<PAGE>
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
PORTFOLIO MANAGEMENT
<TABLE>
<S> <C>
Josephine Jimenez................................. Senior Portfolio Manager
Bryan Sudweeks.................................... Senior Portfolio Manager
Thomas Haslett.................................... Senior Portfolio Manager
Angeline Ee....................................... Portfolio Manager
</TABLE>
INVESTMENT REVIEW
Q: WHAT REGIONS PERFORMED BEST FOR THE FUND AND WHY?
A: The best region for the Fund during the period was Latin America, and the
Fund was overweight in its exposure to Brazil and Mexico (relative to the
index), both of which turned in strong results. Brazil, which we believe has
great promise and potential, is finally beginning to deliver on that promise.
Inflation is low and seems under control, and the political situation is
relatively stable. The country is getting its act together, and its stock
market began to reflect that over the period. Mexico also began to recover
during the year, and its economy is showing real strength. Some Asian markets
in the portfolio, particularly the Philippines, also proved to be strong
performers during the period.
Q: HOW HAVE YOU POSITIONED THE FUND FOR THE PERIOD AHEAD?
A: One guide for our investing in the period ahead is low inflation. In the
aggregate, inflation rates have declined to less than 10% annually. That may
seem high among emerging markets compared to inflation in the developed
economies, but it's very low on a historical basis in the emerging markets and
demonstrates the remarkable progress some of these economies have made in
recent years. Relatively low inflation suggests that high real interest rates
could decline in these markets, and that could be a positive for stocks.
We also believe that economic growth will continue at a sustainable pace in
the United States, Europe and Japan, which would be a positive for emerging
market companies with significant exports. On a regional basis, we remain
overweighted in Latin America, with a focus on Brazil and Mexico.
Q: WHY SHOULD AN INVESTOR CONSIDER THE VARIABLE SERIES: EMERGING MARKETS FUND
NOW?
A: For long-term investors who are comfortable with the volatility that is
characteristic of the emerging markets, there are three reasons to invest.
First, these markets offer, in general, very good valuations. Our projections
for the stocks in our portfolio indicate aggregate growth of over 25% per
year, but they are only trading at around 15 to 16 times 1996 earnings.
Second, the liquidity wave continues. Capital is flowing into the emerging
markets both from foreign and domestic investors, particularly in light of
declining inflation and the possibility of lower interest rates. Finally, the
political turmoil in many large countries seems to have eased. Relations
between Taiwan and China are calmer; Yeltzin's presidential victory
ameliorates concerns of Russia's regressing and India and Brazil are also
demonstrating a more benign political environment.
1
<PAGE>
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
PORTFOLIO INVESTMENTS
JUNE 30, 1996--(UNAUDITED)
<TABLE>
<CAPTION>
VALUE
SHARES (NOTE 1)
------ ----------
<C> <S> <C>
COMMON STOCKS--74.2%
ARGENTINA--3.8%
2,630 Banco Frances, ADR (Banks)....................... $ 75,612
15,000 Perez Companc, "B" Shares (Oil).................. 98,287
32,500 Siderar S.A.+ (Steel)............................ 83,556
----------
257,455
----------
BRAZIL--7.6%
3,800 Cemig Compania New, ADS (Electric Utilities)..... 108,300
4,000 Telebras, ADR (Telephone/Networks)............... 278,500
12,000 Usiminas, ADR*** (Steel)......................... 129,780
----------
516,580
----------
CHILE--2.7%
1,850 Compania de Telefonos de Chile, ADR
(Telecommunications/Wireless)................... 181,531
----------
CHINA--3.0%
118,000 Guangdong Investment Holdings Ltd. (Real Estate) 74,696
3,600 Huaneng Power International, ADS+ (Electric
Utilities) ..................................... 64,350
29,200 Johnson Electric Holdings Ltd., ORD
(Electronics)................................... 65,637
----------
204,683
----------
CZECH REPUBLIC--2.4%
600 SPT Telecom A.S. (Telephone/Networks)............ 73,274
9,200 The Czech Value Fund (Mutual Funds) ............. 87,400
----------
160,674
----------
GREECE--0.3%
2,620 The Greek Progress Fund (Mutual Funds) .......... 23,143
----------
HONG KONG--1.6%
7,400 HSBC Holdings (Banks)............................ 111,850
----------
INDIA--3.6%
1,300 Bajaj Auto Ltd., GDR (Auto/Auto Parts)........... 49,725
800 Bajaj Auto Ltd., GDS*** (Auto/Auto Parts)........ 30,600
7,200 Tata Engineering & Locomotive Company, Ltd.,
GDR*** (Auto/Auto Parts)........................ 129,600
1,900 Tata Engineering & Locomotive Company, Ltd., GDR
(Auto/Auto Parts)............................... 34,200
----------
244,125
----------
INDONESIA--2.8%
22,000 Ciputra Development** (Heavy Construction)....... 44,662
3,000 Hanjaya Mandala Sampoerna (F) (Tobacco).......... 34,157
1,900 Tambang Timah, GDR*** (Metals and Mining)........ 34,485
Telekomunikas Indonesia, ADR
2,700 (Telephone/Regional--Local)...................... 80,325
----------
193,629
----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
PORTFOLIO INVESTMENTS--(CONTINUED)
JUNE 30, 1996--(UNAUDITED)
<TABLE>
<CAPTION>
VALUE
SHARES (NOTE 1)
------ ----------
<C> <S> <C>
COMMON STOCKS--(CONTINUED)
ISRAEL--0.6%
1,100 Teva Pharmaceuticals, ADR (Pharmacy/Drugs)....... $ 41,731
----------
KOREA--7.6%
7,000 Korea Electric Power Corporation, ADR (Electric
Utilities)...................................... 169,750
6,000 Korea Mobile Telecommunications, ADR+
(Telephone/Wireless)............................ 102,750
1,800 Korea Mobile Telecommunications, ADS+
(Telephone/Wireless)............................ 30,825
7,200 Pohang Iron & Steel Company, ADR (Steel)......... 175,500
1,600 Samsung Electronics Ltd., GDS*** (Electronics)... 38,800
----------
517,625
----------
MALAYSIA--5.5%
12,000 Arab Malaysian Corporation (Diversified Financial
Services)....................................... 47,144
8,000 Edaran Otomobil Nasional Berhad** (Auto/Auto
Parts).......................................... 76,649
14,000 IJM Corporation Berhad (Heavy Construction)...... 24,245
17,000 IOI Industrial Oxygen Inc.** (Chemicals)......... 23,580
10,000 Metacorp Berhad (Chemicals)...................... 28,864
7,000 Petronas Gas (Oil)............................... 30,026
20,000 Resorts World Berhad** (Leisure Time)............ 114,652
3,000 Telekom Malaysia** (Telecommunications/Other).... 26,699
----------
371,859
----------
MEXICO--7.1%
6,700 Bufete Industrial S.A. (Heavy Construction)...... 116,413
16,000 Cementos Mexicanos S.A. (Building Materials)..... 56,744
2,775 Empresas La Moderna S.A. de C.V., ADR (Tobacco).. 49,950
13,000 Empresas La Moderna S.A. de C.V., Series A
(Tobacco)....................................... 58,016
96,000 Grupo Financiero Banamex, Class B (Banks)........ 199,467
----------
480,590
----------
PERU--1.6%
1,492 Credicorp Ltd. (Banks)........................... 29,653
37,500 Telefonica del Peru, Series B
(Telephone/Networks)............................ 76,136
----------
105,789
----------
PHILIPPINES--3.5%
162,000 Aboitiz Equity Ventures+ (Conglomerates)......... 30,298
61,000 DMCI Holdings (Building Materials)............... 43,655
119,000 Filinvest Land Inc. (Real Estate)................ 48,826
120,000 Metro Pacific Inc. (Conglomerates)............... 35,725
1,400 Philippine Long Distance Telephone, ADR
(Telephone/Long Distance)....................... 81,375
----------
239,879
----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
PORTFOLIO INVESTMENTS--(CONTINUED)
JUNE 30, 1996--(UNAUDITED)
<TABLE>
<CAPTION>
VALUE
SHARES (NOTE 1)
------ ----------
<C> <S> <C>
COMMON STOCKS--(CONTINUED)
PORTUGAL--2.4%
600 Capital Portugal Fund (Mutual Funds) ............................. $ 59,214
4,000 Sonae Investmentos (Conglomerates)................................ 103,992
----------
163,206
----------
SINGAPORE--0.3%
4,000 Far East Levingston (Heavy Construction).......................... 22,112
----------
SOUTH AFRICA--6.0%
1,500 Anglo American Gold Investment Company (Metals and Mining) ....... 130,164
3,000 Barlow Ltd. (Building Materials).................................. 31,329
55,700 Lonrho (Conglomerates)............................................ 157,472
8,000 Sasol Ltd. (Metals and Mining) ................................... 86,776
----------
405,741
----------
TAIWAN--5.1%
7,600 ASE Ltd., GDR (Semiconductors).................................... 65,550
3,900 China Steel Corporation, GDR*** (Steel) .......................... 99,450
5,500 Taiwan Fund Inc. (Mutual Funds)................................... 132,000
6,000 Yageo Corporation, GDR+*** (Electronics).......................... 46,890
----------
343,890
----------
THAILAND--4.9%
18,600 Bangkok Bank Public Company, Ltd. (F) (Banks)..................... 175,770
4,100 Phatra Thanakit Company Ltd. (F) (Diversified Financial Services). 28,584
19,600 Phatra Thanakit Company Ltd. (Diversified Financial Services)..... 132,104
----------
336,458
----------
TURKEY--1.8%
317,000 Koc Holding (Holding)............................................. 77,204
882,000 Trakya Cam Sanayil (Glass)........................................ 48,331
----------
125,535
----------
TOTAL COMMON STOCKS
(Cost $5,005,645)................................................ 5,048,085
----------
PREFERRED STOCKS--8.2%
BRAZIL--8.2%
32,200,000 Banco Bradesco (Banks)............................................ 262,949
800,000 Petroleo Brasileiros (Oil)........................................ 98,392
5,400,000 Uniao de Bancos Brasileiros (Banks)............................... 146,219
46,500,000 Usiminas (Steel).................................................. 49,086
----------
TOTAL PREFERRED STOCKS
(Cost $542,825).................................................. 556,646
----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
PORTFOLIO INVESTMENTS--(CONTINUED)
JUNE 30, 1996--(UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL VALUE
AMOUNT (NOTE 1)
--------- ----------
<C> <S> <C>
CONVERTIBLE BONDS--3.1%
MEXICO--2.4%
$150,000 Alfa S.A. de C.V., 8.000% due 09/15/2000***
(Steel)..................................... $ 162,000
----------
THAILAND--0.7%
50,000 Ban Pu Public Company, 2.750% due 04/10/2003
(Coal)...................................... 51,775
----------
TOTAL CONVERTIBLE BONDS
(Cost $214,895)............................. 213,775
----------
<CAPTION>
SHARES
------
<C> <S> <C>
WARRANTS--0.5% (Cost $28,571)
MALAYSIA--0.5%
24,000 Development and Commercial Bank Holdings,
Warrants, Expire 12/27/99+ (Banks).......... 31,557
----------
<CAPTION>
PRINCIPAL
AMOUNT
---------
<C> <S> <C>
REPURCHASE AGREEMENTS--26.3%
$896,000 Agreement with Barclays de Zoete Wedd Tri-
Party, 5.600% dated 06/28/96, to be
repurchased at $896,418, on 07/01/96,
collateralized $913,920 market value of U.S.
Government securities, having various
maturities and various interest rates....... 896,000
896,000 Agreement with Bear Stearns Tri-Party, 5.600%
dated 06/28/96, to be repurchased at
$896,418 on 07/01/96, collateralized by
$1,001,931 market value of U.S. Government
securities, having various maturities and
various interest rates...................... 896,000
----------
TOTAL REPURCHASE AGREEMENTS
(Cost $1,792,000)........................... 1,792,000
----------
</TABLE>
<TABLE>
<S> <C> <C>
TOTAL INVESTMENTS (Cost $7,583,936*)........................ 112.3% 7,642,063
OTHER ASSETS AND LIABILITIES (Net).......................... (12.3) (836,682)
----- ----------
NET ASSETS.................................................. 100.0% $6,805,381
===== ==========
</TABLE>
- --------
* Aggregate cost for Federal tax purposes.
** Special Situation Security (See Note 6 to Financial Statements).
*** Security exempt from registration under Rule 144A of the Securities Act
of 1933. These securities may be resold in transactions exempt from
registration, normally to qualified institutional buyers.
+ Non-income producing security.
Abbreviation:
ADR--American Depositary Receipt
ADS--American Depositary Share
(F)--Foreign or alien shares.
GDR--Global Depositary Receipt
GDS--Global Depositary Share
ORD--Ordinary
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
STATEMENT OF ASSETS AND LIABILITIES
JUNE 30, 1996-(UNAUDITED)
<TABLE>
<S> <C> <C>
ASSETS:
Investments in securities, at value (Identified cost
$7,583,936) (Note 1)
Securities............................................ $ 5,850,063
Repurchase agreements................................. 1,792,000
-----------
Total investments....................................... 7,642,063
Cash.................................................... 966
Foreign currency (Cost $211,894)........................ 212,134
Forward foreign currency exchange contracts:
Forward foreign currency exchange contracts to buy, at
value (Contract cost $250,187) (Note 3).............. 249,856
Receivables:
Investment securities sold............................ 274,849
Expenses absorbed by Manager (Note 2)................. 5,450
Interest.............................................. 4,746
Dividends............................................. 4,573
Other Assets:
Organization costs (Note 1)........................... 53,149
-----------
Total Assets............................................ 8,447,786
-----------
LIABILITIES:
Forward foreign currency exchange contracts:
Payable for forward foreign currency exchange con-
tracts to buy (Note 3)............................... $ 250,187
Payables:
Investment securities purchased....................... 1,324,072
Organizational cost................................... 56,847
Custodian fees........................................ 3,598
Trustees' fees and expenses........................... 1,600
Shares of beneficial interest redeemed................ 36
Other accrued liabilities and expenses................ 6,065
---------
Total Liabilities....................................... 1,642,405
-----------
NET ASSETS.............................................. $ 6,805,381
===========
NET ASSETS CONSIST OF:
Undistributed net investment income..................... $ 21,957
Accumulated net realized loss on securities sold,
forward foreign currency exchange contracts and foreign
currency transactions.................................. (2,674)
Net unrealized appreciation of investments, forward
foreign currency contracts, foreign currency
transactions and net other assets...................... 57,651
Shares of beneficial interest........................... 6,443
Additional paid-in capital.............................. 6,722,004
-----------
NET ASSETS.............................................. $ 6,805,381
===========
Net Asset Value, offering and redemption price per share
($6,805,381 / 644,276 shares of beneficial interest
outstanding)........................................... $ 10.56
===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
STATEMENT OF OPERATIONS
FOR THE PERIOD ENDED JUNE 30, 1996-(UNAUDITED)*
<TABLE>
<S> <C> <C>
NET INVESTMENT INCOME:
Interest...................................................... $13,798
Dividends (Net of foreign withholding taxes of $497).......... 8,159
-------
Total Investment Income..................................... 21,957
-------
EXPENSES:
Legal and audit fees.......................................... $ 23,525
Management fee (Note 2)....................................... 9,371
Trustees' fees and expenses (Note 2).......................... 6,253
Custodian fees (Note 2)....................................... 4,844
Amortization of organization expenses (Note 1)................ 4,373
Printing fees................................................. 500
Other......................................................... 2,050
Fees deferred and expenses absorbed by Manager (Note 2)....... (50,916)
--------
Total Expenses.............................................. 0
-------
NET INVESTMENT INCOME......................................... 21,957
=======
NET REALIZED AND UNREALIZED GAIN/ (LOSS) ON INVESTMENTS
(Notes 1 and 3):
Net realized gain/(loss) on:
Security transactions........................................ 214
Forward foreign currency exchange contracts.................. (3,461)
Foreign currency transactions................................ 573
-------
Net realized loss on investments during the period............ (2,674)
-------
Change in unrealized appreciation/(depreciation) of:
Securities................................................... 58,127
Forward foreign currency exchange contracts.................. (331)
Foreign currency transactions and net other assets........... (145)
-------
Net unrealized appreciation of investments during the period.. 57,651
-------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS............... 54,977
-------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS.......... $76,934
=======
</TABLE>
- --------
* Montgomery Variable Series: Emerging Markets Fund commenced operations on
February 1, 1996.
The accompanying notes are an integral part of these financial statements.
7
<PAGE>
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
STATEMENT OF CHANGES IN NET ASSETS
FOR THE PERIOD ENDED JUNE 30, 1996-(UNAUDITED)*
<TABLE>
<S> <C>
NET INCREASE/(DECREASE) IN NET ASSETS FROM OPERATIONS:
Net investment income.............................................. $ 21,957
Net realized loss on securities, forward foreign currency exchange
contracts and foreign currency transactions during the period..... (2,674)
Net unrealized appreciation of securities, forward foreign currency
exchange contracts, foreign currency transactions and net other
assets during the period.......................................... 57,651
----------
Net increase in net assets resulting from operations............... 76,934
BENEFICIAL INTEREST TRANSACTIONS:
Net increase from beneficial interest transactions (Note 4)........ 6,228,447
----------
Net increase in net assets......................................... 6,305,381
NET ASSETS:
Beginning of period................................................ 500,000
----------
End of period...................................................... $6,805,381
==========
Undistributed net investment income................................ $ 21,957
==========
</TABLE>
- --------
* Montgomery Variable Series: Emerging Markets Fund commenced operations on
February 1, 1996.
The accompanying notes are an integral part of these financial statements.
8
<PAGE>
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
FINANCIAL HIGHLIGHTS
SELECTED PER SHARE DATA FOR THE PERIOD ENDED:
<TABLE>
<CAPTION>
06/30/96
(UNAUDITED)*
------------
<S> <C>
Net asset value--beginning of period.............................. $ 10.00
-------
Net investment income............................................. 0.03
Net realized and unrealized gain on investments................... 0.53
-------
Net increase in net assets resulting from investment operations... 0.56
-------
Net asset value--end of period.................................... $ 10.56
=======
Total return**.................................................... 5.60%
=======
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's).............................. $ 6,805
Ratio of net investment income to average net assets.............. 2.93%+
Ratio of operating expenses to average net assets................. 0.00%+
Portfolio turnover rate........................................... 16%
Average commission rate paid(a)................................... $0.0002
Net investment loss before deferral of fees and absorption of
expenses by Manager.............................................. $ (0.04)
Operating expense ratio before deferral of fees and absorption of
expenses by Manager.............................................. 6.79%+
</TABLE>
- --------
* The Montgomery Variable Series: Emerging Markets Fund commenced operations
on February 1, 1996.
** Total return represents aggregate total return for the period indicated.
+ Annualized.
(a) Average commission rate paid per share of securities purchased and sold by
the Fund.
The accompanying notes are an integral part of these financial statements.
9
<PAGE>
THE MONTGOMERY FUNDS III
NOTES TO FINANCIAL STATEMENTS--(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES:
The Montgomery Fund III (the "Trust") is registered under the Investment
Company Act of 1940, as amended (the "1940 Act"), as a diversified, open-end
management investment company. As of June 30, 1996, the Trust had two series,
the Montgomery Variable Series: Growth Fund and the Montgomery Variable
Series: Emerging Markets Fund.
The Montgomery Funds III was organized as a Delaware business trust on
August 24, 1994. Prior to the public offerings of shares of the Fund, a
limited number of shares were sold to Montgomery Asset Management, L.P. and/or
affiliated persons of Montgomery Asset Management in private placement
offerings. Otherwise, the Funds had no significant operations prior to
February 1, 1996, the date on which the Montgomery Variable Series: Emerging
Markets Fund commenced operations (i.e., commenced selling shares to the
public).
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the financial
statements. Actual results could differ from those estimates. Information
presented in these financial statements pertains to the Montgomery Variable
Series: Emerging Markets Fund (the "Fund"). The Montgomery Variable Series:
Growth Fund is presented under a separate cover.
The following is a summary of significant accounting policies.
a. PORTFOLIO VALUATION--The Fund's securities are valued using current
market valuations: either the last reported sales price or, lacking any
reported sales, and in the case of fixed income securities, the mean between
the closing bid and asked prices. 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. Securities 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 supervision of the
Trust in accordance with methods which are authorized by the Trust's 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 maturities of 60 days or less are carried at amortized cost, which
approximates market value.
b. DIVIDENDS AND DISTRIBUTIONS--Dividends, if any, from net investment
income of the Fund are declared and paid at least annually.
Distributions of any short-term capital gains earned by the Fund are
distributed no less frequently than annually. Additional distributions of net
investment income and capital gains for the Fund may be made in order to avoid
the application of a 4% non-deductible excise tax on certain undistributed
amounts of ordinary income and capital gains. Income distributions and capital
gain distributions are determined in accordance with income tax regulations
which may differ from generally accepted accounting principles. These
differences are primarily due to differing treatments of income and gains on
various investment securities held by a Fund, timing differences and differing
characterizations of distributions made by a Fund.
c. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS--The Fund may engage in
forward foreign currency exchange contracts with off balance sheet risk in the
normal course of investing activities in order to manage exposure to market
risks. Forward foreign currency exchange contracts are valued at the forward
rate and are marked-to-market daily. The change in market value is recorded by
the Fund as an unrealized gain or loss.
10
<PAGE>
THE MONTGOMERY FUNDS III
NOTES TO FINANCIAL STATEMENTS--(UNAUDITED)(CONTINUED)
When the contract is closed, a Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it was opened and
the value at the time it was closed. Forward foreign currency exchange
contracts have been used solely to establish a rate of exchange for settlement
of transactions. Although forward foreign currency exchange contracts limit
the risk of loss due to a decline in the value of the hedged currency, they
also limit any potential gain that might result should the value of the
currency increase. In addition, a Fund could be exposed to risks if the
counterparties to the contracts are unable to meet the terms of their
contracts.
d. FOREIGN CURRENCY--Foreign currencies, investments and other assets and
liabilities are translated into U.S. dollars at the exchange rates prevailing
at the end of the period, and purchases and sales of investment securities and
income and expenses are translated on the respective dates of such
transactions. Unrealized gains and losses which result from changes in foreign
currency exchange rates on investments have been included in the unrealized
appreciation/(depreciation) of securities. Net realized foreign currency gains
and losses resulting from movement in exchange rates include foreign currency
gains and losses between trade date and settlement date on investment
securities transactions, foreign currency transactions and the difference
between the amounts of interest and dividends recorded on the books of a Fund
and the amount actually received and the portion of foreign currency gains and
losses related to fluctuations in exchange rates between the initial purchase
trade date and subsequent sale trade date.
e. REPURCHASE AGREEMENTS--The Fund may engage in repurchase agreement
transactions individually or jointly through a joint repurchase account with
other series of the Trust pursuant to a joint repurchase agreement. Under the
terms of a typical repurchase agreement, a Fund writes a financial contract
with a counterparty and takes possession of a government debt obligation as
collateral. The Fund also agrees with the counterparty to allow the
counterparty to repurchase the financial contract at a specified date and
price, thereby determining the yield during the Fund's holding period. This
arrangement results in a fixed rate of return that is not subject to market
fluctuations during the Fund's holding period. The value of the collateral is
at least equal at all times to the total amount of the repurchase obligations,
including interest. In the event of counterparty default, a Fund has the right
to use the collateral to offset losses incurred. There could be potential loss
to the Fund in the event a Fund is delayed or prevented from exercising its
rights to dispose of the collateral securities, including the risk of a
possible decline in the value of the underlying securities during the period
while a Fund seeks to assert its rights. The Fund's investment manager, acting
under the supervision of the Board of Trustees, reviews the value of the
collateral and the creditworthiness of those banks and dealers with which a
Fund enters into repurchase agreements to evaluate potential risks. The Fund
may also participate on an individual or joint basis in tri-party repurchase
agreements which involves a counterparty and a custodian bank.
f. SECURITIES TRANSACTIONS AND INVESTMENT INCOME--Securities transactions
are recorded on a trade-date basis. Realized gain and loss from securities
transactions are recorded on the specific identified cost basis. Dividend
income is recognized on the ex-dividend date and interest income, including,
where applicable, amortization of discount on short-term investments, is
recognized on an accrual basis. Dividend income on foreign securities is
recognized as soon as the Fund is informed of the ex-dividend date.
g. FEDERAL INCOME TAXES--It is the intention of the Fund to qualify and
elect treatment as a regulated investment company under Subchapter M of the
Internal Revenue Code of 1986, as amended (the "Code"), by complying with the
provisions available to certain investment companies, as defined in applicable
sections of the Code, and to make distributions of taxable income to
shareholders sufficient to relieve the Fund from all or substantially all
federal income taxes.
h. ORGANIZATION COSTS--Expenses incurred in connection with the organization
of the Fund, including the fees and expenses of registering and qualifying its
shares for distribution under federal and state
11
<PAGE>
THE MONTGOMERY FUNDS III
NOTES TO FINANCIAL STATEMENTS--(UNAUDITED)(CONTINUED)
securities regulations, are amortized on a straight-line basis over a period
of five years from commencement of operations.
2. MANAGEMENT FEES AND OTHER TRANSACTIONS WITH AFFILIATES:
a. Montgomery Asset Management, L.P. is the Fund's Manager (the "Manager").
The Manager, a California limited partnership, is an investment adviser
registered with the Securities and Exchange Commission under the Investment
Advisers Act of 1940, as amended (the "Advisers Act"). The general partner of
the Manager is Montgomery Asset Management, Inc. The sole limited partner of
the Manager is Montgomery Securities. Under the Advisers Act, both Montgomery
Asset Management, Inc. and Montgomery Securities may be deemed controlling
persons of the Manager. Although the operations and management of the Manager
are independent from those of Montgomery Securities, it is expected that the
Manager may draw upon the research and administrative resources of Montgomery
Securities at its discretion in a manner consistent with applicable
regulations.
Pursuant to investment management agreement ("Investment Management
Agreement"), 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
Trust with respect to the Manager's responsibilities under such Agreement. As
compensation, the Fund pays the Manager a monthly management fee (accrued
daily) at the following annual rates based upon the average daily net assets
of the Fund:
<TABLE>
<CAPTION>
FIRST $250 OVER $250
MILLION MILLION
---------- ---------
<S> <C> <C>
MONTGOMERY VARIABLE SERIES:
Emerging Markets Fund.............................. 1.25% 1.00%
</TABLE>
The Manager has agreed to reduce some or all of its management fee or absorb
the Fund expenses if necessary to keep the Fund's annual operating expenses,
exclusive of interest or taxes, at or below the average daily net assets or
the maximum allowed by applicable state expense limitations for the Fund as
follows:
<TABLE>
<CAPTION>
ANNUAL RATE
-----------
<S> <C>
MONTGOMERY VARIABLE SERIES:
Emerging Markets Fund....................................... 1.75%
</TABLE>
Any reductions or absorptions made for the Fund by the Manager in its fees
are subject to recovery within the following three years provided the Fund is
able to affect such reimbursement and remain in compliance with applicable
expense limitations. Any of the Manager's voluntary absorptions are also
subject to recovery.
For the period ended June 30, 1996, the Manager has deferred fees and
absorbed expenses as follows:
<TABLE>
<CAPTION>
FEES EXPENSES
DEFERRED ABSORBED
-------- --------
<S> <C> <C>
MONTGOMERY VARIABLE SERIES:
Emerging Markets Fund................................. $9,371 $41,545
</TABLE>
As of June 30, 1996, the deferred management fees and and absorbed expenses
subject to recoupment are $50,916 for the Montgomery Variable Series: Emerging
Markets Fund.
b. Certain officers and Trustees of the Trust are, with respect to the
Trust's Manager and/or Montgomery Securities, "affiliated persons" as defined
in the 1940 Act. Each Trustee who is not an "affiliated person"
12
<PAGE>
THE MONTGOMERY FUNDS III
NOTES TO FINANCIAL STATEMENTS--(UNAUDITED)(CONTINUED)
receives an annual retainer and quarterly meeting fees totalling $35,000 per
annum, as well as reimbursement for expenses ($5,000 of which will be
allocated to the Montgomery Funds III).
c. The Fund has no sales load and does not pay distribution (Rule 12b-1)
fees.
3. SECURITIES TRANSACTIONS:
a. The aggregate amount of purchases and sales of investment securities,
other than short-term securities, for the period ended June 30, 1996, was as
follows:
<TABLE>
<CAPTION>
PURCHASES SALES
------------ ------------
<S> <C> <C>
MONTGOMERY VARIABLE SERIES:
Emerging Markets Fund........................ $6,058,942 $267,160
b. At June 30, 1996, aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost and aggregate
gross unrealized depreciation for all securities in which there was an excess
of tax cost over value for federal income tax purposes were as follows:
<CAPTION>
TAX BASIS TAX BASIS
UNREALIZED UNREALIZED
APPRECIATION DEPRECIATION
------------ ------------
<S> <C> <C>
MONTGOMERY VARIABLE SERIES:
Emerging Markets Fund........................ $181,479 $123,352
The schedule of forward foreign currency exchange contracts at June 30, 1996
was as follows:
<CAPTION>
CONTRACT
VALUE VALUE
DATE (NOTE 1)
------------ ------------
<S> <C> <C>
Forward Foreign Currency Exchange Contracts to
Buy:
90,404 Brazilian Real........................ 07/01/96 $ 90,030
1,319,128 Philippine Pesos................... 07/02/96 50,345
474,494 South African Commercial Rand........ 07/02/96 109,481
--------
TOTAL FORWARD FOREIGN CURRENCY EXCHANGE CON-
TRACTS TO BUY (Contract Cost $250,187)........ $249,856
========
</TABLE>
4. TRANSACTIONS IN SHARES OF BENEFICIAL INTEREST:
The Trust has authorized an unlimited number of shares of beneficial
interest which have a par value of $0.01. Transactions in shares of beneficial
interest for the period indicated below were:
<TABLE>
<CAPTION>
PERIOD ENDED
JUNE 30, 1996*
-------------------
SHARES AMOUNT
------- ----------
<S> <C> <C>
MONTGOMERY VARIABLE SERIES:
EMERGING MARKETS FUND:
Shares Sold........................................ 651,218 $6,827,388
Shares Redeemed.................................... (56,942) (598,941)
------- ----------
Net Increase....................................... 594,276 $6,228,447
======= ==========
</TABLE>
- --------
* Montgomery Variable Series: Emerging Markets Fund commenced operations on
February 1, 1996.
13
<PAGE>
THE MONTGOMERY FUNDS III
NOTES TO FINANCIAL STATEMENTS--(UNAUDITED)(CONTINUED)
5. FOREIGN SECURITIES
The Montgomery Variable Series: Emerging Markets Fund purchases securities
in emerging market countries. Securities of foreign companies and foreign
governments involve special risks and considerations not typically associated
with investing in U.S. companies and the U.S. government. These risks include
re-evaluation of currencies, less reliable information about issuers,
differences in the clearance and settlement of securities transactions
practices, and future adverse political and economic developments. These risks
are heightened for investments in emerging market countries. Moreover,
securities of many foreign companies and foreign governments and their markets
may be less liquid and their prices more volatile than those securities of
comparable U.S. companies and U.S. government.
6. SPECIAL SITUATION SECURITIES
The Fund may not invest more than 15% of its net assets in illiquid
securities. The following securities held by the Fund on June 30, 1996, are
generally unrestricted securities for which reliable market prices can be
established. These securities are valued at their market prices. However,
because the process of re-registering foreign securities in the Fund's name
can take more than seven days, the following shares of each of these
securities were deemed restricted or illiquid in the hands of the Fund at June
30, 1996. The Fund bears the cost of re-registering these securities:
<TABLE>
<CAPTION>
06/30/96
ACQUISITION MARKET VALUE % OF TOTAL
SECURITY DATE SHARES VALUE PER SHARE COST NET ASSETS
-------- ----------- ------ -------- --------- ------- ----------
<S> <C> <C> <C> <C> <C> <C>
Ciputra Development..... 6/12/96 22,000 $ 44,662 $2.03 $45,690 0.66%
Edaran Otomobil Nasional
Berhad................. 5/21/96 8,000 76,649 9.58 73,376 1.13
IOI Industrial Oxygen
Inc. .................. 5/21/96 17,000 23,580 1.39 25,410 0.35
Resorts World Berhad.... 6/19/96 20,000 114,652 5.73 114,692 1.68
Telekom Malaysia........ 5/14/96 3,000 26,699 8.90 28,996 0.39
-------- ----
$286,242 4.21%
======== ====
</TABLE>
14
