As filed with the Securities and Exchange Commission on April 10, 1997
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. 5
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 6
THE MONTGOMERY FUNDS III
(Exact Name of Registrant as Specified in its Charter)
101 California Street
San Francisco, California 94111
(Address of Principal Executive Office)
1-800-232-2197
(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, 1996, was filed on February 28, 1997.
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Please Send Copy of Communications to:
JULIE ALLECTA, ESQ. JOAN E. BOROS, ESQ.
DAVID A. HEARTH, 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 (415) 772-6000 Washington, D.C. 20007-5201
(202) 625-3500
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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: Small Cap
Opportunities Fund
Part B - Combined Statement of Additional Information for
Montgomery Variable Series: Growth Fund, Montgomery
Variable Series: Emerging Markets Fund, Montgomery
Variable Series: International Small Cap Fund, and
Montgomery Variable Series: Small Cap Opportunities Fund
Part C - Other Information
Signature Page
This filing does not relate to the following documents: the Prospectus for
Montgomery Variable Series: Growth Fund, the Prospectus for Montgomery Variable
Series: Emerging Markets Fund, and the Prospectus for Montgomery Variable
Series: International Small Cap Fund.
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THE MONTGOMERY FUNDS III
CROSS REFERENCE SHEET
FORM N-1A
<TABLE>
Part A: Information Required in Prospectus
(Prospectus for Montgomery Variable Series: Small Cap Opportunities 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 Financial Highlights
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
of Fund Performance
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
<PAGE>
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, Montgomery Variable Series:
International Small Cap Fund, and Montgomery Variable Series: Small Cap
Opportunities Fund)
Location in the
N-1A Registration Statement
Item No. Item by Heading
- -------- ---- ----------
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 FOR MONTGOMERY VARIABLE SERIES:
SMALL CAP OPPORTUNITIES FUND
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The Montgomery Variable Series
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Montgomery Variable Series:
Small Cap Opportunities Fund
The Montgomery Funds III
101 California Street
San Francisco, California 94111
(800) 572-3863
Shares of Montgomery Variable Series: Small Cap Opportunities Fund, a separate
series of The Montgomery Funds III (the "Trust"), an open-end investment
company, are offered by this Prospectus. Shares of the Fund are sold only to
insurance company separate accounts ("Accounts") to fund the benefits of
variable life insurance policies or variable annuity contracts ("Variable
Contracts") owned by their respective policy holders, or contract holders, and
to qualified pension and retirement plans. References to shareholders or
investors in this Prospectus are to the Accounts or qualified pension and
retirement plans. The variable annuity and variable life insurance contracts
involve fees and expenses not described in this Prospectus. Please refer to the
prospectuses related to those contracts.
The Fund is managed by Montgomery Asset Management, L.P. (the "Manager").
Montgomery Variable Series: Small Cap Opportunities Fund (the "Small Cap
Opportunities Fund") seeks capital appreciation by investing primarily in equity
securities, usually common stock, of small-capitalization domestic companies,
which the Manager currently considers to be companies having market
capitalizations of less than $1 billion. As with 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 June 30, 1997, 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.
The Internet address for Montgomery Funds III is
http://www.xperts.montgomery.com/1.
Prospectus
June 30, 1997
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 3
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Risk Considerations 6
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Management of the Fund 7
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How To Invest in the Fund 9
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How To Redeem an Investment in the Fund 9
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Exchange Privileges and Restrictions 9
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How Net Asset Value is Determined 9
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Dividends and Distributions 9
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Taxation 10
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General Information 10
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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 objective and general investment policies are described
below. Specific portfolio securities that may be purchased by the Fund are
described in "Portfolio Securities" beginning on page 3. 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: Small Cap Opportunities Fund
The investment objective of the Small Cap Opportunities Fund is capital
appreciation which, under normal conditions, it seeks by investing at least 65%
of its total assets in equity securities of small-capitalization domestic
companies, which the Manager currently considers to be companies having total
market capitalizations of less than $1 billion. The Small Cap Opportunities Fund
generally invests the remaining 35% of its total assets in a similar manner, but
may invest those assets in domestic and foreign companies having total market
capitalizations of $1 billion or more. The Small Cap Opportunities Fund invests
primarily in common stock. It also may invest in other types of equity
securities and equity derivative securities. Any debt securities purchased by
the Fund must be investment grade debt securities. See "Portfolio Securities."
Current income from dividends, interest, and other sources is only incidental.
The Fund seeks to identify potential growth companies at an early stage or a
transitional point of their developments, such as the introduction of new
products, favorable management changes, new marketing opportunities, or
increased market share for existing product lines. Using fundamental research,
the Fund targets businesses having positive internal dynamics that can outweigh
unpredictable macro-economic factors, such as interest rates, commodity prices,
foreign currency rates, and overall stock market volatility. The fund searches
for companies with potential to gain market share within their respective
industries; to achieve and maintain high and consistent profitability; to
produce increases in quarterly earnings; and to provide solutions to current or
impending problems in their respective industries or society at large. Early
identification of potential investments is a key to the Fund's investment style.
Heavy emphasis is placed on in-house research, which includes discussions with
company management. The Fund also draws on the expertise of brokerage firms,
including Montgomery Securities, an affiliate of the Manager, and regional firms
that closely follow smaller-capitalization companies within their geographic
regions.
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 (such as
preferred stocks or convertible securities) and equity derivative securities.
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 the common stock's market value rises and
decrease as the common stock's market value declines. For purposes of allocating
the Fund's investments, the Manager regards convertible securities as a form of
equity security.
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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 warrant not exercised or
disposed of by its expiration date expires worthless.
Investment Companies
The Fund may invest up to 10% of its total assets in shares of other investment
companies investing exclusively in securities in which it may otherwise invest.
Such investments may involve the payment of substantial premiums above the net
asset value of those investment companies' portfolio securities and are subject
to limitations under the Investment Company Act. The Fund also may incur tax
liability to the extent it invests in the stock of a foreign issuer 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 its advisory and administration fees.
The Manager has agreed to waive its own management fee with respect to the
portion of the Fund's assets invested in other open-end (but not closed-end)
investment companies.
Debt Securities
The Fund may invest in traditional corporate, governmental debt securities rated
within the four highest grades of S&P (AAA to BBB), Moody's (Aaa to Baa) or
Fitch (AAA to Baa), or rated and deemed to be of comparable quality by the
Manager. See "The Fund's Investment Objective and Policies."
U.S. Government Securities
The Fund may invest in fixed rate and floating or variable rate U.S. Government
securities. Certain of the obligations, including U.S. Treasury bills, notes and
bonds, and mortgage-related securities of the Government National Mortgage
Association ("GNMA"), are issued or guaranteed by the U.S. Government. Other
securities issued by U.S. Government agencies or instrumentalities are supported
only by the credit of the agency or instrumentality, for example those issued by
the Federal Home Loan Bank, while others, such as those issued by the Federal
National Mortgage Association ("FNMA"), Farm Credit System and Student Loan
Marketing Association, have an additional line of credit with the U.S. Treasury.
Short-term U.S. Government securities generally are considered to be among the
safest short-term investments. However, the U.S. Government does not guarantee
the net asset value of the Fund's shares. With respect to U.S. Government
securities supported only by the credit of the issuing agency or instrumentality
or by an additional line of credit with the U.S. Treasury, there is no guarantee
that the U.S. Government will provide support to such agencies or
instrumentalities. Accordingly, such U.S. Government securities may involve risk
of loss of principal and interest.
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, the Fund acquires a U.S. Government security or other high-grade
liquid debt instrument from a financial institution that simultaneously agrees
to repurchase the same security at a specified time and price. The repurchase
price reflects
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The Montgomery Variable Series
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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 one
third 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 one third
of the value of its total assets.
Securities Lending
The Fund may lend securities to brokers, dealers and other financial
organizations. These loans may not exceed 30% of the value of the Fund's total
assets. Such loans of securities are collateralized with Segregable Assets or
liquid equity securities ("collateral assets") in an amount at least equal to
the current market value of the loaned securities, plus accrued interest. Such
collateral 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 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 collateral 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"): stock options, currency options, 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 derivatives guidelines that require the Board to review
each new type of derivative security that may be used by the Fund. Markets in
some countries currently do not have instruments available for hedging
transactions. To the extent that such instruments 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.
Hedging transactions involve certain risks. While the Fund may benefit from the
use of hedging positions, unanticipated changes in interest rates or securities
prices may result in poorer overall performance for the Fund than if it had not
entered into a hedging position. If the correlation between a hedging position
and a portfolio position is not properly protected, the desired protection may
not be obtained and the Fund may be exposed to risk of financial loss. In
addition, the Fund pays commissions and other costs in connection with such
investments.
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
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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 selling that security. Prior to
expiration, most options are expected to be sold in a closing sale transaction.
Profit or loss from the sale depends 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 risks 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 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. In addition, 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 its total assets.
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 objectives or when it appears that a position of the desired
size cannot be accumulated. Portfolio turnover generally involves some expense
to the Fund, including brokerage commissions, dealer mark-ups, and other
transaction costs. Portfolio turnover in excess of 100% is considered high and
increases such costs. The annual portfolio turnover for the Fund is anticipated
to be less than 100%. However, even when portfolio turnover exceeds 100%,
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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.
The Fund has reserved the right, if approved by the Board, 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.
At least 30-days' prior written 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.
Risk Considerations
Shareholders should understand that all investments involve risk and there can
be no guarantee against loss resulting from an investment in the Fund.
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, more mature issuers. Such smaller companies may have limited product
lines, markets or financial resources, and their securities may trade less
frequently and in more limited volume than those of larger, more mature
companies. As a result, the prices of their securities may fluctuate more than
those of larger issuers.
Foreign Securities
The 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 of loss inherent in domestic
investments. Foreign investments involve the possibility of expropriation,
nationalization, confiscatory taxation, taxation of income earned in foreign
nations (including, for example, withholding taxes on interest and dividends) or
other taxes imposed with respect to investments in foreign nations, foreign
exchange controls (which may include suspension of the ability to transfer
currency from a given country and repatriation of investments), default in
foreign government securities, and political or social instability or diplomatic
developments that could adversely affect investment. In 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. Because
certain foreign securities may be denominated in foreign currencies, the value
of such securities will be affected by changes in currency exchange rates and in
exchange control regulations, and costs will be incurred in connection with
conversions between currencies. 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.
Security Lending
The Fund may lend its securities to brokers, dealers and other financial
organizations. There is a risk of delay in receiving collateral or in recovering
the securities loaned or even a loss of rights in the collateral should the
borrower of the securities fail financially.
Interest Rates
The market value of debt securities that are interest-rate sensitive is
inversely related to 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 in value. 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 conditions
and the underlying location and age of the mortgage. In periods of rising
interest rates, the prepayment rate tends to decrease, lengthening the average
life of a pool of
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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 an entity
owned by the principals of 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.
Portfolio Managers
Montgomery Variable Series: Small Cap Opportunities Fund
Roger W. Honour is a managing director and senior portfolio manager. Prior to
joining Montgomery Asset Management in June 1993, Mr. Honour spent one year as
Vice President and Portfolio Manager at Twentieth Century Investors in Kansas
City, Missouri. From 1990 to 1992, he served as Vice President and Portfolio
Manager at Alliance Capital Management. From 1978 to 1990, Mr. Honour was a Vice
President with Merrill Lynch Capital Markets.
Kathryn Peters is a portfolio manager. From 1993 to 1995 she was an Associate in
the investment banking division of Donaldson, Lufkin & Jenrette in New York. At
Donaldson, Lufkin & Jenrette, Ms. Peters evaluated prospective equity
investments for the merchant banking fund and processed investment banking
transactions, including equity and high yield offerings. Prior to that, she
analyzed mezzanine investments for Barclays de Zoete Wedd in New York. From 1988
to 1990, Ms. Peters worked in the leveraged buy-out group of Marine Midland
Bank.
Andrew Pratt, CFA, is a portfolio manager. He joined Montgomery Asset Management
from Hewlett-Packard Company, where he was an equity analyst, managed a
portfolio of small capitalization technology companies, and researched private
placement and venture capital investments. From 1983 through 1988, he worked in
the Capital Markets Group at Fidelity Investments in Boston, Massachusetts.
================================================================================
7
<PAGE>
The Montgomery Variable Series
================================================================================
Management Fees and Other Expenses
<TABLE>
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 but paid
when requested by the Manager) 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.
<CAPTION>
Average Daily Net Assets Annual Rate
- ----------------------------------------------------------------- --------------------------------- -----------------
<S> <C> <C>
Montgomery Variable Series: Small Cap Opportunities Fund First $200 million 1.20 %
Next $300 million 1.10 %
Over $500 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 Small Cap Opportunities Fund at or below one and five-tenths of one percent
(1.50 %) 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 to increase the return to the Fund's shareholders. If 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
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
================================================================================
8
<PAGE>
The Montgomery Variable Series
================================================================================
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 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 New York Stock Exchange
("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
without any change in the foreign-currency denominated values of such
securities.
Because foreign securities markets may close before 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 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 amount and frequency of Fund
distributions are not guaranteed and are at the discretion of the Board.
Currently, the Fund intends to distribute according to the following schedule:
================================================================================
9
<PAGE>
The Montgomery Variable Series
================================================================================
Income Dividends Capital Gains
Montgomery Variable Declared and paid Declared and paid
Series: Small Cap in November or in November or
Opportunities Fund December each year* December each year*
* Additional distributions, if necessary, may be made following the Fund's
fiscal year end (December 31) in order to avoid the imposition of tax on the
Fund.
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.
Distributions Affect a Fund's Net Asset Value
Distributions are paid to you as of the record date of a distribution of the
Fund, regardless of how long you have held the shares. Dividends and capital
gains awaiting distribution are included in the Fund's daily net asset value.
The share price of a Fund drops by the amount of the distribution, net of any
subsequent market fluctuations. For example, assume that on December 31, the
Fund declared a dividend in the amount of $0.50 per share. If the Fund's share
price was $10.00 on December 30, the Fund's share price on December 31 would be
$9.50, barring market fluctuations.
Taxation
The Fund intends to qualify and elect to be treated as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"), by distributing substantially all of its net investment income and net
capital gains to its shareholders and meeting other requirements of the Code
relating to the sources of its income and diversification of its assets.
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. If the Fund is unable to meet certain Code
requirements, 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.
================================================================================
10
<PAGE>
The Montgomery Variable Series
================================================================================
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.
Legal Opinion
The validity of the shares offered by this Prospectus will be passed on by
Heller Ehrman White & McAuliffe, 333 Bush Street, San Francisco, California
94104.
------------------------
No salesman, dealer, or other person is authorized to give any information or
make any representation other than those contained in this Prospectus, the
Statement of Additional Information, or in the Fund's official sales literature.
================================================================================
11
<PAGE>
-----------------------------------------------------------------------
PART B
COMBINED STATEMENT OF ADDITIONAL INFORMATION
MONTGOMERY VARIABLE SERIES: GROWTH FUND
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
MONTGOMERY VARIABLE SERIES: SMALL CAP OPPORTUNITIES FUND
------------------------------------------------------------------------
<PAGE>
MONTGOMERY VARIABLE SERIES: GROWTH FUND
MONTGOMERY VARIABLE SERIES: EMERGING MARKETS FUND
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
MONTGOMERY VARIABLE SERIES: SMALL CAP OPPORTUNITIES FUND
---------------
THE MONTGOMERY FUNDS III
101 California Street
San Francisco, California 94111
1-800-232-2197
STATEMENT OF ADDITIONAL INFORMATION
June 30, 1997
The Montgomery Funds III (the "Trust") is an open-end management
investment company organized as a Delaware business trust, having four 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 Montgomery Variable Series: Growth Fund,
Montgomery Variable Series: Emerging Markets Fund, and Montgomery Variable
Series: International Small Cap Fund, each dated March 31, 1997, and Montgomery
Variable Series: Small Cap Opportunities Fund, dated June 30, 1997, 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-3
Investment Objectives And Policies Of The Funds..............................B-3
Risk Factors................................................................B-14
Investment Restrictions.....................................................B-16
Distributions And Tax Information...........................................B-18
Trustees And Officers.......................................................B-23
Investment Management And Other Services....................................B-27
Execution Of Portfolio Transactions.........................................B-30
Additional Purchase And Redemption Information..............................B-33
Determination Of Net Asset Value............................................B-34
<PAGE>
Performance Information.....................................................B-36
General Information.........................................................B-39
Financial Statements........................................................B-41
Appendix A..................................................................B-42
B-2
<PAGE>
THE TRUST
The Montgomery Funds III is an open-end management investment company
organized as a Delaware business trust on August 24, 1994. The Trust is
registered under the Investment Company Act of 1940, as amended (the "Investment
Company Act"). The Trust currently offers shares of beneficial interest, $.01
par value per share, in four 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"),
Montgomery Variable Series: International Small Cap Fund (the "International
Small Cap Fund"), and Montgomery Variable Series: Small Cap Opportunities Fund
(the "Small Cap Opportunities 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"), Global Depository Receipts ("GDRs"), and other similar global
instruments available in emerging markets, or other securities convertible into
securities of eligible issuers. These securities may not necessarily be
denominated in the same currency as the securities for which they may be
exchanged. Generally, ADRs in registered form are designed for use in U.S.
securities markets, and EDRs and other similar global instruments in bearer form
are designed for use in European securities markets. For purposes of the Fund's
investment policies, the Funds' investments in ADRs, EDRs, and similar
instruments will be deemed to be investments in the equity securities of foreign
issuers into which they may be converted.
Other Investment Companies. Each of the Funds may invest up to 10% of
its total assets in securities issued by other investment companies investing in
securities in which the Fund can invest provided that such investment companies
invest in portfolio securities in a manner consistent with a Fund's investment
objective and policies. Applicable provisions of the Investment Company Act
require that each of the Funds limits its investments so that, as determined
immediately after a securities purchase is made: (a) not more than 10% of the
value of the Fund's total assets will be invested in the aggregate in securities
of investment companies as a group; and (b) either (i) the Fund and affiliated
persons of the Fund not own together more than 3% of the total
B-3
<PAGE>
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.
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 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
B-4
<PAGE>
the borrower's monthly payments during the early years of the mortgage loans
("buydown" mortgage loans); (8) mortgage loans that provide for adjustments on
payments based on periodic changes in interest rates or in other payment terms
of the mortgage loans; and (9) mortgage-backed serial notes.
Mortgage-Related Securities: Federal National Mortgage Association.
FNMA is a federally chartered and privately owned corporation established under
the Federal National Mortgage Association Charter Act. FNMA was originally
organized in 1938 as a U.S. Government agency to add greater liquidity to the
mortgage market. FNMA was transformed into a private sector corporation by
legislation enacted in 1968. FNMA provides funds to the mortgage market
primarily by purchasing home mortgage loans from local lenders, thereby
providing them with funds for additional lending. FNMA acquires funds to
purchase loans from investors that may not ordinarily invest in mortgage loans
directly, thereby expanding the total amount of funds available for housing.
Each FNMA pass-through security represents a proportionate interest in
one or more pools of FHA Loans, VA Loans or conventional mortgage loans (that
is, mortgage loans that are not insured or guaranteed by any U.S. Government
agency). The loans contained in those pools consist of one or more of the
following: (1) fixed-rate level payment mortgage loans; (2) fixed- rate growing
equity mortgage loans; (3) fixed-rate graduated payment mortgage loans; (4)
variable-rate mortgage loans; (5) other adjustable-rate mortgage loans; and (6)
fixed-rate mortgage loans secured by multifamily projects.
Mortgage-Related Securities: Federal Home Loan Mortgage Corporation.
FHLMC is a corporate instrumentality of the United States established by the
Emergency Home Finance Act of 1970, as amended. FHLMC was organized primarily
for the purpose of increasing the availability of mortgage credit to finance
needed housing. The operations of FHLMC currently consist primarily of the
purchase of first lien, conventional, residential mortgage loans and
participation interests in mortgage loans and the resale of the mortgage loans
in the form of mortgage-backed securities.
The mortgage loans underlying FHLMC securities typically consist of
fixed-rate or adjustable-rate mortgage loans with original terms to maturity of
between 10 and 30 years, substantially all of which are secured by first liens
on one- to- four-family residential properties or multifamily projects. Each
FHLMC security 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 Ratings Group ("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.
B-5
<PAGE>
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 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 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, these Funds 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.
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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, except the
Small Cap Opportunities Fund, 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.
These Funds may enter into a forward contract, for example, when they
enter into contracts for the purchase or sale of a security denominated in a
foreign currency or are expecting a dividend or interest payment in order to
"lock in" the U.S. dollar price of the security or dividend or interest payment.
In addition, when a Fund believes that a foreign currency may suffer a
substantial decline against the U.S. dollar, it may enter into a forward
contract to sell an amount of that foreign currency approximating the value of
some or all of that Fund's portfolio securities denominated in such foreign
currency, or when a Fund believes that the U.S. dollar may suffer a substantial
decline against a foreign currency, it may enter into a forward contract to buy
that currency for a fixed dollar amount.
In connection with a Fund's forward contract transactions, an amount of
the Fund's assets equal to the amount of 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 liquid equity or debt securities
denominated in the appropriate currency available in an amount sufficient to
cover any commitments under these contracts. Segregated assets used to cover
forward contracts will be marked to market on a daily basis. While these
contracts are not presently regulated by the Commodity Futures Trading
Commission ("CFTC"), the CFTC may in the future regulate forward contracts. In
such event, a 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 a Fund than if it had not engaged in such contracts.
These Funds 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
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Association, which regulate trading in the futures markets, before engaging in
any purchases or sales of futures contracts or options on futures contracts.
Pursuant to Section 4.5 of the regulations under the Commodity Exchange Act, the
notice of eligibility included the representation that the Funds will use
futures contracts and related options for bona fide hedging purposes within the
meaning of CFTC regulations, provided that the Funds may hold positions in
futures contracts and related options that do not fall within the definition of
bona fide hedging transactions if the aggregate initial margin and premiums
required to establish such positions will not exceed 5% of a Fund's net assets
(after taking into account unrealized profits and unrealized losses on any such
positions) and that in the case of an option that is in-the-money at the time of
purchase, the in-the-money amount may be excluded from such 5%.
The Funds will attempt to determine whether the price fluctuations in
the futures contracts and options on futures used for hedging purposes are
substantially related to price fluctuations in securities held by the Funds or
which they expect to purchase. The Funds' futures transactions generally will be
entered into only for traditional hedging purposes , i.e., futures contracts
will be sold to protect against a decline in the price of securities or
currencies and will be purchased to protect a Fund against an increase in the
price of securities it intends to purchase (or the currencies in which they are
denominated). All 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. 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
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such futures contracts, the Manager will attempt to estimate the extent of this
difference in volatility based on historical patterns and to compensate for it
by having that Fund enter into a greater or lesser number of futures contracts
or by attempting to achieve only a partial hedge against price changes affecting
that Fund's securities portfolio. When hedging of this character is successful,
any depreciation in the value of the portfolio securities can be substantially
offset by appreciation in the value of the futures position. However, any
unanticipated appreciation in the value of a Fund's portfolio securities could
be offset substantially by a decline in the value of the futures position.
The acquisition of put and call options on futures contracts gives a
Fund the right (but not the obligation), for a 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 in whole or in part 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 traded on U.S. and foreign
exchanges. 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
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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, each Fund may, in
the future, write (i.e., sell) covered put and call options on securities,
securities indices, and currencies in which the particular Fund 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 it has written, a Fund
will cause its custodian to segregate cash, cash equivalents, U.S. Government
securities, or other liquid debt or equity securities with at least the value of
the exercise price of the put options.
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 at a mutually agreed-upon time and price. The
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repurchase price is generally higher than the purchase price, the difference
being interest income to the Fund. Alternatively, the purchase and repurchase
prices may be the same, with interest at a stated rate due to the Fund together
with the repurchase price on the date of repurchase. In either case, the income
to the Fund is unrelated to the interest rate on the underlying security.
Under each repurchase agreement, the seller is required to maintain the
value of the securities subject to the repurchase agreement at not less than
their repurchase price. The Manager, acting under the supervision of the Board
of Trustees, reviews on a periodic basis the suitability and creditworthiness,
and the value of the collateral, of those sellers with whom the Funds enter into
repurchase agreements to evaluate potential risk. All repurchase agreements will
be made pursuant to procedures adopted and regularly reviewed by the 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. No Fund may invest more than 15%
of the value of its net assets in illiquid securities, including repurchase
agreements with maturities greater than seven days.
For purposes of the Investment Company Act, a repurchase agreement is
deemed to be a collateralized loan from a Fund to the seller of the security
subject to the repurchase agreement. It is not clear whether a court would
consider the security acquired by a Fund subject to a repurchase agreement as
being owned by that Fund or as being collateral for a loan by that Fund to the
seller. If bankruptcy or insolvency proceedings are commenced with respect to
the seller of the security before its repurchase under a repurchase agreement, a
Fund may encounter delays and incur costs before being able to sell the
security. Delays may involve loss of interest or a decline in price of the
security. If a court characterizes such a transaction as a loan and a Fund has
not perfected a security interest in the security, that Fund may be required to
return the security to the seller's estate and be treated as an unsecured
creditor of the seller. As an unsecured creditor, a Fund would be at risk of
losing some or all of the principal and income involved in the transaction. As
with any unsecured debt instrument purchased for a Fund, the Manager seeks to
minimize the risk of loss through repurchase agreements by analyzing the
creditworthiness of the seller of the security.
Apart from the risk of bankruptcy or insolvency proceedings, a Fund
also runs the risk that the seller may fail to repurchase the security. However,
each Fund always requires collateral for any repurchase agreement to which it is
a party in the form of securities acceptable to it, the market value of which is
equal to at least 100% of the amount invested by the Fund plus accrued interest,
and each Fund makes payment against such securities only upon physical delivery
or evidence of book entry transfer to the account of its custodian bank. If the
market value of the security subject to the repurchase agreement becomes less
than the repurchase price (including interest), a Fund, pursuant to its
repurchase agreement, may require the seller of the security to deliver
additional securities so that the market value of all securities subject to the
repurchase agreement equals or exceeds the repurchase price (including interest)
at all times.
The Funds may participate in one or more joint accounts with other
funds of the Trust that invest in repurchase agreements collateralized, subject
to their investment policies, either by (i)
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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 will in no event have a
duration of more than seven days.
Reverse Repurchase Agreements. The Funds may enter into reverse
repurchase agreements, as set forth in the Prospectus. The Funds typically will
invest the proceeds of a reverse repurchase agreement in money market
instruments or repurchase agreements maturing not later than the expiration of
the reverse repurchase agreement. This use of proceeds involves leverage. A Fund
will enter into a reverse repurchase agreement for leverage purposes only when
the Manager believes that the interest income to be earned from the investment
of the proceeds would be greater than the interest expense of the transaction. A
Fund also may use the proceeds of reverse repurchase agreements to provide
liquidity to meet redemption requests when the sale of the Fund's securities is
disadvantageous.
The Funds cause their custodian to segregate liquid assets, such as
cash, U.S. Government securities or other liquid equity or debt securities equal
in value to their obligations (including accrued interest) with respect to
reverse repurchase agreements. Such assets are marked to market daily to ensure
that full collateralization is maintained.
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
or equity 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.
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When-Issued and Forward Commitment Securities. The Funds may purchase
securities on a "when-issued" basis and may purchase or sell securities on a
"forward commitment" or "delayed delivery" basis. The price of such securities
is fixed at the time the commitment to purchase or sell is made, but delivery
and payment for the securities take place at a later date. Normally, the
settlement date occurs within one month of the purchase; during the period
between purchase and settlement, no payment is made by a Fund to the issuer.
While the Funds reserve the right to sell when-issued or delayed delivery
securities prior to the settlement date, the Funds intend to purchase such
securities with the purpose of actually acquiring them unless a sale appears
desirable for investment reasons. At the time a Fund makes a commitment to
purchase a security on a when-issued or delayed delivery basis, it will record
the transaction and reflect the value of the security in determining its net
asset value. The market value of the when-issued securities may be more or less
than the settlement price. The Funds do not believe that their net asset values
will be adversely affected by their purchase of securities on a when-issued or
delayed delivery basis. The Funds cause their custodian to segregate cash, U.S.
Government securities, or other liquid equity or debt securities 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, repurchase agreements maturing in more
than seven days, certain restricted securities and securities that are otherwise
not freely transferable. Illiquid securities also include shares of an
investment company held by a Fund in excess of 1% of the total outstanding
shares of that investment company. Restricted securities may be sold only in
privately negotiated transactions or in public offerings with respect to which a
registration statement is in effect under the Securities Act of 1933, as amended
("1933 Act"). Illiquid securities acquired by a Fund may include those that are
subject to restrictions on transferability contained in the securities laws of
other countries. Securities that are freely marketable in the country where they
are principally traded, but that would not be freely marketable in the United
States, will not be considered illiquid. Where registration is required, a Fund
may be obligated to pay all or part of the registration expenses, and a
considerable period may elapse between the time of the decision to sell and the
time the Fund may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions were
to develop, that Fund might obtain a less favorable price than prevailed when it
decided to sell.
In recent years a large institutional market has developed for certain
securities that are not registered under the 1933 Act, including securities,
sold in private placements, repurchase agreements, commercial paper, foreign
securities, and corporate bonds and notes. These instruments often are
restricted securities because the securities are sold in transactions not
requiring registration. Institutional investors generally will not seek to sell
these instruments to the general public, but instead will often depend either on
an efficient institutional market in which such unregistered securities can be
resold readily or on an issuer's ability to honor a demand for repayment.
Therefore, the fact that there are contractual or legal restrictions on resale
to the general public or certain institutions is not determinative of the
liquidity of such investments.
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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 U.S. Foreign companies are often not
subject to uniform accounting, auditing and financial reporting standards, and
auditing practices and requirements are often not comparable to those applicable
to U.S. companies. Many foreign markets have substantially less volume than
either the established domestic securities exchanges or the OTC markets.
Securities of some foreign companies are less liquid and more volatile than
securities of comparable U.S. companies. Commission rates in foreign countries,
which may be fixed rather than subject to negotiation as in the U.S., are likely
to be higher. In many foreign countries there is less government supervision and
regulation of securities exchanges, brokers, and listed companies than in the
U.S., and capital requirements for brokerage firms are generally lower.
Settlement of transactions in foreign securities may, in some instances, be
subject to delays and related administrative uncertainties.
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
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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 Policies
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
these Funds' investments in securities of issuers of that country. There also is
the possibility of expropriation, nationalization, confiscatory or other
taxation, foreign exchange controls (which may include suspension of the ability
to transfer currency from a given country), default in foreign government
securities, political or social instability, or diplomatic developments that
could adversely affect investments in securities of issuers in those nations.
These Funds may be affected either favorably or unfavorably by
fluctuations in the relative rates of exchange between the currencies of
different nations, exchange control regulations, and indigenous economic and
political developments.
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
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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
each Fund and (unless otherwise noted) are fundamental and cannot be changed
without the affirmative vote of a majority of a Fund's outstanding voting
securities as defined in the Investment Company Act. Each Fund may not:
1. With respect to 75% of its total assets, invest in the securities of
any one issuer (other than the U.S. Government and its agencies and
instrumentalities) if immediately after and as a result of such investment more
than 5% of the total assets of the Fund would be invested in such issuer. There
are no limitations with respect to the remaining 25% of the Fund's total assets,
except to the extent other investment restrictions may be applicable.
2. Make loans to others, except (a) through the purchase of debt
securities in accordance with its investment objective and policies, (b) through
the lending of up to 10% of its portfolio securities as described above and in
its Prospectus, or (c) to the extent the entry into a repurchase agreement or a
reverse dollar roll transaction is deemed to be a loan.
3. (a) Borrow money, except temporarily for temporary or emergency
purposes from a bank and then not in excess of 10% (one third in the case of the
Small Cap Opportunities Fund) 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% (5% in
the case of the Emerging Markets Fund and one third in the case of the Small Cap
Opportunities Fund) 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 a 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 or commodities or commodity contracts;
however, a Fund, to the extent not otherwise prohibited in the Prospectus or
this Statement of Additional
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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. As an operating policy which may be changed without
shareholder approval, the Fund may invest in real estate investment trusts only
up to 10% of its total assets.
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 in securities of other investment companies, except to the
extent permitted by the Investment Company Act and discussed in the Prospectus
or this Statement of Additional Information, or as such securities may be
acquired as part of a merger, consolidation, or acquisition of assets.
8. Invest, in the aggregate, more than 15% of its net assets in
illiquid securities, including (under current SEC interpretations) restricted
securities (excluding liquid Rule 144A-eligible restricted securities),
securities which are not otherwise readily marketable, repurchase agreements
that mature in more than seven days, and over-the-counter options (and
securities underlying such options) purchased by the Fund. (This is an operating
policy which may be changed without shareholder approval, consistent with the
Investment Company Act and changes in relevant SEC interpretations.)
9. Invest in any issuer for purposes of exercising control or
management of the issuer. (This is an operating policy which may be changed
without shareholder approval, consistent with the Investment Company Act.)
10. 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.
11. 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.
12. Except as described in the Prospectus and this Statement of
Additional Information, acquire or dispose of put, call, straddle, or spread
options, subject to the following conditions:
(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.)
B-17
<PAGE>
13. Except as described in the Prospectus and this Statement of
Additional Information, engage in short sales of securities. (This is an
operating policy which may be changed without shareholder approval, consistent
with applicable regulations.)
14. 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.)
15. (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. (These are operating policies that may be changed without
shareholder approval.)
16. Invest in commodities, except for futures contracts or options on
futures contracts if, as a result thereof, 5% or less of the Fund's total assets
(taken at market value at the time of entering into the contract) would be
committed to initial deposits and premiums on open futures contracts and options
on such contracts.
To the extent these restrictions reflect matters of operating policy
that may be changed without shareholder vote, they may be amended upon approval
by the Board of Trustees and notice to shareholders.
If a percentage restriction is adhered to at the time of investment, a
subsequent increase or decrease in a percentage resulting from a change in the
values of assets will not constitute a violation of that restriction, except as
otherwise noted.
DISTRIBUTIONS AND TAX INFORMATION
Distributions. The Funds will receive income in the form of dividends
and interest earned on their investments in securities. This income, less the
expenses incurred in their operations, is the Funds' net investment income,
substantially all of which will be declared as dividends to the Funds'
shareholders.
The 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
B-18
<PAGE>
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), although technically 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 has elected and intends to continue to
qualify to be treated as a regulated investment company under Subchapter M of
the Internal Revenue Code of 1986, as amended (the "Code"), for each taxable
year by complying with all applicable requirements regarding the source of its
income, the diversification of its assets, and the timing of its distributions.
Each Fund's policy is to distribute to its shareholders all of its investment
company taxable income and any net realized capital gains for each fiscal year
in a manner that complies with the distribution requirements of the Code, so
that a Fund will not be subject to any federal income tax or excise taxes based
on net income. However, the Board of Trustees may elect to pay such excise taxes
if it determines that payment is, under the circumstances, in the best interests
of a Fund.
In order to qualify as a regulated investment company, a Fund must,
among other things, (a) derive at least 90% of its gross income each year from
dividends, interest, payments with respect to loans of stock and securities,
gains from the sale or other disposition of stock or securities or foreign
currency gains related to investments in stocks or other securities, or other
income (generally including gains from options, futures, or forward contracts)
derived with respect to the business of investing in stock, securities, or
currency, (b) derive less than 30% of its gross income each year from the sale
or other disposition of stock or securities (or options thereon) held less than
three months (excluding some amounts otherwise included in income as a result of
certain hedging transactions), and (c) diversify its holdings so that, at the
end of each fiscal quarter, (i) at least 50% of the market value of its assets
is represented by cash, cash items, U.S. Government securities, securities of
other regulated investment companies, and other securities limited, for purposes
of this calculation, in the case of other securities of any one issuer to an
amount not greater than 5% of the Fund's assets or 10% of the voting securities
of the issuer, and (ii) not more than 25% of the value of its assets is invested
in the securities of any one issuer (other than U.S. Government securities or
securities of other regulated investment
B-19
<PAGE>
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 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
B-20
<PAGE>
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
"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.
B-21
<PAGE>
Hedging. The use of hedging strategies, such as entering into futures
contracts and forward contracts and purchasing options, involves complex rules
that will determine the character and timing of recognition of the income
received in connection therewith by a Fund. Income from foreign currencies
(except certain gains therefrom that may be excluded by future regulations) and
income from transactions in options, futures contracts, and forward contracts
derived by a Fund with respect to its business of investing in securities or
foreign currencies will qualify as permissible income under Subchapter M of the
Code.
For accounting purposes, when a Fund purchases an option, the premium
paid by the Fund is recorded as an asset and is subsequently adjusted to the
current market value of the option. Any gain or loss realized by a Fund upon the
expiration or sale of such options held by a Fund generally will be capital gain
or loss.
Any security, option, or other position entered into or held by a Fund
that substantially diminishes the 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 the
Funds 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, rather than as
capital gain or loss.
Distributions and redemptions may be subject to state and local income
taxes, and the treatment thereof may differ from the federal income tax
treatment.
B-22
<PAGE>
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, except for Jerome S. Markowitz
who is a Trustee of The Montgomery Funds II, 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
56).1
101 California 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 43)
101 California Street, San Francisco, California 94111. Geist has been
the President and a Director of Montgomery Asset Management, Inc. and
President of the Manager since April 1990. From October 1988 until
March 1990, Mr. Geist was a Senior Vice President of Analytic
Investment Management. From January 1986 until October 1988, Mr. Geist
was a Vice President with RCB Trust Co. Prior to January 1986, Mr.
Geist was the Pension Fund Administrator for St. Regis Co., a
manufacturing concern.
Jack G. Levin, Secretary (Age 49)
600 Montgomery Street, San Francisco, California 94111. Mr. Levin has
been Director of Legal and Regulatory Affairs for Montgomery Securities
since January 1983.
- --------
1 Trustee deemed an "interested person" of the Funds as defined in the
Investment Company Act.
B-23
<PAGE>
John E. Story, Executive Vice President (Age 56)
101 California 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 42)
101 California 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 44)
101 California 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 42)
101 California 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.
Oscar A. Castro, Vice President (Age 41)
101 California 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 35)
101 California 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
B-24
<PAGE>
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 42)
101 California 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 41)
101 California 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 35)
101 California Street, San Francisco, California 94111. Mr. Haslett is
a Vice President and Senior 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.
Angeline Ee, Vice President (Age 35)
101 California 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.
Michael Carmen, Vice President (Age 34)
600 Montgomery Street, San Francisco, California 94111. Michael Carmen,
CFA, is a Vice President and Senior Portfolio Analyst for the Manager.
From 1993 until joining the Manager in 1996, he was a Vice President
and Associate Portfolio Manager with State Street Research and
Management Company in Boston, where he assisted with the management of
capital appreciation and growth portfolios. Before then, he was a
Senior Equity Analyst with State Street and, from 1991 to 1992, with
Cigna Investments in Hartford.
B-25
<PAGE>
John A. Farnsworth, Trustee (Age 55)
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 52)
750 Vine Street, Denver, Colorado 80206. Since June 1988, Mr. Cox has
been engaged as an independent investment consultant. From September
1976 until June 1988, Mr. Cox was a Vice President of the Founders
Group of Mutual Funds, Denver, Colorado, and Portfolio Manager or
Co-Portfolio Manager of several of the mutual funds in the Founders
Group.
Cecilia H. Herbert, Trustee (Age 47)
2636 Vallejo Street, San Francisco, California 94123. Ms. Herbert was
Managing Director of Morgan Guaranty Trust Company. From 1983 to 1991
she was General Manager of the bank's San Francisco office, with
responsibility for lending, corporate finance, and investment banking.
Ms. Herbert is a member of the Board of Schools of the Sacred Heart,
and is a member of the Archdiocese of San Francisco Finance Council,
where she chairs the Investment Committee.
Jerome S. Markowitz, Trustee* (Age 57)
600 Montgomery Street, San Francisco, California 94111. Mr. Markowitz
was elected as a trustee of The Montgomery Funds III, effective
November 16, 1995. Mr. Markowitz has been the Senior Managing 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
1, 1996 and the aggregate compensation paid to each of the Trustees during the
fiscal year ended December 31, 1996 by all of the registered investment
companies to which the Manager provides investment advisory services, are set
forth below.
B-26
<PAGE>
<TABLE>
<CAPTION>
Pension or Total
Retirement Compensation
Aggregate Benefits From the
Compensation Accrued as Trust and
from The Part of Fund Fund Complex
Name of Trustee Montgomery Funds III Expenses* (2 additional Trust)
- --------------- -------------------- --------- --------------------
<S> <C> <C> <C>
R. Stephen Doyle None -- None
Jerome S. Markowitz None -- None
John A. Farnsworth $5,000 -- $35,000
Andrew Cox $5,000 -- $35,000
Cecilia H. Herbert $5,000 -- $35,000
<FN>
* The Trusts do not maintain pension or retirement plans.
</FN>
</TABLE>
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 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
management fee (accrued daily but paid when requested by the Manager) based upon
the average daily net assets of the Funds at the following annual rates:
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<PAGE>
Fund Average Daily Net Assets Annual 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%
Small Cap Opportunities Fund First $200 million 1.20%
Over $300 million 1.10%
Over $500 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 twenty-five one-hundredths
of one percent (1.25%) 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, one and fifty one-hundredths of one percent (1.50%) of the International
Small Cap Fund's, and one and fifty one-hundredths (1.50%) of the Small Cap
Opportunity Fund's 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 connection with any merger or reorganization,
extraordinary expenses such as litigation, and any other expenses as may be
deemed excludable. 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'
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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,
- ---- ---------------------------------
1996 1995
---- ----
Growth Fund* $0.00 $0.00
Emerging Markets Fund* $19,504 NA
International Small Cap Fund* $0.00 NA
Small Cap Opportunities Fund NA NA
* The Funds did not commence operations during fiscal year 1995.
The Growth Fund had only an initial shareholder, and the
Emerging Markets Fund and the International Small Cap Fund had
no shares outstanding, during that year. The Emerging Markets
Fund commenced operations on February 2, 1996, while the
Growth Fund commenced operations on February 9, 1996, and the
International Small Cap Fund commenced operations on September
30, 1996. The Small Cap Opportunities Fund commenced
operations on June 30, 1997.
The Manager also may act as an investment adviser or administrator to
other persons, entities, and corporations, including other investment companies.
Please refer to the table above, which indicates officers and trustees who are
affiliated persons of the Trust and who are also affiliated persons of the
Manager.
The use of the name "Montgomery" by the Trust and by the Funds is
pursuant to the consent of the Manager, which may be withdrawn if the Manager
ceases to be the Manager of the Funds.
Montgomery Securities may provide certain administrative services to
the Funds on behalf of the Manager. Montgomery Securities will also perform
investment banking, investment advisory, and brokerage services for persons
other than the Funds, including issuers of securities in which the Funds may
invest. These activities from time to time may result in a conflict of interests
of Montgomery Securities with those of the Funds, and may restrict the ability
of Montgomery Securities to provide services to the Funds.
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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.
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.
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<PAGE>
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 the 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 the Fund or
assist the Manager in carrying out its responsibilities to the 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, and suitability is
always a paramount consideration. Nevertheless, it is possible that at times the
same securities will be acceptable for one or more funds and for one or more of
such client accounts. The Manager and its personnel may have interests in one or
more of those client accounts, either through direct investment or because of
management fees based on gains in the account. The manager has adopted
allocation procedures to ensure the fair allocation of securities and prices
between the Funds and the Manager's various other accounts. These procedures
emphasize the desirability of bunching trades and price averaging (see below) to
achieve objective fairness among clients advised by the same portfolio manager
or portfolio team. Where trades cannot be bunched. the procedures specify
alternatives designed to ensure that buy and sell opportunities are allocated
fairly and that, over time, all clients are treated equitably. The Manager's
trade allocation procedures also seek to ensure reasonable efficiency in client
transactions, and they provide portfolio managers with reasonable flexibility to
use allocation methodologies that are appropriate to their investment discipline
on client accounts.
To the extent any of the Manager's client accounts and a Fund seek to
acquire the same security at the same general time (especially if a security is
thinly traded or a small-cap stock), that Fund may not be able to acquire as
large a portion of such security as it desires, or it may have to pay a higher
price or obtain a lower yield for such security. Similarly, 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 generally 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. In many cases, the Funds' transactions are bunched with the
transactions for other client accounts. It is recognized that in some cases
B-31
<PAGE>
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.
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 designed to
provide that commissions payable to Montgomery Securities are reasonable and
fair 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 the Funds 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 not to be comparable to the Funds. The Funds do not deem it practicable
and in their best
B-32
<PAGE>
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.
For the year ended December 31, 1996, the Funds' total securities
transactions generated commissions of $145,114, none of which was paid to
Montgomery Securities.
The Funds do not effect securities transactions through brokers in
accordance with any formula, nor do they effect securities transactions through
such brokers solely for selling shares of a Fund. However, as stated above,
Montgomery Securities may act as one of the Funds' brokers in the purchase and
sale of portfolio securities, and other brokers who execute brokerage
transactions as described above may from time to time effect purchases of shares
of the Funds for their customers.
Depending on the Manager's view of market conditions, a Fund may or may
not purchase securities with the expectation of holding them to maturity,
although its general policy is to hold securities to maturity. A Fund may,
however, sell securities prior to maturity to meet redemptions or as a result of
a revised management evaluation of the issuer.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The Trust reserves the right in its sole discretion to (i) suspend the
continued offering of the Funds' shares, and (ii) reject purchase orders in
whole or in part when in the judgment of the Manager such rejection is in the
best interests of the Funds.
The Funds may suspend the right of redemption or postpone the date of
payment during any period when (a) trading on the New York Stock Exchange
("NYSE") is restricted as determined by the SEC or the NYSE is closed for other
than weekends and holidays; (b) an 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.
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<PAGE>
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 per share net asset value.
Generally, trading in and valuation of foreign securities is
substantially completed each day at various times prior to the close of the
NYSE. In addition, trading in and valuation of foreign securities may not take
place on every day in which the NYSE is open for trading. Furthermore, trading
takes place in various foreign markets on days in which the NYSE is not open for
trading and on which the Funds' net asset values are not calculated.
Occasionally, events affecting the values of such securities in U.S. dollars on
a day on which a Fund calculates its net asset value may occur between the times
when such securities are valued and the close of the NYSE 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, EDRs, and GDRs, which are traded
on securities exchanges are valued at the last sale price on the exchange on
which such securities are traded, as of the close of business on the day the
securities are being valued or, lacking any reported sales, at the mean between
the last available bid and asked price. 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.
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<PAGE>
Short-term debt obligations with remaining maturities in excess of 60
days are valued at current market prices, as discussed above. Short-term
securities with 60 days or less remaining to maturity are, unless conditions
indicate otherwise, amortized to maturity based on their cost to a Fund if
acquired within 60 days of maturity or, if already held by a Fund on the 60th
day, based on the value determined on the 61st day.
Corporate debt securities, mortgage-related securities, and
asset-backed securities held by the Funds are valued on the basis of valuations
provided by dealers in those instruments, by an independent pricing service,
approved by the Board of Trustees, or at fair value as determined in good faith
by procedures approved by the Board of Trustees. Any such pricing service, in
determining value, will use information with respect to transactions in the
securities being valued, quotations from dealers, market transactions in
comparable securities, analyses and evaluations of various relationships between
securities, and yield-to-maturity information.
An option that is written by a Fund is generally valued at the last
sale price or, in the absence of the last sale price, the last offer price. An
option that is purchased by a Fund is generally valued at the last sale price
or, in the absence of the last sale price, the last bid price. The value of a
futures contract equals the unrealized gain or loss on the contract that is
determined by marking the contract to the current settlement price for a like
contract on the valuation date of the futures contract if the securities
underlying the futures contract experience significant price fluctuations after
the determination of the settlement price. When a settlement price cannot be
used, futures contracts will be valued at their fair market value as determined
by or under the direction of the Board of Trustees.
If any securities held by a Fund are restricted as to resale or do not
have readily available market quotations, the Manager and the Trust's Pricing
Committee determine their fair value, following procedures approved by the Board
of Trustees. The Board of Trustees periodically reviews such valuations and
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
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<PAGE>
currency into U.S. dollars, the Board of Trustees in good faith will establish a
conversion rate for such currency.
All other assets of the Funds are valued in such manner as the Board of
Trustees in good faith deems appropriate to reflect their fair value.
PERFORMANCE INFORMATION
As noted in the Prospectus, the Funds may, from time to time and in
accordance with applicable law, quote various performance figures in
advertisements and other communications to illustrate their past performance.
Average Annual Total Return. Total return may be stated for any
relevant period as specified in the advertisement or communication. Any
statements of total return for a Fund will be accompanied by information on that
Fund's average annual compounded rate of return over the most recent four
calendar quarters and the period from that Fund's inception of operations. The
Funds may also advertise aggregate and average total return information over
different periods of time. Each Fund's "average annual total 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:
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<PAGE>
ERV - P
-------
P
Where: P = a hypothetical initial payment of $10,000.
ERV = Ending Redeemable Value of a hypothetical
$10,000 investment made at the beginning of a l-,
5- or 10-year period at the end of a l-, 5- or
10-year period (or fractional portion thereof),
assuming reinvestment of all dividends and
distributions and complete redemption of the
hypothetical investment at the end of the
measuring period.
Each Fund's performance will vary from time to time depending upon
market conditions, the composition of its portfolio and its operating expenses.
Consequently, any given performance quotation should not be considered
representative of that Fund's performance for any specified period in the
future. In addition, because performance will fluctuate, it may not provide a
basis for comparing an investment in that Fund with certain bank deposits or
other investments that pay a fixed yield for a stated period of time.
Shareholders comparing that Fund's performance with that of other investment
companies should give consideration to the quality and maturity of the
respective investment companies' portfolio securities.
The average annual total return for each Fund for the periods indicated
was as follows:
Fund Inception* Through December 31, 1996
---- ------------------------------------
Growth Fund 27.22%
International Small Cap Fund 7.23%
Emerging Markets Fund 6.79%
- ----------------
* Total return for periods of less than one year are aggregate, not
annualized, return figures. The dates of inception (i.e., start of operations)
for the Funds were: Growth Fund, February 9, 1996; Emerging Markets Fund,
February 2, 1996; International Small Cap Fund, September 30, 1996. The Small
Cap Opportunities Fund commenced operations on June 30, 1997; accordingly, no
performance figures are available as of the date of this Statement of Additional
Information for that Fund
Comparisons. To help investors better evaluate how an investment in the
Funds might satisfy their investment objectives, advertisements and other
materials regarding the Funds may discuss various financial publications.
Materials may also compare performance (as calculated above) to performance as
reported by other investments, indices, and averages. Publications,
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<PAGE>
indices, and averages, including but not limited to the following, may be used
in a discussion of a Fund's performance or the investment opportunities it may
offer:
a) Standard & Poor's 500 Composite Stock Index, one or more of the
Morgan Stanley Capital International Indices, and one or more of the
International Finance Corporation Indices.
b) Lipper - Mutual Fund Performance Analysis -- A ranking service that
measures total return and average current yield for the mutual fund industry and
ranks individual mutual fund performance over specified time periods assuming
reinvestment of all distributions, exclusive of any applicable sales charges.
c) Other indices - including Consumer Price Index, Ibbotson, Micropal,
CNBC/Financial News Composite Index, MSCI EAFE Index (Morgan Stanley Capital
International, Europe, Australasia, Far East Index - a capitalization-weighted
index that includes all developed world markets except for those in North
America), Datastream, Worldscope, NASDAQ, Russell 2000, and IFC Emerging Markets
Database.
In addition, one or more portfolio managers or other employees of the
Manager may be interviewed by print media, such as by the Wall Street Journal or
Business Week, or electronic news media, and such interviews may be reprinted or
excerpted for the purpose of advertising regarding the Funds.
In assessing such comparisons of performance, 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 supporting the Manager's belief that a
particular Fund may be appropriate for investors at a particular time. The
information will generally be based on internally generated estimates resulting
from the Manager's research activities and projections from independent sources.
These sources may include, but are not limited to, Bloomberg, Morningstar,
Barings, WEFA , I/B/E/S Consensus Forecast, Worldscope, and Reuters as well as
both local and international brokerage firms. For example, the Funds may suggest
that certain countries or areas may be particularly appealing to investors
because of interest rate movements, increasing exports, and/or economic growth.
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<PAGE>
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 may be used for
the Funds.
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 Funds.
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, 1996, to the knowledge of the Funds, Montgomery
Securities owned of record 4.9% of the outstanding shares of the Growth Fund.
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<PAGE>
As of December 31, 1996, to the knowledge of the Funds, the following
shareholders owned of record 5% or more of the outstanding shares of the
respective Funds indicated:
Name of Fund/Name and Number of Shares Percent
Address of Record Owner Owned of Shares
----------------------- ----- ---------
Growth Fund
Montgomery Securities 53,386.89 30.96
600 Montgomery Street
San Francisco, CA 94111-2702
Providian Corporation 37,139.37 21.54
400 West Market Street
Louisville, Kentucky 40202
Fortis Benefits Insurance Company 72,492.99 42.03
500 Bielenberg Drive
Woodbury, Minnesota 55125
Great West Life 9,440.41 5.47
8515 E. Orchard Road
10th Floor, Tower II
Inglewood, Colorado 80111
Emerging Markets Fund
American Skandia Life Assurance 2,346,446.59 92.67
Corporation
1 Corporate Drive
P.O. Box 883
Shelton, Connecticut 08484-0883
Providian Corporation 133,693.53 5.28
400 West Market
Louisville, Kentucky 40202
International Small Cap Fund
Montgomery Securities 100,498.13 96.93
600 Montgomery Street
San Francisco, CA 94111-2702
As of December 31, 1996, the Trustees and Officers of the Trust, as a
group, owned less than 1% of the outstanding shares of each Fund.
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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.
FINANCIAL STATEMENTS
Audited financial statements for the relevant periods ended December
31, 1996 for the Montgomery Variable Series: Growth Fund, Montgomery Variable
Series: Emerging Markets Fund and the Montgomery Variable Series: International
Small Cap Fund, as contained in the Annual Report to Shareholders of such Funds
for the fiscal year ended December 31, 1996 (the "Report"), are incorporated
herein by reference to the Reports.
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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.
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:
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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 Ratings Group'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 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.
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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.
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PART C
OTHER INFORMATION
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THE MONTGOMERY FUNDS III
--------------
FORM N-1A
--------------
PART C
--------------
Item 24. Financial Statements and Exhibits
(a) Financial Statements:
(1) Portfolio Investments as of December 31, 1996;
Statements of Assets and Liabilities as of December
31, 1996; Statements of Operations for the Period
Ended December 31, 1996; Statements of Changes in Net
Assets for the Period Ended December 31, 1996;
Financial Highlights for a Fund share outstanding
throughout the Period ended December 31, 1996, for
each of Montgomery Variable Series: Growth Fund,
Montgomery Variable Series: Emerging Markets Fund and
Montgomery Variable Series: International Small Cap
Fund; Notes to Financial Statements; Independent
Auditors' Report on the foregoing, all incorporated
by reference to the Annual Report to Shareholders of
the above-named funds.
(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 - Not applicable.
(7) Benefit Plan(s) - Not applicable.
(8) Custody Agreement is incorporated by reference to
Pre-Effective Amendment No. 1.
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(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.
(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.
(14) Model Retirement Plan Documents - Not applicable.
(15) Rule 12b-1 Plan - Not applicable.
(16) Performance Computation Schedule for Montgomery
Variable Series: International Small Cap Fund is
incorporated by reference to Post-Effective Amendment
Number 2 to the Registrant's Registration Statement
as filed with the Commission on April 26, 1996
("Post-Effective Amendment No. 2"). 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 is incorporated by reference to
Post-Effective Amendment Number 1 to the Registrant's
Registration Statement as filed with the Commission
on January 16, 1996 ("Post-Effective Amendment No.
1").
(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.
(19) Financial Data Schedule is incorporated by reference
to Form N-SAR filed for the period ended December 31,
1996.
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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 March 31, 1997
- -------------- ---------------------
Shares of Beneficial
Interest, $0.01 par value
Montgomery Variable Series: Growth Fund 4
Montgomery Variable Series: Emerging Markets Fund 4
Montgomery Variable Series: International Small Cap Fund 2
Montgomery Variable Series: Small Cap Opportunities Fund N/A
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 or was an
agent of the Trust, against expenses, judgments, fines, settlements, 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
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the foregoing provisions or otherwise, the Registrant has been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the 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 is Chief Administrative Officer; Mary Jane Fross is Manager of Mutual
Fund Administration and Finance; and Josephine Jimenez, Bryan L. Sudweeks,
Stuart O. Roberts, John H. Brown, William C. Stevens, 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 the Registrant (namely, Messrs.
Doyle, Geist, Story, and Demarest, Mary Jane Fross, and five of the eight
Managing Directors, Josephine Jimenez and Messrs. Sudweeks, Honour, Castro, and
Boich) is set forth in Part B. Mr. Roberts is a Portfolio Manager for MAM, L.P.,
and has been employed there since 1990. Mr. Brown is a Senior Portfolio Manager
for MAM, L.P. Prior to joining MAM, L.P. in May 1994, Mr. Brown was an analyst
and portfolio manager at Merus Capital Management in San Francisco, California.
Mr. Stevens is a Portfolio Manager for MAM, L.P.
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 101 California Street, San Francisco,
California 94111.
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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: Small
Cap Opportunities Fund, which need not be certified, within four to six months
after the effective date of that series of the Registrant.
(c) Registrant hereby undertakes to furnish each person to
whom a prospectus is delivered with a copy of the Registrant's last annual
report to Shareholders, upon request and without charge.
(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 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.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and
the Investment Company Act of 1940, the Registrant certifies that it 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 9th day of April, 1997.
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 April 9, 1997
- ----------------- Officer; Principal
R. Stephen Doyle Financial and Accounting
Officer; and Trustee
Andrew Cox* Trustee April 9, 1997
- ----------
Andrew Cox
Cecilia H. Herbert* Trustee April 9, 1997
- ------------------
Cecilia H. Herbert
John A. Farnsworth* Trustee April 9, 1997
- ------------------
John A. Farnsworth
Jerome S. Markowitz* Trustee April 9, 1997
- -------------------
Jerome S. Markowitz
* By: /s/ JULIE ALLECTA
----------------------------------------------
Julie Allecta, Attorney-in-Fact
pursuant to Power of Attorney previously filed
