<PAGE>
Montgomery Variable Series:
Growth Fund
Semi-Annual Report
June 30, 1997
[PICTURE APPEARS HERE]
Invest wisely./sm/
The Montgomery Funds
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights
June 30, 1997 (unaudited)
- --------------------------------------------------------------------------------
Investment Review
Q: How did the Fund perform from July 1, 1996, through
June 30, 1997?
A: The Fund gained 28.66 % over that time frame. And though that is solid
performance in absolute terms, it did lag the S&P 500. This reflects a
significant trend over the past year: The largest companies in the stock
market generated the highest returns for investors. In fact, the 35 largest
stocks in the S&P 500 accounted for approximately 50% of its total return
over that time period. Our focus on buying the best combination of growth
stocks that are available at the most attractive prices has led us to
somewhat smaller companies, so we were a bit disadvantaged over the most
recent year compared with the S&P 500.
Q: The Fund turned in a double-digit gain during the second quarter of 1997.
What were some of the factors behind that performance?
A: Many individual stock positions contributed to the Fund's performance over
this period. This was a time when market leadership broadened out. New areas
of the market in which we have identified attractive opportunities,
including some cycle-sensitive and smaller names, participated in the
advance. This was positive for the Fund's performance. We should reiterate,
however, that we do not make portfolio decisions based on broad trends or
themes. Our investment approach is bottom-up, and our weightings are a by-
product of that process.
Q: What's your perspective on the U.S. economy right now?
A: Economic growth has moderated somewhat, after an unsustainably strong first
quarter. Demand continues to ease, inflation remains dormant and interest
rates have declined. The Federal Reserve did not tighten monetary policy at
either its May 20 or July 2 meeting. The stock market reacted very favorably
to this positive environment, although investors and economists continue to
debate whether demand has moderated sufficiently to defuse pressure on
already tight labor markets. So far, wage-based inflation remains under
control, as consolidations, layoffs, restructuring and productivity gains
have helped keep a lid on costs.
Q: And your view of the stock market?
A: If you take the S&P 500 as a proxy for the market, it appears to be fully
valued from a historical perspective. Over the past 100 years, the S&P 500's
price/earnings (P/E) multiple has ranged from around 11 times on the low end
to about 18 times on the high side. Right now, the S&P 500 is trading at a
P/E of nearly 20 times its expected 1997 earnings. As a result, we doubt
that further P/E expansion is likely. Stocks should be able to continue
appreciating along with earnings growth, so long as the backdrop remains
benign. At the moment, consensus expectations for the S&P 500's 1997
earnings-growth rate is in the 8 to 10% range. It is therefore unlikely that
the backdrop for a dramatic rally is in place unless interest rates continue
to decline.
Portfolio Management
- -------------------------------------------
Roger W. Honour....Senior Portfolio Manager
Andrew Pratt..............Portfolio Manager
Kathryn M. Peters.........Portfolio Manager
- -------------------------------------------
Fund Performance
- -------------------------------------------
Average annual total returns for the
periods ended 6/30/97
- -------------------------------------------
Montgomery Variable Series:
Growth Fund
Since inception (2/9/96).............32.61%
One Year.............................28.66%
S&P 500 Index
Since (1/31/96)......................28.97%
One Year.............................34.68%
- -------------------------------------------
Past performance is no guarantee of future
results. Net asset value, investment return
and principal value will fluctuate so that
shares, when redeemed, may be worth more or
less than their original cost.
Growth of a $10,000 Investment
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN
AMONG MONTGOMERY VARIABLE SERIES: GROWTH FUND
S&P 500 INDEX AND S&P FINANCIAL INDEX
Measurement Period Montgomery Variable S&P
(Fiscal Year Covered) Series: Growth Fund 500 INDEX
- --------------------- ------------------- ---------
FYE 01/1996 $ $100.00
Measurement Pt-
02/09/1996 $100.00 $
FYE 02/1996 $100.40 $100.93
FYE 03/1996 $104.37 $101.90
FYE 04/1996 $110.81 $103.40
FYE 05/1996 $117.66 $106.07
FYE 06/1996 $115.08 $106.47
FYE 07/1996 $110.02 $101.77
FYE 08/1996 $114.48 $103.92
FYE 09/1996 $119.54 $109.76
FYE 10/1996 $122.72 $112.79
FYE 11/1996 $128.17 $121.31
FYE 12/1996 $127.22 $118.90
FYE 01/1997 $131.66 $126.33
FYE 02/1997 $131.25 $127.32
FYE 03/1997 $126.71 $122.10
FYE 04/1997 $131.45 $129.38
FYE 05/1997 $142.29 $137.29
FYE 06/1997 $148.07 $143.39
- -------------------------------------------
* The Standard & Poor's 500 Index is
composed of 500 widely held common stocks
listed on the NYSE, AMEX, and OTC market.
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights
June 30, 1997 (unaudited)
Q: How will these views affect your portfolio strategy, if at all?
A: We think that the most attractive opportunities in the U.S. market right now
lie in somewhat smaller-cap stocks and selected cycle-sensitive issues.
Investors have ignored some of these areas for quite a while, creating a
valuation disparity. A great many medium-sized and smaller companies also
offer higher growth rates than those in the S&P 500. We expect that the
broadening of interest to these types of companies will continue, as more
investors recognize the potential in these segments of the market.
Q: Can you discuss a portfolio company that is an example of this?
A: Nordstrom, Inc., a company that we have invested in for quite a while, is
the largest independently owned fashion retailer in the United States,
offering a wide variety of high-quality apparel, shoes and accessories for
women, men and children through 62 full-line stores. Nordstrom prides itself
on quality, value, selection and service. It has been in business for 97
years, and the Nordstrom family still owns 23% of its outstanding shares,
thereby aligning management's interests with those of other shareholders.
The company is extremely well financed, which should allow it to continue
expanding as opportunities are presented. Unlike many retailers, Nordstrom
is consistently profitable, not just in the Christmas quarter. The company
recently reported better-than-expected earnings and had upbeat comments
about its future prospects and expansion possibilities. Even when Nordstrom
was underperforming, it remained one of the most profitable retailers in the
business.
Despite all this, Nordstrom's stock price is about the same as it was six
years ago. In fact, at the end of the second quarter its shares were trading
at a discount to the market for the first time in more than a decade. Herein
lies the opportunity, we believe, for investors to recognize Nordstrom's
improving fundamentals and reward its shares with a higher valuation.
Q: Why should an investor consider the Montgomery Variable Series: Growth Fund
right now?
A: Although we have a generally positive view of the market, we believe that
its historically high valuations make it more crucial than ever for
investors to maintain a dual focus on growth and value. Our investment
philosophy strikes a balance between the two. We use proprietary,
quantitative screening techniques to pinpoint long-term, positive,
fundamental change in a company's business and its expected earnings. We
then conduct fundamental analysis to determine whether this improvement is
sustainable and to project what we believe the appropriate valuation of the
stock should be. Our goal is to identify long-term, fundamental improvement
before that potential is widely recognized by the market, and to avoid
overpaying for the future prospects of the company. Over the long term, we
think that this strategy will best serve the interests of our shareholders.
This Fund remains well diversified, with more than 50 companies across 35
different industries. The portfolio's weighted average market cap is
approximately $9 billion. The average 1997 earnings growth of our holdings
(based on consensus expectations) is 28%. Again, that contrasts with
expected earnings growth of about 10% for the S&P 500. The P/E ratio of our
portfolio is about 18. In other words, we expect our portfolio to deliver
nearly triple the earnings growth of the S&P 500 at a slightly lower P/E.
2
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights
June 30, 1997 (unaudited)
Top Five Industries
(as a percentage of net assets)
----------------------------------------------------
Retail Trade..............................9.1%
Pulp and Paper............................8.7
Machinery and Tools.......................8.7
Software Systems..........................7.4
Telecommunications Equipment..............5.5
----------------------------------------------------
Top Ten Holdings
(as a percentage of net assets)
----------------------------------------------------
Avid Technology Inc.......................4.5%
JLK Direct Distribution Inc., Class A.....4.0
Nordstrom, Inc............................4.0
International Paper Company...............3.8
Masco Corporation.........................3.3
Octel Communications Corporation..........3.3
Interstate Hotels Company.................3.2
Canadian National Railway Company.........3.2
Golden West Financial Corporation.........3.1
Dayton Hudson Corporation.................3.1
----------------------------------------------------
3
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Investments
June 30, 1997 (unaudited)
<TABLE>
<CAPTION>
Common Stocks-86.9% Value
Shares (Note 1)
<S> <C>
Aerospace/Defense-0.5%
1,100 Gulfstream Aerospace Corporation+ $ 32,450
----------
Airlines-2.2%
2,450 Federal Express Corporation+ 141,487
----------
Apparel and Textiles-0.7%
525 VF Corporation. 44,494
----------
Auto/Auto Parts-2.1%
1,900 General Motors Corporation 105,806
600 PACCAR, Inc. 27,863
----------
133,669
----------
Banks/Savings and Loan-4.4%
800 BankAmerica Corporation 51,650
275 Citicorp 33,155
2,800 Golden West Financial Corporation 196,000
----------
280,805
----------
Building Materials-3.3%
5,125 Masco Corporation 213,969
----------
Business Services-2.1%
2,700 AccuStaff Inc.+ 63,956
950 Computer Sciences Corporation+ 68,519
----------
132,475
----------
Chemicals-1.0%
750 Dow Chemical Company 65,344
----------
Conglomerates-1.2%
1,150 Tyco International Ltd. 79,997
----------
Cosmetics and Personal Care-1.0%
300 Unilever N.V., ADR 65,400
----------
Diversified Financial Services-0.6%
700 Norwest Corporation 39,375
----------
Electronics-1.0%
875 Raychem Corporation 65,078
----------
Food and Beverage-1.9%
6,850 Fleming Companies, Inc. 123,300
----------
Health Care-0.6%
500 Healthcare COMPARE Corporation+ 26,219
200 Oxford Health Plans, Inc.+ 14,356
----------
40,575
----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Investments (continued)
June 30, 1997 (unaudited)
<TABLE>
<CAPTION>
Common Stocks-(continued) Value
Shares (Note 1)
<S> <C>
Insurance -0.8%
1,100 Life Re Corporation. $ 51,288
----------
Lodging-4.6%
1,500 HFS Inc.+ 87,000
7,000 Interstate Hotels Company+ 206,062
----------
293,062
----------
Machinery and Tools-8.7%
10,000 JLK Direct Distribution Inc., Class A+ 256,250
1,900 Manitowoc Company, Inc. 88,825
9,000 Octel Communications Corporation+ 210,656
----------
555,731
----------
Metals and Mining-2.3%
1,000 Aluminum Company of America (Alcoa) 75,375
2,250 Freeport-McMoRan Copper and Gold, Inc. Series B 70,031
----------
145,406
----------
Newspapers/Publishing-3.1%
1,600 Dow Jones & Company, Inc. 64,300
1,400 Time Warner, Inc. 67,550
2,850 World Color Press, Inc.+ 67,688
----------
199,538
----------
Oil-5.0%
2,600 Amerada Hess Corporation 144,462
1,725 Belco Oil & Gas Corporation+ 36,872
5,650 Union Pacific Resources Group, Inc. 140,544
----------
321,878
----------
Oilfield Equipment-2.6%
900 Schlumberger Ltd. 112,500
1,200 Tidewater Inc. 52,800
----------
165,300
----------
Pipelines-0.7%
1,100 Enron Corporation 44,894
----------
Pulp and Paper-8.7%
4,400 Boise Cascade Corporation 155,375
1,100 Champion International Corporation 60,775
600 Chesapeake Corporation 20,250
5,000 International Paper Company 242,812
1,100 Willamette Industries, Inc. 77,000
----------
556,212
----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Investments (continued)
June 30, 1997 (unaudited)
<TABLE>
<CAPTION>
Common Stocks-(continued) Value
Shares (Note 1)
<S> <C> <C>
Railroad - 3.2%
4,700 Canadian National Railway Company $ 205,625
----------
Retail Trade-9.1%
3,675 Dayton Hudson Corporation 195,464
5,200 Nordstrom, Inc. 255,125
2,900 Polo Ralph Lauren Corporation+ 79,388
2,000 TJX Companies, Inc. 52,750
----------
582,727
----------
Semiconductors-1.4%
966 Analog Devices Inc.+ 25,659
750 Texas Instruments, Inc. 63,047
----------
88,706
----------
Software Systems-7.4%
10,900 Avid Technology Inc.+ 288,169
200 Structural Dynamics Research Corporation+ 5,256
12,100 Sybase, Inc.+ 179,231
----------
472,656
----------
Telecommunications-1.2%
1,750 Newbridge Networks Corporation+ 76,125
----------
Telecommunications Equipment-5.5%
1,450 Ascend Communications, Inc.+ 56,958
4,750 Aspect Telecommunications Corporation 105,094
3,500 Ericsson (L.M.) Telephone Company, Class B, ADR 137,922
300 Northern Telecom Ltd. 27,300
2,450 PictureTel Corporation+ 23,312
----------
350,586
----------
Total Common Stocks (Cost $4,863,859) 5,568,152
----------
</TABLE>
<TABLE>
Repurchase Agreements-20.3%
Principal Amount
<S> <C> <C>
$651,000 Agreement with Bear Stearns, Tri-Party, 6.200% dated 06/30/97, to be
repurchased at $651,112, on 07/01/97, collateralized by $664,020
market value of U.S. Government securities, having various maturities
and various interest rates 651,000
---------
651,000 Agreement with Nikko Securities Company International Inc., Tri-Party,
6.200% dated 06/30/97, to be repurchased at $651,112, on 07/01/97,
collateralized by $667,018 market value of U.S. Government securities,
having various maturities and various interest rates 651,000
---------
Total Repurchase Agreements (Cost $1,302,000) 1,302,000
---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Investments (continued)
June 30, 1997 (unaudited)
<TABLE>
<CAPTION>
Value
(Note 1)
<S> <C> <C>
Total Investments (Cost $6,165,859*) 107.2 % $6,870,152
Other Assets and Liabilities (Net) (7.2) (463,244)
======= ==========
Net Assets 100.0 % $6,406,908
======= ==========
- ----------------------------------
</TABLE>
* Aggregate cost for Federal tax purposes.
+ Non-income producing security.
Abbreviation:
ADR American Depositary Receipt
The accompanying notes are an integral part of these financial statements.
7
<PAGE>
Montgomery Variable Series: Growth Fund
Statement of Assets and Liabilities
June 30, 1997 (unaudited)
<TABLE>
<S> <C> <C>
Assets:
Investments in securities, at value (Identified cost $6,165,859) (Note 1)
Securities................................................................. $5,568,152
Repurchase agreements...................................................... 1,302,000
----------
Total investments.......................................................... 6,870,152
Cash............................................................................ 892
Receivables:
Shares of beneficial interest sold......................................... 32,146
Investment securities sold................................................. 13,869
Expenses absorbed by Manager (Note 2)...................................... 4,065
Dividends.................................................................. 2,058
Interest................................................................... 224
Other Assets:
Organization costs (Note 1)................................................ 44,713
----------
Total Assets.................................................................... 6,968,119
Liabilities:
Payables:
Investment securities purchased............................................ $ 492,599
Organization cost.......................................................... 60,233
Shares of beneficial interest redeemed..................................... 2,311
Trustees' fees and expenses................................................ 2,059
Other accrued liabilities and expenses..................................... 4,009
----------
Total Liabilities............................................................... 561,211
----------
Net Assets...................................................................... $6,406,908
==========
Net Assets consist of:
Undistributed net investment income............................................. $ 45,999
Accumulated net realized gain on securities sold................................ 111,104
Net unrealized appreciation of investments...................................... 704,293
Shares of beneficial interest................................................... 4,465
Additional paid-in capital...................................................... 5,541,047
----------
Net Assets...................................................................... $6,406,908
==========
Net Asset Value, offering and redemption price per share
($6,406,908 / 446,544 shares of beneficial interest outstanding)................ $ 14.35
==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
8
<PAGE>
Montgomery Variable Series: Growth Fund
Statement of Operations
For the Six Months Ended June 30, 1997 (unaudited)
<TABLE>
<S> <C> <C>
Net Investment Income:
Interest.................................................................... $ 29,921
Dividends (Net of foreign withholding taxes of $364)........................ 16,132
----------
Total Investment Income..................................................... 46,053
Expenses:
Management fee (Note 2)..................................................... $ 20,158
Legal and audit fees........................................................ 8,926
Amortization of organization expenses (Note 1).............................. 6,156
Trustees' fees and expenses (Note 2)........................................ 3,818
Printing fees............................................................... 2,654
Custodian fees.............................................................. 504
Other....................................................................... 2,533
---------
Total Expenses.............................................................. 44,749
Fees deferred and expenses absorbed by Manager (Note 2)..................... (44,695)
----------
Net Expenses................................................................ 54
----------
Net Investment Income....................................................... 45,999
----------
Net Realized and Unrealized Gain on Investments (Notes 1 and 3):
Net realized gain on investments during the period.......................... 97,339
Net unrealized appreciation of investments during the period................ 565,143
Net Realized and Unrealized Gain on Investments............................. 662,482
----------
Net Increase in Net Assets Resulting from Operations........................ $ 708,481
==========
</TABLE>
<TABLE>
<CAPTION>
Statement of Changes in Net Assets
For the Six Months
Ended 06/30/97 For the Period
Net Increase in Net Assets Resulting from Operations: (unaudited) Ended 12/31/96*
---------------- ---------------
<S> <C> <C>
Net investment income....................................................... $ 45,999 $ 26,607
Net realized gain on investments during the period.......................... 97,339 74,537
Net unrealized appreciation of investments during the period................ 565,143 139,150
Net increase in net assets resulting from operations........................ 708,481 240,294
---------- ----------
Distributions to Shareholders:
Distributions from net investment income.................................... - (26,562)
Distributions from net realized gains on investments........................ - (60,772)
Beneficial Interest Transactions:
Net increase from beneficial interest transactions (Note 4)................. 3,571,732 1,854,346
---------- ----------
Net increase in net assets.................................................. 4,280,213 2,007,306
Net Assets:
Beginning of period......................................................... 2,126,695 119,389
---------- ----------
End of period............................................................... $6,406,908 $2,126,695
========== ==========
Undistributed net investment income......................................... $ 45,999 -
========== ==========
- --------------------
</TABLE>
* Montgomery Variable Series: Growth Fund commenced operations on
February 9, 1996.
The accompanying notes are an integral part of these financial statements.
9
<PAGE>
Montgomery Variable Series: Growth Fund
Financial Highlights
Selected Per Share Data for the Period Ended:
<TABLE>
<CAPTION>
06/30/97
(unaudited)++ 12/31/96*
<S> <C> <C>
Net asset value - beginning of period............................................ $ 12.33 $ 10.08
--------- ---------
Net investment income............................................................ 0.15 0.15
Net realized and unrealized gain on investments.................................. 1.87 2.59
--------- ---------
Net increase in net assets resulting from investment operations.................. 2.02 2.74
Distributions to Shareholders:
Distributions from net investment income.................................... - (0.15)
Distributions from net realized gains on investments........................ - (0.34)
--------- ---------
Total Distributions......................................................... (0.49)
--------- ---------
Net asset value-end of period.................................................... $ 14.35 $ 12.33
========= =========
Total return**................................................................... 16.38% 27.22%
========= =========
Ratios to Average Net Assets/Supplemental Data:
Net assets, end of period (in 000's)............................................. $ 6.407 $ 2.127
Ratio of net investment income to average net assets............................. 2.28%+ 2.55%+
Ratio of operating expenses to average net assets................................ 0.00%+(b) 0.01%+
Portfolio turnover rate.......................................................... 31% 78%
Average commission rate paid (a)................................................. $ 0.0578 $ 0.0520
Net investment income/(loss) before deferral of fees and
absorption of expenses by Manager........................................... $ 0.00(c) (0.27)
Operating expense ratio before deferral of fees and absorption
of expenses by Manager...................................................... 2.22%+ 6.98%+
- ---------------------------
</TABLE>
* Montgomery Variable Series: Growth Fund commenced operations on
February 9, 1996.
** Total return represents aggregate total return for the periods indicated.
+ Annualized.
++ Per share numbers have been calculated using the average shares method,
which more appropriately presents the per share data for the period since
use of the undistributed net investment income method did not accord with
the results of operations.
(a) Average commission rate paid per share of securities purchased and sold by
the Fund.
(b) Amount represents less than 0.01%.
(c) Amount represents less than $0.01.
The accompanying notes are an integral part of these financial statements.
10
<PAGE>
The Montgomery Funds III
Notes to Financial Statements (unaudited)
1. Significant Accounting Policies:
The Montgomery Funds III (the "Trust") is registered under the Investment
Company Act of 1940, as amended (the "1940 Act"), as a diversified, open-end
management investment company. As of June 30, 1997, the Trust had four
series, the Montgomery Variable Series: Growth Fund, the Montgomery Variable
Series: Emerging Markets Fund, the Montgomery Variable Series: International
Small Cap Fund and the Montgomery Variable Series: Small Cap Opportunities
Fund. The Montgomery Variable Series: Small Cap Opportunities Fund had not
commenced operations as of June 30, 1997.
The Trust was organized as a Delaware business trust on August 24, 1994.
Prior to the public offerings of shares of the Funds, a limited number of
shares were sold to Montgomery Asset Management, L.P. and/or affiliated
persons of Montgomery Asset Management in private placement offerings.
Otherwise, the Funds had no significant operations prior to February 2,
1996, the date on which the Montgomery Variable Series: Emerging Markets
Fund commenced operations (i.e., commenced selling shares to the public).
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the
financial statements. Actual results could differ from those estimates.
Information presented in these financial statements pertains to the
Montgomery Variable Series: Growth Fund (the "Fund"). The Montgomery
Variable Series: Emerging Markets Fund and the Montgomery Variable Series:
International Small Cap Fund are presented under separate covers.
The following is a summary of significant accounting policies.
a. Portfolio Valuation
The Fund's securities are valued using current market valuations: either
the last reported sales price or, lacking any reported sales, and in the
case of fixed income securities, the mean between the closing bid and
asked prices. Securities for which market quotations are not readily
available (including restricted securities which are subject to
limitations as to their sale) are valued at fair value as determined in
good faith by or under the supervision of the Trust in accordance with
methods which are authorized by the Trust's Board of Trustees.
Short term debt obligations with remaining maturities in excess of 60
days are valued at current market prices, as discussed above. Short-term
securities with maturities of 60 days or less are carried at amortized
cost, which approximates market value.
b. Dividends and Distributions
Dividends, if any, from net investment income of the Fund are declared
and paid at least annually.
Distributions of any short-term capital gains earned by the Fund are
distributed no less frequently than annually. Additional distributions
of net investment income and capital gains for the Fund may be made in
order to avoid the application of a 4% non-deductible excise tax on
certain undistributed amounts of ordinary income and capital gains.
Income distributions and capital gain distributions are determined in
accordance with income tax regulations which may differ from generally
accepted accounting principles. These differences are primarily due to
differing treatments of income and gains on various investment
securities held by the Fund, timing differences and differing
characterizations of distributions made by the Fund.
c. Repurchase Agreements
The Fund may engage in repurchase agreement transactions individually or
jointly through a joint repurchase account with other series of the
Trust and affiliated registered investment companies pursuant to a joint
repurchase agreement. Under the terms of a typical repurchase agreement,
the Fund writes a financial contract with a counterparty and takes
possession of a government debt obligation as collateral. The Fund also
agrees with the counterparty to allow the counterparty to repurchase the
financial contract at a specified date and price, thereby determining
the yield during the Fund's holding period. This arrangement results in
a fixed rate of return that is not subject to market fluctuations during
the Fund's holding period. The value of the collateral is at least equal
at all times to the total amount of the repurchase obligations,
including interest. In the event of counterparty default, the Fund has
the right to use the collateral to offset losses incurred. There could
be potential loss to the Fund in the event the Fund is delayed or
prevented from exercising its rights to dispose of the collateral
securities, including the risk of a possible decline in the value of the
underlying securities during the period while the Fund seeks to assert
its rights. The Fund's investment manager, acting under the supervision
of the Board of Trustees, reviews the value of the collateral and the
creditworthiness of those banks and dealers with which the Fund enters
into repurchase agreements to evaluate potential risks. The Fund may
also participate on an individual or joint basis in tri-party repurchase
agreements which involve a counterparty and a custodian bank.
11
<PAGE>
The Montgomery Funds III
Notes to Financial Statements (unaudited)
(continued)
d. Securities Transactions and Investment Income
Securities transactions are recorded on a trade-date basis. Realized
gain and loss from securities transactions are recorded on the specific
identified cost basis. Dividend income is recognized on the ex-dividend
date and interest income, including, where applicable, amortization of
discount on short-term investments, is recognized on an accrual basis.
e. Federal Income Taxes
The Fund has elected and qualified, and it is the intention of the Fund
to continue to qualify, as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"), by complying with the provisions available to certain
investment companies, as defined in applicable sections of the Code, and
to make distributions of taxable income to shareholders sufficient to
relieve the Fund from all or substantially all federal income taxes.
f. Organization Costs
Expenses incurred in connection with the organization of the Fund are
amortized on a straight-line basis over a period of five years from
commencement of operations.
2. Management Fees and Other Transactions with Affiliates:
a. Montgomery Asset Management, L.P. is the Fund's Manager (the "Manager").
The Manager, a California limited partnership, is an investment adviser
registered with the Securities and Exchange Commission under the
Investment Advisers Act of 1940, as amended (the "Advisers Act"). The
general partner of the Manager is Montgomery Asset Management, Inc., and
its sole limited partner is an affiliate of Montgomery Securities. Under
the Advisers Act, both Montgomery Asset Management, Inc. and Montgomery
Securities may be deemed controlling persons of the Manager. Although
the operations and management of the Manager are independent from those
of Montgomery Securities, it is expected that the Manager may draw upon
the research and administrative resources of Montgomery Securities at
its discretion in a manner consistent with applicable regulations.
Pursuant to the investment management agreement ("Investment Management
Agreement"), the Manager provides the Fund with advice on buying and
selling securities, manages the investments of the Fund including the
placement of orders for portfolio transactions, furnishes the Fund with
office space and certain administrative services, and provides the
personnel needed by the Trust with respect to the Manager's
responsibilities under such Agreement. As compensation, the Fund pays
the Manager a monthly management fee (accrued daily) at the following
annual rates based upon the average daily net assets of the Fund:
First $500 Million Next $500 Million Over $1 Billion
------------------ ----------------- ---------------
1.00% 0.90% 0.80%
The Manager has agreed to reduce some or all of its management fee or
absorb the Fund expenses if necessary to keep the Fund's annual
operating expenses, exclusive of interest or taxes, at or below 1.25% of
the average daily net assets of the Fund.
Any reductions or absorptions made for the Fund by the Manager of its
fees are subject to recovery within the following three years provided
the Fund is able to affect such reimbursement and remain in compliance
with applicable expense limitations. Any of the Manager's voluntary
absorptions are also subject to recovery.
For the six months ended June 30, 1997, the Manager has deferred fees of
$20,158 and absorbed expenses of $24,537.
As of June 30, 1997, the deferred management fees and absorbed expenses
subject to recoupment are $117,522.
b. Certain officers and Trustees of the Trust are, with respect to the
Trust's Manager and/or Montgomery Securities, "affiliated persons" as
defined in the 1940 Act. Each Trustee who is not an "affiliated person"
receives an annual retainer and quarterly meeting fees totalling $35,000
per annum, as well as reimbursement for expenses, for services as a
Trustee of all three Trusts advised by the Manager ($5,000 of which will
be allocated to the Montgomery Funds III).
c. The Fund has no sales load and does not pay distribution (Rule 12b-1)
fees.
d. For the six months ended June 30, 1997, the Fund incurred total
brokerage commissions of $5,471 of which $39 was paid to its affiliates.
12
<PAGE>
The Montgomery Funds III
Notes to Financial Statements (unaudited)
(continued)
3. Securities Transactions:
a. The aggregate amount of purchases and sales of investment securities,
other than short-term securities, for the six months ended June 30,
1997, were $4,109,904 and $972,998, respectively.
b. At June 30, 1997, aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost and
aggregate gross unrealized depreciation for all securities in which
there was an excess of tax cost over value for federal income tax
purposes were $767,075 and $62,782, respectively.
c. Under an unsecured Revolving Credit Agreement with DeutscheBank (New
York), the Montgomery Variable Series: Growth Fund, along with other
funds of the Montgomery Funds I, Montgomery Funds II and Montgomery
Funds III, may for one year starting August 6, 1996, borrow (consistent
with applicable law and its investment policies) up to 10% of its net
asset value, provided that the aggregate principal amount of outstanding
loans under the agreement to all Funds does not exceed $300,000,000. For
the six months ended June 30, 1997, there were no borrowings under this
agreement.
4. Transaction in Shares of Beneficial Interest:
The Trust has authorized an unlimited number of shares of beneficial
interest which have a par value of $0.01. Transactions in shares of
beneficial interest for the periods indicated below were:
<TABLE>
<CAPTION>
Six Months Ended Period Ended
June 30, 1997 December 31, 1996*
Shares Amount Shares Amount
<S> <C> <C> <C> <C>
Shares Sold 590,636 $ 7,604,090 333,351 $ 3,946,116
Issued as Reinvestment of Dividends - - 7,141 87,335
Shares Redeemed (316,551) (4,032,358) (179,876) (2,179,105)
------- ----------- ------- -----------
Net Increase 274,085 $ 3,571,732 160,616 $ 1,854,346
======= =========== ------- ===========
- ---------------------
</TABLE>
* Montgomery Variable Series: Growth Fund commenced operations on
February 9, 1996.
5. Subsequent Event:
On March 25, 1997, Montgomery Securities, the Manager and CAM Acquisition
LLC ("CAM"), a newly organized subsidiary of Commerzbank Aktiengesellschaft,
entered into an agreement providing for the transfer of substantially all
the assets composing the Manager's business to CAM. On June 23, 1997, the
shareholders of the Fund approved a new Investment Management Agreement with
CAM (renamed Montgomery Asset Management, LLC) that became effective upon
the closing of the Manager's transaction with CAM. Such transaction closed
on July 31, 1997.
13
