner Inc.      39,804,603
3,142,800    Warner Music Group Corp.      9,491,256
    

Total Media

      69,009,869
     TOTAL CONSUMER DISCRETIONARY      69,009,871
CONSUMER STAPLES — 5.6%       
     Food & Staples Retailing — 0.0%       
28,868    FHC Delaware Inc.(a)(b)*      0
     Food Products — 1.8%       
1,948    Aurora Foods Inc.(a)(b)*      0
1,163,700    Kraft Foods Inc., Class A Shares      31,245,345
    

Total Food Products

      31,245,345
     Household Products — 3.8%       
671,970    Kimberly-Clark Corp.      35,439,698
479,530    Procter & Gamble Co.      29,644,544
    

Total Household Products

      65,084,242
     TOTAL CONSUMER STAPLES      96,329,587
ENERGY — 8.0%       
     Energy Equipment & Services — 1.9%       
836,605    Halliburton Co.      15,209,479
711,160    National-Oilwell Varco Inc.*      17,380,750
    

Total Energy Equipment & Services

      32,590,229
     Oil, Gas & Consumable Fuels — 6.1%       
2,259,616    Crosstex Energy Inc.      8,812,503
271,310    Devon Energy Corp.      17,827,780
4,218,600    El Paso Corp.      33,031,638
829,320    Total SA, ADR      45,861,396
    

Total Oil, Gas & Consumable Fuels

      105,533,317
     TOTAL ENERGY      138,123,546
EXCHANGE TRADED FUND — 0.4%       
106,000    UltraShort S&P500 ProShares      7,517,096
FINANCIALS — 5.9%       
     Capital Markets — 3.2%       
1,575,300    Charles Schwab Corp.      25,472,601

 

See Notes to Financial Statements.

 

12   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
SHARES    SECURITY    VALUE
     
     Capital Markets — 3.2% continued       
1,602,460    Invesco Ltd.    $ 23,139,523
1,207,429    Och-Ziff Capital Management Group      6,218,259
    

Total Capital Markets

      54,830,383
     Commercial Banks — 1.4%       
851,700    Wells Fargo & Co.      25,108,116
     Diversified Financial Services — 1.3%       
703,900    JPMorgan Chase & Co.      22,193,967
     TOTAL FINANCIALS      102,132,466
HEALTH CARE — 8.6%       
     Health Care Equipment & Supplies — 2.0%       
150,850    Alcon Inc.      13,454,312
649,070    Medtronic Inc.      20,393,779
    

Total Health Care Equipment & Supplies

      33,848,091
     Health Care Technology — 1.8%       
2,879,869    HLTH Corp.*      30,123,430
     Pharmaceuticals — 4.8%       
443,900    Johnson & Johnson      26,558,537
549,350    Novartis AG, ADR      27,335,656
785,000    Wyeth      29,445,350
    

Total Pharmaceuticals

      83,339,543
     TOTAL HEALTH CARE      147,311,064
INDUSTRIALS — 14.2%       
     Aerospace & Defense — 2.4%       
378,050    L-3 Communications Holdings Inc.      27,892,529
419,778    TransDigm Group Inc.*      14,091,948
    

Total Aerospace & Defense

      41,984,477
     Building Products — 2.4%       
3,564,150    Assa Abloy AB(a)      40,440,521
     Commercial Services & Supplies — 3.5%       
2,707,741    Covanta Holding Corp.*      59,461,992
     Industrial Conglomerates — 5.2%       
2,522,590    General Electric Co.      40,865,958
1,270,100    McDermott International Inc.*      12,548,588
690,380    United Technologies Corp.      37,004,368
    

Total Industrial Conglomerates

      90,418,914
     Road & Rail — 0.7%       
360,420    CSX Corp.      11,702,838
     TOTAL INDUSTRIALS      244,008,742

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   13

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
SHARES    SECURITY    VALUE
     
INFORMATION TECHNOLOGY — 5.2%       
     Communications Equipment — 1.9%       
1,237,200    Nokia Oyj, ADR    $ 19,300,320
70,139    Nortel Networks Corp.*      18,236
389,230    QUALCOMM Inc.      13,946,111
    

Total Communications Equipment

      33,264,667
     Computers & Peripherals — 1.2%       
2,028    Axiohm Transaction Solutions Inc.(a)(b)*      0
1,921,610    EMC Corp.*      20,119,257
    

Total Computers & Peripherals

      20,119,257
     Software — 2.1%       
725,320    Autodesk Inc.*      14,252,538
1,272,990    Oracle Corp.*      22,570,112
    

Total Software

      36,822,650
     TOTAL INFORMATION TECHNOLOGY      90,206,574
MATERIALS — 6.1%       
     Chemicals — 3.2%       
458,130    Air Products & Chemicals Inc.      23,030,195
913,200    Celanese Corp., Series A Shares      11,351,076
301,320    Monsanto Co.      21,197,862
    

Total Chemicals

      55,579,133
     Metals & Mining — 2.9%       
380,500    Barrick Gold Corp.      13,990,985
1,099,580    Commercial Metals Co.      13,052,015
345,880    Freeport-McMoRan Copper & Gold Inc., Class B Shares      8,453,307
340,800    Newmont Mining Corp.      13,870,560
    

Total Metals & Mining

      49,366,867
     TOTAL MATERIALS      104,946,000
TELECOMMUNICATION SERVICES — 1.3%       
     Wireless Telecommunication Services — 1.3%       
766,750    American Tower Corp., Class A Shares*      22,481,110
UTILITIES — 1.0%       
     Gas Utilities — 1.0%       
552,740    National Fuel Gas Co.      17,317,344
     TOTAL COMMON STOCKS (Cost — $1,607,756,341)      1,039,383,400
CONVERTIBLE PREFERRED STOCKS — 1.1%       
ENERGY — 0.7%       
     Oil, Gas & Consumable Fuels — 0.7%       
18,600    El Paso Corp., 4.990%(a)      12,280,650

 

See Notes to Financial Statements.

 

14   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
SHARES    SECURITY    VALUE
     
  MATERIALS — 0.4%       
       Metals & Mining — 0.4%       
  9,720    Freeport-McMoRan Copper & Gold Inc., 5.500%    $ 5,977,800
       TOTAL CONVERTIBLE PREFERRED STOCKS
(Cost — $18,173,226)		      18,258,450
  PREFERRED STOCKS — 0.0%       
  FINANCIALS — 0.0%       
       Consumer Finance — 0.0%       
  1,580    Preferred Blocker Inc., 9.000%(c)      474,000
       Diversified Financial Services — 0.0%       
       TCR Holdings Corp.:       
  321   

Class B Shares(a)(b)*

      0
  177   

Class C Shares(a)(b)*

      0
  466   

Class D Shares(a)(b)*

      0
  964   

Class E Shares(a)(b)*

      0
      

Total Diversified Financial Services

      0
       Thrifts & Mortgage Finance — 0.0%       
  74,600    Federal Home Loan Mortgage Corp. (FHLMC), 8.375%(d)*      29,094
  2,800    Federal National Mortgage Association (FNMA), 7.000%(d)(e)*      2,100
  54,025    Federal National Mortgage Association (FNMA), 8.250%(d)*      44,841
      

Total Thrifts & Mortgage Finance

      76,035
       TOTAL PREFERRED STOCKS (Cost — $3,800,531)      550,035
FACE
AMOUNT		            
  ASSET-BACKED SECURITIES — 0.7%       
  FINANCIALS — 0.7%       
       Automobiles — 0.1%       
$ 1,050,000    ARG Funding Corp., 4.290% due 4/20/11(c)      944,194
       Diversified Financial Services — 0.0%       
  2,750,745    Airplanes Pass-Through Trust, Subordinated Notes,
10.875% due 3/15/19(a)(b)(f)		      0
       Home Equity — 0.6%       
  177,977    ACE Securities Corp., 0.641% due 1/25/36(e)      24,972
       Bear Stearns Asset-Backed Securities Trust:       
  137,433   

0.821% due 9/25/34(e)

      129,578
  398,330   

0.751% due 2/25/36(e)

      337,582
  349,152    Centex Home Equity Loan Trust, 3.735% due 2/25/32      291,123
  106,718    Cityscape Home Equity Loan Trust, 3.045% due 7/25/28(e)      55,266
  135,920    Countrywide Asset-Backed Certificates, 1.721% due 6/25/34(e)      56,251
       Countrywide Home Equity Loan Trust:       
  410,531   

1.485% due 12/15/33(e)

      270,659
  576,752   

1.515% due 3/15/34(e)

      164,074

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   15

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Home Equity — 0.6% continued       
$ 648,135   

1.415% due 11/15/35(a)(e)

    $ 190,272
  709,325   

1.425% due 2/15/36(e)

      376,176
  2,070,000    Credit-Based Asset Servicing & Securitization LLC, 5.704% due 12/25/36      1,357,762
  353,840    CS First Boston Mortgage Securities Corp.,
2.021% due 2/25/31(e)		      156,699
  73,417    Finance America Net Interest Margin Trust,
5.250% due 6/27/34(b)(c)(f)		      73
  179,230    First Horizon ABS Trust, 0.631% due 10/25/34(e)      84,662
  159,058    Fremont Home Loan Trust, 2.121% due 2/25/34(e)      51,826
  2,150,000    Green Tree, 8.960% due 4/25/38(c)(e)      1,721,703
  146,028    Green Tree Financial Corp., 7.070% due 1/15/29      124,249
       GSAA Home Equity Trust:       
  2,460,000   

0.771% due 3/25/37(e)

      736,663
  4,800,000   

0.771% due 5/25/47(e)

      979,801
  61,620    GSAMP Trust, 0.571% due 1/25/36(e)      10,617
  120,556    Indymac Home Equity Loan Asset-Backed Trust,
0.641% due 4/25/36(e)		      26,054
       Option One Mortgage Loan Trust:       
  126,454   

1.311% due 2/25/33(e)

      86,441
  269,549   

2.121% due 7/25/33(e)

      123,212
  697,692   

1.521% due 5/25/34(e)

      529,374
       RAAC Series:       
  126,956   

0.741% due 5/25/36(c)(e)

      95,390
  1,931,411   

0.851% due 10/25/46(a)(c)(e)

      865,401
  330,859    Renaissance Home Equity Loan Trust, 2.371% due 3/25/34(e)      148,048
  141,114    SACO I Trust, 0.641% due 3/25/36(e)      30,131
       Sail Net Interest Margin Notes:       
  141,210   

7.750% due 4/27/33(b)(c)(f)

      16
  35,690   

5.500% due 3/27/34(b)(c)(f)

      4
  218,785    Saxon Asset Securities Trust, 8.640% due 12/25/32      145,449
  1,342,778    Structured Asset Securities Corp., 0.721% due 11/25/37(e)      973,783
  268,188    WMC Mortgage Loan Pass-Through Certificates, 3.445% due 10/15/29(e)      89,403
      

Total Home Equity

      10,232,714
       Student Loan — 0.0%       
  990,000    Nelnet Student Loan Trust, 5.015% due 4/25/24(e)      804,428
       TOTAL ASSET-BACKED SECURITIES
(Cost — $22,354,966)		      11,981,336

 

See Notes to Financial Statements.

 

16   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
  COLLATERALIZED MORTGAGE OBLIGATIONS — 1.8%       
$ 380,000    American Home Mortgage Investment Trust,
1.271% due 11/25/45(e)		    $ 42,210
  1,800,000    Banc of America Commercial Mortgage Inc.,
5.372% due 9/10/45(e)		      1,445,890
  1,483,609    Banc of America Funding Corp., 4.123% due 6/20/35(e)      667,245
  142,628    Banc of America Mortgage Securities, 4.802% due 9/25/35(e)      106,397
  727,548    Bayview Commercial Asset Trust, 0.741% due 4/25/36(c)(e)      527,472
  1,899,032    Bear Stearns ARM Trust, 5.786% due 2/25/36(e)      976,221
  1,555,958    Bear Stearns Structured Products Inc.,
2.036% due 9/27/37(a)(c)(e)		      1,513,141
  1,030,575    Citigroup Mortgage Loan Trust Inc., 4.900% due 12/25/35(e)      745,690
       Countrywide Alternative Loan Trust:       
  1,620,599   

0.761% due 5/25/34(e)

      909,920
  182,617   

1.783% due 11/20/35(e)

      91,703
  1,133,089   

0.741% due 1/25/36(e)

      534,438
  150,403   

0.671% due 5/25/36(e)

      61,034
  180,043   

0.681% due 7/25/46(e)

      63,643
       Countrywide Home Loan, Mortgage Pass-Through Trust:       
  99,359   

0.801% due 2/25/35(e)

      48,180
  134,919   

0.771% due 5/25/35(e)

      63,035
  1,800,000    Credit Suisse Mortgage Capital Certificates,
5.552% due 2/15/39(e)		      1,466,937
  120,476    Deutsche ALT-A Securities Inc. Mortgage Loan Trust, 4.938% due 8/25/35(e)      96,682
       Downey Savings & Loan Association Mortgage Loan Trust:       
  442,923   

1.001% due 9/19/44(e)

      172,691
  125,474   

0.791% due 3/19/45(e)

      60,241
  147,041   

3.176% due 3/19/46(e)

      44,112
  147,041   

3.176% due 3/19/47(e)

      33,544
       Federal Home Loan Mortgage Corp. (FHLMC):       
  62,764   

6.000% due 3/15/34(d)(e)

      57,107
  516,050   

PAC, 6.000% due 4/15/34(d)(e)

      494,638
       GSMPS Mortgage Loan Trust:       
  3,573,460   

5.911% due 6/25/34(c)(e)

      1,977,622
  2,436,437   

0.821% due 3/25/35(c)(e)

      1,864,032
  123,440    GSR Mortgage Loan Trust, 5.252% due 10/25/35(e)      72,384
       Harborview Mortgage Loan Trust:       
  122,582   

0.981% due 11/19/34(e)

      61,613
  140,083   

0.931% due 1/19/35(e)

      70,938
  73,615    Indymac Index Mortgage Loan Trust, 5.777% due 3/25/35(e)      33,127

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   17

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
  COLLATERALIZED MORTGAGE OBLIGATIONS — 1.8% continued       
$ 250,000    JPMorgan Chase Commercial Mortgage Securities Corp., 5.814% due 6/12/43(e)    $ 193,142
       JPMorgan Mortgage Trust:       
  1,740,401   

4.587% due 6/25/34(e)

      1,344,356
  2,120,000   

5.889% due 6/25/37(e)

      891,990
  4,807,667    Lehman XS Trust, 0.691% due 4/25/46(e)      1,895,968
  80,620    Luminent Mortgage Trust, 0.711% due 4/25/36(e)      32,801
  630,000    Merrill Lynch Mortgage Trust, 5.657% due 5/12/39(e)      515,004
       MLCC Mortgage Investors Inc.:       
  295,264   

1.391% due 4/25/29(e)

      116,234
  351,932   

1.351% due 5/25/29(e)

      312,662
       Structured ARM Loan Trust:       
  224,324   

4.920% due 3/25/34(e)

      139,743
  54,740   

5.041% due 6/25/34(e)

      37,387
  1,316,576   

5.370% due 5/25/35(e)

      689,957
  1,853,273   

5.891% due 5/25/36(e)

      963,058
  107,875    Structured Asset Mortgage Investments Inc.,
0.681% due 5/25/46(e)		      46,399
       Structured Asset Securities Corp.:       
  1,143,643   

5.500% due 3/25/19

      1,007,863
  354,014   

1.571% due 2/25/28(e)

      336,529
  211,703   

1.471% due 3/25/28(e)

      181,076
       Thornburg Mortgage Securities Trust:       
  2,237,208   

6.203% due 9/25/37(e)

      1,719,141
  2,340,913   

6.216% due 9/25/37(e)

      1,663,636
       WaMu Mortgage Pass-Through Certificates:       
  627,154   

0.791% due 1/25/45(e)

      316,934
  3,864,689   

3.006% due 6/25/47(e)

      1,545,875
       Washington Mutual Inc.:       
  96,872   

5.930% due 9/25/36(e)

      56,141
  681,373   

0.831% due 10/25/45(e)

      229,395
  210,147   

0.741% due 12/25/45(e)

      99,170
  115,504   

0.761% due 12/25/45(e)

      53,465
  731,680    Washington Mutual Mortgage Pass-Through Certificates, 0.811% due 1/25/45(e)      343,338
  127,811    Washington Mutual Pass-Through Certificates,
0.751% due 11/25/45(e)		      62,986
  2,195,826    Wells Fargo Alternative Loan Trust, 0.901% due 6/25/37(e)      834,307
  112,466    Wells Fargo Mortgage Backed Securities Trust,
5.240% due 4/25/36(e)		      81,701

 

See Notes to Financial Statements.

 

18   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
     
  COLLATERALIZED MORTGAGE OBLIGATIONS — 1.8% continued       
$ 110,616    Zuni Mortgage Loan Trust, 0.601% due 8/25/36(e)    $ 104,911
       TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS
(Cost — $45,583,743)		      30,117,056
  COLLATERALIZED SENIOR LOANS — 2.4%       
  CONSUMER DISCRETIONARY — 0.8%       
       Auto Components — 0.1%       
  1,947,742    Allison Transmission Inc., Term Loan B,
4.913% due 8/7/14(e)		      1,097,691
  1,000,000    Visteon Corp., Term Loan, Tranch B, 7.750% due 6/20/13(e)      255,833
      

Total Auto Components

      1,353,524
       Diversified Consumer Services — 0.0%       
  990,000    Thomson Learning Hold, Term Loan B,
3.940% due 7/5/14(e)		      650,650
       Hotels, Restaurants & Leisure — 0.2%       
       Aramark Corp.:       
  58,426   

Letter of Credit Facility Deposits, 1.875% due 1/31/14(e)

      48,402
  919,664   

Term Loan, 4.676% due 1/31/14(e)

      761,885
       Golden Nugget Inc.:       
  363,636   

Delayed Draw Term Loan, 5.457% due 6/8/14(e)

      105,455
  636,364   

First Lien Term Loan, 4.470% due 6/14/14(e)

      184,546
  997,494    Harrahs Operating Co. Inc., Term Loan,
6.536% due 12/28/15(e)		      584,088
  1,033,131    Las Vegas Sands LLC, Term Loan, 5.520% due 5/8/14(e)      477,535
  987,342    MGM MIRAGE Inc., Term Loan B, 7.012% due 4/8/11(e)      422,089
  500,000    Six Flags, Term Loan B, 4.150% due 5/31/13(e)      297,500
      

Total Hotels, Restaurants & Leisure

      2,881,500
       Media — 0.3%       
  1,985,000    Charter Communications, Term Loan B,
5.470% due 3/15/14(e)		      1,468,900
  1,000,000    Citadel Broadcasting Corp., Term Loan A,
5.241% due 6/12/13(e)		      430,000
  989,493    CMP Susquehanna Corp., Term Loan, 4.997% due 6/7/13(e)      232,531
  1,000,000    Dex Media West LLC, Term Loan, 7.133% due 10/13/14(e)      425,000
  1,485,505    Idearc Inc., Term Loan B, Senior Notes,
5.670% due 11/1/14(e)		      468,995
  1,214,375    LodgeNet Entertainment Corp., Term Loan B,
4.810% due 4/4/14(e)		      479,678
  989,899    Regal Cinemas Corp., Term Loan B,
5.262% due 10/19/10(e)		      728,126
  1,000,000    Univision Communications Inc., Term Loan B,
3.686% due 9/15/14(e)		      411,111

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   19

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Media — 0.3% continued       
$ 1,000,000    UPC Broadband Holding BV, Term Loan N,
5.470% due 3/30/14(e)		    $ 675,000
      

Total Media

      5,319,341
       Multiline Retail — 0.1%       
  1,000,000    Dollar General Corp., Term Loan B,
5.649% due 7/15/14(e)		      777,500
  1,500,000    Neiman Marcus Group Inc., Term Loan B,
4.422% due 3/13/13(e)		      962,727
      

Total Multiline Retail

      1,740,227
       Specialty Retail — 0.1%       
  989,950    Amscan Holdings Inc., Term Loan B,
4.557% due 5/1/13(e)		      655,842
  987,406    Michaels Stores Inc., Term Loan B,
4.140% due 10/31/13(e)		      518,635
  989,924    PETCO Animal Supplies Inc., Term Loan B,
5.943% due 11/15/13(e)		      623,652
      

Total Specialty Retail

      1,798,129
       TOTAL CONSUMER DISCRETIONARY      13,743,371
  CONSUMER STAPLES — 0.2%       
       Beverages — 0.1%       
  999,316    Constellation Brands Inc., Term Loan, 4.056% due 6/5/13(e)      887,517
       Food Products — 0.1%       
       Dole Food Co.:       
  98,447   

Credit-Linked Deposit, 2.658% due 4/12/13(e)

      69,200
      

Term Loan:

       
  174,488   

5.396% due 4/12/13(e)

      122,651
  650,093   

6.239% due 4/12/13(e)

      456,961
  1,000,000    Wm. Wrigley Jr. Co., Term Loan, 7.750% due 9/30/14(e)      959,167
      

Total Food Products

      1,607,979
       Household Products — 0.0%       
  927,909    Yankee Candle, Term Loan B, 5.731% due 1/15/14(e)      476,945
       TOTAL CONSUMER STAPLES      2,972,441
  ENERGY — 0.1%       
       Energy Equipment & Services — 0.0%       
  997,475    Hercules Offshore LLC, Term Loan, 5.640% due 7/11/13(e)      658,333
       Oil, Gas & Consumable Fuels — 0.1%       
       Ashmore Energy International:       
  95,952   

Synthetic Revolving Credit Facility, 4.730% due 3/30/14(e)

      58,531
  864,936   

Term Loan, 6.762% due 3/30/14(e)

      493,014

 

See Notes to Financial Statements.

 

20   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Oil, Gas & Consumable Fuels — 0.1% continued       
$ 1,981,200    Brand Energy and Infrastructure Services Inc., Term Loan B,
5.949% due 2/7/14(e)		    $ 1,040,130
      

Total Oil, Gas & Consumable Fuels

      1,591,675
       TOTAL ENERGY      2,250,008
  FINANCIALS — 0.1%
       Diversified Financial Services — 0.1%       
  987,500    Chrysler Financial, Term Loan B, 6.820% due 8/3/12(e)      519,142
  940,664    Iconix, Term Loan B, 6.020% due 5/1/14(e)      681,981
  987,425    Sally Holdings LLC, Term Loan B, 4.605% due 11/15/13(e)      707,655
      

Total Diversified Financial Services

      1,908,778
       Thrifts & Mortgage Finance — 0.0%       
  989,924    GM, Term Loan B, 5.795% due 12/15/13(e)      455,012
       TOTAL FINANCIALS      2,363,790
  HEALTH CARE — 0.3%
       Health Care Equipment & Supplies — 0.0%       
       Bausch & Lomb Inc.:       
  797,189   

Term Loan, 7.012% due 4/11/15(e)

      546,643
  200,803   

Term Loan B, 4.709% due 4/11/15(e)

      137,694
      

Total Health Care Equipment & Supplies

      684,337
       Health Care Providers & Services — 0.2%       
       Community Health Systems Inc.:       
  59,526   

Delayed Draw Term Loan, 4.631% due 7/2/14(e)

      46,639
  893,901   

Term Loan B, 4.854% due 7/2/14(e)

      700,372
  987,437    HCA Inc., Term Loan B, 6.012% due 11/1/13(e)      780,693
  942,994    Health Management Association, Term Loan B,
5.512% due 1/16/14 (e)		      585,329
       IASIS Healthcare LLC, Term Loan:       
  239,971   

3.431% due 6/15/14(e)

      172,629
  693,515   

5.118% due 6/15/14(e)

      398,771
  64,153   

5.704% due 6/15/14(e)

      36,888
  985,358    Manor Care Inc., Term Loan B, 5.719% due 11/15/14(e)      683,181
      

Total Health Care Providers & Services

      3,404,502
       Pharmaceuticals — 0.1%       
  26,742    Leiner Health Products Group, Term Loan B,
8.750% due 5/26/11(e)		      26,073
  989,950    Royalty Pharma, Term Loan B, 6.012% due 5/15/14(e)      881,055
      

Total Pharmaceuticals

      907,128
       TOTAL HEALTH CARE      4,995,967
  INDUSTRIALS — 0.2%       
       Aerospace & Defense — 0.1%       
  713,882    Dubai Aerospace Enterprise, Term Loan, 6.550% due 7/31/14(e)      374,788

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   21

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Aerospace & Defense — 0.1% continued       
$ 1,000,000    Transdigm Inc., Term Loan, 5.210% due 7/1/12(e)    $ 806,500
      

Total Aerospace & Defense

      1,181,288
       Airlines — 0.0%       
  1,421,552    United Airlines Inc., Term Loan B, 3.309% due 1/12/14(e)      692,296
       Commercial Services & Supplies — 0.1%       
  989,905    Nielson Finance, Term Loan B, 4.388% due 8/15/13(e)      673,754
  987,469    US Investigations Services Inc., Term Loan B,
4.275% due 2/21/15(e)		      718,383
      

Total Commercial Services & Supplies

      1,392,137
       Electrical Equipment — 0.0%       
  989,873    Sensata Technologies, Term Loan, 5.115% due 4/27/13(e)      509,785
       TOTAL INDUSTRIALS      3,775,506
  INFORMATION TECHNOLOGY — 0.1%
       IT Services — 0.1%       
  1,940,400    First Data Corp., Term Loan, 4.338% due 10/15/14(e)      1,257,795
       Semiconductors & Semiconductor Equipment — 0.0%       
  992,443    Freescale Semiconductor Inc., Term Loan, Tranch B,
4.221% due 12/1/13(e)		      581,131
       TOTAL INFORMATION TECHNOLOGY      1,838,926
  MATERIALS — 0.2%
       Chemicals — 0.0%       
  997,494    Lyondell Chemical Co., Term Loan, 7.000% due 12/20/14(e)†      382,372
       Containers & Packaging — 0.1%       
  985,453    Graphic Packaging International, Term Loan C,
5.977% due 5/16/14(e)		      736,626
       Paper & Forest Products — 0.1%       
  1,329,502    Georgia-Pacific Corp., Term Loan, 4.441% due 12/23/13(e)      1,092,408
  992,500    NewPage Corp., Term Loan, Tranche B, 7.156% due 11/5/14(e)      636,441
      

Total Paper & Forest Products

      1,728,849
       TOTAL MATERIALS      2,847,847
  TELECOMMUNICATION SERVICES — 0.3%
       Diversified Telecommunication Services — 0.2%       
  1,974,619    Cablevision Systems Corp., Term Loan B,
4.214% due 3/30/13(e)		      1,694,060
  675,000    Insight Midwest, Term Loan B, 4.470% due 4/10/14(e)      508,500
  500,000    Intelsat Corp., Term Loan, 5.288% due 6/30/13(e)      381,785
  1,000,000    Level 3 Communications Inc., Term Loan, 7.000% due 3/1/14(e)      612,500
      

Total Diversified Telecommunication Services

      3,196,845

 

See Notes to Financial Statements.

 

22   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Wireless Telecommunication Services — 0.1%       
$ 496,250    ALLTEL Communications Inc., Term Loan,
5.550% due 5/15/15(e)		    $ 488,682
  997,455    MetroPCS Wireless Inc., Term Loan, 4.843% due 2/20/14(e)      805,445
  66,778    Telesat Canada, Delayed Draw Term Loan, Tranch B,
5.670% due 10/15/14(e)		      46,149
  926,102    Telesat Ganada, Term Loan B, 5.800% due 10/15/14(e)      640,002
      

Total Wireless Telecommunication Services

      1,980,278
       TOTAL TELECOMMUNICATION SERVICES      5,177,123
  UTILITIES — 0.1%
       Electric Utilities — 0.1%       
  1,237,519    TXU Corp., Term Loan B, 6.303% due 10/10/14(e)      863,686
       Independent Power Producers & Energy Traders — 0.0%       
  997,487    Calpine Corp., Term Loan, Senior Notes, 6.645% due 3/29/09(e)      739,922
       TOTAL UTILITIES      1,603,608
       TOTAL COLLATERALIZED SENIOR LOANS
(Cost — $63,656,041)		      41,568,587
  CORPORATE BONDS & NOTES — 17.5%       
  CONSUMER DISCRETIONARY — 2.0%       
       Auto Components — 0.1%       
  730,000    Allison Transmission Inc., Senior Notes,
11.250% due 11/1/15(c)(g)		      292,000
  865,000    Keystone Automotive Operations Inc., Senior Subordinated Notes, 9.750% due 11/1/13      333,025
       Visteon Corp., Senior Notes:       
  2,584,000   

8.250% due 8/1/10

      813,960
  3,210,000   

12.250% due 12/31/16(c)

      786,450
      

Total Auto Components

      2,225,435
       Automobiles — 0.1%       
       Ford Motor Co.:       
  95,000   

Debentures, 8.875% due 1/15/22

      23,275
  2,645,000   

Notes, 7.450% due 7/16/31

      753,825
  6,725,000    General Motors Corp., Senior Debentures, 8.250% due 7/15/23      1,143,250
      

Total Automobiles

      1,920,350
       Diversified Consumer Services — 0.0%       
       Education Management LLC/Education Management
Finance Corp.:		       
  195,000   

Senior Notes, 8.750% due 6/1/14

      149,175
  785,000   

Senior Subordinated Notes, 10.250% due 6/1/16

      573,050
      

Total Diversified Consumer Services

      722,225

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   23

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Hotels, Restaurants & Leisure — 0.5%       
$ 640,000    Buffets Inc., Senior Notes, 12.500% due 11/1/14(b)(f)    $ 4,400
  1,680,000    Caesars Entertainment Inc., Senior Subordinated Notes,
8.125% due 5/15/11		      831,600
  620,000    Denny’s Holdings Inc., Senior Notes, 10.000% due 10/1/12      432,450
  520,000    El Pollo Loco Inc., Senior Notes, 11.750% due 11/15/13      387,400
  140,000    Mandalay Resort Group, Senior Subordinated Debentures,
7.625% due 7/15/13		      44,100
  1,700,000    McDonald’s Corp., Medium Term Notes, 5.350% due 3/1/18      1,769,127
       MGM MIRAGE Inc.:       
  1,500,000   

Senior Notes, 7.625% due 1/15/17

      975,000
  1,670,000   

Senior Subordinated Notes, 8.375% due 2/1/11

      1,002,000
  300,000    Mohegan Tribal Gaming Authority, Senior Subordinated Notes, 6.875% due 2/15/15      153,000
  1,620,000    River Rock Entertainment Authority, Senior Secured Notes, 9.750% due 11/1/11      1,352,700
  590,000    Sbarro Inc., Senior Notes, 10.375% due 2/1/15      312,700
       Station Casinos Inc., Senior Notes:       
  300,000   

6.000% due 4/1/12†

      61,500
  1,205,000   

7.750% due 8/15/16†

      234,975
  250,000    Turning Stone Casino Resort Enterprise, Senior Notes, 9.125% due 12/15/10(c)      211,250
      

Total Hotels, Restaurants & Leisure

      7,772,202
       Household Durables — 0.2%       
  200,000    Holt Group Inc., Senior Notes, 9.750% due 1/15/06(a)(b)(f)      0
  600,000    K Hovnanian Enterprises Inc., Senior Notes,
8.625% due 1/15/17		      153,000
  1,495,000    Norcraft Cos. LP/Norcraft Finance Corp., Senior Subordinated Notes, 9.000% due 11/1/11      1,278,225
  3,000,000    Norcraft Holdings LP/Norcraft Capital Corp., Senior Discount Notes, 9.750% due 9/1/12      2,250,000
      

Total Household Durables

      3,681,225
       Internet & Catalog Retail — 0.0%       
  105,000    Expedia Inc., Senior Notes, 8.500% due 7/1/16(c)      78,750
       Media — 0.9%       
       Affinion Group Inc.:       
  1,030,000   

Senior Notes, 10.125% due 10/15/13

      757,050
  250,000   

Senior Subordinated Notes, 11.500% due 10/15/15

      151,563
  5,754,000    CCH I LLC/CCH I Capital Corp., Senior Secured Notes, 11.000% due 10/1/15      1,035,720
  2,249,000    CCH II LLC/CCH II Capital Corp., Senior Notes,
10.250% due 10/1/13		      820,885

 

See Notes to Financial Statements.

 

24   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Media — 0.9% continued       
$ 490,000    Charter Communications Holdings LLC/Charter Communications Holdings Capital Corp., Senior Discount Notes, 11.750% due 5/15/11    $ 61,250
  1,280,000    Charter Communications Inc., Senior Secured Notes, 10.875% due 9/15/14(c)      1,030,400
  70,000    Clear Channel Communications Inc., Senior Notes, 6.250% due 3/15/11      21,350
  225,000    Comcast Cable Communications Holdings Inc., Notes, 8.375% due 3/15/13      232,972
       Comcast Corp.:       
  730,000   

Notes, 6.500% due 1/15/15

      718,420
  1,950,000   

Senior Notes, 6.500% due 1/15/17

      1,929,010
  2,210,000    Dex Media Inc., Discount Notes, 9.000% due 11/15/13      419,900
  2,420,000    EchoStar DBS Corp., Senior Notes, 7.750% due 5/31/15      2,069,100
  4,840,000    Idearc Inc., Senior Notes, 8.000% due 11/15/16      387,200
  70,000    News America Inc., Senior Notes, 6.650% due 11/15/37      69,504
       R.H. Donnelley Corp.:       
  1,440,000   

Senior Discount Notes, 6.875% due 1/15/13

      201,600
  2,175,000   

Senior Notes, 8.875% due 1/15/16

      337,125
  310,000    Time Warner Entertainment Co., LP, Senior Notes,
8.375% due 7/15/33		      313,645
       Time Warner Inc.:       
  190,000   

Senior Debentures, 7.700% due 5/1/32

      190,747
  2,790,000   

Senior Notes, 6.875% due 5/1/12

      2,682,287
  3,140,000    TL Acquisitions Inc., Senior Notes, 10.500% due 1/15/15(c)      1,303,100
      

Total Media

      14,732,828
       Multiline Retail — 0.2%       
  1,670,000    Dollar General Corp., Senior Subordinated Notes, 11.875% due 7/15/17(g)      1,436,200
  2,885,000    Neiman Marcus Group Inc., Senior Notes,
9.000% due 10/15/15(g)		      1,283,825
      

Total Multiline Retail

      2,720,025
       Specialty Retail — 0.0%       
  1,005,000    Blockbuster Inc., Senior Subordinated Notes,
9.000% due 9/1/12		      492,450
       TOTAL CONSUMER DISCRETIONARY      34,345,490
  CONSUMER STAPLES — 0.6%       
       Beverages — 0.1%       
  1,750,000    Constellation Brands Inc., Senior Notes, 8.375% due 12/15/14      1,671,250

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   25

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Food & Staples Retailing — 0.2%       
       CVS Caremark Corp., Pass-Through Certificates:       
$ 240,664   

5.298% due 1/11/27(c)

    $ 184,888
  1,316,026   

6.943% due 1/10/30(c)

      829,246
       CVS Lease Pass-Through Trust:       
  679,038   

5.880% due 1/10/28(a)(c)

      525,979
  753,421   

6.036% due 12/10/28(c)

      459,301
       Kroger Co., Senior Notes:       
  400,000   

6.750% due 4/15/12

      404,036
  500,000   

5.500% due 2/1/13

      495,944
  475,000    Wal-Mart Stores Inc., 4.550% due 5/1/13      492,264
      

Total Food & Staples Retailing

      3,391,658
       Food Products — 0.1%       
  3,581,000    Dole Food Co. Inc., Senior Notes, 7.250% due 6/15/10      2,515,653
       Tobacco — 0.2%       
       Alliance One International Inc., Senior Notes:       
  430,000   

8.500% due 5/15/12

      318,200
  580,000   

11.000% due 5/15/12

      484,300
  1,960,000    Altria Group Inc., Senior Notes, 9.700% due 11/10/18      2,121,833
      

Total Tobacco

      2,924,333
       TOTAL CONSUMER STAPLES      10,502,894
  ENERGY — 2.4%       
       Energy Equipment & Services — 0.1%       
  1,925,000    Complete Production Services Inc., Senior Notes,
8.000% due 12/15/16		      1,222,375
  20,000    GulfMark Offshore Inc., Senior Subordinated Notes,
7.750% due 7/15/14		      14,300
  500,000    Key Energy Services Inc., Senior Notes, 8.375% due 12/1/14      332,500
  145,000    Southern Natural Gas Co., Senior Notes, 8.000% due 3/1/32      121,549
      

Total Energy Equipment & Services

      1,690,724
       Oil, Gas & Consumable Fuels — 2.3%       
  500,000    Anadarko Finance Co., Senior Notes, 7.500% due 5/1/31      443,253
  740,000    Anadarko Petroleum Corp., Senior Notes, 5.950% due 9/15/16      654,620
  1,325,000    Belden & Blake Corp., Secured Notes, 8.750% due 7/15/12      914,250
  1,830,000    BP Capital Markets PLC, Senior Notes, 5.250% due 11/7/13      1,912,438
       Chesapeake Energy Corp., Senior Notes:       
  2,125,000   

6.375% due 6/15/15

      1,689,375
  1,540,000   

6.875% due 1/15/16

      1,239,700
  175,000   

7.250% due 12/15/18

      137,375

 

See Notes to Financial Statements.

 

26   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Oil, Gas & Consumable Fuels — 2.3% continued       
$ 525,000   

Compagnie Generale de Geophysique SA, Senior Notes,

7.500% due 5/15/15

    $ 328,125
  1,130,000    ConocoPhillips Holding Co., Senior Notes, 6.950% due 4/15/29      1,219,390
       El Paso Corp.:       
      

Medium-Term Notes:

       
  400,000   

7.375% due 12/15/12

      347,452
  1,175,000   

7.800% due 8/1/31

      771,391
  2,780,000   

7.750% due 1/15/32

      1,818,456
  1,620,000   

Senior Subordinated Notes, 7.000% due 6/15/17

      1,275,920
  1,760,000    Energy Transfer Partners LP, Senior Notes, 6.700% due 7/1/18      1,485,950
  740,000    Enterprise Products Operating LP, Junior Subordinated Notes,
8.375% due 8/1/66(e)		      407,465
  2,125,000    EXCO Resources Inc., Senior Notes, 7.250% due 1/15/11      1,668,125
       Gazprom, Loan Participation Notes:       
  2,420,000   

6.212% due 11/22/16(c)

      1,609,300
  100,000   

Senior Notes, 6.510% due 3/7/22(c)

      60,000
  80,000    Hess Corp., Notes, 7.300% due 8/15/31      72,979
  1,045,000    International Coal Group Inc., Senior Notes,
10.250% due 7/15/14		      788,975
       Kerr-McGee Corp., Notes:       
  2,600,000   

6.875% due 9/15/11

      2,574,595
  1,730,000   

6.950% due 7/1/24

      1,520,340
  145,000   

7.875% due 9/15/31

      133,815
       Kinder Morgan Energy Partners LP:       
  60,000   

Notes, 6.750% due 3/15/11

      58,388
      

Senior Notes:

       
  10,000   

6.300% due 2/1/09

      9,991
  160,000   

7.125% due 3/15/12

      154,636
  50,000   

5.000% due 12/15/13

      43,648
  1,350,000   

6.000% due 2/1/17

      1,173,833
  400,000   

5.950% due 2/15/18

      341,958
  85,000    Mariner Energy Inc., Senior Notes, 7.500% due 4/15/13      54,825
       OPTI Canada Inc., Senior Secured Notes:       
  400,000   

7.875% due 12/15/14

      206,000
  1,230,000   

8.250% due 12/15/14

      670,350
  750,000    Overseas Shipholding Group Inc., Senior Notes,
7.500% due 2/15/24		      502,500
  1,350,000    Parker Drilling Co., Senior Notes, 9.625% due 10/1/13      1,053,000
  77,000    Pemex Project Funding Master Trust, Senior Bonds,
6.625% due 6/15/35		      65,277

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   27

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY   VALUE
    
       Oil, Gas & Consumable Fuels — 2.3% continued      
$ 60,000    Petrobras International Finance Co., Senior Notes,
6.125% due 10/6/16		   $ 58,800
  400,000    Petroplus Finance Ltd., Senior Notes, 7.000% due 5/1/17(c)     246,000
  1,900,000    Quicksilver Resources Inc., Senior Subordinated Notes,
7.125% due 4/1/16		     1,026,000
  2,185,000    SemGroup LP, Senior Notes, 8.750% due 11/15/15(b)(c)(f)     87,400
  3,030,000    Stone Energy Corp., Senior Subordinated Notes,
6.750% due 12/15/14		     1,499,850
  1,060,000    Teekay Corp., Senior Notes, 8.875% due 7/15/11     901,000
  545,000    VeraSun Energy Corp., Senior Notes, 9.375% due 6/1/17(f)     68,125
       Whiting Petroleum Corp., Senior Subordinated Notes:      
  1,049,000   

7.250% due 5/1/12

     786,750
  1,415,000   

7.000% due 2/1/14

     1,004,650
       Williams Cos. Inc.:      
  98,000   

Debentures, 7.500% due 1/15/31

     65,798
  1,770,000   

Notes, 8.750% due 3/15/32

     1,321,328
      

Senior Notes:

      
  2,500,000   

7.625% due 7/15/19

     1,956,350
  780,000   

7.750% due 6/15/31

     535,419
       XTO Energy Inc., Senior Notes:      
  1,820,000   

7.500% due 4/15/12

     1,800,095
  800,000   

5.500% due 6/15/18

     725,514
      

Total Oil, Gas & Consumable Fuels

     39,490,774
       TOTAL ENERGY     41,181,498
  FINANCIALS — 4.4%
       Capital Markets — 0.3%      
       Bear Stearns Co. Inc.:      
      

Senior Notes:

      
  1,000,000   

6.400% due 10/2/17

     1,040,915
  680,000   

7.250% due 2/1/18

     746,435
  20,000   

Subordinated Notes, 5.550% due 1/22/17

     19,070
  40,000    Credit Suisse USA Inc., Senior Notes, 5.500% due 8/16/11     39,790
  80,000    Goldman Sachs Capital II, Junior Subordinated Bonds,
5.793% due 6/1/12(e)(h)		     30,773
       Goldman Sachs Group Inc.:      
  80,000   

Notes, 4.500% due 6/15/10

     78,858
  1,700,000   

Senior Notes, 6.150% due 4/1/18

     1,636,457
  4,150,000    Kaupthing Bank HF, Subordinated Notes, 7.125% due 5/19/16(c)(f)     51,875
  130,000    Lehman Brothers Holdings Capital Trust VII, Medium-Term Notes, 5.857% due 5/31/12(e)(f)(h)     13

 

See Notes to Financial Statements.

 

28   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Capital Markets — 0.3% continued       
       Lehman Brothers Holdings Inc., Medium-Term Notes:       
$ 3,320,000   

6.750% due 12/28/17(f)

    $ 332
      

Senior Notes:

       
  50,000   

5.250% due 2/6/12(f)

      5,000
  460,000   

6.200% due 9/26/14(f)

      46,000
       Merrill Lynch & Co. Inc.:       
  1,450,000   

Notes, 6.875% due 4/25/18

      1,519,346
  270,000   

Senior Notes, 5.450% due 2/5/13

      259,770
       Morgan Stanley:       
  30,000   

Medium-Term Notes, 4.953% due 10/18/16(e)

      20,678
  100,000   

Subordinated Notes, 4.750% due 4/1/14

      76,272
      

Total Capital Markets

      5,571,584
       Commercial Banks — 0.7%       
  50,000    BAC Capital Trust XIV, Junior Subordinated Notes, 5.630% due 3/15/12(e)(h)      20,045
  400,000    Depfa ACS Bank, 5.125% due 3/16/37(c)      290,559
       Glitnir Banki HF:       
      

Notes:

       
  240,000   

6.330% due 7/28/11(c)(f)

      12,600
  970,000   

6.375% due 9/25/12(c)(f)

      50,925
  200,000   

Subordinated Bonds, 7.451% due 9/14/16(c)(e)(f)(h)

      1,030
  520,000   

Subordinated Notes, 6.693% due 6/15/16(c)(e)(f)

      2,678
  330,000    HBOS Capital Funding LP, Tier 1 Notes, Perpetual Bonds, 6.071% due 6/30/14(c)(e)(h)      122,160
       ICICI Bank Ltd., Subordinated Bonds:       
  320,000   

6.375% due 4/30/22(c)(e)

      168,971
  100,000   

6.375% due 4/30/22(c)(e)

      52,651
  120,000    Landsbanki Islands HF, Senior Notes, 6.100% due 8/25/11(c)(f)      2,700
  4,500,000    Resona Preferred Global Securities Cayman Ltd., Bonds, 7.191% due 7/30/15(c)(e)(h)      2,144,516
  1,710,000    RSHB Capital, Loan Participation Notes, 6.299% due 5/15/17(c)      983,250
  60,000    Santander Issuances SA Unipersonal, Subordinated Notes, 5.805% due 6/20/16(c)(e)      54,009
  4,575,000    Shinsei Finance Cayman Ltd., Junior Subordinated Bonds,
6.418% due 7/20/16(c)(e)(h)		      957,602
  90,000    SunTrust Capital, Trust Preferred Securities,
6.100% due 12/15/36(e)		      63,532
       TuranAlem Finance BV, Bonds:       
  1,740,000   

8.250% due 1/22/37(c)

      752,550
  170,000   

8.250% due 1/22/37(c)

      73,950

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   29

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Commercial Banks — 0.7% continued       
       Wachovia Corp.:       
$ 4,240,000   

Medium Term Notes, 5.500% due 5/1/13

    $ 4,196,663
  160,000   

Subordinated Notes, 5.250% due 8/1/14

      149,218
  100,000    Wells Fargo Capital X, Capital Securities,
5.950% due 12/15/36		      85,972
  2,270,000    Wells Fargo Capital XV, Junior Subordinated Notes,
9.750% due 9/26/13(h)		      2,294,838
      

Total Commercial Banks

      12,480,419
       Consumer Finance — 1.6%       
  3,730,000    American Express Co., Subordinated Debentures,
6.800% due 9/1/66(e)		      1,933,203
  800,000    Caterpillar Financial Services Corp., Medium-Term Notes,
5.450% due 4/15/18		      750,360
       Ford Motor Credit Co.:       
  4,400,000   

Notes, 7.000% due 10/1/13

      3,042,864
      

Senior Notes:

       
  5,169,000   

9.750% due 9/15/10

      4,136,637
  3,537,000   

7.246% due 6/15/11(e)

      2,338,841
  130,000   

12.000% due 5/15/15

      97,175
  5,000,000    General Motors Acceptance Corp., Notes, 5.625% due 5/15/09      4,805,240
       GMAC LLC:       
  345,000   

7.500% due 12/31/13(c)

      257,025
  3,070,000   

6.750% due 12/1/14(c)

      2,111,484
  78,000   

8.000% due 12/31/18(c)

      40,170
  3,254,000   

8.000% due 11/1/31(c)

      1,937,692
  1,400,000    John Deere Capital Corp., Medium-Term Notes,
5.350% due 4/3/18		      1,314,018
       SLM Corp.:       
      

Medium-Term Notes:

       
  200,000   

3.735% due 1/26/09(e)

      199,974
  500,000   

7.060% due 1/31/14(e)

      265,470
      

Senior Notes:

       
  640,000   

3.695% due 7/26/10(e)

      546,432
  3,530,000   

8.450% due 6/15/18

      2,795,043
      

Total Consumer Finance

      26,571,628
       Diversified Financial Services — 1.4%       
  600,000    AAC Group Holding Corp., Senior Discount Notes,
10.250% due 10/1/12(c)		      399,000
  1,360,000    Aiful Corp., Notes, 5.000% due 8/10/10(c)      747,958
  674,784    Air 2 US, Notes, 8.027% due 10/1/19(c)      506,088

 

See Notes to Financial Statements.

 

30   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Diversified Financial Services — 1.4% continued       
       Bank of America Corp.:       
$ 330,000   

5.125% due 11/15/14

    $ 319,462
  1,400,000   

Notes, Preferred Securities, 8.000% due 1/30/18(h)

      1,008,448
  400,000   

Subordinated Notes, 5.420% due 3/15/17

      356,118
  200,000    Capital One Bank, Notes, 5.750% due 9/15/10      194,190
       Citigroup Inc.:       
  1,150,000   

Junior Subordinated Notes, Preferred Securities,
8.400% due 4/30/18(h)

      760,771
  1,510,000   

Notes, 6.875% due 3/5/38

      1,724,014
  3,320,000   

Senior Notes, 6.500% due 8/19/13

      3,353,472
  915,000    El Paso Performance-Linked Trust Certificates, Senior Notes,
7.750% due 7/15/11(c)		      796,736
       General Electric Capital Corp.:       
  4,500,000   

Senior Notes, 5.625% due 5/1/18

      4,540,774
  1,470,000   

Subordinated Debentures, 6.375% due 11/15/67(e)

      925,359
  900,000    Glen Meadow Pass-Through Certificates,
6.505% due 2/12/67(c)(e)		      402,878
  1,170,000    HSBC Finance Corp., Senior Notes, 8.000% due 7/15/10      1,189,881
  180,000    International Lease Finance Corp., Medium-Term Notes,
4.375% due 11/1/09		      157,842
       JPMorgan Chase & Co.:       
  1,490,000   

Junior Subordinated Notes, 7.900% due 4/30/18(h)

      1,242,699
      

Subordinated Notes:

       
  250,000   

5.750% due 1/2/13

      253,860
  30,000   

6.125% due 6/27/17

      29,572
       Leucadia National Corp., Senior Notes:       
  520,000   

8.125% due 9/15/15

      419,900
  120,000   

7.125% due 3/15/17

      89,700
  200,000    MUFG Capital Finance 1 Ltd., Preferred Securities,
6.346% due 7/25/16(e)(h)		      139,534
  450,000    Pemex Finance Ltd., Notes, 9.030% due 2/15/11      459,000
  100,000    SMFG Preferred Capital, Bonds, 6.078% due 1/25/17(c)(e)(h)      67,963
       TNK-BP Finance SA:       
  1,430,000   

Bonds, 7.500% due 7/18/16(c)

      750,750
  250,000   

Senior Notes, 6.625% due 3/20/17(c)

      121,250
  4,585,000    Vanguard Health Holdings Co., II LLC, Senior Subordinated Notes, 9.000% due 10/1/14      3,851,400
      

Total Diversified Financial Services

      24,808,619

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   31

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Insurance — 0.3%       
       American International Group Inc.:       
$ 220,000   

Medium-Term Notes, 5.850% due 1/16/18

    $ 147,694
  2,760,000   

Senior Notes, 8.250% due 8/15/18(c)

      2,023,077
  130,000    MetLife Inc., Junior Subordinated Debentures,
6.400% due 12/15/36		      78,181
  1,700,000    Pacific Life Global Funding, Notes, 5.150% due 4/15/13(c)      1,598,748
  490,000    Travelers Cos. Inc., Junior Subordinated Debentures,
6.250% due 3/15/37(e)		      321,425
      

Total Insurance

      4,169,125
       Real Estate Investment Trusts (REITs) — 0.0%       
  700,000    Forest City Enterprises Inc., Senior Notes, 6.500% due 2/1/17      248,500
       Real Estate Management & Development — 0.0%       
  905,000    Ashton Woods USA LLC/Ashton Woods Finance Co., Senior Subordinated Notes, 9.500% due 10/1/15(f)      185,525
  1,755,000    Realogy Corp., Senior Subordinated Notes,
12.375% due 4/15/15		      245,700
      

Total Real Estate Management & Development

      431,225
       Thrifts & Mortgage Finance — 0.1%       
  20,000    Countrywide Financial Corp., Medium-Term Notes,
4.348% due 1/5/09(e)		      20,000
  1,300,000    Countrywide Home Loans Inc., Notes, 5.625% due 7/15/09      1,294,448
  1,250,000    Ocwen Capital Trust I, Junior Subordinated Capital Securities,
10.875% due 8/1/27(a)		      862,500
      

Total Thrifts & Mortgage Finance

      2,176,948
       TOTAL FINANCIALS      76,458,048
  HEALTH CARE — 1.3%       
       Health Care Equipment & Supplies — 0.1%       
       Biomet Inc., Senior Notes:       
  230,000   

10.375% due 10/15/17(g)

      182,850
  1,280,000   

11.625% due 10/15/17

      1,100,800
      

Total Health Care Equipment & Supplies

      1,283,650
       Health Care Providers & Services — 1.2%       
  2,650,000    Aetna Inc., Senior Notes, 6.500% due 9/15/18      2,529,353
       Cardinal Health Inc.:       
  70,000   

Senior Bonds, 5.850% due 12/15/17

      63,224
  1,350,000   

Senior Notes, 5.800% due 10/15/16

      1,223,168
  1,140,000    Community Health Systems Inc., Senior Notes,
8.875% due 7/15/15		      1,054,500
       HCA Inc.:       
  2,090,000   

Notes, 6.375% due 1/15/15

      1,285,350

 

See Notes to Financial Statements.

 

32   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Health Care Providers & Services — 1.2% continued       
      

Senior Secured Notes:

       
$ 1,080,000   

9.250% due 11/15/16

    $ 993,600
  6,038,000   

9.625% due 11/15/16(g)

      4,724,735
  3,075,000    IASIS Healthcare LLC/IASIS Capital Corp., Senior Subordinated Notes, 8.750% due 6/15/14      2,398,500
       Tenet Healthcare Corp., Senior Notes:       
  670,000   

6.375% due 12/1/11

      520,925
  2,460,000   

6.500% due 6/1/12

      1,881,900
  2,300,000   

7.375% due 2/1/13

      1,650,250
  1,095,000   

9.875% due 7/1/14

      886,950
  3,065,000    US Oncology Holdings Inc., Senior Notes,
8.334% due 3/15/12(e)(g)		      1,946,275
  80,000    WellPoint Inc., Senior Notes, 5.875% due 6/15/17      72,928
      

Total Health Care Providers & Services

      21,231,658
       Pharmaceuticals — 0.0%       
  2,243,000    Leiner Health Products Inc., Senior Subordinated Notes,
11.000% due 6/1/12(b)(f)		      117,757
       TOTAL HEALTH CARE      22,633,065
  INDUSTRIALS — 1.8%       
       Aerospace & Defense — 0.3%       
  180,000    DRS Technologies Inc., Senior Subordinated Notes,
6.625% due 2/1/16		      180,900
  5,790,000    Hawker Beechcraft Acquisition Co., Senior Notes,
8.875% due 4/1/15(g)		      1,997,550
  5,465    Kac Acquisition Co., Subordinated Notes,
8.000% due 4/26/26(a)(b)(f)		      0
  2,330,000    L-3 Communications Corp., Senior Subordinated Notes,
7.625% due 6/15/12		      2,283,400
      

Total Aerospace & Defense

      4,461,850
       Airlines — 0.1%       
       Continental Airlines Inc., Pass-Through Certificates:       
  41,906   

8.312% due 4/2/11(a)

      31,430
  230,000   

7.339% due 4/19/14

      133,400
  2,020,000    DAE Aviation Holdings Inc., Senior Notes,
11.250% due 8/1/15(c)		      838,300
       United Airlines Inc., Pass-Through Certificates:       
  245,469   

7.811% due 10/1/09(a)

      230,741
  230,000   

6.831% due 3/1/10

      225,400
  162,820   

8.030% due 7/1/11

      159,563
  105,000   

6.932% due 9/1/11

      117,600
      

Total Airlines

      1,736,434

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   33

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Building Products — 0.5%       
$ 5,000,000    American Standard Co. Inc., Senior Notes, 8.250% due 6/1/09    $ 5,030,845
  3,515,000    Associated Materials Inc., Senior Subordinated Notes,
9.750% due 4/15/12		      2,785,637
  1,060,000    Nortek Inc., Senior Subordinated Notes, 8.500% due 9/1/14      249,100
  3,116,000    NTK Holdings Inc., Senior Discount Notes, step bond to yield
18.030% due 3/1/14		      685,520
      

Total Building Products

      8,751,102
       Commercial Services & Supplies — 0.3%       
  700,000    Allied Waste North America Inc., Senior Notes,
6.875% due 6/1/17		      652,009
  1,710,000    DynCorp International LLC/DIV Capital Corp., Senior Subordinated Notes, 9.500% due 2/15/13      1,489,837
  1,420,000    Rental Services Corp., Senior Notes, 9.500% due 12/1/14      788,100
  2,050,000    US Investigations Services Inc., Senior Subordinated Notes,
10.500% due 11/1/15(c)		      1,506,750
  570,000    Waste Management Inc., Senior Notes, 6.375% due 11/15/12      531,983
      

Total Commercial Services & Supplies

      4,968,679
       Construction & Engineering — 0.0%       
  860,000    CSC Holdings Inc., Senior Notes, 8.500% due 6/15/15(c)      761,100
       Electrical Equipment — 0.0%       
  490,000    Sensata Technologies B.V., Senior Notes, 8.000% due 5/1/14      222,950
       Industrial Conglomerates — 0.2%       
  450,000    General Electric Co., Notes, 5.000% due 2/1/13      455,497
       Sequa Corp., Senior Notes:       
  440,000   

11.750% due 12/1/15(c)

      169,400
  470,201   

13.500% due 12/1/15(c)(g)

      152,815
       Tyco International Group SA:       
      

Notes:

       
  40,000   

6.125% due 1/15/09

      39,948
  1,170,000   

6.000% due 11/15/13

      1,098,958
  300,000   

Senior Notes, 6.375% due 10/15/11

      295,068
  1,780,000    Tyco International Ltd./Tyco International Finance SA, Senior Bonds, 6.875% due 1/15/21      1,378,985
      

Total Industrial Conglomerates

      3,590,671
       Road & Rail — 0.2%       
  3,445,000    Hertz Corp., Senior Subordinated Notes, 10.500% due 1/1/16      1,589,006
       Kansas City Southern de Mexico, Senior Notes:       
  2,090,000   

9.375% due 5/1/12

      1,922,800
  30,000   

7.625% due 12/1/13

      24,750
  100,000    Kansas City Southern Railway, Senior Notes,
7.500% due 6/15/09		      100,750

 

See Notes to Financial Statements.

 

34   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Road & Rail — 0.2% continued       
$ 350,646    Union Pacific Corp., Pass-Through Certificates,
5.404% due 7/2/25		    $ 413,272
      

Total Road & Rail

      4,050,578
       Trading Companies & Distributors — 0.2%       
  2,690,000    Ashtead Capital Inc., Notes, 9.000% due 8/15/16(c)      1,398,800
  1,040,000    H&E Equipment Services Inc., Senior Notes,
8.375% due 7/15/16		      556,400
  2,075,000    Penhall International Corp., Senior Secured Notes,
12.000% due 8/1/14(c)		      798,875
      

Total Trading Companies & Distributors

      2,754,075
       Transportation Infrastructure — 0.0%       
       Swift Transportation Co., Senior Secured Notes:       
  380,000   

9.899% due 5/15/15(c)(e)

      32,775
  990,000   

12.500% due 5/15/17(c)

      95,287
      

Total Transportation Infrastructure

      128,062
       TOTAL INDUSTRIALS      31,425,501
  INFORMATION TECHNOLOGY — 0.2%       
       Electronic Equipment, Instruments & Components — 0.1%       
       NXP BV/NXP Funding LLC:       
  3,280,000   

Senior Notes, 9.500% due 10/15/15

      631,400
      

Senior Secured Notes:

       
  1,000,000   

7.503% due 10/15/13(e)

      336,250
  85,000   

7.875% due 10/15/14

      33,575
      

Total Electronic Equipment, Instruments & Components

      1,001,225
       IT Services — 0.1%       
  430,000    Ceridian Corp., Senior Notes, 12.250% due 11/15/15(c)(g)      212,313
  90,000    Electronic Data Systems Corp., Notes, 7.125% due 10/15/09      91,513
  2,878,000    SunGard Data Systems Inc., Senior Subordinated Notes, 10.250% due 8/15/15      1,913,870
      

Total IT Services

      2,217,696
       Software — 0.0%       
  110,000    Activant Solutions Inc., Senior Subordinated Notes, 9.500% due 5/1/16      51,700
       TOTAL INFORMATION TECHNOLOGY      3,270,621
  MATERIALS — 1.4%       
       Chemicals — 0.1%       
  150,000    Arco Chemical Co., Debentures, 9.800% due 2/1/20(f)      17,250
       Georgia Gulf Corp., Senior Notes:       
  367,000   

9.500% due 10/15/14

      111,935
  1,485,000   

10.750% due 10/15/16

      363,825

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   35

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Chemicals — 0.1% continued       
$ 235,000    Huntsman International LLC, Senior Subordinated Notes, 7.875% due 11/15/14    $ 126,900
  110,000    Montell Finance Co. BV, Debentures, 8.100% due 3/15/27(c)†      2,750
  1,020,000    PPG Industries Inc., Senior Notes, 6.650% due 3/15/18      1,006,459
      

Total Chemicals

      1,629,119
       Containers & Packaging — 0.2%       
  2,385,000    Graphic Packaging International Corp., Senior Subordinated Notes, 9.500% due 8/15/13      1,657,575
  1,105,000    Plastipak Holdings Inc., Senior Notes, 8.500% due 12/15/15(c)      745,875
      

Total Containers & Packaging

      2,403,450
       Metals & Mining — 0.8%       
  2,650,000    Barrick Gold Financeco LLC, Senior Notes, 6.125% due 9/15/13      2,515,274
  4,085,000    Freeport-McMoRan Copper & Gold Inc., Senior Notes, 8.375% due 4/1/17      3,354,341
  1,725,000    Metals USA Inc., Senior Secured Notes, 11.125% due 12/1/15      1,026,375
  645,000    Noranda Aluminium Holding Corp., Senior Notes,
8.345% due 11/15/14(e)(g)		      106,425
  1,935,000    Novelis Inc., Senior Notes, 7.250% due 2/15/15      1,131,975
  2,960,000    Ryerson Inc., Senior Secured Notes, 12.000% due 11/1/15(c)      1,842,600
       Steel Dynamics Inc., Senior Notes:       
  240,000   

7.375% due 11/1/12

      176,400
  2,590,000   

7.750% due 4/15/16(c)

      1,806,525
  610,000    Tube City IMS Corp., Senior Subordinated Notes,
9.750% due 2/1/15		      216,550
       Vale Overseas Ltd., Notes:       
  50,000   

8.250% due 1/17/34

      53,385
  2,050,000   

6.875% due 11/21/36

      1,865,910
      

Total Metals & Mining

      14,095,760
       Paper & Forest Products — 0.3%       
  3,000,000    Abitibi-Consolidated Co. of Canada, Senior Secured Notes, 13.750% due 4/1/11(c)      1,935,000
  2,845,000    Appleton Papers Inc., Senior Subordinated Notes,
9.750% due 6/15/14		      1,678,550
  2,105,000    NewPage Corp., Senior Secured Notes, 9.443% due 5/1/12(e)      815,687
  600,000    Weyerhaeuser Co., Senior Notes, 6.750% due 3/15/12      537,461
      

Total Paper & Forest Products

      4,966,698
       TOTAL MATERIALS      23,095,027
  TELECOMMUNICATION SERVICES — 1.6%       
       Diversified Telecommunication Services — 1.0%       
  385,000    Citizens Communications Co., Senior Notes,
7.875% due 1/15/27		      225,225

 

See Notes to Financial Statements.

 

36   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Diversified Telecommunication Services — 1.0% continued       
$ 1,225,000    Deutsche Telekom International Finance, Senior Notes,
5.750% due 3/23/16		    $ 1,174,314
  10,000    Embarq Corp., Notes, 7.995% due 6/1/36      6,764
  455,000    GT Group Telecom Inc., Senior Discount Notes,
13.250% due 2/1/10(a)(b)(f)		      0
  2,225,000    Hawaiian Telcom Communications Inc., Senior Subordinated Notes, 12.500% due 5/1/15(f)      22,250
  3,610,000    Intelsat Bermuda Ltd., Senior Notes, 11.250% due 6/15/16      3,303,150
  470,000    Koninklijke KPN NV, Senior Notes, 8.000% due 10/1/10      474,515
       Level 3 Financing Inc., Senior Notes:       
  500,000   

9.250% due 11/1/14

      292,500
  300,000   

6.845% due 2/15/15(e)

      132,000
  3,020,000    Nordic Telephone Co. Holdings, Senior Secured Bonds,
8.875% due 5/1/16(c)		      2,129,100
  3,645,000    Qwest Communications International Inc., Senior Notes, 7.500% due 2/15/14      2,624,400
  380,000    Telecom Italia Capital S.p.A., Senior Notes,
5.250% due 10/1/15		      289,660
  1,585,000    Verizon Florida Inc., Senior Notes, 6.125% due 1/15/13      1,511,905
  3,060,000    Virgin Media Finance PLC, Senior Notes, 9.125% due 8/15/16      2,279,700
  2,110,000    Wind Acquisition Finance SA, Senior Bonds,
10.750% due 12/1/15(c)		      1,825,150
  2,060,000    Windstream Corp., Senior Notes, 8.625% due 8/1/16      1,833,400
      

Total Diversified Telecommunication Services

      18,124,033
       Wireless Telecommunication Services — 0.6%       
  480,000    ALLTEL Communications Inc., Senior Notes,
10.375% due 12/1/17(c)(g)		      540,000
  130,000    Cellco Partnership, Senior Notes, 8.500% due 11/15/18(c)      152,581
  165,000    MetroPCS Wireless Inc., Senior Notes, 9.250% due 11/1/14      148,500
  4,400,000    New Cingular Wireless Services Inc., Notes, 8.125% due 5/1/12      4,721,856
  60,000    Nextel Communications Inc., Senior Notes,
6.875% due 10/31/13		      25,513
       Sprint Capital Corp., Senior Notes:       
  3,385,000   

8.375% due 3/15/12

      2,709,767
  1,000,000   

6.875% due 11/15/28

      596,208
  10,000   

8.750% due 3/15/32

      6,763
  3,060,000    True Move Co., Ltd., Notes, 10.750% due 12/16/13(c)      1,147,500
      

Total Wireless Telecommunication Services

      10,048,688
       TOTAL TELECOMMUNICATION SERVICES      28,172,721

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   37

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
  UTILITIES — 1.8%       
       Electric Utilities — 0.2%       
$ 90,000    Duke Energy Corp., Senior Notes, 5.625% due 11/30/12    $ 91,736
  30,000    Exelon Corp., Bonds, 5.625% due 6/15/35      18,988
       FirstEnergy Corp., Notes:       
  360,000   

6.450% due 11/15/11

      340,509
  840,000   

7.375% due 11/15/31

      796,774
       Pacific Gas & Electric Co.:       
  50,000   

First Mortgage Bonds, 6.050% due 3/1/34

      53,279
  500,000   

Senior Notes, 4.200% due 3/1/11

      494,187
  2,330,000    Texas Competitive Electric Holding Co. LLC, Senior Notes, 10.500% due 11/1/16(c)(g)      1,176,650
      

Total Electric Utilities

      2,972,123
       Gas Utilities — 0.1%       
  2,410,000    Suburban Propane Partners LP/Suburban Energy Finance Corp., Senior Notes, 6.875% due 12/15/13      1,988,250
       Independent Power Producers & Energy Traders — 1.4%       
       AES Corp., Senior Notes:       
  717,000   

8.875% due 2/15/11

      673,980
  3,000,000   

7.750% due 3/1/14

      2,655,000
  420,000   

7.750% due 10/15/15

      354,900
  3,570,000   

8.000% due 10/15/17

      2,945,250
  390,000    Dynegy Holdings Inc., Senior Notes, 7.750% due 6/1/19      271,050
  3,000,000    Dynegy Inc., Bonds, 7.670% due 11/8/16      2,131,875
       Edison Mission Energy, Senior Notes:       
  1,130,000   

7.750% due 6/15/16

      1,011,350
  765,000   

7.200% due 5/15/19

      631,125
  600,000   

7.625% due 5/15/27

      468,000
  9,280,000    Energy Future Holdings, Senior Notes,
11.250% due 11/1/17(c)(g)		      4,547,200
       Mirant Mid Atlantic LLC, Pass-Through Certificates:       
  384,647   

9.125% due 6/30/17

      346,182
  2,143,448   

10.060% due 12/30/28

      1,971,972
       NRG Energy Inc., Senior Notes:       
  1,300,000   

7.250% due 2/1/14

      1,218,750
  5,185,000   

7.375% due 2/1/16

      4,835,013
  200,000   

7.375% due 1/15/17

      184,500
  1,325,000    TXU Corp., Senior Notes, 5.550% due 11/15/14      625,702
      

Total Independent Power Producers & Energy Traders

      24,871,849

 

See Notes to Financial Statements.

 

38   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Multi-Utilities — 0.1%       
       Dominion Resources Inc., Senior Notes:       
$ 600,000   

5.700% due 9/17/12

    $ 594,596
  910,000   

8.875% due 1/15/19

      982,331
      

Total Multi-Utilities

      1,576,927
       TOTAL UTILITIES      31,409,149
       TOTAL CORPORATE BONDS & NOTES (Cost — $447,806,817)      302,494,014
  CONVERTIBLE BOND & NOTE — 1.6%
  INFORMATION TECHNOLOGY — 1.6%
       Internet Software & Services — 1.6%       
  42,697,000    VeriSign Inc., 3.250% due 8/15/37 (Cost — $28,192,128)      27,059,224
  MORTGAGE-BACKED SECURITIES — 2.8%
  FHLMC — 1.2%
       Federal Home Loan Mortgage Corp. (FHLMC):       
  32,309   

8.000% due 7/1/20(d)

      34,087
  9,234,832   

5.108% due 6/1/35(d)(e)

      9,326,596
  300,762   

6.664% due 8/1/36(d)(e)

      307,785
  520,601   

6.874% due 8/1/36(d)(e)

      527,245
  781,869   

6.453% due 9/1/36(d)(e)

      803,028
  327,533   

6.647% due 10/1/36(d)(e)

      334,263
  567,281   

5.927% due 5/1/37(d)(e)

      583,116
      

Gold:

       
  700,437   

7.000% due 6/1/17(d)

      729,668
  129,652   

8.500% due 9/1/25(d)

      140,032
  983,420   

6.500% due 3/1/26-8/1/29(d)

      1,029,456
  6,855,154   

6.000% due 9/1/32-2/1/36(d)

      7,074,652
       TOTAL FHLMC      20,889,928
  FNMA — 1.5%
       Federal National Mortgage Association (FNMA):       
  644,310   

6.500% due 10/1/10-5/1/29(d)

      674,190
  392,177   

8.000% due 12/1/12-2/1/31(d)

      401,125
  463,250   

5.500% due 1/1/14(d)

      481,993
  2,259,164   

7.000% due 3/15/15-6/1/32(d)

      2,386,034
  7,781,145   

5.000% due 7/1/18-7/1/38(d)

      7,963,537
  277,447   

4.500% due 11/1/23(d)

      282,586
  37,090   

9.000% due 1/1/24(d)

      40,398
  700,953   

7.500% due 11/1/26-7/1/32(d)

      743,351
  43,131   

8.500% due 10/1/30(d)

      46,674
  137,095   

5.129% due 9/1/35(d)(e)

      140,525
  426,603   

5.578% due 8/1/37(d)(e)

      436,296

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   39

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       Federal National Mortgage Association (FNMA): continued       
$ 1,521,093   

6.000% due 7/1/38(d)

    $ 1,567,741
  3,000,000   

5.000% due 1/13/39(d)(i)

      3,063,282
  5,000,000   

5.500% due 1/13/39(d)(i)

      5,125,780
  3,400,000   

6.000% due 1/13/39(d)(i)

      3,500,405
       TOTAL FNMA      26,853,917
  GNMA — 0.1%
  1,159,080    Government National Mortgage Association (GNMA),
7.000% due 2/15/24-12/15/31		      1,226,867
       TOTAL MORTGAGE-BACKED SECURITIES (Cost — $47,914,333)      48,970,712
  SOVEREIGN BONDS — 0.2%
       Mexico — 0.0%       
       United Mexican States, Medium-Term Notes:       
  486,000   

5.625% due 1/15/17

      488,430
  190,000   

6.750% due 9/27/34

      201,400
      

Total Mexico

      689,830
       Russia — 0.1%       
  1,942,360    Russian Federation, 7.500% due 3/31/30(c)      1,713,473
       Supranational — 0.1%       
  1,200,000    Corporacion Andina de Fomento, Notes, 6.875% due 3/15/12      1,162,531
       TOTAL SOVEREIGN BONDS (Cost — $3,953,991)      3,565,834
  U.S. GOVERNMENT & AGENCY OBLIGATIONS — 0.3%
       U.S. Government Agencies — 0.2%       
  475,000    Federal Farm Credit Bank (FFCB), 3.750% due 4/9/10      492,762
       Federal Home Loan Bank (FHLB):       
  420,000   

Bonds, 5.500% due 8/13/14

      484,861
  300,000   

Global Bonds, 5.500% due 7/15/36

      385,973
  430,000    Federal Home Loan Mortgage Corp. (FHLMC),
5.250% due 2/24/11(d)		      432,697
       Federal National Mortgage Association (FNMA):       
  790,000   

Notes, 5.625% due 5/19/11(d)

      801,744
  660,000   

Subordinated Notes, 5.250% due 8/1/12(d)

      696,221
  190,000    Tennessee Valley Authority, Bonds, 5.980% due 4/1/36      247,551
      

Total U.S. Government Agencies

      3,541,809
       U.S. Government Obligations — 0.1%       
       U.S. Treasury Bonds:       
  20,000   

8.750% due 5/15/17

      29,438
  20,000   

4.750% due 2/15/37

      27,875
  170,000    U.S. Treasury Notes, 1.750% due 11/15/11      173,931

 

See Notes to Financial Statements.

 

40   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND
FACE
AMOUNT		    SECURITY    VALUE
     
       U.S. Government Obligations — 0.1% continued       
       U.S. Treasury Strip Principal (STRIPS):       
$ 525,000   

Zero coupon bond to yield 4.350% due 5/15/13

    $ 491,218
  500,000   

Zero coupon bond to yield 4.829% due 2/15/16

      414,864
      

Total U.S. Government Obligations

      1,137,326
       TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(Cost — $4,260,768)		      4,679,135
  U.S. TREASURY INFLATION PROTECTED SECURITIES — 0.3%
       U.S. Treasury Bonds, Inflation Indexed:       
  5,006,145   

2.375% due 1/15/27(j)

      5,030,785
  368,995   

3.875% due 4/15/29(j)

      455,853
       TOTAL U.S. TREASURY INFLATION PROTECTED SECURITIES
(Cost — $5,240,385)		      5,486,638
WARRANTS            
  WARRANTS — 0.0%
  505    Cybernet Internet Services International Inc., Expires 7/1/09(a)(b)(c)*      0
  455    GT Group Telecom Inc., Class B Shares, Expires 2/1/10(a)(b)(c)*      0
  485    IWO Holdings Inc., Expires 1/15/11(a)(b)(c)*      0
  505    Merrill Corp., Class B Shares, Expires 5/1/09(a)(b)(c)*      0
       TOTAL WARRANTS (Cost — $194,409)      0
       TOTAL INVESTMENTS BEFORE SHORT-TERM INVESTMENTS
(Cost — $2,298,887,679)		      1,534,114,421
FACE
AMOUNT		            
  SHORT-TERM INVESTMENTS — 11.2%
       U.S. Government Agency — 1.5%       
$ 25,000,000    Federal Home Loan Bank (FHLB), Discount Notes, 0.751% due 2/2/09 (k) (Cost — $24,983,333)      24,983,333
       Repurchase Agreements — 9.7%       
  118,562,000    Interest in $125,000,000 joint tri-party repurchase agreement dated 12/31/08 with Barclays Capital Inc., 0.050% due 1/2/09; Proceeds at maturity — $118,562,329; (Fully collateralized by various U.S. government agency obligations, 0.770% to 5.000% due 8/25/09 to 7/15/14; Market value — $120,933,504)      118,562,000

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   41

Schedule of investments continued

December 31, 2008

 

LEGG MASON PARTNERS CAPITAL AND INCOME FUND  
FACE
AMOUNT		    SECURITY    VALUE  
     
       Repurchase Agreements — 9.7% continued         
$ 48,979,000    Interest in $228,139,000 joint tri-party repurchase agreement dated 12/31/08 with Morgan Stanley Inc., 0.020% due 1/2/09; Proceeds at maturity — $48,979,054; (Fully collateralized by various U.S. government agency obligations, 2.265% to 5.125% due 4/14/09 to 8/25/16; Market value — $50,866,744)    $ 48,979,000  
      

Total Repurchase Agreements (Cost — $167,541,000)

      167,541,000  
       TOTAL SHORT-TERM INVESTMENTS (Cost — $192,524,333)      192,524,333  
       TOTAL INVESTMENTS — 100.2% (Cost — $2,491,412,012#)      1,726,638,754  
       Liabilities in Excess of Other Assets — (0.2)%      (2,902,153 )
       TOTAL NET ASSETS — 100.0%    $ 1,723,736,601  

 

* Non-income producing security.

 

(a)

Security is valued in good faith at fair value by or under the direction of the Board of Trustees (See Note 1).

 

(b)

Illiquid security.

 

(c)

Security is exempt from registration under Rule 144A of the Securities Act of 1933. This security may be resold in transactions that are exempt from registration, normally to qualified institutional buyers. This security has been deemed liquid pursuant to guidelines approved by the Board of Trustees, unless otherwise noted.

 

(d)

On September 7, 2008, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into Conservatorship.

 

(e)

Variable rate security. Interest rate disclosed is that which is in effect at December 31, 2008.

 

(f)

Security is currently in default.

 

(g)

Payment-in-kind security for which part of the income earned may be paid as additional principal.

 

(h)

Security has no maturity date. The date shown represents the next call date.

 

(i)

This security is traded on a to-be-announced (“TBA”) basis (See Note 1).

 

(j)

All or a portion of this security is held at the broker as collateral for open futures contracts.

 

(k)

Rate shown represents yield-to-maturity.

 

†

Subsequent to the reporting period, security went into default.

 

# Aggregate cost for federal income tax purposes is $2,500,499,613.

 

Abbreviations used in this schedule:
ADR  

—American Depositary Receipt

ARM  

—Adjustable Rate Mortgage

GMAC  

—General Motors Acceptance Corp.

GSAMP  

—Goldman Sachs Alternative Mortgage Products

MLCC  

—Merrill Lynch Credit Corporation

PAC  

—Planned Amortization Class

STRIPS  

—Separate Trading of Registered Interest and Principal Securities

 

SCHEDULE OF WRITTEN OPTIONS
CONTRACTS    SECURITY   EXPIRATION
DATE		   STRIKE
PRICE		   VALUE
43    Eurodollar Futures, Call   3/16/09   $ 97.75   $ 129,538
43    Eurodollar Futures, Call   3/16/09     97.50     155,875
     TOTAL WRITTEN OPTIONS
(Premiums received — $61,942)		             $ 285,413

 

See Notes to Financial Statements.

 

42   Legg Mason Partners Capital and Income Fund 2008 Annual Report

Statement of assets and liabilities

December 31, 2008

 

ASSETS:         
Investments, at value (Cost — $2,491,412,012)    $ 1,726,638,754  
Foreign currency, at value (Cost — $66,233)      65,966  
Cash      1,879,634  
Dividends and interest receivable      13,419,840  
Receivable for open forward currency contracts      2,000,273  
Cash deposits with brokers for open futures and swap contracts      1,295,411  
Receivable for Fund shares sold      982,461  
Unrealized appreciation on swaps      612,547  
Receivable for securities sold      422,431  
Principal paydown receivable      166,374  
Receivable for open swap contracts      12,988  
Prepaid expenses      190,978  

Total Assets

      1,747,687,657  
LIABILITIES:         
Payable for securities purchased      11,871,550  
Payable for Fund shares repurchased      6,432,264  
Payable for open forward foreign currency contracts      1,403,953  
Investment management fee payable      1,052,983  
Payable to broker — variation margin on open futures contracts      624,270  
Distribution fees payable      598,944  
Premium received for open swaps      512,535  
Written options, at value (premium received $61,942)      285,413  
Unrealized depreciation on swaps      163,014  
Trustees’ fees payable      89,591  
Accrued expenses      916,539  

Total Liabilities

      23,951,056  
TOTAL NET ASSETS    $ 1,723,736,601  
NET ASSETS:         
Par value (Note 6)    $ 1,747  
Paid-in capital in excess of par value      2,777,518,719  
Undistributed net investment income      37,562,696  
Accumulated net realized loss on investments, futures contracts, written options, short sales, swap contracts and foreign currency transactions      (335,897,615 )
Net unrealized depreciation on investments, futures contracts, written options, swap contracts and foreign currencies      (755,448,946 )
TOTAL NET ASSETS    $ 1,723,736,601  

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   43

Statement of assets and liabilities continued

December 31, 2008

 

        
Shares Outstanding:     
Class A    125,966,472
Class B    24,152,752
Class C    24,155,480
Class R    6,588
Class I    429,702
Net Asset Value:     
Class A (and redemption price)    $9.91
Class B*    $9.75
Class C*    $9.76
Class R (and redemption price)    $9.91
Class I (and redemption price)    $10.12
Maximum Public Offering Price Per Share:     
Class A (based on maximum initial sales charge of 5.75%)    $10.51

 

* Redemption price per share is NAV of Class B and C shares reduced by a 5.00% and 1.00% CDSC, respectively, if shares are redeemed within one year from purchase payment (See Note 2).

 

See Notes to Financial Statements.

 

44   Legg Mason Partners Capital and Income Fund 2008 Annual Report

Statement of operations

For the year ended December 31, 2008

 

INVESTMENT INCOME:         
Interest    $ 52,141,963  
Dividends      35,815,917  
Less: Foreign taxes withheld      (516,591 )

Total Investment Income

      87,441,289  
EXPENSES:         
Investment management fee (Note 2)      19,249,651  
Distribution fees (Notes 2 and 4)      11,419,408  
Transfer agent fees (Note 4)      3,033,770  
Dividend expense on securities sold short      521,451  
Trustees’ fees      204,990  
Shareholder reports (Note 4)      166,158  
Registration fees      112,183  
Audit and tax      68,908  
Legal fees      54,098  
Insurance      45,316  
Custody fees      29,090  
Miscellaneous expenses      21,107  

Total Expenses

      34,926,130  

Less: Fee waivers and/or expense reimbursements (Notes 2 and 4)

      (77,252 )

Fees paid indirectly (Note 1)

      (374 )

Net Expenses

      34,848,504  
NET INVESTMENT INCOME      52,592,785  
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS, FUTURES CONTRACTS, WRITTEN OPTIONS, SHORT SALES, SWAP CONTRACTS AND FOREIGN CURRENCY TRANSACTIONS (NOTES 1 AND 3):         
Net Realized Gain (Loss) From:         

Investment transactions

      (353,751,897 )

Futures contracts

      21,939,471  

Written options

      11,341,427  

Short sales

      1,671,168  

Swap contracts

      89,091  

Foreign currency transactions

      852,295  
Net Realized Loss      (317,858,445 )
Change in Net Unrealized Appreciation/Depreciation From:         

Investments

      (809,207,470 )

Futures contracts

      8,972,615  

Written options

      (5,231,890 )

Swap contracts

      410,858  

Foreign currencies

      674,327  
Change in Net Unrealized Appreciation/Depreciation      (804,381,560 )
NET LOSS ON INVESTMENTS, FUTURES CONTRACTS, WRITTEN OPTIONS, SHORT SALES, SWAP CONTRACTS AND FOREIGN CURRENCY TRANSACTIONS      (1,122,240,005 )
DECREASE IN NET ASSETS FROM OPERATIONS    $ (1,069,647,220 )

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   45

Statements of changes in net assets

 

FOR THE YEARS ENDED DECEMBER 31,   2008     2007  
OPERATIONS:                
Net investment income   $ 52,592,785     $ 45,135,521  
Net realized gain (loss)     (317,858,445 )     426,114,183  
Change in net unrealized appreciation/depreciation     (804,381,560 )     (245,701,410 )

Increase (Decrease) in Net Assets From Operations

     (1,069,647,220 )     225,548,294  
DISTRIBUTIONS TO SHAREHOLDERS FROM (NOTES 1 AND 5):                
Net investment income     (14,495,422 )     (45,896,633 )
Net realized gains     (87,748,614 )     (371,038,904 )

Decrease in Net Assets From Distributions to Shareholders

     (102,244,036 )     (416,935,537 )
FUND SHARE TRANSACTIONS (NOTE 6):                
Net proceeds from sale of shares     210,814,219       348,092,840  
Reinvestment of distributions     93,933,116       366,270,929  
Cost of shares repurchased     (735,064,687 )     (746,812,745 )
Net assets of shares issued in connection with merger (Note 7)     —       138,433,104  

Increase (Decrease) in Net Assets From Fund Share Transactions

     (430,317,352 )     105,984,128  
DECREASE IN NET ASSETS     (1,602,208,608 )     (85,403,115 )
NET ASSETS:                
Beginning of year     3,325,945,209       3,411,348,324  
End of year*   $ 1,723,736,601     $ 3,325,945,209  

*Includes undistributed and (overdistributed) net investment income, respectively of:

     $37,562,696       $(63,771)  

 

See Notes to Financial Statements.

 

46   Legg Mason Partners Capital and Income Fund 2008 Annual Report

Financial highlights

 

FOR A SHARE OF EACH CLASS OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31:		  
CLASS A SHARES1   2008     2007     2006     2005     2004  

NET ASSET VALUE,
BEGINNING OF YEAR

   $ 16.03     $ 17.06     $ 17.12     $ 16.50     $ 15.55  

INCOME (LOSS) FROM OPERATIONS:

 

                                

Net investment income

     0.30       0.26       0.48       0.53       0.54  

Net realized and unrealized gain (loss)

     (5.88 )     0.88       1.45       0.62       0.94  

Total income (loss) from operations

     (5.58 )     1.14       1.93       1.15       1.48  

LESS DISTRIBUTIONS FROM:

                                        

Net investment income

     (0.09 )     (0.26 )     (0.48 )     (0.53 )     (0.53 )

Net realized gains

     (0.45 )     (1.91 )     (1.51 )     —       —  

Total distributions

     (0.54 )     (2.17 )     (1.99 )     (0.53 )     (0.53 )

NET ASSET VALUE,
END OF YEAR

     $9.91     $ 16.03     $ 17.06     $ 17.12     $ 16.50  

Total return2

     (35.59 )%     6.77 %     11.69 %3     7.11 %     9.75 %

NET ASSETS,
END OF YEAR (MILLIONS)

     $1,248       $2,300       $2,295       $1,602       $1,356  

RATIOS TO AVERAGE NET ASSETS:

                                        

Gross expenses

     1.12 %     1.07 %     1.09 %4     1.13 %     1.12 %

Gross expenses, excluding dividend expense

     1.10       1.07       1.09 4     1.13       1.12  

Net expenses

     1.12 5     1.07       1.08 4,6     1.13       1.09 6

Net expenses, excluding dividend expense

     1.10 5     1.07       1.08 4,6     1.13       1.09 6

Net investment income

     2.19       1.50       2.77       3.17       3.41  

PORTFOLIO TURNOVER RATE

     147 %7     189 %8     175 %7     49 %     66 %

 

1

Per share amounts have been calculated using the average shares method.

 

2

Performance figures may reflect fee waivers and/or expense reimbursements. In the absence of fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results.

 

3

The prior investment manager fully reimbursed the Fund for losses incurred resulting from an investment transaction error. Without this reimbursement, total return would not have changed.

 

4

Included in the expense ratios are certain non-recurring restructuring (and reorganization, if applicable) fees that were incurred by the Fund during the period. Without these fees, the gross and net expense ratios would have been 1.08% and 1.07%, respectively.

 

5

The impact to the expense ratio was less than 0.01% as a result of fees paid indirectly.

 

6

Reflects fee waivers and/or expense reimbursements.

 

7

Excluding mortgage dollar roll transactions. If mortgage dollar roll transactions had been included, the portfolio turnover rate for the years ended December 31, 2008 and 2006 would have been 164% and 185%, respectively.

 

8

Including mortgage dollar roll transactions. If mortgage dollar roll transactions had been excluded, the portfolio turnover rate would have been 166% for the year ended December 31, 2007.

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   47

Financial highlights continued

 

FOR A SHARE OF EACH CLASS OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR ENDED DECEMBER 31:   
CLASS B SHARES1   2008     2007     2006     2005     2004  

NET ASSET VALUE,
BEGINNING OF YEAR

   $ 15.84     $ 16.91     $ 16.99     $ 16.38     $ 15.45  

INCOME (LOSS) FROM OPERATIONS:

                                        

Net investment income

     0.22       0.16       0.39       0.43       0.45  

Net realized and unrealized gain (loss)

     (5.79 )     0.87       1.43       0.63       0.93  

Total income (loss) from operations

     (5.57 )     1.03       1.82       1.06       1.38  

LESS DISTRIBUTIONS FROM:

                                        

Net investment income

     (0.07 )     (0.19 )     (0.39 )     (0.45 )     (0.45 )

Net realized gains

     (0.45 )     (1.91 )     (1.51 )     —       —  

Total distributions

     (0.52 )     (2.10 )     (1.90 )     (0.45 )     (0.45 )

NET ASSET VALUE,
END OF YEAR

     $9.75     $ 15.84     $ 16.91     $ 16.99     $ 16.38  

Total return2

     (35.96 )%     6.16 %     11.03 %3     6.60 %     9.16 %

NET ASSETS,
END OF YEAR (MILLIONS)

     $236       $512       $601       $599       $620  

RATIOS TO AVERAGE NET ASSETS:

                                        

Gross expenses

     1.70 %     1.64 %     1.65 %4     1.66 %     1.63 %

Gross expenses, excluding dividend expense

     1.68       1.64       1.65 4     1.66       1.63  

Net expenses

     1.70 5     1.64       1.64 4,6     1.66       1.61 6

Net expenses, excluding dividend expense

     1.68 5     1.64       1.64 4,6     1.66       1.61 6

Net investment income

     1.58       0.93       2.23       2.63       2.88  

PORTFOLIO TURNOVER RATE

     147 %7     189 %8     175 %7     49 %     66 %

 

1

Per share amounts have been calculated using the average shares method.

 

2

Performance figures may reflect fee waivers and/or expense reimbursements. In the absence of fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results.

 

3

The prior investment manager fully reimbursed the Fund for losses incurred resulting from an investment transaction error. Without this reimbursement, total return would not have changed.

 

4

Included in the expense ratios are certain non-recurring restructuring (and reorganization, if applicable) fees that were incurred by the Fund during the period. Without these fees, the gross and net expense ratios would have been 1.64% and 1.63%, respectively.

 

5

The impact to the expense ratio was less than 0.01% as a result of fees paid indirectly.

 

6

Reflects fee waivers and/or expense reimbursements.

 

7

Excluding mortgage dollar roll transactions. If mortgage dollar roll transactions had been included, the portfolio turnover rate for the years ended December 31, 2008 and 2006 would have been 164% and 185%, respectively.

 

8

Including mortgage dollar roll transactions. If mortgage dollar roll transactions had been excluded, the portfolio turnover rate would have been 166% for the year ended December 31, 2007.

 

See Notes to Financial Statements.

 

48   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

FOR A SHARE OF EACH CLASS OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31:		  
CLASS C SHARES1   2008     2007     2006     2005     2004  

NET ASSET VALUE,
BEGINNING OF YEAR

   $ 15.88     $ 16.96     $ 17.02     $ 16.42     $ 15.50  

INCOME (LOSS) FROM OPERATIONS:

                                        

Net investment income

     0.19       0.13       0.35       0.39       0.41  

Net realized and unrealized gain (loss)

     (5.80 )     0.87       1.45       0.62       0.93  

Total income (loss) from operations

     (5.61 )     1.00       1.80       1.01       1.34  

LESS DISTRIBUTIONS FROM:

                                        

Net investment income

     (0.06 )     (0.17 )     (0.35 )     (0.41 )     (0.42 )

Net realized gains

     (0.45 )     (1.91 )     (1.51 )     —       —  

Total distributions

     (0.51 )     (2.08 )     (1.86 )     (0.41 )     (0.42 )

NET ASSET VALUE,
END OF YEAR

     $9.76     $ 15.88     $ 16.96     $ 17.02     $ 16.42  

Total return2

     (36.09 )%     5.98 %     10.91 %3     6.29 %     8.83 %

NET ASSETS,
END OF YEAR (MILLIONS)

     $236       $506       $513       $445       $392  

RATIOS TO AVERAGE NET ASSETS:

                                        

Gross expenses

     1.90 %     1.82 %     1.86 %4     1.93 %     1.90 %

Gross expenses, excluding dividend expense

     1.88       1.82       1.86 4     1.93       1.90  

Net expenses

     1.88 5,6,7     1.80 6,7     1.83 4,6     1.93       1.88 6

Net expenses, excluding dividend expense

     1.86 5,6,7     1.80 67     1.83 4,6     1.93       1.88 6

Net investment income

     1.41       0.78       2.02       2.37       2.63  

PORTFOLIO TURNOVER RATE

     147 %8     189 %9     175 %8     49 %     66 %

 

1

Per share amounts have been calculated using the average shares method.

 

2

Performance figures may reflect fee waivers and/or expense reimbursements. In the absence of fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results.

 

3

The prior investment manager fully reimbursed the Fund for losses incurred resulting from an investment transaction error. Without this reimbursement, total return would not have changed.

 

4

Included in the expense ratios are certain non-recurring restructuring (and reorganization, if applicable) fees that were incurred by the Fund during the period. Without these fees, the gross and net expense ratios would have been 1.84% and 1.82%, respectively.

 

5

The impact to the expense ratio was less than 0.01% as a result of fees paid indirectly.

 

6

Reflects fee waivers and/or expense reimbursements.

 

7

Effective March 16, 2007, the manager has contractually agreed to waive fees and/or reimburse operating expenses (other than brokerage, taxes and extraordinary expenses) to limit total annual operating expenses to 1.79% for Class C shares until May 1, 2008.

 

8

Excluding mortgage dollar roll transactions. If mortgage dollar roll transactions had been included, the portfolio turnover rate for the years ended December 31, 2008 and 2006 would have been 164% and 185%, respectively.

 

9

Including mortgage dollar roll transactions. If mortgage dollar roll transactions had been excluded, the portfolio turnover rate would have been 166% for the year ended December 31, 2007.

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   49

Financial highlights continued

 

FOR A SHARE OF EACH CLASS OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH PERIOD
ENDED DECEMBER 31, UNLESS OTHERWISE NOTED:

  

CLASS R SHARES1

  

20082

  

NET ASSET VALUE, BEGINNING OF PERIOD

   $15.18  

INCOME (LOSS) FROM OPERATIONS:

      

Net investment income

   0.19  

Net realized and unrealized loss

   (5.11 )

Total loss from operations

   (4.92 )

LESS DISTRIBUTIONS FROM:

      

Net investment income

   (0.08 )

Net realized gains

   (0.27 )

Total distributions

   (0.35 )

NET ASSET VALUE, END OF PERIOD

   $9.91  

Total return3

   (32.82 )%

NET ASSETS, END OF PERIOD (000s)

   $65  

RATIOS TO AVERAGE NET ASSETS:

      

Gross expenses4

   1.33 %

Gross expenses, excluding dividend expense4

   1.30  

Net expenses4,5

   1.33  

Net expenses, excluding dividend expense4,5

   1.30  

Net investment income4

   2.15  

PORTFOLIO TURNOVER RATE6

   147 %

 

1

Per share amounts have been calculated using the average shares method.

 

2

For the period April 30, 2008 (inception date) to December 31, 2008.

 

3

Performance figures may reflect fee waivers and/or expense reimbursements. In the absence of fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results. Total returns for periods of less than one year are not annualized.

 

4

Annualized.

 

5

The impact to the expense ratio was less than 0.01% as a result of fees paid indirectly.

 

6

Excluding mortgage dollar roll transactions. If mortgage dollar roll transactions had been included, the portfolio turnover rate would have been 164% for the period ended December 31, 2008.

 

See Notes to Financial Statements.

 

50   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

FOR A SHARE OF EACH CLASS OF BENEFICIAL INTEREST OUTSTANDING THROUGHOUT EACH YEAR
ENDED DECEMBER 31:		  
CLASS I SHARES1   2008     2007     2006     2005     2004  

NET ASSET VALUE,
BEGINNING OF YEAR

   $ 16.32     $ 17.33     $ 17.37     $ 16.72     $ 15.72  

INCOME (LOSS) FROM OPERATIONS:

                                        

Net investment income

     0.35       0.33       0.56       0.59       0.60  

Net realized and unrealized gain (loss)

     (6.00 )     0.89       1.45       0.64       0.98  

Total income (loss) from operations

     (5.65 )     1.22       2.01       1.23       1.58  

LESS DISTRIBUTIONS FROM:

                                        

Net investment income

     (0.10 )     (0.32 )     (0.54 )     (0.58 )     (0.58 )

Net realized gains

     (0.45 )     (1.91 )     (1.51 )     —       —  

Total distributions

     (0.55 )     (2.23 )     (2.05 )     (0.58 )     (0.58 )

NET ASSET VALUE,
END OF YEAR

   $ 10.12     $ 16.32     $ 17.33     $ 17.37     $ 16.72  

Total return2

     (35.37 )%     7.13 %     12.01 %3     7.53 %     10.32 %

NET ASSETS,
END OF YEAR (MILLIONS)

     $4       $8       $2       $3       $3  

RATIOS TO AVERAGE NET ASSETS:

                                        

Gross expenses

     0.81 %     0.77 %     0.78 %4     0.79 %     0.77 %

Gross expenses, excluding dividend expense

     0.79       0.77       0.78 4     0.79       0.77  

Net expenses

     0.78 5,6,7     0.74 6,7     0.77 4,6     0.79       0.76 6

Net expenses, excluding dividend expense

     0.76 5,6,7     0.74 6,7     0.77 4,6     0.79       0.76 6

Net investment income

     2.54       1.85       3.12       3.50       3.58  

PORTFOLIO TURNOVER RATE

     147 %8     189 %9     175 %8     49 %     66 %

 

1

Per share amounts have been calculated using the average shares method.

 

2

Performance figures may reflect fee waivers and/or expense reimbursements. In the absence of fee waivers and/or expense reimbursements, the total return would have been lower. Past performance is no guarantee of future results.

 

3

The prior investment manager fully reimbursed the Fund for losses incurred resulting from an investment transaction error. Without this reimbursement, total return would not have changed.

 

4

Included in the expense ratios are certain non-recurring restructuring (and reorganization, if applicable) fees that were incurred by the Fund during the period. Without these fees, the gross and net expense ratios would have been 0.77% and 0.76%, respectively.

 

5

The impact to the expense ratio was less than 0.01% as a result of fees paid indirectly.

 

6

Reflects fee waivers and/or expense reimbursements.

 

7

Effective March 16, 2007, the manager has contractually agreed to waive fees and/or reimburse operating expenses (other than brokerage, taxes and extraordinary expenses) to limit total annual expenses to 0.74% until May 1, 2008.

 

8

Excluding mortgage dollar roll transactions. If mortgage dollar roll transactions had been included, the portfolio turnover rate for the years ended December 31, 2008 and 2006 would have been 164% and 185%, respectively.

 

9

Including mortgage dollar roll transactions. If mortgage dollar roll transactions had been excluded, the portfolio turnover rate would have been 166% for the year ended December 31, 2007.

 

See Notes to Financial Statements.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   51

Notes to financial statements

 

1. Organization and significant accounting policies

Legg Mason Partners Capital and Income Fund (the “Fund”), is a separate diversified investment series of Legg Mason Partners Equity Trust (the “Trust”). The Trust, a Maryland business trust, is registered under the Investment Company Act of 1940, as amended, (the “1940 Act”), as an open-end management investment company.

The following are significant accounting policies consistently followed by the Fund and are in conformity with U.S. generally accepted accounting principles (“GAAP”). Estimates and assumptions are required to be made regarding assets, liabilities and changes in net assets resulting from operations when financial statements are prepared. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ.

(a) Investment valuation. Equity securities for which market quotations are available are valued at the last reported sales price or official closing price on the primary market or exchange on which they trade. Debt securities are valued at the mean between the last quoted bid and asked prices provided by an independent pricing service that are based on transactions in debt obligations, quotations from bond dealers, market transactions in comparable securities and various other relationships between securities. Futures contracts are valued daily at the settlement price established by the board of trade or exchange on which they are traded. When prices are not readily available, or are determined not to reflect fair value, such as when the value of a security has been significantly affected by events after the close of the exchange or market on which the security is principally traded, but before the Fund calculates its net asset value, the Fund may value these securities at fair value as determined in accordance with the procedures approved by the Fund’s Board of Trustees. Short-term obligations with maturities of 60 days or less are valued at amortized cost, which approximates fair value.

Effective January 1, 2008, the Fund adopted Statement of Financial Accounting Standards No. 157 (“FAS 157”). FAS 157 establishes a single definition of fair value, creates a three-tier hierarchy as a framework for measuring fair value based on inputs used to value the Fund’s investments, and requires additional disclosure about fair value. The hierarchy of inputs is summarized below.

 

  •  

Level 1 — quoted prices in active markets for identical investments

 

  •  

Level 2 — other significant observable inputs (including quoted prices for similar investments, interest rates, prepayment speeds, credit risk, etc.)

 

  •  

Level 3 — significant unobservable inputs (including the Fund’s own assumptions in determining the fair value of investments)

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

 

52   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

The following is a summary of the inputs used in valuing the Fund’s assets carried at fair value:

 

     DECEMBER 31, 2008   QUOTED PRICES
(LEVEL 1)		   OTHER SIGNIFICANT
OBSERVABLE INPUTS
(LEVEL 2)		   SIGNIFICANT
UNOBSERVABLE
INPUTS
(LEVEL 3)
Investments in securities   $ 1,726,638,754   $ 996,048,003   $ 729,466,078   $ 1,124,673
Other financial instruments*     9,237,458     8,197,278     1,040,180     —
Total   $ 1,735,876,212   $ 1,004,245,281   $ 730,506,258   $ 1,124,673

 

* Other financial instruments may include written options, futures, swaps and forward contracts.

Following is a reconciliation of investments in which significant unobservable inputs (Level 3) were used in determining fair value:

 

      INVESTMENTS
IN SECURITIES		  
Balance as of December 31, 2007    $ 155,303  

Accrued premiums/discounts

      10,224  

Realized gain (loss)

      1,037  

Change in unrealized appreciation (depreciation)

      (15,302 )

Net purchases (sales)

      (5,812 )

Transfers in and/or out of Level 3

      979,223  
Balance as of December 31, 2008    $ 1,124,673  

(b) Repurchase agreements. When entering into repurchase agreements, it is the Fund’s policy that its custodian or a third party custodian take possession of the underlying collateral securities, the market value of which, at all times, at least equals the principal amount of the repurchase transaction, including accrued interest. To the extent that any repurchase transaction exceeds one business day, the value of the collateral is marked-to-market to ensure the adequacy of the collateral. If the seller defaults, and the market value of the collateral declines or if bankruptcy proceedings are commenced with respect to the seller of the security, realization of the collateral by the Fund may be delayed or limited.

(c) Financial futures contracts. The Fund may enter into financial futures contracts to hedge against the economic impact of adverse changes in the market value of the portfolio securities because of the changes in stock market prices or interest rates, as a substitute for buying or selling securities, as a cash management technique, and to increase the Fund’s total return. Upon entering into a financial futures contract, the Fund is required to deposit cash or securities as initial margin, equal in value to a certain percentage of the contract amount (initial margin deposit). Additional securities are also segregated up to the current market value of the financial futures contracts. Subsequent payments, known as “variation margin,” are made or received by

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   53

Notes to financial statements continued

 

the Fund each day, depending on the daily fluctuations in the value of the underlying financial instruments. For foreign currency denominated futures contracts, variation margins are not settled daily. The Fund recognizes an unrealized gain or loss equal to the fluctuation in the value. When the financial futures contracts are closed, a realized gain or loss is recognized equal to the difference between the proceeds from (or cost of) the closing transactions and the Fund’s basis in the contracts.

The risks associated with entering into financial futures contracts include the possibility that a change in the value of the contract may not correlate with the changes in the value of the underlying financial instruments. In addition, investing in financial futures contracts involves the risk that the Fund could lose more than the initial margin deposit and subsequent payments required for a futures transaction. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts.

(d) Written options. When the Fund writes an option, an amount equal to the premium received by the Fund is recorded as a liability, the value of which is marked-to-market daily to reflect the current market value of the option written. If the option expires, the Fund realizes a gain from investments equal to the amount of the premium received. When a written call option is exercised, the difference between the premium received plus the option exercise price and the Fund’s basis in the underlying security (in the case of a covered written call option), or the cost to purchase the underlying security (in the case of an uncovered written call option), including brokerage commission, is treated as a realized gain or loss. When a written put option is exercised, the amount of the premium received is subtracted from the cost of the security purchased by the Fund from the exercise of the written put option to form the Fund’s basis in the underlying security purchased. The writer or buyer of an option traded on an exchange can liquidate the position before the exercise of the option by entering into a closing transaction. The cost of a closing transaction is deducted from the original premium received resulting in a realized gain or loss to the Fund.

The risk in writing a covered call option is that the Fund may forego the opportunity of profit if the market price of the underlying security increases and the option is exercised. The risk in writing a put option is that the Fund may incur a loss if the market price of the underlying security decreases and the option is exercised. The risk in writing a call option is that the Fund is exposed to the risk of loss if the market price of the underlying security increases. In addition, there is the risk that the Fund may not be able to enter into a closing transaction because of an illiquid secondary market.

(e) Swap contracts. Swaps involve the exchange by the Fund with another party of the respective amounts payable with respect to a notional principal amount related to one or more indices or securities. The Fund may enter into these

 

54   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

transactions to preserve a return or spread on a particular investment or portion of its assets, as a duration management technique, or to protect against any increase in the price of securities the Fund anticipates purchasing at a later date.

The Fund may also use these transactions for speculative purposes, such as to obtain the price performance of a security without actually purchasing the security in circumstances where, for example, the subject security is illiquid, is unavailable for direct investment or available only on less attractive terms.

Swaps are marked-to-market daily based upon quotations from market makers and the change in value, if any, is recorded as an unrealized gain or loss in the Statement of Operations. Net receipts or payments of interest are recorded as realized gains or losses, respectively.

Swaps have risks associated with them, including possible default by the counterparty to the transaction, illiquidity and, where swaps are used as hedges, the risk that the use of a swap could result in losses greater than if the swap had not been employed.

(f) Credit default swaps. The Fund may enter into credit default swap (“CDS”) contracts for investment purposes, to manage its credit risk or to add leverage. CDS agreements involve one party making a stream of payments to another party in exchange for the right to receive a specified return in the event of a default by a third party, typically corporate issuers or sovereign issuers of an emerging country, on a specified obligation or in the event of a write-down, principal shortfall, interest shortfall or default of all or part of the referenced entities comprising a credit index. The Fund may use a CDS to provide a measure of protection against defaults of the issuers (i.e., to reduce risk where a Fund has exposure to the sovereign issuer) or to take an active long or short position with respect to the likelihood of a particular issuer’s default. As a seller of protection, the Fund generally receives an upfront payment or a stream of payments throughout the term of the swap provided that there is no credit event. If the Fund is a seller of protection and a credit event occurs, as defined under the terms of that particular swap agreement the maximum potential amount of future payments (undiscounted) that the Fund could be required to make under a credit default swap agreement, would be an amount equal to the notional amount of the agreement. These amounts of potential payments will be partially offset by any recovery of value from the respective referenced obligations. As a seller of protection, the Fund effectively adds leverage to its portfolio because, in addition to its total net assets, the Fund would be subject to investment exposure on the notional amount of the swap. As a buyer of protection, the Fund generally receives an amount up to the notional value of the swap if a credit event occurs.

Implied spreads are the theoretical price a lender receives for credit default protection. When spreads rise, market perceived credit risk rises and when

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   55

Notes to financial statements continued

 

spreads fall, market perceived credit risk falls. The implied credit spread of a particular referenced entity reflects the cost of buying/selling protection and may include upfront payments required to enter into the agreement. Wider credit spreads and decreasing market values, when compared to the notional amount of the swap, represent a deterioration of the referenced entity’s credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement. Credit spreads utilized in determining the period end market value of credit default swap agreements on corporate issues or sovereign issues of an emerging country are disclosed in the Notes to Financial Statements and serve as an indicator of the current status of the payment/performance risk and represent the likelihood or risk of default for credit derivatives. For credit default swap agreements on asset-backed securities and credit indices, the quoted market prices and resulting values particularly in relation to the notional amount of the contract, as well as the annual payment rate serve as an indication of the current status of the payment/performance risk.

Payments received or made at the beginning of the measurement period are reflected as a premium on deposit, respectively on the Statement of Assets and Liabilities. These upfront payments are amortized over the life of the swap and are recognized as realized gain or loss on the Statement of Operations. A liquidation payment received or made at the termination of the swap is recognized as realized gain or loss on the Statement of Operations. Net periodic payments received or paid by the Fund are recognized as realized gain or loss at the time of receipt or payment on the Statement of Operations.

Entering into a CDS agreement involves, to varying degrees, elements of credit, market and documentation risk in excess of the related amounts recognized on the Statement of Assets and Liabilities. Such risks involve the possibility that there will be no liquid market for these agreements, that the counterparty to the agreement may default on its obligation to perform or disagree as to the meaning of the contractual terms in the agreement, and that there will be unfavorable changes in net interest rates.

(g) Mortgage dollar rolls. The Fund may enter into dollar rolls in which the Fund sells mortgage-backed securities for delivery in the current month, realizing a gain or loss, and simultaneously contracts to repurchase substantially similar (same type, coupon and maturity) securities to settle on a specified future date. During the roll period, the Fund forgoes interest paid on the securities. The Fund maintains a segregated account, the dollar value of which is at least equal to its obligations with respect to dollar rolls.

The Fund executes its mortgage dollar rolls entirely in the to-be-announced (“TBA”) market, where the Fund makes a forward commitment to purchase a security and, instead of accepting delivery, the position is offset by a sale of the security with a simultaneous agreement to repurchase at a future date. The Fund accounts for mortgage dollar rolls as purchases and sales.

 

56   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

The risk of entering into a mortgage dollar roll is that the market value of the securities the Fund is obligated to repurchase under the agreement may decline below the repurchase price. In the event the buyer of securities under a mortgage dollar roll files for bankruptcy or becomes insolvent, the Fund’s use of proceeds of the dollar roll may be restricted pending a determination by the other party, or its trustee or receiver, whether to enforce the Fund’s obligation to repurchase the securities.

(h) Securities traded on a to-be-announced basis. The Fund may trade securities on a to-be-announced (“TBA”) basis. In a TBA transaction, the Fund commits to purchasing or selling securities which have not yet been issued by the issuer and for which specific information is not known, such as the face amount and maturity date and the underlying pool of investments in U.S. government agency mortgage pass-through securities. Securities purchased on a TBA basis are not settled until they are delivered to the Fund, normally 15 to 45 days after purchase. Beginning on the date the Fund enters into a TBA transaction, cash, U.S. government securities or other liquid high-grade debt obligations are segregated in an amount equal in value to the purchase price of the TBA security. These securities are subject to market fluctuations and their current value is determined in the same manner as for other securities.

(i) Forward foreign currency contracts. The Fund may enter into a forward foreign currency contract to hedge against foreign currency exchange rate risk on its non-U.S. dollar denominated securities or to facilitate settlement of a foreign currency denominated portfolio transaction. A forward foreign currency contract is an agreement between two parties to buy and sell a currency at a set price with delivery and settlement at a future date. The contract is marked-to-market daily and the change in value is recorded by the Fund as an unrealized gain or loss. When a forward foreign currency contract is closed, through either delivery or offset by entering into another forward foreign currency contract, the Fund records a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value of the contract at the time it was closed.

Forward foreign currency contracts involve elements of market risk in excess of the amounts reflected in the Statement of Assets and Liabilities. The Fund bears the risk of an unfavorable change in the foreign exchange rate underlying the forward foreign currency contract. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts.

(j) Short sales of securities. A short sale is a transaction in which the Fund sells a security it does not own (but has borrowed) in anticipation of a decline in the market price of that security. To complete a short sale, the Fund may arrange through a broker to borrow the security to be delivered to the buyer. The proceeds received by the Fund for the short sale are retained by the broker until the Fund replaces the borrowed security. In borrowing the security to be

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   57

Notes to financial statements continued

 

delivered to the buyer, the Fund becomes obligated to replace the security borrowed at the market price at the time of replacement, whatever that price may be. A gain, limited to the price at which the Fund sold the security short, or a loss, unlimited in size, will be recognized upon the termination of a short sale.

Dividends declared on short positions existing on the record date are recorded on the ex-dividend date as an expense.

(k) Foreign currency translation. Investment securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollar amounts based upon prevailing exchange rates at the date of valuation. Purchases and sales of investment securities and income and expense items denominated in foreign currencies are translated into U.S. dollar amounts based upon prevailing exchange rates on the respective dates of such transactions.

The Fund does not isolate that portion of the results of operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in market prices of securities held. Such fluctuations are included with the net realized and unrealized gain or loss on investments.

Net realized foreign exchange gains or losses arise from sales of foreign currencies, including gains and losses on forward foreign currency contracts, currency gains or losses realized between the trade and settlement dates on securities transactions, and the difference between the amounts of dividends, interest, and foreign withholding taxes recorded on the Fund’s books and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in the fair values of assets and liabilities, other than investments in securities, at the date of valuation, resulting from changes in exchange rates.

Foreign security and currency transactions may involve certain considerations and risks not typically associated with those of U.S. dollar denominated transactions as a result of, among other factors, the possibility of lower levels of governmental supervision and regulation of foreign securities markets and the possibility of political or economic instability.

(l) Stripped securities. The Fund invests in “Stripped Securities,” a term used collectively for stripped fixed income securities. Stripped securities can be principal only securities (“PO”), which are debt obligations that have been stripped of unmatured interest coupons or, interest only securities (“IO”), which are unmatured interest coupons that have been stripped from debt obligations. As is the case with all securities, the market value of Stripped Securities will fluctuate in response to changes in economic conditions, interest rates and the market’s perception of the securities. However, fluctuations in response to interest rates may be greater in Stripped Securities than for debt obligations of comparable maturities that pay interest currently. The amount of fluctuation increases with a longer period of maturity.

 

58   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

The yield to maturity on IO’s is sensitive to the rate of principal repayments (including prepayments) on the related underlying debt obligation and principal payments may have a material effect on yield to maturity. If the underlying debt obligation experiences greater than anticipated prepayments of principal, the Fund may not fully recoup its initial investment in IO’s.

(m) Credit and market risk. The Fund invests in high yield instruments that are subject to certain credit and market risks. The yields of high yield obligations reflect, among other things, perceived credit and market risks. The Fund’s investment in securities rated below investment grade typically involves risks not associated with higher rated securities including, among others, greater risk related to timely and ultimate payment of interest and principal, greater market price volatility and less liquid secondary market trading.

Investments in structured securities (such as those issued by Structured Investment Vehicles, or SIVs) which are collateralized by residential real estate mortgages are subject to certain credit and liquidity risks. When market conditions result in an increase in default rates of the underlying mortgages and the foreclosure values of underlying real estate properties are materially below the outstanding amount of these underlying mortgages, collection of the full amount of accrued interest and principal on these investments may be doubtful. Such market conditions may significantly impair the value of these investments resulting in a lack of correlation between their credit ratings and values.

(n) Security transactions and investment income. Security transactions are accounted for on a trade date basis. Interest income, adjusted for amortization of premium and accretion of discount, is recorded on the accrual basis. Dividend income is recorded on the ex-dividend date. Foreign dividend income is recorded on the ex-dividend date or as soon as practicable after the Fund determines the existence of a dividend declaration after exercising reasonable due diligence. The cost of investments sold is determined by use of the specific identification method. To the extent any issuer defaults on an expected interest payment, the Fund’s policy is to generally halt any additional interest income accruals and consider the realizability of interest accrued up to the date of default.

(o) Distributions to shareholders. The fund generally makes monthly distributions, which may include a combination of net investment income and/or accumulated net realized capital gains that are otherwise required to be distributed. The fund may pay additional distributions and dividends at other times if necessary to avoid federal taxes. Distributions are recorded on ex-dividend date and are determined in accordance with income tax regulations, which may differ from GAAP.

(p) Class accounting. Investment income, common expenses and realized/unrealized gain (loss) on investments are allocated to the various classes of the Fund on the basis of daily net assets of each class. Fees relating to a specific class are charged directly to that class.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   59

Notes to financial statements continued

 

(q) Fees paid indirectly. The Fund’s custody fees are reduced according to a fee arrangement, which provides for a reduction based on the level of cash deposited with the custodian by the Fund. The amount is shown as a reduction of expenses on the Statement of Operations. Interest expense, if any, paid to the custodian related to cash overdrafts is included in interest expense in the Statement of Operations.

(r) Federal and other taxes. It is the Fund’s policy to comply with the federal income and excise tax requirements of the Internal Revenue Code of 1986, as amended, applicable to regulated investment companies. Accordingly, the Fund intends to distribute substantially all of its taxable income and net realized gains, if any, to shareholders each year. Therefore, no federal income tax provision is required in the Fund’s financial statements.

Management has analyzed the Fund’s tax positions taken on federal income tax returns for all open tax years and has concluded that as of December 31, 2008, no provision for income tax would be required in the Fund’s financial statements. The Fund’s federal and state income and federal excise tax returns for tax years for which the applicable statutes of limitations have not expired are subject to examination by the Internal Revenue Service and state departments of revenue.

Under the applicable foreign tax laws, a withholding tax may be imposed on interest, dividends and capital gains at various rates.

(s) Reclassification. GAAP requires that certain components of net assets be adjusted to reflect permanent differences between financial and tax reporting. These reclassifications have no effect on net assets or net asset values per share. During the current year, the following reclassifications have been made:

 

     UNDISTRIBUTED NET
INVESTMENT INCOME		     ACCUMULATED NET
REALIZED LOSS
(a)   $ (470,896 )   $ 470,896

 

(a)

Reclassifications are primarily due to foreign currency transactions treated as ordinary income for tax purposes, differences between book and tax amortization of premium on fixed income securities, losses from mortgage backed securities treated as capital losses for tax purposes, book/tax differences in the treatment of distributions, and tax differences in the treatment of swap contracts.

2. Investment management agreement and other transactions with affiliates

Legg Mason Partners Fund Advisor, LLC (“LMPFA”) is the Fund’s investment manager. ClearBridge Advisors, LLC (“ClearBridge”), Western Asset Management Company (“Western Asset”) and Western Asset Management Company Limited (“Western Asset Limited”) are the Fund’s subadvisers. LMPFA, ClearBridge, Western Asset and Western Asset Limited are wholly-owned subsidiaries of Legg Mason, Inc. (“Legg Mason”).

 

60   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

Under the investment management agreement, the Fund pays an investment management fee calculated daily and paid monthly in accordance with the following breakpoint schedule:

 

AVERAGE DAILY NET ASSETS    ANNUAL RATE  
First $1 billion    0.750 %
Next $1 billion    0.725  
Next $3 billion    0.700  
Next $5 billion    0.675  
Over $10 billion    0.650  

LMPFA provides administrative and certain oversight services to the Fund. LMPFA delegates to the subadvisers the day-to-day portfolio management of the Fund, except for the management of cash and short-term instruments. For its services, LMPFA pays ClearBridge and Western Asset 70% of the net management fee it receives from the Fund. This fee is divided between the subadvisers, on a pro-rata basis, based on the assets allocated to each subadviser, from time to time. Western Asset Limited does not receive any compensation from the Fund and is compensated by Western Asset for its services to the Fund.

During the year ended December 31, 2008, the Fund was reimbursed for expenses in the amount of $77,252.

Legg Mason Investor Services, LLC (“LMIS”), a wholly-owned broker-dealer subsidiary of Legg Mason, serves as the Fund’s sole and exclusive distributor.

There is a maximum initial sales charge of 5.75% for Class A shares. There is a contingent deferred sales charge (“CDSC”) of 5.00% on Class B shares, which applies if redemption occurs within one year from purchase payment. This CDSC declines thereafter by 1.00% per year until no CDSC is incurred. Class C shares have a 1.00% CDSC, which applies if redemption occurs within one year from purchase payment. In certain cases, Class A shares have a 1.00% CDSC, which applies if redemption occurs within one year from purchase payment. This CDSC only applies to those purchases of Class A shares, which, when combined with current holdings of Class A shares, equal or exceed $1,000,000 in the aggregate. These purchases do not incur an initial sales charge.

For the year ended December 31, 2008, LMIS and its affiliates received sales charges of approximately $406,000 on sales of the Fund’s Class A shares. In addition, for the year ended December 31, 2008, CDSCs paid to LMIS and its affiliates were approximately:

 

      CLASS A    CLASS B    CLASS C
CDSCs    $ 2,000    $ 407,000    $ 14,000

The Fund had adopted an unfunded, non-qualified deferred compensation plan (the “Plan”) which allowed non-interested trustees (“Trustees”) to defer the

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   61

Notes to financial statements continued

 

receipt of all or a portion of the trustees’ fees earned until a later date specified by the Trustees. The deferred balances are reported in the Statement of Operations under Trustees’ fees and are considered a general obligation of the Fund and any payments made pursuant to the Plan will be made from the Fund’s general assets. The Plan was terminated effective January 1, 2007. This change will have no effect on fees previously deferred. As of December 31, 2008, the Fund had accrued $38,747 as deferred compensation payable.

Certain officers and one Trustee of the Trust are employees of Legg Mason or its affiliates and do not receive compensation from the Trust.

3. Investments

During the year ended December 31, 2008, the aggregate cost of purchases and proceeds from sales of investments (excluding short-term investments) and U.S Government & Agency Obligations were as follows:

 

      INVESTMENTS    U.S. GOVERNMENT &
AGENCY OBLIGATIONS
Purchases    $ 3,404,264,163    $ 531,547,176
Sales      3,774,158,634      705,371,821

At December 31, 2008, the aggregate gross unrealized appreciation and depreciation of investments for federal income tax purposes were as follows:

 

Gross unrealized appreciation    $ 17,699,027  
Gross unrealized depreciation      (791,559,886 )
Net unrealized depreciation    $ (773,860,859 )

At December 31, 2008, the Fund had the following open futures contracts:

 

     NUMBER OF
CONTRACTS		   EXPIRATION
DATE		   BASIS VALUE   MARKET
VALUE		   UNREALIZED
GAIN
Contracts to Buy:          
90 Day Eurodollar   460   3/09   $ 110,977,053   $ 113,781,000   $ 2,803,947
90 Day Eurodollar   43   6/09     10,507,168     10,628,525     121,357
90 Day Eurodollar   94   9/09     22,869,823     23,205,075     335,252
British Pound 90 Day   27   3/09     4,574,119     4,766,763     192,644
Euro Bundes Obligationer   37   3/09     6,398,187     6,420,748     22,561
U.S. Treasury 30-Year Bonds   108   3/09     13,192,830     14,909,063     1,716,233
U.S. Treasury 5-Year Notes   826   3/09     95,048,475     98,339,172     3,290,697
Net Unrealized Gain on Open Futures Contracts               $ 8,482,691

 

62   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

During the year ended December 31, 2008, written option transactions for the Fund were as follows:

 

      NUMBER OF
CONTRACTS		      PREMIUMS
RECEIVED		  
Written options, outstanding December 31, 2007    51,684      $ 14,745,050  
Options written    81,714        17,952,166  
Options closed    (129,899 )      (31,870,312 )
Options expired    (3,413 )      (764,962 )
Written options, outstanding December 31, 2008    86      $ 61,942  

At December 31, 2008, the Fund had the following open forward foreign currency contracts:

 

FOREIGN CURRENCY    LOCAL
CURRENCY		    MARKET
VALUE		    SETTLEMENT
DATE		    UNREALIZED
GAIN(LOSS)		  
Contracts to Buy:            
British Pound    2,784,000    $ 3,999,442    2/3/09    $ (389,534 )
Euro    5,150,000      7,149,406    2/3/09      549,681  
Japanese Yen    835,590,000      9,223,195    2/3/09      696,767  
                        856,914  
Contracts to Sell:            
British Pound    2,784,000      3,999,442    2/3/09      502,286  
Euro    5,960,000      8,273,876    2/3/09      (615,276 )
Japanese Yen    835,510,000      9,222,312    2/3/09      (399,143 )
British Pound    2,880,000      4,134,519    3/12/09      106,137  
British Pound    2,780,000      3,990,960    3/12/09      145,402  
                        (260,594 )
Net Unrealized Gain on Open Forward Foreign Currency Contracts         $ 596,320  

At December 31, 2008, the Fund held the following swap contracts:

 

SWAP COUNTERPARTY

(REFERENCE ENTITY)

   NOTIONAL
AMOUNT		   TERMINATION
DATE		   PERIODIC
PAYMENTS
MADE BY
THE FUND‡		   PERIODIC
PAYMENTS
RECEIVED BY
THE FUND‡		   UNREALIZED
APPRECIATION/
(DEPRECIATION)
Interest Rate Swaps:        
Barclay’s Capital Inc.   $ 3,419,000   5/31/12   3-Month
LIBOR		   4.400%
Quarterly		   $ 279,934
                      $ 279,934
Credit Default Swaps:        
Barclay’s Capital Inc.
(Juneau Investments LLC, 5.900% due 2/22/21)		     160,000   12/20/12   3.600%
quarterly		   (a)     63,997
Barclay’s Capital Inc.
(Juneau Investments LLC, 5.900% due 2/22/21)		     100,000   12/20/12   3.600%
quarterly		   (a)     39,998
                        103,995
Net Unrealized Appreciation on Open Swap Contracts           $ 383,929

 

‡

Percentage shown is an annual percentage rate.

 

(a)

As a buyer of protection, the Fund generally receives an amount up to the notional value of the swap if a credit event occurs.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   63

Notes to financial statements continued

 

CREDIT DEFAULT SWAP ON CORPORATE ISSUES — SELL PROTECTION1

 

SWAP COUNTERPARTY
(REFERENCE ENTITY)		   NOTIONAL
AMOUNT2		   TERMINATION
DATE		   IMPLIED
CREDIT
SPREAD AT
DECEMBER 31,
20083		     PERIODIC
PAYMENTS
RECEIVED BY
THE FUND‡		   MARKET
VALUE		   UPFRONT
PREMIUMS
PAID/
(RECEIVED)		   UNREALIZED
APPRECIATION/
(DEPRECIATION)		  
Barclay’s Capital Inc. (MBIA Insurance Corp., 5.376% due 10/6/10)   $ 190,000   12/20/12   33.97 %   3.100%
quarterly		   $(96,726)   —   $ (96,726 )
Barclay’s Capital Inc. (MBIA Insurance Corp., 5.376% due 10/6/10)     130,000   12/20/12   33.97 %   3.050%
quarterly		   (66,288)   —     (66,288 )
Net Unrealized Appreciation (Depreciation) on Sales of Credit Default Swaps on Corporate Issues   $ (163,014 )

 

1

If the Fund is a seller of protection and a credit event occurs, as defined under the terms of that particular swap agreement, the Fund will either (i) pay to the buyer of protection an amount equal to the notional amount of the swap and take delivery of the referenced obligation or underlying securities comprising the referenced index or (ii) pay a net settlement amount in the form of cash or securities equal to the notional amount of the swap less the recovery value of the referenced obligation or underlying securities comprising the referenced Index.

 

2

The maximum potential amount the Fund could be required to make as a seller of credit protection or receive as a buyer of credit protection if a credit event occurs as defined under the terms of that particular swap agreement.

 

3

Implied credit spreads, utilized in determining the market value of credit default swap agreements on corporate issues or sovereign issues of an emerging country as of period end serve as an indicator of the current status of the payment/performance risk and represent the likelihood or risk of default for the credit derivative. The implied credit spread of a particular referenced entity reflects the cost of buying/selling protection and may include upfront entity’s credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement. A credit spread identified as “Defaulted” indicates a credit event has occurred for the referenced entity or obligation.

 

‡

Percentage shown is an annual percentage rate.

CREDIT DEFAULT SWAP ON CREDIT INDICES — SELL PROTECTION1

 

SWAP COUNTERPARTY
(REFERENCE ENTITY)		   NOTIONAL
AMOUNT2		   TERMINATION
DATE		   PERIODIC
PAYMENTS
RECEIVED BY
THE FUND‡		   MARKET
VALUE3		     UPFRONT
PREMIUMS
PAID/
(RECEIVED)		     UNREALIZED
APPRECIATION/
(DEPRECIATION)
Morgan Stanley & Co., Inc. (CDX North America Crossover Index)   $ 14,500,000   12/20/13   1.500%
quarterly		   $ (289,590 )   $ (512,535 )   $ 222,945
Net Unrealized Appreciation (Depreciation) on Sales of Credit Default Swaps on Credit Indices      $ 222,945

 

1

If the Fund is a seller of protection and a credit event occurs, as defined under the terms of that particular swap agreement, the Fund will either (i) pay to the buyer of protection an amount equal to the notional amount of the swap and take delivery of the referenced obligation or underlying securities comprising the referenced index or (ii) pay a net settlement amount in the form of cash or securities equal to the notional amount of the swap less the recovery value of the referenced obligation or underlying securities comprising the referenced Index.

 

2

The maximum potential amount the Fund could be required to make as a seller of credit protection or receive as a buyer of credit protection if a credit event occurs as defined under the terms of that particular swap agreement.

 

3

The quoted market prices and resulting values for credit default swap agreements on asset-backed securities and credit indices serve as an indicator of the current status of the payment/performance risk and represent the likelihood of an expected liability (or profit) for the credit derivative should the notional amount of the swap agreement been closed/sold as

 

64   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

 

of the period end. Decreasing market values when compared to the notional amount of the swap, represent a deterioration of the referenced entity’s credit soundness and a greater likelihood or risk of default or other credit event occurring as defined under the terms of the agreement.

 

‡

Percentage shown is an annual percentage rate.

At December 31, 2008, the Fund held TBA securities with a total cost of $11,552,218.

4. Class specific expenses, waivers and/or reimbursements

The Fund has adopted a Rule 12b-1 distribution plan and under that plan each Fund pays a service fee with respect to its Class A, B, C and R shares calculated at the annual rate of 0.25% of the average daily net assets of each respective class. The Fund also pays a distribution fee with respect to its Class B, C and R shares calculated at the annual rate of 0.50%, 0.75% and 0.25% of the average daily net assets of each class, respectively. Distribution fees are accrued daily and paid monthly.

For the year ended December 31, 2008, class specific expenses were as follows:

 

     

DISTRIBUTION

FEES

   

TRANSFER AGENT

FEES

    SHAREHOLDER REPORTS
EXPENSES
Class A    $ 4,668,474    $ 1,835,435    $ 116,672
Class B      2,892,460      691,449      30,156
Class C      3,858,189      505,269      18,837
Class R*      285      20      6
Class I      —      1,597      487
Total    $ 11,419,408    $ 3,033,770    $ 166,158

 

* For the period April 30, 2008 (inception date) to December 31, 2008.

For the year ended December 31, 2008, class specific waivers and/or reimbursements were as follows:

 

      WAIVERS/
REIMBURSEMENTS
Class A      —
Class B      —
Class C    $ 75,783
Class R*      —
Class I      1,469
Total    $ 77,252

 

* For the period April 30, 2008 (inception date) to December 31, 2008.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   65

Notes to financial statements continued

 

5. Distributions to Shareholders by Class

 

      YEAR ENDED
DECEMBER 31, 2008		    YEAR ENDED
DECEMBER 31, 2007
Net Investment Income:      
Class A    $ 11,162,275    $ 34,776,617
Class B      1,708,558      5,856,395
Class C      1,580,534      5,134,713
Class R*      538      —
Class I      43,517      128,908
Total    $ 14,495,422    $ 45,896,633
Net Realized Gains:      
Class A    $ 61,688,918    $ 254,660,161
Class B      12,955,814      58,335,712
Class C      12,922,077      57,181,823
Class R*      1,803      —
Class I      180,002      861,208
Total    $ 87,748,614    $ 371,038,904

 

* For the period April 30, 2008 (inception date) to December 31, 2008.

6. Shares of beneficial interest

At December 31, 2008, the Trust had an unlimited number of shares of beneficial interest authorized with a par value of $0.00001 per share. The Fund has the ability to issue multiple classes of shares. Each share of a class represents an identical interest and has the same rights, except that each class bears certain direct expenses specifically related to the distribution of its shares. Prior to April 16, 2007, the Fund had an unlimited number of shares of beneficial interest authorized with a par value of $0.001 per share.

Transactions in shares of each class were as follows:

 

    YEAR ENDED
DECEMBER 31, 2008		     YEAR ENDED
DECEMBER 31, 2007		  
     SHARES     AMOUNT     SHARES     AMOUNT  
Class A        
Shares sold   10,156,949     $ 139,021,836     13,828,546     $ 241,837,258  
Shares issued on reinvestment   5,140,194       67,303,964     15,601,157       256,399,806  
Shares repurchased   (32,825,792 )     (429,094,223 )   (23,999,573 )     (420,703,490 )
Shares issued with merger   —       —     3,574,604       60,381,532  
Net increase (decrease)   (17,528,649 )   $ (222,768,423 )   9,004,734     $ 137,915,106  
Class B        
Shares sold   2,273,681     $ 30,807,854     3,123,031     $ 54,189,193  
Shares issued on reinvestment   1,023,006       13,457,828     3,468,238       56,391,385  
Shares repurchased   (11,462,240 )     (151,657,622 )   (10,581,964 )     (183,475,732 )
Shares issued with merger   —       —     778,390       13,022,411  
Net decrease   (8,165,553 )   $ (107,391,940 )   (3,212,305 )   $ (59,872,743 )

 

66   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

    YEAR ENDED
DECEMBER 31, 2008		     YEAR ENDED
DECEMBER 31, 2007		  
     SHARES     AMOUNT     SHARES     AMOUNT  
Class C        
Shares sold   2,909,727     $ 38,763,663     2,948,408     $ 51,232,670  
Shares issued on reinvestment   983,979       12,959,128     3,228,611       52,593,061  
Shares repurchased   (11,633,630 )     (151,082,539 )   (7,796,760 )     (135,716,053 )
Shares issued with merger   —       —     3,233,677       54,228,164  
Net increase (decrease)   (7,739,924 )   $ (99,359,748 )   1,613,936     $ 22,337,842  
Class R*        
Shares sold   6,588     $ 100,000     —       —  
Shares issued on reinvestment   —       —     —       —  
Shares repurchased   —       —     —       —  
Net increase   6,588     $ 100,000     —       —  
Class I        
Shares sold   148,685     $ 2,120,866     46,462     $ 833,719  
Shares issued on reinvestment   16,172       212,196     53,115       886,677  
Shares repurchased   (221,658 )     (3,230,303 )   (381,937 )     (6,917,470 )
Shares issued with merger   —       —     629,197       10,800,997  
Net increase (decrease)   (56,801 )   $ (897,241 )   346,837     $ 5,603,923  

 

* For the period April 30, 2008 (inception date) to December 31, 2008.

7. Transfer of net assets

On March 16, 2007, the Fund acquired the assets and certain liabilities of the Legg Mason Partners Balanced Fund and the Legg Mason Balanced Trust (the “Acquired Funds”), pursuant to a plan of reorganization approved by Acquired Funds shareholders. Total shares issued by the Fund and the total net assets of the Legg Mason Partners Balanced Fund and the Legg Mason Balanced Trust on the date of the transfer were as follows:

 

ACQUIRED FUND    SHARES ISSUED
BY THE FUND		    TOTAL NET ASSETS OF THE
ACQUIRED FUNDS
Legg Mason Partners Balanced Fund    5,245,584    $ 88,380,952
Legg Mason Balanced Trust    2,970,284    $ 50,052,152

As part of the reorganization, for each share they held, shareholders of Legg Mason Partners Balanced Fund Class A, Class B, Class C and Class O received 0.790040, 0.795103, 0.796557 and 0.787048 shares of the Fund’s Class A, Class B, Class C and Class I shares, respectively. Also, as part of the reorganization, for each share they held, shareholders of Legg Mason Balanced Trust Class FI, Primary Class and Institutional Class received 0.651559, 0.657772 and 0.637744 shares of the Fund’s Class A, Class C and Class I shares, respectively.

The total net assets of the Fund on the date of the transfer were $3,317,813,311.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   67

Notes to financial statements continued

 

The total net assets of the Legg Mason Partners Balanced Fund and the Legg Mason Balanced Trust before acquisition included unrealized appreciation of $11,812,566 and $7,297,173, respectively, accumulated net realized gain/(loss) of $12,886 and $(411), respectively and accumulated net investment loss of $20,756 and $0, respectively. Total net assets of the Fund immediately after the transfer were $3,456,246,415. The transaction was structured to qualify as a tax-free reorganization under the Internal Revenue Code of 1986, as amended.

8. Income tax information and distributions to shareholders

Subsequent to the fiscal year end, the Fund has made the following distributions:

 

RECORD DATE
PAYABLE DATE		    CLASS A    CLASS B    CLASS C    CLASS R    CLASS I
1/29/2009 1/30/2009    $ 0.044000    $ 0.034700    $ 0.031800    $ 0.040800    $ 0.049600

The tax character of distributions paid during the fiscal years ended December 31, were as follows:

 

      2008    2007
Distributions Paid From:      
Ordinary income    $ 83,141,727    $ 285,143,631
Net long-term capital gains      19,102,309      131,791,906
Total taxable distributions    $ 102,244,036    $ 416,935,537

As of December 31, 2008, the components of accumulated earnings on a tax basis were as follows:

 

Undistributed ordinary income — net    $ 35,202,365  
Capital loss carryforward*      (210,345,047 )
Other book/tax temporary differences(a)      (114,104,636 )
Unrealized appreciation/(depreciation)(b)      (764,536,547 )
Total accumulated earnings/(losses) — net    $ (1,053,783,865 )

 

* As of December 31, 2008, the Fund had the following net capital loss carryforward remaining:

 

YEAR OF EXPIRATION    AMOUNT  
12/31/2016    $ (210,345,047 )

 

  This amount will be available to offset any future taxable capital gains.

 

(a)

Other book/tax temporary differences are attributable primarily to the tax deferral of losses on straddles, the realization for tax purposes of unrealized gains on certain futures contracts, the deferral of post-October capital losses for tax purposes, differences between book/tax accrual of interest income on certain securities and book/tax differences in the timing of the deductibility of various expenses.

 

(b)

The difference between book-basis and tax-basis unrealized appreciation/(depreciation) is attributable primarily to the tax deferral of losses on wash sales, the difference between book and tax amortization methods for premiums on fixed income securities and book/tax differences on partnership interest.

 

68   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

9. Regulatory matters

On May 31, 2005, the U.S. Securities and Exchange Commission (the “SEC”) issued an order in connection with the settlement of an administrative proceeding against Smith Barney Fund Management LLC (“SBFM”), a wholly-owned subsidiary of Legg Mason and Citigroup Global Markets Inc. (“CGM”), a former distributor of the Fund, relating to the appointment of an affiliated transfer agent for the Smith Barney family of mutual funds, including the Fund (the “Affected Funds”).

The SEC order found that SBFM and CGM willfully violated Section 206(1) of the Investment Advisers Act of 1940, as amended, and the rules promulgated thereunder (the “Advisers Act”). Specifically, the order found that SBFM and CGM knowingly or recklessly failed to disclose to the boards of the Affected Funds in 1999 when proposing a new transfer agent arrangement with an affiliated transfer agent that: First Data Investors Services Group (“First Data”), the Affected Funds’ then-existing transfer agent, had offered to continue as transfer agent and do the same work for substantially less money than before; and that Citigroup Asset Management (“CAM”), the Citigroup business unit that, at the time, included the Affected Funds’ investment manager and other investment advisory companies, had entered into a side letter with First Data under which CAM agreed to recommend the appointment of First Data as subtransfer agent to the affiliated transfer agent in exchange for, among other things, a guarantee by First Data of specified amounts of asset management and investment banking fees to CAM and CGM. The order also found that SBFM and CGM willfully violated Section 206(2) of the Advisers Act by virtue of the omissions discussed above and other misrepresentations and omissions in the materials provided to the Affected Funds’ boards, including the failure to make clear that the affiliated transfer agent would earn a high profit for performing limited functions while First Data continued to perform almost all of the transfer agent functions, and the suggestion that the proposed arrangement was in the Affected Funds’ best interests and that no viable alternatives existed.

SBFM and CGM do not admit or deny any wrongdoing or liability. The settlement does not establish wrongdoing or liability for purposes of any other proceeding. The SEC censured SBFM and CGM and ordered them to cease and desist from violations of Sections 206(1) and 206(2) of the Advisers Act. The order required Citigroup to pay $208.1 million, including $109 million in disgorgement of profits, $19.1 million in interest, and a civil money penalty of $80 million. Approximately $24.4 million has already been paid to the Affected Funds, primarily through fee waivers. The remaining $183.7 million, including the penalty, has been paid to the U.S. Treasury and will be distributed pursuant to a plan submitted for the approval of the SEC. At this time, there is no certainty as to how the above described proceeds of the settlement will be distributed, to whom such distributions will be made, the methodology by which such distributions will be allocated, and when such distributions will be made. The order also required that transfer agency fees received from the Affected Funds since December 1, 2004, less certain expenses, be placed in escrow and provided that a portion of such fees might be subsequently distributed in accordance with the terms of the order. On April 3, 2006, an

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   69

Notes to financial statements continued

 

aggregate amount of approximately $9 million held in escrow was distributed to the Affected Funds.

The order required SBFM to recommend a new transfer agent contract to the Affected Funds’ Fund boards within 180 days of the entry of the order; if a Citigroup affiliate submitted a proposal to serve as transfer agent or subtransfer agent, SBFM and CGM would have been required, at their expense, to engage an independent monitor to oversee a competitive bidding process. On November 21, 2005, and within the specified timeframe, the Affected Funds’ Boards selected a new transfer agent for the Affected Funds. No Citigroup affiliate submitted a proposal to serve as transfer agent. Under the order, SBFM also must comply with an amended version of a vendor policy that Citigroup instituted in August 2004.

Although there can be no assurance, the manager does not believe that this matter will have a material adverse effect on the Affected Funds.

On December 1, 2005, Citigroup completed the sale of substantially all of its global asset management business, including SBFM, to Legg Mason.

10. Legal matters

Beginning in June 2004, class action lawsuits alleging violations of the federal securities laws were filed against CGM, a former distributor of the Fund, and other affiliated funds (collectively, the “Funds”) and a number of its then affiliates, including SBFM and Salomon Brothers Asset Management Inc. (“SBAM”), which were then investment adviser or manager to certain of the Funds (the “Managers”), substantially all of the mutual funds then managed by the Managers (the “Defendant Funds”), and Board members of the Defendant Funds (collectively, the “Defendants”). The complaints alleged, among other things, that CGM created various undisclosed incentives for its brokers to sell Smith Barney and Salomon Brothers funds. In addition, according to the complaints, the Managers caused the Defendant Funds to pay excessive brokerage commissions to CGM for steering clients towards proprietary funds. The complaints also alleged that the Defendants breached their fiduciary duty to the Defendant Funds by improperly charging Rule 12b-1 fees and by drawing on fund assets to make undisclosed payments of soft dollars and excessive brokerage commissions. The complaints also alleged that the Defendant Funds failed to adequately disclose certain of the allegedly wrongful conduct. The complaints sought injunctive relief and compensatory and punitive damages, rescission of the Defendant Funds’ contracts with the Managers, recovery of all fees paid to the Managers pursuant to such contracts and an award of attorneys’ fees and litigation expenses.

On December 15, 2004, a consolidated amended complaint (the “Complaint”) was filed alleging substantially similar causes of action. On May 27, 2005, all of the Defendants filed motions to dismiss the Complaint. On July 26, 2006, the court issued a decision and order (1) finding that plaintiffs lacked standing to sue on behalf of the shareholders of the Funds in which none of the plaintiffs had invested and dismissing those Funds from the case (although stating that they could be brought back into the case if standing as to them could be established), and (2) other than one stayed claim, dismissing all of the causes

 

70   Legg Mason Partners Capital and Income Fund 2008 Annual Report

 

of action against the remaining Defendants, with prejudice, except for the cause of action under Section 36(b) of the 1940 Act, which the court granted plaintiffs leave to repeal as a derivative claim.

On October 16, 2006, plaintiffs filed their Second Consolidated Amended Complaint (“Second Amended Complaint”) which alleges derivative claims on behalf of nine funds identified in the Second Amended Complaint, under Section 36(b) of the 1940 Act, against CAM, SBAM and SBFM as investment advisers to the identified funds, as well as CGM as a distributor for the identified funds (collectively, the “Second Amended Complaint Defendants”). The Fund was not identified in the Second Amended Complaint. The Second Amended Complaint alleges no claims against any of the funds or any of their Board Members. Under Section 36(b), the Second Amended Complaint alleges similar facts and seeks similar relief against the Second Amended Complaint Defendants as the Complaint.

On December 3, 2007, the court granted the Defendants’ motion to dismiss, with prejudice. On January 2, 2008, the plaintiffs filed a notice of appeal to the Second Circuit Court of Appeals.

Additional lawsuits arising out of these circumstances and presenting similar allegations and requests for relief may be filed in the future.

* * *

Beginning in August 2005, five class action lawsuits alleging violations of federal securities laws and state law were filed against CGM and SBFM, (collectively, the “Defendants”) based on the May 31, 2005 settlement order issued against the Defendants by the SEC as described in Note 9. The complaints seek injunctive relief and compensatory and punitive damages, removal of SBFM as the investment manager for the Smith Barney family of funds, rescission of the funds’ management and other contracts with SBFM, recovery of all fees paid to SBFM pursuant to such contracts, and an award of attorneys’ fees and litigation expenses. The five actions were subsequently consolidated, and a consolidated complaint was filed.

On September 26, 2007, the United States District Court for the Southern District of New York issued an order dismissing the consolidated complaint, and judgement was later entered. An appeal has been filed and is pending before the U.S. Court of Appeals for the Second Circuit.

11. Recent accounting pronouncement

In March 2008, the Financial Accounting Standards Board issued the Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities (“FAS 161”). FAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. FAS 161 requires enhanced disclosures about the Fund’s derivative and hedging activities, including how such activities are accounted for and their effect on the Fund’s financial position, performance and cash flows. Management is currently evaluating the impact the adoption of FAS 161 will have on the Fund’s financial statements and related disclosures.

 

Legg Mason Partners Capital and Income Fund 2008 Annual Report   71

Report of independent registered public accounting firm

 

The Board of Trustees and Shareholders Legg Mason Partners Equity Trust:

We have audited the accompanying statement of assets and liabilities, including the schedule of investments, of Legg Mason Partners Capital and Income Fund, a series of Legg Mason Partners Equity Trust, as of December 31, 2008, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended, and the financial highlights for each of the years or periods in the five-year period then ended. These financial statements and financial highlights are the responsibility of the Fund’s management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 2008, by correspondence with the custodian and brokers or by other appropriate auditing procedures. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Legg Mason Partners Capital and Income Fund as of December 31, 2008, and the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then ended, and the financial highlights for each of the years or periods in the five-year period then ended, in conformity with U.S. generally accepted accounting principles.

LOGO

New York, New York

February 24, 2009

 

72   Legg Mason Partners Capital and Income Fund 2008 Annual Report

Board approval of management and subadvisory agreements (unaudited)

 

At a meeting of the Fund’s Board of Trustees, the Board considered the re-approval for an annual period of the Fund’s management agreement, pursuant to which Legg Mason Partners Fund Advisor, LLC (the “Manager”) provides the Fund with investment advisory and administrative services, and the Fund’s sub-advisory agreements, pursuant to which ClearBridge Advisors, LLC, Western Asset Management Company and Western Asset Management Company, Ltd. (collectively, the “Sub-Advisers”) provide day-to-day management of the Fund’s portfolio. (The management agreement and sub-advisory agreements are collectively referred to as the “Agreements.”) The Manager and the Sub-Advisers are wholly-owned subsidiaries of Legg Mason, Inc. The Trustees who are not “interested persons” (as defined in the Investment Company Act of 1940, as amended (the “Independent Trustees”)) of the Fund were assisted in their review by Fund counsel and independent legal counsel and met with independent legal counsel in executive sessions separate from representatives of the Manager and the Sub-Advisers. The Independent Trustees requested and received information from the Manager and the Sub-Advisers they deemed reasonably necessary for their review of the Agreements and the performance of the Manager and the Sub-Advisers. Included was information about the Manager, the Sub-Advisers and the Fund’s distributor (including any distributors affiliated with the Fund during the past two years), as well as the management, sub-advisory and distribution arrangements for the Fund and other funds overseen by the Board. This information was initially reviewed by a special committee of the Independent Trustees and then by the full Board.

In voting to approve the Agreements, the Independent Trustees considered whether the approval of the Agreements would be in the best interests of the Fund and its shareholders, an evaluation based on several factors including those discussed below.

Nature, extent and quality of the services provided to the fund under the management agreement and sub-advisory agreements

The Board received and considered information regarding the nature, extent and quality of services provided to the Fund by the Manager and the Sub-Advisers under the Management Agreement and Sub-Advisory Agreements, respectively, during the past two years. The Trustees also considered the Manager’s supervisory activities over the Sub-Advisers. In addition, the Independent Trustees received and considered other information regarding the administrative and other services rendered to the Fund and its shareholders by the Manager. The Board noted information received at regular meetings throughout the year related to the services rendered by the Manager in its management of the Fund’s affairs, including the management of cash and short-term instruments, and the Manager’s role in coordinating the activities of the Sub-Advisers and the Fund’s other service providers. The Board’s evaluation of the services provided by the Manager and the Sub-Advisers took

 

Legg Mason Partners Capital and Income Fund   73

Board approval of management and subadvisory agreements (unaudited) continued

 

into account the Board’s knowledge and familiarity gained as Trustees of funds in the Legg Mason Partners fund complex, including the scope and quality of the investment management and other capabilities of the Manager and the Sub-Advisers and the quality of the Manager’s administrative and other services. The Board observed that the scope of services provided by the Manager had expanded over time as a result of regulatory and other developments, including maintaining and monitoring its own and the Fund’s expanded compliance programs. The Board reviewed information received from the Manager and the Fund’s Chief Compliance Officer regarding the Fund’s compliance policies and procedures established pursuant to Rule 38a-1 under the Investment Company Act of 1940, as amended.

The Board reviewed the qualifications, backgrounds and responsibilities of the Fund’s senior personnel and the portfolio management team primarily responsible for the day-to-day portfolio management of the Fund. The Board considered the degree to which the Manager implemented organizational changes to improve investment results and the services provided to the Legg Mason Partners fund complex. The Board also considered, based on its knowledge of the Manager and the Manager’s affiliates, the financial resources available to the Manager’s parent organization, Legg Mason, Inc.

The Board also considered the division of responsibilities between the Manager and the Sub-Advisers and the oversight provided by the Manager. The Board also considered the Manager’s and the Sub-Advisers’ brokerage policies and practices, the standards applied in seeking best execution, the Manager’s policies and practices regarding soft dollars, and the existence of quality controls applicable to brokerage allocation procedures. In addition, management also reported to the Board on, among other things, its business plans, recent organizational changes, portfolio manager compensation plan and policy regarding portfolio managers’ ownership of fund shares.

The Board concluded that, overall, it was satisfied with the nature, extent and quality of services provided (and expected to be provided) under the respective Agreement by the Manager and the Sub-Advisers.

Fund performance

The Board received and reviewed performance information for the Fund and for all retail and institutional mixed-asset target allocation growth funds (the “Performance Universe”) selected by Lipper, Inc. (“Lipper”), an independent provider of investment company data. The Board was provided with a description of the methodology Lipper used to determine the similarity of the Fund with the funds included in the Performance Universe. The Trustees noted that they also had received and discussed with management information at periodic intervals comparing the Fund’s performance to that of its benchmark index. The information comparing the Fund’s performance to that of the Performance Universe was for the one-, three-, five- and ten-year periods

 

74   Legg Mason Partners Capital and Income Fund

 

ended June 30, 2008. The Fund performed better than the median during each period and was in the first quintile for funds in the Performance Universe for the five- and ten-year periods. The Board also reviewed performance information provided by the Manager for periods ended September 30, 2008, which showed the Fund’s performance was lower than the Lipper category average during the third quarter. The Trustees then discussed with representatives of management the portfolio management strategy of the Fund’s portfolio managers. The Trustees also noted that the Manager was committed to providing the resources necessary to assist the portfolio managers and continue to improve Fund performance. Based on its review, the Board generally was satisfied with the Fund’s performance and management’s efforts to continue to improve performance going forward. The Board determined to continue to evaluate the Fund’s performance and directed the Independent Trustees’ performance committee to continue to periodically review Fund performance with the Manager and report to the full Board during periods between Board meetings.

Management fees and expense ratios

The Board reviewed and considered, the contractual management fee (the “Contractual Management Fee”) payable by the Fund to the Manager in light of the nature, extent and quality of the management and sub-advisory services provided by the Manager and the Sub-Advisers, respectively. The Board noted that the Manager, and not the Fund, pays the sub-advisory fees to the Sub-Advisers and, accordingly, that the retention of the Sub-Advisers does not increase the fees and expenses incurred by the Fund.

The Board also reviewed information regarding the fees the Manager and the Sub-Advisers charged any of their U.S. clients investing primarily in an asset class similar to that of the Fund including, where applicable, separate accounts. The Manager reviewed with the Board the significant differences in the scope of services provided to the Fund and to such other clients, noting that the Fund is provided with regulatory compliance and administrative services, office facilities and Fund officers (including the Fund’s chief financial, chief legal and chief compliance officers), and that the Manager coordinates and oversees the provision of services to the Fund by other fund service providers, including the Sub-Advisers. The Board considered the fee comparisons in light of the scope of services required to manage these different types of accounts.

The Board received an analysis of complex-wide management fees provided by the Manager, which, among other things, set out a framework of fees based on asset classes. Management also discussed with the Board the Fund’s distribution arrangements, including how amounts received by the Fund’s distributors are expended, and the fees received and expenses incurred in connection with such arrangements by affiliates of the Manager.

 

Legg Mason Partners Capital and Income Fund   75

Board approval of management and subadvisory agreements (unaudited) continued

 

Additionally, the Board received and considered information comparing the Fund’s Contractual Management Fee and the Fund’s overall expense ratio with those of a group of ten retail front-end load mixed-asset target allocation growth funds selected by Lipper as comparable to the Fund (the “Expense Group”), and a broader group of funds selected by Lipper consisting of all retail front-end load mixed-asset target allocation growth funds (the “Expense Universe”). This information showed that, while the Fund’s Contractual Management Fee was higher than the median of management fees paid by the other funds in the Expense Group and higher than the average management fee paid by the other funds in the Expense Universe, the Fund’s actual total expense ratio was lower than the median of the total expense ratios of the funds in the Expense Group and lower than the average total expense ratio of the other funds in the Expense Universe.

Manager profitability

The Board received and considered a profitability analysis of the Manager and its affiliates in providing services to the Fund. The Board also received profitability information with respect to the Legg Mason Partners fund complex as a whole. In addition, the Board received information with respect to the Manager’s allocation methodologies used in preparing this profitability data as well as a report from an outside consultant that had reviewed the Manager’s methodology. The Board also noted the profitability percentage ranges determined by appropriate court cases to be reasonable given the services rendered to investment companies. The Board determined that the Manager’s profitability was not excessive in light of the nature, extent and quality of the services provided to the Fund.

Economies of scale

The Board received and considered information regarding whether there have been economies of scale with respect to the management of the Fund as the Fund’s assets grow, whether the Fund has appropriately benefited from any economies of scale, and whether there is potential for realization of any further economies of scale. The Board considered whether economies of scale in the provision of services to the Fund were being passed along to the shareholders.

The Board noted that the Manager instituted breakpoints in the Fund’s Contractual Management Fee, reflecting the potential for reducing the Contractual Management Fee as the Fund’s assets grow. The Board noted that the Fund’s assets exceeded the specified asset level at which one or more breakpoints to its Contractual Management Fee are triggered. Accordingly, the Fund and its shareholders realized economies of scale because the total expense ratio of the Fund was lower than it would have been if no breakpoints were in place. The Board also considered whether the breakpoint fee structure was a reasonable means of sharing any economies of scale, taking into consideration other efficiencies that might accrue as the Fund’s assets

 

76   Legg Mason Partners Capital and Income Fund

 

increase. The Board also noted that as the Fund’s assets increase over time, the Fund and its shareholders should realize economies of scale as certain expenses, such as fixed fund fees, become a smaller percentage of overall assets. The Board noted that it appeared that the benefits of any economies of scale also have been appropriately shared with shareholders through increased investment in fund management and administration resources.

Taking all of the above into consideration, the Board determined that the management fee was reasonable in light of the comparative performance and expense information and the nature, extent and quality of the services provided to the Fund under the Agreements.

Other benefits to the manager

The Board considered other benefits received by the Manager and its affiliates, including the Sub-Advisers, as a result of the Manager’s relationship with the Fund, including the opportunity to offer additional products and services to Fund shareholders.

In light of the costs of providing investment management and other services to the Fund and the Manager’s ongoing commitment to the Fund, the profits and other ancillary benefits that the Manager and its affiliates received were considered reasonable.

Based on their discussions and considerations, including those described above, the Trustees approved the Management Agreement and the Sub-Advisory Agreements to continue for another year.

No single factor reviewed by the Board was identified by the Board as the principal factor in determining whether to approve the Management Agreement and the Sub-Advisory Agreements.

 

Legg Mason Partners Capital and Income Fund   77

Additional information (unaudited)

Information about Trustees and Officers

 

The business and affairs of the Legg Mason Partners Capital and Income Fund (the “Fund”) are managed under the direction of the Board of Trustees. Information pertaining to the Trustees and Officers is set forth below. The Statement of Additional Information includes additional information about Trustees and is available, without charge, upon request by calling Legg Mason Partners Shareholder Services at 1-800-451-2010.

 

NON-INTERESTED TRUSTEES
PAUL R. ADES
c/o R. Jay Gerken, CFA, Legg Mason & Co., LLC (“Legg Mason”) 620 Eighth Avenue, New York, NY 10018
Birth year    1940
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1983
Principal occupation(s) during past five years    Law Firm of Paul R. Ades, PLLC (since 2000)
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None
ANDREW L. BREECH
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1952
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1991
Principal occupation(s) during past five years    President, Dealer Operating Control Service, Inc. (automotive retail management) (since 1985)
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None
DWIGHT B. CRANE
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1937
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1981
Principal occupation(s) during past five years    Independent Consultant (since 1969); formerly, Professor, Harvard Business School (from 1969 to 2007)
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None

 

78   Legg Mason Partners Capital and Income Fund

 

ROBERT M. FRAYN, JR.
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1934
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1981
Principal occupation(s) during past five years    Retired
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None
FRANK G. HUBBARD
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1937
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1993
Principal occupation(s) during past five years    President of Avatar International, Inc. (business development) (since 1998)
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None
HOWARD J. JOHNSON
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1938
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    From 1981 to 1998 and 2000 to Present
Principal occupation(s) during past five years    Chief Executive Officer, Genesis Imaging LLC (technology company) (since 2003)
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None

 

Legg Mason Partners Capital and Income Fund   79

Additional information (unaudited) continued

Information about Trustees and Officers

 

DAVID E. MARYATT
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1936
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1983
Principal occupation(s) during past five years    Private Investor; President and Director, ALS Co. (real estate management and development firm) (since 1993)
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None

JEROME H. MILLER

c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018

Birth year    1938
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1995
Principal occupation(s) during past five years    Retired
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None
KEN MILLER
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1942
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1983
Principal occupation(s) during past five years    President of Young Stuff Apparel Group, Inc. (apparel manufacturer) (since 1963)
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None

 

80   Legg Mason Partners Capital and Income Fund

 

JOHN J. MURPHY
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1944
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 2002
Principal occupation(s) during past five years    President; Murphy Capital Management (investment advice) (since 1983)
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    Director, Nicholas Applegate funds; Trustee; Consulting Group Capital Markets Funds; formerly, Director, Atlantic Stewardship Bank (from 2004 to 2005); Director, Barclays International Funds Group Ltd. and affiliated companies (from 1983 to 2003)
THOMAS F. SCHLAFLY
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1948
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1983
Principal occupation(s) during past five years    Of Counsel, Husch Blackwell Sanders LLP (law firm) (since 1984); President, The Saint Louis Brewery, Inc. (brewery) (since 1989)
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    Director, Citizens National Bank of Greater St. Louis, Maplewood, MO (since 2006)
JERRY A. VISCIONE
c/o R. Jay Gerken, CFA, Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1944
Position(s) held with Fund1    Trustee
Term of office1 and length of time served2    Since 1993
Principal occupation(s) during past five years    Retired
Number of portfolios in fund complex overseen by Trustee    57
Other board memberships held by Trustee    None

 

Legg Mason Partners Capital and Income Fund   81

Additional information (unaudited) continued

Information about Trustees and Officers

 

INTERESTED TRUSTEE
R. JAY GERKEN, CFA3
Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1951
Position(s) held with Fund1    Trustee, President, Chairman, and Chief Executive Officer
Term of office1 and length of time served2    Since 2002
Principal occupation(s) during past five years    Managing Director of Legg Mason; Chairman of the Board and Trustee/Director of 159 funds associated with Legg Mason Partners Fund Advisor, LLC (“LMPFA”) and its affiliates; President of LMPFA (since 2006); Chairman, President and Chief Executive Officer of certain mutual funds associated with Legg Mason and its affiliates; formerly, Chairman, Smith Barney Fund Management LLC (“SBFM”) and CitiFund Management Inc. (“CFM”) (from 2002 to 2005); formerly, Chairman President and Chief Executive Officer of Travelers Investment Adviser, Inc. (“TIA”) (from 2002 to 2005)
Number of portfolios in fund complex overseen by Trustee    146
Other board memberships held by Trustee    Trustee, Consulting Group Capital Markets Funds (from 2002 to 2006)
OFFICERS
KAPREL OZSOLAK
Legg Mason 55 Water Street, New York, NY 10041
Birth year    1965
Position(s) held with Fund1    Chief Financial Officer and Treasurer
Term of office1 and length of time served2    Since 2004
Principal occupation(s) during past five years    Director of Legg Mason; Chief Financial Officer and Treasurer of certain mutual funds associated with Legg Mason; formerly, Controller of certain mutual funds associated with certain predecessor firms of Legg Mason (from 2002 to 2004)
TED P. BECKER
Legg Mason 620 Eighth Avenue, New York, NY 10018
Birth year    1951
Position(s) held with Fund1    Chief Compliance Officer
Term of office1 and length of time served2    Since 2006
Principal occupation(s) during past five years    Director of Global Compliance at Legg Mason (since 2006); Chief Compliance Officer of LMPFA (since 2006); Managing Director of Compliance at Legg Mason (since 2005); Chief Compliance Officer with certain mutual funds associated with Legg Mason, LMPFA and certain affiliates (since 2006); formerly, Managing Director of Compliance at CAM or its predecessor (from 2002 to 2005);

 

82   Legg Mason Partners Capital and Income Fund

 

JOHN CHIOTA
Legg Mason 100 First Stamford Place, Stamford, CT 06902
Birth year    1968
Position(s) held with Fund1    Chief Anti-Money Laundering Compliance Officer/Identity Theft Prevention Officer
Term of office1 and length of time served2    Since 2006/2008
Principal occupation(s) during past five years    Identity Theft Prevention Officer with certain mutual funds associated with Legg Mason or its affiliates (since 2008); Chief Anti-Money Laundering Compliance Officer with certain mutual funds associated with Legg Mason or its affiliates (since 2006); Vice President of Legg Mason or its predecessor (since 2004); Prior to August 2004, Chief AML Compliance Officer with TD Waterhouse
ROBERT I. FRENKEL
Legg Mason 100 First Stamford Place, Stamford, CT 06902
Birth year    1954
Position(s) held with Fund1    Secretary and Chief Legal Officer
Term of office1 and length of time served2    Since 2003
Principal occupation(s) during past five years    Managing Director and General Counsel of Global Mutual Funds for Legg Mason and its predecessors (since 1994); Secretary and Chief Legal Officer of mutual funds associated with Legg Mason (since 2003); formerly, Secretary of CFM (from 2001 to 2004)
THOMAS C. MANDIA
Legg Mason 100 First Stamford Place, Stamford, CT 06902
Birth year    1962
Position(s) held with Fund1    Assistant Secretary
Term of office1 and length of time served2    Since 2000
Principal occupation(s) during past five years    Managing Director and Deputy General Counsel of Legg Mason (since 2005); Managing Director and Deputy General Counsel for CAM (from 1992 to 2005)
ALBERT LASKAJ
Legg Mason 55 Water Street, New York, NY 10041
Birth year    1977
Position(s) held with Fund1    Controller
Term of office1 and length of time served2    Since 2007
Principal occupation(s) during past five years    Vice President of Legg Mason (since 2008); Controller of certain mutual funds associated with Legg Mason (since 2007); formerly, Assistant Controller of certain mutual funds associated with Legg Mason (from 2005 to 2007); formerly, Accounting Manager of certain mutual funds associated with certain predecessor firms of Legg Mason (from 2003 to 2005)

 

Legg Mason Partners Capital and Income Fund   83

Additional information (unaudited) continued

Information about Trustees and Officers

 

STEVEN FRANK
Legg Mason 55 Water Street, New York, NY 10041
Birth year    1967
Position(s) held with Fund1    Controller
Term of office1 and length of time served2    Since 2005
Principal occupation(s) during past five years    Vice President of Legg Mason (since 2002); Controller of certain mutual funds associated with Legg Mason or its predecessors (since 2005); formerly, Assistant Controller of certain mutual funds associated with Legg Mason predecessors (from 2001 to 2005)

 

1

Each Trustee and Officer serves until his or her successor has been duly elected and qualified or until his or her earlier death, resignation, retirement or removal.

 

2

Indicates the earliest year in which the Trustee or Officer became a Board Member or Officer, as applicable for a fund in the Legg Mason Partners funds complex.

 

3

Mr. Gerken is an “interested person” of the Trust as defined in the 1940 Act because Mr. Gerken is an officer of LMPFA and certain of its affiliates.

 

84   Legg Mason Partners Capital and Income Fund

Important tax information (unaudited)

 

The following information is provided with respect to the distributions paid during the taxable year ended December 31, 2008:

 

Record Date:   1/30/2008     2/28/2008     3/28/2008     4/29/2008     5/29/2008   6/27/2008
Payable Date:   1/31/2008     2/29/2008     3/31/2008     4/30/2008     5/30/2008   6/30/2008
Ordinary Income:                                  

Qualified Dividend Income for
Individuals

   11.68 %   11.68 %   11.68 %   11.68 %     —   —

Dividends Qualifying for the Dividends Received Deduction for Corporations

   10.37 %   10.37 %   10.37 %   10.37 %     —   —

Interest from Federal Obligations

   2.05 %   2.05 %   2.05 %   2.05 %          

Long-Term Capital Gain Dividend

   —     —     —     —     $ 0.044000   0.053694

 

Record Date:   7/30/2008     8/28/2008     9/29/2008     10/30/2008     11/26/2008     12/26/2008  
Payable Date:   7/31/2008     8/29/2008     9/30/2008     10/31/2008     11/28/2008     12/29/2008  
Ordinary Income:                                    

Qualified Dividend Income for Individuals

   11.68 %   11.68 %   11.68 %   25.20 %   57.19 %   57.19 %

Dividends Qualifying for the Dividends Received Deduction for Corporations

   10.37 %   10.37 %   10.37 %   22.59 %   51.49 %   51.49 %

Interest from Federal Obligations

   2.05 %   2.05 %   2.05 %   2.05 %   2.05 %   2.05 %

Long-Term Capital Gain Dividend

   —     —     —     —     —     —  

Please retain this information for your records.

 

Legg Mason Partners Capital and Income Fund   85

 

Legg Mason Partners Capital and Income Fund

 

Trustees

 

Paul R. Ades

Andrew L. Breech

Dwight B. Crane

Robert M. Frayn, Jr.

R. Jay Gerken, CFA
Chairman

Frank G. Hubbard

Howard J. Johnson

David E. Maryatt

Jerome H. Miller

Ken Miller

John J. Murphy

Thomas F. Schlafly

Jerry A. Viscione

 

Investment manager

 

Legg Mason Partners Fund
Advisor, LLC

 

Subadvisers

 

ClearBridge Advisors, LLC

 

Western Asset Management Company

 

Western Asset Management Company Limited

  

Distributor

 

Legg Mason Investor Services, LLC

 

Custodian

 

State Street Bank and Trust Company

 

Transfer agent

 

PNC Global Investment Servicing

4400 Computer Drive

Westborough, Massachusetts 01581

 

Independent registered public accounting firm

 

KPMG LLP

345 Park Avenue

New York, New York 10154

 

Legg Mason Partners Capital and Income Fund

The Fund is a separate investment series of Legg Mason Partners Equity Trust, a Maryland business trust.

LEGG MASON PARTNERS CAPITAL AND INCOME FUND

Legg Mason Partners Funds

55 Water Street

New York, New York 10041

The Fund files its complete schedule of portfolio holdings with the Securities and Exchange Commission (“SEC”) for the first and third quarters of each fiscal year on Form N-Q. The Fund’s Forms N-Q are available on the SEC’s website at www.sec.gov. The Fund’s Forms N-Q may be reviewed and copied at the SEC’s Public Reference Room in Washington, D.C., and information on the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330. To obtain information on Form N-Q from the Fund, shareholders can call Legg Mason Partners Shareholder Services at 1-800-451-2010.

Information on how the Fund voted proxies relating to portfolio securities during the prior 12-month period ended June 30th of each year and a description of the policies and procedures that the Fund uses to determine how to vote proxies related to portfolio transactions are available (1) without charge, upon request, by calling 1-800-451-2010, (2) on the Fund’s website at www.leggmason.com/individualinvestors and (3) on the SEC’s website at www.sec.gov.

This report is submitted for the general information of the shareholders of Legg Mason Partners Capital and Income Fund. This report is not authorized for distribution to prospective investors in the Fund unless preceded or accompanied by a current prospectus.

Investors should consider the Fund’s investment objectives, risks, charges and expenses carefully before investing. The prospectus contains this and other important information about the Fund. Please read the prospectus carefully before investing.

www.leggmason.com/individualinvestors

© 2009 Legg Mason Investor Services, LLC

Member FINRA, SIPC

BUILT TO WINSM

LOGO

 

At Legg Mason, we’ve assembled a collection of experienced investment management firms and empowered each of them with the tools, the resources and, most importantly, the independence to pursue the strategies they know best.

 

•  

Each was purposefully chosen for their commitment to investment excellence.

 

•  

Each is focused on specific investment styles and asset classes.

 

•  

Each exhibits thought leadership in their chosen area of focus.

Together, we’ve built a powerful portfolio of solutions for financial advisors and their clients. And it has made us a world leader in money management.*

* Ranked ninth-largest money manager in the world according to Pensions & Investments, May 26, 2008 based on 12/31/07 worldwide assets under management.

www.leggmason.com/individualinvestors

©2009 Legg Mason Investor Services, LLC Member FINRA, SIPC

FD0420 2/09 SR09-764

 

NOT PART OF THE ANNUAL REPORT

 

ITEM 2. CODE OF ETHICS.

The registrant has adopted a code of ethics that applies to the registrant’s principal executive officer, principal financial officer, principal accounting officer or controller.

 

ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.

The Board of Directors of the registrant has determined that Jerry A. Viscione possesses the technical attributes identified in Instruction 2(b) of Item 3 to Form N-CSR to qualify as an “audit committee financial expert,” and has designated Mr. Viscione as the Audit Committee’s financial expert. Mr. Viscione is an “independent” Director pursuant to paragraph (a)(2) of Item 3 to Form N-CSR.

 

ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

a) Audit Fees. The aggregate fees billed in the last two fiscal years ending December 31, 2007 and December 31, 2008 (the “Reporting Periods”) for professional services rendered by the Registrant’s principal accountant (the “Auditor”) for the audit of the Registrant’s annual financial statements, or services that are normally provided by the Auditor in connection with the statutory and regulatory filings or engagements for the Reporting Periods, were $320,200 in 2007 and $310,850 in 2008.

b) Audit-Related Fees. The aggregate fees billed in the Reporting Period for assurance and related services by the Auditor that are reasonably related to the performance of the Registrant’s financial statements were $54,633 in 2007 and $21,900 in 2008. These services consisted of procedures performed in connection with the Re-domiciliation of the various reviews of Prospectus supplements, and consent issuances related to the N-1A filings and calculations pursuant to Funds revolving credit for the Legg Mason Partners Equity Trust.

In addition, there were no Audit-Related Fees billed in the Reporting Period for assurance and related services by the Auditor to the Registrant’s investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the Legg Mason Partners Equity Trust (“service affiliates”), that were reasonably related to the performance of the annual audit of the service affiliates. Accordingly, there were no such fees that required pre-approval by the Audit Committee for the Reporting Periods (prior to August 6, 2003 services provided by the Auditor were not required to be pre-approved).

(c) Tax Fees. The aggregate fees billed in the Reporting Periods for professional services rendered by the Auditor for tax compliance, tax advice and tax planning (“Tax Services”) were $33,900 in 2007 and $53,213 in 2008. These services consisted of (i) review or preparation of U.S. federal, state, local and excise tax returns; (ii) U.S. federal, state and local tax planning, advice and assistance regarding statutory, regulatory or administrative developments, and (iii) tax advice regarding tax qualification matters and/or treatment of various financial instruments held or proposed to be acquired or held.

There were no fees billed for tax services by the Auditors to service affiliates during the Reporting Periods that required pre-approval by the Audit Committee.

d) All Other Fees. The fees billed in the Reporting Periods for products and services provided by the Auditor, other than the services reported in paragraphs (a) through (c) of this Item 4 for the Legg Mason Partners Equity Trust were $35,150 in 2007 and $0 in 2008. These fees consisted of procedures performed in connection with the mergers on December 1, 2006, March 2, 2007 and March 16, 2007.

All Other Fees. There were no other non-audit services rendered by the Auditor to Legg Mason Partners Fund Advisors, LLC (“LMPFA”), and any entity controlling, controlled by or under common control with LMPFA that provided ongoing services to Legg Mason Partners Equity Trust requiring pre-approval by the Audit Committee in the Reporting Period.

(e) Audit Committee’s pre–approval policies and procedures described in paragraph (c) (7) of Rule 2-01 of Regulation S-X.

(1) The Charter for the Audit Committee (the “Committee”) of the Board of each registered investment company (the “Fund”) advised by LMPFA or one of their affiliates (each, an “Adviser”) requires that the Committee shall approve (a) all audit and permissible non-audit services to be provided to the Fund and (b) all permissible non-audit services to be provided by the Fund’s independent auditors to the Adviser and any Covered Service Providers if the engagement relates directly to the operations and financial reporting of the Fund. The Committee may implement policies and procedures by which such services are approved other than by the full Committee.

The Committee shall not approve non-audit services that the Committee believes may impair the independence of the auditors. As of the date of the approval of this Audit Committee Charter, permissible non-audit services include any professional services (including tax services), that are not prohibited services as described below, provided to the Fund by the independent auditors, other than those provided to the Fund in connection with an audit or a review of the financial statements of the Fund. Permissible non-audit services may not include: (i) bookkeeping or other services related to the accounting records or financial statements of the Fund; (ii) financial information systems design and implementation; (iii) appraisal or valuation services, fairness opinions or contribution-in-kind reports; (iv) actuarial services; (v) internal audit outsourcing services; (vi) management functions or human resources; (vii) broker or dealer, investment adviser or investment banking services; (viii) legal services and expert services unrelated to the audit; and (ix) any other service the Public Company Accounting Oversight Board determines, by regulation, is impermissible.

Pre-approval by the Committee of any permissible non-audit services is not required so long as: (i) the aggregate amount of all such permissible non-audit services provided to the Fund, the Adviser and any service providers controlling, controlled by or under common control with the Adviser that provide ongoing services to the Fund (“Covered Service Providers”) constitutes not more than 5% of the total amount of revenues paid to the independent auditors during the fiscal year in which the permissible non-audit services are provided to (a) the Fund, (b) the Adviser and (c) any entity controlling, controlled by or under common control with the Adviser that provides ongoing services to the Fund during the fiscal year in which the services are provided that would have to be approved by the Committee; (ii) the permissible non-audit services were not recognized by the Fund at the time of the engagement to be non-audit services; and (iii) such services are promptly brought to the attention of the Committee and approved by the Committee (or its delegate(s)) prior to the completion of the audit.

(2) For the Legg Mason Partners Equity Trust, the percentage of fees that were approved by the audit committee, with respect to: Audit-Related Fees were 100% and 0% for 2007 and 2008; Tax Fees were 100% and 0% for 2007 and 2008; and Other Fees were 100% and 0% for 2007 and 2008.

(f) N/A

(g) Non-audit fees billed by the Auditor for services rendered to Legg Mason Partners Equity Trust, LMPFA and any entity controlling, controlled by, or under common control with LMPFA that provides ongoing services to Legg Mason Partners Equity Trust during the reporting period were $0 in 2008.

(h) Yes. Legg Mason Partners Equity Trust’s Audit Committee has considered whether the provision of non-audit services that were rendered to Service Affiliates, which were not pre-approved (not requiring pre-approval), is compatible with maintaining the Accountant’s independence. All services provided by the Auditor to the Legg Mason Partners Equity Trust or to Service Affiliates, which were required to be pre-approved, were pre-approved as required.

ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.

 

  a) The independent board members are acting as the registrant’s audit committee as specified in Section 3(a)(58)(B) of the Exchange Act .The Audit Committee consists of the following Board members:

Paul R. Ades

Andrew L. Breech

Dwight B. Crane

Robert M. Frayn, Jr.

Frank G. Hubbard

Howard J. Johnson

David E. Maryatt

Jerome H. Miller

Ken Miller

John J. Murphy

Thomas F. Schlafly

Jerry A. Viscione

 

  b) Not applicable.

 

ITEM 6. SCHEDULE OF INVESTMENTS.

Included herein under Item 1.

 

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

Not applicable.

 

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

Not applicable.

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

Not applicable.

 

ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

Not applicable.

 

ITEM 11. CONTROLS AND PROCEDURES.

 

  (a) The registrant’s principal executive officer and principal financial officer have concluded that the registrant’s disclosure controls and procedures (as defined in Rule 30a- 3(c) under the Investment Company Act of 1940, as amended (the “1940 Act”)) are effective as of a date within 90 days of the filing date of this report that includes the disclosure required by this paragraph, based on their evaluation of the disclosure controls and procedures required by Rule 30a-3(b) under the 1940 Act and 15d-15(b) under the Securities Exchange Act of 1934.

 

  (b) There were no changes in the registrant’s internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act) that occurred during the registrant’s last fiscal half-year (the registrant’s second fiscal half-year in the case of an annual report) that have materially affected, or are likely to materially affect the registrant’s internal control over financial reporting.

 

ITEM 12. EXHIBITS.

(a) (1) Code of Ethics attached hereto.

Exhibit 99.CODE ETH

(a) (2) Certifications pursuant to section 302 of the Sarbanes-Oxley Act of 2002 attached hereto.

Exhibit 99.CERT

(b) Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 attached hereto.

Exhibit 99.906CERT

SIGNATURES

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

 

Legg Mason Partners Equity Trust
By:  

/s/ R. Jay Gerken

  (R. Jay Gerken)
  Chief Executive Officer of
  Legg Mason Partners Equity Trust
Date: March 5, 2009

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

 

By:  

/s/ R. Jay Gerken

  (R. Jay Gerken)
  Chief Executive Officer of
  Legg Mason Partners Equity Trust
Date: March 5, 2009
By:  

/s/ Kaprel Ozsolak

  (Kaprel Ozsolak)
  Chief Financial Officer of
  Legg Mason Partners Equity Trust
Date:   March 5, 2009