<PAGE>
Montgomery Variable Series:
International Small Cap Fund
SEMI-ANNUAL REPORT
JUNE 30, 1997
Invest wisely.sm
The Montgomery Fund
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
PORTFOLIO HIGHLIGHTS
JUNE 30, 1997 (UNAUDITED)
- --------------------------------------------------------------------------------
Investment Review
Q: HOW DID THE FUND PERFORM FROM ITS INCEPTION IN SEPTEMBER 1996 THROUGH JUNE
30, 1997?
A: It dramatically outperformed its benchmark, the Salomon Brothers Extended
Market (ex-U.S.) Index during that period.
Q: WHAT FACTORS EXPLAINED THAT OUTPERFORMANCE?
A: The Fund had more exposure than the indices did to the European markets,
which were generally quite strong over the period, and less to Japan, which
until recently was weak. Many European stock exchanges were driven up by the
same kind of economic equilibrium that we have been enjoying in the United
States-with low inflation, relatively low interest rates and moderate
economic growth. Positive earnings trends there also helped to fuel their
rallies. In fact, several continental European markets reached new highs.
Japan, on the other hand, was depressed for much of the period by sentiment
that we believe was overly pessimistic. Although Japan still faces some
problems, such as the lingering effects of a banking crisis, we believe that
its economy is gaining momentum. And even after its rally this spring, we
continue to see exceptional values there, especially among the shares of
mid- to small-cap companies.
Good decisions when it came to individual stocks within both Japan and
Europe also helped the Fund to outperform the index. During the second
quarter of calendar year 1997, for example, many of our Japanese and
European holdings performed even better than their respective markets during
their rallies.
Q: WERE THERE ANY DISAPPOINTMENTS?
A: Yes, there were some, but fortunately most of them proved to be only
temporary. In December, for instance, Japanese authorities announced plans
to deregulate the country's non-life insurance industry. The initiative
caused shares in the sector-including some of the Fund's holdings there-to
decline by more than 20% in some instances. Deregulation generally leads to
price competition in the industry in which it occurs, so it tends to make
investors uncertain about who will emerge as the winners and losers down the
road.
Although that kind of episode can make for some short-term disappointment,
it can also create an opportunity for us to invest rather cheaply in
companies that we think will carve out a dominant position. After all,
deregulation is becoming more commonplace, and we think it's important to
approach it constructively. That's one of the reasons why we invest only in
companies that have qualities like seasoned management teams, strong cash-
generating capabilities, consistently solid earnings growth and dominant
market share. We think that these attributes will enable the companies to
not only survive in a more competitive environment, but actually thrive in
it.
Portfolio Management
- ----------------------------------------
John D. Boich, CFA
..............Senior Portfolio Manager
- ----------------------------------------
Fund Performance
- ----------------------------------------
Aggregate total returns for the period
ended 6/30/97
- ----------------------------------------
MONTGOMERY VARIABLE SERIES:
INTERNATIONAL SMALL CAP FUND
Since inception (9/30/96)...... 20.70%
SALOMON BROTHERS WORLD EXTENDED
EX-U.S. MARKET INDEX
Since (9/30/96)....... ..........4.56%
- ----------------------------------------
Past performance is no guarantee of future results. Net asset value, investment
return and principal value will fluctuate so that shares, when redeemed, may be
worth more or less than their original cost.
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
S&P 500 INDEX AND S&P FINANCIAL INDEX
PERFORMANCE GRAPH APPEARS HERE
Measurement Period MONTGOMERY VARIABLE SERIES:
(Fiscal Year Covered) INTERNATIONAL SMALL CAP FUND S&P
- --------------------- ---------------------------- --------
Measurement Pt-09/1996 $100.00 $ 100.00
FYE 10/1996 $101.90 $ 9,960.72
FYE 11/1996 $110.50 $10,123.63
FYE 12/1996 $107.23 $ 9,937.42
FYE 01/1997 $111.65 $ 9,722.68
FYE 02/1997 $114.47 $ 9,886.02
FYE 03/1997 $112.26 $ 9,754.94
FYE 04/1997 $111.55 $ 9,609.10
FYE 05/1997 $117.48 $10,244.81
FYE 06/1997 $120.70 $10,455.97
- --------------------
* The Salomon Brothers World Extended ex-U.S. Market Index is a comprehensive
float-weighted equity index consisting of every company with an investable
market capitalization of over $100 million in 21 countries.
1
<PAGE>
Montgomery Variable Series: International Small Cap Fund
Portfolio Highlights (continued)
June 30, 1997 (unaudited)
- -----------------------------------------------------------------------------
Q: THE STRENGTH OF THE U.S. DOLLAR AGAINST THE JAPANESE YEN AND SEVERAL MAJOR
EUROPEAN CURRENCIES MADE HEADLINES OVER THE PAST YEAR. HOW DO CURRENCY
TRENDS LIKE THIS AFFECT YOUR STRATEGY?
A: Our policy, which is one we share with all of Montgomery's foreign and
global stock funds, is not to hedge against currency fluctuations. Hedging
is not only difficult to execute well, but can also be expensive at times.
We don't entirely ignore the impact of currency relationships, though. When
the U.S. dollar strengthens against the currency of a country that we
invest in, for example, it can diminish the Fund's returns from that
market. But the same trend can also put that country's exporters at an
advantage to their U.S. competitors. So in that situation, we may decide to
emphasize exporters in that country, so long as their corporate
fundamentals meet our investment criteria. That, in fact, is what we did
over the past nine months in a number of countries, such as Japan. (The
opposite trend--the dollar weakening--likewise has positive and negative
repercussions for international investors.)
So, broadly speaking, we do pay careful attention to macroeconomic trends
like this, but bottom-up corporate fundamentals remain our chief focus.
Q: WHY SHOULD AN INVESTOR CONSIDER THE MONTGOMERY VARIABLE SERIES:
INTERNATIONAL SMALL CAP FUND RIGHT NOW?
A: First of all, there are many dynamic small companies outside the United
States, and most of them haven't yet been discovered by investors. That
presents an opportunity for shareholders in the Variable Series:
International Small Cap Fund to invest in them at attractive prices. In
addition, many of the structural changes that have driven up the U.S.
market over the past six years are still in their early stages overseas. As
we mentioned, deregulation can give innovative small companies a chance to
become market leaders. These are just some of the reasons why we're excited
about the Fund's prospects.
2
<PAGE>
Montgomery Variable Series: International Small Cap Fund
Portfolio Highlights (continued)
June 30, 1997 (unaudited)
- --------------------------------------------------------------------------------
TOP FIVE COUNTRIES
(as a percentage of total net assets):
------------------------------------------------
Japan................................. 25.4 %
Germany............................... 12.8
Great Britain......................... 10.7
Italy................................. 8.3
France................................ 7.7
------------------------------------------------
Top Ten Holdings
(as a percentage of total net assets):
------------------------------------------------
Turbon International AG.............. 7.0 %
Otsuka Kagu Ltd...................... 4.6
Nissin Company Ltd................... 3.8
Azkoyen S.A.......................... 3.8
Mirai Industry Company, Ltd.......... 3.8
Mediolanum SpA....................... 3.6
Laox................................. 3.3
Fuso Lexel Inc....................... 3.2
Danzas Holding....................... 3.2
Fujitsu Denso........................ 3.0
------------------------------------------------
3
<PAGE>
Montgomery Variable Series: International Small Cap Fund
Portfolio Investments
June 30, 1997 (unaudited)
<TABLE>
<CAPTION>
COMMON STOCKS-93.4% VALUE
SHARES (NOTE 1)
<C> <S> <C>
AUSTRIA-2.6%
2,120 Flughafen Wein AG (Airlines) $ 89,547
----------
CANADA-0.3%
5,000 InMedia Presentations, Inc.+ (Software Systems) 9,052
----------
CHINA/HONG KONG-6.6%
90,000 Esprit Holdings Ltd. (Retail Trade) 63,893
140,000 Four Seas Mercantile Holdings Ltd. (Food and Beverage) 82,222
104,000 Goldlion Holdings, Ltd., ORD (Apparel and Textiles) 58,059
10,500 Smartone Telecommunications+(Telephone/Wireless) 23,854
----------
228,028
----------
FRANCE-7.7%
700 Cardif S.A. (Insurance) 82,189
3,200 Coflexip S.A. (Oilfield Equipment) 97,000
420 Europe 1 Communication (Broadcasting/Advertising) 86,120
----------
265,309
----------
GERMANY-12.8%
5,000 Rofin-Sinar Technologies Inc.+ (Machinery and Tools) 95,625
630 Villeroy & Boch AG (Household Products) 102,234
8,000 Turbon International AG+ (Computers and Office Equipment) 243,126
----------
440,985
----------
GREAT BRITAIN-10.7%
24,500 Avis Europe PLC+ (Retail Trade) 55,692
4,500 Azlan Group PLC+ (Telephone/Networks) 41,590
3,800 Corporate Services Group PLC+ (Business Services) 11,929
800 Dr. Solomon's Group PLC, ADR+ (Software Systems) 20,450
6,100 Eidos PLC+ (Computers and Office Equipment) 74,664
27,100 Firstbus PLC (Railroad) 93,870
120,500 Freepages Group PLC+ (Broadcasting/Advertising) 73,244
----------
371,439
----------
ISRAEL-2.7%
5,500 Matav-Cable Systems Media Ltd.+ (Broadcasting/Advertising) 94,875
----------
ITALY-8.3%
18,000 Editoriale L'Expresso SpA (Newspapers/Publishing) 59,933
1,600 Gucci Group (Retail Trade) 103,000
11,100 Mediolanum SpA (Insurance) 125,176
----------
288,109
----------
JAPAN-25.4%
1,800 Amway Japan Ltd. (Household Products) 60,934
500 Fast Retailing Company Ltd. (Retail Trade) 16,141
3,400 Fujitsu Denso (Electrical Equipment) 104,419
11,000 Fuso Lexel Inc. (Real Estate). 111,329
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
4
<PAGE>
Montgomery Variable Series: International Small Cap Fund
Portfolio Investments (continued)
June 30, 1997 (unaudited)
<TABLE>
<CAPTION>
COMMON STOCKS-(CONTINUED) VALUE
SHARES (NOTE 1)
<C> <S> <C>
JAPAN-(CONTINUED)
8,000 Laox (Retail Trade) $ 112,376
5,750 Mirai Industry Company, Ltd. (Electronics) 131,440
4,400 Nissin Company Ltd. (Diversified Financial Services) 132,443
2,000 Otsuka Kagu Ltd.+ (Retail Trade) 158,269
4,000 Sugimoto & Company+ (Machinery and Tools) 50,604
----------
877,955
----------
NETHERLANDS-1.6%
3,000 Elsag Bailey Process Automation N.V.+ (Machinery and Tools) 55,125
----------
NORWAY-2.5%
2,950 Union Bank of Norway (Banks) 87,342
----------
SPAIN-3.8%
1,060 Azkoyen S.A. (Consumer Services) 131,646
----------
SWEDEN-5.2%
6,100 Hemkopskedjan AB+ (Food and Beverage) 62,691
4,860 Nobel Biocare AB+ (Medical Products) 68,482
3,200 Prosolvia AB+** (Software Systems) 49,228
----------
180,401
----------
SWITZERLAND-3.2%
560 Danzas Holding+ (Airfreight Couriers) 109,263
----------
TOTAL COMMON STOCKS (COST $3,137,373) 3,229,076
==========
REPURCHASE AGREEMENT-9.4%
(COST $323,000)
PRINCIPAL AMOUNT
$323,000 Agreement with Nikko Securities Company International Inc.,
Tri-Party, 6.200% dated 06/30/97, to be repurchased at
$323,056, on 07/01/97, collateralized by $330,948 market
value of U.S. Government securities having various maturities
and various interest rates. 323,000
----------
TOTAL INVESTMENTS (COST $3,460,373*) 102.8% 3,552,076
OTHER ASSETS AND LIABILITIES (NET) (2.8) (95,578)
-------- ----------
NET ASSETS 100.0% $3,456,498
======== ==========
</TABLE>
- ------------------------------------------
* Aggregate cost for Federal tax purposes.
** Illiquid Security or Special Situation Security (See Note 6 to Financial
Statements).
+ Non-income-producing security.
Abbreviations:
ADR American Depositary Receipt
ORD Ordinary
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
5
<PAGE>
Montgomery Variable Series: International Small Cap Fund
Statement of Assets and Liabilities
June 30, 1997 (unaudited)
<TABLE>
<CAPTION>
ASSETS:
<S> <C> <C>
Investments in securities, at value (Identified cost $3,460,373)(Note 1)... $3,552,076
Cash....................................................................... 656
Foreign currency (Cost $81)................................................ 30
Forward foreign currency exchange contracts:
Forward foreign currency exchange contracts to buy, at value
(Contract cost $124,206) (Note 3)..................................... 123,558
Receivables:
Investment securities sold............................................ 32,399
Shares of beneficial interest sold.................................... 13,659
Expenses absorbed by Manager (Note 2)................................. 4,010
Dividends............................................................. 3,821
Interest.............................................................. 56
Other Assets:
Organization costs (Note 1)........................................... 1,662
----------
Total Assets............................................................... 3,731,927
LIABILITIES:
Forward foreign currency exchange contracts:
Payable for forward foreign currency exchange
contracts to buy (Note 3).......................................... $ 124,206
Payables:
Investment securities purchased....................................... 127,782
Organization cost..................................................... 4,247
Trustees' fees and expenses........................................... 2,359
Custodian fees........................................................ 778
Other accrued liabilities and expenses................................ 16,057
----------
Total Liabilities.......................................................... 275,429
----------
NET ASSETS................................................................. $3,456,498
==========
NET ASSETS consist of:
Undistributed net investment income........................................ 23,226
Accumulated net realized gain on securities sold, forward foreign
currency exchange contracts and foreign currency transactions......... 227,129
Net unrealized appreciation of investments, forward foreign
currency exchange contracts and foreign currency transactions......... 91,428
Shares of beneficial interest.............................................. 2,877
Additional paid-in capital................................................. 3,111,838
----------
NET ASSETS................................................................. $3,456,498
==========
Net Asset Value, offering and redemption price per share
($3,456,498 divided by 287,683 shares of beneficial interest outstanding).. $ 12.01
----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
6
<PAGE>
Montgomery Variable Series: International Small Cap Fund
Statement of Operations
For the Six Months Ended June 30, 1997 (unaudited)
<TABLE>
<CAPTION>
NET INVESTMENT INCOME:
<S> <C> <C>
Dividends.................................................................. $ 15,205
Interest................................................................... 7,549
----------
Total Investment Income.................................................... 22,754
EXPENSES:
Management fee (Note 2).................................................... $ 13,550
Legal and audit fees....................................................... 11,405
Trustees' fees and expenses (Note 2)....................................... 3,818
Insurance fees............................................................. 2,975
Custodian fees............................................................. 2,800
Amortization of organization expenses (Note 1)............................. 425
Other...................................................................... 3,220
----------
Total Expenses............................................................. 38,193
Fees deferred and expenses absorbed by Manager (Note 2).................... (38,193)
----------
NET EXPENSES............................................................... 0
----------
NET INVESTMENT INCOME...................................................... 22,754
----------
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS (NOTES 1 AND 3):
Net realized gain/(loss) on:
Security transactions................................................. 221,326
Forward foreign currency exchange contracts........................... (12,309)
Foreign currency transactions......................................... 1,246
----------
Net realized gain on investments during the period......................... 210,263
----------
Change in unrealized appreciation/(depreciation) of:
Securities............................................................ 42,247
Forward foreign currency exchange contracts........................... (648)
Foreign currency transactions and net other assets.................... 347
----------
Net unrealized appreciation of investments during the period............... 41,946
----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS............................ 252,209
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS....................... $ 274,963
==========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
7
<PAGE>
Montgomery Variable Series: International Small Cap Fund
Statement of Changes in Net Assets
<TABLE>
<CAPTION>
For the Six Months
Ended 06/30/97 For the Period
(unaudited) Ended 12/31/96*
------------------ ---------------
<S> <C> <C>
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS:
Net investment income............................................. $ 22,754 $ 5,449
Net realized gain on securities, forward foreign currency exchange
contracts and foreign currency transactions during the period.... 210,263 17,397
Net unrealized appreciation of securities, forward foreign currency
exchange contracts, foreign currency transactions and net other
assets during the period.......................................... 41,946 49,482
---------- ----------
Net increase in net assets resulting from operations............... 274,963 72,323
DISTRIBUTIONS TO SHAREHOLDERS:
Distributions from net investment income........................... -- (4,977)
Distributions from net realized gains on investments............... -- (526)
BENEFICIAL INTEREST TRANSACTIONS:
Net increase from beneficial interest transactions (Note 4)........ 2,074,853 39,862
---------- ----------
Net increase in net assets......................................... 2,349,816 106,682
NET ASSETS:
Beginning of period................................................ 1,106,682 1,000,000
---------- ----------
End of period...................................................... $3,456,498 $1,106,682
========== ==========
Undistributed net investment income................................ $ 23,226 $ 472
========== ==========
</TABLE>
- -----------------------------
* Montgomery Variable Series: International Small Cap Fund commenced operations
on September 30, 1996.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
8
<PAGE>
Montgomery Variable Series: International Small Cap Fund
Financial Highlights
Selected Per Share Data for the Period Ended:
<TABLE>
<CAPTION>
06/30/97
(unaudited)++ 12/31/96*
------------- ---------
<S> <C> <C>
Net asset value--beginning of period................................................... $ 10.67 $ 10.00
------- -------
Net investment income.................................................................. 0.12 0.05
Net realized and unrealized gain on investments........................................ 1.22 0.68
------- -------
Net increase in net assets resulting from investment operations........................ 1.34 0.73
------- -------
Distributions to shareholders:
Distributions from net investment income.......................................... - (0.05)
Distributions from net realized gains on investments.............................. - (0.01)
------- -------
Total distributions............................................................... - (0.06)
------- -------
Net asset value--end of period......................................................... $ 12.01 $ 10.67
======= =======
Total return**......................................................................... 12.56% 7.23%
======= =======
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's)................................................... 3,456 $ 1,107
Ratio of net investment income to average net assets................................... 2.10%+ 2.03%+
Ratio of operating expenses to average net assets...................................... 0.00%+ 0.00%+
Portfolio turnover rate................................................................ 85% 12%
Average commission rate paid (a)....................................................... $0.0089 $0.0059
Net investment loss before deferral of fees and absorption of
expenses by Manager............................................................... $ (0.05) $ (0.11)
Operating expense ratio before deferral of fees and
absorption of expenses by Manager................................................. 3.52%+ 6.30%+
</TABLE>
- --------------------------------------------
* Montgomery Variable Series: International Small Cap Fund commenced
operations on September 30, 1996.
** Total return represents aggregate total return for the periods indicated.
+ Annualized.
++ Per share numbers have been calculated using the average shares method,
which more appropriately presents the per share data for the period since
the use of the undistributed net investment income method did not accord
with the results of operations.
(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 Funds 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, 1997, the Trust had four
series, the Montgomery Variable Series: Growth Fund, the Montgomery Variable
Series: Emerging Markets Fund, the Montgomery Variable Series: International
Small Cap Fund and the Montgomery Variable Series: Small Cap Opportunities
Fund. The Montgomery Variable Series: Small Cap Opportunities Fund had not
commenced operations as of June 30, 1997.
The Trust was organized as a Delaware business trust on August 24, 1994.
Prior to the public offerings of shares of the Funds, 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 2,
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: International Small Cap Fund (the "Fund"). The
Montgomery Variable Series: Emerging Markets Fund and the Montgomery
Variable Series: Growth Fund are presented under separate covers.
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 the Fund, timing differences and differing
characterizations of distributions made by the 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.
When the contract is closed, the 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, the Fund could be exposed to risks if the counterparties to
the contracts are unable to meet the terms of their contracts.
10
<PAGE>
The Montgomery Funds III
Notes to Financial Statements (unaudited) (continued)
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 the 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 and affiliated registered investment companies pursuant to a joint
repurchase agreement. Under the terms of a typical repurchase agreement,
the 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, the Fund has
the right to use the collateral to offset losses incurred. There could
be potential loss to the Fund in the event the 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 the 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 the 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 involve 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
The Fund has elected and qualified, and it is the intention of the Fund
to continue to qualify, 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 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., and
its sole limited partner is an affiliate of 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 the 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
<PAGE>
The Montgomery Funds III
Notes to Financial Statements (unaudited) (continued)
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:
First $250 Million Over $250 Million
------------------ -----------------
1.25% 1.00%
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 1.90% of
the average daily net assets of the Fund.
Any reductions or absorptions made for the Fund by the Manager of 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 six months ended June 30, 1997, the Manager has deferred fees of
$13,550 and absorbed expenses of $24,643.
As of June 30, 1997, the deferred management fees and absorbed expenses
subject to recoupment are $55,124.
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"
receives an annual retainer and quarterly meeting fees totalling $35,000
per annum, as well as reimbursement for expenses, for services as
Trustee of all three Trusts advised by the Manager ($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 six months ended June 30,
1997, were $3,598,048 and $1,694,473, respectively.
b. At June 30, 1997, 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 $189,186 and $97,483, respectively.
c. The schedule of forward foreign currency exchange contracts at June 30,
1997 was as follows:
<TABLE>
<CAPTION>
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS TO BUY: CONTRACT VALUE DATE VALUE (NOTE 1)
<S> <C> <C> <C>
4,208 Great Britain Pound 07/01/97 $ 7,008
74,571 Swedish Krona 07/01/97 9,640
349,596 Swedish Krona 07/02/97 45,194
10,868 Swedish Krona 07/03/97 1,405
87,679,014 Italian Lira 07/03/97 51,578
14,847,066 Italian Lira 07/07/97 8,733
---------
TOTAL FORWARD FOREIGN CURRENCY EXCHANGE
CONTRACTS TO BUY
(CONTRACT COST $124,206) $ 123,558
=========
</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 periods indicated below were:
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1997 PERIOD ENDED DECEMBER 31, 1996*
SHARES AMOUNT SHARES AMOUNT
<S> <C> <C> <C> <C>
Shares Sold 260,586 $2,944,595 3,261 $35,367
Issued as Reinvestment of Dividends -- -- 514 5,504
Shares Redeemed (76,583) (869,742) (95) (1,009)
-------- ---------- ----- -------
Net Increase 184,003 $2,074,853 3,680 $39,862
======== ========== ===== =======
</TABLE>
- ----------------------
* Montgomery Variable Series: International Small Cap Fund commenced operations
on September 30, 1996.
12
<PAGE>
The Montgomery Funds III
Notes to Financial Statements (unaudited) (continued)
5. FOREIGN SECURITIES:
The Fund purchases securities in foreign 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. 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 the
U.S. government.
6. SPECIAL SITUATION SECURITY
The Fund may not invest more than 15% of its net assets in illiquid
securities. The security shown in the table below has been determined by
the Manager to be illiquid because it is restricted or because there is an
exceptionally low trading volume in the primary trading market for this
security at June 30, 1997. This security is valued at market price:
<TABLE>
<CAPTION>
ACQUISITION 6/30/97 VALUE % OF TOTAL
SECURITY DATE SHARES MARKET VALUE PER SHARE COST NET ASSETS
----------- ------ ------------ --------- ------ ----------
<S> <C> <C> <C> <C> <C> <C>
Proslovia AB 06/17/97 3,200 $49,228 $15.38 $51,843 1.42%
</TABLE>
7. SUBSEQUENT EVENT:
On March 25, 1997, Montgomery Securities, the Manager and CAM Acquisition
LLC ("CAM"), a newly organized subsidiary of Commerzbank
Aktiengesellschaft, entered into an agreement providing for the transfer of
substantially all the assets composing the Manager's business to CAM. On
June 23, 1997, the shareholders of the Fund approved a new Investment
Management Agreement with CAM (renamed Montgomery Asset Management, LLC)
that became effective upon the closing of the Manager's transaction with
CAM. Such transaction closed on July 31, 1997.
13
