As filed with the Securities and Exchange Commission on December 2, 1998
File Nos. 33-69686
811-8064
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Post-Effective Amendment No. 39
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 40
THE MONTGOMERY FUNDS II
(Exact Name of Registrant as Specified in its Charter)
101 California Street
San Francisco, California 94111
(Address of Principal Executive Office)
(415) 572-3863
(Registrant's Telephone Number, Including Area Code)
Greg M. Siemons, Assistant Secretary
101 California Street
San Francisco, California 94111
(Name and Address of Agent for Service)
-------------------------
It is proposed that this filing will become effective:
___ immediately upon filing pursuant to Rule 485(b)
___ on January 31, 1999, pursuant to Rule 485(b)
X 60 days after filing pursuant to Rule 485(a)(1)
___ 75 days after filing pursuant to Rule 485(a)(2)
___ on ______________ pursuant to Rule 485(a)
----------
Please Send Copy of Communications to:
JULIE ALLECTA, ESQ.
DAVID A. HEARTH, ESQ.
Paul, Hastings, Janofsky & Walker LLP
345 California Street
San Francisco, California 94104
(415) 835-1600
<PAGE>
THE MONTGOMERY FUNDS II
CONTENTS OF REGISTRATION STATEMENT
This registration statement contains the following documents:
Facing Sheet
Contents of Registration Statement
Part A - Prospectus for Class R shares of Montgomery Global Long-Short
Fund
Part B - Statement of Additional Information for Class R and Class
P shares of Montgomery Growth Fund, Montgomery Equity Income
Fund, Montgomery Small Cap Fund, Montgomery Small Cap
Opportunities Fund, Montgomery U.S. Emerging Growth Fund,
Montgomery Global Opportunities Fund, Montgomery Global
Communications Fund, Montgomery Global Long-Short Fund,
Montgomery International Small Cap Fund, Montgomery
International Growth Fund, Montgomery Latin America Fund,
Montgomery Emerging Asia Fund, Montgomery Emerging Markets
Fund, Montgomery Select 50 Fund, Montgomery U.S. Asset
Allocation Fund, Montgomery Short Duration Government Bond
Fund, Montgomery Total Return Bond Fund, Montgomery Government
Reserve Fund, Montgomery Federal Tax-Free Money Fund,
Montgomery California Tax-Free Intermediate Bond Fund and
Montgomery California Tax-Free Money Fund
Part C - Other Information
Signature Page
Exhibits
<PAGE>
---------------------------------------------------------------------
PART A
PROSPECTUS FOR CLASS R SHARES OF
MONTGOMERY GLOBAL LONG-SHORT FUND
<PAGE>
Prospectus
January 31, 1999
The Montgomery Funds(SM)
Global Long-Short Fund (Fund)
Class R shares
The Montgomery Funds have registered the Fund with the U.S. Securities and
Exchange Commission (SEC). That registration does not imply, however, that the
SEC endorses the Fund.
The SEC has not approved or disapproved these securities or passed upon the
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
1
<PAGE>
[inside front cover of prospectus]
This prospectus contains important information about the investment objectives,
strategies and risks of Montgomery Global Long-Short Fund that you should know
before you invest in it. Please read it carefully and keep it on hand for future
reference.
Please be aware that the Fund:
[ ] Is not a bank deposit.
[ ] Is not guaranteed, endorsed or insured by any financial institution or
government entity such as the Federal Deposit Insurance Corporation (FDIC).
[ ] May not achieve its stated goal(s).
You should also know that:
[ ] The Fund's shares may rise and fall in value.
[ ] You could lose money by investing in the Fund.
2
<PAGE>
[Table of Contents]
TABLE OF CONTENTS
Montgomery Global Long-Short Fund..............................................4
Portfolio Management...........................................................6
Additional Investment Strategies and Related Risks.............................6
Defensive Investments.....................................................6
Portfolio Turnover........................................................6
The Year 2000.............................................................6
Alternative Structures....................................................7
Financial Highlights...........................................................8
Account Information............................................................9
Becoming a Montgomery Shareholder........................................10
How Fund Shares are Priced...............................................11
Buying Additional Shares.................................................12
Exchanging Shares........................................................13
Selling Shares...........................................................13
Other Policies...........................................................15
Tax Withholding Information..............................................16
After You Invest.........................................................16
[Sidebar]
- -------------------
How to Contact Us
- -------------------
Montgomery Shareholder
Service Representatives
800.572.FUND [3863]
Available 5 A.M. to 5 P.M.
Pacific time
Montgomery Web Site
www.montgomeryfunds.com
Address General
Correspondence to:
The Montgomery Funds
101 California Street
San Francisco, CA
94111-9361
3
<PAGE>
Global Long-Short Fund
Objective
[ ] Seeks capital appreciation by investing in long and short positions in
equity securities worldwide.
Strategy [clipart]
The Fund's strategy is to uncover stocks with the greatest potential for changes
in price, and to benefit whether overall stock markets move up or down. The
Fund's stock selection strategy combines computer-based screening techniques
with in-depth financial review and on-site analysis of companies, countries and
regions to identify potential investments. The portfolio managers buy stocks
"long" that they believe are positioned for above-average growth [will go up in
price], and sell stocks "short" that they believe will underperform [go down in
price]. They may also borrow money or use options and financial futures
contracts in an effort to enhance returns.
Under normal conditions, this Fund seeks to achieve its objective by investing
at least 65% of its total assets in long and short positions in equity
securities of publicly traded companies of any size worldwide. A long position
is where the Fund purchases a stock outright, while a short position is where
the Fund sells a security that it has borrowed. Long positions may be partially
hedged by shorting [stocks of companies in the same industry that the portfolio
managers believe are weaker] lower quality industry peers. Short positions may
also be used to garner returns from insights made from the manager's company
research, so the Fund's long and short positions will not necessarily be similar
in value. The Fund will realize a profit or incur a loss from a short position
depending on whether the value of the underlying stock increases or decreases
between the time it is sold and the date the Fund must replace the borrowed
security. Risk management is achieved through diversification across industries
and regions.
Risks [clipart]
This Fund uses sophisticated investment approaches that may present
substantially higher risks than most mutual funds. Although the managers expect
to use derivative instruments on a limited basis in an effort to manage interest
rate, stock market or currency risk, the Fund may [seek to enhance return by
investing] invest a portion of its assets in transactions using margin,
leverage, short sales and other forms of volatile financial derivatives such as
options and futures. As a result, the value of an investment in this Fund may be
more volatile than investments in other mutual funds. This Fund is not an
appropriate investment for conservative investors.
By investing in stocks, the Fund may expose you to certain risks that could
cause you to lose money, particularly a sudden decline in a holding's share
price or an overall decline in the stock market. Short sales are speculative
investments [with the potential for substantial losses] and involve greater
reliance on the manager's ability to accurately anticipate the value of a
security. In addition, the use of borrowing and short sales may cause the Fund
to have higher expenses (especially interest and dividend expenses) than those
of other equity mutual funds.
By investing in foreign stocks the Fund exposes shareholders to additional risks
such as regulatory, political and currency risk. Moreover, the Fund may invest
up to 30% of its total assets in emerging markets, which are far more volatile
than the U.S. due to their relative immaturity and the occasional instability of
their political and economic systems. These markets tend to be less liquid,
offer less regulatory protection to investors and are denominated in currencies
that have the potential to devalue significantly against the U.S. dollar.
For a more detailed discussion of the risks of short sales, using margin and
leverage, investing in foreign stocks and the Fund's investments in below
investment grade securities, see "Additional Investment Strategies and Related
Risks" on page 11.
4
<PAGE>
[bar chart]
1998
- -------------------
[____%]+
Average Annual Returns through 12/31/98
Global Long-Short Fund+ [____%] [____%]
[Appropriate comparison index] [____%] [____%]
- --------------------------------------------------------------------------------
1 Year Inception (12/31/97)
During the one-year period described above in the bar chart, the Fund's best
quarter was [Qx 1998] (+[____%]+)and its worst quarter was [Qx 1998]
(-[____%]+). The Fund's 1999 return through [______] was [_____%]+.
+ The return shown is for a class of shares that is not offered in this
prospectus that would have a substantially similar annual return because the
shares are invested in the same portfolio of securities and the annual returns
would differ only to the extent that the classes do not have the same expenses.
The class whose performance is shown above has identical annual portfolio
operating expenses as the Class R shares.
<TABLE>
Fees & Expenses [clipart]
The following table shows the fees and expenses you may pay if you buy and hold
shares of the Fund. Montgomery does not impose any front-end or deferred sales
loads on this Fund and does not charge shareholders for exchanging shares or
reinvesting dividends.
<CAPTION>
Fund Fees and Expenses
<S> <C>
Shareholder Fees (fees paid directly from your investment)
Redemption Fee* 2.00%
Annual Fund Operating Expenses (expenses that are deducted from Fund assets)+
Management Fee 1.50%
Distribution/Service (12b-1) Fee 0.00%
Other Expenses 3.69%
------------------------------------------------------------------------------------------------------
Total Annual Fund Operating Expenses 5.19%
Fee Waiver and/or Expense Reimbursement 2.84%
Net Expenses 2.35%
<FN>
* Deducted from the net proceeds of shares redeemed (or exchanged) within one
year after purchase (1.00% for Class A shareholders who converted to Class R
shares but who did not pay a sales load).
+ Montgomery Asset Management has contractually agreed to reduce its fees and/or
absorb expenses to limit the Fund's total annual operating expenses (excluding
interest and tax expenses) to 1.90%. This contract has a one-year term,
renewable at the end of each fiscal year.
</FN>
</TABLE>
Example of Fund expenses: This example is intended to help you compare the cost
of investing in the Fund with the cost of investing in other mutual funds. The
table below shows what you would pay in expenses over time, whether or not you
sold your shares at the end of each period. It assumes a $10,000 initial
investment, 5% total return each year and no changes in expenses. This example
is for comparison purposes only. It does not necessarily represent the Fund's
actual expenses or returns.
1 Year 3 Years 5 Years 10 Years
$237 $732 $1252 $2,673
PORTFOLIO MANAGEMENT [clipart] [sidebar]
Angeline Ee For financial highlights,
Nancy Kukacka see page 11
For more details see page 6
5
<PAGE>
PORTFOLIO MANAGEMENT
The investment manager of the Fund is Montgomery Asset Management, LLC. Founded
in 1990, Montgomery Asset Management is a subsidiary of Commerzbank AG, one of
the largest publicly held commercial banks in Germany. As of June 30, 1998,
Montgomery Asset Management managed approximately $5.5 billion on behalf of some
300,000 investors in The Montgomery Funds.
[photo] Nancy Kukacka, portfolio manager and principal. Prior to joining
Montgomery. Ms. Kukacka worked at CS First Boston Investment from April 1994
through April 1995 where she was an equity research analyst covering consumer
cyclical and non-durable sectors. Previously, Ms. Kukacka was an equity research
analyst at RCM Capital Management from April 1990 through March 1994, providing
fundamental-based analysis for more than US$12 billion in equity investments.
Ms. Kukacka holds a bachelor of arts degree in economics with minors in
chemistry and biology from Bucknell University. She is a Level III CFA
candidate.
[photo] Angeline Ee, portfolio manager and principal. From 1990 until joining
the Montgomery in July 1994, Ms. Ee was an investment manager with AIG
Investment Corp. in Hong Kong. From June 1989 until September 1990, Ms. Ee was a
co-manager of a portfolio of Asian equities and bonds at Chase Manhattan Bank in
Singapore.
MANAGEMENT FEES
The table below shows the management fee rate paid to Montgomery Asset
Management over the last fiscal year.
FUND ANNUAL RATE
- --------------------------------------------------------------------------------
Montgomery Global Long-Short Fund 1.50%
ADDITIONAL INVESTMENT STRATEGIES AND RELATED RISKS
General
The Fund is considered to have invested at least 65% of its total assets in long
and short positions in equity securities when the value of long positions in
equity securities and the value of assets serving as collateral for short
positions together constitute at least 65% of the value of its total assets.
Short Sales
When Montgomery believes that a security is overvalued, it may sell the security
short and borrow the same security from a broker or other institution to
complete the sale. If the price of the security decreases in value the Fund may
make a profit and, conversely, if the security increases in value, the Fund will
incur a loss because it will have to replace the borrowed securities by
purchasing them at a higher price. There can be no assurance that the Fund will
be able to close out the position at any particular time or at an acceptable
price. Although the Fund's gain is limited to the amount at which it sold the
security short, its potential loss is not limited. A lender may request the
borrowed securities be returned to it on short notice and if that occurs at a
time when other short sellers of the subject security are receiving similar
requests, a "short squeeze" can occur. This means that the Fund might be
compelled, at the most disadvantageous time, to replace borrowed securities
previously sold short, with purchases on the open market at prices significantly
greater than those the securities were sold short at. Short selling also may
produce higher than normal portfolio turnover and result in increased
transaction costs to the Fund.
6
<PAGE>
The Fund also may make short sales against-the-box, in which it sells short
securities it owns. The Fund will incur transaction costs, including interest
expenses, in connection with opening, maintaining and closing short sales
against-the-box. These sales result in a "constructive sale" requiring the Fund
to recognize any taxable gain in the securities at the time they are sold short.
Until the Fund replaces a borrowed security it will segregate sufficient U.S.
government securities, and other liquid debt and equity securities to cover any
difference between the value of the security sold short and any collateral
deposited with a broker or other custodian. In addition, the value of the
segregated securities must be at least equal to the original value of the
securities sold short. Depending on arrangements made with the broker or
custodian, the Fund may not receive any payments (including interest) on
collateral deposited with the broker or custodian. The Fund will not make a
short sale if, immediately before giving effect to the short sale, the market
value of all securities sold exceeds 100% of the value of the Fund's net assets.
Borrowing/Leverage
The Fund may borrow money from banks and engage in reverse repurchase
transactions for temporary or emergency purposes. In a reverse repurchase
agreement, the Fund sells to a financial institution a security that it holds
and agrees to repurchase the same security at an agreed-upon price and date. The
Fund may borrow from broker-dealers and other institutions in order to leverage
a transaction. Total bank borrowings may not exceed one-third of the value of
the Fund's assets, and theFund may pledge its assets in connection with such
borrowing.
The Fund also may leverage its portfolio through margin borrowing and other
techniques in an effort to increase total return. Although leverage creates an
opportunity for increased income and gain, it also creates special risk
considerations. For example, leveraging may magnify changes in the net asset
values of the Fund's shares and in its portfolio yield. Although the principal
of such borrowings will be fixed and margin borrowing will be fully covered with
collateral assets, the Fund's assets may change in value while the borrowing is
outstanding. Leveraging creates interest expenses that can exceed the income
from the assets retained.
Foreign Securities
By investing in foreign stocks, the Fund exposes shareholders to additional
risks. Foreign stock markets tend to be more volatile than the U.S. market due
to economic and political instability and regulatory conditions in some
countries. In addition, most of the foreign securities in which the Fund invests
are denominated in foreign currencies, whose value may decline against the U.S.
dollar. Furthermore, the January 1, 1999, introduction by the European Union of
a single European currency (the "euro") may cause market uncertainties and even
market disruptions which can affect negatively the Fund's investments in
European companies.
Below Investment Grade Securities [in SAI]
Defensive Investments
At the discretion of its portfolio manager, the Fund may invest up to 100% of
its assets in cash for temporary defensive purposes. Such as stance may help the
Fund minimize or avoid losses during adverse market, economic or political
conditions. During such a period, the Fund may not achieve its investment
objective. For example, should the market advance during this period, the Fund
may not participate as much as it would have if it had been more fully invested.
Portfolio Turnover
The Fund's portfolio managers will sell a security when they believe it is
appropriate to do so, regardless of how long the Fund has owned that security.
Buying and selling securities generally involves some
7
<PAGE>
expense to the Fund, such as commission paid to brokers and other transaction
costs. By selling a security, the Fund may realize taxable capital gains that it
will subsequently distribute to shareholders. Generally speaking, the higher the
Fund's annual portfolio turnover, the greater its brokerage costs and the
greater the likelihood that it will realize taxable capital gains. Increased
brokerage costs may adversely affect the Fund's performance. Also, unless you
are a tax-exempt investor or you purchase shares through a tax-exempt investor
or you purchase shares through a tax-deferred account, the distribution of
capital gains may affect your after-tax return. Annual portfolio turnover of
100% or more is considered high. The Fund will typically have annual turnover in
excess of that rate because of its portfolio managers' investment style. See
"Financial Highlights," beginning on page 11, for the Fund's historical
portfolio turnover.
The Year 2000
Montgomery and our service providers depend on the smooth functioning of our
computer systems. Unfortunately, because of the way dates are encoded and
calculated, many computer systems in use today cannot recognize the year 2000,
but revert to 1900 or another incorrect date. A computer failure due to the year
2000 problem could negatively impact the handling of securities trades, pricing
and account services.
Our software vendors and service providers have assured us that their systems
will be adapted in sufficient time to avoid serious problems. There can be no
guarantee, however, that all of these computer systems will be adapted in time.
We do not expect year 2000 conversion costs to be substantial for the Fund,
because those costs are borne by our vendors and service providers and not
directly by the Funds. Furthermore, brokers and other intermediaries that hold
shareholder accounts may still experience incompatibility problems. It is also
important to keep in mind that year 2000 issues may negatively impact the
companies in which the Fund invests and by extension the value of the shares
held in The Montgomery Funds II. We are in the process of putting in place a
contingency plan to evaluate other vendors and service providers if the existing
vendors and service providers fail to adequately adapt their systems in a timely
manner.
Alternative Structures
The Fund has reserved the right, if approved by the Board of Trustees, to
convert to a "Master/Feeder" structure. In this structure, the assets of mutual
funds with common investment objectives and similar parameters are combined into
a pool, rather than being managed separately. The individual funds are know as
"feeder" funds and the pool as the "master" fund. Although combining assets in
the way allows for economies of scale and other advantages, this change would
not affect the investment objectives, philosophies or disciplines currently
employed by The Montgomery Funds II. You would receive prior notice before we
took any such action. As of the date of this prospectus, we have not proposed
instituting alternative structures for any of The Montgomery Funds II.
8
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
The financial information provided below relates to another class of shares of
the Fund which has substantially similar operating expenses to the Fund and is
shown because Class R shares were not offered during this period.
[table]
<CAPTION>
- -----------------------------------------------------------------------------------------------
Global Long-Short Fund
- -----------------------------------------------------------------------------------------------
<S> <C>
SELECTED PER-SHARE DATA FOR
THE PERIOD ENDED March 31: 1998(a)
Net Asset-Value Beginning of Period $10.00
Net investment income 0.02
Net realized and unrealized gain on investments 2.68
Net increase in net assets
resulting from investment operations 2.70
Net Asset Value-End of Period $12.70
Total Return* 27.20%
Ratios to Average Net Assets/
Supplemental Data
Net assets, end of period (in 000s) $16,579
Ratio of net investment income/(loss) to
average net assets+ 0.65%+
Ratio of operating expenses to average net assets excluding
dividend and interest expense+ 2.35%
Ratio of operating expenses to average net assets including
dividend and interest expense+ 2.78%
Portfolio turnover rate 84.25%
Ratio of net investment income/(loss), before deferral of fees by
Manager, to average net assets+ (1.77)%
Ratio of operating expenses, before deferral of fees by Manager, to
average net assets+ 5.19%++
- -----------------------------------------------------------------------------------------------
<FN>
(a) The Global Long-Short Fund's Class A shares commenced operations on December
31, 1997.
* Total return does not include sales charge or redemption fees.
+ Annualized.
++ Includes dividend and interest expense.
</FN>
</TABLE>
9
<PAGE>
Account Information
[table]
INVESTMENT OPTIONS
[ ] Trade requests received after 1 P.M. PST (4 P.M. eastern time) will be
executed at the following business day's closing price.
Checks should be made payable to:
The Montgomery Funds
The minimum initial investment for the fund is $1,000. The minimum subsequent
investment is $100.
[ ] To open a new account, complete and mail the New Account application in the
back of this Prospectus.
Once an account is established, you can:
[ ] Buy, sell or exchange shares by phone. Contact The Montgomery Funds at
800.572.FUND [3863]. Press (1) for a shareholder service representative.
Press (2) for the automated Montgomery Star System.
[ ] Buy, sell or exchange shares online. Go to www.montgomeryfunds.com. Follow
online instructions to enable this service.
[ ] Buy or sell shares by mail
Mail buy/sell order(s) with your check:
By regular mail
The Montgomery Funds
c/o DST Systems, Inc.
P.O. Box 419073
Kansas City, MO 64141-6073
By express or overnight service:
The Montgomery Funds
c/o DST Systems, Inc.
210 West 10th Street, 7th Floor
Kansas City, MO 64105-1614
[ ] Buy or sell shares by wiring funds
To: Investors Fiduciary Trust Company
ABA #101003621
For: DST Systems, Inc.
Account #7526601
Attention: The Montgomery Funds
For Credit to: [shareholder(s) name]
Shareholder account number:
[shareholder(s) account number]
Name of Fund: Montgomery Global Long-Short Fund, Class R shares
What You Need to Know About Your Montgomery Account
You pay no sales charge to invest in The Montgomery Funds. The minimum initial
investment for the Fund is $1,000. The minimum subsequent investment is $100.
Under certain conditions we may waive these minimums. If you buy shares through
a broker or investment advisor, different requirements may
10
<PAGE>
apply. All investments must be made in U.S. dollars.
We must receive payment from you within three business days of your purchase. In
addition, we reserve the right to reject any purchase.
Becoming a Montgomery Shareholder
To open a new account:
[ ] By Mail Send your completed application, with a check payable to The
Montgomery Funds, to the appropriate address at right. Your check must be in
U.S. dollars and drawn only on a bank located in the United States. We do not
accept third-party checks, "starter" checks, credit-card checks, instant-loan
checks or cash investments. We may impose a charge on checks that do not clear.
Note that if you are investing in a U.S. Fixed-Income or Money Market Fund,
dividends will not begin to accrue on your account until your check clears.
[ ] By Wire Call us at (800) 572-FUND [3863] to let us know that you intend to
make your initial investment by wire. Tell us your name, the amount you want to
invest and the fund(s) in which you want to invest. We will give you further
instructions and a fax number to which you should send your completed New
Account application. To ensure that we handle your investment accurately,
include complete account information in all wire instructions.
Then request your bank to wire money from your account to the attention of:
Investors Fiduciary Trust Company
ABA #101003621
For: DST Systems, Inc.
and include the following:
Account #7526601
Attention: The Montgomery Funds
For credit to: [shareholder(s) name]
Shareholder Account Number:
[shareholder(s) account number]
Name of Fund: Montgomery Global Long-Short Fund Class R shares
Please note: Your bank may charge a wire transfer fee.
[ ] By Phone To make an initial investment by phone, you must have been a
current Montgomery shareholder for at least 30 days. Shares for Individual
Retirement Accounts (IRAs) may not be purchased by phone. Your purchase of a new
fund must meet its investment minimum and is limited to the total value of your
existing accounts or $10,000, whichever is greater. To complete the transaction,
we must receive payment within three business days. We reserve the right to
collect any losses from your account if we do not receive payment within that
time.
11
<PAGE>
How Fund Shares Are Priced
How and when we calculate the Fund's price or net asset value (NAV) determines
the price at which you will buy or sell shares. We calculate the Fund's NAV by
dividing the total value of its assets by the number of outstanding shares. We
base the value of the Fund's investments on its market value, usually the last
price reported for each security before the close of market that day. A market
price may not be available for securities that trade infrequently. Occasionally,
an event that affects a security's value may occur after the market closes. This
is more likely to happen for foreign securities traded in foreign markets that
have different time zones from the United States. Major developments affecting
the price of those securities may happen after the foreign markets in which such
securities trade have closed but before the Fund calculates its NAV. In this
case, Montgomery, in consultation with the Fund's Board of Trustees, will make a
good-faith estimate of the security's "fair value", which may be higher or lower
than security's closing price in its relevant market. More details about how we
calculate the Fund's NAV are in the Statement of Additional Information.
[sidebar]
GETTING STARTED
To invest, complete the New Account application at the back of this prospectus.
Send it with a check payable to The Montgomery Funds.
Regular Mail
The Montgomery Funds
P.O. Box 419073
Kansas City, MO 64141-6073
Express Mail or Overnight Courier
The Montgomery Funds
210 West 10th Street
7th Floor
Kansas City, MO 64105-1614
Foreign Investors:
Foreign citizens and resident aliens of the United States living abroad may not
invest in The Montgomery Funds.
We calculate the net asset value (NAV) of the Fund after the close of trading on
the New York Stock Exchange (NYSE) every day the NYSE is open. We do not
calculate NAVs on the days on which the NYSE is closed for trading. Certain
exceptions apply as described below. If we receive your order by the close of
trading on the NYSE, you can purchase shares at the price calculated for that
day. The NYSE usually closes at 4 P.M. on weekdays, except for holidays. If your
order and payment are received after the NYSE has closed, your shares will be
priced at the next NAV we determine after receipt of your order.
> Foreign Funds. This Fund invests in securities denominated in foreign
currencies and traded on foreign exchanges. To determine its value, we convert
its foreign-currency price into U.S. dollars by using the exchange rate last
quoted by a major bank. Exchange rates fluctuate frequently and may affect the
U.S. dollar value of foreign-denominated securities, even if their market price
does not change. In addition, some foreign exchanges are open for trading when
the U.S. market is closed. As a result, the Fund's foreign securities--and its
price--may fluctuate during periods when you can't buy, sell or exchange shares
in the Fund.
Buying Additional Shares
[ ] By Mail Complete the form at the bottom of any Montgomery statement and mail
it with your check
12
<PAGE>
payable to The Montgomery Funds. Or mail the check with a signed letter noting
the name of the Fund in which you want to invest, your account number and
telephone number. We will mail you a confirmation of your investment. Note that
we may impose a charge on checks that do not clear.
[Sidebar]
TRADING TIMES
Whether buying, exchanging or selling shares, transaction requests received
after 1 P.M. Pacific time (4 P.M. eastern time) will be executed at the next
business day's closing price.
www.montgomeryfunds.com
Manage your account online Our online Shareholder Service Center offers free,
secure access to your Montgomery Funds account(s) around-the-clock. Shareholders
can:
[ ] Check current account balances
[ ] Buy, exchange or sell shares
[ ] View the most recent account activity and up to 80 records of account
history within the past two years
[ ] Order duplicate statements and tax forms
[ ] Reorder checkbooks
[clipart]
Get in-depth information Our Web site is a good source of in-depth information
on The Montgomery Funds, as well as useful information about investing in
general. Click on:
[ ] Funds & Performance for daily performance and net asset values, plus
in-depth information on any of our Funds, including audio broadcasts of
portfolio manager commentaries
[ ] Meet Our Experts to gain weekly insight into market events, browse through a
vast archive of commentaries and read portfolio manager biographies
[ ] Resource Center for answers to your investment questions, a glossary of
financial terms, our online bookstore, plus 11 calculators to help you meet
your investment goals
[ ] Montgomery College Prep to learn how to invest for your children's or
grandchildren's education
[ ] Retirement Planning to start investing for your golden years now
To register call 800.572.FUND [3863] and press (1) to speak with a shareholder
service representative.
[ ] By Phone Current shareholders are automatically eligible to buy shares by
phone. To buy shares in the Fund, call (800) 572-FUND [3863]. Shares for IRAs
may not be purchased by phone. There are restrictions on the dollar amount of
shares you may buy by phone.
We must receive payment for your purchase within three business days of your
request. To ensure that we do, you can:
> Transfer money directly from your bank account by mailing a written request
and a voided check or deposit slip (for a savings account).
> Send us a check by overnight or second-day courier service.
> Instruct your bank to wire money to our affiliated bank using the information
in "Becoming A Montgomery Shareholder."
[ ] Online To buy shares online, you must first set up an Electronic Link
(described in the sidebar on p. 64). Then visit our Web site,
www.montgomeryfunds.com, where you can purchase up to $25,000 per day in
additional shares of any Fund, except those held in a retirement account. The
cost of the shares will be automatically deducted from your bank account.
13
<PAGE>
[ ] By Wire There is no need to contact us when buying additional shares by
wire. Instruct your bank to wire funds to our affiliated bank using the
information under "Becoming a Montgomery Shareholder."
Exchanging Shares
Montgomery shareholders may exchange Class R shares in the Fund for Class R
shares in another Montgomery Fund with the same registration, Taxpayer
Identification number and address. There is a $100 minimum to exchange into a
Fund you currently own and a $1,000 minimum for investing in a new Montgomery
Fund. Note that an exchange may result in a realized gain or loss for tax
purposes. You may exchange shares by phone, at (800) 572-FUND [3863] or through
our online shareholder service center at www.montgomeryasset.com.
Other Exchange Policies
[ ] Depending on what time we receive your request, we will process your
exchange order at the next-calculated NAV.
[ ] You may exchange shares only in Funds that are qualified for sale in your
state. You may not exchange shares in the Fund for shares of another Montgomery
Fund that is currently closed to new shareholders unless you are already a
shareholder in the closed Montgomery Fund.
[ ] Because excessive exchanges can harm the Fund's performance, we reserve the
right to terminate your exchange privileges if you make more than four exchanges
out of any the Fund during a 12-month period. We may also refuse an exchange
into a Montgomery Fund from which you have sold shares within the previous 90
days (accounts under common control and accounts having the same Taxpayer
Identification number will be counted together).
[sidebar]
Our Electronic Link program allows us to automatically debit or credit your bank
account for transactions made by phone or online. To take advantage of this
service, simply mail us a voided check or preprinted deposit slip from your bank
account along with a request to establish an Electronic Link.
[ ] We may restrict or refuse your exchanges if we receive, or anticipate
receiving, simultaneous orders affecting a large portion of the Fund's assets or
if we detect a pattern of exchanges that suggests a market-timing strategy.
[ ] We reserve the right to refuse exchanges into the Fund by any person or
group if, in our judgment, the Fund would be unable to effectively invest the
money in accordance with its investment objective and policies, or might be
adversely affected in other ways.
Selling Shares
You may sell some or all of your Fund shares on days that the New York Stock
Exchange is open for trading.
Your shares will be sold at the next NAV we calculate for the Fund after
receiving your order. We will promptly pay the proceeds to you, normally within
three business days of receiving your order and all necessary documents
(including a written redemption order with the appropriate signature guarantee).
We will mail or wire you the proceeds, depending on your instructions. If you
purchase shares and sell them shortly thereafter, we will not mail the proceeds
until 15 days from the date you first purchased the shares.
Generally, we will not charge you any fees when you sell your shares, although
there are some minor exceptions:
[ ] Shareholders who sell shares by wire pay a $10 wire transfer fee that will
be deducted directly from their proceeds.
[ ] Shareholders who want redemption checks sent by Federal Express must pay a
$10 fee, deducted
14
<PAGE>
directly from their redemption proceeds.
In accordance with the rules of the Securities and Exchange Commission (SEC) we
reserve the right to suspend redemptions under extraordinary circumstances.
Shares can be sold in several ways:
[ ] Mail Send us a letter including your name, Montgomery account number, the
Fund from which you would like to sell shares and the dollar amount or number of
shares you want to sell. You must sign the letter the same way your account is
registered. If you have a joint account, all accountholders must sign the
letter.
If you want the proceeds to go to a party other than the account owner(s) or
your predesignated bank account, or if the dollar amount of your redemption
exceeds $50,000, you must obtain a signature guarantee (not a notarization),
available from many commercial banks, savings associations, stock brokers and
other NASD member firms.
If you want to wire your redemption proceeds but do not have a predesignated
bank account, include a voided check or deposit slip with your letter. The
minimum wire amount is $500. Wire charges, if any, will be deducted from the
redemption proceeds. We may permit lesser wire amounts or fees at our
discretion. Call (800) 572-FUND [3863] for more details.
[sidebar]
Shareholder service is available Monday through Friday from 5 A.M. to 5 P.M.
Pacific time. Shareholders can get information or perform transactions
around-the-clock through the Montgomery Star System or www.montgomeryfunds.com.
[ ] By Check If you have check writing privileges in your account, you may write
a check to redeem some of your shares. This option is not available for funds in
an IRA. Checks may not be written for amounts below $250. Checks require only
one signature unless otherwise indicated. We will return your checks at the end
of the month. Note that we may impose a charge for a stop-payment request.
[ ] By Phone You may accept or decline telephone redemption privileges on your
New Account application. If you accept, you will be able to sell up to $50,000
in shares through one of our shareholder service representatives or through our
automated Star System at (800) 572-FUND [3863]. You may not buy, sell or
exchange shares in an IRA account by phone. If you included bank wire
information on your New Account application or made arrangements later for wire
redemptions, proceeds can be wired to your bank account. Please allow at least
two business days for the proceeds to be credited to your bank account. If you
want proceeds to arrive at your bank on the same business day (subject to bank
cutoff times), there is a $10 fee. For more information about our telephone
transaction policies, see "Other Policies."
[ ] Online You can sell up to $50,000 in shares in a regular account through our
online Shareholder Service Center at www.montgomeryfunds.com.
OTHER POLICIES
Minimum Account Balances
Due to the cost of maintaining small accounts, we require a minimum combined
account balance of $1,000. If your account balance falls below that amount for
any reason other than market fluctuations, we will ask you to add to your
account. If your account balance is not brought up to the minimum or you do not
send us other instructions, we will redeem your shares and send you the
proceeds. We believe that this policy is in the best interests of all our
shareholders.
15
<PAGE>
Uncashed Redemption Checks
If you receive your Fund redemption proceeds or distributions by check (instead
of by wire) and it does not arrive within a reasonable period of time, call us
at (800) 572-FUND [3863]. Please note that we are responsible only for mailing
redemption or distribution checks and are not responsible for tracking uncashed
checks or determining why checks are uncashed. If your check is returned to us
by the U.S. Postal Service or other delivery service, we will hold it on your
behalf for a reasonable period of time. We will not invest the money in any
interest-bearing account. No interest will accrue on uncashed distribution or
redemption proceeds.
[sidebar]
Buying and Selling Shares Through Securities Brokers and Benefit Plan
Administrators
You may purchase and sell shares through securities brokers and benefit plan
administrators or their subagents. You should contact them directly for
information regarding how to invest or redeem through them. They may also charge
you service or transaction fees. If you purchase or redeem shares through them,
you will receive the NAV calculated after receipt of the order by them
(generally, 4:00 P.M. eastern time) on any day the NYSE is open. If your order
is received by them after that time, it will be purchased or redeemed at the
next-calculated NAV. Brokers and benefit plan administrators who perform
shareholder servicing for the Fund may receive fees from the Fund or Montgomery
for providing these services.
Telephone Transactions
By buying, selling or exchanging shares over the phone, you agree to reimburse
the Fund for any expenses or losses incurred in connection with transfers of
money from your account. This includes any losses or expenses caused by your
bank's failure to honor your debit or act in accordance with your instructions.
If your bank makes erroneous payments or fails to make payment after you buy
shares, we may cancel the purchase and immediately terminate your telephone
transaction privilege. In addition, we may discontinue these privileges at any
time upon 30 days' written notice. You may discontinue phone privileges at any
time.
The shares you purchase by phone will be priced at the first net asset value we
determine after receiving your purchase. You will not actually own the shares,
however, until we receive your payment in full. If we do not receive your
payment within three business days of your request, we will cancel your
purchase. You may be responsible for any losses incurred by the Fund as a
result.
Please note that we cannot be held liable for following telephone instructions
that we reasonably believe to be genuine. We use several safeguards to ensure
that the instructions we receive are accurate and authentic, such as:
> recording certain calls,
> requiring a special authorization number or other personal information not
likely to be known by others, and
> sending a transaction confirmation to the investor.
The Fund and our Transfer Agent may be held liable for any losses due to
unauthorized or fraudulent telephone transactions only if we have not followed
these reasonable procedures.
We reserve the right to revoke the telephone privilege of any shareholder at any
time if he or she has used abusive language or misused the phone privilege by
making purchases and redemptions that appear to be part of a systematic
market-timing strategy.
If you notify us that your address has changed, we will temporarily suspend your
telephone redemption privileges until 30 days after your notification to protect
you and your account. We require all redemption
16
<PAGE>
requests made during this period to be in writing with a signature guarantee.
Shareholders may experience delays in exercising telephone redemption privileges
during periods of volatile economic or market conditions. In these cases you may
want to transmit your redemption request:
> using the automated Star System
> online
> by overnight courier
> by telegram
Tax Withholding Information
Be sure to complete the Taxpayer Identification Number (TIN) section of the New
Account application. If you don't have a Social Security Number or TIN, apply
for one immediately by contacting your local office of the Social Security
Administration or the Internal Revenue Service (IRS). If you do not provide us
with a TIN or a certified Social Security number, federal tax law may require us
to withhold 31% of your taxable dividends, capital-gains distributions, and
redemption and exchange proceeds (unless you qualify as an exempt payee under
certain rules).
Other rules about TINs apply for certain investors. For example, if you are
establishing an account for a minor under the Uniform Gifts to Minors Act, you
should furnish the minor's TIN. If the IRS has notified you that you are subject
to backup withholding because you failed to report all interest and dividend
income on your tax return, you must check the appropriate item on the New
Account application. Foreign shareholders should note that any dividends the
Fund pay to them may be subject to up to 30% withholding instead of backup
withholding.
[sidebar]
Investment Minimums
For regular accounts and IRAs, the minimum initial investment is $1,000. Minimum
subsequent investment is $100.
AFTER YOU INVEST
Taxes
IRS rules require that the Fund distribute all of its net investment income and
capital gains, if any, to shareholders. Capital gains may be taxable at
different rates depending upon the length of time the Fund holds its assets. We
will inform you about the source of any dividends and capital gains upon
payment. After the close of each calendar year, we will advise you of their tax
status. The Fund's distributions, whether received in cash or reinvested, may be
taxable. Furthermore, any exchange of the Fund's shares for another Fund will be
treated as a sale, and any gain may be taxable.
Additional information about tax issues relating to the Fund can be found in our
Statement of Additional Information, available free by calling (800) 572-FUND
[3863]. Consult your tax advisor about the potential tax consequences of
investing in the Fund.
Dividends and Distributions
As a shareholder in The Montgomery Funds, you may receive dividends and
distributions for which you will owe taxes (unless you invest solely through a
tax-advantaged account such as an IRA or a 401k plan). Dividends and
distributions are paid to all shareholders who maintain accounts with the Fund
as of its "record date."
If you would like to receive distributions in cash, indicate that choice on your
New Account application. Otherwise, the distribution will be reinvested in
additional Fund shares.
17
<PAGE>
Keeping You Informed
After you invest you will receive our Shareholder Services Guide, which includes
more information about buying, exchanging and selling shares in the Montgomery
Funds. It also describes in more detail useful tools for investors such as the
Montgomery Star System and online transactions.
[sidebar]
Our Partners
As a Montgomery shareholder, you may see the names of our partners on a regular
basis. We all work together to ensure that your investments are handled
accurately and efficiently.
Funds Distributor, Inc., located in New York City and Boston, distributes the
Fund.
Investors Fiduciary Trust Company, located in Kansas City, Missouri, is the
Fund's master transfer agent. It performs certain record keeping and accounting
functions for the Fund.
DST Systems, also located in Kansas City, Missouri, assists Investors Fiduciary
Trust with certain record keeping and accounting functions for the Fund.
<TABLE>
[table]
<CAPTION>
Dividends Distributions
<S> <C> <C>
GLOBAL LONG-SHORT Fund Declared and paid in the last Declared and paid in the last
quarter of each calendar year* quarter of each calendar year*
<FN>
*Following its fiscal year end (June 30), the Fund may make additional
distributions to avoid the imposition of a tax.
</FN>
</TABLE>
During the year, we will also send you the following communications:
[ ] Confirmation statements
[ ] Account statements-Mailed after the close of each calendar quarter.
[ ] Annual and semiannual reports-Mailed approximately 60 days after June 30 and
December 31.
[ ] 1099 tax form-Sent by January 31.
[ ] Annual updated prospectus-Mailed to existing shareholders in the Fall.
To save you money, we will send only one copy of each shareholder report or
other mailing to your household if you hold accounts under common ownership or
at the same address (regardless of the number of shareholders or accounts at
that household or address), unless you request additional copies.
[sidebar]
How to avoid "buying a dividend"
If you plan to purchase shares in the Fund, check if it is planning to make a
distribution in the near future. Here's why: If you buy shares of the Fund just
before a distribution, you'll pay full price for the shares but receive a
portion of your purchase price back as a taxable distribution. This is called
"buying a dividend." Unless you hold the Fund in a tax-deferred account, you
will have to include the distribution in your gross income for tax purposes,
even though you may not have participated in the increase of the Fund's
appreciation.
18
<PAGE>
[Outside back cover: Contact Info; Logo]
You can find more information about Montgomery Global Long-Short's investment
policies in the Statement of Additional Information (SAI), which is available
free of charge.
To request a copy, please call us at (800) 572-FUND [3863]. If you have access
to the Internet, you can also view a copy of Montgomery Global Long-Short's SAI
at the Security and Exchange Commission's Web site: www.sec.gov. You may also
request a copy by writing to the Public Reference Section of the SEC,
Washington, D.C., 20549-6009. The SEC charges a duplicating fee for this
service. You can also visit the SEC's Public Reference Room (telephone
800.SEC.0330)
You can find further information about Montgomery Global Long-Short Fund in our
annual and semiannual shareholder reports, which discuss the market conditions
and investment strategies that significantly affected the Fund's performance
during its most recent fiscal period. To request a copy of the most recent
annual or semiannual report, please call us at (800) 572-FUND [3863].
Corporate Headquarters:
The Montgomery Funds
101 California Street
San Francisco, CA 94111-9361
(800) 572-FUND [3863]
www.montgomeryfunds.com
SEC File Nos.: The Montgomery Funds II 811-8064
19
<PAGE>
---------------------------------------------------------------------
PART B
STATEMENT OF ADDITIONAL INFORMATION
FOR CLASS R AND CLASS P SHARES OF
MONTGOMERY GROWTH FUND
MONTGOMERY EQUITY INCOME FUND
MONTGOMERY SMALL CAP FUND
MONTGOMERY SMALL CAP OPPORTUNITIES FUND
MONTGOMERY U.S. EMERGING GROWTH FUND
MONTGOMERY GLOBAL OPPORTUNITIES FUND
MONTGOMERY GLOBAL COMMUNICATIONS FUND
MONTGOMERY GLOBAL LONG-SHORT FUND
MONTGOMERY INTERNATIONAL SMALL CAP FUND
MONTGOMERY INTERNATIONAL GROWTH FUND
MONTGOMERY LATIN AMERICA FUND
MONTGOMERY EMERGING ASIA FUND
MONTGOMERY EMERGING MARKETS FUND
MONTGOMERY SELECT 50 FUND
MONTGOMERY U.S. ASSET ALLOCATION FUND
MONTGOMERY SHORT DURATION GOVERNMENT BOND FUND
MONTGOMERY TOTAL RETURN BOND FUND
MONTGOMERY GOVERNMENT RESERVE FUND
MONTGOMERY FEDERAL TAX-FREE MONEY FUND
MONTGOMERY CALIFORNIA TAX-FREE INTERMEDIATE BOND FUND
MONTGOMERY CALIFORNIA TAX-FREE MONEY FUND
---------------------------------------------------------------------
<PAGE>
The Montgomery Funds File Nos. 33-34841 and 811-6011
The Montgomery Funds II File Nos. 33-69686 and 811-8064
- --------------------------------------------------------------------------------
THE MONTGOMERY FUNDS
- --------------------------------------------------------------------------------
MONTGOMERY GROWTH FUND
MONTGOMERY SMALL CAP OPPORTUNITIES FUND
MONTGOMERY SMALL CAP FUND
MONTGOMERY U.S. EMERGING GROWTH FUND
MONTGOMERY EQUITY INCOME FUND
MONTGOMERY INTERNATIONAL GROWTH FUND
MONTGOMERY INTERNATIONAL SMALL CAP FUND
MONTGOMERY EMERGING MARKETS FUND
MONTGOMERY EMERGING ASIA FUND
MONTGOMERY LATIN AMERICA FUND
MONTGOMERY GLOBAL OPPORTUNITIES FUND
MONTGOMERY GLOBAL COMMUNICATIONS FUND
MONTGOMERY GLOBAL LONG-SHORT FUND
MONTGOMERY SELECT 50 FUND
MONTGOMERY U.S. ASSET ALLOCATION FUND
MONTGOMERY TOTAL RETURN BOND FUND
MONTGOMERY SHORT DURATION GOVERNMENT BOND FUND
MONTGOMERY GOVERNMENT RESERVE FUND
MONTGOMERY CALIFORNIA TAX-FREE INTERMEDIATE BOND FUND
MONTGOMERY CALIFORNIA TAX-FREE MONEY FUND
MONTGOMERY FEDERAL TAX-FREE MONEY FUND
101 California Street
San Francisco, California 94111
(800) 572-FUND [3863]
- --------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
October 31, 1998
The Montgomery Funds and The Montgomery Funds II are open-end
management investment companies organized, respectively, as a Massachusetts and
a Delaware business trust (together, the "Trusts"), each having different series
of shares of beneficial interest. Each of the above-named funds is a series of
The Montgomery Funds, with the exception of the Montgomery U.S. Asset Allocation
Fund, which is a series of The Montgomery Funds II (each a "Fund" and,
collectively, the "Funds"). This Statement of Additional Information contains
information in addition to that set forth in the combined prospectus for the
Class R shares for all Funds dated October 31, 1998, and that set forth in the
combined prospectuses for the Class P shares of certain Funds dated October 31,
1998, as those prospectuses may be revised from time to time (in reference to
the appropriate Fund or Funds, the "Prospectuses"). The Prospectuses may be
obtained without charge at the address or telephone number provided above. This
Statement of Additional Information is not a prospectus and should be read in
conjunction with a Prospectus. The Annual Report to Shareholders for each Fund
for the fiscal year ended June 30, 1998, containing financial statements for
each Fund for that fiscal year, is incorporated by reference to this Statement
of Additional Information and also may be obtained without charge as noted
above.
B-1
<PAGE>
TABLE OF CONTENTS
PAGE
STATEMENT OF ADDITIONAL INFORMATION............................................1
THE TRUSTS.....................................................................3
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS................................4
RISK FACTORS..................................................................25
INVESTMENT RESTRICTIONS.......................................................35
DISTRIBUTIONS AND TAX INFORMATION.............................................38
TRUSTEES AND OFFICERS.........................................................43
INVESTMENT MANAGEMENT AND OTHER SERVICES......................................47
EXECUTION OF PORTFOLIO TRANSACTIONS...........................................52
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION................................55
DETERMINATION OF NET ASSET VALUE..............................................57
PRINCIPAL UNDERWRITER.........................................................60
PERFORMANCE INFORMATION.......................................................60
GENERAL INFORMATION...........................................................66
FINANCIAL STATEMENTS..........................................................79
Appendix......................................................................81
B-2
<PAGE>
THE TRUSTS
The Montgomery Funds is an open-end management investment company
organized as a Massachusetts business trust on May 10, 1990, and The Montgomery
Funds II is an open-end management investment company organized as a Delaware
business trust on September 10, 1993. Both are registered under the Investment
Company Act of 1940, as amended (the "Investment Company Act"). The Trusts
currently offer shares of beneficial interest, $0.01 par value per share, in
various series. Each series offers three classes of shares (Class R, Class P and
Class L). This Statement of Additional Information pertains to the following
series of The Montgomery Funds:
>> Montgomery Growth Fund (the "Growth Fund");
>> Montgomery Small Cap Opportunities Fund (the "Small Cap Opportunities
Fund");
>> Montgomery Small Cap Fund (the "Small Cap Fund");
>> Montgomery U.S. Emerging Growth Fund (the "U.S. Emerging Growth Fund,"
prior to 6/98, called "Montgomery Micro Cap Fund");
>> Montgomery Equity Income Fund (the "Equity Income Fund");
>> Montgomery International Growth Fund (the "International Growth Fund");
>> Montgomery International Small Cap Fund (the "International Small Cap
Fund");
>> Montgomery Emerging Markets Fund (the "Emerging Markets Fund");
>> Montgomery Emerging Asia Fund (the "Emerging Asia Fund");
>> Montgomery Latin America Fund (the "Latin America Fund");
>> Montgomery Global Opportunities Fund (the "Opportunities Fund");
>> Montgomery Global Communications Fund (the "Communications Fund");
>> Montgomery Global Long-Short Fund (the "Global Long-Short Fund");
>> Montgomery Select 50 Fund (the "Select 50 Fund");
>> Montgomery Total Return Bond Fund (the "Total Return Bond Fund");
>> Montgomery Short Duration Government Bond Fund (the "Short Bond Fund,"
prior to 2/97, called "Montgomery Short Government Bond Fund");
>> Montgomery Government Reserve Fund (the "Reserve Fund");
>> Montgomery California Tax-Free Intermediate Bond Fund (the "California
Intermediate Bond Fund," prior to 6/95, called "Montgomery California
Tax-Free Short/Intermediate Fund," prior to 12/94, called "Montgomery
California Tax-Free Bond Fund");
>> Montgomery California Tax-Free Money Fund (the "California Money
Fund");
>> Montgomery Federal Tax-Free Money Fund (the "Federal Money Fund");
as well as one series of The Montgomery Funds II:
>> Montgomery U.S. Asset Allocation Fund (the "U.S. Asset Allocation
Fund," prior to 10/97, called "Montgomery Asset Allocation Fund").
Throughout this Statement of Additional Information, certain Funds may
be referred to together using the following terms: the Growth, Small Cap
Opportunities, Small Cap, U.S. Emerging Growth and Equity Income Funds as the
"U.S. Equity Funds"; the International Growth, International Small Cap, Emerging
Markets, Emerging Asia, Latin America, Opportunities and Communications Funds as
the "Foreign and Global Equity Funds"; the Select 50 and U.S. Asset Allocation
Funds as the "Multi-Strategy Funds"; the Total Return Bond, Short Bond and
California Intermediate Bond Funds as the "Fixed Income Funds"; the California
B-3
<PAGE>
Intermediate Bond, California Money and Federal Money Funds as the "Tax-Free
Funds"; the Reserve, California Money and Federal Money Funds as the "Money
Market Funds"; and all of the Funds other than the Tax-Free Funds as the
"Taxable Funds."
Note that the two Trusts share responsibility for the accuracy of the
Prospectuses and this Statement of Additional Information, and that each Trust
may be liable for misstatements in the Prospectuses and the Statement of
Additional Information that relate solely to the other Trust.
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS
The Funds are managed by Montgomery Asset Management, LLC (the
"Manager") and their shares are distributed by Funds Distributor, Inc. (the
"Distributor"). The investment objectives and policies of the Funds are
described in detail in its Prospectus. The following discussion supplements the
discussion in the Prospectus.
Each Fund is a diversified series, except for the Tax-Free Funds, which
are nondiversified series of either the Montgomery Funds or The Montgomery Funds
II. The achievement of each Fund's investment objective will depend upon market
conditions generally and on the Manager's analytical and portfolio management
skills.
The U.S. Asset Allocation Fund is a fund-of-funds. Other than U.S.
government securities, the U.S. Asset Allocation Fund does not own securities of
its own. Instead, the U.S. Asset Allocation Fund invests its assets in a number
of funds in The Montgomery Funds family (each, an "Underlying Fund"). Investors
of the U.S. Asset Allocation Fund should therefore review the discussion in this
Statement of Additional Information that relates to each Underlying Fund of the
U.S. Asset Allocation Fund.
SPECIAL INVESTMENT STRATEGIES AND RISKS
Certain of the Funds have special investment policies, strategies and
risks in addition to those discussed in the Prospectus, as described below.
MONTGOMERY EQUITY INCOME FUND. The Equity Income Fund may invest up to
20% of its total assets in the equity or debt securities of foreign issuers,
which may involve special risks. See "Risk Factors" below.
MONTGOMERY EMERGING ASIA FUND. The Emerging Asia Fund invests primarily
in "emerging Asian companies." This Fund considers a company to be an emerging
Asian company if its securities are principally traded in the capital market of
an emerging Asian country; it derives at least 50% of its total revenue from
either goods produced or services rendered in emerging Asian countries or from
sales made in such emerging Asian countries, regardless of where the securities
of such company are primarily traded; or it is organized under the laws of, and
with a principal office in, an emerging Asian country.
Investing in Asia involves special risks. Emerging Asian countries are
in various stages of economic development, with most being considered emerging
markets. Each country has its unique risks. Most emerging Asian countries are
heavily dependent on international trade. Some have prosperous economies but are
sensitive to world commodity prices. Others are especially vulnerable to
recession in other countries. Some emerging Asian countries have experienced
rapid growth, although many suffer from obsolete financial systems, economic
problems or archaic legal systems. The Fund may invest in certain debt
securities issued by the governments of emerging Asian countries that are, or
may be eligible for, conversion into investments in
B-4
<PAGE>
emerging Asian companies under debt conversion programs sponsored by such
governments. The Fund deems securities that are convertible to equity
investments to be equity-derivative securities.
The Emerging Asia Fund concentrates its investments in companies that
have their principal activities in emerging Asian countries. Consequently, the
Fund's share value may be more volatile than that of investment companies not
sharing this geographic concentration. The value of the Fund's shares may vary
in response to political and economic factors affecting issuers in emerging
Asian countries. Although the Fund normally does not expect to invest in
Japanese companies, some emerging Asian economies are directly affected by
Japanese capital investment in the region and by Japanese consumer demands. Many
of the emerging Asian countries are developing both economically and
politically. Emerging Asian countries may have relatively unstable governments,
economies based on only a few commodities or industries, and securities markets
trading infrequently or in low volumes. Some emerging Asian countries restrict
the extent to which foreigners may invest in their securities markets.
Securities of issuers located in some emerging Asian countries tend to have
volatile prices and may offer significant potential for loss as well as gain.
Further, certain companies in emerging Asian may not have firmly established
product markets, may lack depth of management or may be more vulnerable to
political or economic developments such as nationalization of their own
industries.
MONTGOMERY LATIN AMERICA FUND. The Latin America Fund invests primarily
in Latin American companies. The Fund considers a company to be a Latin American
company if its securities are principally traded in the capital market of a
Latin American country; it derives at least 50% of its total revenues from
either goods produced or services rendered in Latin American countries or from
sales made in such Latin American countries, regardless of where the securities
of such company are primarily traded; or it is organized under the laws of, and
with a principal office in, a Latin American country.
The Fund invests primarily in common stock, but also may invest in
other types of equity-derivative securities. It also may invest up to 35% of its
total assets in debt securities, including up to 15% in high-yield debt
securities rated below investment grade (also known as "junk bonds"). The debt
securities may be dollar-denominated U.S. securities or debt securities of
companies or governments of Latin America. The Fund may also invest in certain
debt securities issued by the governments of Latin American countries that are,
or may be eligible for, conversion into investments in Latin American companies
under debt conversion programs sponsored by such governments. The Fund deems
securities that are convertible to equity investments to be equity-derivative
securities.
The Latin America Fund concentrates its investments in companies that
have their principal activities in Latin American countries. Consequently, the
Latin America Fund's share value may be more volatile than that of investment
companies not sharing this geographic concentration. The value of the Latin
America Fund's shares may vary in response to political and economic factors
affecting issuers in Latin American countries. Investors should be aware that
the Latin American economies have experienced considerable difficulties in the
past decade. Although there have been significant improvements in recent years,
the Latin American economies continue to experience challenging problems,
including high inflation rates and high interest rates relative to the United
States. The emergence of the Latin American economies and securities markets
will require continued economic and fiscal discipline, which has been lacking at
times in the past, as well as stable political and social conditions. Recovery
may also be influenced by international economic conditions, particularly those
in the United States, and by world prices for oil and other commodities. There
is no assurance that recent economic initiatives will be successful.
B-5
<PAGE>
Certain risks associated with international investments and investing
in smaller, developing capital markets are heightened for investments in Latin
American countries. For example, some of the currencies of Latin American
countries have experienced steady devaluations relative to the U.S. dollar, and
major adjustments have been made in certain of these currencies periodically. In
addition, although there is a trend toward less government involvement in
commerce, governments of many Latin American countries have exercised and
continue to exercise substantial influence over many aspects of the private
sector. In certain cases, the government still owns or controls many companies,
including some of the largest in the country. Accordingly, government actions in
the future could have a significant effect on economic conditions in Latin
American countries, which could affect private sector companies and the Fund, as
well as the value of securities in the Fund's portfolio.
MONTGOMERY GLOBAL COMMUNICATIONS FUND. The Communications Fund defines
a "communications company" as a company engaged in the development, manufacture
or sale of communications equipment or services that derived at least 50% of
either its revenues or earnings from these activities, or that devoted at least
50% of its assets to these activities, based on the company's most recent fiscal
year.
The Communications Fund's portfolio management believes that worldwide
demand for components, products, media and systems to collect, store, retrieve,
transmit, process, distribute, record, reproduce and use information will
continue to grow in the future. It also believes that the global trend appears
to be toward lower costs and higher efficiencies resulting from combining
communications systems with computers, and, accordingly, the Fund may invest in
companies engaged in the development of methods for using new technologies to
communicate information as well as companies using established communications
technologies.
The Communications Fund may invest up to 35% of its total assets in
debt securities, including up to 5% in debt securities rated below investment
grade. The Communications Fund invests in companies that, in the opinion of the
Manager, have potential for above-average, long-term growth in sales and
earnings on a sustained basis and that are reasonably priced. The Manager
considers a number of factors in evaluating potential investments, including a
company's per-share sales and earnings growth; return on capital; balance sheet;
financial and accounting policies; overall financial strength; industry sector;
competitive advantages and disadvantages; research, product development and
marketing; development of new technologies; service; pricing flexibility;
quality of management; and general operating characteristics.
The Communications Fund may invest substantially in securities
denominated in one or more foreign currencies. Under normal conditions, the
Communications Fund invests in at least three different countries, which may
include the United States, but no country other than the United States may
represent more than 40% of its assets. A significant portion of the
Communications Fund's assets are invested in the securities of foreign issuers,
because many attractive investment opportunities, including many of the world's
communications companies, are outside the United States.
Montgomery Global Long-Short Fund
---------------------------------
This Fund uses sophisticated investment approaches that may present
substantially higher risks than most mutual funds. It may invest a larger
percentage of its assets in transactions using margin, leverage, short sales and
other forms of volatile financial derivatives such as options and futures. As a
result, the value of an investment in this Fund may be more volatile than
investments in other mutual funds. This Fund may not be an appropriate
investment for conservative investors.
The Long-Short Fund's investment objective is to seek capital
appreciation. Under normal conditions, this Fund seeks to achieve its objective
by investing at least 65% of its total assets in long and short positions in
equity securities of publicly traded companies of any size worldwide. This Fund
measures short sale exposure by the current market value of the collateral used
to secure the short sale positions. Any income derived from dividends and
interest will be incidental to this Fund's investment objective. Investors
should note that this Fund uses an approach different from the traditional
long-term investment approach of most other mutual funds. The use of borrowing
and short sales may cause the Fund to have higher expenses (especially interest
expenses and dividend expenses) than those of other equity mutual funds. Like
all mutual funds, there can be no assurance that the Fund's investment objective
will be attained.
This Fund may employ margin leverage and engage in short sales of
securities it does not own. This Fund also may use options and financial indices
for hedging purposes and/or to establish or increase its long or short
positions. This Fund invests primarily in common stocks (including depositary
receipts) but also may invest in other types of equity and equity-derivative
securities. It may invest up to 35% of its total assets in debt securities,
including up to 5% in debt securities rated investment grade. See "Portfolio
Securities," "Risk Considerations" and the Appendix in the Statement of
Additional Information.
This Fund may invest in certain debt securities issued by the
governments of emerging markets countries that are, or may be eligible for,
conversion into investments in emerging markets companies under debt conversion
programs sponsored by such governments. This Fund deems securities that are
convertible to equity investments to be equity-derivative securities.
MONTGOMERY FEDERAL MONEY FUND, CALIFORNIA MONEY FUND AND CALIFORNIA
INTERMEDIATE BOND FUND. The Federal Money Fund seeks to, under normal
conditions, achieve its objective by investing at least 80% of its net assets in
municipal securities, the interest from which is, in the opinion of counsel to
the issuer, exempt from federal income tax. The California Money Fund seeks to
achieve its objective by investing at least 80% of its net assets in municipal
securities and at least 65% of its net assets in debt securities, the interest
from which is, in the opinion of counsel to the issuer, also exempt from
California personal income taxes ("California municipal securities"). Under
normal conditions, the California Intermediate Bond Fund seeks to achieve its
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objective by investing at least 80% of its net assets in California municipal
securities. The California Money Fund and the California Intermediate Bond Fund
are not suitable for investors who cannot benefit from the tax-exempt character
of its dividends, such as IRAs, qualified retirement plans or tax-exempt
entities.
At least 80% of the value of the California Intermediate Bond Fund's
net assets must consist of California municipal securities that, at the time of
purchase, are rated investment grade, that is, within the four highest ratings
of municipal securities (AAA to BBB) assigned by Standard & Poor's Corporation
("S&P"), (Aaa to Baa) assigned by Moody's Investors Service, Inc. ("Moody's"),
or (AAA to BBB) assigned by Fitch Investor Services ("Fitch"); or have S&P's
short-term municipal rating of SP-2 or higher, or a municipal commercial paper
rating of A-2 or higher; Moody's short-term municipal securities rating of MIG-2
or higher, or VMIG-2 or higher or a municipal commercial paper rating of P-2 or
higher; or have Fitch's short-term municipal securities rating of FIN-2 or
higher or a municipal commercial paper rating of Fitch-2 or higher; or, if
unrated by S&P, Moody's or Fitch, are deemed by the Manager to be of comparable
quality, using guidelines approved by the Board of Trustees, but not to exceed
20% of the Fund's net assets. Debt securities rated in the lowest category of
investment-grade debt may have speculative characteristics; changes in economic
conditions or other circumstances are more likely to lead to weakened capacity
to make principal and interest payments than is the case with higher-grade
bonds. There is no assurance that any municipal issuers will make full payments
of principal and interest or remain solvent, however. For a description of the
ratings, see the Appendix.
The Federal Money and California Money Funds seek to maintain a stable
net asset value of $1 per share in compliance with Rule 2a-7 under the
Investment Company Act and, pursuant to procedures adopted under that Rule,
limit their investments to those securities that the Board determines present
minimal credit risks and have remaining maturities, as determined under the
Rule, of 397 calendar days or less. These Funds also maintain a dollar-weighted
average maturity of their portfolio securities of 90 days or less.
PORTFOLIO SECURITIES
DEPOSITARY RECEIPTS, CONVERTIBLE SECURITIES AND SECURITIES WARRANTS.
The Foreign and Global Equity Funds, the Select 50 Fund and the U.S. Equity
Funds may hold securities of foreign issuers in the form of American Depositary
Receipts ("ADRs"), European Depositary Receipts ("EDRs"), Global Depository
Receipts ("GDRs"), and other similar global instruments available in emerging
markets, or other securities convertible into securities of eligible issuers.
These securities may not necessarily be denominated in the same currency as the
securities for which they may be exchanged. Generally, ADRs in registered form
are designed for use in U.S. securities markets, and EDRs and other similar
global instruments in bearer form are designed for use in European securities
markets. For purposes of a Fund's investment policies, a Fund's investments in
ADRs, EDRs and similar instruments will be deemed to be investments in the
equity securities representing the securities of foreign issuers into which they
may be converted. Each such Fund may also invest in convertible securities and
securities warrants.
OTHER INVESTMENT COMPANIES. Each Fund may invest in securities issued
by other investment companies. Those investment companies must invest in
securities in which the Fund can invest in a manner consistent with the Fund's
investment objective and policies. Applicable provisions of the Investment
Company Act require that a Fund limit its investments so that, as determined
immediately after a securities purchase is made: (a) not more than 10% (or 35%
for the Money Market Funds) of the value of a Fund's total assets will be
invested in the aggregate in securities of investment companies as a group; and
(b) either (i) a Fund and affiliated persons
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of that Fund not own together more than 3% of the total outstanding shares of
any one investment company at the time of purchase (and that all shares of the
investment company held by that Fund in excess of 1% of the company's total
outstanding shares be deemed illiquid), or (ii) a Fund not invest more than 5%
of its total assets in any one investment company and the investment not
represent more than 3% of the total outstanding voting stock of the investment
company at the time of purchase.
Because of restrictions on direct investment by U.S. entities in
certain countries, other investment companies may provide the most practical or
only way for the Foreign and Global Equity Funds to invest in certain markets.
Such investments may involve the payment of substantial premiums above the net
asset value of those investment companies' portfolio securities and are subject
to limitations under the Investment Company Act. The Foreign and Global Equity
Funds also may incur tax liability to the extent that they invest in the stock
of a foreign issuer that is a "passive foreign investment company" regardless of
whether such "passive foreign investment company" makes distributions to the
Funds.
The U.S. Equity Funds, the Foreign and Global Equity Funds, the Select
50 Fund and the U.S. Fixed-Income and Money Market Funds do not intend to invest
in other investment companies unless, in the Manager's judgment, the potential
benefits exceed associated costs. As a shareholder in an investment company,
these Funds bear their ratable share of that investment company's expenses,
including advisory and administration fees. The Manager has agreed to waive its
own management fee with respect to the portion of these Funds' assets invested
in other open-end (but not closed-end) investment companies.
DEBT SECURITIES. Each Fund may purchase debt securities that complement
its objective of capital appreciation through anticipated favorable changes in
relative foreign exchange rates, in relative interest rate levels or in the
creditworthiness of issuers. Debt securities may constitute up to 35% of the
U.S. Equity Funds', the Foreign and Global Equity Funds' and the Select 50
Fund's total assets. In selecting debt securities, the Manager seeks out good
credits and analyzes interest rate trends and specific developments that may
affect individual issuers. As an operating policy, which may be changed by the
Board, each Fund may invest up to 5% (except the Latin America Fund which may
invest up to 15%) of their total assets in debt securities rated lower than
investment grade. Subject to this limitation, each of these Funds may invest in
any debt security, including securities in default. After its purchase by a
Fund, a debt security may cease to be rated or its rating may be reduced below
that required for purchase by the Fund. A security downgraded below the minimum
level may be retained if determined by the Manager and the Board to be in the
best interests of the Fund.
Debt securities may also consist of participation certificates in large
loans made by financial institutions to various borrowers, typically in the form
of large unsecured corporate loans. These certificates must otherwise comply
with the maturity and credit-quality standards of each Fund and will be limited
to 5% of a Fund's total assets.
In addition to traditional corporate, government and supranational debt
securities, each of the Equity Income Fund and the Foreign and Global Equity
Funds may invest in external (i.e., to foreign lenders) debt obligations issued
by the governments, government entities and companies of emerging markets
countries. The percentage distribution between equity and debt will vary from
country to country, based on anticipated trends in inflation and interest rates;
expected rates of economic and corporate profits growth; changes in government
policy; stability, solvency and expected trends of government finances; and
conditions of the balance of payments and terms of trade.
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U.S. GOVERNMENT SECURITIES. Each Fund may invest a substantial portion,
if not all, of its net assets in obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, including repurchase agreements
backed by such securities. ("U.S. Government securities"). These Funds generally
will have a lower yield than if they purchased higher yielding commercial paper
or other securities with correspondingly greater risk instead of U.S. Government
securities.
Certain of the obligations, including U.S. Treasury bills, notes and
bonds, and mortgage-related securities of the GNMA, are issued or guaranteed by
the U.S. government. Other securities issued by U.S. government agencies or
instrumentalities are supported only by the credit of the agency or
instrumentality, such as those issued by the Federal Home Loan Bank, whereas
others, such as those issued by the FNMA, Farm Credit System and Student Loan
Marketing Association, have an additional line of credit with the U.S. Treasury.
Short-term U.S. government securities generally are considered to be among the
safest short-term investments. The U.S. government does not guarantee the net
asset value of the Funds' shares, however. With respect to U.S. government
securities supported only by the credit of the issuing agency or instrumentality
or by an additional line of credit with the U.S. Treasury, there is no guarantee
that the U.S. government will provide support to such agencies or
instrumentalities. Accordingly, such U.S. government securities may involve risk
of loss of principal and interest.
PRIVATIZATIONS. The Select 50 Fund and the Foreign and Global Equity
Funds may invest in privatizations. Foreign governmental programs of selling
interests in government-owned or -controlled enterprises ("privatizations") may
represent opportunities for significant capital appreciation and these Funds may
invest in privatizations. The ability of U.S. entities, such as these Funds, to
participate in privatizations may be limited by local law, or the terms for
participation may be less advantageous than for local investors. There can be no
assurance that privatization programs will be successful.
SPECIAL SITUATIONS. The Select 50 Fund and the Foreign and Global
Equity Funds may invest in special situations. The Funds believe that carefully
selected investments in joint ventures, cooperatives, partnerships, private
placements, unlisted securities and similar vehicles (collectively, "special
situations") could enhance their capital appreciation potential. These Funds
also may invest in certain types of vehicles or derivative securities that
represent indirect investments in foreign markets or securities in which it is
impracticable for the Funds to invest directly. Investments in special
situations may be illiquid, as determined by the Manager based on criteria
reviewed by the Board. These Funds do not invest more than 15% of their net
assets in illiquid investments, including special situations.
Mortgage-Related Securities and Derivative Securities. The U.S.
Fixed-Income and Money Market Funds may invest in mortgage-related securities. A
mortgage-related security is an interest in a pool of mortgage loans and is
considered a derivative security. Most mortgage-related securities are
pass-through securities, which means that investors receive payments consisting
of a pro rata share of both principal and interest (less servicing and other
fees), as well as unscheduled prepayments, as mortgages in the underlying
mortgage pool are paid off by the borrowers. Certain mortgage-related securities
are subject to high volatility. These Funds use these derivative securities in
an effort to enhance return and as a means to make certain investments not
otherwise available to the Funds.
AGENCY MORTGAGE-RELATED SECURITIES. Investors in the U.S. Fixed-Income
and Money Market Funds should note that the dominant issuers or guarantors of
mortgage-related securities today are GNMA, FNMA and the FHLMC. GNMA creates
pass-through securities from pools of government-guaranteed or -insured (Federal
Housing Authority or Veterans Administration) mortgages. FNMA and FHLMC issue
pass-through securities
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from pools of conventional and federally insured and/or guaranteed residential
mortgages. The principal and interest on GNMA pass-through securities are
guaranteed by GNMA and backed by the full faith and credit of the U.S.
government. FNMA guarantees full and timely payment of all interest and
principal, and FHLMC guarantees timely payment of interest and ultimate
collection of principal of its pass-through securities. Securities from FNMA and
FHLMC are not backed by the full faith and credit of the U.S. government but are
generally considered to offer minimal credit risks. The yields provided by these
mortgage-related securities have historically exceeded the yields on other types
of U.S. government securities with comparable "lives" largely due to the risks
associated with prepayment.
Adjustable rate mortgage securities ("ARMs") are pass-through
securities representing interests in pools of mortgage loans with adjustable
interest rates determined in accordance with a predetermined interest rate index
and which may be subject to certain limits. The adjustment feature of ARMs tends
to lessen their interest rate sensitivity.
The U.S. Fixed-Income and Money Market Funds consider GNMA, FNMA and
FHLMC-issued pass-through certificates, Collateralized Mortgage Obligations
("CMOs") and other mortgage-related securities to be U.S. government securities
for purposes of their investment policies. The Money Market Funds do not invest
in stripped mortgage securities, however, and the Short Bond Fund limits its
stripped mortgage securities investments to 10% of total assets. The liquidity
of Interest-Only bonds ("IOs") and Principal-Only bonds ("POs") issued by the
U.S. government or its agencies and instrumentalities and backed by fixed-rate
mortgage-related securities will be determined by the Manager under the direct
supervision of the Trusts' Pricing Committee and reviewed by the Board, and all
other IOs and POs will be deemed illiquid for purposes of the U.S. Fixed-Income
and Money Market Funds' limitation on illiquid securities. The Short Bond and
Total Return Bond Funds may invest in derivative securities known as "floaters"
and "inverse floaters," the values of which vary in response to interest rates.
These securities may be illiquid and their values may be very volatile.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES/DERIVATIVES. The Total
Return Bond Fund and the Short Bond Fund may invest in mortgage-related
securities offered by private issuers, including pass-through securities for
pools of conventional residential mortgage loans; mortgage pay-through
obligations and mortgage-backed bonds, which are considered to be obligations of
the institution issuing the bonds and are collateralized by mortgage loans; and
bonds and CMOs collateralized by mortgage-related securities issued by GNMA,
FNMA, FHLMC or by pools of conventional mortgages, multifamily or commercial
mortgage loans.
Privately issued mortgage-related securities generally offer a higher
rate of interest (but greater credit and interest rate risk) than U.S.
government and agency mortgage-related securities because they offer no direct
or indirect governmental guarantees. Many issuers or servicers of
mortgage-related securities guarantee or provide insurance for timely payment of
interest and principal, however. The Short Bond Fund and Total Return Bond Fund
may purchase some mortgage-related securities through private placements that
are restricted as to further sale. The value of these securities may be very
volatile.
STRUCTURED NOTES AND INDEXED SECURITIES. The Funds may invest in
structured notes and indexed securities. Structured notes are debt securities,
the interest rate or principal of which is determined by an unrelated indicator.
Indexed securities include structured notes as well as securities other than
debt securities, the interest rate or principal of which is determined by an
unrelated indicator. Index securities may include a multiplier that multiplies
the indexed element by a specified factor and, therefore, the value of such
securities may be very volatile. To the extent a Fund invests in these
securities, however, the Manager analyzes these
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securities in its overall assessment of the effective duration of the Fund's
portfolio in an effort to monitor the Fund's interest rate risk.
VARIABLE-RATE DEMAND NOTES. The U.S. Fixed-Income and Money Market
Funds may invest in variable-rate demand notes ("VRDNs"). These are instruments
with rates of interest adjusted periodically or that "float" continuously
according to specific formulas and often have a demand feature entitling the
purchaser to resell the securities.
ASSET-BACKED SECURITIES. Each Fund may invest up to 5% (25% in the case
of the Total Return Bond Fund and the Short Bond Fund) of its total assets in
asset-backed securities. These are secured by and payable from pools of assets,
such as motor vehicle installment loan contracts, leases of various types of
real and personal property, and receivables from revolving credit (e.g., credit
card) agreements. Like mortgage-related securities, these securities are subject
to the risk of prepayment.
MORTGAGE-RELATED SECURITIES: GOVERNMENT NATIONAL MORTGAGE ASSOCIATION.
GNMA is a wholly owned corporate instrumentality of the U.S. Government within
the Department of Housing and Urban Development. The National Housing Act of
1934, as amended (the "Housing Act"), authorizes GNMA to guarantee the timely
payment of the principal of, and interest on, securities that are based on and
backed by a pool of specified mortgage loans. For these types of securities to
qualify for a GNMA guarantee, the underlying collateral must be mortgages
insured by the FHA under the Housing Act, or Title V of the Housing Act of 1949,
as amended ("VA Loans"), or be pools of other eligible mortgage loans. The
Housing Act provides that the full faith and credit of the U.S. Government is
pledged to the payment of all amounts that may be required to be paid under any
guarantee. In order to meet its obligations under a guarantee, GNMA is
authorized to borrow from the U.S. Treasury with no limitations as to amount.
GNMA pass-through securities may represent a proportionate interest in
one or more pools of the following types of mortgage loans: (1) fixed-rate level
payment mortgage loans; (2) fixed-rate graduated payment mortgage loans; (3)
fixed-rate growing equity mortgage loans; (4) fixed-rate mortgage loans secured
by manufactured (mobile) homes; (5) mortgage loans on multifamily residential
properties under construction; (6) mortgage loans on completed multifamily
projects; (7) fixed-rate mortgage loans as to which escrowed funds are used to
reduce the borrower's monthly payments during the early years of the mortgage
loans ("buydown" mortgage loans); (8) mortgage loans that provide for
adjustments on payments based on periodic changes in interest rates or in other
payment terms of the mortgage loans; and (9) mortgage-backed serial notes.
MORTGAGE-RELATED SECURITIES: FEDERAL NATIONAL MORTGAGE ASSOCIATION.
FNMA is a federally chartered and privately owned corporation established under
the Federal National Mortgage Association Charter Act. FNMA was originally
organized in 1938 as a U.S. Government agency to add greater liquidity to the
mortgage market. FNMA was transformed into a private sector corporation by
legislation enacted in 1968. FNMA provides funds to the mortgage market
primarily by purchasing home mortgage loans from local lenders, thereby
providing them with funds for additional lending. FNMA acquires funds to
purchase loans from investors that may not ordinarily invest in mortgage loans
directly, thereby expanding the total amount of funds available for housing.
Each FNMA pass-through security represents a proportionate interest in
one or more pools of FHA Loans, VA Loans or conventional mortgage loans (that
is, mortgage loans that are not insured or guaranteed by any U.S. Government
agency). The loans contained in those pools consist of one or more of the
following: (1)
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fixed-rate level payment mortgage loans; (2) fixed-rate growing equity mortgage
loans; (3) fixed-rate graduated payment mortgage loans; (4) variable-rate
mortgage loans; (5) other adjustable-rate mortgage loans; and (6) fixed-rate
mortgage loans secured by multifamily projects.
MORTGAGE-RELATED SECURITIES: FEDERAL HOME LOAN MORTGAGE CORPORATION.
FHLMC is a corporate instrumentality of the United States established by the
Emergency Home Finance Act of 1970, as amended. FHLMC was organized primarily
for the purpose of increasing the availability of mortgage credit to finance
needed housing. The operations of FHLMC currently consist primarily of the
purchase of first lien, conventional, residential mortgage loans and
participation interests in mortgage loans and the resale of the mortgage loans
in the form of mortgage-backed securities.
The mortgage loans underlying FHLMC securities typically consist of
fixed-rate or adjustable-rate mortgage loans with original terms to maturity of
between 10 and 30 years, substantially all of which are secured by first liens
on one-to-four-family residential properties or multifamily projects. Each
mortgage loan must include whole loans, participation interests in whole loans
and undivided interests in whole loans and participation in another FHLMC
security.
PRIVATELY ISSUED MORTGAGE-RELATED SECURITIES. To the extent allowed in
its Prospectus, a Fund may invest in mortgage-related securities offered by
private issuers, including pass-through securities comprised of pools of
conventional residential mortgage loans; mortgage-backed bonds which are
considered to be obligations of the institution issuing the bonds and are
collateralized by mortgage loans; and bonds and collateralized mortgage
obligations ("CMOs").
Each class of a CMO is issued at a specific fixed or floating coupon
rate and has a stated maturity or final distribution date. Principal prepayments
on the collateral pool may cause the various classes of a CMO to be retired
substantially earlier than their stated maturities or final distribution dates.
The principal of and interest on the collateral pool may be allocated among the
several classes of a CMO in a number of different ways. Generally, the purpose
of the allocation of the cash flow of a CMO to the various classes is to obtain
a more predictable cash flow to some of the individual tranches than exists with
the underlying collateral of the CMO. As a general rule, the more predictable
the cash flow is on a CMO tranche, the lower the anticipated yield will be on
that tranche at the time of issuance relative to prevailing market yields on
mortgage-related securities. Certain classes of CMOs may have priority over
others with respect to the receipt of prepayments on the mortgages.
To the extent allowed in its Prospectus, a Fund may invest in, among
other things, "parallel pay" CMOs and Planned Amortization Class CMOs ("PAC
Bonds"). Parallel pay CMOs are structured to provide payments of principal on
each payment date to more than one class. These simultaneous payments are taken
into account in calculating the stated maturity date or final distribution date
of each class which, like the other CMO structures, must be retired by its
stated maturity date or final distribution date, but may be retired earlier. PAC
Bonds are parallel pay CMOs that generally require payments of a specified
amount of principal on each payment date; the required principal payment on PAC
Bonds have the highest priority after interest has been paid to all classes.
ADJUSTABLE-RATE MORTGAGE-RELATED SECURITIES. Because the interest rates
on the mortgages underlying adjustable-rate mortgage-related securities ("ARMS")
reset periodically, yields of such portfolio securities will gradually align
themselves to reflect changes in market rates. Unlike fixed-rate mortgages,
which generally
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decline in value during periods of rising interest rates, ARMS allow a Fund to
participate in increases in interest rates through periodic adjustments in the
coupons of the underlying mortgages, resulting in both higher current yields and
low price fluctuations. Furthermore, if prepayments of principal are made on the
underlying mortgages during periods of rising interest rates, a Fund may be able
to reinvest such amounts in securities with a higher current rate of return.
During periods of declining interest rates, of course, the coupon rates may
readjust downward, resulting in lower yields to a Fund. Further, because of this
feature, the value of ARMS is unlikely to rise during periods of declining
interest rates to the same extent as fixed rate instruments. For further
discussion of the risks associated with mortgage-related securities generally.
VARIABLE RATE DEMAND NOTES. Variable rate demand notes ("VRDNs") are
tax-exempt obligations that contain a floating or variable interest rate
adjustment formula and an unconditional right of demand to receive payment of
the unpaid principal balance plus accrued interest upon a short notice period
prior to specified dates, generally at 30-, 60-, 90-, 180-, or 365-day
intervals. The interest rates are adjustable at intervals ranging from daily to
six months. Adjustment formulas are designed to maintain the market value of the
VRDN at approximately the par value of the VRDN upon the adjustment date. The
adjustments typically are based upon the prime rate of a bank or some other
appropriate interest rate adjustment index.
The Tax-Free Funds also may invest in VRDNs in the form of
participation interests ("Participating VRDNs") in variable rate tax-exempt
obligations held by a financial institution, typically a commercial bank
("institution"). Participating VRDNs provide a Fund with a specified undivided
interest (up to 100%) of the underlying obligation and the right to demand
payment of the unpaid principal balance plus accrued interest on the
Participating VRDNs from the institution upon a specified number of days'
notice, not to exceed seven. In addition, the Participating VRDN is backed by an
irrevocable letter of credit or guaranty of the institution. A Fund has an
undivided interest in the underlying obligation and thus participates on the
same basis as the institution in such obligation except that the institution
typically retains fees out of the interest paid on the obligation for servicing
the obligation, providing the letter of credit and issuing the repurchase
commitment.
Participating VRDNs may be unrated or rated, and their creditworthiness
may be a function of the creditworthiness of the issuer, the institution
furnishing the irrevocable letter of credit, or both. Accordingly, the Tax-Free
Funds may invest in such VRDNs, the issuers or underlying institutions of which
the Manager believes are creditworthy and satisfy the quality requirements of
the Funds. The Manager periodically monitors the creditworthiness of the issuer
of such securities and the underlying institution.
During periods of high inflation and periods of economic slowdown,
together with the fiscal measures adopted by governmental authorities to attempt
to deal with them, interest rates have varied widely. While the value of the
underlying VRDN may change with changes in interest rates generally, the
variable rate nature of the underlying VRDN should minimize changes in the value
of the instruments. Accordingly, as interest rates decrease or increase, the
potential for capital appreciation and the risk of potential capital
depreciation is less than would be the case with a portfolio of fixed-income
securities. The Tax-Free Funds may invest in VRDNs on which stated minimum or
maximum rates, or maximum rates set by state law, limit the degree to which
interest on such VRDNs may fluctuate; to the extent they do increases or
decreases in value may be somewhat greater than would be the case without such
limits. Because the adjustment of interest rates on the VRDNs is made in
relation to movements of various interest rate adjustment indices, the VRDNs are
not comparable to long-term fixed-rate securities. Accordingly, interest rates
on the VRDNs may be higher or lower than current market rates for fixed-rate
obligations of comparable quality with similar maturities.
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MUNICIPAL SECURITIES. Because the Tax-Free Funds invest at least 80% of
their total assets in obligations either issued by or on behalf of states,
territories and possessions of the United States and the District of Columbia
and their political subdivisions, agencies, authorities and instrumentalities,
including industrial development bonds, as well as obligations of certain
agencies and instrumentalities of the U.S. Government, the interest from which
is, in the opinion of bond counsel to the issuer, exempt from federal income tax
("Municipal Securities"), or exempt from federal and California personal income
tax ("California Municipal Securities"), and the California Money Fund invests
at least 65% of its total assets in California Municipal Securities, and may
invest in Municipal Securities, these Funds generally will have a lower yield
than if they primarily purchased higher yielding taxable securities, commercial
paper or other securities with correspondingly greater risk. Generally, the
value of the Municipal Securities and California Municipal Securities held by
these Funds will fluctuate inversely with interest rates.
GENERAL OBLIGATION BONDS. Issuers of general obligation bonds include
states, counties, cities, towns and regional districts. The proceeds of these
obligations are used to fund a wide range of public projects, including
construction or improvement of schools, highways and roads, and water and sewer
systems. The basic security behind general obligation bonds is the issuer's
pledge of its full faith, credit and taxing power for the payment of principal
and interest. The taxes that can be levied for the payment of debt service may
be limited or unlimited as to the rate or amount of special assessments.
REVENUE BONDS. A revenue bond is not secured by the full faith, credit
and taxing power of an issuer. Rather, the principal security for a revenue bond
is generally the net revenue derived from a particular facility, group of
facilities or, in some cases, the proceeds of a special excise or other specific
revenue source. Revenue bonds are issued to finance a wide variety of capital
projects, including electric, gas, water, and sewer systems; highways, bridges,
and tunnels; port and airport facilities; colleges and universities; and
hospitals. Although the principal security behind these bonds may vary, many
provide additional security in the form of a debt service reserve fund that may
be used to make principal and interest payments on the issuer's obligations.
Housing finance authorities have a wide range of security, including partially
or fully insured mortgages, rent subsidized and/or collateralized mortgages,
and/or the net revenues from housing or other public projects. Some authorities
provide further security in the form of a governmental assurance (although
without obligation) to make up deficiencies in the debt service reserve fund.
INDUSTRIAL DEVELOPMENT BONDS. Industrial development bonds, which may
pay tax-exempt interest, are, in most cases, revenue bonds and are issued by or
on behalf of public authorities to raise money to finance various privately
operated facilities for business manufacturing, housing, sports, and pollution
control. These bonds also are used to finance public facilities, such as
airports, mass transit systems, ports and parking. The payment of the principal
and interest on such bonds is dependent solely on the ability of the facility's
user to meet its financial obligations and the pledge, if any, of the real and
personal property so financed as security for such payment. As a result of 1986
federal tax legislation, industrial revenue bonds may no longer be issued on a
tax-exempt basis for certain previously permissible purposes, including sports
and pollution control facilities.
PARTICIPATION INTERESTS. The Tax-Free Funds may purchase from financial
institutions participation interests in Municipal Securities, such as industrial
development bonds and municipal lease/purchase agreements. A participation
interest gives a Fund an undivided interest in a Municipal Security in the
proportion that the Fund's participation interest bears to the total principal
amount of the Municipal Security. These instruments may have fixed, floating or
variable rates of interest. If the participation interest is unrated, it will be
backed by an irrevocable letter of credit or guarantee of a bank that the Board
of Trustees has approved as
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meeting the Board's standards, or, alternatively, the payment obligation will be
collateralized by U.S. Government securities.
For certain participation interests, these Funds will have the right to
demand payment, on not more than seven days' notice, for all or any part of
their participation interest in a Municipal Security, plus accrued interest. As
to these instruments, these Funds intend to exercise their right to demand
payment only upon a default under the terms of the Municipal Securities, as
needed to provide liquidity to meet redemptions, or to maintain or improve the
quality of their investment portfolios. The California Intermediate Bond Fund
will not invest more than 15% of its total assets and the California Money Fund
will not invest more than 10% of its total assets in participation interests
that do not have this demand feature, and in other illiquid securities.
Some participation interests are subject to a "nonappropriation" or
"abatement" feature by which, under certain conditions, the issuer of the
underlying Municipal Security may, without penalty, terminate its obligation to
make payment. In such event, the holder of such security must look to the
underlying collateral, which is often a municipal facility used by the issuer.
CUSTODIAL RECEIPTS. The Tax-Free Funds may purchase custodial receipts
representing the right to receive certain future principal and interest payments
on Municipal Securities that underlie the custodial receipts. A number of
different arrangements are possible. In the most common custodial receipt
arrangement, an issuer or a third party owning the Municipal Securities deposits
such obligations with a custodian in exchange for two classes of custodial
receipts with different characteristics. In each case, however, payments on the
two classes are based on payments received on the underlying Municipal
Securities. One class has the characteristics of a typical auction-rate
security, having its interest rate adjusted at specified intervals, and its
ownership changes based on an auction mechanism. The interest rate of this class
generally is expected to be below the coupon rate of the underlying Municipal
Securities and generally is at a level comparable to that of a Municipal
Security of similar quality and having a maturity equal to the period between
interest rate adjustments. The second class bears interest at a rate that
exceeds the interest rate typically borne by a security of comparable quality
and maturity; this rate also is adjusted, although inversely to changes in the
rate of interest of the first class. If the interest rate on the first class
exceeds the coupon rate of the underlying Municipal Securities, its interest
rate will exceed the rate paid on the second class. In no event will the
aggregate interest paid with respect to the two classes exceed the interest paid
by the underlying Municipal Securities. The value of the second class and
similar securities should be expected to fluctuate more than the value of a
Municipal Security of comparable quality and maturity and their purchase by one
of these Funds should increase the volatility of its net asset value and, thus,
its price per share. These custodial receipts are sold in private placements and
are subject to these Funds' limitation with respect to illiquid investments. The
Tax-Free Funds also may purchase directly from issuers, and not in a private
placement, Municipal Securities having the same characteristics as the custodial
receipts.
TENDER OPTION BONDS. The Tax-Free Funds may purchase tender option
bonds and similar securities. A tender option bond is a Municipal Security,
generally held pursuant to a custodial arrangement, having a relatively long
maturity and bearing interest at a fixed rate substantially higher than
prevailing short-term tax-exempt rates, coupled with an agreement of a third
party, such as a bank, broker-dealer or other financial institution, granting
the security holders the option, at periodic intervals, to tender their
securities to the institution and receive their face value. As consideration for
providing the option, the financial institution receives periodic fees equal to
the difference between the Municipal Security's fixed coupon rate and the rate,
as determined by a remarketing or similar agent at or near the commencement of
such period, that would cause
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the securities, coupled with the tender option, to trade at par on the date of
such determination. Thus, after payment of this fee, the security holder
effectively holds a demand obligation that bears interest at the prevailing
short-term tax-exempt rate. The Manager, on behalf of a Tax-Free Fund, considers
on a periodic basis the creditworthiness of the issuer of the underlying
Municipal Security, of any custodian and of the third party provider of the
tender option. In certain instances and for certain tender option bonds, the
option may be terminable in the event of a default in payment of principal or
interest on the underlying Municipal Obligations and for other reasons. The
California Intermediate Bond Fund will not invest more than 15% of its total
assets and the California Money Fund more than 10% of its total assets in
securities that are illiquid (including tender option bonds with a tender
feature that cannot be exercised on not more than seven days' notice if there is
no secondary market available for these obligations).
OBLIGATIONS WITH PUTS ATTACHED. The Tax-Free Funds may purchase
Municipal Securities together with the right to resell the securities to the
seller at an agreed-upon price or yield within a specified period prior to the
securities' maturity date. Although an obligation with a put attached is not a
put option in the usual sense, it is commonly known as a "put" and is also
referred to as a "stand-by commitment." These Funds will use such puts in
accordance with regulations issued by the Securities and Exchange Commission
("SEC"). In 1982, the Internal Revenue Service (the "IRS") issued a revenue
ruling to the effect that, under specified circumstances, a regulated investment
company would be the owner of tax-exempt municipal obligations acquired with a
put option. The IRS also has issued private letter rulings to certain taxpayers
(which do not serve as precedent for other taxpayers) to the effect that
tax-exempt interest received by a regulated investment company with respect to
such obligations will be tax-exempt in the hands of the company and may be
distributed to its shareholders as exempt-interest dividends. The last such
ruling was issued in 1983. The IRS subsequently announced that it will not
ordinarily issue advance ruling letters as to the identity of the true owner of
property in cases involving the sale of securities or participation interests
therein if the purchaser has the right to cause the securities, or the
participation interest therein, to be purchased by either the seller or a third
party. The Tax-Free Funds intend to take the position that they are the owners
of any municipal obligations acquired subject to a stand-by commitment or a
similar put right and that tax-exempt interest earned with respect to such
municipal obligations will be tax exempt in its hands. There is no assurance
that stand-by commitments will be available to these Funds nor have they assumed
that such commitments would continue to be available under all market
conditions. There may be other types of municipal securities that become
available and are similar to the foregoing described Municipal Securities in
which these Funds may invest.
ZERO COUPON BONDS. The U.S. Fixed-Income and Money Market Funds may
invest in zero coupon securities, which are debt securities issued or sold at a
discount from their face value and do not entitle the holder to any periodic
payment of interest prior to maturity, a specified redemption date or a cash
payment date. The amount of the discount varies depending on the time remaining
until maturity or cash payment date, prevailing interest rates, liquidity of the
security and perceived credit quality of the issuer. Zero coupon securities also
may take the form of debt securities that have been stripped of their unmatured
interest coupons, the coupons themselves and receipts or certificates
representing interests in such stripped debt obligations and coupons. The market
prices of zero coupon securities are generally more volatile than the market
prices of interest-bearing securities and respond more to changes in interest
rates than interest-bearing securities with similar maturities and credit
qualities. The original issue discount on the zero coupon bonds must be included
ratably in the income of the U.S. Fixed-Income and Money Market Funds as the
income accrues even though payment has not been received. These Funds
nevertheless intend to distribute an amount of cash equal to the
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currently accrued original issue discount, and this may require liquidating
securities at times they might not otherwise do so and may result in capital
loss.
RISK FACTORS/SPECIAL CONSIDERATIONS RELATING TO DEBT SECURITIES
The Select 50, International and the Global Funds may invest in debt
securities that are rated below BBB by S&P, Baa by Moody's or BBB by Fitch, or,
if unrated, are deemed to be of equivalent investment quality by the Manager. As
an operating policy, which may be changed by the Board of Trustees without
shareholder approval, a Fund will invest no more than 5% (15% for the Latin
America Fund) of its assets in debt securities rated below Baa by Moody's or BBB
by S&P, or, if unrated, of equivalent investment quality as determined by the
Manager. The market value of debt securities generally varies in response to
changes in interest rates and the financial condition of each issuer. During
periods of declining interest rates, the value of debt securities generally
increases. Conversely, during periods of rising interest rates, the value of
such securities generally declines. The net asset value of a Fund will reflect
these changes in market value.
Bonds rated C by Moody's are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing. Bonds rated C by S&P are obligations on
which no interest is being paid. Bonds rated below BBB or Baa are often referred
to as "junk bonds."
Although such bonds may offer higher yields than higher-rated
securities, low-rated debt securities generally involve greater price volatility
and risk of principal and income loss, including the possibility of default by,
or bankruptcy of, the issuers of the securities. In addition, the markets in
which low-rated debt securities are traded are more limited than those for
higher-rated securities. The existence of limited markets for particular
securities may diminish the ability of a Fund to sell the securities at fair
value either to meet redemption requests or to respond to changes in the economy
or financial markets and could adversely affect, and cause fluctuations in, the
per-share net asset value of that Fund.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of low-rated debt
securities, especially in a thinly traded market. Analysis of the
creditworthiness of issuers of low-rated debt securities may be more complex
than for issuers of higher-rated securities, and the ability of a Fund to
achieve its investment objectives may, to the extent it invests in low-rated
debt securities, be more dependent upon such credit analysis than would be the
case if that Fund invested in higher-rated debt securities.
Low-rated debt securities may be more susceptible to real or perceived
adverse economic and competitive industry conditions than investment-grade
securities. The prices of low-rated debt securities have been found to be less
sensitive to interest rate changes than higher-rated debt securities but more
sensitive to adverse economic downturns or individual corporate developments. A
projection of an economic downturn or of a period of rising interest rates, for
example, could cause a sharper decline in the prices of low-rated debt
securities because the advent of a recession could lessen the ability of a
highly leveraged company to make principal and interest payments on its debt
securities. If the issuer of low-rated debt securities defaults, a Fund may
incur additional expenses to seek financial recovery. The low-rated bond market
is relatively new, and many of the outstanding low-rated bonds have not endured
a major business downturn.
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HEDGING AND RISK MANAGEMENT PRACTICES
In order to hedge against foreign currency exchange rate risks, the
Select 50, International, Global and Equity Income Funds may enter into forward
foreign currency exchange contracts ("forward contracts") and foreign currency
futures contracts, as well as purchase put or call options on foreign
currencies, as described below. Funds may enter into hedging transactions when,
in fact, it is inopportune to do so and, conversely, when it is more opportune
to enter into hedging transactions the Funds might not enter into such
transactions. Such inopportune timing of utilization of hedging practices could
result in substantial losses to the Funds.
The Funds also may conduct their foreign currency exchange transactions
on a spot (I.E., cash) basis at the spot rate prevailing in the foreign currency
exchange market.
The Funds (except the Money Market Funds) also may purchase other types
of options and futures and may, in the future, write covered options.
FORWARD CONTRACTS. The Select 50, International and Global Funds may
enter into forward contracts to attempt to minimize the risk from adverse
changes in the relationship between the U.S. dollar and foreign currencies. A
forward contract, which is individually negotiated and privately traded by
currency traders and their customers, involves an obligation to purchase or sell
a specific currency for an agreed-upon price at a future date.
A Fund may enter into a forward contract, for example, when it enters
into a contract for the purchase or sale of a security denominated in a foreign
currency or is expecting a dividend or interest payment in order to "lock in"
the U.S. dollar price of a security, dividend or interest payment. When a Fund
believes that a foreign currency may suffer a substantial decline against the
U.S. dollar, it may enter into a forward contract to sell an amount of that
foreign currency approximating the value of some or all of that Fund's portfolio
securities denominated in such currency, or when a Fund believes that the U.S.
dollar may suffer a substantial decline against a foreign currency, it may enter
into a forward contract to buy that currency for a fixed dollar amount.
In connection with a Fund's forward contract transactions, an amount of
the Fund's assets equal to the amount of its commitments will be held aside or
segregated to be used to pay for the commitments. Accordingly, a Fund always
will have cash, cash equivalents or liquid equity or debt securities denominated
in the appropriate currency available in an amount sufficient to cover any
commitments under these contracts. Segregated assets used to cover forward
contracts will be marked to market on a daily basis. While these contracts are
not presently regulated by the Commodity Futures Trading Commission ("CFTC"),
the CFTC may in the future regulate them, and the ability of a Fund to utilize
forward contracts may be restricted. Forward contracts may limit potential gain
from a positive change in the relationship between the U.S. dollar and foreign
currencies. Unanticipated changes in currency prices may result in poorer
overall performance by a Fund than if it had not entered into such contracts. A
Fund generally will not enter into a forward foreign currency exchange contract
with a term greater than one year.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. To hedge against
movements in interest rates, securities prices or currency exchange rates a
Fund, the Funds (except the Money Market Funds) may purchase and sell various
kinds of futures contracts and options on futures contracts. The Fund also may
enter into closing purchase and sale transactions with respect to any such
contracts and options. Futures contracts may be based on various securities
(such as U.S. Government securities), securities indices, foreign currencies and
other financial instruments and indices.
These Funds have filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the CFTC and the National
Futures Association, which regulate trading in the futures markets, before
engaging in any purchases or sales of futures contracts or options on futures
contracts. Pursuant
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to Section 4.5 of the regulations under the Commodity Exchange Act, the notice
of eligibility included the representation that these Funds will use futures
contracts and related options for bona fide hedging purposes within the meaning
of CFTC regulations, provided that a Fund may hold positions in futures
contracts and related options that do not fall within the definition of bona
fide hedging transactions if the aggregate initial margin and premiums required
to establish such positions will not exceed 5% of that Fund's net assets (after
taking into account unrealized profits and unrealized losses on any such
positions) and that in the case of an option that is in-the-money at the time of
purchase, the in-the-money amount may be excluded from such 5%.
These Funds will attempt to determine whether the price fluctuations in
the futures contracts and options on futures used for hedging purposes are
substantially related to price fluctuations in securities held by these Funds or
which they expect to purchase. These Funds' futures transactions generally will
be entered into only for traditional hedging purposes--I.E., futures contracts
will be sold to protect against a decline in the price of securities or
currencies and will be purchased to protect a Fund against an increase in the
price of securities it intends to purchase (or the currencies in which they are
denominated). All futures contracts entered into by these Funds are traded on
U.S. exchanges or boards of trade licensed and regulated by the CFTC or on
foreign exchanges.
Positions taken in the futures markets are not normally held to
maturity but are instead liquidated through offsetting or "closing" purchase or
sale transactions, which may result in a profit or a loss. While these Funds'
futures contracts on securities or currencies will usually be liquidated in this
manner, a Fund may make or take delivery of the underlying securities or
currencies whenever it appears economically advantageous. A clearing corporation
associated with the exchange on which futures on securities or currencies are
traded guarantees that, if still open, the sale or purchase will be performed on
the settlement date.
By using futures contracts to hedge their positions, these Funds seek
to establish more certainty than would otherwise be possible with respect to the
effective price, rate of return or currency exchange rate on portfolio
securities or securities that these Funds propose to acquire. For example, when
interest rates are rising or securities prices are falling, a Fund can seek,
through the sale of futures contracts, to offset a decline in the value of its
current portfolio securities. When rates are falling or prices are rising, a
Fund, through the purchase of futures contracts, can attempt to secure better
rates or prices than might later be available in the market with respect to
anticipated purchases. Similarly, a Fund can sell futures contracts on a
specified currency to protect against a decline in the value of such currency
and its portfolio securities which are denominated in such currency. A Fund can
purchase futures contracts on a foreign currency to fix the price in U.S.
dollars of a security denominated in such currency that Fund has acquired or
expects to acquire.
As part of its hedging strategy, a Fund also may enter into other types
of financial futures contracts if, in the opinion of the Manager, there is a
sufficient degree of correlation between price trends for that Fund's portfolio
securities and such futures contracts. Although under some circumstances prices
of securities in a Fund's portfolio may be more or less volatile than prices of
such futures contracts, the Manager will attempt to estimate the extent of this
difference in volatility based on historical patterns and to compensate for it
by having that Fund enter into a greater or lesser number of futures contracts
or by attempting to achieve only a partial hedge against price changes affecting
that Fund's securities portfolio. When hedging of this character is successful,
any depreciation in the value of portfolio securities can be substantially
offset by appreciation in the value of the futures position. However, any
unanticipated appreciation in the value of a Fund's portfolio securities could
be offset substantially by a decline in the value of the futures position.
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The acquisition of put and call options on futures contracts gives a
Fund the right (but not the obligation), for a specified price, to sell or
purchase the underlying futures contract at any time during the option period.
Purchasing an option on a futures contract gives a Fund the benefit of the
futures position if prices move in a favorable direction, and limits its risk of
loss, in the event of an unfavorable price movement, to the loss of the premium
and transaction costs.
A Fund may terminate its position in an option contract by selling an
offsetting option on the same series. There is no guarantee that such a closing
transaction can be effected. A Fund's ability to establish and close out
positions on such options is dependent upon a liquid market.
Loss from investing in futures transactions by a Fund is potentially
unlimited.
A Fund will engage in transactions in futures contracts and related
options only to the extent such transactions are consistent with the
requirements of the Internal Revenue Code of 1986, as amended, for maintaining
its qualification as a regulated investment company for federal income tax
purposes.
OPTIONS ON SECURITIES, SECURITIES INDICES AND CURRENCIES. Each Fund
(other than the Money Market Funds) may purchase put and call options on
securities in which it has invested, on foreign currencies represented in its
portfolios and on any securities index based in whole or in part on securities
in which that Fund may invest. A Fund also may enter into closing sales
transactions in order to realize gains or minimize losses on options they have
purchased.
A Fund normally will purchase call options in anticipation of an
increase in the market value of securities of the type in which it may invest or
a positive change in the currency in which such securities are denominated. The
purchase of a call option would entitle a Fund, in return for the premium paid,
to purchase specified securities or a specified amount of a foreign currency at
a specified price during the option period.
A Fund may purchase and sell options traded on U.S. and foreign
exchanges. Although a Fund will generally purchase only those options for which
there appears to be an active secondary market, there can be no assurance that a
liquid secondary market on an exchange will exist for any particular option or
at any particular time. For some options, no secondary market on an exchange may
exist. In such event, it might not be possible to effect closing transactions in
particular options, with the result that a Fund would have to exercise its
options in order to realize any profit and would incur transaction costs upon
the purchase or sale of the underlying securities.
Secondary markets on an exchange may not exist or may not be liquid for
a variety of reasons including: (i) insufficient trading interest in certain
options; (ii) restrictions on opening transactions or closing transactions
imposed by an exchange; (iii) trading halts, suspensions or other restrictions
may be imposed with respect to particular classes or series of options; (iv)
unusual or unforeseen circumstances which interrupt normal operations on an
exchange; (v) inadequate facilities of an exchange or the Options Clearing
Corporation to handle current trading volume at all times; or (vi)
discontinuance in the future by one or more exchanges for economic or other
reasons, of trading of options (or of a particular class or series of options),
in which event the secondary market on that exchange (or in that class or series
of options) would cease to exist, although outstanding options on that exchange
that had been issued by the Options Clearing Corporation as a result of trades
on that exchange would continue to be exercisable in accordance with their
terms.
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Although the Funds do not (with the exception of the Global Long-Short
Fund) currently intend to do so, they may, in the future, write (I.E., sell)
covered put and call options on securities, securities indices and currencies in
which they may invest. A covered call option involves a Fund's giving another
party, in return for a premium, the right to buy specified securities owned by
that Fund at a specified future date and price set at the time of the contract.
A covered call option serves as a partial hedge against a price decline of the
underlying security. However, by writing a covered call option, a Fund gives up
the opportunity, while the option is in effect, to realize gain from any price
increase (above the option exercise price) in the underlying security. In
addition, a Fund's ability to sell the underlying security is limited while the
option is in effect unless that Fund effects a closing purchase transaction.
Each Fund also may write covered put options that give the holder of
the option the right to sell the underlying security to the Fund at the stated
exercise price. A Fund will receive a premium for writing a put option but will
be obligated for as long as the option is outstanding to purchase the underlying
security at a price that may be higher than the market value of that security at
the time of exercise. In order to "cover" put options it has written, a Fund
will cause its custodian to segregate cash, cash equivalents, U.S. Government
securities or other liquid equity or debt securities with at least the value of
the exercise price of the put options. A Fund will not write put options if the
aggregate value of the obligations underlying the put options exceeds 25% of
that Fund's total assets.
The Global Long-Short Fund may write options that are not covered by
portfolio securities. This is regarded as a speculative investment technique
that could expose the Fund to substantial losses. The Global Long-Short Fund
will designate liquid securities in the amount of its potential obligation under
uncovered options, and increase or decrease the amount of designated assets
daily based on the amount of the then-current obligation under the option. This
designation of liquid assets will not eliminate the risk of loss from writing
the option but it will ensure that the Global Long-Short Fund can satisfy its
obligations under the option.
There is no assurance that higher than anticipated trading activity or
other unforeseen events might not, at times, render certain of the facilities of
the Options Clearing Corporation inadequate, and result in the institution by an
exchange of special procedures that may interfere with the timely execution of
the Funds' orders.
EQUITY-LINKED DERIVATIVES--SPDRs, WEBS, DIAMONDS and OPALS. Each Fund
may invest in Standard & Poor's ("S&P") Depository Receipts ("SPDRs") and S&P's
MidCap 400 Depository Receipts ("MidCap SPDRs"), World Equity Benchmark Series
("WEBS"), Dow Jones Industrial Average instruments ("DIAMONDS") and assets of
Country Securities ("OPALS"). Each of these instruments are derivative
securities whose value follows a well-known securities index or baskets of
securities.
SPDRs and MidCap SPDRs are designed to follow the performance of S&P
500 Index and the S&P MidCap 400 Index, respectively. WEBS are currently
available in 17 varieties, each designed to follow the performance of a
different Morgan Stanley Capital International country index. DIAMONDS are
designed to follow the performance of the Dow Jones Industrial Average which
tracks the composite stock performance of 30 major U.S. companies in a diverse
range of industries.
OPALS track the performance of adjustable baskets of stocks owned by
Morgan Stanley Capital (Luxembourg) S.A. (the "Counterparty") until a specified
maturity date. Holders of OPALS will receive semi-annual distributions
corresponding to dividends received on shares contained in the underlying basket
of stocks and certain amounts, net of expenses. On the maturity date of the
OPALS, the holder will reveive the physical securities comprising the underlying
baskets. OPALS, like many of these types of instruments, represent an unsecured
obligation and therefore carry with them the risk that the Counterparty will
default.
Because the prices of SPDRs, MidCap SPDRs, WEBS, DIAMONDS and OPALS are
correlated to diversified portfolios, they are subject to the risk that the
general level of stock prices may decline or that the underlying indices
decline. In addition, because SPDRs, MidCap SPDRs, WEBS, DIAMONDS and OPALS will
continue to be traded even when trading is halted in component stocks of the
underlying indices, price quotations for these securities may, at times, be
based upon non-current price information with respect to some of even all of the
stocks in the underlying indices. In addition to the risks disclosed in "Foreign
Securities" below, because WEBS mirror the performance of a single country
index, a economic downturn in a single country could significantly adversely
affect the price of the WEBS for that country.
OTHER INVESTMENT PRACTICES
REPURCHASE AGREEMENTS. Each Fund may enter into repurchase agreements.
A Fund's repurchase agreements will generally involve a short-term investment in
a U.S. Government security or other high-grade
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liquid debt security, with the seller of the underlying security agreeing to
repurchase it at a mutually agreed-upon time and price. The repurchase price is
generally higher than the purchase price, the difference being interest income
to that Fund. Alternatively, the purchase and repurchase prices may be the same,
with interest at a stated rate due to a Fund together with the repurchase price
on the date of repurchase. In either case, the income to a Fund is unrelated to
the interest rate on the underlying security.
Under each repurchase agreement, the seller is required to maintain the
value of the securities subject to the repurchase agreement at not less than
their repurchase price. The Manager, acting under the supervision of the Boards,
reviews on a periodic basis the suitability and creditworthiness, and the value
of the collateral, of those sellers with whom the Funds enter into repurchase
agreements to evaluate potential risk. All repurchase agreements will be made
pursuant to procedures adopted and regularly reviewed by the Boards.
The Funds generally will enter into repurchase agreements of short
maturities, from overnight to one week, although the underlying securities will
generally have longer maturities. The Funds regard repurchase agreements with
maturities in excess of seven days as illiquid. A Fund may not invest more than
15% (10% in the case of the Money Market Funds) of the value of its net assets
in illiquid securities, including repurchase agreements with maturities greater
than seven days.
For purposes of the Investment Company Act, a repurchase agreement is
deemed to be a collateralized loan from a Fund to the seller of the security
subject to the repurchase agreement. It is not clear whether a court would
consider the security acquired by a Fund subject to a repurchase agreement as
being owned by that Fund or as being collateral for a loan by that Fund to the
seller. If bankruptcy or insolvency proceedings are commenced with respect to
the seller of the security before its repurchase, a Fund may encounter delays
and incur costs before being able to sell the security. Delays may involve loss
of interest or a decline in price of the security. If a court characterizes such
a transaction as a loan and a Fund has not perfected a security interest in the
security, that Fund may be required to return the security to the seller's
estate and be treated as an unsecured creditor. As such, a Fund would be at risk
of losing some or all of the principal and income involved in the transaction.
As with any unsecured debt instrument purchased for a Fund, the Manager seeks to
minimize the risk of loss through repurchase agreements by analyzing the
creditworthiness of the seller of the security.
Apart from the risk of bankruptcy or insolvency proceedings, a Fund
also runs the risk that the seller may fail to repurchase the security. However,
each Fund always requires collateral for any repurchase agreement to which it is
a party in the form of securities acceptable to it, the market value of which is
equal to at least 100% of the amount invested by the Fund plus accrued interest,
and each Fund makes payment against such securities only upon physical delivery
or evidence of book entry transfer to the account of its custodian bank. If the
market value of the security subject to the repurchase agreement becomes less
than the repurchase price (including interest), a Fund, pursuant to its
repurchase agreement, may require the seller of the security to deliver
additional securities so that the market value of all securities subject to the
repurchase agreement equals or exceeds the repurchase price (including interest)
at all times.
The Funds may participate in one or more joint accounts with each other
and other series of the Trusts that invest in repurchase agreements
collateralized, subject to their investment policies, either by (i) obligations
issued or guaranteed as to principal and interest by the U.S. Government or by
one of its agencies or instrumentalities, or (ii) privately issued
mortgage-related securities that are in turn collateralized by securities issued
by GNMA, FNMA or FHLMC, and are rated in the highest rating category by a
nationally recognized statistical rating organization, or, if unrated, are
deemed by the Manager to be of comparable quality using
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objective criteria. Any such repurchase agreement will have, with rare
exceptions, an overnight, over-the-weekend or over-the-holiday duration, and in
no event have a duration of more than seven days.
REVERSE REPURCHASE AGREEMENTS. The Domestic Equity, Select 50,
International, Opportunities, Short, Reserve and Tax- Free Funds may enter into
reverse repurchase. A Fund typically will invest the proceeds of a reverse
repurchase agreement in money market instruments or repurchase agreements
maturing not later than the expiration of the reverse repurchase agreement. This
use of proceeds involves leverage, and a Fund will enter into a reverse
repurchase agreement for leverage purposes only when the Manager believes that
the interest income to be earned from the investment of the proceeds would be
greater than the interest expense of the transaction. A Fund also may use the
proceeds of reverse repurchase agreements to provide liquidity to meet
redemption requests when sale of the Fund's securities is disadvantageous.
The Funds cause their custodian to segregate liquid assets, such as
cash, U.S. Government securities or other liquid equity or debt securities equal
in value to their obligations (including accrued interest) with respect to
reverse repurchase agreements. Such assets are marked to market daily to ensure
that full collateralization is maintained.
DOLLAR ROLL TRANSACTIONS. The Total Return Bond Fund and the Government
Reserve Fund may enter into dollar roll transactions. A dollar roll transaction
involves a sale by a Fund of a security to a financial institution concurrently
with an agreement by that Fund to purchase a similar security from the
institution at a later date at an agreed-upon price. The securities that are
repurchased will bear the same interest rate as those sold, but generally will
be collateralized by different pools of mortgages with different prepayment
histories than those sold. During the period between the sale and repurchase, a
Fund will not be entitled to receive interest and principal payments on the
securities sold. Proceeds of the sale will be invested in additional portfolio
securities of that Fund, and the income from these investments, together with
any additional fee income received on the sale, may or may not generate income
for that Fund exceeding the yield on the securities sold.
At the time a Fund enters into a dollar roll transaction, it causes its
custodian to segregate liquid assets such as cash, U.S. Government securities or
other liquid equity or debt securities having a value equal to the purchase
price for the similar security (including accrued interest) and subsequently
marks the assets to market daily to ensure that full collateralization is
maintained.
LENDING OF PORTFOLIO SECURITIES. Although the Funds currently do not
intend to do so, a Fund may lend its portfolio securities in order to generate
additional income. Such loans may be made to broker-dealers or other financial
institutions whose creditworthiness is acceptable to the Manager. These loans
would be required to be secured continuously by collateral, including cash, cash
equivalents, irrevocable letters of credit, U.S. Government securities, or other
high-grade liquid debt securities, maintained on a current basis (I.E., marked
to market daily) at an amount at least equal to 100% of the market value of the
securities loaned plus accrued interest. A Fund may pay reasonable
administrative and custodial fees in connection with a loan and may pay a
negotiated portion of the income earned on the cash to the borrower or placing
broker. Loans are subject to termination at the option of a Fund or the borrower
at any time. Upon such termination, that Fund is entitled to obtain the return
of the securities loaned within five business days.
For the duration of the loan, a Fund will continue to receive the
equivalent of the interest or dividends paid by the issuer on the securities
loaned, will receive proceeds from the investment of the collateral and will
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continue to retain any voting rights with respect to those securities. As with
other extensions of credit, there are risks of delay in recovery or even losses
of rights in the securities loaned should the borrower of the securities fail
financially. However, the loans will be made only to borrowers deemed by the
Manager to be creditworthy, and when, in the judgment of the Manager, the income
which can be earned currently from such loans justifies the attendant risk.
WHEN-ISSUED AND FORWARD COMMITMENT SECURITIES. The Funds may purchase
securities on a "when-issued" basis and may purchase or sell securities on a
"forward commitment" or "delayed delivery" basis. The price of such securities
is fixed at the time the commitment to purchase or sell is made, but delivery
and payment for the securities take place at a later date. Normally, the
settlement date occurs within one month of the purchase; during the period
between purchase and settlement, no payment is made by a Fund to the issuer.
While the Funds reserve the right to sell when-issued or delayed delivery
securities prior to the settlement date, the Funds intend to purchase such
securities with the purpose of actually acquiring them unless a sale appears
desirable for investment reasons. At the time a Fund makes a commitment to
purchase a security on a when-issued or delayed delivery basis, it will record
the transaction and reflect the value of the security in determining its net
asset value. The market value of the when-issued securities may be more or less
than the settlement price. The Funds do not believe that their net asset values
will be adversely affected by their purchase of securities on a when-issued or
delayed delivery basis. The Funds cause their custodian to segregate cash, U.S.
Government securities or other liquid equity or debt securities with a value
equal in value to commitments for when-issued or delayed delivery securities.
The segregated securities either will mature or, if necessary, be sold on or
before the settlement date. To the extent that assets of a Fund are held in cash
pending the settlement of a purchase of securities, that Fund will earn no
income on these assets.
The Funds may seek to hedge investments or to realize additional gains
through forward commitments to sell high-grade liquid debt securities it does
not own at the time it enters into the commitments. Such forward commitments
effectively constitute a form of short sale. To complete such a transaction, the
Fund must obtain the security which it has made a commitment to deliver. If the
Fund does not have cash available to purchase the security it is obligated to
deliver, it may be required to liquidate securities in its portfolio at either a
gain or a loss, or borrow cash under a reverse repurchase or other short-term
arrangement, thus incurring an additional expense. In addition, the Fund may
incur a loss as a result of this type of forward commitment if the price of the
security increases between the date the Fund enters into the forward commitment
and the date on which it must purchase the security it is committed to deliver.
The Fund will realize a gain from this type of forward commitment if the
security declines in price between those dates. The amount of any gain will be
reduced, and the amount of any loss increased, by the amount of the interest or
other transaction expenses the Fund may be required to pay in connection with
this type of forward commitment. Whenever this Fund engages in this type of
transaction, it will segregate assets as discussed above.
ILLIQUID SECURITIES. A Fund may invest up to 15% (10% for the Money
Market Funds) of its net assets in illiquid securities. The term "illiquid
securities" for this purpose means securities that cannot be disposed of within
seven days in the ordinary course of business at approximately the amount at
which a Fund has valued the securities and includes, among others, repurchase
agreements maturing in more than seven days, certain restricted securities and
securities that are otherwise not freely transferable. Illiquid securities also
include shares of an investment company held by a Fund in excess of 1% of the
total outstanding shares of that investment company. Restricted securities may
be sold only in privately negotiated transactions or in public offerings with
respect to which a registration statement is in effect under the Securities Act
of 1933, as amended
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("1933 Act"). Illiquid securities acquired by a Fund may include those that are
subject to restrictions on transferability contained in the securities laws of
other countries. Securities that are freely marketable in the country where they
are principally traded, but that would not be freely marketable in the United
States, will not be considered illiquid. Where registration is required, a Fund
may be obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the
time that Fund may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions were
to develop, that Fund might obtain a less favorable price than prevailed when it
decided to sell.
In recent years a large institutional market has developed for certain
securities that are not registered under the 1933 Act, including securities sold
in private placements, repurchase agreements, commercial paper, foreign
securities and corporate bonds and notes. These instruments often are restricted
securities because the securities are sold in transactions not requiring
registration. Institutional investors generally will not seek to sell these
instruments to the general public, but instead will often depend either on an
efficient institutional market in which such unregistered securities can be
resold readily or on an issuer's ability to honor a demand for repayment.
Therefore, the fact that there are contractual or legal restrictions on resale
to the general public or certain institutions is not determinative of the
liquidity of such investments.
Rule 144A under the 1933 Act establishes a safe harbor from the
registration requirements of the 1933 Act for resales of certain securities to
qualified institutional buyers. Institutional markets for restricted securities
sold pursuant to Rule 144A in many cases provide both readily ascertainable
values for restricted securities and the ability to liquidate an investment to
satisfy share redemption orders. Such markets might include automated systems
for the trading, clearance and settlement of unregistered securities of domestic
and foreign issuers, such as the PORTAL System sponsored by the National
Association of Securities Dealers, Inc. An insufficient number of qualified
buyers interested in purchasing Rule 144A-eligible restricted securities,
however, could adversely affect the marketability of such portfolio securities
and result in a Fund's inability to dispose of such securities promptly or at
favorable prices.
The Boards have delegated the function of making day-to-day
determinations of liquidity to the Manager pursuant to guidelines approved by
the Boards. The Manager takes into account a number of factors in reaching
liquidity decisions, including, but not limited to: (i) the frequency of trades
for the security, (ii) the number of dealers that quote prices for the security,
(iii) the number of dealers that have undertaken to make a market in the
security, (iv) the number of other potential purchasers, and (v) the nature of
the security and how trading is effected (E.G., the time needed to sell the
security, how bids are solicited and the mechanics of transfer). The Manager
monitors the liquidity of restricted securities in the Funds' portfolios and
reports periodically on such decisions to the Boards.
RISK FACTORS
The following describes certain risks involved with investing in the
Funds. Investors in the U.S. Asset Allocation Fund should note the risks
involved with each Underlying Fund, because the U.S. Asset Allocation Fund is a
"fund-of-funds."
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SMALL COMPANIES
Investors in Funds that invests in smaller companies should consider
carefully the special risks involved. Such smaller companies may present greater
opportunities for capital appreciation but may involve greater risk than larger,
more mature issuers. Such smaller companies may have limited product lines,
markets or financial resources, and their securities may trade less frequently
and in more limited volume than those of larger, more mature companies. As a
result, the prices of their securities may fluctuate more than those of larger
issuers.
FOREIGN SECURITIES
The U.S. Equity Funds, the Select 50 Fund, the Total Return Bond Fund
and the Foreign and Global Equity Funds may purchase securities in foreign
countries. According, shareholders should consider carefully the substantial
risks involved in investing in securities issued by companies and governments of
foreign nations, which are in addition to the usual risks inherent in domestic
investments. Foreign investments involve the possibility of expropriation,
nationalization or confiscatory taxation; taxation of income earned in foreign
nations (including, for example, withholding taxes on interest and dividends) or
other taxes imposed with respect to investments in foreign nations; foreign
exchange controls (which may include suspension of the ability to transfer
currency from a given country and repatriation of investments); default in
foreign government securities, and political or social instability or diplomatic
developments that could adversely affect investments. In addition, there is
often less publicly available information about foreign issuers than those in
the United States. Foreign companies are often not subject to uniform
accounting, auditing and financial reporting standards. Further, these Funds may
encounter difficulties in pursuing legal remedies or in obtaining judgments in
foreign courts.
Brokerage commissions, fees for custodial services and other costs
relating to investments by the Funds in other countries are generally greater
than in the United States. Foreign markets have different clearance and
settlement procedures from those in the United States, and certain markets have
experienced times when settlements did not keep pace with the volume of
securities transactions which resulted in settlement difficulty. The inability
of a Fund to make intended security purchases due to settlement difficulties
could cause it to miss attractive investment opportunities. Inability to sell a
portfolio security due to settlement problems could result in loss to the Fund
if the value of the portfolio security declined, or result in claims against the
Fund if it had entered into a contract to sell the security. In certain
countries there is less government supervision and regulation of business and
industry practices, stock exchanges, brokers and listed companies than in the
United States. The securities markets of many of the countries in which these
Funds may invest may also be smaller, less liquid and subject to greater price
volatility than those in the United States.
Because certain securities may be denominated in foreign currencies,
the value of such securities will be affected by changes in currency exchange
rates and in exchange control regulations, and costs will be incurred in
connection with conversions between currencies. A change in the value of a
foreign currency against the U.S. dollar results in a corresponding change in
the U.S. dollar value of a Fund's securities denominated in the currency. Such
changes also affect the Fund's income and distributions to shareholders. A Fund
may be affected either favorably or unfavorably by changes in the relative rates
of exchange among the currencies of different nations, and a Fund may therefore
engage in foreign currency hedging strategies. Such strategies, however, involve
certain transaction costs and investment risks, including dependence upon the
Manager's ability to predict movements in exchange rates.
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<PAGE>
Some countries in which one of these Funds may invest may also have
fixed or managed currencies that are not freely convertible at market rates into
the U.S. dollar. Certain currencies may not be internationally traded. A number
of these currencies have experienced steady devaluation relative to the U.S.
dollar, and such devaluations in the currencies may have a detrimental impact on
the Fund. Many countries in which a Fund may invest have experienced
substantial, and in some periods extremely high, rates of inflation for many
years. Inflation and rapid fluctuation in inflation rates may have negative
effects on certain economies and securities markets. Moreover, the economies of
some countries may differ favorably or unfavorably from the U.S. economy in such
respects as the rate of growth of gross domestic product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments. Certain
countries also limit the amount of foreign capital that can be invested in their
markets and local companies, creating a "foreign premium" on capital investments
available to foreign investors such as the Funds. The Funds may pay a "foreign
premium" to establish an investment position which it cannot later recoup
because of changes in that country's foreign investment laws.
EMERGING MARKET COUNTRIES
The Select 50, International and Global Funds, particularly the Latin
America, Emerging Asia and Emerging Markets Funds, may invest in securities of
companies domiciled in, and in markets of, so-called "emerging market
countries." These investments may be subject to potentially higher risks than
investments in developed countries. These risks include (i) volatile social,
political and economic conditions; (ii) the small current size of the markets
for such securities and the currently low or nonexistent volume of trading,
which result in a lack of liquidity and in greater price volatility; (iii) the
existence of national policies which may restrict these Funds' investment
opportunities, including restrictions on investment in issuers or industries
deemed sensitive to national interests; (iv) foreign taxation; (v) the absence
of developed structures governing private or foreign investment or allowing for
judicial redress for injury to private property; (vi) the absence, until
recently in certain emerging market countries, of a capital market structure or
market-oriented economy; and (vii) the possibility that recent favorable
economic developments in certain emerging market countries may be slowed or
reversed by unanticipated political or social events in such countries.
EXCHANGE RATES AND POLICIES
The Select 50, International and Global Funds endeavor to buy and sell
foreign currencies on favorable terms. Some price spreads on currency exchange
(to cover service charges) may be incurred, particularly when these Funds change
investments from one country to another or when proceeds from the sale of shares
in U.S. dollars are used for the purchase of securities in foreign countries.
Also, some countries may adopt policies which would prevent these Funds from
repatriating invested capital and dividends, withhold portions of interest and
dividends at the source, or impose other taxes, with respect to these Funds'
investments in securities of issuers of that country. There also is the
possibility of expropriation, nationalization, confiscatory or other taxation,
foreign exchange controls (which may include suspension of the ability to
transfer currency from a given country), default in foreign government
securities, political or social instability, or diplomatic developments that
could adversely affect investments in securities of issuers in those nations.
These Funds may be affected either favorably or unfavorably by
fluctuations in the relative rates of exchange between the currencies of
different nations, exchange control regulations and indigenous economic and
political developments.
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The Boards of both Trusts consider at least annually the likelihood of
the imposition by any foreign government of exchange control restrictions that
would affect the liquidity of the Funds' assets maintained with custodians in
foreign countries, as well as the degree of risk from political acts of foreign
governments to which such assets may be exposed. The Boards also consider the
degree of risk attendant to holding portfolio securities in domestic and foreign
securities depositories (see "Investment Management and Other Services").
HEDGING TRANSACTIONS
While transactions in forward contracts, options, futures contracts and
options on futures (I.E., "hedging positions") may reduce certain risks, such
transactions themselves entail certain other risks. Thus, while a Fund may
benefit from the use of hedging positions, unanticipated changes in interest
rates, securities prices or currency exchange rates may result in a poorer
overall performance for that Fund than if it had not entered into any hedging
positions. If the correlation between a hedging position and portfolio position
which is intended to be protected is imperfect, the desired protection may not
be obtained, and a Fund may be exposed to risk of financial loss. Furthermore,
the Funds may enter into hedging transactions when, in fact, it is inopportune
to do so and, conversely, when it is more opportune to enter into hedging
transactions the Funds might not enter into such transactions. Such inopportune
timing of utilization of hedging practices could result in substantial losses to
the Funds.
Perfect correlation between a Fund's hedging positions and portfolio
positions may be difficult to achieve because hedging instruments in many
foreign countries are not yet available. In addition, it is not possible to
hedge fully against currency fluctuations affecting the value of securities
denominated in foreign currencies because the value of such securities is likely
to fluctuate as a result of independent factors not related to currency
fluctuations.
LOWER-QUALITY DEBT
The Select 50, the Foreign and the Global Equity Funds may invest in
lower-quality debts. Medium-quality debt securities are those rated or
equivalent to BBB by S&P or Fitch's, or Baa by Moody's. These Funds, however,
may not invest more than 5% (except for the Latin America Fund which may invest
up to 15%) of its total assets in high-risk debt securities rated below
investment grade (these securities are sometimes called "Junk bonds").
Medium-quality debt securities have speculative characteristics, and changes in
economic conditions or other circumstances are more likely to lead to a weakened
capacity to make principal and interest payments than with higher-grade debt
securities. Junk bonds offer greater speculative characteristics and are
regarded as having a great vulnerability to default although currently having
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The ability to maintain other
terms of the contract over any long period of time may be small. Junk bonds are
more subject to default during periods of economic downturns or increases in
interest rates and their yields will fluctuate over time. It may be more
difficult to dispose of or to value junk bonds. Achievement of a Fund's
investment objective may also be more dependent on the Manager's own credit
analysis to the extent a Fund's portfolio includes junk bonds.
The Board may consider a change in this operating policy if, in its
judgment, economic conditions change such that a higher level of investment in
high-risk, lower-quality debt securities would be consistent with the interests
of these Funds and their shareholders. Unrated debt securities are not
necessarily of lower quality than rated securities but may not be attractive to
as many buyers. Regardless of rating levels, all debt securities considered for
purchase (whether rated or unrated) are analyzed by the Manager to determine, to
the extent reasonably possible, that the planned investment is sound. From time
to time, these Funds may purchase
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defaulted debt securities if, in the opinion of the Manager, the issuer may
resume interest payments in the near future.
CONCENTRATION IN COMMUNICATIONS INDUSTRY
The Communications Fund concentrates its investments in the global
communications industry. Consequently, the Fund's share value may be more
volatile than that of mutual funds not sharing this concentration. The value of
the Fund's shares may vary in response to factors affecting the global
communications industry, which may be subject to greater changes in governmental
policies and regulation than many other industries, and regulatory approval
requirements may materially affect the products and services. Because the Fund
must satisfy certain diversification requirements in order to maintain its
qualification as a regulated investment company within the meaning of the
Internal Revenue Code, the Fund may not always be able to take full advantage of
opportunities to invest in certain communications companies.
INTEREST RATES
The market value of debt securities that are interest rate sensitive is
inversely related to changes in interest rates. That is, an interest rate
decline produces an increase in a security's market value and an interest rate
increase produces a decrease in value. The longer the remaining maturity of a
security, the greater the effect of interest rate changes. Changes in the
ability of an issuer to make payments of interest and principal and in the
market's perception of its creditworthiness also affect the market value of that
issuer's debt securities.
Prepayments of principal of mortgage-related securities by mortgagors
or mortgage foreclosures affect the average life of the mortgage-related
securities in a Fund's portfolio. Mortgage prepayments are affected by the level
of interest rates and other factors, including general economic conditions and
the underlying location and age of the mortgage. In periods of rising interest
rates, the prepayment rate tends to decrease, lengthening the average life of a
pool of mortgage-related securities. In periods of falling interest rates, the
prepayment rate tends to increase, shortening the average life of a pool.
Because prepayments of principal generally occur when interest rates are
declining, it is likely that a U.S. Fixed-Income and Money Market Fund, to the
extent that it retains the same percentage of debt securities, may have to
reinvest the proceeds of prepayments at lower interest rates than those of its
previous investments. If this occurs, that Fund's yield will correspondingly
decline. Thus, mortgage-related securities may have less potential for capital
appreciation in periods of falling interest rates than other fixed-income
securities of comparable duration, although they may have a comparable risk of
decline in market value in periods of rising interest rates. To the extent that
a U.S. Fixed-Income and Money Market Funds purchases mortgage-related securities
at a premium, unscheduled prepayments, which are made at par, result in a loss
equal to any unamortized premium. Duration is one of the fundamental tools used
by the Manager in managing interest rate risks including prepayment risks.
Traditionally, a debt security's "term to maturity" characterizes a security's
sensitivity to changes in interest rates "Term to maturity," however, measures
only the time until a debt security provides its final payment, taking no
account of prematurity payments. Most debt securities provide interest
("coupon") payments in addition to a final ("par") payment at maturity, and some
securities have call provisions allowing the issuer to repay the instrument in
full before maturity date, each of which affect the security's response to
interest rate changes. "Duration" is considered a more precise measure of
interest rate risk than "term to maturity." Determining duration may involve the
Manager's estimates of future economic parameters, which may vary from actual
future values. Fixed-income securities with effective durations of three years
are more responsive to interest rate fluctuations
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than those with effective durations of one year. For example, if interest rates
rise by 1%, the value of securities having an effective duration of three years
will generally decrease by approximately 3%.
EQUITY SWAPS
The U.S. Equity, Foreign and Global Funds may invest in equity swaps.
Equity swaps allow the parties to exchange the dividend income or other
components of return on an equity investment (e.g., a group of equity securities
or an index) for a component of return on another non-equity or equity
investment. Equity swaps are derivatives, and their values can be very volatile.
To the extent that the Manager does not accurately analyze and predict the
potential relative fluctuation of the components swapped with another party, a
Fund may suffer a loss. The value of some components of an equity swap (like the
dividends on a common stock) may also be sensitive to changes in interest rates.
Furthermore, during the period a swap is outstanding, the Fund may suffer a loss
if the counterparty defaults.
NON-DIVERSIFIED PORTFOLIO
The California Intermediate Bond Fund is a "non-diversified" investment
company under the Investment Company Act. This means that, with respect to 50%
of its total assets, it may not invest more than 5% of its total assets in the
securities of any one issuer (other than the U.S. government). The balance of
its assets may be invested in as few as two issuers. Thus, up to 25% of the
Fund's total assets may be invested in the securities of any one issuer. For
purposes of this limitation, a security is considered to be issued by the
governmental entity (or entities) the assets and revenues of which back the
security, or, with respect to an industrial development bond, that is backed
only by the assets and revenues of a non-governmental user, by such
non-governmental user. In certain circumstances, the guarantor of a guaranteed
security also may be considered to be an issuer in connection with such
guarantee. By investing in a portfolio of municipal securities, a shareholder in
the California Intermediate Bond Fund enjoys greater diversification than an
investor holding a single municipal security. The investment return on a
non-diversified portfolio, however, typically is dependent upon the performance
of a smaller number of issuers relative to the number of issuers held in a
diversified portfolio. If the financial condition or market assessment of
certain issuers changes, this Fund's policy of acquiring large positions in the
obligations of a relatively small number of issuers may affect the value of its
portfolio to a greater extent than if its portfolio were fully diversified.
CALIFORNIA MUNICIPAL SECURITIES
The information set forth below is a general summary intended to give a
recent historical description. It is not a discussion of any specific factors
that may affect any particular issuer of California Municipal Securities. The
information is not intended to indicate continuing or future trends in the
condition, financial or otherwise, of California. Such information is derived
from official statements utilized in connection with securities offerings of the
State of California that have come to the attention of the Trusts and were
available prior to the date of this Statement of Additional Information. Such
information has not been independently verified by the California Intermediate
Bond and California Money Funds.
Because the California Intermediate Bond and California Money Funds
expect to invest substantially all of their assets in California Municipal
Securities, they will be susceptible to a number of complex factors affecting
the issuers of California Municipal Securities, including national and local
political, economic, social, environmental and regulatory policies and
conditions. These Funds cannot predict whether or to what extent such factors or
other factors may affect the issuers of California Municipal Securities, the
market value or
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marketability of such securities or the ability of the respective issuers of
such securities acquired by these Funds to pay interest on, or principal of,
such securities. The creditworthiness of obligations issued by local California
issuers may be unrelated to the creditworthiness of obligations issued by the
State of California, and there is no responsibility on the part of the State of
California to make payments on such local obligations. There may be specific
factors that are applicable in connection with investment in the obligations of
particular issuers located within California, and it is possible these Funds
will invest in obligations of particular issuers as to which such specific
factors are applicable.
From mid-1990 to late 1993, California suffered the most severe
recession in the State since the 1930s. Construction, manufacturing (especially
aerospace), exports and financial services, among other industries, have been
severely affected. Since the start of 1994, however, California's economy has
been on a steady recovery. The rate of economic growth in California in 1997, in
terms of job gains, exceeded that of the rest of the United States. The State
added nearly 430,000 non-farm jobs during 1997. In 1996 California surpassed its
pre-recession employment peak of 12.7 million jobs. The unemployment rate, while
still higher than the national average, fell to 5.9% in early 1998, compared to
over 10 percent during the recession. Many of the new jobs were created in such
industries as computer services, software design, motion pictures and high
technology manufacturing. Business services, export trade and other
manufacturing also experienced growth. All major economic regions of the State
grew. The rate of employment growth for the Los Angeles region indicates that
its growth has almost caught up with that in the San Francisco bay region on a
population share basis. The unsettled financial situation occurring in certain
Asian economies may adversely affect the State's export-related industries and,
therefore, the State's rate of economic growth.
The recession severely affected State revenues while the State's health
and welfare costs were increasing. Consequently, the State had a lengthy period
of budget imbalance; the State's accumulated budget deficit approached $2.8
billion at its peak at June 30, 1993. A consequence of the large budget deficits
has been that the State depleted its available cash resources and had to use a
series of external borrowings to meet its cash needs. With the end of the
recession, the State's financial condition has improved in the 1995-96, 1996-97
and 1997-98 fiscal years, with a combination of better than expected revenues,
slowdown in growth of social welfare programs, and continued spending restraint.
As of June 30, 1997, the State's budget reserve had a positive cash balance of
$461 million. No deficit borrowing has occurred at the end of the last three
fiscal years and the State's cash flow borrowing was limited to $3 billion in
1997-98.
In each of these the 1995-96 and 1996-97 fiscal years, the State budget
contained the following major features:
1. Expenditures for K-14 schools grew significantly, as new
revenues were directed to school spending under Proposition
98.
2. The budgets restrained health and welfare spending levels and
attempted to reduce General Fund spending by calling for
greater support from the federal government. The State also
attempted to shift to the federal government a larger share of
the cost of incarceration and social services for illegal
immigrants. Federal support never reached the levels
anticipated when the budgets were enacted. These funding
shortfalls were filled, however, by revenue collections which
exceeded expectations.
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3. General Fund support for the University of California and
California State Universities grew by an average of 5.2
percent and 3.3 percent per year, respectively, and there were
no increases in student fees.
4. General Fund support for the Department of Corrections grew as
needed to meet increased prison population. No new prisons
were approved for construction, however.
5. There were no tax increases and, starting January 1, 1997,
there was a 5 percent cut in corporate taxes. The suspension
of the Renters Tax Credit was continued.
As noted, the economy grew strongly during these fiscal years, and as a
result, the General Fund took in substantially greater tax revenues (around $2.2
billion in 1995-96 and $1.6 billion in 1996-97) than were initially planned when
the budgets were enacted. These additional funds were largely directed to school
spending as mandated by Proposition 98, and to make up shortfalls from reduced
federal health and welfare aid. The accumulated budget deficit from the
recession years was finally eliminated.
On August 18, 1997, the Governor signed the 1997-98 Budget Act. The
Budget Act anticipates General Fund revenues and transfers of $52.5 billion (a
6.8 percent increase over the final 1996-97 levels), and expenditures of $52.8
billion (an 8.0 percent increase from the 1996-97 levels). On a budgetary basis,
the budget reserve (SFEU) is projected to decrease from $408 million at June 30,
1997, to $112 million at June 30, 1998. The Budget Act also includes Special
Fund expenditures of $14.4 billion (as against estimated Special Fund revenues
of $14.0 billion), and $2.1 billion of expenditures from various Bond Funds.
Following enactment of the Budget Act, the State implemented its annual cash
flow borrowing program, issuing $3 billion of notes which mature on June 30,
1998.
The following are major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contains a large
increase in funding for K-14 education, reflecting strong
revenues which have exceeded initial budgeted amounts. Part of
the nearly $1.75 billion in increased spending is allocated to
prior fiscal years.
2. The Budget Act reflects a $1.235 billion pension case judgment
payment, and returns funding of the State's pension
contribution to the quarterly basis existing prior to the
deferral actions invalidated by the courts.
3. Continuing the third year of a four-year "compact" which the
State Administration has made with higher education units,
funding from the General Fund for the University of California
and California State University has increased by about 6
percent ($121 million and $107 million, respectively), and
there was no increase in student fees.
4. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels.
5. Health and welfare costs are contained, continuing generally
the grant levels from prior years, as part of the initial
implementation of the new CalWORKs welfare reform program.
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6. Unlike prior years, this Budget Act does not depend on
uncertain federal budget actions. About $300 million in
federal funds, already included in the federal FY 1997 and
1998 budgets, are included in the Budget Act, to offset
incarceration costs for illegal immigrants.
7. The Budget Act contains no tax increases, and no tax
reductions. The Renters Tax Credit was suspended for another
year, saving approximately $500 million.
After enactment of the Budget Act, and prior to the end of the
Legislative Session on September 13, 1997, the Legislature and the Governor
reached certain agreements related to State expenditures and taxes. The
Legislature passed a bill restoring $203 million of education-related
expenditures which the Governor had vetoed in the original Budget Act, based on
agreement with the Governor on an education testing program. The Legislature
also passed a bill to restore $48 million of welfare cost savings which had been
part of earlier legislation vetoed by the Governor. The Legislature also passed
several bills encompassing a coordinated package of fiscal reforms, mostly to
take effect after the 1997-98 Fiscal Year. Included in the legislation signed by
the Governor are a variety of phased-in tax cuts, conformity with certain
provisions of the federal tax reform law passed earlier in the year, and reform
of funding for county trial courts, with the State to assume greater financial
responsibility.
The May 1998 Revision to the Governor's proposed budget increases the
General Fund revenue forecast by nearly $1.8 billion in 1997-98 and $2.5 billion
in 1998-99. The May Revision provides for a balanced budget and a budget reserve
for economic uncertainties of $1.6 billion. In the May Revision the
administration proposed, among other things, a two-step reduction in the State's
vehicle license fee (VLF) which, when fully phased in, would reduce State
revenues by more than $3 billion annually. Since VLF is a primary source of
revenue for local governments, the May Revision proposed continuous
appropriation from the General Fund to replace that loss in revenues.
The VLF proposal met significant opposition in the Legislature and
continuing disagreement over the nature and extent of the proposed tax cut
delayed final adoption of the 1998-99 budget. Local government concern about the
potential impact of the VLF proposal on local government revenues underscores
the extent to which California county and other local government budgets are
affected by State budget decisions beyond their control.
In early August, 1998 the Governor and leaders of the State Legislature
reached agreement on a $76 billion State budget that includes a $1.4 billion tax
cut. The main feature of the tax cut is a 25% reduction in the VLF, with future
reductions contingent upon higher than forecast State revenues. The budget
accord included significant additional funding for public schools and community
colleges intended, among other things, to increase the length of the California
school year and extend the class size reduction initiatives already under way.
The budget accord also included a 7.9% increase in welfare recipients' monthly
checks, as well as a variety of smaller tax credits and cuts, including an
increase in the income tax credit for dependents, a modest renters' credit and a
number of tax credits and cuts aimed at specific industries important to the
California economy. The budget must be approved by a two-thirds vote of the
State Senate and Assembly. The Governor may exercise a line-item veto to ensure
the final budget includes sufficient reserves.
In October 1997 the Governor issued Executive Order W-163-97 stating
that Year 2000 solutions would be a State priority and requiring each agency of
the State, no later than December 31, 1998, to address Year 2000 problems in
their essential systems and protect those systems from corruption by
non-compliant systems,
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in accordance with the Department of Information Technology's California 2000
Program. There can be no assurance that steps being taken by state or local
government agencies with respect to the Year 2000 problem will be sufficient to
avoid any adverse impact upon the budgets or operations of those agencies or
upon the California Trust.
Because of the deterioration in the State's budget and cash situation,
the State's credit ratings have been reduced. Since late 1991, all three major
nationally recognized statistical rating organizations have lowered their
ratings for general obligation bonds of the State from the highest ranking of
"AAA" to "A+" by S&P, "A1" by Moody's and "A+" by Fitch Investors Services, Inc.
However, prior to the October 8, 1997, sale of $1 billion in general obligation
bonds, Fitch raised California's general obligation bond rating from "A+" to
"AA-", however S&P and Moody's did not follow suit, confirming those ratings at
"A+" and "A1", respectively. It is not presently possible to determine whether,
or the extent to which, Moody's, S&P or Fitch will change such ratings in the
future. It should be noted that the creditworthiness of obligations issued by
local California issuers may be unrelated to the creditworthiness of obligations
issued by the State, and there is no obligation on the part of the State to make
payment on such local obligations in the event of default.
Constitutional and Statutory Limitations. Article XIII A of the
California Constitution (which resulted from the voter approved Proposition 13
in 1978) limits the taxing powers of California public agencies. With certain
exceptions, the maximum AD VALOREM tax on real property cannot exceed one
percent of the "full cash value" of the property; Article XIII A also
effectively prohibits the levying of any other AD VALOREM property tax for
general purposes. One exception to Article XIII A permits an increase in AD
VALOREM taxes on real property in excess of one percent for certain bonded
indebtedness approved by two-thirds of the voters voting on the proposed
indebtedness. The "full cash value" of property may be adjusted annually to
reflect increases (not to exceed two percent) or decreases, in the consumer
price index or comparable local data, or to reflect reductions in property value
caused by substantial damage, destruction or other factors, or when there is a
"change in ownership" or "new construction".
Constitutional challenges to Article XIII A to date have been
unsuccessful. In 1992, the United States Supreme Court ruled that
notwithstanding the disparate property tax burdens that Proposition 13 might
place on otherwise comparable properties, those provisions of Proposition 13 do
not violate the Equal Protection Clause of the United States Constitution.
In response to the significant reduction in local property tax revenue
caused by the passage of Proposition 13, the State enacted legislation to
provide local governments with increased expenditures from the General Fund.
This fiscal relief has ended, however.
Article XIII B of the California Constitution generally limits the
amount of appropriations of the State and of local governments to the amount of
appropriations of the entity for such prior year, adjusted for changes in the
cost of living, population and the services that the government entity has
financial responsibility for providing. To the extent the "proceeds of taxes" of
the State and/or local government exceed its appropriations limit, the excess
revenues must be rebated. Certain expenditures, including debt service on
certain bonds and appropriations for qualified capital outlay projects, are not
included in the appropriations limit.
In 1986, California voters approved an initiative statute known as
Proposition 62. This initiative further restricts the ability of local
governments to raise taxes and allocate approved tax receipts. While some
decisions of the California Courts of Appeal have held that portions of
Proposition 62 are unconstitutional, the California
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Supreme Court recently upheld Proposition 62's requirement that special taxes be
approved by a two-thirds vote of the voters voting in an election on the issue.
This recent decision may invalidate other taxes that have been imposed by local
governments in California and make it more difficult for local governments to
raise taxes.
In 1988 and 1990, California voters approved initiatives known as
Proposition 98 and Proposition 111, respectively. These initiatives changed the
State's appropriations limit under Article XIII B to (i) require that the State
set aside a prudent reserve fund for public education, and (ii) guarantee a
minimum level of State funding for public elementary and secondary schools and
community colleges.
In November 1996, California voters approved Proposition 218. The
initiative applied the provisions of Proposition 62 to all entities, including
charter cities. It requires that all taxes for general purposes obtain a simple
majority popular vote and that taxes for special purposes obtain a two-thirds
majority vote. Prior to the effectiveness of Proposition 218, charter cities
could levy certain taxes such as transient occupancy taxes and utility user's
taxes without a popular vote. Proposition 218 will also limit the authority of
local governments to impose property-related assessments, fees and charges,
requiring that such assessments be limited to the special benefit conferred and
prohibiting their use for general governmental services. Proposition 218 also
allows voters to use their initiative power to reduce or repeal
previously-authorized taxes, assessments, fees and charges.
The effect of constitutional and statutory changes and of budget
developments on the ability of California issuers to pay interest and principal
on their obligations remains unclear, and may depend on whether a particular
bond is a general obligation or limited obligation bond (limited obligation
bonds being generally less affected). There is no assurance that any California
issuer will make full or timely payments of principal or interest or remain
solvent. For example, in December 1994, Orange County filed for bankruptcy.
Certain tax-exempt securities in which a Fund may invest may be
obligations payable solely from the revenues of specific institutions, or may be
secured by specific properties, which are subject to provisions of California
law that could adversely affect the holders of such obligations. For example,
the revenues of California health care institutions may be subject to state
laws, and California law limits the remedies of a creditor secured by a mortgage
or deed of trust on real property.
In addition, it is impossible to predict the time, magnitude, or
location of a major earthquake or its effect on the California economy. In
January 1994, a major earthquake struck the Los Angeles area, causing
significant damage in a four-county area. The possibility exists that another
such earthquake could create a major dislocation of the California economy.
The Tax-Free Funds' (other than the Federal Money Fund) concentration
in California Municipal Securities provides a greater level of risk than a fund
that is diversified across numerous states and municipal entities.
INVESTMENT RESTRICTIONS
The following policies and investment restrictions have been adopted by
each Fund and (unless otherwise noted) are fundamental and cannot be changed
without the affirmative vote of a majority of a Fund's outstanding voting
securities as defined in the Investment Company Act. Each Fund MAY NOT:
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1. In the case of each Fixed Income Fund, purchase any common
stocks or other equity securities, except that a Fund may
invest in securities of other investment companies as
described above and consistent with restriction number 9
below.
2. With respect to 75% (100% for the Federal Money Fund) of its
total assets, invest in the securities of any one issuer
(other than the U.S. Government and its agencies and
instrumentalities) if immediately after and as a result of
such investment more than 5% of the total assets of a Fund
would be invested in such issuer. There are no limitations
with respect to the remaining 25% of its total assets, except
to the extent other investment restrictions may be applicable
(not applicable to the Federal Money Fund). This investment
restriction does not apply to the U.S. Asset Allocation and
the California Intermediate Bond Fund.
3. Make loans to others, except (a) through the purchase of debt
securities in accordance with its investment objective and
policies, (b) through the lending of up to 30% of its
portfolio securities as described above and in its Prospectus,
or (c) to the extent the entry into a repurchase agreement or
a reverse dollar roll transaction is deemed to be a loan.
4.
(a) Borrow money, except for temporary or emergency
purposes from a bank, or pursuant to reverse
repurchase agreements or dollar roll transactions for
that Fund that uses such investment techniques and
then not in excess of one-third of the value of its
total assets (including the proceeds of such
borrowings, at the lower of cost or fair market
value). Any such borrowing will be made only if
immediately thereafter there is an asset coverage of
at least 300% of all borrowings, and no additional
investments may be made while any such borrowings are
in excess of 10% of total assets. Transactions that
are fully collateralized in a manner that does not
involve the prohibited issuance of a "senior
security" within the meaning of Section 18(f) of the
Investment Company Act shall not be regarded as
borrowings for the purposes of this restriction.
(b) Mortgage, pledge or hypothecate any of its assets
except in connection with permissible borrowings and
permissible forward contracts, futures contracts,
option contracts or other hedging transactions.
5. Except as required in connection with permissible hedging
activities, purchase securities on margin or underwrite
securities(This does not preclude each Fund from obtaining
such short-term credit as may be necessary for the clearance
of purchases and sales of its portfolio securities.)
6. Buy or sell real estate or commodities or commodity contracts;
however, each Fund, to the extent not otherwise prohibited in
the Prospectus or this Statement of Additional Information,
may invest in securities secured by real estate or interests
therein or issued by companies which invest in real estate or
interests therein, including real estate investment trusts,
and may purchase or sell currencies (including forward
currency exchange contracts), futures contracts and related
options generally as described in the Prospectus and this
Statement of Additional Information.
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7. Invest in securities of other investment companies, except to
the extent permitted by the Investment Company Act and
discussed in the Prospectus or this Statement of Additional
Information, or as such securities may be acquired as part of
a merger, consolidation or acquisition of assets.
8. Invest, in the aggregate, more than 15% (10% for the Money
Market Funds) of its net assets in illiquid securities,
including (under current SEC interpretations) restricted
securities (excluding liquid Rule 144A-eligible restricted
securities), securities which are not otherwise readily
marketable, repurchase agreements that mature in more than
seven days and over-the-counter options (and securities
underlying such options) purchased by that Fund. (This is an
operating policy which may be changed without shareholder
approval, consistent with the Investment Company Act, changes
in relevant SEC interpretations).
9. Invest in any issuer for purposes of exercising control or
management of the issuer(This is an operating policy which may
be changed without shareholder approval, consistent with the
Investment Company Act.)
10. Except with respect to communications companies for the
Communications Fund, as described in the Prospectus, invest
more than 25% of the market value of its total assets in the
securities of companies engaged in any one industry(This does
not apply to investment in the securities of the U.S.
Government, its agencies or instrumentalities or California
Municipal Obligations or Municipal Obligations for the
Tax-Free Funds.) For purposes of this restriction, each Fund
generally relies on the U.S. Office of Management and Budget's
Standard Industrial Classifications.
11. Issue senior securities, as defined in the Investment Company
Act, except that this restriction shall not be deemed to
prohibit that Fund from (a) making any permitted borrowings,
mortgages or pledges, or (b) entering into permissible
repurchase and dollar roll transactions.
12. Except as described in the Prospectus and this Statement of
Additional Information, acquire or dispose of put, call,
straddle or spread options subject to the following conditions
(for other than the Total Return Bond, Short Bond and
California Intermediate Bond Funds):
(a) such options are written by other persons, and
(b) the aggregate premiums paid on all such options which
are held at any time do not exceed 5% of that Fund's
total assets.
(This is an operating policy which may be changed without
shareholder approval.)
13. Except as described in the Prospectus and this Statement of
Additional Information, engage in short sales of
securities(This is an operating policy which may be changed
without shareholder approval, consistent with applicable
regulations.)
14. Purchase more than 10% of the outstanding voting securities of
any one issuer. This investment restriction does not relate to
the Fixed Income Funds. (This is an operating policy which may
be changed without shareholder approval.)
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15. Invest in commodities, except for futures contracts or options
on futures contracts if, as a result thereof, more than 5% of
that Fund's total assets (taken at market value at the time of
entering into the contract) would be committed to initial
deposits and premiums on open futures contracts and options on
such contracts. The Money Market Funds may not enter into a
futures contract or option on a futures contract regardless of
the amount of the initial deposit or premium.
To the extent these restrictions reflect matters of operating policy
which may be changed without shareholder vote, these restrictions may be amended
upon approval by the appropriate Board and notice to shareholders.
If a percentage restriction is adhered to at the time of investment, a
subsequent increase or decrease in a percentage resulting from a change in the
values of assets will not constitute a violation of that restriction, except as
otherwise noted.
The Board of Trustees of The Montgomery Funds has elected to value the
assets of the Money Market Funds in accordance with Rule 2a-7 under the
Investment Company Act. This Rule also imposes various restrictions on these
Funds' portfolios which are, in some cases, more restrictive than these Funds'
stated fundamental policies and investment restrictions. Due to amendments to
Rule 2a-7 adopted by the SEC in 1991, any fund which holds itself out as a money
market fund must also follow certain portfolio provisions of Rule 2a-7 regarding
the maturity and quality of each portfolio investment, and the diversity of such
investments. Thus, although the restrictions imposed by Rule 2a-7 are not
fundamental policies of these Funds, these Funds must comply with these
provisions unless their shareholders vote to change their policies of being
money market funds.
DISTRIBUTIONS AND TAX INFORMATION
DISTRIBUTIONS. The Funds receive income in the form of dividends and
interest earned on their investments in securities. This income, less the
expenses incurred in their operations, is the Funds' net investment income,
substantially all of which will be declared as dividends to the Funds'
shareholders.
The amount of ordinary income dividend payments by the Funds is
dependent upon the amount of net investment income received by the Funds from
their portfolio holdings, is not guaranteed and is subject to the discretion of
the Funds' Board. These Funds do not pay "interest" or guarantee any fixed rate
of return on an investment in their shares.
The Funds also may derive capital gains or losses in connection with
sales or other dispositions of their portfolio securities. Any net gain a Fund
may realize from transactions involving investments held less than the period
required for long-term capital gain or loss recognition or otherwise producing
short-term capital gains and losses (taking into account any carryover of
capital losses from the eight previous taxable years), although a distribution
from capital gains, will be distributed to shareholders with and as a part of
dividends giving rise to ordinary income. If during any year a Fund realizes a
net gain on transactions involving investments held for the period required for
long-term capital gain or loss recognition or otherwise producing long-term
capital gains and losses, the Fund will have a net long-term capital gain. After
deduction of the amount of any net short-term capital loss, the balance (to the
extent not offset by any capital losses carried over from the eight previous
taxable years) will be distributed and treated as long-term capital gains in the
hands of the shareholders regardless of the length of time that Fund's shares
may have been held by the shareholders.
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The maximum long-term federal capital gains rate for individuals is 20%
with respect to capital assets held for more than 12 months. The maximum capital
gains rate for corporate shareholders is the same as the maximum tax rate for
ordinary income.
Any dividend or distribution per share paid by a Fund reduces that
Fund's net asset value per share on the date paid by the amount of the dividend
or distribution per share. Accordingly, a dividend or distribution paid shortly
after a purchase of shares by a shareholder would represent, in substance, a
partial return of capital (to the extent it is paid on the shares so purchased),
even though it would be subject to income taxes (except for distributions from
the Tax-Free Funds to the extent not subject to income taxes).
Dividends and other distributions will be reinvested in additional
shares of the applicable Fund unless the shareholder has otherwise indicated.
Investors have the right to change their elections with respect to the
reinvestment of dividends and distributions by notifying the Transfer Agent in
writing, but any such change will be effective only as to dividends and other
distributions for which the record date is seven or more business days after the
Transfer Agent has received the written request.
TAX INFORMATION. Each Fund has elected and intends to continue to
qualify to be treated as a regulated investment company under Subchapter M of
the Internal Revenue Code of 1986, as amended (the "Code"), for each taxable
year by complying with all applicable requirements regarding the source of its
income, the diversification of its assets, and the timing of its distributions.
Each Fund that has filed a tax return has so qualified and elected in prior tax
years. Each Fund's policy is to distribute to its shareholders all of its
investment company taxable income and any net realized capital gains for each
fiscal year in a manner that complies with the distribution requirements of the
Code, so that Fund will not be subject to any federal income tax or excise taxes
based on net income. However, the Boards of Trustees may elect to pay such
excise taxes if it determines that payment is, under the circumstances, in the
best interests of a Fund.
In order to qualify as a regulated investment company, each Fund must,
among other things, (a) derive at least 90% of its gross income each year from
dividends, interest, payments with respect to loans of stock and securities,
gains from the sale or other disposition of stock or securities or foreign
currency gains related to investments in stocks or other securities, or other
income (generally including gains from options, futures or forward contracts)
derived with respect to the business of investing in stock, securities or
currency, and (b) diversify its holdings so that, at the end of each fiscal
quarter, (i) at least 50% of the market value of its assets is represented by
cash, cash items, U.S. Government securities, securities of other regulated
investment companies and other securities limited, for purposes of this
calculation, in the case of other securities of any one issuer to an amount not
greater than 5% of that Fund's assets or 10% of the voting securities of the
issuer, and (ii) not more than 25% of the value of its assets is invested in the
securities of any one issuer (other than U.S. Government securities or
securities of other regulated investment companies). As such, and by complying
with the applicable provisions of the Code, a Fund will not be subject to
federal income tax on taxable income (including realized capital gains) that is
distributed to shareholders in accordance with the timing requirements of the
Code. If a Fund is unable to meet certain requirements of the Code, it may be
subject to taxation as a corporation.
Distributions of net investment income and net realized capital gains
by a Fund will be taxable to shareholders whether made in cash or reinvested in
shares. In determining amounts of net realized capital gains to be distributed,
any capital loss carryovers from the eight prior taxable years will be applied
against capital gains. Shareholders receiving distributions in the form of
additional shares will have a cost basis for federal
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income tax purposes in each share so received equal to the net asset value of a
share of a Fund on the reinvestment date. Fund distributions also will be
included in individual and corporate shareholders' income on which the
alternative minimum tax may be imposed.
The Funds or any securities dealer effecting a redemption of the Funds'
shares by a shareholder will be required to file information reports with the
IRS with respect to distributions and payments made to the shareholder. In
addition, the Funds will be required to withhold federal income tax at the rate
of 31% on taxable dividends, redemptions and other payments made to accounts of
individual or other non-exempt shareholders who have not furnished their correct
taxpayer identification numbers and made certain required certifications on the
Account Application Form or with respect to which a Fund or the securities
dealer has been notified by the IRS that the number furnished is incorrect or
that the account is otherwise subject to withholding.
The Funds intend to declare and pay dividends and other distributions,
as stated in the Prospectus. In order to avoid the payment of any federal excise
tax based on net income, each Fund must declare on or before December 31 of each
year, and pay on or before January 31 of the following year, distributions at
least equal to 98% of its ordinary income for that calendar year and at least
98% of the excess of any capital gains over any capital losses realized in the
one-year period ending October 31 of that year, together with any undistributed
amounts of ordinary income and capital gains (in excess of capital losses) from
the previous calendar year.
A Fund may receive dividend distributions from U.S. corporations. To
the extent that a Fund receives such dividends and distributes them to its
shareholders, and meets certain other requirements of the Code, corporate
shareholders of the Fund may be entitled to the "dividends received" deduction.
Availability of the deduction is subject to certain holding period and
debt-financing limitations.
If more than 50% in value of the total assets of a Fund at the end of
its fiscal year is invested in stock or other securities of foreign
corporations, that Fund may elect to pass through to its shareholders the pro
rata share of all foreign income taxes paid by that Fund. If this election is
made, shareholders will be (i) required to include in their gross income their
pro rata share of any foreign income taxes paid by that Fund, and (ii) entitled
either to deduct their share of such foreign taxes in computing their taxable
income or to claim a credit for such taxes against their U.S. income tax,
subject to certain limitations under the Code, including certain holding period
requirements. In this case, shareholders will be informed in writing by that
Fund at the end of each calendar year regarding the availability of any credits
on and the amount of foreign source income (including or excluding foreign
income taxes paid by that Fund) to be included in their income tax returns. If
50% or less in value of that Fund's total assets at the end of its fiscal year
are invested in stock or other securities of foreign corporations, that Fund
will not be entitled under the Code to pass through to its shareholders their
pro rata share of the foreign income taxes paid by that Fund. In this case,
these taxes will be taken as a deduction by that Fund
A Fund may be subject to foreign withholding taxes on dividends and
interest earned with respect to securities of foreign corporations. A Fund may
invest up to 10% of its total assets in the stock of foreign investment
companies. Such companies are likely to be treated as "passive foreign
investment companies" ("PFICs") under the Code. Certain other foreign
corporations, not operated as investment companies, may nevertheless satisfy the
PFIC definition. A portion of the income and gains that these Funds derive from
PFIC stock may be subject to a non-deductible federal income tax at the Fund
level. In some cases, a Fund may be able to avoid this tax by electing to be
taxed currently on its share of the PFIC's income, whether or not such income is
actually distributed by the PFIC. A Fund will endeavor to limit its exposure to
the PFIC tax by
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investing in PFICs only where the election to be taxed currently will be made.
Because it is not always possible to identify a foreign issuer as a PFIC in
advance of making the investment, a Fund may incur the PFIC tax in some
instances.
THE TAX-FREE FUNDS. Provided that, as anticipated, each Tax-Free Fund
qualifies as a regulated investment company under the Code, and, at the close of
each quarter of its taxable year, at least 50% of the value of the total assets
of each of the California Intermediate Bond and California Money Funds consist
of obligations (including California Municipal Securities) the interest on which
is exempt from California personal income taxation under the laws of California,
such Fund will be qualified to pay exempt-interest dividends to its shareholders
that, to the extent attributable to interest received by the Fund on such
obligations, are exempt from California personal income tax. If at the close of
each quarter of its taxable year, at least 50% of the value of the total assets
of the Federal Money Fund consists of obligations (including Municipal
Securities) the interest on which is exempt from federal personal income
taxation under the Constitution or laws of the United States, the Federal Money
Fund will be qualified to pay exempt-interest dividends to its shareholders
that, to the extent attributable to interest received by the Fund on such
obligations, are exempt from federal personal income tax. The total amount of
exempt-interest dividends paid by these Funds to their shareholders with respect
to any taxable year cannot exceed the amount of interest received by these Funds
during such year on tax-exempt obligations less any expenses attributable to
such interest. Income from other transactions engaged in by these Funds, such as
income from options, repurchase agreements and market discount on tax-exempt
securities purchased by these Funds, will be taxable distributions to its
shareholders.
The Code may also subject interest received on certain otherwise
tax-exempt securities to an alternative minimum tax. In addition, certain
corporations which are subject to the alternative minimum tax may have to
include a portion of exempt-interest dividends in calculating their alternative
minimum taxable income.
Exempt-interest dividends paid to shareholders that are corporations
subject to California franchise tax will be taxed as ordinary income to such
shareholders. Moreover, no exempt-interest dividends paid by these Funds will
qualify for the corporate dividends-received deduction for federal income tax
purposes.
Interest on indebtedness incurred or continued by a shareholder to
purchase or carry shares of these Funds is not deductible for federal income tax
purposes. Under regulations used by the IRS for determining when borrowed funds
are considered used for the purposes of purchasing or carrying particular
assets, the purchase of shares may be considered to have been made with borrowed
funds even though the borrowed funds are not directly traceable to the purchase
of shares of these Funds. California personal income tax law restricts the
deductibility of interest on indebtedness incurred by a shareholder to purchase
or carry shares of a fund paying dividends exempt from California personal
income tax, as well as the allowance of losses realized upon a sale or
redemption of shares, in substantially the same manner as federal tax law.
Further, these Funds may not be appropriate investments for persons who are
"substantial users" of facilities financed by industrial revenue bonds or are
"related persons" to such users. Such persons should consult their own tax
advisers before investing in these Funds.
Up to 85% of social security or railroad retirement benefits may be
included in federal (but not California) taxable income for benefit recipients
whose adjusted gross income (including income from tax-exempt sources such as
tax-exempt bonds and these Funds) plus 50% of their benefits exceeding certain
base amounts. Income from these Funds, and other funds like them, is included in
the calculation of whether a recipient's income exceeds these base amounts, but
is not taxable directly.
B-41
<PAGE>
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the federal income tax exemption for
interest on Municipal Securities. It can be expected that similar proposals may
be introduced in the future. Proposals by members of state legislatures may also
be introduced which could affect the state tax treatment of these Funds'
distributions. If such proposals were enacted, the availability of Municipal
Securities for investment by these Funds and the value of these Funds'
portfolios would be affected. In such event, these Funds would reevaluate their
investment objectives and policies.
HEDGING. The use of hedging strategies, such as entering into futures
contracts and forward contracts and purchasing options, involves complex rules
that will determine the character and timing of recognition of the income
received in connection therewith by a Fund. Income from foreign currencies
(except certain gains therefrom that may be excluded by future regulations) and
income from transactions in options, futures contracts and forward contracts
derived by a Fund with respect to its business of investing in securities or
foreign currencies will qualify as permissible income under Subchapter M of the
Code.
For accounting purposes, when a Fund purchases an option, the premium
paid by that Fund is recorded as an asset and is subsequently adjusted to the
current market value of the option. Any gain or loss realized by a Fund upon the
expiration or sale of such options held by that Fund generally will be capital
gain or loss.
Any security, option, or other position entered into or held by a Fund
that substantially diminishes that Fund's risk of loss from any other position
held by that Fund may constitute a "straddle" for federal income tax purposes.
In general, straddles are subject to certain rules that may affect the amount,
character and timing of a Fund's gains and losses with respect to straddle
positions by requiring, among other things, that the loss realized on
disposition of one position of a straddle be deferred until gain is realized on
disposition of the offsetting position; that a Fund's holding period in certain
straddle positions not begin until the straddle is terminated (possibly
resulting in the gain being treated as short-term capital gain rather than
long-term capital gain); and that losses recognized with respect to certain
straddle positions, which would otherwise constitute short-term capital losses,
be treated as long-term capital losses. Different elections are available to a
Fund that may mitigate the effects of the straddle rules.
Certain options, futures contracts and forward contracts that are
subject to Section 1256 of the Code ("Section 1256 Contracts") and that are held
by a Fund at the end of its taxable year generally will be required to be
"marked to market" for federal income tax purposes, that is, deemed to have been
sold at market value. Sixty percent of any net gain or loss recognized on these
deemed sales and 60% of any net gain or loss realized from any actual sales of
Section 1256 Contracts will be treated as long-term capital gain or loss, and
the balance will be treated as short-term capital gain or loss.
Section 988 of the Code contains special tax rules applicable to
certain foreign currency transactions that may affect the amount, timing and
character of income, gain or loss recognized by a Fund. Under these rules,
foreign exchange gain or loss realized with respect to foreign
currency-denominated debt instruments, foreign currency forward contracts,
foreign currency-denominated payables and receivables and foreign currency
options and futures contracts (other than options and futures contracts that are
governed by the mark-to-market and 60/40 rules of Section 1256 of the Code and
for which no election is made) is treated as ordinary income or loss. Some part
of a Fund's gain or loss on the sale or other disposition of shares of a foreign
corporation may, because of changes in foreign currency exchange rates, be
treated as ordinary income or loss under Section 988 of the Code, rather than as
capital gain or loss.
B-42
<PAGE>
Redemptions and exchanges of shares of a Fund will result in gains or
losses for tax purposes to the extent of the difference between the proceeds and
the shareholder's adjusted tax basis for the shares. Any loss realized upon the
redemption or exchange of shares within six months from their date of purchase
will be treated as a long-term capital loss to the extent of distributions of
long-term capital gain dividends with respect to such shares during such
six-month period. Any loss realized upon the redemption or exchange of shares of
a Tax-Free Fund within six months from their date of purchase will be disallowed
to the extent of distributions of exempt-interest dividends with respect to such
shares during such six-month period. All or a portion of a loss realized upon
the redemption of shares of a Fund may be disallowed to the extent shares of
that Fund are purchased (including shares acquired by means of reinvested
dividends) within 30 days before or after such redemption.
Distributions and redemptions may be subject to state and local income
taxes, and the treatment thereof may differ from the federal income tax
treatment. Foreign taxes may apply to non-U.S. investors.
The above discussion and the related discussion in the Prospectus are
not intended to be complete discussions of all applicable federal tax
consequences of an investment in the Funds. The law firm of Paul, Hastings,
Janofsky & Walker LLP has expressed no opinion in respect thereof. Nonresident
aliens and foreign persons are subject to different tax rules, and may be
subject to withholding of up to 30% on certain payments received from the Funds.
Shareholders are advised to consult with their own tax advisers concerning the
application of foreign, federal, state and local taxes to an investment in the
Funds.
TRUSTEES AND OFFICERS
The Trustees of the Trusts (the two Trusts have the same members on
their Boards), are responsible for the overall management of the Funds,
including establishing the Funds' policies, general supervision and review of
their investment activities. The officers (the two Trusts, as well as an
affiliated Trust, The Montgomery Funds III, have the same officers), who
administer the Funds' daily operations, are appointed by the Boards of Trustees.
The current Trustees and officers of the Trusts performing a policy-making
function and their affiliations and principal occupations for the past five
years are set forth below:
GEORGE A. RIO, President and Treasurer (born 1955)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Mr. Rio is Executive
Vice President and Client Service Director of Funds Distributor, Inc. (since
April 1998). From June 1995 to March 1998, he was Senior Vice President, Senior
Key Account Manager for Putnam Mutual Funds. From May 1994 to June 1995, he was
Director of business development for First Data Corporation. From September 1993
to May 1994, he was Senior Vice President and Manager of Client Services; and
Director of Internal Audit at the Boston Company.
KAREN JACOPPO-WOOD, Vice President and Assistant Secretary (born 1966)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Ms. Jacoppo-Wood is
the Assistant Vice President of FDI and an officer of certain investment
companies advised or administered by Morgan, Waterhouse, RCM and Harris or their
respective affiliates. From June 1994 to January 1996, Ms. Jacoppo-Wood was a
Manager, SEC Registration, Scudder, Stevens & Clark, Inc. From 1988 to May 1994,
Ms. Jacoppo-Wood was a Senior Paralegal at The Boston Company Advisers, Inc.
(TBCA)
B-43
<PAGE>
MARGARET W. CHAMBERS, Secretary (born 1959)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Ms. Chambers is Senior
Vice President and General Counsel of Funds Distributor Inc. (since April 1998).
From August 1996 to March 1998, Ms. Chambers was Vice President and Assistant
General Counsel for Loomis, Sayles & Company, L.P. From January 1986 to July
1996, she was an associate with the law firm of Ropes & Gray.
CHRISTOPHER J. KELLEY, Vice President and Assistant Secretary (born 1964)
60 State Street, Suite 300, Boston, Massachusetts 02109. Mr. Kelley is the Vice
President and Associate General Counsel of FDI and Premier Mutual, and an
officer of certain investment companies advised or administered by Morgan,
Waterhouse and Harris or their respective affiliates. From April 1994 to July
1996, Mr. Kelley was Assistant Counsel at Forum Financial Group. From 1992 to
1994, Mr. Kelley was employed by Putnam Investments in Legal and Compliance
capacities. Prior to 1992, Mr. Kelley attended Boston College Law School, from
which he graduated in May 1992.
MARY A. NELSON, Vice President and Assistant Treasurer (born 1964)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Ms. Nelson is the Vice
President and Manager of Treasury Services and Administration of FDI and Premier
Mutual, and an officer of certain investment companies advised or administered
by Morgan, Dreyfus, Waterhouse, RCM and Harris or their respective affiliates.
From 1989 to 1994 Ms. Nelson was Assistant Vice President and Client Manager for
The Boston Company, Inc.
GARY S. MACDONALD, Vice President and Assistant Treasurer (born 1964)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Mr. MacDonald is the
Vice President of FDI with which he has been associated since November 1996. He
also is an officer of certain investment companies advised or administered by
RCM. From September 1992 to November 1996 he was Vice President of Bay. Banks
Investment Management/Bay Bank Financial Services; and from April 1989 to
September 1992 he was an Analyst at Wellington Management Company.
MARIE E. CONNOLLY, Vice President and Assistant Treasurer (born 1957)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Ms. Connolly is the
President, Chief Executive Officer, Chief Compliance Officer and Director of FDI
and Premier Mutual, and an officer of certain investment companies advised or
administered by Morgan and Dreyfus or their respective affiliates. From December
1991 to July 1994, Ms. Connolly was President and Chief Compliance Officer of
FDI. Prior to December 1991, Ms. Connolly served as Vice President and
Controller, and later Senior Vice President of TBCA.
B-44
<PAGE>
DOUGLAS C. CONROY, Vice President and Assistant Treasurer (born 1969)
60 State Street, Suite 130, Boston, Massachusetts 02109. Mr. Conroy is the
Assistant Vice President and Manager of Treasury Services and Administration of
FDI and an officer of certain investment companies advised or administered by
Morgan and Dreyfus or their respective affiliates. Prior to April 1997, Mr.
Conroy was Supervisor of Treasury Services and Administration of FDI. From April
1993 to January 1995, Mr. Conroy was a Senior Fund Accountant for Investors Bank
& Trust Company. From December 1991 to March 1993, Mr. Conroy was employed as a
Fund Accountant at The Boston Company, Inc.
JOSEPH F. TOWER, III, Vice President and Assistant Treasurer (born 1962)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Mr. Tower is the
Executive Vice President, Treasurer and Chief Financial Officer, Chief
Administrative Officer and Director of FDI; Senior Vice President, Treasurer and
Chief Financial Officer, Chief Administrative Officer and Director of Premier
Mutual, and an officer of certain investment companies advised or administered
by Morgan, Dreyfus and Waterhouse or their respective affiliates. Prior to April
1997, Mr. Tower was Senior Vice President, Treasurer and Chief Financial
Officer, Chief Administrative Officer and Director of FDI. From July 1988 to
November 1993, Mr. Tower was Financial Manager of The Boston Company, Inc.
JOHN A. FARNSWORTH, Trustee (born 1941)
One California Street, Suite 1950, San Francisco, California 94111. Mr.
Farnsworth is a partner of Pearson, Caldwell & Farnsworth, Inc., an executive
search consulting firm. From May 1988 to September 1991, Mr. Farnsworth was the
Managing Partner of the San Francisco office of Ward Howell International, Inc.,
an executive recruiting firm. From May 1987 until May 1988, Mr. Farnsworth was
Managing Director of Jeffrey Casdin & Company, an investment management firm
specializing in biotechnology companies. From May 1984 until May 1987, Mr.
Farnsworth served as a Senior Vice President of Bank of America and head of the
U.S. Private Banking Division.
ANDREW COX, Trustee (born 1944)
750 Vine Street, Denver, Colorado 80206. Since June 1988, Mr. Cox has been
engaged as an independent investment consultant. From September 1976 until June
1988, Mr. Cox was a Vice President of the Founders Group of Mutual Funds,
Denver, Colorado, and Portfolio Manager or Co-Portfolio Manager of several of
the mutual funds in the Founders Group.
CECILIA H. HERBERT, Trustee (born 1949)
2636 Vallejo Street, San Francisco, California 94123. Ms. Herbert was Managing
Director of Morgan Guaranty Trust Company. From 1983 to 1991 she was General
Manager of the bank's San Francisco office, with responsibility for lending,
corporate finance and investment banking. Ms. Herbert is a member of the Board
of Schools of the Sacred Heart, and is a member of the Archdiocese of San
Francisco Finance Council, where she chairs the Investment Committee.
B-45
<PAGE>
R. STEPHEN DOYLE, Chairman of the Board of Trustees (born 1939).+
101 California Street, San Francisco, California 94111.R. Stephen Doyle, the
founder of Montgomery Asset Management, began his career in the financial
services industry in 1974. Before starting Montgomery Asset Management in 1990,
Mr. Doyle was a General partner and member of the Management Committee at
Montgomery Securities with specific responsibility for private placements and
venture capital. Prior to joining Montgomery Securities, Mr. Doyle was at E. F.
Hutton & Co. as a Vice President with responsibility for both retail and
institutional accounts. Mr. Doyle was also with Connecticut General Insurance,
where he served as a Consultant to New York Stock Exchange Member Firms in the
area of financial planning.
The officers of the Trusts, and the Trustees who are considered
"interested persons" of the Trusts, receive no compensation directly from the
Trusts for performing the duties of their offices. However, those officers and
Trustees who are officers or partners of the Manager or the Distributor may
receive remuneration indirectly because the Manager will receive a management
fee from the Funds and Funds Distributor, Inc., will receive commissions for
executing portfolio transactions for the Funds. The Trustees who are not
affiliated with the Manager or the Distributor receive an annual retainer and
fees and expenses for each regular Board meeting attended. The aggregate
compensation paid by each Trust to each of the Trustees during the fiscal year
ended June 30, 1998, and to be paid during the fiscal year ending June 30, 1999,
and the aggregate compensation paid to each of the Trustees during the fiscal
year ended June 30, 1998, and to be paid during the fiscal year ending June 30,
1999, by all of the registered investment companies to which the Manager
provides investment advisory services, are set forth below.
-----------------------------------------------------
FISCAL YEAR
ENDED
JUNE 30, 1998
--------------------------------------------------------------------------
TOTAL
PENSION OR COMPENSATION
AGGREGATE AGGREGATE RETIREMENT FROM THE
COMPENSATION COMPENSATION BENEFITS TRUST AND
FROM THE FROM THE ACCRUED AS FUND COMPLEX
MONTGOMERY MONTGOMERY PART OF FUND (1 ADDITIONAL
NAME OF TRUSTEE FUNDS FUNDS II EXPENSES* TRUST)
-------------------- -----------------------------------------------------
R. STEPHEN DOYLE None None -- None
-------------------- -----------------------------------------------------
JOHN A. FARNSWORTH** $25,000 $5,000 -- $35,000
-------------------- -----------------------------------------------------
ANDREW COX** $25,000 $5,000 -- $35,000
-------------------- -----------------------------------------------------
CECILIA H. HERBERT** $25,000 $5,000 -- $35,000
-------------------- -----------------------------------------------------
* The Trusts do not maintain pension or retirement plans.
.
** For the fiscal year ending June 30, 1999, the aggregate compensation from
the Montgomery Funds, The Montgomery Funds II and the total compensation
from the Trust and Fund complex (including one additional Trust) is
expected to be $35,000, $15,000 and $55,000, respectively.
The Class R, Class P and Class L shares of the Funds are all sold
without a sales load. Therefore, there is no existing arrangement to reduce or
eliminate any sales loads for Trustees and other affiliated persons of the
Trust.
- ------------------------
+ Trustee deemed an "interested person" of the Funds as defined in the
Investment Company Act.
B-46
<PAGE>
INVESTMENT MANAGEMENT AND OTHER SERVICES
INVESTMENT MANAGEMENT SERVICES. As stated in each Prospectus,
investment management services are provided to the Funds (except the U.S. Asset
Allocation Fund) by Montgomery Asset Management LLC (the "Manager"), pursuant to
an Investment Management Agreement between the Manager and The Montgomery Funds
dated July 31, 1997; and to the U.S. Asset Allocation Fund by the Manager
pursuant to an Investment Management Agreement between the Manager and The
Montgomery Funds II dated July 31, 1997(together, the "Agreements").
The Agreements are in effect with respect to each Fund for two years
after the Fund's inclusion in its Trust's Agreement (on or around its beginning
of public operations) and then continue for each Fund for periods not exceeding
one year so long as such continuation is approved at least annually by (1) the
Board of the appropriate Trust or the vote of a majority of the outstanding
shares of that Fund, and (2) a majority of the Trustees who are not interested
persons of any party to the relevant Agreement, in each case by a vote cast in
person at a meeting called for the purpose of voting on such approval. The
Agreements may be terminated at any time, without penalty, by a Fund or the
Manager upon 60 days' written notice, and are automatically terminated in the
event of its assignment as defined in the Investment Company Act.
For services performed under the Agreements, each Fund pays the Manager
a management fee (accrued daily but paid when requested by the Manager) based
upon the average daily net assets of the Fund at the following annual rates:
<TABLE>
<CAPTION>
FUND AVERAGE DAILY NET ASSETS ANNUAL RATE
<S> <C> <C>
U.S. EQUITY FUNDS
Montgomery Growth Fund First $500 million 1.00%
Next $500 million 0.90%
Over $1 billion 0.80%
Montgomery Small Cap Opportunities Fund First $200 million 1.20%
Next $300 million 1.10%
Over $500 million 1.00%
Montgomery Small Cap Fund First $250 million 1.00%
Over $250 million 0.80%
Montgomery U.S. Emerging Growth Fund First $200 million 1.40%
Over $200 million 1.25%
Montgomery Equity Income Fund First $500 million 0.60%
Over $500 million 0.50%
FOREIGN AND GLOBAL EQUITY FUNDS
Montgomery International Growth Fund First $500 million 1.10%
Next $500 million 1.00%
Over $1 billion 0.90%
Montgomery International Small Cap Fund First $250 million 1.25%
Over $250 million 1.00%
Montgomery Emerging Markets Fund First $250 million 1.25%
Over $250 million 1.00%
</TABLE>
B-47
<PAGE>
<TABLE>
<CAPTION>
FUND AVERAGE DAILY NET ASSETS ANNUAL RATE
<S> <C> <C>
Montgomery Emerging Asia Fund First $500 million 1.25%
Next $500 million 1.10%
Over $1 billion 1.00%
Montgomery Latin America Fund First $500 million 1.25%
Next $500 million 1.10%
Over $1 billion 1.00%
Montgomery Global Opportunities Fund First $500 million 1.25%
Next $500 million 1.10%
Over $1 billion 1.00%
Montgomery Global Communications Fund First $250 million 1.25%
Over $250 million 1.00%
Montgomery Global Long-Short Fund First $250 million 1.50%
Over $250 million 1.25%
MULTI-STRATEGY FUNDS
Montgomery Select 50 Fund First $250 million 1.25%
Next $250 million 1.00%
Over $500 million 0.90%
Montgomery U.S. Asset Allocation Fund All Amounts None*
U.S. FIXED-INCOME AND MONEY MARKET FUNDS
Montgomery Total Return Bond Fund First $500 million 0.50%
Over $500 million 0.40%
Montgomery Short Duration Government Bond Fund First $500 million 0.50%
Over $500 million 0.40%
Montgomery Government Reserve Fund First $250 million 0.40%
Next $250 million 0.30%
Over $500 million 0.20%
Montgomery California Tax-Free Intermediate Bond Fund First $500 million 0.50%
Over $500 million 0.40%
Montgomery California Tax-Free Money Fund First $500 million 0.40%
Over $500 million 0.30%
Montgomery Federal Tax-Free Money Fund First $500 million 0.40%
Over $500 million 0.30%
</TABLE>
* This amount represents only the management fee of the U.S. Asset
Allocation.
As noted in the Prospectus, the Manager has agreed to reduce some or
all of its management fee if necessary to keep total operating expenses,
expressed on an annualized basis, at or below the following percentages of each
Fund's average net assets (excluding Rule 12b-1 Plan fees): International Small
Cap, Emerging Markets, Emerging Asia, Latin America, Opportunities and
Communications Funds, 1.90% each; Global Long-Short Fund, 2.10%; Select 50 Fund,
1.80%; U.S. Emerging Growth Fund, 1.75%; International Growth Fund, 1.65%;
Growth and Small Cap Opportunities Fund, 1.50%; Small Cap Fund, 1.40%; U.S.
Asset Allocation Fund, the Short Bond, Total Return Bond, and California
Intermediate Bond Funds, 0.70% each; the Equity Income Fund, 0.85%; and the
Money Market Funds, 0.60%, each. The Manager also may voluntarily reduce
additional amounts to
B-48
<PAGE>
increase the return to a Fund's investors. Any reductions made by the Manager in
its fees are subject to reimbursement by that Fund within the following three
years provided the Fund is able to effect such reimbursement and remain in
compliance with the foregoing expense limitations. The Manager generally seeks
reimbursement for the oldest reductions and waivers before payment by the Funds
for fees and expenses for the current year.
Operating expenses for purposes of the Agreements include the Manager's
management fee but do not include any taxes, interest, brokerage commissions,
expenses incurred in connection with any merger or reorganization or
extraordinary expenses such as litigation.
The Agreements were approved with respect to each Fund by the Boards at
duly called meetings. In considering the Agreements, the Trustees specifically
considered and approved the provision which permits the Manager to seek
reimbursement of any reduction made to its management fee within the three-year
period. The Manager's ability to request reimbursement is subject to various
conditions. First, any reimbursement is subject to a Fund's ability to effect
such reimbursement and remain in compliance with applicable expense limitations
in place at that time. Second, the Manager must specifically request the
reimbursement from the relevant Board. Third, the relevant Board must approve
such reimbursement as appropriate and not inconsistent with the best interests
of the Fund and the shareholders at the time such reimbursement is requested.
Because of these substantial contingencies, the potential reimbursements will be
accounted for as contingent liabilities that are not recordable on the balance
sheet of a Fund until collection is probable; but the full amount of the
potential liability will appear footnote to each Fund's financial statements. At
such time as it appears probable that a Fund is able to effect such
reimbursement, that the Manager intends to seek such reimbursement and that the
Board of Trustees has or is likely to approve the payment of such reimbursement,
the amount of the reimbursement will be accrued as an expense of that Fund for
that current period.
As compensation for its investment management services, each of the
following Funds paid the Manager investment advisory fees in the amounts
specified below. Additional investment advisory fees payable under the
Agreements may have instead been waived by the Manager, but may be subject to
reimbursement by the respective Funds as discussed previously.
<TABLE>
<CAPTION>
FUND YEAR OR PERIOD ENDED JUNE 30,
1998 1997 1996
<S> <C> <C> <C>
U.S. EQUITY FUNDS
Montgomery Growth Fund $ 12,414,444 $ 9,429,758 $ 8,336,529
Montgomery Small Cap Opportunities Fund $ 3,268,221 $ 2,352,549 $ 217,603
Montgomery Small Cap Fund $ 2,244,080 $ 2,290,187 $ 2,364,834
Montgomery U.S. Emerging Growth Fund $ 4,997,558 $ 4,042,815 $ 3,732,720
Montgomery Equity Income Fund $ 427,314 $ 244,249 $ 101,709
Montgomery International Growth Fund $ 626,903 $ 378,515 $ 97,137
Montgomery International Small Cap Fund $ 893,323 $ 823,594 $ 611,587
Montgomery Emerging Markets Fund $ 11,315,548 $ 10,621,310 $ 10,262,601
Montgomery Emerging Asia Fund $ 643,231 $ 257,092 N/A
Montgomery Latin America Fund $ 92,848 N/A N/A
</TABLE>
B-49
<PAGE>
<TABLE>
<CAPTION>
YEAR OR PERIOD ENDED JUNE 30,
FUND 1998 1997 1996
<S> <C> <C> <C>
Montgomery Global Opportunities Fund $ 833,421 $ 562,210 $ 381,316
Montgomery Global Communications Fund $ 2,423,093 $ 2,298,528 $ 3,186,649
Montgomery Global Long-Short Fund [___________] N/A N/A
Montgomery Select 50 Fund $ 3,130,440 $ 1,366,989 $ 359,453
Montgomery U.S. Asset Allocation Fund $ 0+ 1,211,759 $ 998,198
Montgomery Total Return Bond Fund $ 386,758 N/A N/A
Montgomery Short Duration Government Bond Fund $ 296,242 $ 231,870 $ 93,531
Montgomery Government Reserve Fund $ 2,147,103 $ 2,175,561 $ 1,703,723
Montgomery California Tax-Free Intermediate Bond Fund $ 235,081 $ 103,992 $ 48,596
Montgomery California Tax-Free Money Fund $ 886,895 $ 640,819 $ 538,030
Montgomery Federal Tax-Free Money Fund $ 783,661 $ 319,348 N/A
</TABLE>
+ Does not include investment advisory fees paid to the underlying Funds.
The Manager also may act as an investment adviser or administrator to
other persons, entities, and corporations, including other investment companies.
Please refer to the table above, which indicates officers and trustees who are
affiliated persons of the Trusts and who are also affiliated persons of the
Manager.
The use of the name "Montgomery" by the Trusts and by the Funds is
pursuant to the consent of the Manager, which may be withdrawn if the Manager
ceases to be the Manager of the Funds.
Share Marketing Plan. The Trusts have adopted a Share Marketing Plan
(or Rule 12b-1 Plan) (the "12b-1 Plan") with respect to the Funds pursuant to
Rule 12b-1 under the Investment Company Act. The Distributor serves as the
distribution coordinator under the 12b-1 Plan and, as such, receives any fees
paid by the Funds pursuant to the 12b-1 Plan.
Prior to August 24, 1995, the Funds offered only one class of shares.
On that date, the Board of Trustees of the Trusts, including a majority of the
Trustees who are not interested persons of the Trust and who have no direct or
indirect financial interest in the operation of the 12b-1 Plan or in any
agreement related to the 12b-1 Plan (the "Independent Trustees"), at their
regular quarterly meeting, adopted the 12b-1 Plan for the newly designated Class
P and Class L shares of each Fund. The initial shareholder of the Class P and
Class L shares, if any, of each Fund approved the 12b-1 Plan covering each
Class. The single class of shares existing before that date was redesignated the
Class R shares. Class R shares are not covered by the 12b-1 Plan.
Under the 12b-1 Plan, each Fund pays distribution fees to the
Distributor at an annual rate of 0.25% of the Fund's aggregate average daily net
assets attributable to its Class P shares and at an annual rate of 0.75% of the
Fund's aggregate average daily net assets attributable to its Class L shares,
respectively, to reimburse the Distributor for its expenses in connection with
the promotion and distribution of those Classes.
B-50
<PAGE>
The 12b-1 Plan provides that the Distributor may use the distribution
fees received from the Class of the Fund covered by the 12b-1 Plan only to pay
for the distribution expenses of that Class. The 12b-1 Plan reimburses the
Distributor only for expenses incurred.
For the fiscal year ended June 30, 1998, the 12b-1 Plan incurred the
following expenses:
FUND COMPENSATION TO BROKER-DEALERS
Montgomery Growth Fund $ 410.49
Montgomery Equity Income Fund $ 4,440.16
Montgomery Small Cap Fund $31,409.23
Montgomery Small Cap Opportunities Fund $ 17.85
Montgomery U.S. Asset Allocation Fund $ 159.53
Montgomery International Growth Fund $ 12.30
Montgomery International Small Cap Fund $ 505.86
Montgomery Emerging Markets Fund $ 1,412.70
Montgomery Select 50 Fund $ 73.48
Montgomery Short Duration Government Bond Fund $ 0.38
Montgomery Government Reserve Fund $ 0.33
All 12b-1 Plan expenses were used to compensate broker-dealers who sold
the Funds. None of the 12b-1 Plan expenses were used towards advertising,
printing/mailing of prospectuses to other than current shareholders of the
Funds, compensation to underwriters, compensation to sales personnel, interest,
carrying or other financing charges.
Distribution fees are accrued daily and paid monthly, and are charged
as expenses of the Class P and Class L shares as accrued. To the extent that
12b-1 Plan fees are incurred in connection with distribution of the shares of
more than one Fund, the fees paid by each such participating Fund may be used to
finance the distribution of another Fund. In such instances, the distribution
fees incurred will be allocated among the participating Funds according to
relative net asset size of the participating Funds.
Class P and Class L shares are not obligated under the 12b-1 Plan to
pay any distribution expense in excess of the distribution fee. Thus, if the
12b-1 Plan were terminated or otherwise not continued, no amounts (other than
current amounts accrued but not yet paid) would be owed by the Class to the
Distributor. As of June 30, 1998, the total 12b-1 Plan expenses accrued but not
paid for The Montgomery Funds and The Montgomery Funds II were $182.86, which
amounted to 0.00% of the Funds' net assets at that time.
The 12b-1 Plan provides that it shall continue in effect from year to
year provided that a majority of the Board of Trustees of the Trust, including a
majority of the Independent Trustees, vote annually to continue the 12b-1 Plan.
The Board determined that there are various anticipated benefits to the Funds
from such continuation, including the likelihood that the Plan will stimulate
sales of shares of the Trusts and assist in increasing the asset base of the
Trusts in the face of competition from a variety of financial products and the
potential advantage to the shareholders of the Trusts of prompt and significant
growth of the asset base of the Trusts, including greater liquidity, more
investment flexibility and achievement of greater economies of scale. The 12b-1
Plan (and any distribution agreement between the Fund, the Distributor or the
Manager and a selling agent with respect to the Class P or Class L shares) may
be terminated without penalty upon at least 60-days'
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notice by the Distributor or the Manager, or by the Fund by vote of a majority
of the Independent Trustees, or by vote of a majority of the outstanding shares
(as defined in the Investment Company Act) of the Class to which the 12b-1 Plan
applies. Neither any "interested person" of the Trusts (as that term is used
under the 1940 Act) nor any trustee of the Trusts who is not any interested
person of the Trusts has any direct or indirect financial interests in the
operation of the 12b-1 Plan.
All distribution fees paid by the Funds under the 12b-1 Plan will be
paid in accordance with Rule 2830 of the NASD Rules of Conduct, as such Rule may
change from time to time. Pursuant to the 12b-1 Plan, the Boards of Trustees
will review at least quarterly a written report of the distribution expenses
incurred by the Manager on behalf of the Class P and Class L shares of each
Fund. In addition, as long as the 12b-1 Plan remains in effect, the selection
and nomination of Trustees who are not interested persons (as defined in the
Investment Company Act) of the Trust shall be made by the Trustees then in
office who are not interested persons of the Trust.
SHAREHOLDER SERVICES PLAN. The Trusts have adopted a Shareholder
Services Plan (the "Services Plan") with respect to the Funds. The Manager (or
its affiliate) serves as the service provider under the Services Plan and, as
such, receives any fees paid by the Funds pursuant to the Services Plan. The
Trusts have not yet implemented the Services Plan for any Fund and have not set
a date for implementation. Affected shareholders will be notified at least 60
days before implementation of the Services Plan.
On August 24, 1995, the Board of Trustees of the Trusts, including a
majority of the Trustees who are not interested persons of the Trust and who
have no direct or indirect financial interest in the operation of the Services
Plan or in any agreement related to the Services Plan (the "Independent
Trustees"), at their regular quarterly meeting, adopted the Services Plan for
the newly designated Class P and Class L shares of each Fund. The initial
shareholder of the Class P and Class L shares, if any, of each Fund approved the
Services Plan covering each Class. Class R shares are not covered by the
Services Plan.
Under the Services Plan, when implemented, Class P and Class L of each
Fund will pay a continuing service fee to the Manager, the Distributor or other
service providers, in an amount, computed and prorated on a daily basis, equal
to 0.25% per annum of the average daily net assets of Class P and Class L shares
of each Fund. Such amounts are compensation for providing certain services to
clients owning shares of Class P or Class L of the Funds, including personal
services such as processing purchase and redemption transactions, assisting in
change of address requests and similar administrative details, and providing
other information and assistance with respect to a Fund, including responding to
shareholder inquiries.
THE DISTRIBUTOR. Funds Distributor, Inc., the Distributor, may provide
certain administrative services to the Funds on behalf of the Manager. The
Distributor will also perform investment banking, investment advisory and
brokerage services for persons other than the Funds, including issuers of
securities in which the Funds may invest. These activities from time to time may
result in a conflict of interests of the Distributor with those of the Funds,
and may restrict the ability of the Distributor to provide services to the
Funds.
THE CUSTODIAN. Morgan Stanley Trust Company serves as principal
Custodian of the Funds' assets, which are maintained at the Custodian's
principal office, One Pierrepont Plaza, Brooklyn, NY 11201, and at the offices
of its branches and agencies throughout the world. The Custodian has entered
into agreements with foreign sub-custodians in accordance with delegation
instructions approved by the Board pursuant to Rule 17f-5 under the Investment
Company Act. The Custodian, its branches and sub-custodians generally hold
certificates
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for the securities in their custody, but may, in certain cases, have book
records with domestic and foreign securities depositories, which in turn have
book records with the transfer agents of the issuers of the securities.
Compensation for the services of the Custodian is based on a schedule of charges
agreed on from time to time.
EXECUTION OF PORTFOLIO TRANSACTIONS
In all purchases and sales of securities for the Funds, the primary
consideration is to obtain the most favorable price and execution available.
Pursuant to the Agreements, the Manager determines which securities are to be
purchased and sold by the Funds and which broker-dealers are eligible to execute
the Funds' portfolio transactions, subject to the instructions of, and review
by, the Funds and their Boards. Purchases and sales of securities within the
U.S. other than on a securities exchange will generally be executed directly
with a "market-maker" unless, in the opinion of the Manager or a Fund, a better
price and execution can otherwise be obtained by using a broker for the
transaction.
The Foreign and Global Equity Funds contemplate purchasing most equity
securities directly in the securities markets located in emerging or developing
countries or in the over-the-counter markets. A Fund purchasing ADRs and EDRs
may purchase those listed on stock exchanges, or traded in the over-the-counter
markets in the U.S. or Europe, as the case may be. ADRs, like other securities
traded in the U.S., will be subject to negotiated commission rates. The foreign
and domestic debt securities and money market instruments in which a Fund may
invest may be traded in the over-the-counter markets.
Purchases of portfolio securities for the Funds also may be made
directly from issuers or from underwriters. Where possible, purchase and sale
transactions will be effected through dealers (including banks) which specialize
in the types of securities which the Funds will be holding, unless better
executions are available elsewhere. Dealers and underwriters usually act as
principals for their own account. Purchases from underwriters will include a
concession paid by the issuer to the underwriter and purchases from dealers will
include the spread between the bid and the asked price. If the execution and
price offered by more than one dealer or underwriter are comparable, the order
may be allocated to a dealer or underwriter that has provided research or other
services as discussed below.
In placing portfolio transactions, the Manager will use its best
efforts to choose a broker-dealer capable of providing the services necessary
generally to obtain the most favorable price and execution available. The full
range and quality of services available will be considered in making these
determinations, such as the firm's ability to execute trades in a specific
market required by a Fund, such as in an emerging market, the size of the order,
the difficulty of execution, the operational facilities of the firm involved,
the firm's risk in positioning a block of securities, and other factors.
Provided the Trusts' officers are satisfied that the Funds are
receiving the most favorable price and execution available, the Manager may also
consider the sale of the Funds' shares as a factor in the selection of
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broker-dealers to execute their portfolio transactions. The placement of
portfolio transactions with broker-dealers who sell shares of the Funds is
subject to rules adopted by the National Association of Securities Dealers, Inc.
While the Funds' general policy is to seek first to obtain the most
favorable price and execution available, in selecting a broker-dealer to execute
portfolio transactions, weight may also be given to the ability of a
broker-dealer to furnish brokerage, research and statistical services to the
Funds or to the Manager, even if the specific services were not imputed just to
the Funds and may be lawfully and appropriately used by the Manager in advising
other clients. The Manager considers such information, which is in addition to,
and not in lieu of, the services required to be performed by it under the
Agreement, to be useful in varying degrees, but of indeterminable value. In
negotiating any commissions with a broker or evaluating the spread to be paid to
a dealer, a Fund may therefore pay a higher commission or spread than would be
the case if no weight were given to the furnishing of these supplemental
services, provided that the amount of such commission or spread has been
determined in good faith by that Fund and the Manager to be reasonable in
relation to the value of the brokerage and/or research services provided by such
broker-dealer, which services either produce a direct benefit to that Fund or
assist the Manager in carrying out its responsibilities to that Fund. The
standard of reasonableness is to be measured in light of the Manager's overall
responsibilities to the Funds. The Boards review all brokerage allocations where
services other than best price and execution capabilities are a factor to ensure
that the other services provided meet the criteria outlined above and produce a
benefit to the Funds.
Investment decisions for a Funds are made independently from those of
other client accounts of the Manager or its affiliates, and suitability is
always a paramount consideration. Nevertheless, it is possible that at times the
same securities will be acceptable for one or more Funds and for one or more of
such client accounts. The Manager and its personnel may have interests in one or
more of those client accounts, either through direct investment or because of
management fees based on gains in the account. The Manager has adopted
allocation procedures to ensure the fair allocation of securities and prices
between the Funds and the Manager's various other accounts. These procedures
emphasize the desirability of bunching trades and price averaging (see below) to
achieve objective fairness among clients advised by the same portfolio manager
or portfolio team. Where trades cannot be bunched, the procedures specify
alternatives designed to ensure that buy and sell opportunities are allocated
fairly and that, over time, all clients are treated equitably. The Manager's
trade allocation procedures also seek to ensure reasonable efficiency in client
transactions, and they provide portfolio managers with reasonable flexibility to
use allocation methodologies that are appropriate to their investment discipline
on client accounts.
To the extent any of the Manager's client accounts and a Fund seek to
acquire the same security at the same general time (especially if that security
is thinly traded or is a small-cap stock), that Fund may not be able to acquire
as large a portion of such security as it desires, or it may have to pay a
higher price or obtain a lower yield for such security. Similarly, a Fund may
not be able to obtain as high a price for, or as large an execution of, an order
to sell any particular security at the same time. If one or more of such client
accounts simultaneously purchases or sells the same security that a Fund is
purchasing or selling, each day's transactions in such security generally will
be allocated between that Fund and all such client accounts in a manner deemed
equitable by the Manager, taking into account the respective sizes of the
accounts, the amount being purchased or sold and other factors deemed relevant
by the Manager. In many cases, a Funds' transactions are bunched with the
transactions for other client accounts. It is recognized that in some cases this
system could have a detrimental effect on the price or value of the security
insofar as that Fund is concerned. In other cases,
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however, it is believed that the ability of the Fund to participate in volume
transactions may produce better executions for that Fund.
Other than for the U.S. Fixed Income and Money Market Funds, the
Manager's sell discipline for investments in issuers is based on the premise of
a long-term investment horizon; however, sudden changes in valuation levels
arising from, for example, new macroeconomic policies, political developments,
and industry conditions could change the assumed time horizon. Liquidity,
volatility, and overall risk of a position are other factors considered by the
Manager in determining the appropriate investment horizon.
For each Fund, sell decisions at the country level are dependent on the
results of the Manager's asset allocation model. Some countries impose
restrictions on repatriation of capital and/or dividends which would lengthen
the Manager's assumed time horizon in those countries. In addition, the rapid
pace of privatization and initial public offerings creates a flood of new
opportunities which must continually be assessed against current holdings.
At the company level, sell decisions are influenced by a number of
factors including current stock valuation relative to the estimated fair value
range, or a high P/E relative to expected growth. Negative changes in the
relevant industry sector, or a reduction in international competitiveness and a
declining financial flexibility may also signal a sell.
For the year ended June 30, 1998, the Funds total securities
transactions generated commissions of $21,467,826. For the year ended June 30,
1997, the Funds total securities transactions generated commissions of
$12,725,341, of which $27,015 was paid to Montgomery Securities. For the year
ended June 30, 1996, the Funds' total securities transactions generated
commissions of $14,874,777, of which $164,056 was paid to Montgomery Securities.
Throughout the fiscal years ended June 30, 1996, and June 30, 1997, Montgomery
Securities was affiliated with the Funds through its ownership of Montgomery
Asset Management L.P., the former Manager of the Funds. For the three fiscal
years ended June 30, 1998, The Funds' securities transactions generated
commissions of:
<TABLE>
<CAPTION>
FUND COMMISSIONS FOR FISCAL YEAR ENDED:
JUNE 30, 1996 JUNE 30, 1997 JUNE 30, 1998
<S> <C> <C> <C>
Montgomery Growth Fund $2,390,473 $2,419,136 $2,798,653
Montgomery Small Cap Opportunities Fund $ 430,377 $1,637,452 $1,027,948
Montgomery Small Cap Fund $ 658,254 $ 788,684 $1,416,883
Montgomery U.S. Emerging Growth Fund $ 912,650 $1,358,276 $1,209,313
Montgomery Equity Income Fund $ 35,626 $ 72,299 $ 81,709
Montgomery International Growth Fund $ 165,167 $ 243,582 $ 332,532
Montgomery International Small Cap Fund $ 503,070 $ 337,216 $ 413,896
Montgomery Emerging Markets Fund $9,910,296 $8,753,182 $9,442,852
Montgomery Emerging Asia Fund N/A $ 539,472 $ 675,563
Montgomery Latin America Fund N/A N/A $ 125,435
Montgomery Global Opportunities Fund $ 270,415 $ 297,275 $ 532,520
Montgomery Global Communications Fund $1,922,505 $1,334,931 $1,370,035
Montgomery Global Long-Short Fund [_________] N/A N/A
Montgomery Select 50 Fund $ 422,527 $1,181,215 $2,040,486
Montgomery U.S. Asset Allocation Fund $ 307,877 $ 289,657 $ 0+
Montgomery Short Duration Government Bond Fund $ 650 N/A N/A
</TABLE>
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<PAGE>
+ Does not include commissions paid to the Underlying Funds.
The Funds do not direct brokerage or effect securities transactions
through brokers in accordance with any formula, nor do they effect securities
transactions through such brokers solely for selling shares of the Funds.
However, brokers who execute brokerage transactions as described above may from
time to time effect purchases of shares of the Funds for their customers.
Depending on the Manager's view of market conditions, a Fund may or may
not purchase securities with the expectation of holding them to maturity,
although its general policy is to hold securities to maturity. A Funds may,
however, sell securities prior to maturity to meet redemptions or as a result of
a revised management evaluation of the issuer.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
Each Trust reserves the right in its sole discretion to (i) suspend the
continued offering of its Funds' shares, and (ii) reject purchase orders in
whole or in part when in the judgment of the Manager or the Distributor such
suspension or rejection is in the best interest of a Fund.
When in the judgment of the Manager it is in the best interests of a
Fund, an investor may purchase shares of that Fund by tendering payment in kind
in the form of securities, provided that any such tendered securities are
readily marketable (E.G., the Funds will not acquire restricted securities),
their acquisition is consistent with that Fund's investment objective and
policies, and the tendered securities are otherwise acceptable to that Fund's
Manager. Such securities are acquired by that Fund only for the purpose of
investment and not for resale. For the purposes of sales of shares of that Fund
for such securities, the tendered securities shall be valued at the identical
time and in the identical manner that the portfolio securities of that Fund are
valued for the purpose of calculating the net asset value of that Fund's shares.
A shareholder who purchases shares of a Fund by tendering payment for the shares
in the form of other securities may be required to recognize gain or loss for
income tax purposes on the difference, if any, between the adjusted basis of the
securities tendered to the Fund and the purchase price of the Fund's shares
acquired by the shareholder.
Payments to shareholders for shares of a Fund redeemed directly from
that Fund will be made as promptly as possible but no later than three days
after receipt by the Transfer Agent of the written request in proper form, with
the appropriate documentation as stated in the Prospectus, except that a Fund
may suspend the right of redemption or postpone the date of payment during any
period when (i) trading on the New York Stock Exchange ("NYSE") is restricted as
determined by the SEC or the NYSE is closed for other than weekends and
holidays; (ii) an emergency exists as determined by the SEC (upon application by
a Fund pursuant to Section 22(e) of the Investment Company Act) making disposal
of portfolio securities or valuation of net assets of a Fund not reasonably
practicable; or (iii) for such other period as the SEC may permit for the
protection of the Fund's shareholders.
The Funds intend to pay cash (U.S. dollars) for all shares redeemed,
but, under abnormal conditions that make payment in cash unwise, the Funds may
make payment partly in their portfolio securities with a current amortized cost
or market value, as appropriate, equal to the redemption price. Although the
Funds do not anticipate that they will make any part of a redemption payment in
securities, if such payment were made, an investor may incur brokerage costs in
converting such securities to cash. The Trusts have elected to be governed by
the provisions of Rule 18f-1 under the Investment Company Act, which require
that the Funds pay in cash all
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requests for redemption by any shareholder of record limited in amount, however,
during any 90-day period to the lesser of $250,000 or 1% of the value of the
Trust's net assets at the beginning of such period.
The value of shares on redemption or repurchase may be more or less
than the investor's cost, depending upon the market value of a Fund's portfolio
securities at the time of redemption or repurchase.
RETIREMENT PLANS. Shares of the Taxable Funds are available for
purchase by any retirement plan, including Keogh plans, 401(k) plans, 403(b)
plans and individual retirement accounts ("IRAs").
For individuals who wish to purchase shares of the Taxable Funds
through an IRA, there is available through these Funds a prototype individual
retirement account and custody agreement. The custody agreement provides that
DST Systems, Inc. will act as custodian under the plan, and will furnish
custodial services for an annual maintenance fee per participating account of
$10 (These fees are in addition to the normal custodian charges paid by these
Funds and will be deducted automatically from each Participant's account.) For
further details, including the right to appoint a successor custodian, see the
plan and custody agreements and the IRA Disclosure Statement as provided by
these Funds. An IRA that invests in shares of these Funds may also be used by
employers who have adopted a Simplified Employee Pension Plan. Individuals or
employers who wish to invest in shares of a Fund under a custodianship with
another bank or trust company must make individual arrangements with such
institution.
The IRA Disclosure Statement available from the Taxable Funds contains
more information on the amount investors may contribute and the deductibility of
IRA contributions. In summary, an individual may make deductible contributions
to the IRA of up to 100% of earned compensation, not to exceed $2,000 annually
(or $2,250 to two IRAs if there is a non-working spouse). For tax years
beginning after 1996, however, the $2,250 limitation is expended to $4,000. An
IRA may be established whether or not the amount of the contribution is
deductible. Generally, a full deduction for federal income tax purposes will
only be allowed to taxpayers who meet one of the following two additional tests:
(A) the individual and the individual's spouse are each not an
active participant in an employer's qualified retirement plan,
or
(B) the individual's adjusted gross income (with some
modifications) before the IRA deduction is (i) $40,000 or less
for married couples filing jointly, or (ii) $25,000 or less
for single individuals. The maximum deduction is reduced for a
married couple filing jointly with a combined adjusted gross
income (before the IRA deduction) between $40,000 and $50,000,
and for a single individual with an adjusted gross income
(before the IRA deduction) between $25,000 and $35,000.
It is advisable for an investor considering the funding of any
retirement plan to consult with an attorney or to obtain advice from a competent
retirement plan consultant with respect to the requirements of such plans and
the tax aspects thereof.
DETERMINATION OF NET ASSET VALUE
The net asset value per share of a Fund is calculated as follows: all
liabilities incurred or accrued are deducted from the valuation of total assets,
which includes accrued but undistributed income; the resulting net
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assets are divided by the number of shares of that Fund outstanding at the time
of the valuation and the result (adjusted to the nearest cent) is the net asset
value per share.
As noted in the Prospectus, the net asset value of shares of the Funds
generally will be determined at least once daily as of 4:00 P.M. (12:00 noon for
the Money Market Funds), eastern time, (or earlier when trading closes earlier)
on each day the NYSE is open for trading (except national bank holidays for the
Fixed Income Funds). It is expected that the NYSE will be closed on Saturdays
and Sundays and for New Year's Day, Martin Luther King Day, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas. The national bank holidays, in addition to New Year's Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas, include: Good Friday, Columbus Day, and
Veteran's Day. The Funds may, but do not expect to, determine the net asset
values of their shares on any day when the NYSE is not open for trading if there
is sufficient trading in their portfolio securities on such days to affect
materially per-share net asset value.
Generally, trading in and valuation of foreign securities is
substantially completed each day at various times prior to the close of the
NYSE. In addition, trading in and valuation of foreign securities may not take
place on every day in which the NYSE is open for trading. Furthermore, trading
takes place in various foreign markets on days in which the NYSE is not open for
trading and on which the Funds' net asset values are not calculated.
Occasionally, events affecting the values of such securities in U.S. dollars on
a day on which a Fund calculates its net asset value may occur between the times
when such securities are valued and the close of the NYSE that will not be
reflected in the computation of that Fund's net asset value unless the Board or
its delegates deem that such events would materially affect the net asset value,
in which case an adjustment would be made.
Generally, the Funds' investments are valued at market value or, in the
absence of a market value, at fair value as determined in good faith by the
Manager and the Trust's Pricing Committee pursuant to procedures approved by or
under the direction of the Boards.
The Funds' securities, including ADRs, EDRs and GDRs, which are traded
on securities exchanges are valued at the last sale price on the exchange on
which such securities are traded, as of the close of business on the day the
securities are being valued or, lacking any reported sales, at the mean between
the last available bid and asked price. Securities that are traded on more than
one exchange are valued on the exchange determined by the Manager to be the
primary market. Securities traded in the over-the-counter market are valued at
the mean between the last available bid and asked price prior to the time of
valuation. Securities and assets for which market quotations are not readily
available (including restricted securities which are subject to limitations as
to their sale) are valued at fair value as determined in good faith by or under
the direction of the Boards.
Short-term debt obligations with remaining maturities in excess of 60
days are valued at current market prices, as discussed above. Short-term
securities with 60 days or less remaining to maturity are, unless conditions
indicate otherwise, amortized to maturity based on their cost to a Fund if
acquired within 60 days of maturity or, if already held by a Fund on the 60th
day, based on the value determined on the 61st day.
Corporate debt securities, mortgage-related securities and asset-backed
securities held by the Funds are valued on the basis of valuations provided by
dealers in those instruments, by an independent pricing service, approved by the
appropriate Board, or at fair value as determined in good faith by procedures
approved by the Boards. Any such pricing service, in determining value, will use
information with respect to transactions in the
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securities being valued, quotations from dealers, market transactions in
comparable securities, analyses and evaluations of various relationships between
securities and yield-to-maturity information.
An option that is written by a Fund is generally valued at the last
sale price or, in the absence of the last sale price, the last offer price. An
option that is purchased by a Fund is generally valued at the last sale price
or, in the absence of the last sale price, the last bid price. The value of a
futures contract equals the unrealized gain or loss on the contract that is
determined by marking the contract to the current settlement price for a like
contract on the valuation date of the futures contract if the securities
underlying the futures contract experience significant price fluctuations after
the determination of the settlement price. When a settlement price cannot be
used, futures contracts will be valued at their fair market value as determined
by or under the direction of the Boards.
If any securities held by a Fund are restricted as to resale or do not
have readily available market quotations, the Manager and the Trusts' Pricing
Committees determine their fair value, following procedures approved by the
Boards. The Trustees periodically review such valuations and valuation
procedures. The fair value of such securities is generally determined as the
amount which a Fund could reasonably expect to realize from an orderly
disposition of such securities over a reasonable period of time. The valuation
procedures applied in any specific instance are likely to vary from case to
case. However, consideration is generally given to the financial position of the
issuer and other fundamental analytical data relating to the investment and to
the nature of the restrictions on disposition of the securities (including any
registration expenses that might be borne by a Fund in connection with such
disposition). In addition, specific factors are also generally considered, such
as the cost of the investment, the market value of any unrestricted securities
of the same class (both at the time of purchase and at the time of valuation),
the size of the holding, the prices of any recent transactions or offers with
respect to such securities and any available analysts' reports regarding the
issuer.
Any assets or liabilities initially expressed in terms of foreign
currencies are translated into U.S. dollars at the official exchange rate or,
alternatively, at the mean of the current bid and asked prices of such
currencies against the U.S. dollar last quoted by a major bank that is a regular
participant in the foreign exchange market or on the basis of a pricing service
that takes into account the quotes provided by a number of such major banks. If
neither of these alternatives is available or both are deemed not to provide a
suitable methodology for converting a foreign currency into U.S. dollars, the
Boards in good faith will establish a conversion rate for such currency.
All other assets of the Funds are valued in such manner as the Boards
in good faith deem appropriate to reflect their fair value.
The Money Market Funds value their portfolio instruments at amortized
cost, which means that securities are valued at their acquisition cost, as
adjusted for amortization of premium or discount, rather than at current market
value. Calculations are made at least weekly to compare the value of these
Funds' investments valued at amortized cost with market values. Market
valuations are obtained by using actual quotations provided by market makers,
estimates of market value, or values obtained from yield data relating to
classes of money market instruments published by reputable sources at the mean
between the bid and asked prices for the instruments. The amortized cost method
of valuation seeks to maintain a stable $1.00 per-share net asset value even
where there are fluctuations in interest rates that affect the value of
portfolio instruments. Accordingly, this method of valuation can in certain
circumstances lead to a dilution of shareholders' interest. If a deviation of
0.50% or more were to occur between the net asset value per share calculated by
reference to market values and
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these Fund's $1.00 per-share net asset value, or if there were any other
deviation which the Board of Trustees believed would result in a material
dilution to shareholders or purchasers, the Board would promptly consider what
action, if any, should be initiated. If these Funds' per-share net asset values
(computed using market values) declined, or were expected to decline, below
$1.00 (computed using amortized cost), the Board might temporarily reduce or
suspend dividend payments or take other action in an effort to maintain the net
asset value at $1.00 per share. As a result of such reduction or suspension of
dividends or other action by the Board, an investor would receive less income
during a given period than if such a reduction or suspension had not taken
place. Such action could result in investors receiving no dividend for the
period during which they hold their shares and receiving, upon redemption, a
price per share lower than that which they paid. On the other hand, if these
Funds' per-share net asset values (computed using market values) were to
increase, or were anticipated to increase, above $1.00 (computed using amortized
cost), the Board might supplement dividends in an effort to maintain the net
asset value at $1.00 per share.
PRINCIPAL UNDERWRITER
The Distributor, Funds Distributor, Inc., 60 State Street, Suite 1300,
Boston, Massachusetts 02109, also acts as the Funds' principal underwriter in a
continuous public offering of the Funds' shares. The Distributor is currently
registered as a broker-dealer with the SEC and in all 50 states, is a member of
most of the principal securities exchanges in the U.S., and is a member of the
National Association of Securities Dealers, Inc. The Underwriting Agreement
between each Fund and the Distributor is in effect for each Fund for the same
periods as the Agreements, and shall continue in effect thereafter for periods
not exceeding one year if approved at least annually by (i) the appropriate
Board or the vote of a majority of the outstanding securities of that Fund (as
defined in the Investment Company Act), and (ii) a majority of the Trustees who
are not interested persons of any such party, in each case by a vote cast in
person at a meeting called for the purpose of voting on such approval. The
Underwriting Agreement with respect to each Fund may be terminated without
penalty by the parties thereto upon 60 days' written notice and is automatically
terminated in the event of its assignment as defined in the Investment Company
Act. There are no underwriting commissions paid with respect to sales of the
Funds' shares. The Principal Underwriter has not been paid any underwriting
commissions for underwriting securities of the Funds during each of the Funds'
last three fiscal years.
PERFORMANCE INFORMATION
As noted in the Prospectus, the Funds may, from time to time, quote
various performance figures in advertisements and other communications to
illustrate their past performance. Performance figures will be calculated
separately for the Class R, Class P and Class L shares.
THE MONEY MARKET FUNDS. Current yield reflects the interest income per
share earned by these Funds' investments. Current yield is computed by
determining the net change, excluding capital changes, in the value of a
hypothetical pre-existing account having a balance of one share at the beginning
of a seven-day period, subtracting a hypothetical charge reflecting deductions
from shareholder accounts, and dividing the difference by the value of the
account at the beginning of the base period to obtain the base period return,
and then annualizing the result by multiplying the base period return by
(365/7).
Effective yield is computed in the same manner except that the
annualization of the return for the seven-day period reflects the results of
compounding by adding 1 to the base period return, raising the sum to a power
B-60
<PAGE>
equal to 365 divided by 7, and subtracting 1 from the result. This figure is
obtained using the Securities and Exchange Commission formula:
365/7
Effective Yield = [(Base Period Return + 1) ] - 1
The Short Bond Fund and California Intermediate Bond Fund. These Funds'
30-day yield figure described in the Prospectus is calculated according to a
formula prescribed by the SEC, expressed as follows:
YIELD = 2[(1+[a-b]/cd)6 - 1]
Where: a = dividends and interest earned during the
period.
b = expenses accrued for the period (net of
reimbursement).
c = the average daily number of shares
outstanding during the period that were
entitled to receive dividends.
d = the maximum offering price per share on
the last day of the period.
For the purpose of determining the interest earned (variable "a" in the
formula) on debt obligations that were purchased by these Funds at a discount or
premium, the formula generally calls for amortization of the discount or
premium; the amortization schedule will be adjusted monthly to reflect changes
in the market values of the debt obligations.
Investors should recognize that, in periods of declining interest
rates, these Funds' yields will tend to be somewhat higher than prevailing
market rates and, in periods of rising interest rates, will tend to be somewhat
lower. In addition, when interest rates are falling, monies received by these
Funds from the continuous sale of their shares will likely be invested in
instruments producing lower yields than the balance of their portfolio of
securities, thereby reducing the current yield of these Funds. In periods of
rising interest rates, the opposite result can be expected to occur.
The Tax-Free Funds. A tax equivalent yield demonstrates the taxable
yield necessary to produce an after-tax yield equivalent to that of a fund that
invests in tax-exempt obligations. The tax equivalent yield for one of the
Tax-Free Funds is computed by dividing that portion of the current yield (or
effective yield) of the Tax-Free Fund (computed for the Fund as indicated above)
that is tax exempt by one minus a stated income tax rate and adding the quotient
to that portion (if any) of the yield of the Fund that is not tax exempt. In
calculating tax equivalent yields for the California Intermediate Bond and
California Money Funds, these Funds assume an effective tax rate (combining
federal and California tax rates) of 45.22%, based on a California tax rate of
9.3% combined with a 39.6% federal tax rate. The Federal Money Fund assumes a
federal tax rate of 39.6% The effective rate used in determining such yield does
not reflect the tax costs resulting from the loss of the benefit of personal
exemptions and itemized deductions that may result from the receipt of
additional taxable income by taxpayers with adjusted gross incomes exceeding
certain levels. The tax equivalent yield may be higher than the rate stated for
taxpayers subject to the loss of these benefits.
YIELDS. The yields for the indicated periods ended June 30, 1998, were
as follows:
<TABLE>
<CAPTION>
TAX-EQUIV. TAX-EQUIV.
YIELD EFFECTIVE CURRENT EFFECTIVE CURRENT TAX-EQUIV.
B-61
<PAGE>
FUND (7-DAY) YIELD YIELD* YIELD* YIELD YIELD*
(7-DAY) (7-DAY) (7-DAY) (30-DAY) (30-DAY)
MONTGOMERY TOTAL RETURN BOND
<S> <C> <C> <C> <C> <C> <C>
FUND N/A N/A N/A N/A 5.76% N/A
MONTGOMERY SHORT DURATION
GOVERNMENT BOND FUND N/A N/A N/A N/A 5.80% N/A
MONTGOMERY GOVERNMENT RESERVE
FUND 5.21% 5.35% N/A N/A N/A N/A
MONTGOMERY FEDERAL TAX-FREE
MONEY FUND 3.28% 3.33% 5.43% 5.52% N/A N/A
MONTGOMERY CALIFORNIA TAX-FREE
INTERMEDIATE BOND FUND N/A N/A N/A N/A 3.70% 6.13%
MONTGOMERY CALIFORNIA TAX-FREE
MONEY FUND 2.97% 3.01% 5.42% 5.50% N/A N/A
</TABLE>
* Calculated using a combined federal and California income tax rate of 45.22%
for the California Funds and a federal rate of 39.6% for the Federal Money Fund.
AVERAGE ANNUAL TOTAL RETURN. Total return may be stated for any
relevant period as specified in the advertisement or communication. Any
statements of total return for a Fund will be accompanied by information on that
Fund's average annual compounded rate of return over the most recent four
calendar quarters and the period from that Fund's inception of operations. The
Funds may also advertise aggregate and average total return information over
different periods of time. A Fund's "average annual total return" figures are
computed according to a formula prescribed by the SEC expressed as follows:
P(1 + T)n = ERV
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = Ending Redeemable Value of a hypothetical
$1,000 investment made at the beginning of
a 1-, 5- or 10-year period at the end of
each respective period (or fractional
portion thereof), assuming reinvestment of
all dividends and distributions and
complete redemption of the hypothetical
investment at the end of the measuring
period.
AGGREGATE TOTAL RETURN. A Fund's "aggregate total return" figures
represent the cumulative change in the value of an investment in that Fund for
the specified period and are computed by the following formula:
ERV - P
-------
P
Where: P = a hypothetical initial payment of $1,000.
ERV = Ending Redeemable Value of a hypothetical
$1,000 investment made at the beginning of
a l-, 5- or 10-year period at the end of a
l-, 5- or 10-year period (or fractional
portion thereof), assuming reinvestment of
all dividends and distributions and
complete redemption of the hypothetical
investment at the end of the measuring
period.
B-62
<PAGE>
Each Fund's performance will vary from time to time depending upon
market conditions, the composition of its portfolio and its operating expenses.
Consequently, any given performance quotation should not be considered
representative of that Fund's performance for any specified period in the
future. In addition, because performance will fluctuate, it may not provide a
basis for comparing an investment in that Fund with certain bank deposits or
other investments that pay a fixed yield for a stated period of time. Investors
comparing that Fund's performance with that of other investment companies should
give consideration to the quality and maturity of the respective investment
companies' portfolio securities.
The average annual total return for each Fund for the periods indicated
was as follows:
<TABLE>
<CAPTION>
YEAR 5-YEARS INCEPTION*
FUND ENDED ENDED THROUGH
JUNE 30, 1998 JUNE 30, 1998 JUNE 30, 1998
<S> <C> <C> <C>
Montgomery Growth Fund 17.31% N/A 24.74%
Montgomery Small Cap Opportunities Fund 11.86% N/A 21.68%
Montgomery Small Cap Fund 23.23% 16.73% 20.82%
Montgomery U.S. Emerging Growth Fund 21.76% N/A 23.57%
Montgomery Equity Income Fund 15.83% N/A 21.54%
Montgomery International Growth Fund 23.27% N/A 23.35%
Montgomery International Small Cap Fund 4.46% N/A 8.86%
Montgomery Emerging Markets Fund (39.20%) 0.01% 1.63%
Montgomery Emerging Asia Fund (63.45%) N/A (27.01%)
Montgomery Latin America Fund (25.42%) N/A (25.42%)
Montgomery Global Opportunities Fund 27.12% N/A 18.34%
Montgomery Global Communications Fund 45.45% 19.32% 19.85%
Montgomery Global Long-Short Fund [____] N/A [______]
Montgomery Select 50 Fund 15.44% N/A 28.94%
Montgomery U.S. Asset Allocation Fund 14.67% N/A 21.15%
Montgomery Total Return Bond Fund 10.92% N/A 10.92%
Montgomery Short Duration Government Bond Fund 7.56% 6.15% 6.6%
Montgomery California Tax-Free Intermediate Bond Fund 6.85% N/A 5.51%
</TABLE>
- ----------------
* Total return for periods of less than one year are aggregate, not
annualized, return figures. The dates of inception for the Funds were:
Growth Fund, September 30, 1993; Small Cap Opportunities Fund, December
29, 1995; Small Cap Fund, July 13, 1990; U.S. Emerging Growth Fund,
December 30, 1994; Equity Income Fund, September 30, 1994;
International Growth Fund, June 30, 1995; International Small Cap Fund,
September 30, 1993; Emerging Markets Fund, March 1, 1992; Emerging Asia
Fund, September 30, 1996; Latin America Fund, June 30, 1997; Global
Opportunities Fund, September 30, 1993; Global Communications Fund,
June 1, 1993; Select 50 Fund, October 27, 1995; U.S. Asset Allocation
Fund, March 31, 1994; Total Return Bond Fund, June 30, 1997; Short
Duration Government Bond Fund, December 18, 1992; Government Reserve
Fund, September 14, 1992; California Intermediate Bond Fund, July 1,
1993; California Tax-Free Money Fund, September 30, 1994; and Federal
Tax-Free Money Fund, June 30, 1996.
B-63
<PAGE>
PRESENTATION OF OTHER PERFORMANCE INFORMATION REGARDING THE GLOBAL OPPORTUNITIES
FUND
John Boich and Oscar Castro jointly managed a limited partnership
called the Common Goal World Fund Limited Partnership (the "Partnership") before
joining the Manager. John Boich has served as the Partnership's General Partner
since its inception on January 7, 1990 until April 1993, when Mr. Castro and Mr.
Boich joined the Manager as Managing Directors and Portfolio Managers. On
September 30, 1993, the Montgomery Global Opportunities Fund, which has a
similar investment strategy as the partnership, was launched On October 1, 1993,
the Partnership was dissolved and the assets were transferred in-kind into the
Opportunities Fund. Consistent with applicable law, the Managers may advertise
the performance of the Partnership as part of materials concerning the
Opportunity Fund.
The annual total return for the Partnership for the periods indicated
was as follows:
------------------------------------ ---------------------------------
PERIOD PARTNERSHIP ANNUAL TOTAL RETURN
(NET OF FEES)
------------------------------------ ---------------------------------
Year ended Dec. 31, 1990* 2.04%
------------------------------------ ---------------------------------
Year ended Dec. 31, 1991 25.32%
------------------------------------ ---------------------------------
Year ended Dec. 31, 1992 4.53%
------------------------------------ ---------------------------------
9-month Period ended Sept. 30, 1993 17.29%
------------------------------------ ---------------------------------
* The Partnership commenced operations on January 7, 1990.
PRESENTATION OF OTHER PERFORMANCE INFORMATION REGARDING THE EMERGING ASIA FUND
From time to time, the Manager may advertise the performance of a
related mutual fund sold only in Canada and advised by the Manager that has a
substantially similar investment objective as the Emerging Asia Fund. The
related mutual fund, called the "Navigator Asia Pacific Fund" commenced
operations on May 19, 1995. The Manager managed that Fund until July 31, 1997.
The performance information of the Navigator Asia Pacific Fund (net of fees) was
as follows:
--------------------------------- ------------------------
PERIOD AGGREGATE TOTAL RETURN
(NET OF FEES)
--------------------------------- ------------------------
Year to date ended July 31, 1997 42.09%
--------------------------------- ------------------------
Since inception 78.70%
--------------------------------- ------------------------
COMPARISONS. To help investors better evaluate how an investment in the
Funds might satisfy their investment objectives, advertisements and other
materials regarding the Funds may discuss various financial publications.
Materials may also compare performance (as calculated above) to performance as
reported by other investments, indices, and averages. Publications, indices and
averages, including but not limited to, the following may be used in discussion
of a Fund's performance or the investment opportunities it may offer:
a) Standard & Poor's 500 Composite Stock Index, one or more of
the Morgan Stanley Capital International Indices, and one or
more of the International Finance Corporation Indices.
b) Bank Rate Monitor--A weekly publication which reports various
bank investments, such as certificate of deposit rates,
average savings account rates and average loan rates.
B-64
<PAGE>
c) Lipper Mutual Fund Performance Analysis and Lipper Fixed
Income Fund Performance Analysis--A ranking service that
measures total return and average current yield for the mutual
fund industry and ranks individual mutual fund performance
over specified time periods assuming reinvestment of all
distributions, exclusive of any applicable sales charges.
d) Donoghue's Money Fund Report--Industry averages for 7-day
annualized and compounded yields of taxable, tax-free, and
government money funds.
e) Salomon Brothers Bond Market Roundup--A weekly publication
which reviews yield spread changes in the major sectors of the
money, government agency, futures, options, mortgage,
corporate, Yankee, Eurodollar, municipal, and preferred stock
markets. This publication also summarizes changes in banking
statistics and reserve aggregates.
f) Lehman Brothers indices--Lehman Brothers fixed-income indices
may be used for appropriate comparisons.
g) other indices--including Consumer Price Index, Ibbotson,
Micropal, CNBC/Financial News Composite Index, MSCI EAFE Index
(Morgan Stanley Capital International, Europe, Australasia,
Far East Index--a capitalization-weighted index that includes
all developed world markets except for those in North
America), Datastream, Worldscope, NASDAQ, Russell 2000 and IFC
Emerging Markets Database.
In addition, one or more portfolio managers or other employees of the
Manager may be interviewed by print media, such as by the Wall Street Journal or
Business Week, or electronic news media, and such interviews may be reprinted or
excerpted for the purpose of advertising regarding the Funds.
In assessing such comparisons of performance, an investor should keep
in mind that the composition of the investments in the reported indices and
averages is not identical to the Funds' portfolios, that the averages are
generally unmanaged, and that the items included in the calculations of such
averages may not be identical to the formulae used by the Funds to calculate
their figures.
The Funds may also publish their relative rankings as determined by
independent mutual fund ranking services like Lipper Analytical Services, Inc.
and Morningstar, Inc.
Investors should note that the investment results of the Funds will
fluctuate over time, and any presentation of a Fund's total return for any
period should not be considered as a representation of what an investment may
earn or what an investor's total return may be in any future period.
REASONS TO INVEST IN THE FUNDS. From time to time, the Funds may
publish or distribute information and reasons supporting the Manager's belief
that a particular Fund may be appropriate for investors at a particular time.
The information will generally be based on internally generated estimates
resulting from the Manager's research activities and projections from
independent sources. These sources may include, but are not limited to,
Bloomberg, Morningstar, Barings, WEFA, consensus estimates, Datastream,
Micropal, I/B/E/S Consensus Forecast, Worldscope and Reuters as well as both
local and international brokerage firms. For example, the Funds may suggest that
certain countries or areas may be particularly appealing to investors because of
interest rate movements, increasing exports and/or economic growth. The Funds
may, by way of further example, present a region as possessing the fastest
growing economies and may also present projected gross domestic
B-65
<PAGE>
product (GDP) for selected economies. In using this information, the Montgomery
Emerging Asia Fund also may claim that certain Asian countries are regarded as
having high rates of growth for their economies (GDP), international trade and
corporate earnings; thus producing what the Manager believes to be a favorable
investment climate.
RESEARCH. The Manager has developed its own tradition of intensive
research and has made intensive research one of the important characteristics of
the Montgomery Funds style
The portfolio managers for Montgomery's Foreign and Global Equity Funds
work extensively on developing an in-depth understanding of particular foreign
markets and particular companies. And they very often discover that they are the
first analysts from the United States to meet with representatives of foreign
companies, especially those in emerging markets nations.
Extensive research into companies that are not well known--discovering
new opportunities for investment--is a theme that crosses a number of the Funds
and is reflected in the number of Funds oriented towards smaller capitalization
businesses
In-depth research, however, goes beyond gaining an understanding of
unknown opportunities. The portfolio analysts have also developed new ways of
gaining information about well-known parts of the domestic market. The growth
equity team, for example, has developed its own strategy and proprietary
database for analyzing the growth potential of U.S. companies, often large,
well-known companies.
From time to time, advertising and sales materials for the Montgomery
Funds may include biographical information about portfolio managers as well as
commentary by portfolio managers regarding investment strategy, asset growth,
current or past economic, political or financial conditions that may be of
interest to investors.
Also, from time to time, the Manager may refer to its quality and size,
including references to its total assets under management (as of June 30, 1998,
approximately $5.5 billion for retail and institutional investors in The
Montgomery Funds) and total shareholders invested in the Funds (as of June 30,
1998, around 300,000).
GENERAL INFORMATION
Investors in the Funds will be informed of the Funds' progress through
periodic reports. Financial statements will be submitted to shareholders
semi-annually, at least one of which will be certified by independent public
accountants. All expenses incurred in connection with the organization of The
Montgomery Funds and the registration of shares of the Small Cap Fund as the
initial series of the Trust have been assumed by the Small Cap Fund; all
expenses incurred in connection with the organization of The Montgomery Funds II
have been assumed by Montgomery Institutional Series: Emerging Markets Portfolio
and the Manager. Expenses incurred in connection with the establishment and
registration of shares of each of the other funds constituting Trusts as
separate series of the Trusts have been assumed by each respective Fund. The
expenses incurred in connection with the establishment and registration of
shares of the Funds as separate series of the Trusts have been assumed by the
respective Funds and are being amortized over a period of five years commencing
with their respective dates of inception. The Manager has agreed, to the extent
necessary, to advance the organizational expenses incurred by certain Funds and
will be reimbursed for such expenses after
B-66
<PAGE>
commencement of those Funds' operations. Investors purchasing shares of a Fund
bear such expenses only as they are amortized daily against that Fund's
investment income.
As noted above, Morgan Stanley Trust Company (the "Custodian") acts as
custodian of the securities and other assets of the Funds. The Custodian does
not participate in decisions relating to the purchase and sale of securities by
the Funds.
Investors Fiduciary Trust Company, 127 West 10th Street, Kansas City,
Missouri 64105, is the Funds' Master Transfer Agent. The Master Transfer Agent
has delegated certain transfer agent functions to DST Systems, Inc., P.O. Box
419073, Kansas City, Missouri 64141-6073, the Funds' Transfer and Dividend
Disbursing Agent.
_______________________ is the independent auditor for the Funds.
The validity of shares offered hereby have been passed on by Paul,
Hastings, Janofsky & Walker LLP, 345 California Street, San Francisco,
California 94104.
The shareholders of The Montgomery Funds (but not The Montgomery Funds
II) as shareholders of a Massachusetts business trust could, under certain
circumstances, be held personally liable as partners for its obligations.
However, the Trust's Agreement and Declaration of Trust ("Declaration of Trust")
contains an express disclaimer of shareholder liability for acts or obligations
of the Trust. The Declaration of Trust also provides for indemnification and
reimbursement of expenses out of the Funds' assets for any shareholder held
personally liable for obligations of the Funds or Trust. The Declaration of
Trust provides that the Trust shall, upon request, assume the defense of any
claim made against any shareholder for any act or obligation of the Funds or
Trust and satisfy any judgment thereon. All such rights are limited to the
assets of the Funds. The Declaration of Trust further provides that the Trust
may maintain appropriate insurance (for example, fidelity bonding and errors and
omissions insurance) for the protection of the Trust, its shareholders,
Trustees, officers, employees and agents to cover possible tort and other
liabilities. Furthermore, the activities of the Trust as an investment company
as distinguished from an operating company would not likely give rise to
liabilities in excess of the Funds' total assets. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
extremely remote because it is limited to the unlikely circumstances in which
both inadequate insurance exists and a Fund itself is unable to meet its
obligations.
Among the Boards' powers enumerated in the Agreements and Declaration
of Trust is the authority to terminate the Trusts or any of their series, or to
merge or consolidate the Trusts or one or more of their series with another
trust or company without the need to seek shareholder approval of any such
action.
As of September 30, 1998, to the knowledge of the Funds, the following
shareholders owned of record 5 percent or more of the outstanding Class R Shares
of the respective Funds indicated:
B-67
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
GROWTH FUND
Charles Schwab & Co., Inc. 17,752,539 34.53%
101 Montgomery Street
San Francisco, CA 94104-4122
National Financial Services Corp. 3,553,354 6.91%
For The Exclusive Benefit of Our Customers
ATTN: Mutual Funds
P.O. Box 3730
Church Street Station
New York, NY 10008-3730
SMALL CAP OPPORTUNITIES FUND
Charles Schwab & Co., Inc. 2,139,255 34.18%
101 Montgomery Street
San Francisco, CA 94104-4122
National Financial Services Corp. 531,499 8.49%
For the Exclusive Benefit of Our Customers
Attn Mutual Funds
P.O. Box 3730
Church Street Station
New York, NY 10008-3730
SMALL CAP FUND
The Trust Company of Knoxville 1,138,749 12.96%
620 Market Street, #300
Knoxville, TN 37902-2232
Charles Schwab & Co., Inc. 1,088,392 12.39%
101 Montgomery Street
San Francisco, CA 94104-4122
U.S. EMERGING GROWTH FUND
Charles Schwab & Co., Inc. 6,749,944 36.05%
101 Montgomery Street
San Francisco, CA 94104-4122
</TABLE>
B-68
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
National Financial Services Corp. 1,082,366 5.78%
For the Exclusive Benefit of Our Customers
Attn Mutual Funds
P.O. Box 3730
Church Street Station
New York, NY 10008-3730
EQUITY INCOME FUND
Charles Schwab & Co., Inc. 874,423 44.84%
101 Montgomery Street
San Francisco, CA 94104-4122
NationsBanc Montgomery Securities 125,403 6.43%
600 Montgomery Street
San Francisco, CA 94111-2702
INTERNATIONAL GROWTH FUND
Charles Schwab & Co., Inc. 3,811,228 44.83%
101 Montgomery Street
San Francisco, CA 94104-4122
National Financial Services Corp. 566,757 6.67%
PO Box 3730
Church Street Station
New York, NY 10008-3730
INTERNATIONAL SMALL CAP FUND
Charles Schwab & Co., Inc. 1,246,672 34.65%
101 Montgomery Street
San Francisco, CA 94104-4122
National Financial Services Corp. 306,404 8.52%
For the Exclusive Use of Our Customers
Attn: Mutual Funds
PO Box 3730
Church Street Station
New York, NY 10008-3730
Donaldson Lufkin & Jenrette Securities Corporation 669,857 18.62%
Mutual Funds 7th Floor
PO Box 2052
Jersey City, NJ 07303-2052
</TABLE>
B-69
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
EMERGING MARKETS FUND
Charles Schwab & Co., Inc. 20,080,940 34.19%
101 Montgomery Street
San Francisco, CA 94014-4122
National Financial Services Corp. 5,472,042 9.32%
For the Exclusive Benefit of Our Cstomers
Attn: Mutual Funds
P.O. Box 3730
Church Street Station
New York, NY 10008-3730
Smith Barney, Inc. 4,726,114 8.05%
333 Greenwich Street, 11th Floor
New York, NY 10013-3318
Merrill Lynch Pierce Fenner & Smith 9,344,466 15.91%
4800 Deer Lake Drive, East Fl. 2
Jacksonville, FL 32246-6484
EMERGING ASIA FUND
Charles Schwab & Co., Inc. 1,076,970 29.35%
101 Montgomery Street
San Francisco, CA 94104-4122
National Financial Services Corp. 459,272 12.52%
For the Exclusive Benefit of Our Customers
Attn Mutual Funds
P.O. Box 3730
Church Street Station
New York, NY 10008-3730
Westheim Schroeder & Co., Inc. 752,027 20.49%
Mutual Fund Control A/C
c/o Lewco Sec Attn: Tony Mnoio/Robt
34 Exchange Pl, FL4
Jersey City, NJ 07302-3901
Donaldson Lufkin & Jenrette 268,508 7.32%
Securities Corporation
PO Box 2052
Jersey City, NJ 07303-2052
</TABLE>
B-70
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
LATIN AMERICA FUND
Charles Schwab & Co., Inc. 72,473 14.97%
101 Montgomery Street
San Francisco, CA 94104-9122
National Financial Services Corp. 82,225 16.98%
For the Exclusive Benefit of Our
Customers - Attn: Mutual Funds
P.O. Box 3730
Church Street Station
New York, NY 10008-3730
GLOBAL OPPORTUNITIES FUND
Charles Schwab & Co., Inc. 773,598 29.40%
101 Montgomery Street
San Francisco, CA 94104-4122
National Financial Services Corp. 278,881 10.60%
For The Exclusive Benefit of Our Customers
Attn Mutual Funds
P.O. Box 3730
Church Street Station
New York, NY 10008-3730
Wayne Boich 169,450 6.44%
155 East Broad, No. 23
Columbus, OH 43215-3609
GLOBAL COMMUNICATIONS FUND
Charles Schwab & Co., Inc. 4,674,770 39.46%
101 Montgomery Street
San Francisco, CA 94104-4122
National Financial Services Corp. 946,024 7.99%
For The Exclusive Benefit Our Customers
PO Box 3730
Church Street Station
New York, NY 10008-3730
</TABLE>
B-71
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
SELECT 50 FUND
Charles Schwab & Co., Inc. 2,792,043 28.27%
101 Montgomery Street
San Francisco, CA 94104-4122
National Financial Services Corp. 733,891 7.43%
For the Exclusive Benefit of Our Customers
Attn Mutual Funds
P.O. Box 3730
Church Street Station
New York, NY 10008-3730
Resources Trust Co. Cust. 495,205 5.01%
For The Exclusive Benefit of Ian
PO Box 3865
Englewood, CO 80155-3865
U.S. ASSET ALLOCATION FUND
Charles Schwab & Co., Inc. 2,012,474 33.22%
101 Montgomery St.
San Francisco, CA 94104-4122
National Financial Services Corp. 713,260 11.77%
For the Exclusive Benefit of Our Customers Attn Mutual Funds
P.O. Box 3730
Church Street Station
New York, NY 10008-3730
TOTAL RETURN BOND FUND
Asset Allocation Fund 4,726,283 80.18%
Attn: Gina Lopez
101 California Street
San Francisco, CA 94111-5802
Charles Schwab & Co., Inc.
101 Montgomery Street 844,333 14.32%
San Francisco, CA 94104-4122
SHORT DURATION GOVERNMENT BOND FUND
Charles Schwab & Co., Inc. 5,926,471 49.88%
101 Montgomery Street
San Francisco, CA 94104-4122
</TABLE>
B-72
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
Donaldson, Lufkin & Jenrette 990,231 8.33%
Securities Corp.
Mutual Funds Department, 5th Floor
P. O. Box 2052
Jersey City, NJ 07383-2052
Prudential Securities Inc. 1,554,352 13.08%
Special Custody Account for The Exclusive Benefit of Customers-PC
1 New York Plaza
Attn: Mutual Funds
New York, NY 10004-1902
GOVERNMENT RESERVE FUND
Mary Miner, Trustee for Robert Miner and Mary Miner Trust 88,333,427 11.80%
U/A dated 3/14/94
1832 Baker Street
San Francisco, CA 94115-2011
CALIFORNIA TAX-FREE INTERMEDIATE BOND FUND
Charles Schwab & Co., Inc. 2,238,411 75.91%
101 Montgomery Street
San Francisco, CA 94104-4122
FEDERAL TAX--FREE MONEY FUND
John & Peter Sperling TTEES 13,357,707 11.53%
FBO John Sperling
1994 Irrevocable Trust U/A DTD 4/7/98
4835 E. Exeter
Phoenix, AZ 85018-2940
William Thompson 5,822,455 5.03%
301 Haines Drive
N. Wales, PA 19454-2702
CALIFORNIA TAX FREE MONEY MARKET
John D. Murphy 9,486,319 5.03%
FBO: The Murphy Revocable Trust
Dated 2/26/93
2520 Pacific St.
San Francisco, CA 94115-1126
</TABLE>
B-73
<PAGE>
As of September 30, 1998, to the knowledge of the Funds, the following
shareholders owned of record 5 percent or more of the outstanding Class P Shares
of the respective Funds indicated:
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
GROWTH FUND
Dreyfus Investment Services Corp. 1,156 14.75%
FBO 649772181
2 Mellon Bank Center, Room 177
Pittsburgh, PA 15259-0001
Dreyfus Investment Services Corp. 853 10.87%
FBO 632636441
2 Mellon Bank Center, Room 177
Pittsburgh, PA 15259-0001
Inv. Fiduciary Trust Co. 2,031 25.90%
IRA Carl N. Grant
2008 Cutwater Court
Reston, VA 20191-3604
Inv. Fiduciary Trust Co. 533 6.67%
IRA R/O Jeanne M. Grant
11865 Dunlop Court
Reston, VA 20191-2709
Walter J. Klein Company, LTD 466 5.94%
Profit Sharing Trust
PO Box 472087
Charlotte, NC 28247-2087
National Investor Services Corp. 733 9.35%
For The Exclusive Benefit Of Our Customers
55 Water St., 32nd Floor
New York, NY 10041-3299
SMALL CAP OPPORTUNITIES FUND
Sharon G. Roberts 35 38.05%
341 Bobwhite Drive
Pensacola, FL 32514-2705
</TABLE>
B-74
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
Southwest Securities Inc. 56 61.95%
FBO: Jamil S. Jones & Thad Jones JTWROS
Acct: 47689580
PO Box 509002
Dallas, TX 75250-9002
SMALL CAP FUND
Saxon & Co. 465,063 43.62%
FBO T/A Leaseway Transport
A/C #20-35-002-1037303
PO Box 7780-1888
Philadelphia, PA 19182-0001
State Street Bank & Trust Co. 99,006 9.29%
U/A January 2, 1996
Wavetek US Inc. Employee Savings &
Investment Plan
P.O. Box 1992
Boston, MA 02105-1992
State Street Bank & Trust Co. Tr. 64,277 6.03%
GE 401K Trac Plans
c/o Defined Contributions BFDS
P.O. Box 8705
Boston, MA 0226-8705
State Street Bank & Trust Co. Tr. 219,601 20.60%
U/A December 1, 1993
Ameridata Tech. Employee Svgs. Plan
Attn: Steven Shipman - Master Tr. W6C
One Enterprise Drive
No. Quincy, MA 02171-2126
State Street Bank & Trust Co. 81,591 7.65%
The Bardon Group, Inc.
401K Retirement & P.S.P.
P.O. Box 1992
Boston, MA 02105-1992
</TABLE>
B-75
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
State Street 74,708 7.01%
Retirement Savings Plan
P.O. Box 1992
Boston, MA 02105-1992
EQUITY-INCOME FUND
State Street Bank & Trust Co. Tr. 153,907 99.87%
U/A Dec. 01, 1993
Ameridata Tech Employee Svgs. Plan
Attn: Steven Shipman Master Tr. W6C
One Enterprise Drive
No. Quincy, MA 02171-2126
INTERNATIONAL GROWTH FUND
National Investor Services Corp. 272 5.64%
For The Exclusive Benefit Of Our Customers
55 Water Street, 32nd Floor
New York, NY 10041-3299
E*Trade Securities Inc. 522 10.81%
A/C 6892-1702
Linda H. Quasney
Four Embarcadero Place
2400 Geng Road
Palo Alto, CA 94303-3306
E*Trade Securities, Inc. 522 10.81%
A/C 6892-1821
James S. Quasney
Four Embarcadero Place
2400 Geng Road
Palo Alto, CA 94303-3306
E*Trade Securities, Inc. 1,198 24.82%
A/C 4331-3198
Charles R. House
Four Embarcadero Place
2400 Geng Road
Palo Alto, CA 94303-3306
</TABLE>
B-76
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
US Clearing Corp. 1,000 20.71%
FBO 780-34028-20
26 Broadway
New York, NY 10004-1703
US Clearing Corp. 545 11.28%
FBO 780-40227-18
26 Broadway
New York, NY 10004-1703
EMERGING MARKETS FUND
State Street Bank & Trust Co. 27,521 65.65%
V/A Jan. 2, 1996
Wavetek US Inc. Employee Savings &
Investment Plan
P.O. Box 1992
Boston, MA 02105-1992
Dreyfus Investment Services Corp. 2,609 6.22%
FB0 636931621
2 Mellon Bank Center, Room 177
Pittsburgh, PA 15259-0001
US Clearing Corp. 6,066 14.47%
FBO 780-16649-18
26 Broadway
New York, NY 10004-1798
SELECT 50 FUND
National Investor Services Corp. 197 8.15%
For The Exclusive Benefit of Our Customers
55 Water St., 32nd Floor
New York, NY 10041-3299
BA Investment Services 146 6.02%
FBO 211129251
185 Berry Street, 3rd Floor
San Francisco, CA 94107-1729
</TABLE>
B-77
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
Post & Co. 1,376 56.82%
A/C 223523
C/O The Bank of New York
Mutual Fund/Reorg Dept.
PO Box 1066 Wall Street Station
New York, NY 10286
US Clearing Corp. 123 5.08%
FBO 780-95473-13
26 Broadway
New York, NY 10004-1798
U.S. ASSET ALLOCATION FUND
Inv. Fiduciary Trust Co. 2,035 55.05%
IRA Carl N. Grant
2008 Cutwater Court
Reston, VA 20191-3604
Inv. Fiduciary Trust Co. 742 20.08%
IRA R/O Jeanne M. Grant
11865 Dunlop Court
Reston, VA 20191-2709
National Investor Services Corp. 401 10.84%
For The Exclusive Benefit of Our Customers
55 Water St., 32nd Floor
New York, NY 10041-3299
Charles E. Carson 266 7.20%
115 Beechwood Lane
Chambersburg, PA 17201-1489
GOVERNMENT RESERVE FUND
Painewebber 2.0 100.00%
For the Benefit of Painewebber, Inc.
Non-Proprietary M/F
1000 Harbor Blvd., 8th Floor
Attn: Department Manager
Weehawken, NJ 07087-6727
</TABLE>
B-78
<PAGE>
<TABLE>
<CAPTION>
NAME OF FUND/NAME AND ADDRESS OF RECORD OWNER NUMBER OF SHARES OWNED PERCENT OF SHARES
<S> <C> <C>
SHORT GOVERNMENT BOND FUND
E*Trade Securities, Inc. 300 43.07%
A/C 7928-0709
Advanced Communications
Four Embarcadero Place
2400 Geng Road
Palo Alto, CA 94303-3306
E*Trade Securities, Inc. 99 14.22%
A/C 6552-5759
Donald C. Pack III
Four Embarcadero Place
2400 Geng Road
Palo Alto, CA 94303-3306
E*Trade Securities, Inc. 98 14.12%
A/C Eric Henneke
Four Embarcadero Place
2400 Geng Road
Palo Alto, CA 94303-3306
US Clearing Corp. 199 28.59%
FBO 780-42531-15
26 Broadway
New York, NY 10004-1703
</TABLE>
As of September 30, 1998, officers and directors of the Montgomery
Funds owned, in aggregate, of record more than 1% of the outstanding shares in:
Montgomery California Tax-Free Intermediate Bond Fund Class R Shares, holding a
combined 11.4% of shares outstanding.
The Trusts are registered with the Securities and Exchange Commission
as non-diversified management investment companies, although each Fund, except
for the Tax-Free Funds, is a diversified series of the Trust. Such a
registration does not involve supervision of the management or policies of the
Funds. The Prospectus and this Statement of Additional Information omit certain
of the information contained in the Registration Statements filed with the SEC.
Copies of the Registration Statements may be obtained from the SEC upon payment
of the prescribed fee.
FINANCIAL STATEMENTS
B-79
<PAGE>
B-80
<PAGE>
APPENDIX
Description ratings for Standard & Poor's Ratings Group ("S&P");
Moody's Investors Service, Inc., ("MOODY's"), Fitch Investors Service, L.P.
("Fitch") and Duff & Phelps Credit Rating Co. ("Duff & Phelps").
STANDARD & POOR'S RATING GROUP
BOND RATINGS
AAA Bonds rated AAA have the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely
strong.
AA Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the highest rated issues only
in small degree.
A Bonds rated A have a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions than obligations in higher-rated categories.
BBB Bonds rated BBB are regarded as having an adequate capacity to
pay interest and repay principal. Whereas they normally
exhibit adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead
to a weakened capacity to pay interest and repay principal for
bonds in this category than for bonds in higher rated
categories.
BB Bonds rated BB have less near-term vulnerability to default
than other speculative grade debt. However, they face major
ongoing uncertainties or exposure to adverse business,
financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal
payments.
B Bonds rated B have a greater vulnerability to default but
presently have the capacity to meet interest payments and
principal repayments. Adverse business, financial or economic
conditions would likely impair capacity or willingness to pay
interest and repay principal.
CCC Bonds rated CCC have a current identifiable vulnerability to
default and are dependent upon favorable business, financial
and economic conditions to meet timely payments of interest
and repayment of principal. In the event of adverse business,
financial or economic conditions, they are not likely to have
the capacity to pay interest and repay principal.
CC The rating CC is typically applied to debt subordinated to
senior debt which is assigned an actual or implied CCC rating.
C The rating C is typically applied to debt subordinated to
senior debt which is assigned an actual or implied CCC- debt
rating.
D Bonds rated D are in default, and payment of interest and/or
repayment of principal is in arrears.
B-81
<PAGE>
S&P's letter ratings may be modified by the addition of a plus
(+) or a minus (-) sign designation, which is used to show relative
standing within the major rating categories, except in the AAA (Prime
Grade) category.
COMMERCIAL PAPER RATINGS
An S&P commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no
more than 365 days. Issues assigned an A rating are regarded as having
the greatest capacity for timely payment. Issues in this category are
delineated with the numbers 1, 2 and 3 to indicate the relative degree
of safety.
A-1 This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those
issues determined to possess overwhelming safety
characteristics are denoted with a plus (+) designation.
A-2 Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as high
as for issues designated A-1.
A-3 Issues carrying this designation have a satisfactory capacity
for timely payment. They are, however, somewhat more
vulnerable to the adverse effects of changes in circumstances
than obligations carrying the higher designations.
B Issues carrying this designation are regarded as having only
speculative capacity for timely payment.
C This designation is assigned to short-term obligations with
doubtful capacity for payment.
D Issues carrying this designation are in default, and payment
of interest and/or repayment of principal is in arrears.
MOODY'S INVESTORS SERVICE, INC.
BOND RATINGS
Aaa Bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and
generally are referred to as "gilt edge." Interest payments
are protected by a large or by an exceptionally stable margin
and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of
such issues.
Aa Bonds which are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what
generally are known as high-grade bonds. They are rated lower
than the best bonds because margins of protection may not be
as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other
elements present which make the long-term risks appear
somewhat larger than in Aaa securities.
A Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper medium grade
obligations. Factors giving security to principal and interest
are
B-82
<PAGE>
considered adequate, but elements may be present which suggest
a susceptibility to impairment sometime in the future.
Baa Bonds which are rated Baa are considered as medium-grade
obligations, I.E., they are neither highly protected nor
poorly secured. Interest payments and principal security
appear adequate for the present but certain protective
elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack
outstanding investment characteristics and, in fact, have
speculative characteristics as well.
Ba Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured.
Often the protection of interest and principal payments may be
very moderate and, therefore, not well safeguarded during both
good and bad times in the future. Uncertainty of position
characterizes bonds in this class.
B Bonds which are rated B generally lack the characteristics of
a desirable investment. Assurance of interest and principal
payments or of maintenance of other terms of the contract over
any long period of time may be small.
Caa Bonds which are rated Caa are of poor standing. Such issues
may be in default or there may be present elements of danger
with respect to principal or interest.
Ca Bonds which are rated Ca present obligations which are
speculative in a high degree. Such issues are often in default
or have other marked shortcomings.
C Bonds which are rated C are the lowest rated class of bonds,
and issues so rated can be regarded as having extremely poor
prospects of ever attaining any real investment standing.
Moody's applies the numerical modifiers 1, 2 and 3 to show relative
standing within the major rating categories, except in the Aaa category
and in the categories below B. The modifier 1 indicates a ranking for
the security in the higher end of a rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates a ranking
in the lower end of a rating category.
COMMERCIAL PAPER RATINGS
The rating Prime-1 (P-1) is the highest commercial paper
rating assigned by Moody's. Issuers of P-1 paper must have a superior
capacity for repayment of short-term promissory obligations, and
ordinarily will be evidenced by leading market positions in well
established industries, high rates of return on funds employed,
conservative capitalization structures with moderate reliance on debt
and ample asset protection, broad margins in earnings coverage of fixed
financial charges and high internal cash generation, and well
established access to a range of financial markets and assured sources
of alternate liquidity.
Issuers (or related supporting institutions) rated Prime-2 (P-2) have a
strong capacity for repayment of short-term promissory obligations.
This ordinarily will be evidenced by many of the characteristics cited
above but to a lesser degree. Earnings trends and coverage ratios,
while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
B-83
<PAGE>
Issuers (or related supporting institutions) rated Prime-3 (P-3) have
an acceptable capacity for repayment of short-term promissory
obligations. The effect of industry characteristics and market
composition may be more pronounced. Variability in earnings and
profitability may result in changes in the level of debt protection
measurements and the requirements for relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers (or related supporting institutions) rated Not Prime do not
fall within any of the Prime rating categories.
FITCH INVESTORS SERVICE, L.P.
BOND RATINGS
The ratings represent Fitch's assessment of the issuer's ability to
meet the obligations of a specific debt issue or class of debt. The
ratings take into consideration special features of the issue, its
relationship to other obligations of the issuer, the current financial
condition and operative performance of the issuer and of any guarantor,
as well as the political and economic environment that might affect the
issuer's future financial strength and credit quality.
AAA Bonds rated AAA are considered to be investment grade and of
the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and repay principal, which is
unlikely to be affected by reasonably foreseeable events.
AA Bonds rated AA are considered to be investment grade and of
very high credit quality. The obligor's ability to pay
interest and repay principal is very strong, although not
quite as strong as bonds rated AAA. Because bonds rated in the
AAA and AA categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these
issuers is generally rated F-1+.
A Bonds rated A are considered to be investment grade and of
high credit quality. The obligor's ability to pay interest and
repay principal is considered to be strong, but may be more
vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB Bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay
interest and repay principal is considered to be adequate.
Adverse changes in economic conditions and circumstances,
however, are more likely to have an adverse impact on these
bonds and, therefore, impair timely payment. The likelihood
that the ratings of these bonds will fall below investment
grade is higher than for bonds with higher ratings.
BB Bonds rated BB are considered speculative. The obligor's
ability to pay interest and repay principal may be affected
over time by adverse economic changes. However, business and
financial alternatives can be identified which could assist
the obligor in satisfying its debt service requirements.
B Bonds rated B are considered highly speculative. While bonds
in this class are currently meeting debt service requirements,
the probability of continued timely payment of principal and
interest
B-84
<PAGE>
reflects the obligor's limited margin of safety and the need
for reasonable business and economic activity throughout the
life of the issue.
CCC Bonds rated CCC have certain identifiable characteristics,
which, if not remedied, may lead to default. The ability to
meet obligations requires an advantageous business and
economic environment.
CC Bonds rated CC are minimally protected. Default in payment of
interest and/or principal seems probable over time.
C Bonds rated C are in imminent default in payment of interest
or principal.
DDD, DD AND D Bonds rated DDD, DD and D are in actual default of
interest and/or principal payments. Such bonds are extremely
speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of
the obligor. DDD represents the highest potential for recovery
on these bonds and D represents the lowest potential for
recovery.
Plus (+) and minus (-) signs are used with a rating symbol to indicate
the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the AAA category covering 12-36
months.
SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable
on demand or have original maturities of up to three years, including
commercial paper, certificates of deposit, medium-term notes, and
municipal and investment notes.
Although the credit analysis is similar to Fitch's bond rating
analysis, the short-term rating places greater emphasis than bond
ratings on the existence of liquidity necessary to meet the issuer's
obligations in a timely manner.
F-1+ Exceptionally strong credit quality. Issues assigned this
rating are regarded as having the strongest degree of
assurance for timely payment.
F-1 Very strong credit quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in
degree than issues rated F-1+.
F-2 Good credit quality. Issues carrying this rating have a
satisfactory degree of assurance for timely payments, but the
margin of safety is not as great as the F-l+ and F-1
categories.
F-3 Fair credit quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for
timely payment is adequate; however, near-term adverse changes
could cause these securities to be rated below investment
grade.
F-S Weak credit quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse changes
in financial and economic conditions.
B-85
<PAGE>
D Default. Issues assigned this rating are in actual or imminent
payment default.
DUFF & PHELPS CREDIT RATING CO.
BOND RATINGS
AAA Bonds rated AAA are considered highest credit quality. The
risk factors are negligible, being only slightly more than for
risk-free U.S. Treasury debt.
AA Bonds rated AA are considered high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from
time to time because of economic conditions.
A Bonds rated A have protection factors which are average but
adequate. However, risk factors are more variable and greater
in periods of economic stress.
BBB Bonds rated BBB are considered to have below average
protection factors but still considered sufficient for prudent
investment. There may be considerable variability in risk for
bonds in this category during economic cycles.
BB Bonds rated BB are below investment grade but are deemed by
Duff as likely to meet obligations when due. Present or
prospective financial protection factors fluctuate according
to industry conditions or company fortunes. Overall quality
may move up or down frequently within the category.
B Bonds rated B are below investment grade and possess the risk
that obligations will not be met when due. Financial
protection factors will fluctuate widely according to economic
cycles, industry conditions and/or company fortunes. Potential
exists for frequent changes in quality rating within this
category or into a higher or lower quality rating grade.
CCC Bonds rated CCC are well below investment grade securities.
Such bonds may be in default or have considerable uncertainty
as to timely payment of interest, preferred dividends and/or
principal. Protection factors are narrow and risk can be
substantial with unfavorable economic or industry conditions
and/or with unfavorable company developments.
DD Defaulted debt obligations. Issuer has failed to meet
scheduled principal and/or interest payments.
Plus (+) and minus (-) signs are used with a rating symbol (except AAA)
to indicate the relative position of a credit within the rating
category.
COMMERCIAL PAPER RATINGS
Duff-1 The rating Duff-1 is the highest commercial paper rating
assigned by Duff. Paper rated Duff-1 is regarded as having
very high certainty of timely payment with excellent liquidity
factors which are supported by ample asset protection. Risk
factors are minor.
Duff-2 Paper rated Duff-2 is regarded as having good certainty of
timely payment, good access to capital markets and sound
liquidity factors and company fundamentals. Risk factors are
small.
B-86
<PAGE>
Duff-3 Paper rated Duff-3 is regarded as having satisfactory
liquidity and other protection factors. Risk factors are
larger and subject to more variation. Nevertheless, timely
payment is expected.
Duff-4 Paper rated Duff-4 is regarded as having speculative
investment characteristics. Liquidity is not sufficient to
insure against disruption in debt service. Operating factors
and market access may be subject to a high degree of
variation.
Duff-5 Paper rated Duff-5 is in default. The issuer has failed to
meet scheduled principal and/or interest payments.
B-87
<PAGE>
----------------------------------------------------
PART C
OTHER INFORMATION
---------------------------------------------------
<PAGE>
THE MONTGOMERY FUNDS II
--------------
FORM N-1A
--------------
PART C
--------------
Item 23. Exhibits
(a) Amended and Restated Agreement and Declaration of Trust as
incorporated by reference to Post-Effective Amendment No. 37
to the Registration Statement as filed with the Commission on
October 29, 1998 ("Post-Effective Amendment No. 37").
(b) Amended and Restated By-Laws is incorporated by reference to
Post-Effective Amendment No. 37.
(c) Instruments Defining Rights of Security Holder--Not
applicable.
(d) Investment Advisory Contracts--Form of Investment Management
Agreement is incorporated by reference to Post-Effective
Amendment No. 22 to the Registration Statement as filed with
the Commission on July 31, 1997 ("Post-Effective Amendment No.
22").
(e) Form of Underwriting Agreement is incorporated by reference to
Post-Effective Amendment No. 22.
(f) Bonus or Profit Sharing Contracts--Not applicable.
(g) Form of Custody Agreement is incorporated by reference to
Post-Effective Amendment No. 37.
(h) Other Material Contracts:
(1) Form of Administrative Services Agreement is
incorporated by reference to Post-Effective Amendment
No. 22.
(2) Form of Shareholder Services Plan is incorporated by
reference to Post-Effective Amendment No. 37.
(i) Opinion of Counsel as to legality of shares is incorporated by
reference to Post-Effective Amendment No. 37.
(j) Other Opinions: Independent Auditors' Consent--Not applicable.
(k) Omitted Financial Statements--Not applicable.
(l) Initial Capital Agreements: Letter of Understanding re:
Initial Shares is incorporated by reference to Post-Effective
Amendment No. 37.
(m) Rule 12b-1 Plan: Form of Share Marketing Plan (Rule 12b-1
Plan) is incorporated by reference to Post-Effective Amendment
No. 22.
(n) Financial Data Schedule. Financial Data Schedules are
incorporated by reference to Form NSAR-B filed on August 28,
1998.
(o) 18f-3 Plan--Form of Amended and Restated Multiple Class Plan
is incorporated by reference to Post-Effective Amendment No.
37.
C-1
<PAGE>
Item 24. Persons Controlled by or Under Common Control with the Fund
Montgomery Asset Management, LLC, a Delaware limited liability
company, is the manager of each series of the Registrant, of The Montgomery
Funds , a Massachusetts business trust, and of The Montgomery Funds III, a
Delaware business trust. Montgomery Asset Management, LLC is a subsidiary of
Commerzbank AG based in Frankfurt, Germany. The Registrant, The Montgomery Funds
and The Montgomery Funds III are deemed to be under the common control of each
of those two entities.
Item 25. Indemnification
Article VII of the Agreement and Declaration of Trust empowers the
Trustees of the Trust, to the full extent permitted by law, to purchase with
Trust assets insurance for indemnification from liability and to pay for all
expenses reasonably incurred or paid or expected to be paid by a Trustee or
officer in connection with any claim, action, suit or proceeding in which he or
she becomes involved by virtue of his or her capacity or former capacity with
the Trust.
Article VI of the By-Laws of the Trust provides that the Trust shall
indemnify any person who was or is a party or is threatened to be made a party
to any proceeding by reason of the fact that such person is and other amounts or
was an agent of the Trust, against expenses, judgments, fines, settlement and
other amounts actually and reasonable incurred in connection with such
proceeding if that person acted in good faith and reasonably believed his or her
conduct to be in the best interests of the Trust. Indemnification will not be
provided in certain circumstances, however, including instances of willful
misfeasance, bad faith, gross negligence, and reckless disregard of the duties
involved in the conduct of the particular office involved.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended (the "1933 Act"), may be permitted to the Trustees,
officers and controlling persons of the Registrant pursuant to the foregoing
provisions or otherwise, the Registrant has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the 1933 Act and is, therefore, unenforceable in the
event that a claim for indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a Trustee, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such Trustee, officer or controlling person
in connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the 1933 Act
and will be governed by the final adjudication of such issue.
Item 26. Business and Other Connections of the Investment Adviser
Effective July 31, 1997, Montgomery Asset Management, L.P. completed
the sale of substantially all of its assets to the current investment manager,
Montgomery Asset Management, LLC ("MAM, LLC"), a subsidiary of Commerzbank A.G.
Information about the officers and directors of MAM, LLC is provided below. The
address for the following persons is 101 California Street, San Francisco,
California 94111.
C-2
<PAGE>
R. Stephen Doyle Chairman of the Board of Directors and
Chief Executive Officer of MAM, LLC
Mark B. Geist President and Director of MAM, LLC
John T. Story Executive Vice President of MAM, LLC
David E. Demarest Chief Administrative Officer and
Managing Director of MAM, LLC
The following directors of MAM, LLC also are officers of Commerzbank
AG. The address for the following persons is Neue Mainzer Strasse 32-36,
Frankfurt am Main, Germany.
Heinz Josef Hockmann Director of MAM, LLC
Dietrich-Kurt Frowein Director of MAM, LLC
Andreas Kleffel Director of MAM, LLC
Before July 31, 1997, Montgomery Securities, which is a broker-dealer
and the prior principal underwriter of The Montgomery Funds II, was the sole
limited partner of the prior investment manager, Montgomery Asset Management,
L.P. ("MAM, L.P."). The general partner of MAM, L.P. was a corporation,
Montgomery Asset Management, Inc. ("MAM, Inc."), certain of the officers and
directors of which now serve in similar capacities for MAM, LLC.
Item 27. Principal Underwriter
(a) Funds Distributor, Inc. (the "Distributor") acts as principal
underwriter for the following investment companies.
American Century California Tax-Free and Municipal Funds
American Century Capital Portfolios, Inc.
American Century Government Income Trust
American Century International Bond Funds
American Century Investment Trust
American Century Municipal Trust
American Century Mutual Funds, Inc.
American Century Premium Reserves, Inc.
American Century Quantitative Equity Funds
American Century Strategic Asset Allocations, Inc.
American Century Target Maturities Trust
American Century Variable Portfolios, Inc.
American Century World Mutual Funds, Inc.
BJB Investment Funds
The Brinson Funds
Dresdner RCM Capital Funds, Inc.
Dresdner RCM Equity Funds, Inc.
Founders Funds, Inc.
Harris Insight Funds Trust
HT Insight Funds, Inc. d/b/a Harris Insight Funds
J.P. Morgan Institutional Funds
J.P. Morgan Funds
JPM Series Trust
JPM Series Trust II
LaSalle Partners Funds, Inc.
Kobrick-Cendant Investment Trust
Merrimac Series
Monetta Fund, Inc.
Monetta Trust
C-3
<PAGE>
The Montgomery Funds I
The Montgomery Funds II
The Munder Framlington Funds Trust
The Munder Funds Trust
The Munder Funds, Inc.
National Investors Cash Management Fund, Inc.
Orbitex Group of Funds
SG Cowen Funds, Inc.
SG Cowen Income + Growth Fund, Inc.
SG Cowen Standby Reserve Fund, Inc.
SG Cowen Standby Tax-Exempt Reserve Fund, Inc.
SG Cowen Series Funds, Inc.
St. Clair Funds, Inc.
The Skyline Funds
Waterhouse Investors Family of Funds, Inc.
WEBS Index Fund, Inc.
Funds Distributor is registered with the Securities and
Exchange Commission as a broker-dealer and is a member of the
National Association of Securities Dealers. Funds Distributor
is located at 60 State Street, Suite 1300, Boston,
Massachusetts 02109. Funds Distributor is an indirect
wholly-owned subsidiary of Boston Institutional Group, Inc., a
holding company all of whose outstanding shares are owned by
key employees.
<TABLE>
(b) The following is a list of the executive officers, directors
and partners of Funds Distributor, Inc.
<CAPTION>
<S> <C>
Director, President and Chief Executive Officer Marie E. Connolly
Executive Vice President George A. Rio
Executive Vice President Donald R. Roberson
Executive Vice President William S. Nichols
Senior Vice President, General Counsel, Chief Margaret W. Chambers
Compliance Officer, Secretary and Clerk
Senior Vice President Michael S. Petrucelli
Director, Senior Vice President, Treasurer and Joseph F. Tower, III
Chief Financial Officer
Senior Vice President Paula R. David
Senior Vice President Allen B. Closser
Senior Vice President Bernard A. Whalen
Chairman and Director William J. Nutt
</TABLE>
(c) Not Applicable.
Item 28. Location of Accounts and Records.
The accounts, books, or other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940, as amended (the "Investment
Company Act") will be kept by the Registrant's Transfer Agent, DST Systems,
Inc., P.O. Box 1004 Baltimore, Kansas City, Missouri 64105, except those records
relating to portfolio transactions and the basic organizational and Trust
documents of the Registrant (see Subsections (2)(iii), (4), (5), (6), (7), (9),
(10) and (11) of Rule 31a-1(b)), which will be kept by the Registrant at 101
California Street, San Francisco, California 94111.
Item 29. Management Services.
There are no management-related service contracts not discussed in
Parts A and B.
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<PAGE>
Item 30. Undertakings.
(a) Not applicable.
(b) Registrant hereby undertakes to furnish each person to whom a
prospectus is delivered with a copy of the Registrant's last
annual report to Shareholders, upon request and without
charge.
(c) Registrant has undertaken to comply with Section 16(a) of the
Investment Company Act which requires the prompt convening of
a meeting of shareholders to elect trustees to fill existing
vacancies in the Registrant's Board of Trustees in the event
that less than a majority of the trustees have been elected to
such position by shareholders. Registrant has also undertaken
promptly to call a meeting of shareholders for the purpose of
voting upon the question of removal of any Trustee or Trustees
when requested in writing to do so by the record holders of
not less than 10 percent of the Registrant's outstanding
shares and to assist its shareholders in communicating with
other shareholders in accordance with the requirements of
Section 16(c) of the Investment Company Act.
C-5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Amendment to
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of San Francisco, the State of California, on this
2nd day of December, 1998.
THE MONTGOMERY FUNDS
By: Margaret W. Chambers*
---------------------
Margaret W. Chambers
Secretary
Pursuant to the requirements of the Securities Act of 1933, this
Amendment to Registrant's Registration Statement has been signed below by the
following persons in the capacities and on the dates indicated.
R. Stephen Doyle * Trustee December 2, 1998
- ------------------
R. Stephen Doyle
Andrew Cox * Trustee December 2, 1998
- ------------
Andrew Cox
Cecilia H. Herbert * Trustee December 2, 1998
- --------------------
Cecilia H. Herbert
John A. Farnsworth * Trustee December 2, 1998
- --------------------
John A. Farnsworth
* By: /s/ Julie Allecta
-----------------
Julie Allecta, Attorney-in-Fact
pursuant to Powers of Attorney previously filed.
C-6
