GLOBAL EQUITY FUND
ANNUAL REPORT
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
IAI INVESTMENT FUNDS III, INC.
[LOGO] IAI
MUTUAL FUNDS
<PAGE>
TABLE OF CONTENTS
IAI INTERNATIONAL FUND
ANNUAL REPORT
OCTOBER 31, 1998
President's Letter.............................................. 2
Fund Manager's Review........................................... 4
Fund Portfolio...................................................8
Notes to Fund Portfolio........................................ 13
Statement of Assets and Liabilities............................ 14
Statements of Operations....................................... 15
Statements of Changes in Net Assets............................ 16
Financial Highlights........................................... 17
Notes to Financial Statements.................................. 18
Independent Auditors' Report....................................22
Federal Tax Information.........................................23
IAI Mutual Fund Family......................................... 24
Adviser, Custodian, Legal Counsel,
Independent Auditors,
Directors....................................... Inside Back Cover
<PAGE>
PRESIDENT'S LETTER
IAI INTERNATIONAL FUND
WHAT'S RIGHT WITH THIS MARKET
[PHOTO]
ROY C. GILLSON
PRESIDENT
The stock market has been on a roller coaster of late, and that naturally makes
people uneasy. But if you're a long-term investor, then I would argue that there
are a lot more good things influencing the market than bad things.
True, U.S. corporate earnings are flattening out, and that's putting a damper on
the stock market. When you buy a stock, you're buying a future stream of
dividends as well as a stronger company because most of the profits are being
reinvested. After double-digit growth during much of the 1990s, profits in 1998
are growing in the low single digits. A major reason why profits are sluggish is
the economic and currency turmoil in Asia, which hurts U.S. companies doing
business there.
Another reason for sluggish profit growth is the great job that Corporate
America has done to become more efficient. After years of cost-cutting, there
isn't much cutting left to do. To enhance profits, companies must either boost
prices or sell more products and services. But with inflation at virtually zero,
it's tough to raise prices. So, profit growth must come through increased unit
volume.
And that's where the good news is likely to begin. Even with the dampening
effects of Asia, the U.S. economy is still basically healthy, making it possible
for U.S. corporations to sell more products and services here at home. True,
we're losing business in Asia, because the dollar is so strong compared to their
currencies. But what we're losing in Asia, we're gaining in Europe, as that
region of the world begins to enjoy U.S.-style prosperity. Europe will look even
stronger once the Euro, the continent's single currency, begins to replace 11
currencies on January 1, 1999.
Asia has helped keep inflation worries away, and that has kept interest rates
low. Recently, the 30-year Treasury bond yield reached its lowest level ever, as
global investors buy our securities for the greatest safety and liquidity.
Partly because of our low inflation environment, worldwide demand for U.S.
stocks and bonds continues to be strong.
Even if 1998 turns out to be a mediocre year for stocks, let's not feel too
sorry for ourselves. The Dow Jones Industrial Average has more than doubled
since 1995 and virtually tripled since the beginning of this decade. Where was
the Dow in 1982? 800! Has your house gone up by a factor of ten in fifteen
years? Probably not. The point is that markets do not go up in a straight line,
and there is bound to be volatility. But if you're an investor for the long
term, then you should be able to step back and see the good in this market.
2
<PAGE>
PRESIDENT'S LETTER
IAI INTERNATIONAL FUND
ECONOMIC OUTLOOK
A summary of economic outlook as provided by Larry Hill, IAI's Chief Fixed
Income Officer, follows.
Growth in the U.S. economy is likely to slow in the months ahead, but it is hard
to become too negative on the outlook for the coming year. Although past
performance does not guarantee future success, there is little evidence of a
recession on the horizon. A modest slowdown is more likely, with real growth
dropping to about 2.5% for 1999. Inflation should continue to drift downward.
In general, the world has built excess capacity. Even in the United States,
which is one of the best performing economies, capacity utilization rates are
below peak levels and credit is readily available to make further productive
investments. Although labor markets are tight and employment costs are rising,
inflation is not a near-term threat.
To be sure, the economy is losing some of its forward momentum. The manu
facturing sector is clearly showing signs of weakness. This sector is directly
exposed to the global glut of commodity goods. With weakness overseas, exports
are slowing while imports are rising. Layoff announcements have picked-up, and
consumer confidence has dropped sharply in response to stock market volatility.
Disposable income is still growing, but at a slower pace. Corporate profits are
also being squeezed, which is likely to reduce capital spending plans for next
year. These indicators all point to slower growth ahead.
Yet, growing evidence of economic deterioration--if this occurs--will prompt
further rate reduction. Having taken the first step to ease in three years, the
Fed is now sensitive to overseas conditions and the fluid economic environment.
If the economy appears to be stumbling, the Fed has plenty of room to drop rates
and will do so with little hesitation. Likewise, renewed turmoil in the markets
will also prompt Fed action. Thus our outlook for no recession is driven by our
confidence that the Fed can and will act if necessary.
Fed diligence is also a key ingredient for the markets. Subdued inflation and
the prospect for further cuts in short rates--if need be--will provide good
support for bonds. Stock prices remain trapped in a tug-of-war between feeble
earnings and favorable liquidity. The stock market will be pulled up and down
until one force overcomes the other and sets the next trend.
Please read the Fund Manager's Review, which follows this letter, for a detailed
perspective on Fund performance and our strategy going forward. We appreciate
your continued trust and confidence in IAI. If there is any way we can serve you
better, please let us know by calling our toll-free Investor Services Hotline at
1-800-945-3863.
SINCERELY,
/s/ Roy C. Gillson
Roy C. Gillson
President
3
<PAGE>
FUND MANAGER'S REVIEW
IAI INTERNATIONAL FUND
IAI INTERNATIONAL
[PHOTO]
ROY C. GILLSON
IAI INTERNATIONAL
FUND MANAGER
FUND HOW HAS THE FUND PERFORMED?
The IAI International Fund returned (5.31)% for the twelve months ended October
31, 1998 compared to the Morgan Stanley EAFE Index which produced a return of
9.95%. The Fund benefited from an overweighting of Finland, France and Portugal
and underweighting of Japan, Malaysia, Norway and Sweden. Conversely, an
overweighting of Australia, New Zealand and Singapore and underweighting of
Belgium, the U.K. and Switzerland, coupled with emerging markets and small cap
stocks, detracted from performance.
WHICH HOLDINGS WERE PARTICULARLY SUCCESSFUL FOR THE FUND? WERE THERE ANY
DISAPPOINTMENTS?
Given the volatile nature of the markets over the course of the past twelve
months, stock performance was mixed. Our best performing stocks were in
Continental Europe, particularly France and Portugal. Disappointments were
primarily found in the Far East and Latin America, which suffered as a result of
the Asian turmoil.
WERE THERE ANY SIGNIFICANT CHANGES?
Changes within our overall allocation to the major geographic regions were
modest. Within the Far East, we sold our holdings in Hong Kong and Malaysia,
while increasing our commitment to Singapore. We also reduced our exposure to
Japan. Within Europe, we increased our commitment to Continental Europe,
establishing positions in Switzerland and Italy, and decreased our exposure to
the UK.
We continue to maintain an overweight position in the Far East relative to
the benchmark, although we remain underweighted in Japan. Within Continental
Europe, we are maintaining a strong presence in France. Our commitment to
emerging markets and small cap stocks remained unchanged.
CAN YOU POINT TO ANY SPECIFIC MARKET FACTORS THAT INFLUENCED THE FUND'S
PERFORMANCE?
The focus of world equity markets has been on the collapse of the Far East,
which began in Thailand in the summer of 1997 and has continued throughout 1998
despite a short-lived rally in the first quarter. In Malaysia, the government
imposed capital controls, while in Japan, the market continued its decline as
further evidence of the financial sector crisis and slowing domestic demand
emerged. Australasian markets declined by more modest amounts as investors moved
money into these more predictable economies.
Many European markets enjoyed strong double-digit returns as investors
sought shelter in a region thought to be relatively safe. In contrast, most
emerging markets and small cap stocks were negatively affected by the Asian
crisis..
WHAT IS YOUR OUTLOOK FOR THE FUND?
Asian markets have now reached attractive levels of valuation and offer
attractive long term opportunities. We remain committed to Singapore and select
sectors of the Japanese market, and are cautiously assessing other markets
within the region. In Australasia, although raw material stocks declined as
growth forecasts were reduced, commodity plays still offer good long-term value
and we are maintaining a strong presence in this region.
Continental European economies are likely to continue their slow recovery,
influenced by capital investment and some pick-up in consumer spending. We
remain committed to France where we continue to find companies offering superior
value.
Emerging markets and international small cap stocks offer select
opportunities on a long-term basis and we remain convinced of the relative
attractiveness of these two asset classes. Current depressed prices are
providing clear buying opportunities.
4
<PAGE>
FUND MANAGER'S REVIEW
IAI INTERNATIONAL FUND
PORTFOLIO WEIGHTING:
IAI INTERNATIONAL FUND VS. EAFE INDEX
10/31/98
------------------------------------ Country Returns
IAI EAFE for the 12 Months
International Fund Index Ended 10/31/98
- --------------------------------------------------------------------------------
AFRICA
Egypt --% --% n/a
South Africa -- -- (25%)
EUROPE
Austria -- -- 4%
Belgium 1 2 52%
Denmark -- 1 15%
Finland 2 1 58%
France 25 9 36%
Germany 9 10 30%
Greece -- -- 44%
Ireland -- 1 20%
Italy 3 5 41%
Netherlands 3 5 10%
Norway -- 1 (27%)
Poland -- -- (16%)
Portugal 3 1 38%
Spain 4 3 48%
Sweden 1 3 5%
Switzerland 3 8 25%
Turkey -- -- (51%)
United Kingdom 10 22 14%
FAR EAST
Australia 6 3 2%
Hong Kong 1 2 (1%)
India -- -- (36%)
Israel 1 -- (19%)
Japan 12 22 (14%)
Malaysia -- -- (63%)
New Zealand 1 -- (32%)
Philippines -- -- (16%)
Singapore 4 1 (22%)
South Korea -- -- (37%)
Taiwan -- -- (13%)
Thailand 1 -- (15%)
LATIN AMERICA
Argentina 1 -- (16%)
Brazil 1 -- (35%)
Chile -- -- (38%)
Mexico 1 -- (27%)
Peru 1 -- (41%)
OTHER COUNTRIES 1 --
CASH 5 --
==========================================================================
TOTAL 100% 100%
==========================================================================
5
<PAGE>
FUND MANAGER'S REVIEW
IAI INTERNATIONAL FUND
TOP TEN STOCK HOLDINGS
% of Net Assets
---------------------
Issues Country Industry 10/31/98 1/31/98
- --------------------------------------------------------------------------------
Qualis* France Financial 11.53 5.80
Telecom Italia Italy Services 2.48 --
Eisai Japan Consumer Goods 2.05 2.29
Suez Lyonnaise des Eaux France Services 2.04 2.20
Groupe Danone France Consumer Goods 2.00 --
Dexia France France Financial 1.99 1.50
Sekisui Chemical Japan Materials 1.83 1.58
United Overseas Bank Singapore Financial 1.80 0.43
Eridania Beghin-Say France Consumer Goods 1.79 1.87
UPM-Kymmene Finland Materials 1.77 1.88
================================================================================
TOTAL 29.28 17.55
================================================================================
*DENOTES AN ILLIQUID RESTRICTED SECURITY WHICH IS INCLUDED IN "OTHER SECURITIES"
IN THE FUND PORTFOLIO.
TOP FIVE COUNTRIES
% OF NET ASSETS
[BAR CHART]
AS OF 10/31/98 AS OF 1/31/98
FRANCE 22.9% 17.5%
JAPAN 11.5% 16.4%
UNITED KINGDOM 9.1% 13.4%
GERMANY 8.4% 8.5%
AUSTRALIA 5.3% 2.8%
6
<PAGE>
FUND MANAGER'S REVIEW
IAI INTERNATIONAL FUND
VALUE OF $10,000 INVESTMENT+
[PLOT POINTS CHART]
IAI INTERNATIONAL EAFE
FUND INDEX
11/01/88 10,000 10,000
10/31/89 11,376 10,840
10/31/90 10,865 9,479
10/31/91 12,191 10,172
10/31/92 11,177 8,860
10/31/93 15,516 12,216
10/31/94 17,139 13,483
10/31/95 17,160 13,474
10/31/96 18,682 14,930
10/31/97 19,051 15,664
10/31/98 18,039 17,223
AVERAGE ANNUAL RETURNS+
THROUGH 10/31/98
1 Year 5 Years 10 Years
- --------------------------------------------------------------------------------
IAI INTERNATIONAL FUND (5.31%) 3.06% 6.08%
- --------------------------------------------------------------------------------
EAFE Index 9.95% 7.11% 5.59%
+ PAST PERFORMANCE IS NOT PREDICTIVE OF FUTURE PERFORMANCE.
NOTE TO PRESIDENT'S LETTER & FUND MANAGER'S REVIEW
PERFORMANCE DATA FOR THE IAI INTERNATIONAL FUND INCLUDES CHANGES IN SHARE VALUE
AND ASSUMES REIN-VESTMENT OF ALL DIVIDENDS AND CAPITAL GAINS. PAST PERFORMANCE
IS NOT A GUARANTEE OF FUTURE RESULTS. THE FUND'S INVESTMENT RETURN AND PRINCIPAL
MAY FLUCTUATE, SO THAT WHEN REDEEMED, SHARES MAY BE WORTH MORE OR LESS THAN THE
ORIGINAL COST. MORE COMPLETE INFORMATION ABOUT THE FUND, INCLUDING CHARGES AND
EXPENSES, IS AVAILABLE IN THE PROSPECTUS. PLEASE READ THE FUND'S PROSPECTUS
CAREFULLY BEFORE INVESTING. ALL INDICES CITED ARE UNMANAGED, AND ARE EITHER
TRADEMARKS, REGISTERED TRADEMARKS OR COPYRIGHTS OF THEIR RESPECTIVE SPONSORING
COMPANIES.
7
<PAGE>
FUND PORTFOLIO
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
(PERCENTAGE FIGURES INDICATE PERCENTAGE OF TOTAL NET ASSETS)
COMMON STOCKS - 73.9%
Market
Quantity Value (a)
- --------------------------------------------------------------------------------
ARGENTINA - 0.6%
Gas Natural Ban
Class B (Energy) (b) 48,890 $ 75,802
Telefonica de Argentina
Class B ADR (Services) 1,770 58,521
YPF Class D ADR (Energy) 3,139 90,835
------------
225,158
- --------------------------------------------------------------------------------
AUSTRALIA - 5.3%
Australian National Industries
(Materials) 80,000 47,046
Boral (Materials) 138,600 224,252
Broken Hill Proprietary (Materials) 66,966 566,752
Commonwealth Bank
of Australia (Financial) 36,900 456,731
David Jones (Services) 150,000 152,059
Henry Walker Group (Energy) 110,000 122,532
M.I.M. Holdings (Materials) 620,000 300,944
------------
1,870,316
- --------------------------------------------------------------------------------
BELGIUM - 0.4%
Compagnie Maritime
Belge (Services) 2,650 136,533
- --------------------------------------------------------------------------------
BRAZIL - 0.2%
Electricidade do Estado
da Bahia (Energy) 1,087,000 34,809
Usinas Siderurgicas de
Minas Gerais ADR (Materials) 6,700 20,100
------------
54,909
- --------------------------------------------------------------------------------
CHILE - 0.3%
Enersis ADR (Energy) 3,026 63,168
Supermercados Unimarc
ADR (Consumer Goods) 9,491 32,625
------------
95,793
- --------------------------------------------------------------------------------
Market
Quantity Value (a)
- --------------------------------------------------------------------------------
EGYPT - 0.2%
Suez Cement GDR (Materials) (c) 4,555 $ 66,959
- --------------------------------------------------------------------------------
FINLAND - 1.8%
Orion-Yhtyma Class B
(Consumer Goods) 333 7,997
UPM-Kymmene (Materials) 26,100 621,614
------------
629,611
- --------------------------------------------------------------------------------
FRANCE - 11.4%
CNP Assurances (Financial) (b) 11,754 399,556
Compagnie des Alpes (Services) 3,000 92,856
Dexia France (Financial) 4,740 698,589
Eridania Beghin-Say
(Consumer Goods) 3,490 628,037
Groupe Danone (Consumer Goods) 2,657 702,381
La Rochette (Materials) (b) 60,000 192,190
Michelin Class B (Consumer Goods) 11,486 473,330
Rubis (Materials) 3,800 100,522
Suez Lyonnaise des Eaux
(Services) 4,010 718,004
------------
4,005,465
- --------------------------------------------------------------------------------
GERMANY - 7.1%
BASF (Materials) 5,730 242,873
Bayer (Materials) 12,926 525,250
Berliner Elektro Holding
(Capital Equipment) 5,613 77,271
BHF-Bank (Financial) 7,300 280,990
Deutsche Bank (Financial) 2,550 158,586
Deutsche Telekom (Services) 7,140 193,136
Dyckerhoff & Widmann (Materials) 1,800 195,629
Fuchs Petrolub (Materials) 1,750 188,609
KM Europa Metal (Materials) 3,850 205,727
VEBA (Energy) 7,400 413,296
------------
2,481,367
- --------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 13
8
<PAGE>
FUND PORTFOLIO
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
COMMON STOCKS (CONT.)
Market
Quantity Value (a)
- --------------------------------------------------------------------------------
GREECE - 0.2%
Delta Informatics
(Capital Equipment) 3,296 $ 61,348
Texniki Et Boloy
(Capital Equipment) 3,853 13,618
------------
74,966
- --------------------------------------------------------------------------------
HONG KONG - 1.3%
Giordano International
(Consumer Goods) 740,000 88,846
Jardine Strategic (Multi - Industry) 216,000 345,600
Sinocan Holdings
(Consumer Goods) (b) 1,338,893 14,519
------------
448,965
- --------------------------------------------------------------------------------
INDIA - 0.1%
Indian Petrochemicals GDR
(Materials) 12,100 47,190
- --------------------------------------------------------------------------------
ISRAEL - 0.6%
Bank Hapoalim (Financial) 28,173 50,763
Blue Square Chain Investments
& Properties (Consumer Goods) (b) 3,544 45,139
Blue Square-Israel ADR
(Consumer Goods) 3,886 50,032
Tadiran Telecommunications ADR
(Services) (c) 4,170 69,848
------------
215,782
- --------------------------------------------------------------------------------
ITALY - 2.8%
Banca Popolare di Milano (Financial) 4,102 32,155
Caffaro (Materials) 70,000 72,852
Telecom Italia (Services) 171,920 870,698
------------
975,705
- --------------------------------------------------------------------------------
Market
Quantity Value (a)
- --------------------------------------------------------------------------------
JAPAN - 11.5%
Eisai (Consumer Goods) 46,000 $ 721,600
Hitachi (Capital Equipment) 116,000 590,303
Mazda Motor
(Consumer Goods) (b) 125,000 466,618
Mitsui Wood Systems
(Capital Equipment) 36,000 64,876
NAMCO (Consumer Goods) 15,000 330,172
New Japan Radio
(Capital Equipment) 45,000 104,265
Nippon Telegraph & Telephone
(Services) 102 400,017
Nippon Yusen Kabushiki Kaisha
(Services) 186,000 616,116
Sekisui Chemical (Materials) 118,000 643,010
Toyoda Gosei (Materials) 23,000 82,108
------------
4,019,085
- --------------------------------------------------------------------------------
MALAYSIA - 0.2%
Boustead Holdings
(Multi - Industry) 48,236 22,182
Land & General
(Multi - Industry) (b) 214,000 27,665
Petronas Dagangan
(Energy) 74,400 33,627
------------
83,474
- --------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 13
9
<PAGE>
FUND PORTFOLIO
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
COMMON STOCKS (CONT.)
Market
Quantity Value (a)
- --------------------------------------------------------------------------------
MEXICO - 0.7%
Corporacion GEO Series B
(Financial) (b) 9,455 $ 16,344
Grupo Carso Series A-1
(Multi - Industry) 10,700 36,942
Grupo Industrial Maseca ADR
(Consumer Goods) 1,420 17,573
Grupo Tribasa ADR
(Capital Equipment) (b) 9,530 19,060
Industrias Series B
(Capital Equipment) (b) 23,000 52,939
Telefonos de Mexico ADR
(Services) 1,629 86,032
------------
228,890
- --------------------------------------------------------------------------------
NETHERLANDS - 2.7%
Boskalis Westminster
(Capital Equipment) 13,000 175,403
European Vinyls Corporation
International (Materials) 2,000 18,633
KLM Royal Dutch Air Lines
(Services) 11,470 346,366
Macintosh Retail Group
(Consumer Goods) 8,200 228,302
Ten Cate (Consumer Goods) 6,250 194,089
------------
962,793
- --------------------------------------------------------------------------------
NEW ZEALAND - 0.9%
Carter Holt Harvey (Materials) 201,300 164,115
Restaurant Brands
(Consumer Goods) 150,000 65,116
Wrightson (Services) 500,000 87,351
------------
316,582
- --------------------------------------------------------------------------------
NORWAY - 0.4%
Awilco Class B (Energy) 60,000 97,664
Petroleum
Geo-Services (Energy) (b) 2,304 48,754
------------
146,418
- --------------------------------------------------------------------------------
Market
Quantity Value (a)
- --------------------------------------------------------------------------------
PERU - 0.4%
Credicorp ADR (Financial) 1,160 $ 8,120
Credicorp ADR (Financial) 5,640 38,070
Edegel Class B
(Energy) 235,740 60,702
Telefonica del Peru Class B ADR
(Services) 3,560 46,280
------------
153,172
- --------------------------------------------------------------------------------
PHILIPPINES - 0.2%
Universal Robina (Services) 833,539 66,105
- --------------------------------------------------------------------------------
POLAND - 0.3%
Elektrim (Capital Equipment) 7,600 90,437
- --------------------------------------------------------------------------------
PORTUGAL - 2.7%
Banco Pinto & Sotto Mayor
(Financial) 31,346 601,199
Brisa-Auto Estradas
(Capital Equipment) 7,358 356,707
------------
957,906
- --------------------------------------------------------------------------------
SINGAPORE - 4.0%
Amteck Engineering
(Capital Equipment) 275,000 119,066
GPE Industries
(Capital Equipment) 250,000 86,250
Hong Leong Finance,
foreign (Financial) 60,000 68,906
Singapore Airlines,
foreign (Services) 81,289 499,226
United Overseas Bank,
foreign (Financial) 134,453 631,681
------------
1,405,129
- --------------------------------------------------------------------------------
SOUTH AFRICA - 0.3%
Bidvest Group (Consumer Goods) 10,691 77,180
South African Iron & Steel Industrial
(Materials) 162,500 41,132
------------
118,312
- --------------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 13
10
<PAGE>
FUND PORTFOLIO
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
COMMON STOCKS (CONT.)
Market
Quantity Value (a)
- --------------------------------------------------------------------------------
SOUTH KOREA - 0.2%
Pohang Iron & Steel, foreign
(Materials) 1,060 $ 58,708
Samsung Electronics, foreign
(Consumer Goods) 421 17,229
------------
75,937
- --------------------------------------------------------------------------------
SPAIN - 3.5%
Banco de Valencia (Financial) 4,000 106,293
Catalana Occidente (Financial) 1,500 39,753
Fuerzas Electricas de Cataluna
Class A (Energy) 47,633 479,300
Iberdrola (Energy) 36,230 584,065
------------
1,209,411
- --------------------------------------------------------------------------------
SWEDEN - 0.7%
ICB Shipping Class B (Services) 19,000 143,404
N&T Argonaut Class A (Services) (b) 55,052 39,437
N&T Argonaut Class B (Services) (b) 104,948 68,470
------------
251,311
- --------------------------------------------------------------------------------
SWITZERLAND - 2.9%
Danzas Holding (Services) 200 55,088
Forbo Holding (Materials) 100 41,353
Swatch Group Class B
(Consumer Goods) 1,060 584,714
Swisscom (Services) (b) 978 331,489
------------
1,012,644
- --------------------------------------------------------------------------------
TAIWAN - 0.3%
Taipei Fund IDR (Financial) (b) 14 (e) 116,200
- --------------------------------------------------------------------------------
THAILAND - 0.4%
Bangkok Bank, foreign (Financial) (b) 24,916 37,972
Charoen Pokphand Feedmill, foreign
(Consumer Goods) (b) 28,930 31,493
Hana Microelectronics, foreign
(Capital Equipment) (b) 24,760 66,372
Siam City Bank, foreign (Financial) (b) 30,825 252
Srithai Superware, foreign
(Consumer Goods) (b) 39,100 7,555
------------
143,644
- --------------------------------------------------------------------------------
Market
Quantity Value (a)
- --------------------------------------------------------------------------------
TURKEY - 0.1%
Tofas Turk Otomobile GDR
(Consumer Goods) (b) (c) 262,500 $ 18,374
- --------------------------------------------------------------------------------
UNITED STATES - 0.1%
Morgan Stanley India Investment
Fund (Multi-Industry) (b) 7,400 49,950
- --------------------------------------------------------------------------------
UNITED KINGDOM - 9.1%
Blue Circle Industries (Materials) 80,560 440,156
BTR (Consumer Goods) 252,190 441,348
Cookson Group (Materials) 18,116 37,924
Delta (Electronic Technology) 30,000 66,318
Enterprise Oil (Energy) 40,200 274,678
Eurocamp (Services) 47,000 145,615
Greenalls Group (Services) 54,531 299,083
Imperial Tobacco Group
(Consumer Goods) 34,380 354,094
Low & Bonar (Consumer Goods) 36,000 125,402
Medeva (Consumer Goods) 15,000 30,396
Rolls-Royce (Capital Equipment) 132,956 490,968
Tomkins (Multi - Industry) 90,197 417,661
United Biscuits (Services) 16,651 65,530
------------
3,189,173
================================================================================
TOTAL INVESTMENTS IN COMMON STOCKS
(COST: $29,966,226)........................................... $ 25,943,666
================================================================================
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 13
11
<PAGE>
FUND PORTFOLIO
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
NON-CONVERTIBLE PREFERRED STOCKS - 1.9%
Market
Quantity Value (a)
- --------------------------------------------------------------------------------
AUSTRIA - 0.1%
Baumax (Consumer Goods) 1,250 $ 24,136
- --------------------------------------------------------------------------------
BRAZIL - 0.4%
Centrais Electricas de Santa
Catarina Series B (Energy) 90,600 50,886
Centrais Electricas de Santa
Catarina Series B GDR (Energy) (c) 120 6,600
Eletricidade do Estado
da Bahia (Energy) (b) 2,147,000 68,393
Mineracado da Trinidade-Samitri
(Materials) 2,424,235 25,403
------------
151,282
- --------------------------------------------------------------------------------
GERMANY - 1.3%
Koenig & Bauer (Capital Equipment) 875 216,610
Rheinmetall (Capital Equipment) 11,500 229,139
------------
445,749
- --------------------------------------------------------------------------------
SOUTH KOREA - 0.1%
Samsung Electronics, foreign
(Consumer Goods) 1,600 20,129
================================================================================
TOTAL INVESTMENTS IN NON-CONVERTIBLE
PREFERRED STOCKS
(COST: $733,603).............................................. $ 641,296
================================================================================
OTHER SECURITIES - 11.5%
Ownership Market
Percentage Value (a)
- --------------------------------------------------------------------------------
FRANCE - 11.5%
Qualis (LIMITED PARTNERSHIP) (b) (d) 2.82% $ 4,048,947
================================================================================
TOTAL INVESTMENTS IN OTHER SECURITIES
(COST: $3,709,515)............................................ $ 4,048,947
================================================================================
TOTAL INVESTMENTS IN LONG-TERM SECURITIES
(COST: $34,409,344)........................................... $ 30,633,909
================================================================================
SHORT-TERM SECURITIES - 4.9%
Principal Market
Rate Maturity Amount Value (a)
- --------------------------------------------------------------------------------
COMMERCIAL PAPER - 4.9%
Ford Motor Credit (Financial)
5.72% 11/02/98 $ 1,730,000 0 $ 1,729,725
================================================================================
TOTAL INVESTMENTS IN SHORT-TERM SECURITIES
(COST: $1,729,725)............................................ $ 1,729,725
================================================================================
TOTAL INVESTMENTS IN SECURITIES
(COST: $36,139,069) (f)....................................... $ 32,363,634
================================================================================
OTHER ASSETS AND LIABILITIES (NET) - 7.8%
.............................................................. $ 2,752,789
================================================================================
TOTAL NET ASSETS
.............................................................. $ 35,116,423
================================================================================
SEE ACCOMPANYING NOTES TO FUND PORTFOLIO ON PAGE 13
12
<PAGE>
NOTES TO FUND PORTFOLIO
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
(a)
Market values of securities are stated in U.S. dollars and are determined as
described in Note 1 to the financial statements, under "Security Valuation."
(b)
Currently non-income producing security.
(c)
Represents security sold within terms of a private placement memorandum exempt
from registration under Section 144A of the Securities Act of 1933. This issue
may be only sold to other qualified institutional buyers and is considered
liquid under guidelines established by the Board of Directors.
(d)
Restricted securities generally must be registered with the Securities and
Exchange Commission under the Securities Act of 1933 prior to being sold to the
public and are considered illiquid. For the restricted security issue held at
October 31, 1998, the Fund held no unrestricted securities of the same issuer as
of either the date the purchase price was agreed to or the date the Fund first
obtained an enforceable right to obtain the security. The restricted security
held was acquired on 04/02/96 and 01/13/98 for a total cost of $3,709,515.
(e)
Quantity disclosed in units. One unit represents 100 shares.
(f)
At October 31, 1998, the cost of securities for federal income tax purposes and
the aggregate gross unrealized appreciation and depreciation based on that cost
were as follows:
Cost for federal tax purposes......................... $ 37,204,234
======================
Gross unrealized appreciation......................... $ 1,614,302
Gross unrealized depreciation......................... (6,454,902)
----------------------
Net unrealized depreciation .......................... $ (4,840,600)
======================
13
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Investments in securities, at market (Cost: $36,139,069) $ 32,363,634
Cash in bank on demand deposit 281,454
Receivable for investment securities sold 302,555
Receivable for Fund shares sold 2,055,396
Dividends receivable 379,549
Unrealized appreciation on foreign currency contracts held, at value (Note 6) 4,475
Other 8,002
-----------------
TOTAL ASSETS 35,395,065
-----------------
LIABILITIES
Payable for investment securities purchased 140,938
Unrealized depreciation on foreign currency contracts held, at value (Note 6) 135,879
Accrued management fee 1,635
Other accrued expenses 190
-----------------
TOTAL LIABILITIES 278,642
-----------------
NET ASSETS APPLICABLE TO OUTSTANDING CAPITAL STOCK $ 35,116,423
=================
REPRESENTED BY:
Capital stock $ 35,788
Additional paid-in capital 40,794,359
Undistributed net investment income 62,615
Accumulated net realized losses on investments (1,863,618)
Unrealized appreciation or depreciation on:
Investment securities $ (3,775,435)
Other assets and liabilities denominated in foreign currency (137,286)
----------------
(3,912,721)
-----------------
TOTAL - REPRESENTING NET ASSETS APPLICABLE TO OUTSTANDING CAPITAL STOCK $ 35,116,423
=================
Shares of capital stock outstanding; authorized 10 billion shares of $.01 par value stock 3,578,772
-----------------
NET ASSET VALUE PER SHARE OF OUTSTANDING CAPITAL STOCK $ 9.81
=================
</TABLE>
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS ON PAGE 18
14
<PAGE>
STATEMENTS OF OPERATIONS
IAI INTERNATIONAL FUND
<TABLE>
<CAPTION>
Period from
February 1, 1998 Year ended
to October 31, 1998* January 31, 1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
NET INVESTMENT INCOME
INCOME
Dividends (net of foreign income taxes withheld
of $111,412 and $375,988, respectively) $ 877,834 $ 3,103,120
Interest 115,458 160,631
---------------------------------------------------
TOTAL INCOME 993,292 3,263,751
---------------------------------------------------
EXPENSES
Management fees 554,928 1,762,718
Compensation of Directors 6,871 11,961
Interest 19,245 --
---------------------------------------------------
TOTAL EXPENSES 581,044 1,774,679
Less fees reimbursed by Advisers (6,871) (11,961)
---------------------------------------------------
NET EXPENSES 574,173 1,762,718
---------------------------------------------------
NET INVESTMENT INCOME 419,119 1,501,033
---------------------------------------------------
NET REALIZED AND UNREALIZED GAINS (LOSSES)
Net realized gains (losses) on:
Investment securities $ (161,857) $ 7,105,354
Foreign currency transactions (net of foreign currency tax of
$951 and $4,580, respectively) (310,672) (41,314)
------------- --------------
(472,529) 7,064,040
Net change in unrealized appreciation or depreciation on:
Investment securities $ 1,476,248 $ (7,735,915)
Other assets and liabilities denominated in
foreign currency (126,686) (397,700)
------------- --------------
1,349,562 (8,133,615)
---------------------------------------------------
NET GAIN (LOSS) ON INVESTMENTS 877,033 (1,069,575)
---------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 1,296,152 $ 431,458
===================================================
</TABLE>
*REFLECTS FISCAL YEAR END CHANGE FROM JANUARY 31 TO OCTOBER 31.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS ON PAGE 18
15
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
IAI INTERNATIONAL FUND
<TABLE>
<CAPTION>
Period from
February 1, 1998 Year ended Year ended
to October 31, 1998* January 31, 1998 January 31, 1997
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
OPERATIONS
Net investment income $ 419,119 $ 1,501,033 $ 2,042,362
Net realized gains (losses) (472,529) 7,064,040 12,005,271
Net change in unrealized appreciation or depreciation 1,349,562 (8,133,615) (10,839,388)
----------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 1,296,152 431,458 3,208,245
----------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (104,831) (2,498,912) (2,507,284)
Net realized gains (7,073) (9,915,596) (10,555,519)
----------------------------------------------------------------
TOTAL DISTRIBUTIONS (111,904) (12,414,508) (13,062,803)
----------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (NOTE 4)
Net proceeds from sale of shares 141,661,893 132,201,297 118,509,652
Net asset value of shares issued in
reinvestment of distributions 91,242 11,993,205 12,833,206
Cost of shares redeemed (171,169,607) (185,054,041) (156,960,324)
----------------------------------------------------------------
DECREASE IN NET ASSETS FROM CAPITAL SHARE TRANSACTIONS (29,416,472) (40,859,539) (25,617,466)
----------------------------------------------------------------
TOTAL DECREASE IN NET ASSETS (28,232,224) (52,842,589) (35,472,024)
NET ASSETS AT BEGINNING OF PERIOD 63,348,647 116,191,236 151,663,260
----------------------------------------------------------------
NET ASSETS AT END OF PERIOD $ 35,116,423 $ 63,348,647 $ 116,191,236
================================================================
INCLUDING UNDISTRIBUTED (OVERDISTRIBUTED)
NET INVESTMENT INCOME OF: $ 62,615 $ (121,935) $ 615,608
================================================================
</TABLE>
*REFLECTS FISCAL YEAR END CHANGE FROM JANUARY 31 TO OCTOBER 31.
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS ON PAGE 18
16
<PAGE>
FINANCIAL HIGHLIGHTS
IAI INTERNATIONAL FUND
PER SHARE DATA FOR A SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH PERIOD
AND SELECTED INFORMATION FOR EACH PERIOD INDICATED ARE AS FOLLOWS:
<TABLE>
<CAPTION>
Years ended
Period from January 31, Period from Year ended
February 1, 1998 to ------------------------------------- April 1, 1994 to March 31,
October 31, 1998++ 1998 1997 1996 January 31, 1995+ 1994
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE
Beginning of period $ 10.26 $ 12.11 $ 13.24 $ 12.06 $ 13.45 $ 11.22
---------------------------------------------------------------------------------------
OPERATIONS
Net investment income 0.10 0.20 0.24 0.19 0.11 0.06
Net realized and unrealized
gains (losses) (0.52) (0.34) 0.08 2.17 (0.62) 2.56
---------------------------------------------------------------------------------------
TOTAL FROM OPERATIONS (0.42) (0.14) 0.32 2.36 (0.51) 2.62
---------------------------------------------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (0.03) (0.32) (0.28) (0.16) -- (0.34)
Net realized gains -- (1.39) (1.17) (1.02) (0.88) (0.05)
---------------------------------------------------------------------------------------
TOTAL DISTRIBUTIONS (0.03) (1.71) (1.45) (1.18) (0.88) (0.39)
---------------------------------------------------------------------------------------
NET ASSET VALUE
End of period $ 9.81 $ 10.26 $ 12.11 $ 13.24 $ 12.06 $ 13.45
=======================================================================================
Total investment return* (4.15%) (1.04%) 2.39% 20.15% (4.14%) 23.85%
Net assets at end of period
(000's omitted) $ 35,116 $ 63,349 $ 116,191 $ 151,663 $ 136,474 $ 134,796
RATIOS
Expenses to average net assets
(including interest expense) 1.76%** 1.67% 1.65% 1.66% 1.72%** 1.74%
Expenses to average net assets
(excluding interest expense) 1.70%** 1.67% 1.65% 1.66% 1.72%** 1.74%
Net investment income to
average net assets 1.28%** 1.42% 1.56% 1.12% 1.04%** .87%
Portfolio turnover rate
(excluding short-term securities) 50.2% 76.4% 32.1% 39.2% 27.6% 50.9%
</TABLE>
* TOTAL INVESTMENT RETURN IS BASED ON THE CHANGE IN NET ASSET VALUE OF A
SHARE DURING THE PERIOD AND ASSUMES REINVESTMENT OF ALL DISTRIBUTIONS AT
NET ASSET VALUE.
** ANNUALIZED
+ REFLECTS FISCAL YEAR END CHANGE FROM MARCH 31 TO JANUARY 31.
++ REFLECTS FISCAL YEAR END CHANGE FROM JANUARY 31 TO OCTOBER 31.
17
<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
IAI Investment Funds III, Inc. is registered under the Investment Company Act of
1940 (as amended) as a diversified, open-end management investment company. IAI
International Fund is a separate portfolio of IAI Investment Funds III, Inc. The
Fund has a primary objective of capital appreciation mainly through investment
in equity securities of developed and emerging countries. This report covers
only the International Fund (the Fund).
On May 13, 1998, the Board of Directors elected to change the fiscal year end of
the Fund from January 31 to October 31. Accordingly, these financial statements
include the nine-month period from February 1, 1998 to October 31, 1998.
Significant accounting policies followed by the Fund are summarized below:
SECURITY VALUATION
Portfolio securities are valued at the close of the New York Stock Exchange on
each trading day. Listed and unlisted securities for which such information is
regularly reported are valued at the last sale price of the day or, in the
absence of sales, at values based on the closing bid or the last sale price on
the prior trading day. Long-term and short-term "non-money market" debt
securities are valued by a portfolio pricing service. Securities which cannot be
valued by the portfolio pricing service are valued using dealer-supplied
valuations, or are valued under consistently applied procedures established by
the Board of Directors to determine fair value in good faith. Short-term "money
market type" debt securities having a remaining maturity of 60 days or less at
acquisition are valued at cost adjusted for amortization to maturity of any
premium or discount. Forward foreign currency exchange contracts are valued
based on the closing prices of the forward currency contract rates in the London
foreign exchange markets on a daily basis as provided by a reliable bank or
dealer.
Restricted securities for which there is no public market are valued at fair
value in good faith under procedures established by the Board of Directors. Such
procedures consider various factors including, but not limited to, the cost of
the security at date of purchase, the current financial statements of the issuer
and special reports prepared by analysts, the size of the position held, recent
purchases or sales of securities of the company, prices and public trading
activity of comparable companies, the nature and duration of restrictions on
disposition, pending public offerings with respect to the security, changes in
economic conditions and industry developments affecting the issuer, and other
relevant matters. Such securities represent $4,048,947 (11.5% of net assets) as
of October 31, 1998. Because of the inherent uncertainty of valuation, those
estimated values may differ significantly from the values that would have been
used had a ready market for the securities existed, and the differences could be
material.
FOREIGN CURRENCY TRANSLATIONS AND FORWARD FOREIGN CURRENCY CONTRACTS
The Fund invests in foreign securities. The market value of securities and other
assets and liabilities denominated in foreign currencies is translated daily
into U.S. dollars at the closing rate of exchange. Purchases and sales of
securities, income and expenses are translated at the exchange rate on the
transaction date and are recorded in realized and unrealized appreciation
(depreciation) on foreign currency transactions. Exchange gains (losses) may
also be realized between the trade and settlement dates on security and forward
currency contract 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 from investments.
The Fund may enter into forward foreign currency exchange contracts for
operational purposes and to hedge against adverse exchange rate fluctuations.
The net U.S. dollar value of foreign currency underlying all contractual
commitments held by the Fund and the resulting
18
<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
[1] SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
unrealized appreciation or depreciation are determined using foreign currency
exchange rates from an independent pricing service. The Fund is subject to the
credit risk that the other party will not complete the obligations of the
contract.
FEDERAL TAXES
Since it is the Fund's policy to comply with the provisions of the Internal
Revenue Code applicable to regulated investment companies and to distribute all
of its taxable income to its shareholders, no provision for income taxes is
required. In order to avoid the payment of any federal excise taxes, the Fund is
required to distribute substantially all of its net investment income and net
realized gains on a calendar year basis.
Net investment income and net realized gains (losses) may differ for financial
statement and tax purposes primarily due to differing treatments for foreign
currency transactions, passive foreign investment companies (PFICs), and losses
deferred due to "wash sales." The character of distributions made during the
year for net investment income or net realized gains may differ from its
ultimate characterization for tax purposes.
The Fund may be subject to foreign taxes on income, gains on investments, or
currency repatriation. The Fund accrues such taxes as applicable.
On the statement of assets and liabilities, as a result of permanent book-to-tax
differences, additional paid-in capital has been decreased by $120,277,
undistributed net investment income has been decreased by $129,738 and
accumulated net realized gains have been increased by $250,015.
For federal income tax purposes, the Fund has a capital loss carryover of
approximately $835,000, at October 31, 1998, which, if not offset by subsequent
capital gains, will expire in 2006. It is unlikely the Board of Directors will
authorize a distribution of any net realized gains until the available capital
loss carryover is offset or expires.
SECURITY TRANSACTIONS AND INVESTMENT INCOME
The Fund records security transactions on trade date, the date the securities
are purchased or sold. Dividend income is recorded on the ex-dividend date or
upon receipt of ex-dividend notification in the case of certain foreign
securities.
Security gains and losses are determined on the basis of identified cost, which
is the same basis used for federal income tax purposes. Investment income is
recorded net of foreign taxes withheld where recovery of such taxes is
uncertain.
DISTRIBUTIONS TO SHAREHOLDERS
Distributions to shareholders are recorded on the ex-dividend date.
Distributions from net investment income are paid semi-annually. Capital gains,
if any, are primarily distributed as of the end of the calendar year. Additional
capital gains distributions as needed to comply with federal tax regulations are
distributed during the year.
CONCENTRATION OF RISK
Investments in countries with limited or developing capital markets may involve
greater risks than investments in more developed markets and the prices of such
investments may be volatile. The consequences of political, social or economic
changes in these markets may have disruptive effects on the market prices of the
Fund's investments and the income it generates, as well as the Fund's ability to
repatriate such amounts.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts in the financial statements. Actual results could
differ from those estimates.
19
<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
[2] COMMITMENTS AND CONTINGENCIES
INSURANCE
For purposes of obtaining certain types of insurance coverage for the Fund and
its officers and directors, the Fund is a policyholder in an industry-sponsored
mutual insurance company (the Company). The Fund is committed to make capital
contributions, if requested by the Company.
LINE OF CREDIT
The Fund had available a line of credit of $6,660,000, with a bank at the prime
interest rate. To the extent funds are drawn against the line, securities are
held in a segregated account. No compensating balances or commitment fees are
required under the line of credit. There were no borrowings outstanding at
October 31, 1998.
[3] FEES AND EXPENSES
Under terms of the Fund's Management Agreement, Investment Advisers, Inc.
(Advisers) is required to pay for all expenses of the Fund, except certain costs
(primarily those incurred in the purchase and sale of assets, taxes, interest
and extraordinary expenses), in return for the Fund paying an all inclusive
management fee (unified fee) to Advisers. The fee is equal to an annual rate of
1.70% declining to 1.30% of average daily net assets. The fee is paid monthly.
The Management Agreement further provides that Advisers will reimburse the Fund
for the fees and expenses it pays to Directors who are not "interested persons"
of the Fund or reduce its fee by an equivalent amount.
[4] CAPITAL STOCK
The Fund has authorized 10 billion shares of $.01 par value stock. Transactions
in shares of capital stock during the periods indicated were as follows:
Years ended
Period from January 31,
February 1, 1998 to ----------------------------
October 31, 1998 1998 1997
- --------------------------------------------------------------------------------
SOLD 13,642,998 10,833,124 9,050,644
ISSUED FOR REINVESTED
DISTRIBUTIONS 8,519 1,143,039 1,043,904
REDEEMED (16,247,561) (15,399,390) (11,955,329)
--------------------------------------------------------
INCREASE (DECREASE)
IN SHARES OUTSTANDING (2,596,044) (3,423,227) (1,860,781)
========================================================
20
<PAGE>
NOTES TO FINANCIAL STATEMENTS
IAI INTERNATIONAL FUND
OCTOBER 31, 1998
[5] INVESTMENT TRANSACTIONS
PURCHASES AND SALES OF SECURITIES
For the period ended October 31, 1998, purchases of securities and sales
proceeds, other than investments in short-term securities, for the Fund
aggregated $20,512,171 and $47,582,014, respectively.
RESTRICTED SECURITIES
Included in the Fund's portfolio of investments in securities at October 31,
1998, is an issue which generally cannot be offered for sale to the public
without first being registered under the Securities Act of 1933 ("restricted
securities"). This security, which represents 11.5% of net assets, is consider
illiquid.
The Fund limits investments in securities that are not readily marketable to 15%
of its net assets at the time of purchase. This limitation does not include Rule
144A securities that have been determined to be liquid based upon guidelines
approved by the Fund's Board of Directors.
[6] FOREIGN CURRENCY COMMITMENTS
At October 31, 1998, the Fund had entered into foreign currency exchange
contracts. The unrealized appreciation and/or depreciation on those contracts at
October 31, 1998 is included in unrealized appreciation or depreciation on other
assets and liabilities denominated in foreign currency. The terms of the open
contracts are as follows:
<TABLE>
<CAPTION>
Exchange Unrealized Unrealized
Date Currency to be Delivered Currency to be Received Appreciation Depreciation
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
11/02/98 9,992 U.S. Dollar 16,121 Australian Dollar $ 40 $ --
11/02/98 15,238 U.S. Dollar 24,585 Australian Dollar 61 --
11/02/98 22,207 U.S. Dollar 13,306 British Pound 76 --
11/02/98 106,385 Greek Drachma 376 U.S. Dollar -- 2
11/03/98 12,557 Argentine Peso 12,542 U.S. Dollar -- 19
11/03/98 3,153 U.S. Dollar 3,745 Brazilian Real -- 14
11/03/98 9,292 U.S. Dollar 17,766 New Zealand Dollar 113 --
11/03/98 32,395 Peruvian New Sol 10,491 U.S. Dollar -- 68
11/04/98 9,990 U.S. Dollar 11,870 Brazilian Real -- 40
11/04/98 3,324 U.S. Dollar 385,963 Japanese Yen -- 12
11/05/98 26,986 British Pound 45,093 U.S. Dollar -- 100
11/05/98 2,109 Singapore Dollar 1,294 U.S. Dollar -- 1
11/06/98 203,001 Singapore Dollar 124,540 U.S. Dollar -- 130
11/30/98 38,187 U.S. Dollar 210,447 French Franc -- 316
12/02/98 75,947,034 Japanese Yen 558,660 U.S. Dollar -- 96,242
12/02/98 53,787,240 Japanese Yen 468,000 U.S. Dollar 4,185 --
03/19/99 739,991 Singapore Dollar 427,000 U.S. Dollar -- 31,735
03/19/99 121,310 Singapore Dollar 70,000 U.S. Dollar -- 5,203
10/07/99 395,063 Hong Kong Dollar 48,900 U.S. Dollar -- 750
10/07/99 656,823 Hong Kong Dollar 81,300 U.S. Dollar -- 1,247
- --------------------------------------------------------------------------------------------------------------------
$ 4,475 $ 135,879
====================================================================================================================
</TABLE>
21
<PAGE>
INDEPENDENT AUDITORS' REPORT
IAI INTERNATIONAL FUND
THE BOARD OF DIRECTORS AND SHAREHOLDERS
IAI INVESTMENT FUNDS III, INC.:
We have audited the accompanying statement of assets and liabilities, including
the fund portfolio, of IAI International Fund (a portfolio within IAI Investment
Funds III, Inc.) as of October 31, 1998, and the related statements of
operations for the period from February 1, 1998 to October 31, 1998 and the year
ended January 31, 1998, the statements of changes in net assets for the period
from February 1, 1998 to October 31, 1998 and each of the years in the two-year
period ended January 31, 1998, and the financial highlights for the periods
presented on page 17 of the annual report. These financial statements and the
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and the 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. Investment securities held in custody are confirmed to us by the
custodian. As to securities purchased and sold but not received or delivered, we
request confirmations from brokers and where replies are not received, we carry
out 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 the financial highlights referred
to above present fairly, in all material respects, the financial position of IAI
International Fund at October 31, 1998, and the results of its operations, the
changes in its net assets and the financial highlights for the periods stated in
the first paragraph above, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Minneapolis, Minnesota
December 11, 1998
22
<PAGE>
FEDERAL TAX INFORMATION
IAI INTERNATIONAL FUND
We are required by federal tax regulations to provide shareholders with
certain information regarding dividend distributions paid during our fiscal
year. The figures provided are for informational purposes only and should not be
used for reporting to federal or state revenue agencies. You will receive all
necessary tax information on Form 1099-DIV, Dividends and Distributions, in
January of each year.
TAX INFORMATION
- -------------------------------------------------------------------------------
Payable Date Ordinary Income (A) Capital Gains
- -------------------------------------------------------------------------------
JUNE 1998 $ 0.0252 $ 0.0017
===============================================================================
$ 0.0252 $ 0.0017
(A) INCLUDES DISTRIBUTIONS OF SHORT-TERM CAPITAL GAINS, IF ANY, WHICH ARE
TAXABLE AS ORDINARY INCOME.
23
<PAGE>
IAI MUTUAL FUND FAMILY
TO DIVERSIFY YOUR PORTFOLIO, PLEASE CONSIDER ALL OF THE MUTUAL FUNDS IN OUR
FUND FAMILY
<TABLE>
<CAPTION>
SECONDARY
IAI FUND PRIMARY OBJECTIVE OBJECTIVE PORTFOLIO COMPOSITION
....................................................................................................................................
<S> <C> <C> <C>
IAI INTERNATIONAL FUND Capital Appreciation Income Equity securities of non-U.S. companies
- ------------------------------------------------------------------------------------------------------------------------------------
IAI EMERGING GROWTH FUND Capital Appreciation -- Common stocks of small- to medium-sized
emerging growth companies
- ------------------------------------------------------------------------------------------------------------------------------------
IAI CAPITAL Capital Appreciation -- Common stocks of small- to medium-sized
APPRECIATION FUND growth companies
- ------------------------------------------------------------------------------------------------------------------------------------
IAI MIDCAP GROWTH FUND Capital Appreciation -- Common stocks of medium-sized growth companies
- ------------------------------------------------------------------------------------------------------------------------------------
IAI REGIONAL FUND Capital Appreciation -- Common stocks of Upper Midwest companies
- ------------------------------------------------------------------------------------------------------------------------------------
IAI GROWTH FUND Capital Appreciation -- Common stocks with potential for above-average
growth and appreciation
- ------------------------------------------------------------------------------------------------------------------------------------
IAI VALUE FUND Capital Appreciation -- Common stocks which are considered to be undervalued
- ------------------------------------------------------------------------------------------------------------------------------------
IAI GROWTH AND INCOME FUND Capital Appreciation Income Common stocks with potential for long-term appreciation,
and common stocks that are expected to produce income
- ------------------------------------------------------------------------------------------------------------------------------------
IAI BALANCED FUND Total Return Income Common stocks, investment-grade bonds and
[CAPITAL APPRECIATION short-term instruments
+ INCOME]
- ------------------------------------------------------------------------------------------------------------------------------------
IAI BOND FUND Income Capital Preservation Investment-grade bonds
- ------------------------------------------------------------------------------------------------------------------------------------
IAI MONEY MARKET FUND Stability/Liquidity Income The portfolio's average dollar-weighted maturity is less
than 90 days, investing in high quality, money market
securities
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
24
<PAGE>
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<PAGE>
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<PAGE>
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<PAGE>
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<PAGE>
INVESTMENT ADVISER
AND MANAGER
Investment Advisers, Inc.
P.O. Box 357
Minneapolis, MN 55440-0357 USA
800.945.3863
612.376.2700
http://www.iaifunds.com
CUSTODIAN
Norwest Bank Minnesota, N.A.
Sixth and Marquette
Minneapolis, MN 55479
LEGAL COUNSEL
Dorsey & Whitney LLP
220 South Sixth Street
Minneapolis, MN 55402
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP
4200 Norwest Center
Minneapolis, MN 55402
DIRECTORS
Madeline Betsch
W. William Hodgson
George R. Long
J. Peter Thompson
Charles H. Withers
<PAGE>
[LOGO] IAI
MUTUAL FUNDS
P.O. BOX 357, MINNEAPOLIS, MINNESOTA 55440-0357 USA FAX 612.376.2737
800.945.3863
612.376.2700
