<PAGE>
Montgomery Variable Series:
International Small Cap Fund
Semi-Annual Report
June 30, 1998
[LOGO]
Invest wisely.(R)
The Montgomery Funds
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
PORTFOLIO HIGHLIGHTS
JUNE 30, 1998
- --------------------------------------------------------------------------------
INVESTMENT REVIEW
Q: HOW DID THE FUND PERFORM OVER THE PAST YEAR?
A: For the 12 months ended June 30, the Fund recorded a loss of 1.05%, compared
with its main benchmark, the unmanaged Salomon Smith Barney World Extended
(ex-U.S.) Market Index (SB EMI ex-U.S.), which gained 0.56%. We
underperformed against the Morgan Stanley Capital International Europe,
Australia and Far East Index (MSCI EAFE) as well which generated a return of
6.10%. The SB EMI ex-U.S., which tracks small-cap stocks in the world's
developed markets outside the United States, provides a more relevant
benchmark than the MSCI EAFE, which comprises some of the very largest
stocks in those markets.
Over the past six months to June 30, 1998, the performance of the Fund
improved over that of the first six months of the financial year. The Fund
recorded a gain of 17.37%, compared with 16.8% for the SB EMI ex-U.S. and
15.9% for the MSCI EAFE.
Q: What factors explain the Fund's performance?
A: A major factor explaining the Fund's strong performance is our disciplined
approach to stock selection in various industry sectors. In Europe, for
example, the transportation sector is performing well; for the year-to-date,
our investment in Avis Europe was up more than the U.K. market as a whole.
National Express, a U.K.-based operator of trains and buses, was also up
nicely for the year. The positive trend in the transportation sector is
migrating from the U.K. to continental Europe this year, so we remain
optimistic about that sector. We also continue to seek opportunities to
capitalize on the world's most promising economic trends, including the
rapid growth in technology (20% of assets), consumer cyclicals (18%) and
services (16%).
Additionally, our relatively underweight position in Japan, with only 14% of
Fund assets invested, added to our performance. We continue to be
overweighted in Europe (60% of assets), with its environment of relatively
low interest rates, low inflation and moderate economic growth. As
valuations of large-cap stocks are driven higher, investors are looking for
alternative investments in Europe, which is helping fuel the growth of
European small-cap stocks. The deregulation of the pension fund system in
Europe, combined with corporate restructuring, has also helped buoy returns
there.
PORTFOLIO MANAGEMENT
- ----------------------------------------------------------
John D. Boich, CFA
....................Senior Portfolio Manager
FUND PERFORMANCE
- ----------------------------------------------------------
Average annual total returns for the period
ended 6/30/98
- ----------------------------------------------------------
MONTGOMERY VARIABLE SERIES:
INTERNATIONAL SMALL CAP FUND
Since inception (9/30/96)......................... 10.70%
One Year.......................................... -1.05%
SALOMON SMITH BARNEY WORLD
EXTENDED EX-U.S. MARKET INDEX
Since 9/30/96..................................... 2.91%
One Year.......................................... 0.56%
- ----------------------------------------------------------
Past performance is no guarantee of future results. Net
asset value, investment return and principal value will
fluctuate so that shares, when redeemed, may be worth more
or less than their original cost.
- ----------------------------------------------------------
GROWTH OF A $10,000 INVESTMENT
[_] Montgomery Variable Series: International Small Cap Fund
--- Salomon Smith Barney World Small Extended ex-U.S. Market Index
<TABLE>
<CAPTION>
Montgomery Variable Series: International Salomon Smith Barney World Small Cap Fund Extended ex-U.S. Market Index
<S> <C> <C>
9/96 $10,000.00 $10,000.00
10/96 $10,190.00 $ 9,961.00
11/96 $11,050.00 $10,124.36
12/96 $10,723.00 $ 9,938.07
1/97 $11,165.00 $ 9,723.41
2/97 $11,447.00 $ 9,886.76
3/97 $11,226.00 $ 9,755.27
4/97 $11,155.00 $ 9,608.94
5/97 $11,748.00 $10,224.87
6/97 $12,070.00 $10,455.96
7/97 $11,919.00 $10,298.07
8/97 $11,527.00 $ 9,858.34
9/97 $11,638.00 $10,033.82
10/97 $10,864.00 $ 9,637.49
11/97 $10,191.00 $ 9,207.65
12/97 $10,176.00 $ 9,004.16
1/98 $10,593.00 $ 9,379.64
2/98 $11,244.00 $10,079.36
3/98 $11,944.00 $10,553.09
4/98 $12,165.00 $10,633.29
5/98 $12,115.00 $10,831.07
6/98 $11,944.00 $10,514.80
</TABLE>
The Salomon Smith Barney World Equity Index is a comprehensive float-weighted
equity index consisting of every company with an investable market
capitalization of over $100 million in 21 countries. Within this index, the
Extended ex-U.S. Market Index defines the small capitalization stock universe.
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
PORTFOLIO HIGHLIGHTS (continued)
JUNE 30, 1998
- --------------------------------------------------------------------------------
Q: WERE THERE ANY DISAPPOINTMENTS?
A: Japan has continued to be a disappointment. Policy changes announced by the
government designed to boost the ailing economy have not met investor
expectations so far in 1998. We continue to look for Japanese companies that
are essentially "self-reforming", that is, firms that are instituting change
on their own. Good examples include Fast Retailing and Otsuka, which are
both domestic retailers. On the other hand, retailers such as Laox and Mirai
continue to come under pressure from the downdrafts in the Japanese economy
in spite of good long-term fundamentals.
Q: THE STRENGTH OF THE U.S. DOLLAR AGAINST THE JAPANESE YEN AND OTHER
CURRENCIES MADE HEADLINES OVER THE PAST YEAR. HOW DO CURRENCY TRENDS LIKE
THIS AFFECT THE FUND'S STRATEGY?
A: It appears that the strength of the dollar we have been seeing over the past
two and a half years is abating due to relative shifts in economic momentum.
The U.S. economy is decelerating, and the European economies are
accelerating. The opposite is true for Japan. The yen has weakened
dramatically against the dollar. Our strategy going forward will depend on
the Japanese reform package. If the government delivers when Japan announces
its reform package, our position in Japan will quickly increase. If the
government continues to disappoint, we will remain extremely underweighted
in Japan.
Q: WHY INVEST IN SMALL-CAP STOCKS NOW?
A: There are many dynamic small companies outside the United States, and most
of them have not yet been discovered by investors. There continue to be
material inefficiencies in the small-cap market, because it is undercovered
and undervalued compared with large-cap stocks. With the International Small
Cap Fund, our goal is to capitalize on this valuation gap between large and
small companies.
There are risks of investing in a fund of this type that invests in securities
of foreign countries, such as erratic market conditions, economic and political
instability, and fluctuations in currency exchange rates. There are also risks
associated with investing in small-cap companies, which tend to be more volatile
and less liquid than stocks of large companies, including the increased risks of
price fluctuations.
2
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
PORTFOLIO HIGHLIGHTS (continued)
JUNE 30, 1998
- --------------------------------------------------------------------------------
TOP FIVE COUNTRIES
(AS A PERCENTAGE OF TOTAL NET ASSETS):
<TABLE>
---------------------------------------------------------------------
<S> <C>
United Kingdom............................................. 14.0%
Japan...................................................... 13.9
Germany.................................................... 13.3
China/Hong Kong............................................ 8.0
Norway..................................................... 6.5
---------------------------------------------------------------------
</TABLE>
TOP TEN INDUSTRIES
(AS A PERCENTAGE OF TOTAL NET ASSETS):
<TABLE>
---------------------------------------------------------------------
<S> <C>
Electronics................................................ 10.5%
Software Systems........................................... 9.5
Auto/Auto Parts............................................ 8.9
Business Services.......................................... 8.9
Telephone/Wireless......................................... 6.9
Lodging.................................................... 5.0
Home Appliance............................................. 4.9
Retail Trade............................................... 4.7
Railroad................................................... 4.7
Diversified Financial Services............................. 4.3
---------------------------------------------------------------------
</TABLE>
TOP TEN HOLDINGS
(AS A PERCENTAGE OF TOTAL NET ASSETS):
<TABLE>
---------------------------------------------------------------------
<S> <C>
Henlys Group PLC........................................... 4.7%
V-Tech Holdings Ltd........................................ 4.1
Flextronics International Ltd.............................. 4.1
Smartone Telecommunications................................ 3.8
Otsuka Kagu Ltd............................................ 2.8
Scandic Hotels AB.......................................... 2.7
Tecnomatrixs Technologies Ltd.............................. 2.6
Schaltbau AG............................................... 2.6
Aker Maritime ASA.......................................... 2.5
Sawako Corporation......................................... 2.5
---------------------------------------------------------------------
</TABLE>
3
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
PORTFOLIO INVESTMENTS
JUNE 30, 1998 (unaudited)
<TABLE>
<CAPTION>
COMMON STOCKS--99.4% VALUE
SHARES (NOTE 1)
<S> <C>
AUSTRALIA - 2.2%
38,541 Tyndall Australia Ltd. (Diversified Financial Services) $ 50,242
5,204 Tyndall Australia Ltd., Bonus Shares+ (Diversified Financial Services) 6,461
----------
56,703
----------
AUSTRIA - 1.8%
355 Voest Alpine Eisenbahnsystem (Heavy Construction) 47,427
----------
CANADA - 1.9%
1,800 Cognos, Inc.+ (Software Systems) 47,981
5,000 InMedia Presentations, Inc.+ (Software Systems) 2,888
----------
50,869
----------
CHINA/HONG KONG - 8.0%
41,000 Smartone Telecommunications (Telephone/Wireless) 100,013
21,000 V-Tech Holdings Ltd. (Electronics) 107,983
----------
207,996
----------
FRANCE - 1.8%
1,000 Dassault Systemes S.A., ADR (Computers and Office Equipment) 47,469
----------
GERMANY - 13.3%
55 Axel Springer Verlag, Class A (Newspapers/Publishing) 40,569
1,788 Eurobike AG (Retail Trade) 46,606
1,030 Kiekart AG (Auto/Auto Parts) 58,266
755 Schaltbau AG (Railroad) 67,833
1,700 Turbon International AG (Business Services) 36,864
870 Vossloh AG (Building Materials) 55,488
960 Winkler & Duennebier AG+ (Machinery & Tools) 43,126
----------
348,752
----------
IRELAND - 1.7%
17,162 Anglo Irish Bank Corporation (Banks) 46,149
----------
ISRAEL - 5.0%
2,700 ForSoft Ltd.+ (Software Systems) 41,006
3,000 Paradigm Geophysical Ltd.+ (Software Systems) 21,188
3,400 Tecnomatix Technologies Ltd.+ (Software Systems) 68,106
----------
130,300
----------
ITALY - 6.1%
4,400 Credito Agrario Bresciano (Banks) 53,491
2,100 Industrie Natuzzi SpA, Sponsored ADR (Home Appliance) 54,600
9,600 Manuli Rubber Industries SpA (Auto/Auto Parts) 51,870
----------
159,961
----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
4
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
PORTFOLIO INVESTMENTS (CONTINUED)
JUNE 30, 1998 (UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCKS (CONTINUED) VALUE
SHARES (NOTE 1)
<S> <C>
JAPAN - 13.9%
2,200 Fast Retailing Company Ltd. (Retail Trade) $ 20,684
9,000 Laox (Retail Trade) 55,652
1,900 Meitec (Software Systems) 65,958
3,000 Mirai Industry Company, Ltd. (Building Materials) 25,277
3,000 Nissin Company Ltd. (Diversified Financial Services) 55,327
1,600 Otsuka Kagu Ltd. (Home Appliance) 74,058
7,100 Sawako Corporation (Real Estate) 66,240
----------
363,196
----------
NETHERLANDS - 1.5%
1,230 Ordina Beheer NV+ (Business Services) 39,878
----------
NORWAY - 6.5%
3,770 Aker Maritime ASA (Oil) 66,412
20,100 Choice Hotels Scandinavia ASA+ (Lodging) 60,325
4,600 CN Selmer A.S. (Heavy Construction) 43,818
----------
170,555
----------
POLAND - 1.7%
2,600 Prokom ADR (Business Services) 44,655
----------
PORTUGAL - 0.7%
100 Telecel-Comunicacoes Pessoais, S.A (Telephone/Wireless) 17,768
----------
RUSSIA - 4.3%
1,000 Global TeleSystems Group Inc., ADR+ (Telephone/Networks) 48,625
1,400 Vimpel-Communications, ADR+ (Telephone/Wireless) 62,650
----------
111,275
----------
SINGAPORE - 4.1%
2,450 Flextronics International Ltd.+ (Electronics) 106,498
----------
SPAIN - 2.2%
372 Azkoyen S.A. (Consumer Services) 57,177
----------
SWEDEN - 3.9%
2,850 Munters AB (Machinery and Tools) 31,091
1,950 Scandic Hotels AB (Lodging) 70,909
----------
102,000
----------
SWITZERLAND - 4.8%
200 Fotolabo S.A. (Photography) 65,772
220 SAIA-Burgess Electronics AG+ (Electronics) 59,275
----------
125,047
----------
</TABLE>
5
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
PORTFOLIO INVESTMENTS (continued)
JUNE 30, 1998 (unaudited)
<TABLE>
<CAPTION>
COMMON STOCKS (continued) VALUE
SHARES (NOTE 1)
<S> <C> <C>
UNITED KINGDOM - 14.0%
9,835 Avis Europe PLC (Consumer Services) $ 44,420
3,850 Delphi Group PLC (Business Services) 38,088
1,600 ECsoft Group PLC, ADR (Business Services) 51,400
87,200 Freepages Group PLC+ (Broadcasting/Advertising) 54,963
13,949 Henlys Group PLC (Auto/Auto Parts) 122,858
3,328 National Express Group PLC (Railroad) 53,817
-----------
365,546
-----------
TOTAL COMMON STOCKS (Cost $2,610,032) 2,599,221
-----------
TOTAL INVESTMENTS (Cost $2,610,032*) 99.4% 2,599,221
-----------
OTHER ASSETS AND LIABILITIES (Net) 0.6 15,000
------- -----------
NET ASSETS 100.0% $2,614,221
======= ===========
</TABLE>
_____________
* Aggregate cost for federal tax purposes.
+ Non-income producing security.
# Amount represents less than 0.01%.
ABBREVIATION:
ADR American Depositary Receipt
6
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
STATEMENT OF ASSETS AND LIABILITIES
JUNE 30, 1998 (unaudited)
<TABLE>
<CAPTION>
ASSETS:
<S> <C> <C>
Investments in securities, at value (Identified cost $2,610,032)(Note 1)....... 2,599,221
Foreign currency (Cost $32,227)................................................ 2,418
Receivables:
Investment securities sold................................................ 72,834
Expenses absorbed by Manager (Note 2)..................................... 13,372
Dividends................................................................. 4,661
Other Assets:
Organization costs (Note 1)............................................... 747
----------
Total Assets................................................................... 2,573,253
LIABILITIES:
Forward foreign currency exchange contracts:
Net unrealized depreciation of forward foreign currency
contracts (Note 3)..................................................... $ 55
Payables:
Cash overdraft............................................................ 62,758
Trustees' fees and expenses (Note 2)...................................... 4,979
Organization cost......................................................... 4,247
Custodian fees............................................................ 2,706
Investment securities purchased........................................... 440
Other accrued liabilities and expenses.................................... 33,847
----------
Total Liabilities.............................................................. 109,032
----------
NET ASSETS..................................................................... $2,614,221
==========
NET ASSETS consist of:
Undistributed net investment income....................................... $ 30,385
Accumulated net investment loss on securities sold, forward foreign
currency exchange contracts and foreign currency transactions........... (266,179)
Net unrealized depreciation of investments, forward foreign currency
exchange contracts and foreign currency transactions.
and other net assets.................................................... (10,882)
Shares of beneficial interest............................................. 2,687
Additional paid-in capital................................................ 2,858,210
----------
NET ASSETS..................................................................... $2,614,221
==========
Net Asset Value, offering and redemption price per share
($2,614,221 divided by 268,683 shares of beneficial interest outstanding)...... $ 9.73
==========
</TABLE>
7
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 (unaudited)
INVESTMENT INCOME:
<TABLE>
<S> <C>
Dividends (net of foreign withholding taxes of $3,075)..... $ 22,765
Interest................................................... 13,387
-----------
Total Investment Income.................................... 36,152
EXPENSES:
Management fee (Note 2).................................... $ 61,664
Custodian fees............................................. 12,301
Legal and audit fees....................................... 7,907
Trustees' fees and expenses (Note 2)....................... 3,819
Amortization of organization expenses (Note 1)............. 217
Other...................................................... 7,755
Interest................................................... 2,976
-----------
Total Expenses............................................. 96,639
Fees deferred and expenses absorbed by Manager (Note 2).... (96,639)
-----------
NET EXPENSES............................................... 0
-----------
NET INVESTMENT INCOME...................................... 34,330
-----------
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS (NOTES 1 AND 3):
Net realized loss on:
Security transactions................................. (39,444)
Forward foreign currency exchange contracts........... (2,735)
Foreign currency transactions......................... (1,039)
-----------
Net realized loss on investments during the year........... (43,218)
Change in unrealized appreciation/(depreciation) of:
Securities transactions............................... 361,570
Forward foreign currency exchange contracts........... (203)
Foreign currency transactions and net other assets.... 242
-----------
Net unrealized appreciation of investments during the
period................................................ 361,609
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS............ 318,391
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS....... $ 352,721
===========
</TABLE>
<TABLE>
<CAPTION>
STATEMENTS OF CHANGES IN NET ASSETS
For the Six Months
Ended 6/30/98 Year Ended
Net Increase in Net Assets Resulting from Operations: (unaudited) 2/31/97
---------------------------------------------------
<S> <C>
Net investment income...................................... $ 34,330 $ 59,017
Net realized gain/(loss) on securities, forward foreign
currency exchange contracts and foreign currency
transactions during the period............................ (43,218) 61,658
Net unrealized appreciation/(depreciation)
of securities transactions, forward foreign currency
exchange contracts, foreign currency transactions
and net other assets during the period................... 361,609 (421,973)
---------------------------------------------------
Net increase/(decrease) in net assets resulting from
operations................................................ 352,721 (301,298)
DISTRIBUTIONS TO SHAREHOLDERS:
Distributions from net investment income................... -- (40,393)
Distributions from net realized gain....................... -- (325,197)
BENEFICIAL INTEREST TRANSACTIONS:
Net increase from beneficial interest transactions (Note 4) 198,068 1,623,638
---------------------------------------------------
Net increase in net assets................................. 550,789 1,322,340
NET ASSETS:
Beginning of period........................................ 2,063,432 1,106,682
---------------------------------------------------
End of period.............................................. $ 2,614,221 $2,429,022
===================================================
Undistributed/(Distribution in excess of)
net investment income..................................... $ 30,385 $ (3,945)
</TABLE>
8
<PAGE>
MONTGOMERY VARIABLE SERIES: INTERNATIONAL SMALL CAP FUND
FINANCIAL HIGHLIGHTS
SELECTED PER SHARE DATA FOR THE YEAR OR PERIOD ENDED:
<TABLE>
<CAPTION> 6/30/98
(unaudited) 12/31/97 12/31/96*
<S> <C> <C> <C>
Net asset value--beginning of period..................... $ 8.29 $ 10.67 $ 10.00
------------------------------------------------------------------------
Net investment income.................................... 0.13 0.22 0.05
Net realized and unrealized gain/(loss) on investments... 1.31 (0.78) 0.68
------------------------------------------------------------------------
Net increase/(decrease) in net assets resulting from
investment operations................................... 1.44 (0.56) 0.73
------------------------------------------------------------------------
Distributions to shareholders:
Distributions from net investment income............ -- (0.20) (0.05)
Distributions from net realized
gains on investments............................... -- (1.62) (0.01)
------------------------------------------------------------------------
Total distributions...................................... -- (1.82) (0.06)
------------------------------------------------------------------------
Net asset value--end of period........................... $ 9.73 8.29 $ 10.67
========================================================================
Total return**........................................... 17.37% (5.10)% 7.23%
========================================================================
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's)..................... $ 2,614 2,063 $ 1,107
Ratio of net investment income to average net assets..... 2.37%+ 2.15% 2.03%+
Ratio of operating expenses to average net assets........ 0.00%+ 0.00% 0.00%+
Portfolio turnover rate.................................. 87% 176% 12%
Net investment loss before deferral of fees and
absorption of expenses by Manager....................... $ (0.07) $ (0.17) $ (0.11)
Operating expense ratio before deferral of fees and
absorption of expenses by Manager....................... 3.31%+ 3.50% 6.30%+
</TABLE>
______________________________
* Montgomery Variable Series: International Small Cap Fund commenced operations
on September 30, 1996.
** Total return represents aggregate total return for the periods indicated.
+ Annualized.
9
<PAGE>
THE MONTGOMERY FUNDS III
NOTES TO FINANCIAL STATEMENTS (unaudited)
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, and was organized as a Delaware business
trust on August 24, 1994. As of June 30, 1998, 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. Prior to the public offerings of shares of the Funds, a
limited number of shares were sold to Montgomery Asset Management, LLC (or
its predecessor), 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). Information presented in these
financial statements pertains to the Montgomery Variable Series:
International Small Cap Fund (the Fund). The Montgomery Variable Series:
Emerging Markets Fund, the Montgomery Variable Series: Growth Fund and the
Montgomery Variable Series: Small Cap Opportunities Fund are presented
under separate covers.
1. SIGNIFICANT ACCOUNTING POLICIES:
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. The
following is a summary of significant accounting policies.
A. PORTFOLIO VALUATION
The Fund's securities are valued using current market valuations:
either the last reported sales price or, lacking any reported sales,
and in the case of fixed income securities, the mean between the
closing bid and asked prices. The value of securities denominated in
foreign currencies and traded on foreign exchanges or in foreign
markets are translated into U.S. dollars at the last price of their
respective currency denomination against U.S. dollars quoted by a
major bank or, if no such quotation is available, at the rate of
exchange determined in accordance with policies established in good
faith by the Board of Trustees. Securities for which market quotations
are not readily available (including restricted securities which are
subject to limitations as to their sale) are valued at fair value by
management 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 from net investment income, if any, are declared and paid at
least annually. Distributions of net realized capital gains (including
net short-term capital gains) are distributed no less frequently than
annually. Additional distributions of net investment income and
capital gains for the Fund may be made in order to avoid the
application of a 4% non-deductible excise tax on certain undistributed
amounts of ordinary income and capital gains. Income distributions and
capital gain distributions are determined in accordance with income
tax regulations which may differ from generally accepted accounting
principles. These differences are primarily due to differing
treatments of income and gains on various investment securities held
by the Fund, timing differences and differing characterizations of
distributions made by the Fund.
C. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may engage in forward foreign currency exchange contracts
with off balance sheet risk in the normal course of investing
activities in order to manage exposure to market risks. Forward
foreign currency exchange contracts are valued at the forward rate and
are marked-to-market daily. The change in market value is recorded by
the Fund as an unrealized gain or loss.
When the contract is closed, the Fund records a realized gain or loss
equal to the difference between the value of the contract at the time
it was opened and the value at the time it was closed. Forward foreign
currency exchange contracts are used solely to establish a rate of
exchange for settlement of transactions. Although forward foreign
currency exchange contracts limit the risk of loss due to a decline in
the value of the hedged currency, they also limit any potential gain
that might result should the value of the currency increase. In
addition, the Fund could be exposed to risks if the counterparties to
the contracts are unable to meet the terms of their contracts.
D. FOREIGN CURRENCY
Foreign currencies, investments and other assets and liabilities are
translated into U.S. dollars at the exchange rates prevailing at the
end of the period, and purchases and sales of investment securities
and income and expenses are translated on the respective dates of such
transactions. Unrealized gains and losses which result from changes in
foreign currency exchange rates on investments have been included in
the unrealized appreciation/(depreciation) of securities. Net realized
foreign currency gains and losses resulting from movement in exchange
rates include foreign currency gains and losses between trade date and
10
<PAGE>
THE MONTGOMERY FUNDS III
NOTES TO FINANCIAL STATEMENTS (unaudited)
(continued)
settlement date on investment securities transactions foreign currency
transactions and the difference between the amounts of interest and
dividends recorded on the books of the Fund and the amount actually
received and the portion of foreign currency gains and losses related
to fluctuations in exchange rates between the initial purchase trade
date and subsequent sale trade date.
E. REPURCHASE AGREEMENTS
The Fund may engage in repurchase agreement transactions individually
or jointly through a joint repurchase account with other series of the
Trust and affiliated registered investment companies pursuant to a
joint repurchase agreement. Under the terms of a typical repurchase
agreement, the Fund takes possession of a government debt obligation
as collateral. The Fund also agrees with the counterparty to allow the
counterparty to repurchase, and the Fund to resell 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 if 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 the Fund seeks to assert its
rights. The Fund's investment manager, acting under the supervision of
the Board of Trustees, reviews the value of the collateral and the
creditworthiness of those banks and dealers with which the Fund enters
into repurchase agreements to evaluate potential risks. The Fund may
also participate on an individual or joint basis in tri-party
repurchase agreements which involve a counterparty and a custodian
bank.
F. SECURITIES TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are recorded on a trade-date basis. Realized
gain and loss from securities transactions are computed on the
specific identified cost basis of the securities sold. Dividend income
is recognized on the ex-dividend date and interest income, including,
amortization of discount on short-term investments, is recognized on
an accrual basis. Dividend income on foreign securities is recognized
as soon as the Fund is informed of the ex-dividend date.
G. FEDERAL INCOME TAXES
The Fund has elected and qualified and it is the intention of the Fund
to continue to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the
Code), by complying with the applicable requirements of the Code, and
by making distributions of taxable income to shareholders sufficient
to relieve the Fund from all or substantially all federal income
taxes. Accordingly, no provision for federal income taxes is required.
H. ORGANIZATION COSTS
Expenses incurred in connection with the organization of the Fund
amounted to $4,247 and are amortized on a straight-line basis over a
period of sixty months from commencement of operations.
I. EXPENSES
General expenses of the Trust are allocated to the Fund and other
series of the Trust based upon relative net assets. Operating expenses
directly attributable to the Fund are charged to the Fund's
operations.
2. MANAGEMENT FEES AND OTHER TRANSACTIONS WITH AFFILIATES:
a. Montgomery Asset Management, LLC is the Fund's Manager (the Manager).
The Manager, a Delaware limited liability company, is an investment
adviser registered with the Securities and Exchange Commission under
the Investment Advisers Act of 1940, as amended (the Advisers Act).
The Manager is a subsidiary of Commerzbank AG.
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 $250 Million Over $250 Million
1.25% 1.00%
11
<PAGE>
THE MONTGOMERY FUNDS III
NOTES TO FINANCIAL STATEMENTS (unaudited)
(continued)
The Manager has voluntarily 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 1.50% 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 period ended June
30, 1998, the Manager recouped fees of $43,659.
For the six months ended June 30, 1998, the Manager has deferred fees
of $18,005 and absorbed expenses of $78,634
As of June 30, 1998, deferred management fees and absorbed expenses
subject to recoupment are $166,238.
b. Certain officers and Trustees of the Trust are, with respect to the
Trust's Manager affiliated personsas defined in the 1940 Act. Each
Trustee who is not an affiliated person receives an annual retainer
and quarterly meeting fees totalling $35,000 per annum, as well as
reimbursement for expenses, for services as Trustee of all three
Trusts advised by the Manager ($5,000 of which will be allocated to
The Montgomery Funds III).
MAM Securities LLC ("MAM Securities"), an affiliate of the Manager,
serves as the Fund's transfer agent.
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,
1998, were $2,481,792 and $2,077,531, respectively.
b. At June 30, 1998, 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 $260,236 and $271,047, respectively.
c. The schedule of forward foreign currency exchange contracts at June
30, 1998 was as follows:
<TABLE>
<CAPTION>
NET UNREALIZED
CONTRACT VALUE VALUE DEPRECIATION
DATE (NOTE 1) OF CONTRACTS
<S> <C> <C> <C>
FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS TO SELL:
(Contract Cost $34,692)
20,810 Great Britain Pounds 07/01/98 $34,747 $55
======================
</TABLE>
4. TRANSACTIONS IN SHARES OF BENEFICIAL INTEREST:
The Trust has authorized an unlimited number of shares of beneficial
interest which have a par value of $0.01. Transactions in shares of
beneficial interest for the periods indicated below were:
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, 1998 DECEMBER 31, 1997
SHARES AMOUNT SHARES AMOUNT
<S> <C> <C> <C> <C>
Shares Sold 438,314 $ 4,286,538 456,763 $ 5,184,384
Issued as Reinvestment of Dividends -- -- 44,584 365,590
Shares Redeemed (418,578) (4,088,470) (356,080) (3,936,336)
-------------------------------------------------------------
Net Increase 19,736 $ 198,068 145,267 $ 1,623,638
=============================================================
</TABLE>
5. FOREIGN SECURITIES
The Fund purchases securities in foreign countries. Securities of foreign
companies and foreign governments involve special risks and considerations
not typically associated with investing in U.S. companies and the U.S.
government. These risks include revaluation of currencies, less reliable
information about issuers, differences in the clearance and settlement of
securities transactions practices, and future adverse political and
economic developments. Moreover, securities of many foreign companies and
foreign governments and their markets may be less liquid and their prices
more volatile than those securities of comparable U.S. companies and the
U.S. government.
12
