As filed with the Securities and Exchange Commission on January 16, 1996
Registration Nos. 33-84450
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811-8782
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Post-Effective Amendment No. 1
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 2
THE MONTGOMERY FUNDS III
(Exact Name of Registrant as Specified in its Charter)
600 Montgomery Street
San Francisco, California 94111
(Address of Principal Executive Office)
1-800-572-3863
(Registrant's Telephone Number, Including Area Code)
JACK G. LEVIN
600 Montgomery Street
San Francisco, California 94111
(Name and Address of Agent for Service)
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It is proposed that the filing will become effective:
___ immediately upon filing pursuant to Rule 485(b)
___ on ________________, pursuant to Rule 485(b)
___ 60 days after filing pursuant to Rule 485(a)(1)
X 75 days after filing pursuant to Rule 485(a)(2)
---
___ on ________________, pursuant to Rule 485(a)
Pursuant to Rule 24f-2 under the Investment Company Act of 1940, the
Registrant has registered an indefinite number of securities under the
Securities Act of 1933. The Rule 24f-2 Notice for the Registrant's fiscal year
ended December 31, 1995 is expected to be filed on or before February 29, 1996.
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Please Send Copy of Communications to:
JULIE ALLECTA, ESQ. JOAN E. BOROS, ESQ.
MATTHEW A. ANDERSON, ESQ. Katten Muchin & Zavis
Heller, Ehrman, White & McAuliffe 1025 Thomas Jefferson Street, N.W.
333 Bush Street East Lobby - Suite 700
San Francisco, CA 94104 Washington, D.C. 20007-5201
(415) 772-6000 (202) 625-3500
Total number of pages 87. Exhibit Index appears at 85.
<PAGE>
THE MONTGOMERY FUNDS III
CONTENTS OF POST-EFFECTIVE AMENDMENT
This post-effective amendment to the registration statement of the Registrant
contains the following documents:*
Facing Sheet
Contents of Post-Effective Amendment
Cross-Reference Sheet for The Montgomery Funds III
Part A - Prospectus for Montgomery Variable Series: International
Small Cap Fund
Part B - Combined Statement of Additional Information for Montgomery
Variable Series: Growth Fund, Montgomery Variable Series:
Emerging Markets Fund and Montgomery Variable Series:
International Small Cap Fund
Part C - Other Information
Signature Page
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* This Amendment does not relate to the following documents: Prospectuses
for Montgomery Variable Series: Growth Fund and Montgomery Variable
Series: Emerging Markets Fund.
<PAGE>
<TABLE>
THE MONTGOMERY FUNDS III
CROSS REFERENCE SHEET
FORM N-1A
PART A: INFORMATION REQUIRED IN PROSPECTUS
(PROSPECTUSES FOR MONTGOMERY VARIABLE SERIES: GROWTH FUND,
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND AND MONTGOMERY
VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND)
<CAPTION>
LOCATION IN THE
N-1A REGISTRATION STATEMENT
ITEM NO. ITEM BY HEADING
- -------- ---- ----------------------
<S> <C> <C>
1. Cover Page Cover Page
2. Synopsis Cover Page
3. Condensed Financial Not applicable
Information
4. General Description Cover Page,
of Registrant "The Fund's Investment Objective and Policies,"
"Portfolio Securities," "Other Investment Practices," "Risk
Considerations" and "General Information"
5. Management of "The Fund's Investment Objective and Policies,"
the Fund "Management of the Fund" and
"How to Invest in the Fund"
5A. Management's Discussion Not Applicable (to be contained in the Funds' Annual
of Fund Performance Report)
6. Capital Stock and "Dividends and Distributions,"
Other Securities "Taxation" and "General Information"
7. Purchase of Securities "How to Invest in the Fund,"
Being Offered "How Net Asset Value is Determined" and
"General Information"
8. Redemption or "How to Redeem an Investment in the Fund" and
Repurchase "General Information"
9. Pending Legal Not Applicable
Proceedings
</TABLE>
<PAGE>
<TABLE>
PART B: INFORMATION REQUIRED IN
STATEMENT OF ADDITIONAL INFORMATION
(COMBINED STATEMENT OF ADDITIONAL INFORMATION
FOR MONTGOMERY VARIABLE SERIES: GROWTH FUND,
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND AND
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND)
<CAPTION>
LOCATION IN THE
N-1A REGISTRATION STATEMENT
ITEM NO. ITEM BY HEADING
- -------- ---- ----------------------
<S> <C> <C>
10. Cover Page Cover Page
11. Table of Contents Table of Contents
12. General Information "The Trust" and "General Information"
and History
13. Investment Objectives "Investment Objectives and Policies of the Funds," "Risk
Considerations" and "Investment Restrictions"
14. Management of the "Trustees and Officers"
Registrant
15. Control Persons and "Trustees and Officers" and
Principal Holders of "General Information"
Securities
16. Investment Advisory "Investment Management and Other Services"
and Other Services
17. Brokerage Allocation "Execution of Portfolio Transactions"
18. Capital Stock and "The Trust" and "General Information"
Other Securities
19. Purchase, Redemption "Additional Purchase and Redemption Information"
and Pricing of and "Determination of Net Asset Value"
Securities Being
Offered
20. Tax Status "Distributions and Tax Information"
21. Underwriters Not applicable
22. Calculation of "Performance Information"
Performance Data
23. Financial Statements "Financial Statements"
</TABLE>
<PAGE>
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PART A
PROSPECTUS
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<PAGE>
MONTGOMERY VARIABLE SERIES:
INTERNATIONAL SMALL CAP FUND PROSPECTUS
March __, 1996
THE MONTGOMERY FUNDS III
600 MONTGOMERY STREET
SAN FRANCISCO, CALIFORNIA 94111
(800) 572-3863
Shares of Montgomery Variable Series: International Small Cap Fund, a 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: International Small Cap Fund ("International Small
Cap Fund") seeks capital appreciation by investing primarily in equity
securities of companies outside the U.S. having total market capitalizations of
less than $1 billion, sound fundamental values and potential for long-term
growth at a reasonable price. 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 March __, 1996, 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. If you are
viewing the electronic version of this prospectus through an online computer
service, you may request a printed version free of charge by calling (800)
572-3863.
The Internet address for the Montgomery Funds III is
http://www.xperts.montgomery.com/1.
TABLE OF CONTENTS
- ------------------------------------------------------------
The Fund's Investment Objective and Policies 2
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Portfolio Securities 2
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Other Investment Practices 4
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Risk Considerations 7
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Management of the Fund 8
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How To Invest in the Fund 10
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How To Redeem an Investment in the Fund 10
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Exchange Privileges and Restrictions 10
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How Net Asset Value is Determined 10
- ------------------------------------------------------------
Dividends and Distributions 10
- ------------------------------------------------------------
Taxation 10
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General Information 11
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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.
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THE FUND'S INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objectives 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 4, and
certain risks associated with investments in the Fund are described in those
sections as well as in "Risk Considerations" beginning on page 7.
o MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL
CAP FUND
The investment objective of Montgomery International Small Cap Fund (the
"International Small Cap Fund") is capital appreciation, which under normal
conditions it seeks by investing at least 65% of its total assets in equity
securities of companies outside the United States having total market
capitalizations of less than $1 billion. The Fund generally invests the
remaining 35% of its total assets in a similar manner but may invest those
assets in companies having market capitalizations of $1 billion or more, or in
debt securities, including up to 5% of its total assets in debt securities rated
below investment grade. See "Portfolio Securities," "Risk Considerations" and
the Appendix in the Statement of Additional Information.
This Fund targets companies with potential for above average, long-term growth
in sales and earnings on a sustained basis with securities reasonably priced at
the time of purchase, in the Manager's opinion, compared to the potential for
capital appreciation. In evaluating investments, the Fund considers a number of
factors, including a company's per-share sales and earnings growth; return on
capital; balance sheet; financial and accounting policies; overall financial
strength; industry sector; competitive advantages and disadvantages; research,
product development and marketing; new technologies or services; pricing
flexibility; quality of management; and general operating characteristics.
This Fund may invest substantially in securities denominated in one or more
foreign currencies. Under normal conditions, it invests in at least three
different countries outside the U.S., but no country may represent more than 40%
of its total assets. The Manager uses its financial expertise and research
capabilities in markets throughout the world in attempting to identify those
countries, currencies and companies providing the greatest potential for
long-term growth. See "Risk Considerations."
Oscar A. Castro and John D. Boich are responsible for managing the International
Small Cap Fund's portfolio. 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, and 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. 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 that permits the holder to buy a specified number of
shares of the issuer's 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 specified stock index. A
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warrant not exercised or disposed of by its expiration date expires worthless.
PRIVATIZATIONS
The Fund believes that foreign government programs of selling interests in
government-owned or controlled enterprises ("privatizations") may represent
opportunities for significant capital appreciation, and the Fund may invest in
privatizations. The ability of U.S. entities such as this Fund to participate in
privatizations may be limited by local law, or the terms for participation may
be less advantageous than for local investors. There can be no assurance that
privatization programs will be successful.
SPECIAL SITUATIONS
The Fund believes that carefully selected investments in joint ventures,
cooperatives, partnerships, private placements, unlisted securities and similar
vehicles (collectively, "special situations") could enhance its capital
appreciation potential. This Fund may also invest in certain types of vehicles
or derivative securities that represent indirect investments in foreign markets
or securities in which it is impracticable for the Fund to invest directly.
Investments in special situations may be illiquid, as determined by the Manager
based on criteria approved by the Board of Trustees. This Fund does not invest
more than 15% of its net assets in illiquid investments, including special
situations.
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.
Because of restrictions on direct investment by U.S. entities in certain
countries, other investment companies may provide the most practical or only way
for the Fund to invest in certain markets. Such investments may involve the
payment of substantial premiums above the net asset value of those investment
companies' portfolio securities and are subject to limitations under the
Investment Company Act. This Fund also may incur tax liability to the extent it
invests in the stock of a foreign issuer that is a "passive foreign investment
company" regardless of whether such "passive foreign investment company" makes
distributions to the 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 exceed associated costs. As a
shareholder in an investment company, the Fund bears its ratable share of that
investment company's expenses, including advisory and administration fees. In
accordance with applicable state regulatory provisions, 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 Fund may purchase debt securities that complement its objective of capital
appreciation, through anticipated favorable changes in relative foreign exchange
rates, in relative interest rate levels, or in the creditworthiness of issuers.
In selecting debt securities, the Manager seeks out good credits and analyzes
interest rate trends and specific developments that may affect individual
issuers. As an operating policy that may be changed by the Board of Trustees,
this Fund will not invest more than 5% of its total assets in debt securities
rated lower than BBB by S&P, Baa by Moody's or BBB by Fitch, or in unrated debt
securities deemed to be of comparable quality by the Manager using guidelines
approved by the Board of Trustees. Subject to this limitation, this Fund may
invest in any debt security, including securities in default. After its purchase
by the Fund a debt security may cease to be rated or its rating may be reduced
below that required for purchase by the Fund. Neither event would require the
elimination of that security from the Fund's portfolio. However, a security
downgraded below the Fund's minimum credit levels generally would be retained
only if such retention was determined by the Manager and subsequently by the
Board of Trustees to be in the best interests of the Fund. See "Risk
Considerations."
In addition to traditional corporate, government and supranational debt
securities, the Fund may invest in external (i.e., to foreign lenders) debt
obligations issued by the governments, governmental entities and companies of
emerging market countries.
The percentage distribution between equity and debt will vary from country to
country. The following factors, among others, will influence the proportion of
the Fund's assets to be invested in equity securities versus debt securities:
levels and anticipated trends in inflation and interest rates; expected rates of
economic growth and corporate profits growth; changes in government policy,
including regulations governing industry, trade, financial markets, and foreign
and domestic investment; solvency and expected trends of government finances;
and conditions of the balance of payments and changes in the terms of trade.
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
3
<PAGE>
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.
ASSET-BACKED SECURITIES
The Fund may invest up to 5% of its total assets in asset-backed securities,
which represent a direct or indirect participation in, or are secured by and
payable from, pools of assets, such as motor vehicle installment sales
contracts, installment loan contracts, leases of various types of real and
personal property and receivables from revolving credit (e.g., credit card)
agreements. Payments or distributions of principal and interest on asset-backed
securities may be supported by credit enhancements, such as various forms of
cash collateral accounts or letters of credit. Like mortgage-related securities,
these securities are subject to the risk of prepayment. See "Risk
Considerations."
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 risks.
REPURCHASE AGREEMENTS
The Fund may enter into repurchase agreements. Pursuant to a repurchase
agreement, a 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, repurchase agreements are considered to be loans by the Fund and
must be fully collateralized by cash, letters of credit, U.S. Government
securities or other high-grade liquid debt securities ("Segregable Assets"),
either placed in a segregated account or separately identified and rendered
unavailable for investment. If the seller defaults on its obligation to
repurchase the underlying security, the Fund may experience delay or difficulty
in exercising its rights to realize upon the security, may incur a loss if the
value of the security declines and may incur disposition costs in liquidating
the security. See the Statement of Additional Information for further
information.
BORROWING
The Fund may borrow money from banks, in an aggregate amount not to exceed 10%
of the value of the Fund's total assets for temporary or emergency purposes. 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 to a financial institution a security that it holds
and agrees to repurchase the same security at an agreed-upon price and date.
Although reverse repurchase agreements are fully collateralized with Segregable
Assets, 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 portfolio in an effort to increase total return.
Although leverage creates an opportunity for increased income and gain, it also
creates special risk considerations. For example, leveraging may magnify changes
in the net asset value of the Fund's shares and in the yield on its portfolio.
Although the principal of such borrowings will be fixed, the Fund's assets may
change in value while the borrowing is outstanding. Leveraging creates interest
expenses that can exceed the income from the assets retained. 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 with Segregable Assets in an
amount at least equal to the current market value of the loaned securities, plus
accrued interest. Such Segregable Assets are either placed in a segregated
account or are separately identified and rendered 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
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<PAGE>
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, as the case may be. 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 Segregable Assets equal
to the value of the when-issued or forward commitment securities and causes the
Segregable 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 the effect of 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,
swaps 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. The Board of Trustees has adopted
derivative guidelines that require the Board to review each new type of
derivative that may be used by the Fund. 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. See
the Statement of Additional Information for further information on related risks
and other special considerations.
FORWARD CURRENCY CONTRACTS. A forward currency contract 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 currency movements will not be accurately predicted.
OPTIONS ON SECURITIES, SECURITIES INDICES AND CURRENCIES.
The Fund may purchase put and call options on securities and currencies traded
on U.S. exchanges and, to the extent permitted by law, foreign exchanges. 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 below the exercise price less the premium paid for the
option (or an adverse movement in the applicable currency relative to the U.S.
dollar). 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 are expected to 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 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 in order to hedge its positions in a
manner similar to its use of forward foreign exchange contracts and futures
contracts on currencies.
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 to purchase
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<PAGE>
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 Segregable Assets 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 hedging transactions by
the Fund 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
Segregable Assets) lengthens the effective duration of the Fund's portfolio.
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 or in
predicting market changes. In addition, the Fund pays commissions and other
costs in connection with such investments. Further discussion of the possible
risks 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 any securities 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 as
illiquid. The Fund also treats repurchase agreements with maturities in excess
of seven days as illiquid. Illiquid securities do not include securities that
are restricted from trading on formal markets for some period of time but for
which an active informal market exists, or securities that meet the requirements
of Rule 144A under the Securities Act of 1933, as amended, and that, subject to
review by the Board and guidelines adopted by the Board, the Manager has
determined to be liquid. State securities laws may impose further restrictions
on the amount of illiquid or restricted securities the Fund may purchase.
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 objective 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, and may result in the recognition of capital gains that may
be distributed to shareholders. The annual portfolio turnover for the Fund is
expected to be approximately 100%. Portfolio turnover in excess of 100% is
considered high and increases such costs. 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.
6
<PAGE>
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. The Fund may invest 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
more developed countries.
Foreign investments involve the possibility of expropriation, nationalization or
confiscatory taxation, taxation of income earned in foreign nations (including,
for example, withholding taxes on interest and dividends) or other taxes imposed
with respect to investments in foreign nations, foreign exchange controls (which
may include suspension of the ability to transfer currency from a given country
and repatriation of investments), default in foreign government securities, and
political or social instability or diplomatic developments that could adversely
affect investments. In addition, there is often less publicly available
information about foreign issuers than those in the U.S. Foreign companies are
often not subject to uniform accounting, auditing and financial reporting
standards. 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 certain markets have experienced times when
settlements did not keep 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 declined or result in claims against the Fund if it had
entered into a contract to sell the security. In certain countries, there is
less government supervision and regulation of business and industry practices,
stock exchanges, brokers and listed companies than in the 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 owned by 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 the 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 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 movements in exchange rates.
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,
and such devaluations in the currencies may have a 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 markets. 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.
SMALL COMPANIES
The Fund emphasizes investments in smaller companies that may benefit from the
development of new products and services. Such 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 their securities may fluctuate more than those of larger
issuers.
LOWER QUALITY DEBT
The Fund is authorized to invest in medium quality (rated or equivalent to BBB
by S&P or Baa by Moody's) and in limited amounts of high risk, lower quality
debt securities (i.e., securities rated below BBB or Baa) or, if unrated, deemed
to be of equivalent investment quality as determined by the Manager.
Medium-quality debt
7
<PAGE>
securities have speculative characteristics, and changes in economic conditions
or other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments than is the case with higher grade debt
securities.
As an operating policy, which may be changed by the Board of Trustees without
shareholder approval, the Fund does not invest more than 5% of its total assets
in debt securities rated lower than BBB by S&P or Baa by Moody's or, if unrated,
deemed to be of comparable quality as determined by the Manager using guidelines
approved by the Board of Trustees. The Board may consider a change in this
operating policy if, in its judgment, economic conditions change such that a
higher level of investment in high risk, lower quality debt securities would be
consistent with the interests of the Fund and its shareholders. Unrated debt
securities are not necessarily of lower quality than rated securities but they
may not be attractive to as many buyers. Regardless of rating levels, all debt
securities considered for purchase (whether rated or unrated) are analyzed by
the Manager to determine, to the extent reasonably possible, that the planned
investment is sound. The Fund, from time to time, may purchase defaulted debt
securities if, in the opinion of the Manager, the issuer may resume interest
payments in the near future.
INTEREST RATES
The market value of debt securities that are 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. The longer
the remaining maturity of a security, the greater is the effect of interest rate
change. Changes in the ability of an issuer to make payments of interest and
principal and in the market's perception of its creditworthiness also affect the
market value of that issuer's debt securities.
Prepayments of principal of mortgage-related securities by mortgagors or
mortgage foreclosures affect the average life of the mortgage-related securities
remaining in the Fund's portfolio. Mortgage prepayments are affected by the
level of interest rates and other factors, including general economic factors
and the underlying location and age of the mortgage. In periods of rising
interest rates, the prepayment rate tends to decrease, lengthening the average
life of a pool of mortgage-related securities. In periods of falling interest
rates, the prepayment rate tends to increase, shortening the average life of
such a pool. Reinvestment of prepayments may occur at higher or lower interest
rates than the original investment, affecting the Fund's yield.
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 its 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 broad distribution of securities
through its sales and trading organization.
PORTFOLIO MANAGERS
o MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL
CAP FUND
Oscar A. Castro is a Managing Director and Portfolio Manager. Before joining the
Manager, he was vice president/portfolio manager at G.T. Capital Management,
Inc. from 1991 to 1993. From 1989 to 1990, he was co-founder and co-manager of
The Common Goal World Fund, a global equity partnership. From 1987 to 1989, he
8
<PAGE>
was deputy portfolio manager/analyst at Templeton International.
John D. Boich is a Managing Director and Portfolio Manager. From 1990 to 1993,
he was vice president and portfolio manager at The Boston Company Institutional
Investors Inc. From 1989 to 1990, he was the founder and co-manager of The
Common Goal World Fund, a global equity partnership. From 1987 to 1989, Mr.
Boich worked as a financial adviser with Prudential-Bache Securities and E.F.
Hutton & Company.
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.
<TABLE>
<CAPTION>
| Average Daily Net Assets | Annual Rate
- -----------------------------------------------------------------------|---------------------------------------------|--------------
<S> <C> <C>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND | First $250 million | 1.25%
| Over $250 million | 1.00%
- -----------------------------------------------------------------------|---------------------------------------------|--------------
</TABLE>
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 its 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 and applicable state securities 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 International Small Cap Fund at or below one and nine-tenths of one percent
(1.90%) of its average net assets. The Manager also may voluntarily reduce
additional amounts to increase the return to the Fund's investors. 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 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 of 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, reasonableness of commissions, quality of services and
execution and 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
9
<PAGE>
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 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
10
<PAGE>
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. Accordingly, the Fund generally will not be liable for federal income
tax or excise tax based on net income except to the extent its earnings are not
distributed or are distributed in a manner that does not satisfy the
requirements of the Code pertaining to the timing of distributions. If the Fund
is unable to meet certain requirements of the Code, it may be subject to
taxation as a corporation. The Fund may also incur tax liability to the extent
it invests in "passive foreign investment companies." See "Portfolio Securities"
and the Statement of Additional 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 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.
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.
11
<PAGE>
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.
12
<PAGE>
------------------------------------------------------------
PART B
COMBINED STATEMENT OF ADDITIONAL INFORMATION
------------------------------------------------------------
<PAGE>
MONTGOMERY VARIABLE SERIES: GROWTH FUND
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
THE MONTGOMERY FUNDS III
600 Montgomery Street
San Francisco, California 94111
1-800-572-3863
STATEMENT OF ADDITIONAL INFORMATION
March __, 1996
The Montgomery Funds III (the "Trust") is an open-end
management investment company organized as a Delaware business trust, having
three 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 Prospectuses for the Montgomery
Variable Series: Growth Fund and Montgomery Variable Series: Emerging Markets
Fund, each dated April 25, 1995 (as amended November 1, 1995), and the
Prospectus for the Montgomery Variable Series: International Small Cap Fund,
dated March __, 1996, and as each prospectus may be revised from time to time
(in reference to the appropriate Fund or Funds, the "Prospectuses"). The
Prospectuses provide 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
Prospectuses 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 appropriate
Prospectuses, 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-21
Trustees and Officers....................................................B-26
Investment Management and Other Services.................................B-31
Execution of Portfolio Transactions......................................B-34
Additional Purchase and Redemption Information...........................B-37
Determination of Net Asset Value.........................................B-38
Performance Information..................................................B-40
General Information......................................................B-43
<PAGE>
Financial Statements.....................................................B-45
Appendix A...............................................................B-46
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 three series. This Statement of Additional Information
pertains to Montgomery Variable Series: Growth Fund (the "Growth Fund"),
Montgomery Variable Series: Emerging Markets Fund (the "Emerging Markets Fund"),
and Montgomery Variable Series: International Small Cap Fund (the "International
Small Cap 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 each Fund's investment objective 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
B-2
<PAGE>
companies as a group; and (b) either (i) 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 deemed illiquid); or (ii) 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 the Fund bears
directly in connection with its own operations.
In accordance with applicable regulatory provisions of the
State of California, 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. Generally, the value of U.S.
Government securities held by the Funds will fluctuate inversely with interest
rates. 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
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the Housing Act, or Title V of the Housing Act of 1949, as amended ("VA Loans"),
or be pools of other eligible mortgage loans. The Housing Act provides that the
full faith and credit of the U.S. Government is pledged to the payment of all
amounts that may be required to be paid under any guarantee. In order to meet
its obligations under a guarantee, GNMA is authorized to borrow from the U.S.
Treasury with no limitations as to amount.
GNMA pass-through securities may represent a proportionate
interest in one or more pools of the following types of mortgage loans: (1)
fixed-rate level payment mortgage loans; (2) fixed-rate graduated payment
mortgage loans; (3) fixed-rate growing equity mortgage loans; (4) fixed-rate
mortgage loans secured by manufactured (mobile) homes; (5) mortgage loans on
multifamily residential properties under construction; (6) mortgage loans on
completed multifamily projects; (7) fixed-rate mortgage loans as to which
escrowed funds are used to reduce the borrower's monthly payments during the
early years of the mortgage loans ("buydown" mortgage loans); (8) mortgage loans
that provide for adjustments on payments based on periodic changes in interest
rates or in other payment terms of the mortgage loans; and (9) mortgage-backed
serial notes.
Mortgage-Related Securities: Federal National Mortgage
Association. FNMA is a federally chartered and privately owned corporation
established under the Federal National Mortgage Association Charter Act. FNMA
was originally organized in 1938 as a U.S. Government agency to add greater
liquidity to the mortgage market. FNMA was transformed into a private sector
corporation by legislation enacted in 1968. FNMA provides funds to the mortgage
market primarily by purchasing home mortgage loans from local lenders, thereby
providing them with funds for additional lending. FNMA acquires funds to
purchase loans from investors that may not ordinarily invest in mortgage loans
directly, thereby expanding the total amount of funds available for housing.
Each FNMA pass-through security represents a proportionate
interest in one or more pools of FHA Loans, VA Loans or conventional mortgage
loans (that is, mortgage loans that are not insured or guaranteed by any U.S.
Government agency). The loans contained in those pools consist of one or more of
the following: (1) 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
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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 must include whole loans, participation interests
in 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 and the International Small Cap Fund
may invest in debt securities which are rated below Baa by Moody's Investors
Service, Inc. ("Moody's"), BBB by Standard & Poor's Corporation ("S&P") or BBB
by Fitch Investor Services ("Fitch"), or, if unrated, are deemed to be of
equivalent investment quality by the Manager. As an operating policy, which may
be changed by the Board of Trustees without shareholder approval, these Funds
will invest no more than 5% of their assets in debt securities rated below Baa
by Moody's or BBB by S&P, or, if unrated, of equivalent investment quality as
determined by the Manager. The market value of debt securities generally varies
in response to changes in interest rates and the financial condition of each
issuer. During periods of declining interest rates, the value of debt securities
generally increases. Conversely, during periods of rising interest rates, the
value of such securities generally declines. The net asset value of these Funds
will reflect these changes in market value.
Bonds rated C by Moody's are the lowest rated class of bonds,
and issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing. Bonds rated C by S&P are obligations on
which no interest is being paid. Bonds rated below BBB or Baa are often referred
to as "junk bonds."
Although such bonds may offer higher yields than higher-rated
securities, low-rated debt securities generally involve greater price volatility
and risk of principal and income loss, including the possibility of default by,
or bankruptcy of, the issuers of the securities. In addition, the markets in
which low-rated debt securities are traded are more limited than those for
higher-rated securities. The existence of limited markets for particular
securities may diminish the ability of these Funds 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 per-share net asset value of these Funds.
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
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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 these Funds to achieve their investment objectives may, to the
extent they invest in low-rated debt securities, be more dependent upon such
credit analysis than would be the case if these Funds invested in higher-rated
debt securities.
Low-rated debt securities may be more susceptible to real or
perceived adverse economic and competitive industry conditions than investment
grade securities. The prices of low-rated debt securities have been found to be
less sensitive to interest rate changes than higher-rated debt securities but
more sensitive to adverse economic downturns or individual corporate
developments. A projection of an economic downturn or of a period of rising
interest rates, for example, could cause a sharper decline in the prices of
low-rated debt securities because the advent of a recession could lessen the
ability of a highly leveraged company to make principal and interest payments on
its debt securities. If the issuer of low-rated debt securities defaults, 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. These
Funds also may conduct their foreign currency exchange transactions on a spot
(i.e., cash) basis at the spot rate prevailing in the foreign currency exchange
market.
The Funds 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 from adverse
changes in the relationship between the U.S. dollar and foreign currencies. A
forward contract, which is individually negotiated and privately traded by
currency traders and their customers, involves an obligation to purchase or sell
a specific currency for an agreed-upon price at a future date.
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
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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 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%.
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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 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
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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 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
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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 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
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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, 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
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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 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
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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
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 at the time the commitment to purchase or sell is made, but
delivery and payment for the securities take place at a later date. Normally,
the settlement date occurs within one month of the purchase; during the period
between purchase and settlement, no payment is made by a Fund to the issuer.
While the Funds reserve the right to sell when-issued or delayed delivery
securities prior to the settlement
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date, the Funds intend to purchase such securities with the purpose of actually
acquiring them unless a sale appears desirable for investment reasons. At the
time a Fund makes a commitment to purchase a security on a when-issued or
delayed delivery basis, it will record the transaction and reflect the value of
the security in determining its net asset value. The market value of the
when-issued securities may be more or less than the settlement price. The Funds
do not believe that their net asset values will be adversely affected by their
purchase of securities on a when-issued or delayed delivery basis. The Funds
cause their custodian to segregate cash, U.S. Government securities or other
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
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<PAGE>
issuer's ability to honor a demand for repayment. Therefore, the fact that there
are contractual or legal restrictions on resale to the general public or certain
institutions is not determinative of the liquidity of such investments.
Rule 144A under the 1933 Act establishes a safe harbor from
the registration requirements of the 1933 Act for resales of certain securities
to qualified institutional buyers. Institutional markets for restricted
securities sold pursuant to Rule 144A in many cases provide both readily
ascertainable values for restricted securities and the ability to liquidate an
investment to satisfy share redemption orders. Such markets might include
automated systems for the trading, clearance and settlement of unregistered
securities of domestic and foreign issuers, such as the PORTAL System sponsored
by the National Association of Securities Dealers, Inc. An insufficient number
of qualified buyers interested in purchasing Rule 144A-eligible restricted
securities 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
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<PAGE>
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.
Emerging Market Countries
The Emerging Markets Fund and the International Small Cap Fund
invest 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 and the International Small Cap Fund
endeavor to buy and sell foreign currencies on favorable terms. Some price
spreads on currency exchange (to cover service charges) may be incurred,
particularly when these Funds change investments from one country to another or
when proceeds from the sale of shares in U.S. dollars are used for the purchase
of securities in foreign countries. Also, some countries may adopt policies that
would prevent these Funds from repatriating invested capital and dividends,
withhold portions of interest and dividends at the source, or impose other
taxes, with respect to 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.
These Funds may be affected either favorably or unfavorably by
fluctuations in the relative rates of exchange
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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 Funds' assets maintained
with custodians in foreign countries, as well as the degree of risk from
political acts of foreign governments to which such assets may be exposed. The
Board also considers the degree of risk attendant to holding portfolio
securities in domestic and foreign securities depositories (see "Investment
Management and Other Services").
Hedging Transactions
While transactions in forward contracts, options, futures
contracts and options on futures (i.e., "hedging positions") may reduce certain
risks, such transactions themselves entail certain other risks. Thus, while a
Fund may benefit from the use of hedging positions, unanticipated changes in
interest rates, securities prices or currency exchange rates may result in a
poorer overall performance for that Fund than if it had not entered into any
hedging positions. If the correlation between a hedging position and 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.
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<PAGE>
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 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, consistent
with the regulations of the State of Arkansas.)
8. (a) 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
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<PAGE>
Information, or as such securities may be acquired as part of a merger,
consolidation or acquisition of assets.
(b) Invest in securities of other investment companies
except by purchase in the open market where no commission or profit to a sponsor
or dealer results from the purchase other than the customary broker's
commission, or except when the purchase is part of a plan of merger,
consolidation, reorganization or acquisition. (This is an operating policy which
may be changed without shareholder approval, consistent with the regulations of
the State of Ohio.)
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, changes in relevant SEC interpretations and the
regulations of the State of Ohio.)
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, consistent
with state regulations.)
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<PAGE>
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, consistent
with applicable regulations.)
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, consistent with the regulations of the State of Texas.)
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) 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, consistent with the regulations of the State of
Ohio.)
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.
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<PAGE>
The amount of income dividend payments by the Funds is
dependent upon the amount of net investment income received by the Funds from
their portfolio holdings, is not guaranteed and is subject to the discretion of
the Funds' Board. These Funds do not pay "interest" or guarantee any fixed rate
of return on an investment in their shares.
The Funds also may derive capital gains or losses in
connection with sales or other dispositions of their portfolio securities. Any
net gain a Fund may realize from transactions involving investments held less
than the period required for long-term capital gain or loss recognition or
otherwise producing short-term capital gains and losses (taking into account any
carryover of capital losses from 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 for the period required for long-term capital gain or
loss recognition or otherwise producing long-term capital gains and losses, the
Fund will have a net long-term capital gain. After deduction of the amount of
any net short-term capital loss, the balance (to the extent not offset by any
capital losses carried over from 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.
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
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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, each Fund must declare on or before
December 31 of each year, and pay on or before January 31 of the following year,
distributions at least equal to 98% of its ordinary income for that calendar
year and at least 98% of the excess of any capital gains over any capital losses
realized in the one-year period ending October 31 of that year, together with
any undistributed amounts of ordinary income and capital gains (in excess of
capital losses) from the previous calendar year.
The Emerging Markets Fund and the International Small Cap Fund
may be subject to foreign withholding taxes on dividends and interest earned
with respect to securities of foreign corporations. The Emerging Markets Fund
and the International Small Cap Fund may each 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 each of the
Funds derives from PFIC stock may be subject to a non-deductible federal income
tax at the Fund level. In some cases, each 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. These Funds will endeavor to
limit their exposure to the PFIC tax by investing
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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, these Funds 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.
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
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"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.
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.
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<PAGE>
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.
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.
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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 banking firm of Montgomery
Securities, and has been employed by Montgomery Securities
since October 1983.
Mark B. Geist, President (Age 42)
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.
- --------
* Trustee deemed an "interested person" of the Funds as defined in the
Investment Company Act.
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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.
John E. Story, Executive Vice President (Age 55)
600 Montgomery Street, San Francisco, California 94111. Mr.
Story has been the Managing Director of Mutual Funds and
Executive Vice President of Montgomery Asset Management, L.P.
since January 1994. From December 1978 to January 1994, he was
Managing Director - Senior Vice President of Alliance Capital
Management.
David E. Demarest, Chief Administrative Officer (Age 41)
600 Montgomery Street, San Francisco, California 94111. Mr.
Demarest has been the Chief Administrative Officer since 1994.
From 1991 until 1994, he was Vice President of Copeland
Financial Services. Prior to joining Copeland, Mr. Demarest
was Vice President/Manager for the Overland Express Funds
Division for Wells Fargo Bank.
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 41)
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.
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<PAGE>
Oscar A. Castro, Vice President (Age 40)
600 Montgomery Street, San Francisco, California 94111. Mr.
Castro, CFA, is a Managing Director and Portfolio Manager for
the Manager. Before joining the Manager, he was vice
president/portfolio manager at G.T. Capital Management, Inc.
from 1991 to 1993. From 1989 to 1990, he was co-founder and
co-manager of The Common Goal World Fund, a global equity
partnership. From 1987 to 1989, Mr. Castro was deputy
portfolio manager/analyst at Templeton International.
John D. Boich, Vice President (Age 34)
600 Montgomery Street, San Francisco, California 94111. Mr.
Boich, CFA, is a Managing Director and Portfolio Manager.
Prior to joining the Manager, Mr. Boich was vice president and
portfolio manager at The Boston Company Institutional
Investors Inc. from 1990 to 1993. From 1989 to 1990, Mr. Boich
was the founder and co-manager of The Common Goal World Fund,
a global equity partnership. From 1987 to 1989, Mr. Boich
worked as a financial adviser with Prudential-Bache Securities
and E.F. Hutton & Company.
Josephine S. Jimenez, Vice President (Age 41)
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 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.
Thomas R. Haslett, Vice President (Age 34)
600 Montgomery Street, San Francisco, California 94111. Mr.
Haslett is a Vice President and Portfolio Manager for the
Manager. From September 1987 until joining the Manager in
April 1992, Mr. Haslett was a Portfolio Manager with Gannett,
Welsh and Kotler in Boston, Massachusetts.
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<PAGE>
Angeline Ee, Vice President (Age 34)
600 Montgomery Street, San Francisco, California 94111. Ms. Ee
is a Vice President and Portfolio Manager for the Manager.
From 1990 until joining the Manager in July, 1994, Ms. Ee was
an Investment Manager with AIG Investment Corp. in Hong Kong.
From June, 1989 until September, 1990, Ms. Ee was a co-manager
of a portfolio of Asian equities and bonds at Chase Manhattan
Bank in Singapore.
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.
Jerome S. Markowitz, Trustee* (Age 56)
600 Montgomery Street, San Francisco, California 94111. Mr.
Markowitz was elected as a trustee of The Montgomery Funds
III, effective November 16, 1995. As a trustee- designate, Mr.
Markowitz attends meetings of the Board of Trustees of the
Montgomery Funds but is not eligible to vote. Mr. Markowitz
has been the Senior Managing
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<PAGE>
Director of Montgomery Securities since January 1991. Mr.
Markowitz joined Montgomery Securities in December 1987.
The officers of the Trust, and the Trustees who are considered
"interested persons" of the Trust, receive no compensation directly from the
Trust for performing the duties of their offices, except for the Funds' payment
of part of the compensation for the Trust's Treasurer. 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. The Trustees who
are not affiliated with the Manager receive an annual retainer and fees and
expenses for each regular Board meeting attended. The aggregate compensation
paid by the Trust to each of the Trustees during the fiscal year ended December
31, 1995, and the aggregate compensation paid to each of the Trustees during the
fiscal year ended December 31, 1995 by all of the registered investment
companies to which the Manager provides investment advisory services, are set
forth below.
Total
Pension or Compensation
Retirement From the
Aggregate Benefits Trust and
Compensation Accrued as Fund Complex
from The Part of Fund (2 additional
Name of Trustee Montgomery Funds III* Expenses** Trusts)
- --------------- --------------------- ------------ -------------
R. Stephen Doyle None -- None
Jerome S. Markowitz None -- None
John A. Farnsworth $ 5,000 -- $30,000
Andrew Cox $ 5,000 -- $30,000
Cecilia H. Herbert $ 5,000 -- $30,000
* This fee represents compensation for service as Trustees to both
The Montgomery Funds III and The Montgomery Funds II, another
Trust advised by the Manager.
** The Trusts do not maintain pension or retirement plans.
INVESTMENT MANAGEMENT AND OTHER SERVICES
As stated in each 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
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<PAGE>
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%
International Small Cap 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 five-tenths of one percent
(1.50%) of the Growth Fund's average net assets, one and seventy-five one
hundredths of one percent (1.75%) of the Emerging Markets Fund's and one and
nine-tenths of one percent (1.90%) of the International Small Cap Fund's average
net assets. Currently, the most restrictive state limitation is two and one-half
percent (2 1/2%) of the first $30,000,000 of average net assets of a Fund, two
percent (2%) of the next $70,000,000, and one and one-half percent (1 1/2%) of
the value of the remaining average net assets. The Manager also may 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.
The Manager will generally seek reimbursement for the oldest reductions and
waivers before payment by the Funds for fees and expenses for the current year.
Operating expenses for purposes of the Agreement include the
Manager's management fee but do not include any taxes, interest, brokerage
commissions, if any, expenses incurred in
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<PAGE>
connection with any merger or reorganization, extraordinary expenses such as
litigation and any other expenses as may be deemed excludable with the prior
written approval of any state securities commission imposing an expense
limitation. 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.
As compensation for its investment management services, each
of the following Funds paid the Manager investment advisory fees in the amounts
specified below. Additional investment advisory fees payable under the
Agreements may have instead been waived by the Manager, but may be subject to
reimbursement by the respective Funds as discussed previously.
Fund Year or Period Ended December 31,
- ----
1995
----
Growth Fund* $--
Emerging Markets Fund* NA
International Small Cap NA
Fund*
* None of the Funds are yet publicly offered. Only the Growth
Fund has an initial shareholder.
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.
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<PAGE>
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 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.
B-33
<PAGE>
Purchases of portfolio securities for the Funds also may be
made directly from issuers or from underwriters. Where possible, purchase and
sale transactions will be effected through dealers (including banks) which
specialize in the types of securities which the Funds will be holding, unless
better executions are available elsewhere. Dealers and underwriters usually act
as principals for their own account. Purchases from underwriters will include a
concession paid by the issuer to the underwriter and purchases from dealers will
include the spread between the bid and the asked price. If the execution and
price offered by more than one dealer or underwriter are comparable, the order
may be allocated to a dealer or underwriter that has provided research or other
services as discussed below.
In placing portfolio transactions, the Manager will use its
best efforts to choose a broker-dealer capable of providing the services
necessary generally to obtain the most favorable price and execution available.
The full range and quality of services available will be considered in making
these determinations, such as the firm's ability to execute trades in a specific
market required by 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
B-34
<PAGE>
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 such 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 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.
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<PAGE>
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
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 Trust has 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
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<PAGE>
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 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
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<PAGE>
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.
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,
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<PAGE>
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 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.
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<PAGE>
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 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
B-40
<PAGE>
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.
The average annual total return for each Fund for the periods
indicated was as follows:
Inception*
Through
Fund December 31, 1995
---- -----------------
Growth Fund** NA
International Small Cap NA
Fund**
Emerging Markets Fund** NA
- ----------------
* Total return for periods of less than one year are aggregate,
not annualized, return figures. The dates of inception for the
Funds were: Growth Fund, NA; Emerging Markets Fund, NA;
International Small Cap Fund, NA.
** Only the Growth Fund currently has an initial shareholder.
None of the Funds are publicly held.
Comparisons. To help investors better evaluate how an
investment in the Funds might satisfy their investment objectives,
advertisements and other materials regarding the Funds may discuss various
financial publications. Materials may also compare performance (as calculated
above) to performance as reported by other investments, indices, and averages.
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
B-41
<PAGE>
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. 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.
B-42
<PAGE>
In-depth research, however, goes beyond gaining an
understanding of unknown opportunities. The portfolio analysts have also
developed new ways of gaining information about well-known parts of the domestic
market. The growth equity team, for example, has developed its own strategy for
analyzing the growth potential of U.S. companies, often large, well-known
companies.
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.
__________________________________________________, 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 December 31, 1995, to the knowledge of the Funds, the
Manager owned of record 100% of the outstanding shares of the Growth Fund.
The Trust is registered with the SEC as a non-diversified
management investment company. Such a registration does not involve supervision
of the management or policies of the Funds. The Prospectus and this Statement of
Additional Information omit certain of the information contained in the
Registration Statement filed with the SEC. Copies of the Registration Statement
may be obtained from the SEC upon payment of the prescribed fee.
B-43
<PAGE>
FINANCIAL STATEMENTS
Audited financial statements for the relevant periods ended
December 31, 1995 for the Growth Fund, as contained in the Annual Report of such
Fund for the fiscal year ended December 31, 1995, are incorporated by reference
to that Report. [Not Available Yet.]
B-44
<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-45
<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-46
<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-47
<PAGE>
----------------------------------------------------
PART C
OTHER INFORMATION
---------------------------------------------------
<PAGE>
THE MONTGOMERY FUNDS III
--------------
FORM N-1A
--------------
PART C
--------------
Item 24. Financial Statements and Exhibits
(a) Financial Statements:
(1) 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, all incorporated by reference to
Pre-Effective Amendment No. 1 to the Registrant's
Registration Statement as filed with the Commission
on September 27, 1994 ("Pre-Effective Amendment No.
1").
(b) Exhibits:
(1) Agreement and Declaration of Trust is incorporated by
reference to the Registrant's Registration Statement
as filed with the Commission on September 27, 1994
("Registration Statement").
(2) By-Laws are incorporated by reference to the
Registration Statement.
(3) Voting Trust Agreement - Not applicable.
(4) Specimen Share Certificate - Not applicable.
(5) Form of Investment Management Agreement is
incorporated by reference to Pre-Effective Amendment
No. 1.
(6) Form of Underwriting Agreement is incorporated by
reference to the Registration Statement.
(7) Benefit Plan(s) - Not applicable.
(8) Custody Agreement is incorporated by reference to
Pre-Effective Amendment No. 1.
(9)(A) Form of Administrative Services Agreement is
incorporated by reference to Pre- Effective Amendment
No. 1.
(B) Form of Participation Agreement is incorporated by
reference to Pre-Effective Amendment No. 1.
(10) Consent and Opinion of Counsel as to legality of
shares is incorporated by reference to Pre-Effective
Amendment No. 1.
(11) Consent of Independent Public Accountants - Not
applicable.
(12) Financial Statements omitted from Item 23 - Not
applicable.
(13) Letter of Understanding re: Initial Capital is
incorporated by reference to Pre- Effective Amendment
No. 1.
C-1
<PAGE>
(14) Model Retirement Plan Documents - Not applicable.
(15) Rule 12b-1 Plan - Not applicable.
(16) Performance Computation Schedule for Montgomery
Variable Series: Growth Fund and Montgomery Variable
Series: Emerging Markets Fund is incorporated by
reference to Pre-Effective Amendment No. 1.
(17) Power of Attorney.
(18) Specimen Price-Make-Up Sheets (Item 19(b)5 of N-1A)
for Montgomery Variable Series: Growth Fund and
Montgomery Variable Series: Emerging Markets Fund are
incorporated by reference to Pre-Effective Amendment
No. 1.
Item 25. Persons Controlled by or Under Common Control with Registrant.
Montgomery Asset Management, L.P., a California limited
partnership, is the manager of each series of the Registrant, The Montgomery
Funds (a Massachusetts business trust) and The Montgomery Funds II (a Delaware
business trust). Montgomery Asset Management, Inc., a California corporation is
the general partner of Montgomery Asset Management, L.P., and Montgomery
Securities is its sole limited partner. The Registrant, The Montgomery Funds and
The Montgomery Funds II are deemed to be under the common control of each of
those three entities.
Item 26. Number of Holders of Securities
Number of Record Holders
Title of Class as of December 31, 1995
--------------
Shares of Beneficial
Interest, $0.01 par value
Montgomery Variable Series: Growth Fund 1
Montgomery Variable Series: Emerging Markets Fund 0
Montgomery Variable Series: International Small Cap Fund 0
Item 27. Indemnification
Article VII, Section 3 of the Agreement and Declaration of
Trust empowers the Trustees of the Trust, to the full extent permitted by law,
to purchase with Trust assets insurance for indemnification from liability and
to pay for all expenses reasonably incurred or paid or expected to be paid by a
Trustee or officer in connection with any claim, action, suit or proceeding in
which he or she becomes involved by virtue of his or her capacity or former
capacity with the Trust.
Article VI of the By-Laws of the Trust provides that the Trust
shall indemnify any person who was or is a party or is threatened to be made a
party to any proceeding by reason of the fact that such person is and other
amounts or was an agent of the Trust, against expenses, judgments, fines,
settlement and other amounts actually and reasonable incurred in connection with
such proceeding if that person acted in good faith and reasonably believed his
or her conduct to be in the best interests of the Trust. Indemnification will
not be provided in certain circumstances, however, including instances of
willful misfeasance, bad faith, gross negligence, and reckless disregard of the
duties involved in the conduct of the particular office involved.
Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to the Trustees, officers and
controlling persons of the Registrant pursuant to the
C-2
<PAGE>
foregoing provisions or otherwise, the Registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable in the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a Trustee, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
Trustee, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act of 1933 and will be governed by the
final adjudication of such issue.
Item 28. Business and Other Connections of Investment Adviser.
Montgomery Securities, which is a broker-dealer and principal
underwriter of The Montgomery Funds I and II, is the sole limited partner of the
investment manager, Montgomery Asset Management, L.P. ("MAM, L.P."). The general
partner of MAM, L.P. is a corporation, Montgomery Asset Management, Inc. ("MAM,
Inc."), certain of the officers and directors of which serve in similar
capacities for MAM, L.P. One of these officers and directors, Mr. R. Stephen
Doyle, also is a capital limited partner of Montgomery Securities, and Mr. Jack
G. Levin, Secretary of The Montgomery Funds III, is a Managing Director of
Montgomery Securities. R. Stephen Doyle is the Chairman and Chief Executive
Officer of MAM, L.P.; Mark B. Geist is the President; John T. Story is the
Managing Director of Mutual Funds and Executive Vice President; David E.
Demarest, Chief Administrative Officer; Mary Jane Fross is Manager of Mutual
Fund Administration and Finance; and Josephine Jimenez, Bryan L. Sudweeks, Roger
Honour, Oscar A. Castro and John D. Boich are Managing Directors of MAM, L.P.
Information about the individuals who function as officers of MAM, L.P. (namely,
Messrs. Doyle, Geist, Story and Demarest and Mary Jane Fross and the five
Managing Directors) is set forth in Part B.
Item 29. Principal Underwriter - Not applicable.
Item 30. Location of Accounts and Records.
The accounts, books, or other documents required to be
maintained by Section 31(a) of the Investment Company Act of 1940 will be kept
by the Registrant's Transfer Agent, DST Systems, Inc., 1004 Baltimore, Kansas
City, Missouri 64105, except those records relating to portfolio transactions
and the basic organizational and Trust documents of the Registrant (see
Subsections (2)(iii), (4), (5), (6), (7), (9), (10) and (11) of Rule 31a-1(b)),
which will be kept by the Registrant at 600 Montgomery Street, San Francisco,
California 94111.
Item 31. Management Services.
There are no management-related service contracts not
discussed in Parts A and B.
Item 32. Undertakings.
(a) Not applicable.
(b) Registrant hereby undertakes to file a post-effective
amendment including financial statements of Montgomery Variable Series: Emerging
Markets Fund, Montgomery Variable Series: Growth Fund, and Montgomery Variable
Series: International Small Cap Fund, which need not be certified, within four
to six months from the later of the effective date of those series of the
Registrant or the commencement of operations of those series.
(c) Not applicable.
(d) Registrant has undertaken to comply with Section 16(a) of
the Investment Company Act of 1940, as amended, which requires the prompt
convening of a meeting of shareholders to elect trustees to fill existing
vacancies in the Registrant's Board of Trustees in the
C-3
<PAGE>
event that less than a majority of the trustees have been elected to such
position by shareholders. Registrant has also undertaken promptly to call a
meeting of shareholders for the purpose of voting upon the question of removal
of any Trustee or Trustees when requested in writing to do so by the record
holders of not less than 10 percent of the Registrant's outstanding shares and
to assist its shareholders in communicating with other shareholders in
accordance with the requirements of Section 16(c) of the Investment Company Act
of 1940, as amended.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and
the Investment Company Act of 1940, the Registrant has duly caused this
Amendment to its Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of San Francisco, and the
State of California, on this 12th day of January, 1996.
THE MONTGOMERY FUNDS III
By: R. Stephen Doyle*
-------------------------------------------
R. Stephen Doyle
Chairman and Principal Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this Amendment to
the Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
R. Stephen Doyle* Principal Executive January 12, 1996
- -----------------
R. Stephen Doyle Officer; Principal
Financial and Accounting
Officer; and Trustee
Andrew Cox * Trustee January 12, 1996
Andrew Cox
Cecilia H. Herbert * Trustee January 12, 1996
- --------------------
Cecilia H. Herbert
John A. Farnsworth * Trustee January 12, 1996
- --------------------
John A. Farnsworth
Jerome S. Markowitz * Trustee January 12, 1996
- ---------------------
Jerome S. Markowitz
* By: /s/ JULIE ALLECTA
----------------------------------
Julie Allecta, Attorney-in-Fact
pursuant to Power of Attorney filed herewith
<PAGE>
Exhibit(s) Index
Exhibit No. Document Page No.
- ----------- -------- ---------
(17) Power of Attorney
EXHIBIT 17
POWER OF ATTORNEY
<PAGE>
THE MONTGOMERY FUNDS II
THE MONTGOMERY FUNDS III
POWER OF ATTORNEY
FOR
SECURITIES AND EXCHANGE COMMISSION
AND RELATED FILINGS
---------------------------------------
Each of the undersigned Trustees and Officers of THE
MONTGOMERY FUNDS II and THE MONTGOMERY FUNDS III (collectively, "the Trusts")
hereby appoints R. STEPHEN DOYLE, MARK B. GEIST, JULIE ALLECTA and MITCHELL E.
NICHTER (with full power to each of them to act alone) his or her
attorney-in-fact and agent, in all capacities, to execute and to file any
documents relating to the Registration Statements on Forms N-8A and N-1A under
the Investment Company Act of 1940, under the Securities Act of 1933 of the
Trusts and under the laws of the states and other jurisdictions, including any
and all amendments thereto, covering the registration and the sale of shares by
the Trusts, including all exhibits and any and all documents required to be
filed with respect thereto with any regulatory authority, including applications
for exemptive orders or rulings. Each of the undersigned grants to each of said
attorneys full authority to do every act necessary to be done in order to
effectuate the same as fully, to all intents and purposes, as he or she could do
if personally present, thereby ratifying all that said attorneys-in-fact and
agents may lawfully do or cause to be done by virtue hereof.
The undersigned Trustees and Officers hereby execute this
Power of Attorney as of this 16th day of November, 1995.
/s/ R. Stephen Doyle /s/ John A. Farnsworth
- ----------------------------------- -----------------------------------
R. Stephen Doyle, John A. Farnsworth,
Chairman of the Board, Trustee
Principal Executive Officer,
Principal Financial and /s/ Jerome S. Markowitz
Accounting Officer and Trustee -----------------------------------
Jerome S. Markowitz,
Trustee
/s/ Cecilia H. Herbert /s/ Andrew Cox
- ----------------------------------- -----------------------------------
Cecilia H. Herbert, Andrew Cox,
Trustee Trustee
