RULE 497(e)
33-84450:811-8782
The Montgomery Variable Series
- --------------------------------------------------------------------------------
Montgomery Variable Series:
Growth Fund
The Montgomery Funds III
600 Montgomery Street
San Francisco, California 94111
(800) 572-3863
Prospectus
April 25, 1995
(as amended November 1, 1995)
Shares of Montgomery Variable Series: Growth Fund, a separate series of The
Montgomery Funds III (the "Trust"), an open-end investment company, are offered
by this Prospectus. Shares of the Fund are sold only to insurance company
separate accounts ("Accounts") to fund the benefits of variable life insurance
policies or variable annuity contracts ("Variable Contracts") owned by their
respective policy holders, or contract holders, and to qualified pension and
retirement plans. References to shareholders or investors in this Prospectus are
to the Accounts or qualified pension and retirement plans. The variable annuity
and variable life insurance contracts involve fees and expenses not described in
this Prospectus. Please refer to the prospectuses related to those contracts.
The Fund is managed by Montgomery Asset Management, L.P. (the "Manager").
Montgomery Variable Series: Growth Fund (the "Growth Fund") seeks capital
appreciation by investing primarily in equity securities, usually common stock,
of domestic companies of all sizes. As is the case for all mutual funds,
attainment of the Fund's investment objective cannot be assured.
Please read this Prospectus before investing in an Account or a sub-account of
an Account that invests in the Fund or, in the case of a qualified pension or
retirement plan, investing directly in the Fund and retain it for future
reference. A Statement of Additional Information dated April 25, 1995, as may be
revised, has been filed with the Securities and Exchange Commission, is
incorporated by this reference and is available without charge by calling (800)
572-3863 or the insurance company whose Account invests in the Fund.
Prospectus
April 25, 1995
(as amended November 1, 1995)
TABLE OF CONTENTS
- -------------------------------------------------------------------------------
The Fund's Investment Objective and Policies 2
- -------------------------------------------------------------------------------
Portfolio Securities 2
- -------------------------------------------------------------------------------
Other Investment Practices 3
- -------------------------------------------------------------------------------
Risk Considerations 6
- -------------------------------------------------------------------------------
Management of the Fund 7
- -------------------------------------------------------------------------------
How To Invest in the Fund 9
- -------------------------------------------------------------------------------
How To Redeem an Investment in the Fund 9
- -------------------------------------------------------------------------------
Exchange Privileges and Restrictions 9
- -------------------------------------------------------------------------------
How Net Asset Value is Determined 9
- -------------------------------------------------------------------------------
Dividends and Distributions 10
- -------------------------------------------------------------------------------
Taxation 10
- -------------------------------------------------------------------------------
General Information 10
- -------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
- --------------------------------------------------------------------------------
1
<PAGE>
The Fund's Investment Objective And Policies
The Fund's investment objective and general investment policies are described
below. Specific portfolio securities that may be purchased by the Fund are
described in "Portfolio Securities" beginning on page 2. Specific investment
practices are described in "Other Investment Practices" beginning on page 3, and
certain risks associated with investments in the Fund are described in those
sections as well as in "Risk Considerations" beginning on page 6.
o Montgomery Variable Series: Growth Fund
The investment objective of the Growth Fund is capital appreciation, which under
normal conditions it seeks by investing at least 65% of its total assets in the
equity securities of domestic companies. In addition to capital appreciation,
the Fund emphasizes value.
The Fund emphasizes investments in common stock but also invests in other types
of equity and equity derivative securities (including options on equity
securities, warrants and futures contracts on equity securities). The Fund may
invest up to 35% of its total assets in debt securities rated within the three
highest grades of S&P (AAA to A), Moody's (Aaa to A) or Fitch (AAA to A), or
unrated and deemed to be of comparable quality by the Manager using guidelines
approved by the Board of Trustees. See "Portfolio Securities." An Appendix
discussing these debt ratings is included in the Statement of Additional
Information.
The Fund seeks to identify companies having sound fundamental value and the
potential for substantial growth. The Fund selects its investments based on a
combination of quantitative screening techniques and fundamental analysis. It
initially identifies a universe of investment candidates by screening companies
based on changes in rates of growth and valuation ratios such as price to sales,
price to earnings and price to cash flows. Through this process the Fund seeks
to identify rapidly growing companies with reasonable valuations and
accelerating growth rates, or having low valuations and the first signs of
growth. The Fund then subjects these companies to a rigorous fundamental
analysis focusing on balance sheets and income statements; company visits and
discussions with management; contact with industry specialists and industry
analysts; and review of the competitive environments. See "Portfolio
Securities," "Risk Considerations" and the Appendix in the Statement of
Additional Information.
The Growth Fund is managed by the growth equity team. Its key members are Roger
W. Honour and Andrew Pratt. See "Management of the Fund."
Portfolio Securities
Equity Securities
In seeking its investment objective, the Fund emphasizes investments in common
stock. The Fund may invest in other types of equity securities and equity
derivative securities, such as preferred stocks, convertible securities,
warrants, units, rights, options on securities and on securities indices.
Depositary Receipts
The Fund may invest in both sponsored and unsponsored American Depositary
Receipts ("ADRs"), European Depositary Receipts ("EDRs") and other similar
global instruments. ADRs typically are issued by an American bank or trust
company and evidence ownership of underlying securities issued by a foreign
corporation. EDRs, sometimes called Continental Depositary Receipts, are issued
in Europe, typically by foreign banks and trust companies, and evidence
ownership of either foreign or domestic underlying securities. Unsponsored ADR
and EDR programs are organized without the cooperation of the issuer of the
underlying securities. As a result, available information concerning the issuer
may not be as current as for sponsored ADRs and EDRs, and the prices of
unsponsored ADRs and EDRs may be more volatile.
Convertible Securities
The Fund may invest in convertible securities as a form of equity security. A
convertible security is a fixed-income security (a bond or preferred stock) that
may be converted at a stated price within a specified period of time into a
certain quantity of the common stock of the same or a different issuer.
Convertible securities are senior to common stock in a corporation's capital
structure but are usually subordinated to similar non-convertible securities.
Through their conversion feature, they provide an opportunity to participate in
capital appreciation resulting from a market price advance in the underlying
common stock. The price of a convertible security is influenced by the market
value of the underlying common stock and tends to increase as its market value
rises and decrease as the market value declines. For purposes of allocating the
Fund's investments, the Manager regards convertible securities as a form of
equity security.
Securities Warrants
The Fund may invest up to 5% of its net assets in warrants, including up to 2%
of net assets for those not listed on a securities exchange. A warrant typically
is a long-term option issued by a corporation that generally gives the holder
the privilege of buying a specified number of shares of its underlying common
stock at a specified exercise price by a particular expiration date. Stock index
warrants entitle the holder to receive, upon exercise, an amount in cash
determined by reference to fluctuations in the level of a
2
<PAGE>
specified stock index. If a warrant is not exercised or disposed of by its
expiration, it will expire worthless.
Investment Companies
The Fund may invest up to 10% of its total assets in shares of other investment
companies investing exclusively in securities in which it may otherwise invest.
Such investments may involve the payment of substantial premiums above the total
asset value of those investment companies' portfolio securities and are subject
to limitations under the Investment Company Act. The Fund also may incur tax
liability to the extent it invests in the stock of a foreign issuer deemed to be
a "passive foreign investment company" regardless of whether such "passive
foreign investment company" makes distributions to the Fund. See the Statement
of Additional Information.
The Fund does not intend to invest in other investment companies unless, in the
Manager's judgment, the potential benefits of such investment exceed associated
costs. As a shareholder in an investment company, the Fund bears its ratable
share of that investment company's expenses, including its advisory and
administration fees. The Manager has agreed to waive its own management fee with
respect to the portion of the Fund's assets invested in other open-end (but not
closed-end) investment companies.
Debt Securities
The Growth Fund may invest in traditional corporate, governmental debt
securities rated within the three highest grades of S&P (AAA to A), Moody's (Aaa
to A) or Fitch (AAA to A), or rated and deemed to be of comparable quality by
the Manager. See "The Fund's Investment Objective and Policies."
U.S. Government Securities
The Fund may invest in fixed rate and floating or variable rate U.S. Government
securities. Certain of the obligations, including U.S. Treasury Bills, Notes and
Bonds, and mortgage-related securities of the Government National Mortgage
Association ("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, for example those issued by
the Federal Home Loan Bank, while others, such as those issued by the Federal
National Mortgage Association ("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. However, the U.S. Government does not guarantee
the net asset value of the Fund's shares. 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.
Other Investment Practices
The Fund also may engage in the investment practices described below, each of
which may involve certain special risks. The Statement of Additional
Information, under the heading "Investment Objectives and Policies of the
Funds," contains more detailed information about certain of these practices,
including limitations designed to reduce related risks.
Repurchase Agreements
The Fund may enter into repurchase agreements. Pursuant to a repurchase
agreement, the Fund acquires a U.S. Government security or other high-grade
liquid debt instrument from a bank, a broker-dealer or other financial
institution that simultaneously agrees to repurchase the same security at a
specified time and price. The repurchase price reflects an agreed-upon rate of
return not determined by the coupon rate on the underlying security. Under the
Investment Company Act of 1940, repurchase agreements are considered to be loans
by the Fund and must therefore be fully collateralized in a manner similar to
the Fund's loan of its portfolio securities. If the seller should default on its
obligation to repurchase the underlying security, the Fund may experience delay
or difficulty in exercising its rights to realize upon the security and might
incur a loss if the value of the security declines, as well as disposition costs
in liquidating the security. See the Statement of Additional Information for
further information.
Borrowing
The Fund may borrow money from banks only for temporary or emergency purposes,
and then not in excess of 10% of the value of its total assets. The Fund may
pledge its assets in connection with such borrowings. The Fund will not purchase
any security while any such borrowings exceed 10% of the value of its total
assets.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements. In a reverse repurchase
agreement, the Fund sells one of its portfolio securities to a financial
institution concurrently agreeing to repurchase the same security at an
agreed-upon price and date. Although reverse repurchase agreements are fully
collateralized transactions, the Fund aggregates such transactions with its bank
borrowings in applying its borrowing limits. See the Statement of Additional
Information for further information.
Leverage
The Fund may leverage its portfolios to increase total return. Although leverage
creates an opportunity for
3
<PAGE>
increased net income, it also creates special risk considerations. For example,
leveraging may magnify changes in the net asset value of the Fund's shares.
Although the principal of such borrowings will be fixed, the Fund's assets may
change in value during the time the borrowing is outstanding. Leveraging creates
interest expenses that can exceed the income from the assets retained. To the
extent income derived from securities purchased with borrowed funds exceeds the
interest owed, the Fund's net income will be greater than if leveraging were not
used, and to the extent such income is less, the Fund's net income will be less
than if leveraging were not used.
Securities Lending
The Fund may lend securities to brokers, dealers and other financial
organizations. These loans may not exceed 10% of the value of the Fund's total
assets. Such loans of securities are collateralized in an amount at least equal
to the current market value of the loaned securities, plus any accrued interest,
by cash, letters of credit, U.S. Government securities or other high-grade
liquid debt securities that the Fund's custodian, or a designated sub-custodian,
segregates from other Fund assets. In segregating such assets, the Fund
custodian either places such assets in a segregated account or separately
identifies such assets and renders them unavailable for investment.
When-Issued and Forward Commitment Securities
The Fund may purchase U.S. Government or other securities on a "when-issued"
basis and may purchase or sell securities on a "forward commitment" or "delayed-
delivery" basis. The price is fixed at the time the commitment is made, but
delivery and payment for the securities take place at a later date, normally 7
to 15 days later. When-issued securities and forward commitments may be sold
prior to the settlement date, but the Fund will enter into when-issued and
forward commitments only with the intention of actually receiving or delivering
the securities. No income accrues on securities that have been purchased
pursuant to a forward commitment or on a when-issued basis prior to delivery to
the Fund. If the Fund disposes of the right to acquire a when-issued security
prior to its acquisition or disposes of its right to deliver or receive against
a forward commitment, it may incur a gain or loss.
At the time the Fund enters into a transaction on a when- issued or forward
commitment basis, it causes its custodian to segregate cash, U.S. Government
securities or other high-grade liquid debt securities equal to the value of the
when-issued or forward commitment securities and causes the segregated assets to
be marked to market daily. There is a risk that the securities may not be
delivered and that the Fund may incur a loss.
Hedging and Risk Management Practices
In seeking to protect against adverse changes in financial markets or against
currency exchange rate or interest rate changes that are adverse to the present
or prospective positions of the Fund, the Fund may employ certain risk
management practices using the following derivative securities and techniques
(known as "derivatives"): forward currency exchange contracts, stock options,
currency options, and stock and stock index options, futures contracts and
options on futures contracts on U.S. Government and foreign government
securities and currencies. The Fund will not commit more than 10% of its total
assets to such derivatives. Markets in some countries currently do not have
instruments available for hedging transactions relating to currencies or to
securities denominated in such currencies or to securities of issuers domiciled
or principally engaged in business in such countries. To the extent that such
markets do not exist, the Manager may not be able to hedge Fund investments
effectively in such countries. Furthermore, the Fund engages in hedging
activities only when the Manager deems it to be appropriate and does not
necessarily engage in hedging transactions with respect to each investment. The
Statement of Additional Information contains further information on the Fund's
hedging and risk management practices, including related risks and other special
considerations.
Forward Currency Contracts. A forward currency contract is a contract that is
individually negotiated and privately traded by currency traders and their
customers and creates an obligation to purchase or sell a specific currency for
an agreed-upon price at a future date. The Fund normally conducts its foreign
currency exchange transactions either on a spot (i.e., cash) basis at the spot
rate prevailing in the foreign currency exchange market at the time of the
transaction, or through entering into forward contracts to purchase or sell
foreign currencies at a future date. The Fund generally does not enter into
forward contracts with terms greater than one year.
The Fund generally enters into forward contracts only under two circumstances.
First, if the Fund enters into a contract for the purchase or sale of a security
denominated in a foreign currency, it may desire to "lock in" the U.S. dollar
price of the security by entering into a forward contract to buy the amount of a
foreign currency needed to settle the transaction. Second, if the Manager
believes that the currency of a particular foreign country will substantially
rise or fall against the U.S. dollar, it may enter into a forward contract to
buy or sell the currency approximating the value of some or all of the Fund's
portfolio securities denominated in such currency. Although forward contracts
are used primarily to protect the Fund from adverse currency movements, they
involve the risk that anticipated currency movements will not be accurately
predicted.
Options on Securities, Securities Indices and Currencies. The Fund also may
purchase put and call options on securities and currencies traded on U.S.
exchanges and, to
4
<PAGE>
the extent permitted by law, foreign exchanges, as well as in the
over-the-counter market. The Fund may purchase call options on securities that
it intends to purchase (or on currencies in which those securities are
denominated) in order to limit the risk of a substantial increase in the market
price of such security (or an adverse movement in the applicable currency). The
Fund may purchase put options on particular securities (or on currencies in
which those securities are denominated) in order to protect against a decline in
the market value of the underlying security (or an adverse movement in the
applicable currency) below the exercise price less the premium paid for the
option. Put options allow the Fund to protect unrealized gain in an appreciated
security that it owns without actually selling the security. Prior to
expiration, most options may be sold in a closing sale transaction. Profit or
loss from the sale will depend upon whether the amount received is more or less
than the premium paid for the option plus transaction costs.
The Fund also may purchase put and call options on stock indices in order to
hedge against the risk of stock market or industry-wide stock price
fluctuations.
The Fund may purchase options on currencies for hedging its positions in a
manner similar to their use of forward foreign exchange contracts and futures
contracts on currencies.
The Fund may purchase and write options in the over-the-counter market ("OTC
options") to the same extent as it may engage in transactions in exchange-traded
options. OTC options differ from exchange-traded options in that they are
negotiated individually and terms of the contract are not standardized as is the
case with exchange traded options. Because no clearing corporation is involved
in an OTC option, there is a risk of non-performance by the option counterparty.
However, the OTC options market generally provides a wider range of expiration
dates and exercise prices than do the exchanges. It is the current position of
the SEC staff that OTC options (and their underlying securities) are illiquid
except to the extent that they are entered into with U.S. Government securities
dealers designated by the Federal Reserve Bank of New York under guidelines
specified by the SEC staff. Accordingly, the Fund will treat OTC options as
illiquid pending a change in the SEC position. State laws may impose further
limitations.
Futures and Options on Futures. To protect against the effect of adverse changes
in interest rates, the Fund may purchase and sell interest rate futures
contracts. An interest rate futures contract is an agreement by a Fund to
purchase or sell debt securities, usually U.S. Government securities, at a
specified date and price. The Fund may sell interest rate futures contracts
(i.e., enter into a futures contract to sell the underlying debt security) in an
attempt to hedge against an anticipated increase in interest rates and a
corresponding decline in the value of debt securities it owns. Conversely, the
Fund may purchase an interest rate futures contract (i.e., enter into a futures
contract to purchase an underlying security) to hedge against interest rate
decreases and corresponding increases in the value of debt securities it
anticipates purchasing. The Fund also may purchase and sell put and call options
on interest rate futures contracts in lieu of entering into the underlying
interest rate futures contracts. The Fund segregates cash, U.S. Government
securities or other high-grade liquid debt obligations equal to the purchase
price of the portfolio securities represented by the underlying interest rate
futures contracts it has an obligation to purchase.
The Fund does not enter into any futures contracts or related options if the sum
of initial margin deposits on futures contracts, related options (including
options on securities, securities indices and currencies) and premiums paid for
any such related options would exceed 5% of total assets.
Hedging Considerations. There can be no assurance that the Fund's hedging
transactions will be successful, and the Fund may be exposed to risk if it is
unable to close out its futures or options positions due to an illiquid
secondary market.
Futures, options and options on futures have effective durations which, in
general, are closely related to the effective duration of their underlying
securities. Holding purchased futures or call option positions (backed by
segregated cash, U.S. Government securities or other high-grade liquid debt
obligations) lengthens the effective duration of the Fund's portfolio. (While
"term to maturity" measures only the period until debt securities finally
mature, "effective duration" accounts for earlier payments and interest rate
resets, so that it is a more useful indicator of the interest rate risk of a
debt security.) Holding purchased futures or call option positions, by
lengthening the effective duration of the portfolio, increases interest rate
risk.
While the utilization of options, futures contracts and related options and
similar instruments may be advantageous to the Fund, its performance will be
impaired if the Manager is unsuccessful in employing such instruments in
managing the Fund's investments or in predicting changes in the market. In
addition, the Fund pays commissions and other costs in connection with such
investments. Further discussion of the possible risks involved in such
transactions is contained in the Statement of Additional Information.
Illiquid Securities
The Fund may invest up to 15% of its net assets in illiquid securities. The Fund
treats as illiquid any securities that are subject to restrictions on
repatriation for more than seven days and securities issued in connection with
foreign debt conversion programs that are restricted as to remittance of
invested capital or profit. The Fund treats repurchase agreements with
maturities in excess of seven days as illiquid. Illiquid securities do not
include securities that meet the requirements of Rule 144A under the Securities
Act of 1933, as amended, and that, subject to review by the
5
<PAGE>
Board of Trustees and guidelines adopted by the Board, the Manager has
determined to be liquid.
Defensive Investments and Portfolio Turnover
Notwithstanding its investment objective, the Fund may adopt up to a 100% cash
or cash equivalent position for temporary defensive purposes to protect against
the erosion of its capital base. Depending upon the Manager's analysis of the
various markets and other considerations, all or part of the assets of the Fund
may be held in cash and cash equivalents (denominated in U.S. dollars or foreign
currencies) such as U.S. Government securities or obligations issued or
guaranteed by the government of a foreign country or by an international
organization designed or supported by multiple foreign governmental entities to
promote economic reconstruction or development, high-quality commercial paper,
time deposits, savings accounts, certificates of deposit, bankers' acceptances
and repurchase agreements with respect to all of the foregoing. Such investments
also may be made for temporary purposes pending investment in other securities
and following substantial new investment in the Fund.
Portfolio securities are sold whenever the Manager believes it appropriate,
regardless of how long the securities have been held. The Manager therefore
changes the Fund's investments whenever it believes doing so will further the
Fund's investment objectives or when it appears that a position of the desired
size cannot be accumulated. Portfolio turnover generally involves some expense
to the Fund, including brokerage commissions or dealer mark-ups and other
transaction costs on the sale of securities and reinvestment in other
securities. The annual portfolio turnover for the Fund is anticipated to be less
than 100%. However, even when portfolio turnover exceeds 100%, the Fund does not
regard portfolio turnover as a limiting factor.
Investment Restrictions
The investment objective of the Fund is fundamental and may not be changed
without shareholder approval, but unless otherwise stated, the Fund's other
investment policies may be changed by the Board of Trustees. If there is a
change in the investment objective or policies of the Fund, a shareholder should
consider whether the Fund remains an appropriate investment in light of its
then-current financial positions and needs. The Fund is subject to additional
investment policies and restrictions described in the Statement of Additional
Information, some of which are fundamental.
Risk Considerations
Foreign Securities
All investments involve risk and there can be no guarantee against loss
resulting from an investment in the Fund. The Fund has the right to purchase
securities in foreign countries. Accordingly, 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 investment in
securities of issuers in foreign nations. In addition, there is often less
publicly available information about foreign issuers than those in the U.S.
Foreign companies are often not subject to uniform accounting, auditing and
financial reporting standards, and auditing practices and requirements are often
not comparable to those applicable to U.S. companies. Further, the Fund may
encounter difficulties in pursuing legal remedies or in obtaining judgments in
foreign courts. Additional risk factors, including use of domestic and foreign
custodian banks and depositories, are described elsewhere in the Prospectus and
in the Statement of Additional Information.
Brokerage commissions, fees for custodial services, and other costs relating to
investments by the Fund in other countries are generally greater than in the
United States. Foreign markets have different clearance and settlement
procedures from the U.S., and in certain markets there have been times when
settlements have not kept pace with the volume of securities transactions,
resulting in settlement difficulty. The inability of the Fund to make intended
security purchases due to settlement difficulty could cause the Fund 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 declines in the intervening period or result in claims
against the Fund if it has 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 U.S. The securities markets of many of the countries in which the
Fund may invest may also be smaller, less liquid, and subject to greater price
volatility than those in the U.S.
Because the securities of the Fund 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 the Fund's securities denominated in that currency. Such changes also
affect the Fund's income and distributions to shareholders. The Fund may be
affected either favorably or unfavorably by changes in the relative rates of
exchange between the currencies of different nations, and the Fund
6
<PAGE>
may therefore engage in foreign currency hedging strategies. Such strategies,
however, involve certain transaction costs and investment risks, including
dependence on the Manager's ability to predict exchange rate movements.
Some countries in which the Fund 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 a steady devaluation relative to the U.S. dollar.
Any devaluations in the currencies in which the Fund's portfolio securities are
denominated may have the detrimental impact on the Fund.
Many countries in which the 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 have had and may continue to have negative
effects on certain economies and securities. Moreover, the economies of some
countries may differ favorably or unfavorably from the U.S. economy in such
respects as rate of growth of gross domestic product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments position.
Small Companies
While the Fund may invest in mature suppliers of products and services, and
technologies, the Fund also may invest in smaller companies that may benefit
from the development of new products and services. These smaller companies may
present greater opportunities for capital appreciation but may involve greater
risk than larger, 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 the securities of such smaller companies
may fluctuate more than the prices of the securities of larger issuers.
Interest Rates
The market value of debt securities sensitive to prevailing interest rates is
inversely related to actual changes in interest rates. That is, a decline in
interest rates produces an increase in the market value of these securities, and
an increase in interest rates produces a decrease. Moreover, the longer the
remaining maturity of a security, the greater is the effect of interest rate
change on its market value. 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 debt securities of that issuer.
Prepayments of principal of mortgage-related securities by mortgagors or
mortgage foreclosures affect the average life of the mortgage-related securities
remaining in the Fund's portfolio. Mortgage prepayments are affected by the
level of interest rates and by factors including general economic factors, the
underlying location and age of the mortgage and other social and demographic
conditions. In periods of rising interest rates, the rate of prepayments tends
to decrease, lengthening the average life of a pool of mortgage-related
securities. Conversely, in periods of falling interest rates, the rate of
prepayments tends to increase, shortening the average life of a pool of
mortgages. Reinvestment of prepayments may occur at higher or lower interest
rates than the original investment.
Mixed and Shared Funding
Shares of the Fund are sold to insurance company separate accounts that fund
both variable life insurance contracts and variable annuity contracts (as well
as to qualified pension and retirement plans), referred to as "mixed funding."
In addition, shares of the Fund are sold to separate accounts of more than one
insurance company, referred to as "shared funding." At this time, the Fund does
not foresee any disadvantage to any of the Fund's shareholders resulting either
from mixed or shared funding. The Board of Trustees, however, will continue to
review the Fund's mixed and shared funding to determine whether disadvantages to
any shareholders develop.
Management Of The Fund
The Montgomery Funds III has a Board of Trustees that establishes the Fund's
policies and supervises and reviews their management. Day-to-day operations of
the Fund are administered by the officers of the Trust and by the Manager
pursuant to the terms of an investment management agreement with the Fund.
Montgomery Asset Management, L.P., is the Fund's Manager. The Manager, a
California limited partnership, was formed in 1990 as an investment adviser
registered as such with the SEC under the Investment Advisers Act of 1940, as
amended, and since then has advised private accounts, series of two other
registered investment companies and the Trust. Its general partner is Montgomery
Asset Management, Inc., and its sole limited partner is Montgomery Securities.
Under the Investment Company Act, both Montgomery Asset Management, Inc. and
Montgomery Securities may be deemed control persons of the Manager. Although the
operations and management of the Manager are independent from those of
Montgomery Securities, the Manager may draw upon the research and administrative
resources of Montgomery Securities in its discretion and consistent with
applicable regulations.
Founded in 1969, Montgomery Securities is a fully integrated and highly focused
investment banking partnership specializing in emerging growth companies. The
firm's areas of expertise include research, corporate finance, sales and
trading, and venture capital. Its research department is one of the largest,
most experienced groups headquartered outside the East Coast. Through its
corporate finance department, Montgomery Securities is a well recognized
underwriter of public offerings, and provides
7
<PAGE>
broad distribution of securities through its sales and trading organization.
Portfolio Managers
o Montgomery Variable Series: Growth Fund
The Growth Fund is managed by the growth equity team. Key members of that team
are Roger W. Honour and Andrew Pratt.
Roger W. Honour is a Managing Director and Senior Portfolio Manager. Prior to
joining Montgomery Asset Management in June 1993, Mr. Honour spent one year as
Vice President and Portfolio Manager at Twentieth Century Investors in Kansas
City, Missouri. From 1990 to 1992, he served as Vice President and Portfolio
Manager at Alliance Capital Management. From 1978 to 1990, Mr. Honour was a Vice
President with Merrill Lynch Capital Markets. Mr. Honour is the subject of a
settled SEC administrative proceeding (by Order dated September 29, 1995)
arising out of personal trading activities that created undisclosed conflicts of
interest. These activities occurred prior to Mr. Honour's joining Montgomery
Asset Management.
Andrew Pratt, CFA, is Senior Portfolio Analyst. He joined Montgomery Asset
Management from Hewlett- Packard Company, where he was an equity analyst,
managed a portfolio of small capitalization technology companies, and researched
private placement and venture capital investments. From 1983 through 1988, he
worked in the Capital Markets Group at Fidelity Investments in Boston,
Massachusetts.
Management Fees and Other Expenses
The Manager provides the Fund with advice on buying and selling securities,
manages the investments of the Fund, including the placement of orders for
portfolio transactions, furnishes the Fund with office space and certain
administrative services, and provides the personnel needed by the Fund with
respect to the Manager's responsibilities under the Manager's Investment
Management Agreement with the Fund. The Manager also compensates the members of
the Board of Trustees who are interested persons of the Manager. As
compensation, the Fund pays the Manager a management fee (accrued daily) based
upon the value of the average daily net assets of the Fund, according to the
following table. The management fees for the Fund are higher than for most
mutual funds, but may be consistent with fees paid to managers of funds with
comparable investment objectives and techniques.
|Average Daily Net Assets | Annual Rate
- -----------------------------------------|-------------------------|------------
| |
Montgomery Variable Series: Growth Fund | First $500 million | 1.00%
| Next $500 million | 0.90%
| Over $1 billion | 0.80%
- -----------------------------------------|-------------------------|------------
The Fund is responsible for its own operating expenses including, but not
limited to: the Manager's fee; the Administrator's fee; taxes, if any; brokerage
and commission expenses, if any; interest charges on any borrowings; transfer
agent, custodian, administrator, legal and auditing fees; fees and expenses of
Trustees who are not interested persons of the Manager; salaries of certain
personnel; costs and expenses of calculating their daily net asset value; costs
and expenses of accounting, bookkeeping and recordkeeping required under the
Investment Company Act; insurance premiums; trade association dues; fees and
expenses of registering and maintaining registration of shares for sale under
federal laws; all costs associated with shareholders meetings and the
preparation and dissemination of proxy materials, except for meetings called
solely for the benefit of the Manager or its affiliates; printing and mailing
prospectuses, statements of additional information and reports to shareholders;
and other expenses relating to the Fund's operations, plus any extraordinary and
nonrecurring expenses that are not expressly assumed by the Manager.
The Manager has agreed to reduce some or all of its management fees if necessary
to keep total annual operating expenses, expressed on an annualized basis, for
the Growth Fund at or below one and one-quarter percent (1.25%) of their average
net assets. The Manager may terminate these voluntary reductions at any time.
Any reductions made by the Manager in its fees are subject to reimbursement by
the Fund within the following three years, provided the Fund is
8
<PAGE>
able to effect such reimbursement and remain in compliance with applicable
expense limitations.
In addition, the Manager may elect to absorb operating expenses that the Fund is
obligated to pay in order to increase the return to the Fund's shareholders. To
the extent the Manager performs a service or assumes an operating expense for
which the Fund is obligated to pay and the performance of such service or
payment of such expense is not an obligation of the Manager under the Investment
Management Agreement, the Manager is entitled to seek reimbursement from the
Fund for the Manager's costs incurred in rendering such service or assuming such
expense. The Manager, out of its own funds, also may compensate persons who
distribute the Fund's shares as well as other service providers who provide
shareholder and administrative services.
The Manager considers a number of factors in determining which brokers or
dealers to use for the Fund's portfolio transactions. While these factors are
more fully discussed in the Statement of Additional Information, they include,
but are not limited to, the reasonableness of commissions, the quality of
services and execution and the availability of research that the Manager may
lawfully and appropriately use in its investment management and advisory
capacities.
It is anticipated that Montgomery Securities, an affiliate of the Manager may
act as one of the Fund's brokers in the purchase and sale of portfolio
securities and, in that capacity, will receive brokerage commissions from the
Fund. The Fund will use Montgomery Securities as its broker only when, in the
judgment of the Manager and pursuant to review by the Board of Trustees,
Montgomery Securities will obtain for the Fund a price and execution at least as
favorable as that available from other qualified brokers. See "Execution of
Portfolio Transactions" in the Statement of Additional Information for further
information regarding Fund policies concerning execution of portfolio
transactions.
Morgan Stanley Trust Company, located at One Pierrepont Plaza, Brooklyn, New
York 11201, serves as the Fund's principal custodian (the "Custodian").
How To Invest In The Fund
The Trust offers shares of the Fund, without sales charge, at their
next-determined net asset value after receipt of an order with payment only by
one of the insurance companies for the Accounts to fund benefits under variable
life insurance contracts and variable annuity contracts, or by a qualified
pension or retirement plan.
How To Redeem An Investment In The Fund
The Trust redeems shares of the Fund on any day that the NYSE is open for
trading. The redemption price is the net asset value per share next determined
after the shares are validly tendered for redemption by the Accounts or by the
trustee in the case of qualified pension and retirement plans.
Exchange Privileges And Restrictions
Shares of the Fund may be exchanged for shares of another series of the Trust on
the basis of their relative net asset values (with no sales charge or exchange
fee) next determined after the time of the request by an Account or by a
qualified pension or retirement plan, subject to the terms of the Account or
plan. Holders of Variable Contracts should refer to the prospectuses related to
their contracts with regard to their exchange privileges.
How Net Asset Value Is Determined
The net asset value of the Fund is determined once daily as of 4:00 p.m., New
York time, on each day that the NYSE is open for trading. Per-share net asset
value is calculated by dividing the value of the Fund's total net assets by the
total number of the Fund's shares then outstanding.
As more fully described in the Statement of Additional Information, portfolio
securities are valued using current market valuations: either the last reported
sales price or, in the case of securities for which there is no reported last
sale and fixed-income securities, the mean between the closing bid and asked
price. Securities for which market quotations are not readily available or which
are illiquid are valued at their fair values as determined in good faith under
the supervision of the Trust's officers, and by the manager and the Pricing
Committee of the Board of Trustees, respectively, in accordance with methods
that are specifically authorized by the Board of Trustees. Short-term
obligations with maturities of 60 days or less are valued at amortized cost as
reflecting fair value.
The value of securities denominated in foreign currencies and traded on foreign
exchanges or in foreign markets will be translated into U.S. dollars at the last
price of their respective currency denomination against U.S. dollars quoted by a
major bank or, if no such quotation is available, at the rate of exchange
determined in accordance with policies established in good faith by the Board of
Trustees. Because the value of securities denominated in foreign currencies must
be translated into U.S. dollars, fluctuations in the value of such currencies in
relation to the U.S. dollar may affect the net asset value of Fund shares even
if there has not been any change in the foreign-currency denominated values of
such securities.
Because foreign securities markets may close prior to the time the Fund
determines its net asset value, events affecting the value of portfolio
securities occurring between the time prices are determined and the time the
Fund calculates its net asset value may not be reflected in the Fund's
calculations of net asset values unless the Manager, under supervision of the
Board of Trustees, determines that a
9
<PAGE>
particular event would materially affect the Fund's net asset value.
Dividends And Distributions
The Fund distributes substantially all of its net investment income and net
capital gains to shareholders each year. The Fund currently intends to make one
or, if necessary to avoid the imposition of tax on the Fund, more distributions
during each calendar year. A distribution may be made between November 1 and
December 31 of each year with respect to any undistributed capital gains earned
during the one year period ended October 31 of such calendar year. Another
distribution of any undistributed capital gains may also be made following the
Fund's fiscal year end (December 31). The amount and frequency of Fund
distributions are not guaranteed and are at the discretion of the Board of
Trustees.
Unless the Fund is otherwise instructed, all dividends and other distributions
will be reinvested automatically in additional shares of the Fund and credited
to the shareholder's account at the closing net asset value on the reinvestment
date.
Taxation
The Fund intends to qualify and elect to be treated as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"), by distributing substantially all of its net investment income and net
capital gains to its shareholders and meeting other requirements of the Code
relating to the sources of its income and diversification of its assets. The
Fund generally will not be liable for federal income tax except to the extent it
does not meet the requirements of Subchapter M by, for example, not distributing
its earnings in a manner that satisfies the requirements of the Code. If the
Fund is unable to meet certain requirements of the Code, it may be subject to
taxation as a corporation. See the Statement of Additional Information for
further information.
In addition to the diversification requirements in Subchapter M, the Fund is
required to satisfy diversification requirements of Section 817(h) of the Code
and the Investment Company Act. Pursuant to the requirements of Section 817(h)
of the Code and related regulations, only Accounts and qualified pension and
retirement plans may be shareholders of the Fund. Failure to comply with the
requirements of Section 817(h) could result in taxation of the insurance company
and immediate taxation of the owners of Variable Contracts to the full extent of
appreciation under the contracts.
Holders of Variable Contracts should refer to the prospectuses relating to their
contracts regarding the federal income tax treatment of ownership of such
contracts.
General Information
The Trust
The Fund is a series of The Montgomery Funds III, a Delaware business trust
organized on August 24, 1994. The Trust's Agreement and Declaration of Trust
permits the Board of Trustees to issue an unlimited number of full and
fractional shares of beneficial interest, $.01 par value, in any number of
series. The assets and liabilities of each series within the Trust are separate
and distinct from each other series.
Shareholder Rights
Shares issued by the Fund have no preemptive, conversion, or subscription
rights. Each whole share shall be entitled to one vote as to any matter on which
it is entitled to vote and each fractional share shall be entitled to a
proportionate fractional vote. Shareholders have equal and exclusive rights as
to dividends and distributions declared by the Fund and to the net assets of the
Fund upon liquidation or dissolution. Each series of the Trust votes separately
on matters affecting only that Series (e.g., approval of the Investment
Management Agreement); all series of the Trust will vote as a single class on a
dollar-weighted basis on matters affecting all series of the Trust jointly or
the Trust as a whole (e.g., election or removal of Trustees). Voting rights are
not cumulative, so that the holders of more than 50% of the shares voting in any
election of Trustees can, if they so choose, elect all of the Trustees of the
Trust. While the Trust is not required to and does not intend to hold annual
meetings of shareholders, such meetings may be called by the Board of Trustees
at its discretion, or upon demand by the holders of 10% or more of the
outstanding shares of the Trust for the purpose of electing or removing
Trustees. Shareholders may receive assistance in communicating with other
shareholders in connection with the election or removal of Trustees pursuant to
the provisions of Section 16(c) of the Investment Company Act.
The Fund may in the future offer shares to Accounts and qualified pension and
retirement plans in separate classes, subject to appropriate exemptive relief
and other applicable regulatory requirements.
The Fund has reserved the right, if approved by the Board of Trustees, to
convert in the future to a "feeder" fund that would invest all of its assets in
a "master" fund having substantially the same investment objective, policies and
restrictions. Prior notice of any such action would be given to all shareholders
if and when such a proposal is approved, although no such action has been
proposed as of the date of this Prospectus.
For information on Variable Contract holders' rights to instruct the Accounts to
vote shares of the Fund attributable to their Variable Contracts, such holders
should refer to the prospectuses related to their Variable Contracts.
10
<PAGE>
Performance Information
From time to time, the Fund may publish its total return in advertisements and
communications. Total return information generally will include the Fund's
average annual compounded rate of return over the most recent four calendar
quarters and over the period from the Fund's inception of operations. The Fund
may also advertise aggregate and average total return information over different
periods of time. The Fund's average annual compounded rate of return is
determined by reference to a hypothetical $1,000 investment that includes
capital appreciation and depreciation for the stated period according to a
specific formula. Aggregate total return is calculated in a similar manner,
except that the results are not annualized. Total return figures will reflect
all recurring charges against the Fund's income.
Investment results of the Fund will fluctuate over time, and any presentation of
the Fund's total return for any prior period should not be considered as a
representation of what an investor's total return may be in any future period.
Legal Opinion
The validity of the shares offered by this Prospectus will be passed on by
Heller, Ehrman, White & McAuliffe, 333 Bush Street, San Francisco, California
94104.
------------------------------
No salesman, dealer or other person is authorized to give any information or
make any representation other than those contained in this Prospectus, the
Statement of Additional Information, or in the Fund's official sales literature.
11
<PAGE>
RULE 497(e)
33-84450:811-8782
MONTGOMERY VARIABLE SERIES: GROWTH FUND
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
THE MONTGOMERY FUNDS III
600 Montgomery Street
San Francisco, California 94111
1-800-572-3863
STATEMENT OF ADDITIONAL INFORMATION
April 25, 1995
The Montgomery Funds III (the "Trust") is an open-end
management investment company organized as a Delaware business trust, having two
series of shares of beneficial interest. Each of the funds named above (each a
"Fund" and, collectively, the "Funds") is a separate series of the Trust. The
Funds are managed by Montgomery Asset Management, L.P. (the "Manager"). Shares
of the Funds may be purchased only by insurance company separate accounts
("Accounts") to fund the benefits of variable life insurance policies or
variable annuity contracts ("Variable Contracts") and by qualified pension and
retirement plans. This Statement of Additional Information contains information
in addition to that set forth in the Prospectus for the Funds (the
"Prospectus"), dated April 25, 1995, as may be revised from time to time. The
Prospectus provides the basic information a prospective investor should know
before investing in an Account or sub-account of an Account that invests in the
Funds, or in the case of qualified pension and retirement plans, investing
directly in the Funds. References to shareholders and investors in the
Prospectus and this Statement of Additional Information are to Accounts or
qualified pension and retirement plans. This Statement of Additional Information
is not a prospectus and should be read in conjunction with the Prospectus, into
which this Statement of Additional Information is incorporated by reference.
TABLE OF CONTENTS
Page
The Trust...................................................................B- 2
Investment Objectives and Policies of the Funds.............................B- 2
Risk Factors................................................................B-15
Investment Restrictions.....................................................B-17
Distributions and Tax Information...........................................B-20
Trustees and Officers.......................................................B-25
Investment Management and Other Services....................................B-28
Execution of Portfolio Transactions.........................................B-30
Additional Purchase and Redemption Information..............................B-33
Determination of Net Asset Value............................................B-34
Performance Information.....................................................B-36
General Information.........................................................B-39
Financial Statements........................................................B-40
Appendix A..................................................................B-41
B-1
<PAGE>
THE TRUST
The Montgomery Funds III is an open-end management investment
company organized as a Delaware business trust on August 24, 1994. The Trust is
registered under the Investment Company Act of 1940, as amended (the "Investment
Company Act"). The Trust currently offers shares of beneficial interest, $.01
par value per share, in two series. This Statement of Additional Information
pertains to Montgomery Variable Series: Growth Fund (the "Growth Fund") and
Montgomery Variable Series: Emerging Markets Fund (the "Emerging Markets Fund").
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS
The investment objectives and policies of the Funds are
described in detail in the Prospectus. The following discussion supplements the
discussion in the Prospectus.
The Funds are diversified series of The Montgomery Funds III.
The achievement of the Funds' investment objectives will depend upon market
conditions generally and on the Manager's analytical and portfolio management
skills.
Portfolio Securities
Depositary Receipts. The Funds may hold securities of foreign
issuers in the form of American Depositary Receipts ("ADRs"), European
Depositary Receipts ("EDRs") 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 the Fund's investment policies, the Funds'
investments in ADRs, EDRs, and similar instruments will be deemed to be
investments in the equity securities of foreign issuers into which they may be
converted.
Other Investment Companies. Each of the Funds may invest up to
10% of its total assets in securities issued by other investment companies
investing in securities in which the Fund can invest provided that such
investment companies invest in portfolio securities in a manner consistent with
a Fund's investment objective and policies. Applicable provisions of the
Investment Company Act require that each of the Funds limits its investments so
that, as determined immediately after a securities purchase is made: (a) not
more than 10% of the value of the Fund's total assets will be invested in the
aggregate in securities of investment companies as a group; and (b) either the
Fund and affiliated persons of the 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 the Fund in excess of 1%
of the company's total outstanding shares be
B-2
<PAGE>
deemed illiquid); or the 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. As a shareholder of another investment company, a Fund would bear,
along with other shareholders, its pro rata portion of the other investment
company's expenses, including advisory fees. These expenses would be in addition
to the advisory and other expenses that that Fund bears directly in connection
with its own operations. The Manager has agreed to waive its management fee with
respect to assets of the Funds that are invested in other open-end investment
companies.
U.S. Government Securities. U.S. Government securities in
which the Funds may invest include debt obligations of varying maturities issued
by the U.S. Treasury or issued or guaranteed by an agency or instrumentality of
the U.S. Government, including the Federal Housing Administration ("FHA"),
Farmers Home Administration, Export-Import Bank of the United States, Small
Business Administration, Government National Mortgage Association ("GNMA"),
General Services Administration, Central Bank for Cooperatives, Federal Farm
Credit Bank, Farm Credit System Financial Assistance Corporation, Federal Home
Loan Banks, Federal Home Loan Mortgage Corporation ("FHLMC"), Federal
Intermediate Credit Banks, Federal Land Banks, Financing Corporation, Federal
Financing Bank, Federal National Mortgage Association ("FNMA"), Maritime
Administration, Tennessee Valley Authority, Resolution Funding Corporation,
Student Loan Marketing Association and Washington Metropolitan Area Transit
Authority. Direct obligations of the U.S. Treasury include a variety of
securities that differ primarily in their interest rates, maturities and dates
of issuance. Because the U.S. Government is not obligated by law to provide
support to an instrumentality that it sponsors, the Funds will not invest in
obligations issued by an instrumentality of the U.S. Government unless the
Manager determines that the instrumentality's credit risk makes its securities
suitable for investment by the Funds.
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.
B-3
<PAGE>
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) 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 FHLMC security may include whole loans, participation interests
in
B-4
<PAGE>
whole loans and undivided interests in whole loans and participation in another
FHLMC security.
Risk Factors/Special Considerations Relating to Debt Securities
The Emerging Markets Fund may invest in debt securities which
are rated below Baa by Moody's Investors Service, Inc. ("Moody's") or BBB by
Standard & Poor's Corporation ("S&P"), 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, this Fund will
invest no more than 5% 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. These changes in market value will
be reflected in the Fund's net asset value.
Bonds which are 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, 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 this Fund's ability to sell the securities at fair value
either to meet redemption requests or to respond to changes in the economy or in
the financial markets and could adversely affect, and cause fluctuations in, the
daily net asset value of this Fund's shares.
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 the Fund to
achieve its investment objective may, to the extent it invests in low-rated debt
securities, be more dependent upon such credit analysis than would be the case
if this Fund were investing in higher-rated debt securities.
Low-rated debt securities may be more susceptible to real or
perceived adverse economic and competitive industry conditions
B-5
<PAGE>
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, this
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.
Hedging and Risk Management Practices
In order to hedge against foreign currency exchange rate
risks, the 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. 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 at the time of the transaction.
The Funds also may purchase other types of options and futures
and may, in the future, write covered options, as described below and in the
Prospectus.
Forward Foreign Currency Exchange Contracts. The Funds may
enter into forward contracts to attempt to minimize the risk to them from
adverse changes in the relationship between the U.S. dollar and foreign
currencies. A forward contract is an obligation to purchase or sell a specific
currency for an agreed-upon price at a future date which is individually
negotiated and privately traded by currency traders and their customers.
The Funds may enter into a forward contract, for example, when
they enter into contracts for the purchase or sale of a security denominated in
a foreign currency or are expecting a dividend or interest payment in order to
"lock in" the U.S. dollar price of the security or dividend or interest payment.
In addition, 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 foreign
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 foreign currency for a fixed dollar amount.
In connection with a Fund's forward contract transactions, an
amount of that Fund's assets equal to the amount of that Fund's commitment will
be held aside or segregated to be used to pay for the commitment. Accordingly, a
Fund always will
B-6
<PAGE>
have cash, cash equivalents or high-quality liquid 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 forward contracts. In such event, the Fund's
ability to utilize forward contracts in the manner set forth above 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 the Fund
than if it had not engaged in such contracts. The 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, the Funds may purchase and sell various kinds of futures contracts and
options on futures contracts. The Funds 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.
The Trust, on behalf of the Funds, has 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 to Section 4.5 of
the regulations under the Commodity Exchange Act, the notice of eligibility
included the representation that the Funds will use futures contracts and
related options for bona fide hedging purposes within the meaning of CFTC
regulations, provided that the Funds 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 a 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%.
The 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
the Funds or which they expect to purchase. The 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
B-7
<PAGE>
futures contracts entered into by the Funds are traded on U.S. exchanges or
boards of trade that are 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 the Funds'
futures contracts on securities or currencies will usually be liquidated in this
manner, a Fund may instead make or take delivery of the underlying securities or
currencies whenever it appears economically advantageous for it to do so. 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, the 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 the Funds propose to acquire. For example, when
interest rates are rising or securities prices are falling, the Funds can seek,
through the sale of futures contracts, to offset a decline in the value of their
current portfolio securities. When rates are falling or prices are rising, the
Funds, 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 the 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 the
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.
The acquisition of put and call options on futures contracts
gives a Fund the right (but not the obligation), for a
B-8
<PAGE>
specified price, to sell or purchase, respectively, 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 will be subject to the development and maintenance
of a liquid market.
Loss from investing in futures transactions by the Funds 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. The
Funds may purchase put and call options on securities in which they have
invested, on foreign currencies represented in their portfolios and on any
securities index based on securities in which the Funds may invest. The Funds
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 foreign 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 that are traded on U.S.
and foreign exchanges and options traded over the counter ("OTC options") with
broker-dealers who make markets in these options. The ability to terminate OTC
options is more limited than with exchange-traded options and may involve the
risk that broker-dealers participating in such transactions will not fulfill
their obligations. Trading in OTC options is also subject to the risk that the
other party will be unable or unwilling to close out options purchased by a
Fund.
Although the Funds 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
B-9
<PAGE>
transactions in particular options, with the result that a Fund would have to
exercise those 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.
Although the Funds do not 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 the Funds 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 the price of the underlying security declining. 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 in the underlying
security above the option exercise price. In addition, a Fund's ability to sell
the underlying security will be limited while the option is in effect unless the
Fund effects a closing purchase transaction.
The Funds also may write covered put options that give the
holder of the option the right to sell the underlying security to the Funds 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" the put
options that it has written, a Fund will cause its custodian to segregate cash,
cash equivalents, U.S. Government securities or other high-grade liquid debt
securities with a value equal to or greater than the exercise price of the
underlying securities. In segregating such assets, a Fund's custodian either
deposits such assets in a segregated account or separately identifies such
assets and renders them unavailable for investment by the Fund.
There is no assurance that higher than anticipated trading
activity or other unforeseen events might not, at times,
B-10
<PAGE>
render certain of the facilities of the Options Clearing Corporation inadequate,
and thereby result in the institution by an exchange of special procedures that
may interfere with the timely execution of the Funds' orders.
Other Investment Practices
Repurchase Agreements. As noted in the Prospectus, the Funds
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 liquid debt security, with the seller of the underlying security
agreeing to repurchase it from that Fund 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 selling institution 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 Board of Trustees, reviews on a periodic basis the
suitability and creditworthiness, and the value of the collateral, of those
banks and dealers 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 Board of Trustees.
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. Neither Fund may invest
more than 15% 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 under a repurchase
agreement, 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 of the seller. As an unsecured creditor, a Fund would be at risk of
losing some or all of the principal and income involved in the transaction. As
with any
B-11
<PAGE>
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, the Funds always require collateral for any repurchase agreement to
which they are a party in the form of securities acceptable to them, the market
value of which is equal to at least 100% of the amount invested by a Fund plus
accrued interest, and the Funds make payment against such securities only upon
physical delivery or evidence of book entry transfer to the account of their
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 at all times equals or exceeds the repurchase price.
The Funds may participate in one or more joint accounts with
other funds of the Trust that may invest in repurchase agreements
collateralized, subject to its 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 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 will it have a
duration of more than seven days.
Reverse Repurchase Agreements. The Funds may enter into
reverse repurchase agreements, as set forth in the Prospectus. The Funds
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. 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 the sale of the
Fund's securities is considered to be disadvantageous.
The Funds cause their custodian to segregate liquid assets,
such as cash, U.S. Government securities or other high-grade liquid debt
securities equal in value to their obligations (including accrued interest) with
respect to reverse repurchase agreements. In segregating such assets, the Funds'
custodian either places such securities in a segregated account or separately
B-12
<PAGE>
identifies such assets and renders them unavailable for investment by the Funds.
Such assets are marked to market daily to ensure that full collateralization is
maintained.
Lending of Portfolio Securities. Although the Funds do not
currently intend to do so, each may lend its portfolio securities having a value
of up to 10% of its total assets 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. The Funds 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 the Fund or the borrower at any time. Upon such
termination, the Funds are 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
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 when 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
B-13
<PAGE>
segregate cash, U.S. Government securities or other high-grade liquid debt
securities with a value equal in value to commitments for when-issued or delayed
delivery securities. The segregated securities will either 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.
Illiquid Securities. A Fund may invest up to 15% 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, purchased OTC options, 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 the 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 ("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 the 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
B-14
<PAGE>
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 held by a
Fund, however, could adversely affect the marketability of such portfolio
securities and result in that Fund's inability to dispose of such securities
promptly or at favorable prices.
The Board of Trustees has delegated the function of making
day-to-day determinations of liquidity to the Manager pursuant to guidelines
approved by the Board. 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 Board of Trustees.
RISK FACTORS
Foreign Securities
Shareholders in the Funds should consider carefully the
substantial risks involved in securities of companies located or doing business
in, and governments of, foreign nations, which are in addition to the usual
risks inherent in domestic investments. There may be less publicly available
information about foreign companies comparable to the reports and ratings
published regarding companies in the United States. Foreign companies are often
not subject to uniform accounting, auditing and financial reporting standards,
and auditing practices and requirements are often not comparable to those
applicable to U.S. companies. Many foreign markets have substantially less
volume than either the established domestic securities exchanges or the OTC
markets. Securities of some foreign companies are less liquid and more volatile
than securities of comparable U.S. companies. Commission rates in foreign
countries, which may be fixed rather than subject to negotiation as in the U.S.,
are likely to be higher. In many foreign countries there is less government
supervision and regulation of securities exchanges, brokers and listed companies
than in the U.S., and capital requirements for brokerage firms are generally
lower. Settlement of transactions in foreign securities may, in some instances,
be subject to delays and related administrative uncertainties.
B-15
<PAGE>
Emerging Market Countries
The Emerging Markets Fund invests in securities of companies
domiciled in, and in markets of, so-called "emerging market countries." These
investments may be subject to 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 that may restrict the Fund's 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 Polices
The Emerging Markets Fund endeavors to buy and sell foreign
currencies on favorable terms. Some price spreads on currency exchange (to cover
service charges) may be incurred, particularly when this Fund changes
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 that would prevent the Fund from
repatriating invested capital and dividends, withhold portions of interest and
dividends at the source, or impose other taxes, with respect to this Fund's
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.
This Fund 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.
The Board of Trustees considers at least annually the
likelihood of the imposition by any foreign government of exchange control
restrictions that would affect the liquidity of the Fund's 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
Board also considers the degree of risk attendant to holding portfolio
securities in
B-16
<PAGE>
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 the
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.
Perfect correlation between the Emerging Markets Fund's
hedging positions and its 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.
INVESTMENT RESTRICTIONS
The following policies and investment restrictions have been
adopted by the Funds 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:
1. With respect to 75% 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 the Fund would be invested in such issuer.
There are no limitations with respect to the remaining 25% of the Fund's total
assets, except to the extent other investment restrictions may be applicable.
2. 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 10% 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.
3. (a) Borrow money, except temporarily for temporary
or emergency purposes from a bank and then not in excess of 10% of its total
assets (at the lower of cost or fair market value). Any such borrowing will be
made only if immediately thereafter there is
B-17
<PAGE>
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.
(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.
4. Except as required in connection with permissible hedging
activities, purchase securities on margin or underwrite securities. (This does
not preclude the Fund from obtaining such short-term credit as may be necessary
for the clearance of purchases and sales of its portfolio securities.)
5. Buy or sell real estate (including interests in real estate
limited partnerships or issuers that qualify as real estate investment trusts
under federal income tax law) or commodities or commodity contracts; however,
the 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.
6. Buy or sell interests in oil, gas or mineral exploration or
development leases and programs. (This does not preclude permissible investments
in marketable securities of issuers engaged in such activities.)
7. Invest more than 5% of the value of its total assets in
securities of any issuer which has not had a record, together with its
predecessors, of at least three years of continuous operation. (This is an
operating policy which may be changed without shareholder approval.)
8. 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.
9. Invest, in the aggregate, more than 15% 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 the Fund. (This is an operating policy
which may be changed without shareholder approval, consistent with the
Investment Company Act and changes in relevant SEC interpretations.)
B-18
<PAGE>
10. 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.)
11. 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.) For purposes of this restriction, the Fund generally
relies on the U.S. Office of Management and Budget's Standard Industrial
Classifications.
12. Issue senior securities, as defined in the Investment
Company Act, except that this restriction shall not be deemed to prohibit the
Fund from (a) making any permitted borrowings, mortgages or pledges, or (b)
entering into permissible repurchase and dollar roll transactions.
13. 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:
(A) such options are written by other persons, and
(B) the aggregate premiums paid on all such options
that are held at any time do not exceed 5% of the Fund's total assets. (This is
an operating policy which may be changed without shareholder approval.)
14. 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.)
15. Invest in warrants, valued at the lower of cost or market,
in excess of 5% of the value of the Fund's net assets. Included in such amount,
but not to exceed 2% of the value of the Fund's net assets, may be warrants
which are not listed on the New York Stock Exchange or American Stock Exchange.
Warrants acquired by the Fund in units or attached to securities may be deemed
to be without value. (This is an operating policy which may be changed without
shareholder approval.)
16. (a) Purchase or retain in the Fund's portfolio any
security if any officer, trustee or shareholder of the issuer is at the same
time an officer, trustee or employee of the Trust or of its investment adviser
and such person owns beneficially more than 1/2 of 1% of the securities and all
such persons owning more than 1/2 of 1% own more than 5% of the outstanding
securities of the issuer.
B-19
<PAGE>
(b) Purchase more than 10% of the outstanding
voting securities of any one issuer. (This is an operating policy
which may be changed without shareholder approval.)
17. Enter into a futures contract or option on a futures
contract if, as a result thereof, more than 5% of the 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.
To the extent these restrictions reflect matters of operating
policy that may be changed without shareholder vote, they may be amended upon
approval by the Board of Trustees 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.
DISTRIBUTIONS AND TAX INFORMATION
Distributions. The Funds will 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 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 previous years), while a distribution from
capital gains, will be distributed to shareholders with and as a part of income
dividends. If during any year a Fund realizes a net gain on transactions
involving investments held more than 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 previous years) will be distributed and
treated as long-term capital gains in the hands of the shareholders regardless
of the length of time the Fund's shares may have been held.
Any per-share dividend or distribution 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.
B-20
<PAGE>
As stated in the Prospectus, dividends and other distributions
will generally be made in the form of additional shares of the Funds.
Tax Information. Each Fund intends to qualify and elect 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'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 a
Fund will not be subject to any federal income tax or excise taxes based on net
income. However, the Board 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, a 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, (b) derive less than 30% of its gross income each year
from the sale or other disposition of stock or securities (or options thereon)
held less than three months (excluding some amounts otherwise included in income
as a result of certain hedging transactions), and (c) 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 the 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.
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, a 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%
B-21
<PAGE>
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.
The Emerging Markets Fund may be subject to foreign
withholding taxes on dividends and interest earned with respect to securities of
foreign corporations. The Emerging Markets Fund may invest up to 10% of its
total assets in the stock of foreign investment companies that may 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 the Fund
derives from PFIC stock may be subject to a non-deductible federal income tax at
the Fund level. In some cases, the 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. That Fund will endeavor to
limit its exposure to the PFIC tax by 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, that
Fund may incur the PFIC tax in some instances.
The Trust and the Funds intend to comply with the requirements
of Section 817(h) of the Code and related regulations, including certain
diversification requirements that are in addition to the diversification
requirements of Subchapter M and the Investment Company Act. Failure to comply
with the requirements of Section 817(h) could result in taxation of the
insurance company and immediate taxation of the owners of Variable Contracts to
the full extent of appreciation under the contracts.
Shares of a Fund underlying Variable Contracts that comply
with the requirements of Section 817(h) and related regulations will generally
be treated as owned by the insurance company and not by the owners of Variable
Contracts. In that case, income derived from, and appreciation in, shares of the
Fund would not be currently taxable to the owners of Variable Contracts. Owners
of Variable Contracts that do not comply with the requirements of Section 817(h)
would generally be subject to immediate taxation on the appreciation under the
contracts.
Section 817(h) requires that the investment portfolios
underlying variable life insurance and variable annuity contracts be "adequately
diversified". Section 817(h) contains a safe harbor provision which provides
that a variable life insurance or variable annuity contract will meet the
diversification requirements if, as of the close of each calendar quarter, (i)
the assets underlying the contract meet the diversification standards for a
regulated investment company under Subchapter M of the Code, and (ii) no more
than 55% of the total assets of the account consist of cash, cash items, U.S.
government securities and securities of regulated investment companies.
B-22
<PAGE>
Treasury Department regulations provide an alternative test to
the safe harbor provision to meet the diversification requirements. Under these
regulations, an investment portfolio will be adequately diversified if (i) not
more than 55% of the value of its total assets is represented by any one
investment; (2) not more than 70% of the value of its total assets is
represented by any two investments; (3) not more than 80% of the value of its
total assets is represented by any three investments; and (4) not more than 90%
of the value of its total assets is represented by any four investments. These
limitations are increased for investment portfolios which are invested in whole
or in part in U.S. Treasury securities.
Stock of a regulated investment company, such as a Fund, held
in an insurance company's separate accounts underlying variable life insurance
or variable annuity contracts may be treated as a single investment for purposes
of the diversification rules of Section 817(h). A special rule in Section
817(h), however, allows a shareholder of a regulated investment company to
"look-through" the company and treat a pro rata share of the company's assets as
owned directly by the shareholder. This special "look-through" rule may make it
easier to comply with the diversification requirements of Section 817(h). To
qualify for "look-through" treatment, public access to the regulated investment
company must generally be limited to (i) the purchase of a variable contract,
(ii) life insurance companies' general accounts, and (iii) qualified pension or
retirement plans. Interests in the Funds are sold only to insurance company
separate accounts to fund the benefits of Variable Contracts, and to qualified
pension and retirement plans.
The investment objectives and strategies of the Funds are very
similar to those of other regulated investment companies that are managed by the
Manager and that are, unlike the Funds, available for purchase by the general
public. The Internal Revenue Service ("IRS") might assert that shares of a Fund
do not qualify for "look-through treatment" because shares of those other,
similar regulated investment companies are publicly available. The IRS recently
issued two private letter rulings that reserve this issue. The legislative
history of Section 817(h) indicates that the fact that a "similar" fund is
available to the public will not disqualify a fund that is available only
through the purchase of a variable life insurance or variable annuity contract
from "look- through" treatment.
Even if the diversification requirements of Section 817(h) are
met, the owner of a variable life insurance contract or the owner of a variable
annuity contract might be subject to current federal income taxation if the
owner has excessive control over the investments underlying the contract. The
Treasury Department has indicated that guidelines might be forthcoming that
address this issue. At this time, it is impossible to predict what the
guidelines will include and the extent, if any, to which they may be
retroactive.
B-23
<PAGE>
In order to maintain the Variable Contracts' status as
annuities or insurance contracts, the Trust may in the future find it necessary,
and reserves the right, to take certain actions, including, without limitation,
amending a Fund's investment objective (upon SEC or shareholder approval) or
substituting shares of one Fund for another.
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 the Fund is recorded as an asset and is subsequently adjusted to
the current market value of the option. Any gain or loss realized by the Funds
upon the expiration or sale of such options held by the Funds generally will be
capital gain or loss.
Any security, option or other position entered into or held by
the Fund that substantially diminishes a Fund's risk of loss from any other
position held by the 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 the 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 as short-term capital gain or loss.
B-24
<PAGE>
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.
Distributions and redemptions may be subject to state and
local income taxes, and the treatment thereof may differ from the federal income
tax treatment.
The above discussion and the related discussion in the
Prospectus are not intended to be complete discussions of all applicable tax
consequences of an investment in the Funds. The law firm of Heller, Ehrman,
White & McAuliffe has expressed no opinion in respect thereof. Shareholders are
advised to consult with their own tax advisers concerning the application of
foreign, federal, state and local taxes to the ownership of a Variable Contract
and to an investment in the Fund.
TRUSTEES AND OFFICERS
The Board of Trustees is responsible for the overall
management of the Funds, including general supervision and review of their
investment activities. The officers who administer the Funds' daily operations
are appointed by the Board of Trustees. The current Trustees and officers of the
Trust performing a policy-making function and their affiliations and principal
occupations for the past five years are set forth below (note that each of the
below Trustees and officers fill the same positions for The Montgomery Funds and
The Montgomery Funds II, two other investment companies advised by the Manager):
R. Stephen Doyle, Chairman of the Board, Chief Executive
Officer, Treasurer, Principal Financial and Accounting Officer
and Trustee (Age 55).*
600 Montgomery Street, San Francisco, California 94111. Mr.
Doyle has been the Chairman and a Director of Montgomery Asset
Management, Inc., the general partner of the Manager, and
Chairman of the Manager since April 1990. Mr. Doyle is a
managing director of the investment
- --------
* Trustee deemed an "interested person" of the Funds as defined in the
Investment Company Act.
B-25
<PAGE>
banking firm of Montgomery Securities, and has been employed
by Montgomery Securities since October 1983.
Mark B. Geist, President (Age 41)
600 Montgomery Street, San Francisco, California 94111. Mr.
Geist has been the President and a Director of Montgomery
Asset Management, Inc. and President of the Manager since
April 1990. From October 1988 until March 1990, Mr. Geist was
a Senior Vice President of Analytic Investment Management.
From January 1986 until October 1988, Mr. Geist was a Vice
President with RCB Trust Co. Prior to January 1986, Mr. Geist
was the Pension Fund Administrator for St. Regis Co., a
manufacturing concern.
Jack G. Levin, Secretary (Age 47)
600 Montgomery Street, San Francisco, California 94111. Mr.
Levin has been Director of Legal and Regulatory Affairs for
Montgomery Securities since January 1983.
Mary Jane Fross, Treasurer (Age 43)
600 Montgomery Street, San Francisco, California 94111. Ms.
Fross is Manager of Mutual Fund Administration and Finance for
the Manager. From November 1990 to her arrival at the Manager
in 1993, Ms. Fross was Financial Analyst/Senior Accountant
with Charles Schwab, San Francisco, California. From 1989 to
November 1990, Ms. Fross was Assistant Controller of Bay Bank
of Commerce, San Leandro, California.
Roger W. Honour, Vice President (Age 40)
600 Montgomery Street, San Francisco, California 94111. Mr.
Honour is a Managing Director and Senior Portfolio Manager for
the Manager. Roger Honour joined the Manager in June 1993 as
Managing Director and Portfolio Manager responsible for mid-
and large-capitalization growth stock investing. Prior to
joining Montgomery Asset Management, he was Vice President and
Portfolio Manager at Twentieth Century Investors from 1992 to
1993. Mr. Honour was a Vice President and Portfolio Manager at
Alliance Capital Management from 1990 to 1992. Mr. Honour was
a Vice President of Institutional Equity Research and Sales at
Merrill Lynch Capital Markets from 1980 to 1990.
Josephine S. Jimenez, Vice President (Age 40)
600 Montgomery Street, San Francisco, California 94111. Ms.
Jimenez, CFA, is a Managing Director and Portfolio Manager for
the Manager. From 1988 through 1991, Ms. Jimenez worked at
Emerging Markets Investors
B-26
<PAGE>
Corporation/Emerging Markets Management in Washington, D.C. as
senior analyst and portfolio manager.
Bryan L. Sudweeks, Vice President (Age 40)
600 Montgomery Street, San Francisco, California 94111. Dr.
Sudweeks, Ph.D., CFA, is a Managing Director and Portfolio
Manager for the Manager. Prior to joining the Manager, he was
a senior analyst and portfolio manager at Emerging Markets
Investors Corporation/Emerging Markets Management in
Washington, D.C. Previously, Dr. Sudweeks was a Professor of
International Finance and Investments at George Washington
University and also served as an Adjunct Professor of
International Investments from 1988 until May 1991.
John A. Farnsworth, Trustee (Age 53)
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 (Age 51)
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 Herbert, Trustee (Age 46)
2636 Vallejo Street, San Francisco, California 94123. Ms.
Herbert was a managing director of Morgan Guaranty Trust
Company with responsibility for lending, corporate finance and
investment banking for that firm's West Coast office at which
she worked from January 1979 through September 1991. Ms.
Herbert is a member of the Boards of the following
organizations: California Pacific Medical Center and Schools
of the Sacred Hearts.
The Trustees who are not affiliated with the Manager receive
an annual retainer and fees and expenses for each regular
B-27
<PAGE>
Board meeting attended. Except for the Funds' payment of part of the
compensation for the Trust's Treasurer, the officers of the Trust receive no
compensation directly from them for performing the duties of their offices.
However, those officers and Trustees who are officers or partners of the Manager
or Montgomery Securities may receive remuneration indirectly because the Manager
will receive a management fee from the Funds and Montgomery Securities will
receive commissions for executing portfolio transactions for the Funds.
INVESTMENT MANAGEMENT AND OTHER SERVICES
As stated in the Prospectus, investment management services
are provided to the Funds by Montgomery Asset Management, L.P., the Manager,
pursuant to an Investment Management Agreement initially dated April 24, 1995
(the "Agreement"). The Agreement is in effect with respect to the Funds for two
years after each Fund's inclusion in the Agreement (on or around its beginning
of public operations) and then continues for periods not exceeding one year so
long as such continuation is approved at least annually by (i) the Board of
Trustees or the vote of a majority of the outstanding shares of a Fund, and (ii)
a majority of the Trustees who are not interested persons of any party to the
Agreement, in each case by a vote cast in person at a meeting called for the
purpose of voting on such approval. The Agreement may be terminated at any time,
without penalty, by a Fund or the Manager upon 60 days' written notice, and is
automatically terminated in the event of its assignment as defined in the
Investment Company Act.
For services performed under the Agreement, the Funds pay the
Manager a monthly management fee (accrued daily) based upon the average daily
net assets of the Funds at the following annual rates:
Average Daily Net Annual
Fund Assets Rate
---- ------------------ ------
Growth Fund First $500 million 1.00%
Next $500 million 0.90%
Over $1 billion .80%
Emerging Markets Fund First $250 million 1.25%
Over $250 million 1.00%
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 one and one-quarter percent
(1.25%) of the Growth Fund's average net assets and one and three quarters
percent (1.75%) of the Emerging Markets Fund's average net assets. The Manager
also may
B-28
<PAGE>
voluntarily reduce additional amounts to increase the return to the Funds'
shareholders. Any reductions made by the Manager in its fees are subject to
reimbursement by the Funds within the following three years provided the Fund is
able to effect such reimbursement and remain in compliance with the foregoing
expense limitations.
Operating expenses for purposes of the Agreement include the
Manager's management fee but do not include any taxes, interest, brokerage
commissions, if any, expenses incurred in connection with any merger or
reorganization and any extraordinary expenses such as litigation. The Manager
may also at its discretion from time to time pay for other Fund expenses from
its own funds or reduce the management fee of the Funds in excess of that
required.
The Agreement was approved with respect to the Funds by the
Board of Trustees at duly called meetings. In considering the Agreement, the
Trustees specifically considered and approved the provision which permits the
Manager to seek reimbursement of any reductions made to its management fee
within the three-year period following such reduction subject to the Funds'
ability to effect such reimbursement and remain in compliance with applicable
expense limitations. The Board of Trustees also considered that any such
management fee reimbursement will be accounted for on the financial statements
of the Funds as a contingent liability of the Funds and will appear as a
footnote to the Funds' financial statements until such time as it appears that
the Funds will be able to effect such reimbursement. At such time as it appears
probable that the Funds are able to effect such reimbursement, the amount of
reimbursement that the Funds are able to effect will be accrued as an expense of
the Funds for that current period.
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 Trust and who are also affiliated
persons of the Manager.
The use of the name "Montgomery" by the Trust 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.
Montgomery Securities may provide certain administrative
services to the Funds on behalf of the Manager. Montgomery Securities 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 Montgomery Securities with those of the Funds, and may restrict the
ability of Montgomery Securities to provide services to the Funds.
Morgan Stanley Trust Company (the "Custodian") serves as
principal custodian of the Funds' assets, which are maintained at
B-29
<PAGE>
the Custodian's principal office and at the offices of its branches and agencies
throughout the world. The Custodian has entered into agreements with foreign
sub-custodians approved by the Board of Trustees pursuant to Rule 17f-5 under
the Investment Company Act. The Custodian, its branches and sub-custodians
generally hold certificates 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 upon 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 Agreement, the Manager determines which securities
are to be purchased and sold by a Fund and which broker-dealers are eligible to
execute the Fund's portfolio transactions, subject to the instructions of, and
review by, that Fund and the Board of Trustees. 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 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
B-30
<PAGE>
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 the Funds, 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.
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 a 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 a Fund or
assist the Manager in carrying out its responsibilities to a Fund. The standard
of reasonableness is to be measured in light of the Manager's overall
responsibilities to a Fund. The Board of Trustees reviews 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 the Fund are made independently from
those of other client accounts of the Manager or its affiliates. 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. To the extent any of
these client accounts and a fund seek to acquire the same security at the same
time, 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, the Funds 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 will be allocated between the 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. It is recognized that in some
cases this system could have a detrimental effect on the price or value of the
security insofar as a Fund is concerned. In other
B-31
<PAGE>
cases, however, it is believed that the ability of a Fund to participate in
volume transactions may produce better executions for that Fund.
In addition, on occasion, situations may arise in which legal
and regulatory considerations will preclude trading for the Funds' accounts by
reason of activities of Montgomery Securities or its affiliates. It is the
judgment of the Board of Trustees that the Funds will not be materially
disadvantaged by any such trading preclusion and that the desirability of
continuing its advisory arrangements with the Manager and the Manager's
affiliation with Montgomery Securities and other affiliates of Montgomery
Securities outweigh any disadvantages that may result from the foregoing.
The Manager's sell discipline for Funds' investment 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. The Funds will limit investments in illiquid securities to
15% of their net assets.
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.
Subject to the foregoing policies, the Funds may use
Montgomery Securities as a broker to execute portfolio transactions. In
accordance with the provisions of Section 17(e) of the Investment Company Act
and Rule 17e-1 promulgated thereunder, the Trust has adopted certain procedures
which are designed to provide that commissions payable to Montgomery Securities
are reasonable and fair as compared to the commissions received by other brokers
in connection with comparable transactions involving similar securities being
purchased or sold on securities or options exchanges during a comparable period
of time. In determining the commissions to be paid to Montgomery Securities, it
is the policy of the Funds that such commissions will be, in the judgment of the
Manager, (i) at least as favorable as those which would be charged by other
qualified brokers having comparable execution capability, and (ii) at least as
favorable as commissions contemporaneously charged by Montgomery Securities on
B-32
<PAGE>
comparable transactions for its most favored unaffiliated customers, except for
(a) accounts for which Montgomery Securities acts as a clearing broker for
another brokerage firm, and (b) any customers of Montgomery Securities
considered by a majority of the Trustees who are not interested persons to be
not comparable to the Funds. The Funds do not deem it practicable and in their
best interests to solicit competitive bids for commission rates on each
transaction. However, consideration is regularly given to information concerning
the prevailing level of commissions charged on comparable transactions by other
qualified brokers. The Board of Trustees reviews the procedures adopted by the
Trust with respect to the payment of brokerage commissions at least annually to
ensure their continuing appropriateness, and determines, on at least a quarterly
basis, that all such transactions during the preceding quarter were effected in
compliance with such procedures.
The Funds have also adopted certain procedures, pursuant to
Rule 10f-3 under the Investment Company Act, which must be followed any time a
Fund purchases or otherwise acquires, during the existence of an underwriting or
selling syndicate, a security of which Montgomery Securities is an underwriter
or member of the underwriting syndicate. The Board of Trustees will review such
procedures at least annually for their continuing appropriateness and determine,
on at least a quarterly basis, that any such purchases made during the preceding
quarter were effected in compliance with such procedures.
The Funds do not effect securities transactions through
brokers in accordance with any formula, nor do they effect securities
transactions through such brokers solely for selling shares of a Fund. However,
as stated above, Montgomery Securities may act as one of the Funds' brokers in
the purchase and sale of portfolio securities, and other 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 Fund
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
The Trust reserves the right in its sole discretion to (i)
suspend the continued offering of the Funds' shares, and (ii) reject purchase
orders in whole or in part when in the judgment of the Manager such rejection is
in the best interests of the Funds.
The Funds may suspend the right of redemption or postpone the
date of payment during any period when (a) 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; (b) an
B-33
<PAGE>
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
(c) for such other period as the SEC may permit for the protection of a Fund's
shareholders.
The value of shares on redemption or repurchase may be more or
less than the shareholder's cost, depending upon the market value of a Fund's
portfolio securities at the time of redemption or repurchase.
DETERMINATION OF NET ASSET VALUE
The net asset value per share of each 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
assets are divided by the number of shares of the 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., New
York City time, on each day the NYSE is open for trading. It is expected that
the Exchange will be closed on Saturdays and Sundays and on New Year's Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas. The Funds may, but do not expect to, determine
the net asset value 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 the net asset value per share.
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 which will not be
reflected in the computation of that Fund's net asset value unless the Board of
Trustees 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 Board of Trustees.
B-34
<PAGE>
The Funds' securities, including ADRs and EDRs, 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. In cases where securities are traded on
more than one exchange, the securities 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 Board of Trustees.
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 Board of Trustees, or at fair value as determined in good faith
by procedures approved by the Board of Trustees. Any such pricing service, in
determining value, will use information with respect to transactions in the
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 Board of Trustees.
If any securities held by a Fund are restricted as to resale
or do not have readily available market quotations, the Manager and the Trust's
Pricing Committee determine their fair value, following procedures approved by
the Board of Trustees. The Board of Trustees periodically reviews such
valuations and
B-35
<PAGE>
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
Board of Trustees in good faith will establish a conversion rate for such
currency.
All other assets of the Funds are valued in such manner as the
Board of Trustees in good faith deems appropriate to reflect their fair value.
PERFORMANCE INFORMATION
As noted in the Prospectus, the Funds may, from time to time
and in accordance with applicable law, quote various performance figures in
advertisements and other communications to illustrate their past performance.
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. Each Fund's "average annual total
B-36
<PAGE>
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
$10,000.
ERV = Ending Redeemable Value of a hypothetical
$10,000 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.
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.
Shareholders 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.
B-37
<PAGE>
Comparisons. 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. The following publications, indices and
averages (as well as similar publications, indices and averages) may be used:
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) Lipper - Mutual 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.
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, a shareholder
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 ranking services like Lipper Analytical Services,
Inc., VARDS and Morningstar, Inc.
The investment results of the Funds will fluctuate over time,
and any presentation of the Funds' total returns for any period should not be
considered as a representation of what an investment may earn or what a
shareholder'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 why the Manager believes
shareholders should invest in the Funds. For example, the Funds may refer to the
belief that over two-thirds of the world's investment opportunities are to be
found outside of the United States, compared to approximately 30 percent 20
years ago. The Manager may also state that the Funds are "performance oriented
portfolios."
Research. Largely inspired by its affiliate, Montgomery
Securities -- which has established a tradition for specialized research in
emerging growth companies -- the portfolio management of the Funds has developed
its own tradition of intensive research.
B-38
<PAGE>
The Manager has made intensive research one of the important characteristics of
the Montgomery style.
The portfolio managers for the 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 generally
applies to the Manager and the Trust.
GENERAL INFORMATION
Shareholders 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 Trust have been assumed by the Emerging Markets Fund and the
Growth Fund. The Manager has agreed, to the extent necessary, to advance the
organizational expenses incurred by the Funds and will be reimbursed for such
expenses after commencement of the Funds' operations. Shareholders purchasing
shares of the Funds bear such expenses only as they are amortized daily against
the Funds' investment income.
As noted above, the Custodian acts as custodian of the
securities and other assets of the Funds, and provides accounting and pricing
services to the Funds. The Custodian does not participate in decisions relating
to the purchase and sale of securities by the Funds.
Deloitte & Touche, LLP, 50 Fremont Street, San Francisco,
California 94105, are the independent auditors for the Fund.
The validity of shares offered hereby will be passed on by
Heller, Ehrman, White & McAuliffe, 333 Bush Street, San
Francisco, California 94104.
Among the Board of Trustees' powers enumerated in the
Declaration of Trust is the authority to terminate the Trust or any series of
the Trust, or to merge or consolidate the Trust or one or more of its series
with another trust or company without the need to seek shareholder approval of
any such action.
As of April 7, 1995, to the knowledge of the Funds, the
Manager owned of record 100% of the outstanding shares of the Funds.
The Trust is registered with the SEC as a non-diversified
management investment company. Such a registration does not
B-39
<PAGE>
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 Statement filed with the SEC. Copies of the
Registration Statement may be obtained from the SEC upon payment of the
prescribed fee.
FINANCIAL STATEMENTS
Attached to this Statement of Additional Information are the
Independent Auditors' Report for the Montgomery Variable Series: Growth Fund,
dated as of April 11, 1995, the accompanying Statement of Assets and Liabilities
as of April 7, 1995 and the Notes to Financial Statement.
B-40
<PAGE>
Appendix A
Description of Moody's corporate bond ratings:
Aaa - Bonds which are rated Aaa are judged to be the best quality. They carry
the smallest degree of investment risk and are generally referred to a
"gilt-edged." 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 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 are generally 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 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 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 predominantly speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and thereby
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the 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 represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
B-41
<PAGE>
Nonrated - where no rating has been assigned or where a rating has been
suspended or withdrawn, it may be for reasons unrelated to the quality of the
issue.
Should no rating be assigned, the reason may be one of the following:
1. An application for rating was not received or accepted.
2. The issue or issuer belongs to a group of securities that are not rated as a
matter of policy.
3. There is a lack of essential data pertaining to the issuer.
4. The issue was privately placed, in which case the rating is not published in
Moody's publications.
Suspension or withdrawal may occur if new and material circumstances arise, the
effects of which preclude satisfactory analysis; if there is no longer available
reasonably up-to-date data to permit a judgment to be formed; if a bond is
called for redemption; or for other reasons.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa 1,
A 1, Baa 1, Ba 1 and B 1.
Description of Standard & Poor's Corporation's corporate bond ratings:
AAA - This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA - Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong and, in the majority of instances,
they differ from AAA issues only in small degree.
A - Bonds rated A have a strong capacity to pay principal and interest, although
they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions.
BBB - Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay principal and interest for bonds in this capacity
than for bonds in the A category.
BB, B, CCC, CC, C - Bonds rated BB, B, CCC, CC, and C are regarded, on balance,
as predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligations. BB
indicates the lowest degree
B-42
<PAGE>
of speculation and C the highest degree of speculation. While such bonds will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions.
C1 - The rating C1 is reserved for income bonds on which no interest is being
paid.
D - Debt rated D is in default, and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or Minus (-) - The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
NR - indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that Standard & Poor's does not rate a
particular type of obligation as a matter of policy.
Fitch Investor's Service
AAA - Bonds and notes rated AAA are regarded as being of the highest quality,
with the obligor having an extraordinary ability to pay interest and repay
principal which is unlikely to be affected by reasonably foreseeable events.
AA - Bonds and notes rated AA are regarded as high quality obligations. The
obligor's ability to pay interest and repay principal, while very strong, is
somewhat less than for AAA-rated securities, and more subject to possible change
over the term of the issue.
A - Bonds and notes rated A are regarded as being of good quality. The obligor's
ability to pay interest and repay principal is strong but may be more vulnerable
to adverse changes in economic conditions and circumstances than bonds and notes
with higher ratings.
BBB - Bonds and notes rated BBB are regarded as being of satisfactory 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 weaken this ability than bonds with higher ratings.
Note: Fitch ratings may be modified by the addition of a plus (+) or a minus (-)
sign to show relative standing within the major rating categories. These are
refinements more closely reflecting strengths and weaknesses, and are not to be
used as trend indicators.
B-43
