Rule 497(e)
33-84450 and 811-8782
Montgomery Variable Series: Growth Fund
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Montgomery Variable Series:
Growth Fund
The Montgomery Funds III
101 California Street
San Francisco, California 94111
(800) 572-FUND (3863)
Shares of Montgomery Variable Series: Growth 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 policyholders, 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, LLC (the "Manager"), a
subsidiary of Commerzbank AG. Montgomery Variable Series: Growth Fund (the
"Growth Fund") seeks capital appreciation by investing primarily in equity
securities, usually common stock, of domestic companies of all sizes and
emphasizes companies having market capitalizations of $1 billion or more. As
with all mutual funds, attainment of the Fund's investment objective cannot be
ensured.
This prospectus sets forth concisely the information about the Fund that a
prospective investor should know before investing in an Account or a subaccount
of an Account that invests in the Fund or, in the case of a qualified pension or
retirement plan, investing directly in the Fund. Please read it and retain it
for future reference. A Statement of Additional Information dated April 30,
1998, as may be revised, has been filed with the Securities and Exchange
Commission (the "SEC"), is incorporated by this reference and is available
without charge by calling (800) 572-FUND (3863) or the insurance company whose
Account invests in the Fund.
Prospectus
April 30, 1998
TABLE OF CONTENTS
Financial Highlights 2
The Fund's Investment Objective and Policies 2
Portfolio Securities 3
Other Investment Practices 4
Risk Considerations 7
Management of the Fund 8
How to Invest in the Fund 10
How to Redeem an Investment in the Fund 10
Exchange Privileges and Restrictions 10
How Net Asset Value Is Determined 10
Dividends and Distributions 11
Taxation 11
General Information 11
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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1
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Montgomery Variable Series: Growth Fund
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Financial Highlights
Selected Per-Share Data and Ratios
<TABLE>
The following financial information for the period ended December 31,
1997, was audited by Price Waterhouse LLP, whose report, dated February 11,
1998, appears in the 1997 Annual Report of the Fund. The information for the
period ended December 31, 1996, was audited by other independent accountants
whose report is not included herein.
<CAPTION>
MONTGOMERY VARIABLE SERIES:
GROWTH FUND
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Selected Per-Share Data for the Period Ended December 31: 1997 1996 (a)
<S> <C> <C>
Net asset value--beginning of period $ 12.33 $ 10.08
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Net investment income 0.16 0.15
Net realized and unrealized gain on investments 3.35 2.59
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Net increase in net assets resulting from investment
operations 3.51 2.74
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Distributions:
Distributions from net investment income (0.16) (0.15)
Distributions from net realized gains on investments (0.59) (0.34)
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Total distributions (0.75) (0.49)
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Net asset value--end of period $ 15.09 $ 12.33
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Total return* 28.57% 27.22%
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Ratios to Average Net Assets/Supplemental Data:
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Net assets, end of period (in 000's) $ 12,597 $ 2,127
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Ratio of net investment income to average net assets 1.74% 2.55%+
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Ratio of operating expenses to average net assets, including 0.35% 0.01%+
interest expense
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Ratio of operating expenses to average net assets, excluding 0.34%** --
interest expense
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Portfolio turnover rate 53% 78%
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Average commission rate paid++ $ 0.0586 $ 0.0520
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Net investment income/(loss) before deferral of fees and
absorption of expenses by Manager $ 0.01 $ (0.27)
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Operating expense ratio before deferral of fees and
absorption of expenses by Manager, including interest expense 1.97% 6.98%+
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<FN>
(a) The Montgomery Variable Series: Growth Fund commenced operations on
February 9, 1996. * Total return represents aggregate total return for
the period indicated.
** After voluntary reduction of fees by Manager.
+ Annualized.
++ Average commission rate paid per share of securities purchased and sold
by the Fund.
</FN>
</TABLE>
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." Specific investment practices are described
in "Other Investment Practices" and certain risks associated with investments in
the Fund are described in those sections as well as in "Risk Considerations."
o Montgomery Variable Series: Growth Fund
The investment objective of the Growth Fund is capital appreciation which, under
normal conditions, it seeks by investing at least 65% of its total assets in the
equity securities of domestic companies. Although such companies may be of any
size, the Fund targets companies having total market capitalizations of $1
billion or more.
The Fund emphasizes investments in common stock, but also invests in other types
of equity securities and
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Montgomery Variable Series: Growth Fund
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equity-derivative securities. Current income from dividends, interest and other
sources is only incidental. The Fund also may invest up to 35% of its total
assets in investment-grade debt securities or in foreign securities. See
"Portfolio Securities." The Manager does not expect the Fund to be consistently
fully invested in equity securities. During periods that the Manager deems
appropriate, the Fund may take a more defensive position and be significantly
invested in cash and cash equivalents.
The Fund seeks growth at a reasonable value, identifying companies with sound
fundamental value and the potential for substantial growth. The Fund selects its
investments based on a combination of quantitative screening techniques and
fundamental analysis. The Fund initially identifies a universe of investment
candidates by screening companies based on changes in rates of growth and
valuation ratios such as price to sales, price to earnings, and price to cash
flows. Through this process the Fund seeks to identify rapidly growing companies
with reasonable valuations and accelerating growth rates, or having low
valuations and initial signs of growth. The Fund then subjects these companies
to a rigorous fundamental analysis, focusing on balance sheets and income
statements; company visits and discussions with management; contact with
industry specialists and industry analysts; and review of the competitive
environments. See "Portfolio Securities," "Risk Considerations" and the Appendix
in the Statement of Additional Information.
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) as well as 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 a United States 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. For purposes of allocating the Fund's investments, the Manager
regards convertible securities as a form of equity security.
Securities Warrants
The Fund may invest up to 5% of its net assets in warrants. Typically, a warrant
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. 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.
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Montgomery Variable Series: Growth Fund
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Debt Securities
The Fund may invest in traditional corporate, government debt securities rated
within the four highest grades by S&P (at least BBB), Moody's (at least Baa) or
Fitch (at least Baa), or unrated debt securities deemed to be of comparable
quality by the Manager using guidelines approved by the Board of Trustees.
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, whereas 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. The U.S. government does not guarantee the net
asset value of the Fund's shares, however. 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.
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 an agreed-upon rate of return not determined by the coupon rate
on the underlying security. Under the Investment Company Act of 1940
("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 or equity securities
("collateral assets"). 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 10% of the
value of its total assets.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements. In a reverse repurchase
agreement, the Fund sells to a financial institution a security that it holds
and agrees to repurchase the same security at an agreed-upon price and date.
Although reverse repurchase agreements are fully collateralized with collateral
assets, the Fund aggregates such transactions with its bank borrowings in
applying its borrowing limits. See the Statement of Additional Information for
further information.
Leverage
The Fund may leverage its portfolio in an effort to increase return. Although
leverage creates an opportunity for increased income and gain, it also creates
special risk considerations. For example, leveraging may magnify changes in the
net asset value of the Fund's shares and in the yield on its portfolio. Although
the principal of such
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Montgomery Variable Series: Growth Fund
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borrowings will be fixed, the Fund's assets may change in value while the
borrowing is outstanding. Leveraging creates interest expenses that can exceed
the income from the assets retained.
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 collateral assets in an
amount at least equal to the current market value of the loaned securities, plus
accrued interest. 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 fail financially.
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.
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. At the time a Fund enters into a transaction on a
when-issued or forward commitment basis, it supports its obligation with
collateral assets equal to the value of the when-issued or forward commitment
securities and causes the collateral 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"): forward currency exchange contracts, stock
options, currency options, and stock and 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 (the "Board") has adopted
derivative guidelines that require the Board to review each new type of
derivative 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. Although 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.
Forward Currency Contracts. A forward currency contract is individually
negotiated and privately traded by currency traders and their customers and
creates an obligation to purchase or sell a specific currency for an agreed-upon
price at a future date. The Fund normally conducts its foreign-currency exchange
transactions either on a spot (i.e., cash) basis at the spot rate in the
foreign-currency exchange market at the time of the transaction, or through
entering into forward contracts to purchase or sell foreign currencies at a
future date. The Fund generally does not enter into forward contracts with terms
greater than one year.
The Fund generally enters into forward contracts only under two circumstances.
First, if the Fund enters into a contract for the purchase or sale of a security
denominated in a foreign currency, it may desire to "lock in" the U.S. dollar
price of the security by entering into a forward contract to buy the amount of a
foreign currency needed to settle the transaction. Second, if the Manager
believes that the currency of a particular foreign country will substantially
rise or fall against the U.S. dollar, it may enter into a forward contract to
buy or sell the currency approximating the value of some or all of the Fund's
portfolio securities denominated in such currency. Although forward contracts
are used primarily to protect the Fund from adverse currency movements, they
involve the risk that currency movements will not be accurately predicted.
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.
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Montgomery Variable Series: Growth Fund
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The Fund may purchase call options on securities that it 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 industrywide 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. The Fund may purchase and sell equity index
futures contracts like S&P 500 Index futures contracts. The S&P 500 Index
futures contract (or other similar equity futures contract) is an agreement to
purchase or sell the cash value of the S&P 500 Index (or other applicable basket
of securities) at a specified date and price. The Fund may sell an equity index
futures contract (i.e., enter into a futures contract to sell a basket of the
securities underlying the index) in an attempt to hedge against an anticipated
market decline. Conversely, the Fund may purchase an equity index futures
contract (i.e., enter into a futures contract to purchase a basket of securities
underlying the index) in an attempt to hedge against any increase in the value
of securities it anticipates purchasing. In addition, the Fund may also purchase
and sell put and call options on futures contracts. The Fund will have
collateral assets equal to the purchase price of the portfolio securities
represented by the underlying 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.
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 markups and other
transaction costs and may result in the recognition of capital gains that may be
distributed to shareholders. See "Financial Highlights" for portfolio turnover
information. Portfolio turnover in excess of 100% is considered high and
increases such costs. Even when portfolio turnover exceeds 100%, however, the
Fund does not regard portfolio turnover as a limiting factor.
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Montgomery Variable Series: Growth Fund
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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.
Risk Considerations
Foreign Securities
Shareholders should understand that all investments involve risk and there can
be no guarantee against loss resulting from an investment in the Fund. 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 or 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
United States. 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. 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.
Brokerage commissions, fees for custodial services, and other costs relating to
investments by the Fund in other countries are generally greater than in the
United States. Foreign markets have different clearance and settlement
procedures from those in the United States, and certain markets have experienced
times when settlements did not keep pace with the volume of securities
transactions, which resulted in settlement difficulty. The inability of the Fund
to make intended security purchases due to settlement difficulty could cause the
Fund to miss attractive investment opportunities. Inability to sell a portfolio
security due to settlement problems could result in loss to the Fund if the
value of the portfolio security declined, or result in claims against the Fund
if it had entered into a contract to sell the security. In certain countries,
there is less government supervision and regulation of business and industry
practices, stock exchanges, brokers and listed companies than in the United
States. The securities markets of many of the countries in which the Fund may
invest may also be smaller, less liquid, and subject to greater price volatility
than those in the United States.
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. A change in the value of a foreign currency
against the U.S. dollar results in a corresponding change in the U.S. dollar
value of the Fund's securities denominated in that currency. Such changes also
affect the Fund's income and distributions to shareholders. The Fund may be
affected either favorably or unfavorably by changes in the relative rates of
exchange among the currencies of different nations, and the Fund may therefore
engage in foreign-currency hedging strategies. Such strategies, however, involve
certain transaction costs and investment risks, including dependence on the
Manager's ability to predict movements in exchange rates.
Some countries in which the Fund may invest also may have fixed or managed
currencies that are not freely convertible at market rates into the U.S. dollar.
Certain currencies may not be internationally traded. A number of these
currencies have experienced a steady devaluation relative to the U.S. dollar,
and such devaluations in the currencies may have a detrimental impact on the
Fund.
Small Companies
The Fund may make 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.
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Montgomery Variable Series: Growth Fund
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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
changes. 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 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.
Equity Swaps
The Fund may invest in equity swaps. Equity swaps are derivatives that allow the
parties to exchange the dividend income or other components of return on an
equity investment (e.g., a group of equity securities or an index) for a
component of return on another non-equity or equity investment. The value of
equity swaps can be very volatile. To the extent the Manager does not accurately
analyze and predict the potential relative fluctuation of the components swapped
with another party, the Fund may suffer a loss. The value of some components of
an equity swap (like the dividends on a common stock) may also be sensitive to
changes in interest rates. Furthermore, during the period a swap is outstanding,
the Fund may suffer a loss if the counterparty defaults.
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, LLC, is the Funds' Manager. The Manager, a Delaware
limited liability company, is a subsidiary of Commerzbank AG ("Commerzbank").
The Manager was formed in February 1997 as an investment adviser registered as
such with the SEC under the Investment Advisers Act of 1940, as amended. It
advises private accounts as well as the Funds. Commerzbank, one of the largest
publicly held commercial banks in Germany, had total assets of approximately
$288 billion as of December 31, 1997. Commerzbank and its affiliates had more
than $92 billion in assets under management as of October 31, 1997.
Commerzbank's asset management operations involve more than 1,000 employees in
13 countries worldwide.
On July 31, 1997, Montgomery Asset Management, L.P., the former manager of the
Funds, completed the sale of substantially all of its assets to the Manager. At
a special meeting of shareholders on June 23, 1997, the shareholders of each
Fund approved a new Investment Management Agreement with the Manager, effective
July 31, 1997, for an initial two-year period.
Portfolio Managers
Montgomery Variable Series: Growth Fund
The Growth Fund is managed by the Growth Equity team. Key members of that team
are Roger W. Honour, Andrew Pratt and Kathryn M. Peters.
Roger W. Honour is a senior portfolio manager and principal. 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.
Andrew G. Pratt, CFA, is a portfolio manager and principal. He joined Montgomery
Asset Management from Hewlett-Packard Company, where he was an equity analyst,
managed a portfolio of small-capitalization
- --------------------------------------------------------------------------------
8
<PAGE>
Montgomery Variable Series: Growth Fund
- --------------------------------------------------------------------------------
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.
Kathryn M. Peters is a portfolio manager and principal. From 1993 to 1995, Ms.
Peters was an associate in the investment banking division of Donaldson, Lufkin
& Jenrette in New York, where she 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 buyout group of Marine Midland Bank.
Management Fees and Other Expenses
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.
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 Growth Fund at or below one and one quarter percent (1.25%) of its average
net assets. The Manager also may voluntarily reduce additional amounts and/or
reimburse the Fund for its expenses to increase the return to the Fund's
investors. The Manager may terminate these voluntary reductions and/or
reimbursements at any time. Any reductions made by the Manager in its fees and
any reimbursements by the Manager of the Fund expenses are subject to
reimbursement by the Fund within the subsequent three years, provided the Fund
is able to effect such reimbursement and remain in compliance with applicable
expense limitations. The Manager generally seeks reimbursement for the oldest
reductions before payment by the Fund of fees and expenses for the current year.
- --------------------------------------------------------------------------------
9
<PAGE>
Montgomery Variable Series: Growth Fund
- --------------------------------------------------------------------------------
Management Fee
Average Daily Net Assets (Annual Rate)
- --------------------------------------------------------------------------------
Montgomery Variable Series: Growth Fund First $500 million 1.00%
Next $500 million 0.90%
More than $1 billion 0.80%
- --------------------------------------------------------------------------------
In addition, the Manager may elect to absorb operating expenses that the Fund is
obligated to pay in order to increase the return to the Fund's shareholders. To
the extent 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, out of its own funds, also may compensate persons who
distribute the Fund's shares as well as other service providers of shareholder
and administrative services. The Manager may also sponsor seminars and education
programs on the Fund for financial intermediaries and shareholders.
The Manager considers a number of factors in determining which brokers or
dealers to use for the Fund's portfolio transactions. 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.
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 the Fund's cutoff
time on each day that the NYSE is open for trading. Generally, this is 4:00 p.m.
eastern time or earlier when trading closes earlier. 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 that
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
- --------------------------------------------------------------------------------
10
<PAGE>
Montgomery Variable Series: Growth Fund
- --------------------------------------------------------------------------------
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 in the Fund's calculation of
its net asset value unless the Manager, under the 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:
Income
Dividends Capital Gains
--------- -------------
Montgomery Declared and paid Declared and paid
Variable Series: in the last in the last
Growth Fund quarter of each quarter of each
year* 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
Growth Fund declared a dividend in the amount of $0.50 per share. If the Growth
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 has elected and intends to continue 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 pertaining to the timing of
distributions. If the Fund is unable to meet certain requirements of the Code,
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, $0.01 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
- --------------------------------------------------------------------------------
11
<PAGE>
Montgomery Variable Series: Growth Fund
- --------------------------------------------------------------------------------
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 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. Although 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.
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. 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.
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 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 Paul,
Hastings, Janofsky & Walker LLP, 345 California Street, San Francisco,
California 94104.
------------------------
No salesperson, 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.
- --------------------------------------------------------------------------------
12
<PAGE>
Montgomery Variable Series: Growth Fund
- --------------------------------------------------------------------------------
SF:37479.2
13
<PAGE>
Rule 497(e)
33-84450 and 811-8782
Montgomery Variable Series: Emerging Markets Fund
- --------------------------------------------------------------------------------
Montgomery Variable Series:
Emerging Markets Fund
The Montgomery Funds III
101 California Street
San Francisco, California 94111
(800) 572-FUND (3863)
Shares of Montgomery Variable Series: Emerging Markets Fund, a 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 policyholders, 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, LLC (the "Manager"), a
subsidiary of Commerzbank AG. Montgomery Variable Series: Emerging Markets Fund
(the "Emerging Markets Fund") seeks capital appreciation by investing primarily
in equity securities of companies in countries having economics and markets
generally considered by the World Bank or the United Nations to be emerging or
developing. As with all mutual funds, attainment of the Fund's investment
objective cannot be ensured.
This prospectus sets forth concisely the information about the Fund that a
prospective investor should know before investing in an Account or a subaccount
of an Account that invests in the Fund or, in the case of a qualified pension or
retirement plan, investing directly in the Fund. Please read it and retain it
for future reference. A Statement of Additional Information dated April 30,
1998, as may be revised, has been filed with the Securities and Exchange
Commission (the "SEC"), is incorporated by this reference and is available
without charge by calling (800) 572-FUND (3863) or the insurance company whose
Account invests in the Fund.
Prospectus
April 30, 1998
TABLE OF CONTENTS
Financial Highlights 2
The Fund's Investment Objective and Policies 2
Portfolio Securities 3
Other Investment Practices 5
Risk Considerations 7
Management of the Fund 9
How to Invest in the Fund 11
How to Redeem an Investment in the Fund 11
Exchange Privileges and Restrictions 11
How Net Asset Value Is Determined 11
Dividends and Distributions 12
Taxation 12
General Information 12
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.
- --------------------------------------------------------------------------------
1
<PAGE>
Montgomery Variable Series: Emerging Markets Fund
- --------------------------------------------------------------------------------
Financial Highlights
Selected Per-Share Data and Ratios
<TABLE>
The following financial information for the period ended December 31,
1997, was audited by Price Waterhouse LLP, whose report, dated February 11,
1998, appears in the 1997 Annual Report of the Fund. The information for the
period ended December 31, 1996, was audited by other independent accountants
whose report is not included here.
<CAPTION>
MONTGOMERY VARIABLE SERIES:
EMERGING MARKETS FUND
-------------------------------------------------
Selected Per-Share Data for the Period Ended December 31: 1997 1996(a)
<S> <C> <C>
Net asset value--beginning of period $ 10.65 $ 10.00
- ----------------------------------------------------------------------------------------------------------------------
Net investment income 0.02 0.03
Net realized and unrealized gain/(loss) on investments (0.08) 0.65
- ----------------------------------------------------------------------------------------------------------------------
Net increase/(decrease) in net assets resulting from investment
operations (0.06) 0.68
- ----------------------------------------------------------------------------------------------------------------------
Distributions to shareholders:
Distributions from net investment income (0.02) (0.03)
- ----------------------------------------------------------------------------------------------------------------------
Net asset value--end of period $ 10.57 $ 10.65
============ ============
- ----------------------------------------------------------------------------------------------------------------------
Total return* (0.58)% 6.79%
============ ============
- ----------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets/Supplemental Data:
- ----------------------------------------------------------------------------------------------------------------------
Net assets, end of period (000's) $ 114,837 $ 26,966
- ----------------------------------------------------------------------------------------------------------------------
Ratio of net investment income to average net assets 0.63% 0.81%+
- ----------------------------------------------------------------------------------------------------------------------
Ratio of operating expenses to average net assets, including 1.76% 1.45%+
interest expense
- ----------------------------------------------------------------------------------------------------------------------
Ratio of operating expenses to average net assets, 1.75% 1.44%+
excluding interest expense
- ----------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate 71% 43%
- ----------------------------------------------------------------------------------------------------------------------
Average commission rate paid++ $ 0.0012 $ 0.0002
- ----------------------------------------------------------------------------------------------------------------------
Net investment income/(loss) before deferral of fees and
absorption of expenses by Manager $ 0.05 $ (0.01)
- ----------------------------------------------------------------------------------------------------------------------
Operating expense ratio before deferral of fees and
absorption of expenses by Manager, including interest expense 1.81% 2.47%+
- ----------------------------------------------------------------------------------------------------------------------
<FN>
(a) The Montgomery Variable Series: Emerging Markets Fund commenced
operations on February 2, 1996.
* Total return represents aggregate total return for the period
indicated.
+ Annualized.
++ Average commission rate paid per share of securities purchased and sold
by the Fund.
</FN>
</TABLE>
The Fund's Investment Objective and Policies
The Fund's investment objectives and general investment policies are described
below. Specific portfolio securities that may be purchased by the Fund are
described in "Portfolio Securities." Specific investment practices are described
in "Other Investment Practices" and certain risks associated with investments in
the Fund are described in those sections as well as in "Risk Considerations."
o Montgomery Variable Series: Emerging Markets Fund
The investment objective of the Emerging Markets Fund is capital appreciation
which, under normal conditions, it seeks by investing at least 65% of its total
assets in equity securities of emerging markets companies. Under normal
conditions, this Fund maintains investments in at least six emerging markets
countries at all times and does not invest more than 25% of its net assets in
any one emerging markets country. The Manager currently regards the following to
be emerging markets countries: Latin America (Argentina, Brazil, Chile,
Colombia, Costa Rica, Jamaica, Mexico, Peru, Trinidad and Tobago, Uruguay and
Venezuela); Asia (Bangladesh, China/Hong Kong, India, Indonesia, Korea,
Malaysia, Pakistan, the Philippines, Singapore, Sri Lanka, Taiwan, Thailand and
Vietnam); southern and eastern Europe (the Czech Republic, Greece, Hungary,
Kazakstan, Poland, Portugal, Romania, Russia, Slovakia, Slovenia, Turkey and
Ukraine); the Middle East (Israel and Jordan); and Africa (Egypt, Ghana, Ivory
Coast, Kenya, Morocco, Nigeria, South Africa, Tunisia and
- --------------------------------------------------------------------------------
2
<PAGE>
Montgomery Variable Series: Emerging Markets Fund
- --------------------------------------------------------------------------------
Zimbabwe). In the future, the Fund may invest in other emerging markets
countries.
The Fund considers a company to be an emerging markets company if its securities
are principally traded in the capital market of an emerging markets country, it
derives at least 50% of its total revenue from either goods produced or services
rendered in emerging markets countries or from sales made in such emerging
markets countries, regardless of where the securities of such companies are
principally traded; or it is organized under the laws of, and with a principal
office in, an emerging markets country. An emerging markets country is one
having an economy that is or would be considered by the World Bank or the United
Nations to be emerging or developing.
The Fund uses a proprietary, quantitative asset allocation model created by the
Manager. This model employs mean-variance optimization, a process used in
developed markets based on modern portfolio theory and statistics. Mean-variance
optimization helps determine the percentage of assets to invest in each country
to maximize expected returns for a given risk level. This Fund's aims are to
invest in those countries that are expected to have the highest risk/reward
tradeoff when incorporated into a total portfolio context and to construct a
portfolio of emerging markets investments approximating the risk level of an
internationally diversified portfolio of securities in developed markets. This
"top-down" country selection is combined with "bottom-up" fundamental industry
analysis and stock selection based on original research and publicly available
information and company visits.
The Fund invests primarily in common stock but also may invest in other types of
equity and equity-derivative securities. It may invest up to 35% of its total
assets in debt securities, including up to 5% in debt securities rated below
investment grade. See "Portfolio Securities," "Risk Considerations" and the
Appendix in the Statement of Additional Information.
The Fund may invest in certain debt securities issued by the governments of
emerging markets countries that are, or may be eligible for, conversion into
investments in emerging markets companies under debt conversion programs
sponsored by such governments. The Fund deems securities that are convertible to
equity investments to be equity-derivative securities.
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) as well as 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 a United States 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. For purposes of allocating the Fund's investments, the Manager
regards convertible securities as a form of equity security.
Securities Warrants
The Fund may invest up to 5% of its net assets in warrants. Typically, a warrant
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. A warrant not exercised or disposed of by its
expiration date expires worthless.
Privatizations
The Fund believes that foreign governmental programs of selling interests in
government-owned or -controlled enterprises ("privatizations") may represent
opportunities for significant capital appreciation, and the Fund may invest in
privatizations. The ability of U.S. entities, such as the Fund, to participate
in privatizations may be limited by local law, or the terms for participation
may be less advantageous than for local investors. There can be no assurance
that privatization programs will be successful.
- --------------------------------------------------------------------------------
3
<PAGE>
Montgomery Variable Series: Emerging Markets Fund
- --------------------------------------------------------------------------------
Special Situations
The Fund believes that carefully selected investments in joint ventures,
cooperatives, partnerships, private placements, unlisted securities and similar
vehicles (collectively, "special situations") could enhance its capital
appreciation potential. The Fund may also invest in certain types of vehicles or
derivative securities that represent indirect investments in foreign markets or
securities in which it is impracticable for the Fund to invest directly.
Investments in special situations may be illiquid, as determined by the Manager
based on criteria approved by the Board of Trustees. The Fund does not invest
more than 15% of its net assets in illiquid investments, including special
situations.
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.
Because of restrictions on direct investment by U.S. entities in certain
countries, other investment companies may provide the most practical or only way
for the Fund to invest in certain markets. 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 of 1940 ("Investment Company Act"). The Fund 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 purchase debt securities that complement its objective of capital
appreciation, through anticipated favorable changes in relative foreign exchange
rates, in relative interest rate levels or in the creditworthiness of issuers.
In selecting debt securities, the Manager seeks out good credits and analyzes
interest rate trends and specific developments that may affect individual
issuers. As an operating policy that may be changed by the Board of Trustees,
the Fund will not invest more than 5% of its total assets in debt securities
rated lower than BBB by S&P, Baa by Moody's or BBB by Fitch, or in unrated debt
securities deemed to be of comparable quality by the Manager using guidelines
approved by the Board of Trustees. Subject to this limitation, the Fund may
invest in any debt security, including securities in default. After its purchase
by the Fund, a debt security may cease to be rated or its rating may be reduced
below that required for purchase by the Fund. A security downgraded below the
minimum level may be retained if determined by the Manager and by the Board to
be in the best interests of the Fund. See "Risk Considerations."
In addition to traditional corporate, government and supranational debt
securities, the Fund may invest in external (i.e., to foreign lenders) debt
obligations issued by the governments, governmental entities and companies of
emerging markets countries.
The percentage distribution between equity and debt will vary from country to
country based on anticipated trends in inflation and interest rates; expected
rates of economic and corporate profits growth; changes in government policy;
stability, solvency and expected trends of government finances; and conditions
of the balance of payments and terms of trade.
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, whereas 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. The U.S. government does not guarantee the net
asset value of the Fund's shares, however. 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
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4
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Montgomery Variable Series: Emerging Markets Fund
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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.
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, a 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 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 or
equity securities ("collateral assets"). 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 10% of the
value of its total assets.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements. In a reverse repurchase
agreement, the Fund sells to a financial institution a security that it holds
and agrees to repurchase the same security at an agreed-upon price and date.
Although reverse repurchase agreements are fully collateralized with collateral
assets, the Fund aggregates such transactions with its bank borrowings in
applying its borrowing limits. See the Statement of Additional Information for
further information.
Leverage
The Fund may leverage its portfolio in an effort to increase total return.
Although leverage creates an opportunity for increased income and gain, it also
creates special risk considerations. For example, leveraging may magnify changes
in the net asset value of the Fund's shares and in the yield on its portfolio.
Although the principal of such borrowings will be fixed, the Fund's assets may
change in value while the borrowing is outstanding. Leveraging creates interest
expenses that can exceed the income from the assets retained.
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 collateral assets in an
amount at least equal to the current market value of the loaned securities, plus
accrued interest. 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 fail financially.
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.
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. At the time a Fund enters into a transaction on a
when-issued or forward commitment basis, it supports its obligation with
collateral assets equal to the value of the when-issued or forward commitment
securities and causes the collateral 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.
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5
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Montgomery Variable Series: Emerging Markets Fund
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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"): forward currency exchange contracts, stock
options, currency options, and stock and 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 ("the Board") has adopted
derivative guidelines that require the Board to review each new type of
derivative 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. Although 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.
Forward Currency Contracts. A forward currency contract is individually
negotiated and privately traded by currency traders and their customers and
creates an obligation to purchase or sell a specific currency for an agreed-upon
price at a future date. The Fund normally conducts its foreign currency exchange
transactions either on a spot (i.e., cash) basis at the spot rate in the
foreign-currency exchange market at the time of the transaction, or through
entering into forward contracts to purchase or sell foreign currencies at a
future date. The Fund generally does not enter into forward contracts with terms
greater than one year.
The Fund generally enters into forward contracts only under two circumstances.
First, if the Fund enters into a contract for the purchase or sale of a security
denominated in a foreign currency, it may desire to "lock in" the U.S. dollar
price of the security by entering into a forward contract to buy the amount of a
foreign currency needed to settle the transaction. Second, if the Manager
believes that the currency of a particular foreign country will substantially
rise or fall against the U.S. dollar, it may enter into a forward contract to
buy or sell the currency approximating the value of some or all of the Fund's
portfolio securities denominated in such currency. Although forward contracts
are used primarily to protect the Fund from adverse currency movements, they
involve the risk that currency movements will not be accurately predicted.
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 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 industrywide 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. The Fund may purchase and sell equity index
futures contracts like S&P 500 Index futures contracts. The S&P 500 Index
futures contract (or other similar equity futures contract) is an agreement to
purchase or sell the cash value of the S&P 500 Index (or other applicable basket
of securities) at a specified date and price. The Fund may sell an equity index
futures contract (i.e., enter into a futures contract to sell a basket of the
securities underlying the index) in an attempt to hedge against an anticipated
market decline. Conversely, the Fund may purchase an equity index futures
contract (i.e., enter into a futures contract to purchase a basket of securities
underlying the index) in an attempt to hedge against any increase in the value
of securities it anticipates purchasing.
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6
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Montgomery Variable Series: Emerging Markets Fund
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In addition, the Fund may also purchase and sell put and call options on futures
contracts. The Fund will have collateral 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 the 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.
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 objective 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 markups and other transaction costs and may result
in the recognition of capital gains that may be distributed to shareholders. See
"Financial Highlights" for portfolio turnover information. Portfolio turnover in
excess of 100% is considered high and increases such costs. Even when portfolio
turnover exceeds 100%, however, 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.
Risk Considerations
Foreign Securities
Shareholders should understand that all investments involve risk and there can
be no guarantee against loss resulting from an investment in the Fund. 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. The Fund may invest in securities of companies domiciled in, and in
markets of, so-called "emerging markets countries." These investments may be
subject to higher risks than investments in more-developed countries.
Foreign investments involve the possibility of expropriation, nationalization or
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 investments. In addition, there is often less publicly available
information about foreign issuers than those in the United States. 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
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7
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Montgomery Variable Series: Emerging Markets Fund
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foreign courts. 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.
Brokerage commissions, fees for custodial services, and other costs relating to
investments by the Fund in other countries are generally greater than in the
United States. Foreign markets have different clearance and settlement
procedures from those in the United States, and certain markets have experienced
times when settlements did not keep pace with the volume of securities
transactions which resulted in settlement difficulty. The inability of the Fund
to make intended security purchases due to settlement difficulty could cause the
Fund to miss attractive investment opportunities. Inability to sell a portfolio
security due to settlement problems could result in loss to the Fund if the
value of the portfolio security declined, or result in claims against the Fund
if it had entered into a contract to sell the security. In certain countries,
there is less government supervision and regulation of business and industry
practices, stock exchanges, brokers and listed companies than in the United
States. The securities markets of many of the countries in which the Fund may
invest may also be smaller, less liquid, and subject to greater price volatility
than those in the United States.
Because certain 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. A change in the value of a foreign currency
against the U.S. dollar results in a corresponding change in the U.S. dollar
value of the Fund's securities denominated in that currency. Such changes also
affect the Fund's income and distributions to shareholders. The Fund may be
affected either favorably or unfavorably by changes in the relative rates of
exchange among the currencies of different nations, and the Fund may therefore
engage in foreign-currency hedging strategies. Such strategies, however, involve
certain transaction costs and investment risks, including dependence on the
Manager's ability to predict movements in exchange rates.
Some countries in which the Fund may invest also may have fixed or managed
currencies that are not freely convertible at market rates into the U.S. dollar.
Certain currencies may not be internationally traded. A number of these
currencies have experienced a steady devaluation relative to the U.S. dollar,
and such devaluations in the currencies may have a detrimental impact on the
Fund.
Many countries in which the Fund may invest have experienced substantial, and in
some periods extremely high, rates of inflation for many years. Inflation and
rapid fluctuation in inflation rates have had and may continue to have negative
effects on certain economies and securities markets. Moreover, the economies of
some countries may differ favorably or unfavorably from the U.S. economy in such
respects as rate of growth of gross domestic product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments.
Certain countries also limit the amount of foreign capital that can be invested
in their markets and local companies, creating a "foreign premium" on capital
investments available to foreign investors such as the Fund. The Fund may pay a
"foreign premium" to establish an investment position which it cannot later
recoup because of changes in the country's foreign-investment laws.
Small Companies
The Fund may make 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.
Lower-Quality Debt
The Fund is authorized to invest in medium-quality (rated or equivalent to BBB
by S&P or Fitch's or Baa by Moody's) and in limited amounts of high-risk,
lower-quality debt securities (i.e., securities rated below BBB or Baa) or, if
unrated, deemed to be of equivalent investment quality as determined by the
Manager. Medium-quality debt securities have speculative characteristics, and
changes in economic conditions or other circumstances are more likely to lead to
a weakened capacity to make principal and interest payments than with
higher-grade debt securities.
As an operating policy, which may be changed by the Board of Trustees without
shareholder approval, the Fund does not invest more than 5% of its total assets
in debt securities rated lower than BBB by S&P or Baa by Moody's or, if unrated,
deemed to be of comparable quality as determined by the Manager using guidelines
approved by the Board. The Board may consider a change in this operating policy
if, in its judgment, economic conditions change such that a higher level of
investment in high-risk, lower-quality debt securities would be consistent with
the interests of the Fund and its shareholders. Unrated debt securities are not
necessarily of lower quality than rated securities, but they may not be
attractive to as many buyers. Regardless of rating levels, all debt securities
considered for purchase (whether rated or unrated) are analyzed by the Manager
to determine, to the extent reasonably possible, that the planned investment is
sound. From time to time, the
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8
<PAGE>
Montgomery Variable Series: Emerging Markets Fund
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Fund may purchase defaulted debt securities if, in the opinion of the Manager,
the issuer may resume interest payments in the near future.
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
changes. 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 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.
Equity Swaps
The Fund may invest in equity swaps. Equity swaps are derivatives that allow the
parties to exchange the dividend income or other components of return on an
equity investment (e.g., a group of equity securities or an index) for a
component of return on another non-equity or equity investment. The value of
equity swaps can be very volatile. To the extent the Manager does not accurately
analyze and predict the potential relative fluctuation of the components swapped
with another party, the Fund may suffer a loss. The value of some components of
an equity swap (like the dividends on a common stock) may also be sensitive to
changes in interest rates. Furthermore, during the period a swap is outstanding,
the Fund may suffer a loss if the counterparty defaults.
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, LLC, is the Funds' Manager. The Manager, a Delaware
limited liability company, is a subsidiary of Commerzbank AG ("Commerzbank").
The Manager was formed in February 1997 as an investment adviser registered as
such with the SEC under the Investment Advisers Act of 1940, as amended. It
advises private accounts as well as the Funds. Commerzbank, one of the largest
publicly held commercial banks in Germany, had total assets of approximately
$288 billion as of December 31, 1997. Commerzbank and its affiliates had more
than $92 billion in assets under management as of October 31, 1997.
Commerzbank's asset management operations involve more than 1,000 employees in
13 countries worldwide.
On July 31, 1997, Montgomery Asset Management, L.P., the former manager of the
Funds, completed the sale of substantially all of its assets to the Manager. At
a special meeting of shareholders on June 23, 1997, the shareholders of each
Fund approved a new Investment Management Agreement with the Manager, effective
July 31, 1997, for an initial two-year period.
Portfolio Managers
Montgomery Variable Series: Emerging Markets Fund
Josephine S. Jimenez, CFA, a founding partner of the emerging markets
discipline, is a senior portfolio manager and principal responsible for
strategic research and qualitative analysis of countries and industries. 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 in charge of investments in Latin America, the Philippines
and Portugal. From 1984 through 1987, she was an investment officer at Shawmut
Corporation, where she designed a stock valuation model for hyperinflationary
economies, which has served as the foundation for most of her work since that
time.
Bryan L. Sudweeks, Ph.D., CFA, a founding partner of the emerging markets
discipline, is a senior portfolio
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9
<PAGE>
Montgomery Variable Series: Emerging Markets Fund
- --------------------------------------------------------------------------------
manager and principal responsible for all quantitative modeling as it relates to
the investment process. From 1988 until joining the Manager in 1991, he was a
senior analyst and portfolio manager at Emerging Markets Investors
Corporation/Emerging Markets Management in Washington, D.C., specializing in
Asia, Greece, Jordan and Turkey. He was instrumental in the design and
implementation of the firm's asset allocation model. Previously, Dr. Sudweeks
was a professor of international finance and investments at George Washington
University and served as adjunct professor of international investments from
1988 until May 1991. Dr. Sudweeks is fluent in Mandarin Chinese.
Angeline Ee is a portfolio manager and principal focusing on Southeast Asian
investments. From 1990 until joining the Manager in July 1994, Ms. Ee was an
investment manager with AIG Investment Corp. in Hong Kong responsible for US$110
million invested in Singapore, Malaysia and Thailand. From June 1989 until
September 1990, Ms. Ee was co-manager of a portfolio of Asian equities and bonds
at Chase Manhattan Bank in Singapore.
Frank Chiang is a portfolio manager and principal responsible for North Asian
markets. From 1993 until joining the Manager in 1996, Mr. Chiang was managing
director and portfolio manager with TCW Asia Ltd., Hong Kong, responsible for
TCW's Asian Equity strategy. While at TCW, Mr. Chiang co-managed US$ 1.3 billion
invested throughout the Asia Pacific region. Prior to TCW Asia, he was an
associate director and portfolio manager for Wardley Investment Services, Hong
Kong, where he created and managed three dedicated China funds. Mr. Chiang is
fluent in three Chinese dialects: Mandarin, Shanghainese and Cantonese.
Jesus Isidoro Duarte is a portfolio manager and principal for the Manager,
responsible for the Latin American markets. From 1993 until joining the Manager,
he was director and vice president of Latinvest Management Co. in Brazil, where
he was responsible for research and portfolio management for the firm's Latin
American funds. From 1989 to 1992, Mr. Duarte worked at W.I. Carr in Tokyo as a
securities analyst of Japanese equities. He is fluent in Spanish and Japanese
and conversant in French and Portuguese.
Management Fees and Other Expenses
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, and provides administrative services and 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.
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 Emerging Markets Fund at or below one and three-quarters of one percent
(1.75%) of its average net assets. The Manager also may voluntarily reduce
additional amounts and/or reimburse the Fund for its expenses to increase the
return to the Fund's investors. The Manager may terminate these voluntary
reductions and/or reimbursements at any time. Any reductions made by the Manager
in its fees and any reimbursements by the Manager of Fund expenses are subject
to reimbursement by the Fund within the subsequent three years, provided the
Fund is able to effect such reimbursement and remain in compliance with
applicable expense limitations. The Manager generally seeks reimbursement for
the oldest reductions before payment by the Fund of fees and expenses for the
current year.
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10
<PAGE>
Montgomery Variable Series: Emerging Markets Fund
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Management Fee
Average Daily Net Assets (Annual Rate)
- --------------------------------------------------------------------------------
Montgomery Variable Series:
Emerging Markets Fund First $250 million 1.25%
More than $250 million 1.00%
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In addition, the Manager may elect to absorb operating expenses that the Fund is
obligated to pay in order to increase the return to the Fund's shareholders. To
the extent 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, out of its own funds, also may compensate persons who
distribute the Fund's shares as well as other service providers of shareholder
and administrative services. The Manager may also sponsor seminars and education
programs on the Fund for financial intermediaries and shareholders.
The Manager considers a number of factors in determining which brokers or
dealers to use for the Fund's portfolio transactions. 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.
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 the Fund's cutoff
time on each day that the NYSE is open for trading. Generally, this is 4:00 p.m.
eastern time or earlier when trading closes earlier. 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 that
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.
- --------------------------------------------------------------------------------
11
<PAGE>
Montgomery Variable Series: Emerging Markets Fund
- --------------------------------------------------------------------------------
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 in the Fund's calculation of
its net asset value unless the Manager, under the 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:
Income Dividends Capital Gains
---------------- -------------
Montgomery Declared and paid Declared and paid
Variable Series: in the last in the last
Emerging Markets quarter of each quarter of each
Fund year* 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
Emerging Markets Fund declared a dividend in the amount of $0.50 per share. If
the Emerging Markets 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 has elected and intends to continue 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 pertaining to the timing of
distributions. If the Fund is unable to meet certain requirements of the Code,
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, $0.01 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 the holders of more than 50%
- --------------------------------------------------------------------------------
12
<PAGE>
Montgomery Variable Series: Emerging Markets Fund
- --------------------------------------------------------------------------------
of the shares voting in any election of Trustees can, if they so choose, elect
all of the Trustees of the Trust. Although 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.
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. 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.
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 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 Paul,
Hastings, Janofsky & Walker LLP, 345 California Street, San Francisco,
California 94104.
-----------------
No salesperson, 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.
- --------------------------------------------------------------------------------
13
<PAGE>
Rule 497(e)
33-84450 and 811-8782
Montgomery Variable Series: International Small Cap Fund
- --------------------------------------------------------------------------------
Montgomery Variable Series:
International Small Cap Fund
The Montgomery Funds III
101 California Street
San Francisco, California 94111
(800) 572-FUND (3863)
Shares of Montgomery Variable Series: International Small Cap 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 policyholders, 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, LLC (the "Manager"), a
subsidiary of Commerzbank AG. Montgomery Variable Series: International Small
Cap Fund (the "International Small Cap Fund") seeks capital appreciation by
investing primarily in equity securities of companies outside the United States
having total market capitalizations of less than $1 billion, sound fundamental
values and potential for long-term growth at a reasonable price. As with all
mutual funds, attainment of the Fund's investment objective cannot be ensured.
This prospectus sets forth concisely the information about the Fund that a
prospective investor should know before investing in an Account or a subaccount
of an Account that invests in the Fund or, in the case of a qualified pension or
retirement plan, investing directly in the Fund. Please read it and retain it
for future reference. A Statement of Additional Information dated April 30,
1998, as may be revised, has been filed with the Securities and Exchange
Commission (the "SEC"), is incorporated by this reference and is available
without charge by calling (800) 572-FUND (3863) or the insurance company whose
Account invests in the Fund.
Prospectus
April 30, 1998
TABLE OF CONTENTS
Financial Highlights 2
The Fund's Investment Objective and Policies 2
Portfolio Securities 3
Other Investment Practices 4
Risk Considerations 7
Management of the Fund 9
How to Invest in the Fund 11
How to Redeem an Investment in the Fund 11
Exchange Privileges and Restrictions 11
How Net Asset Value Is Determined 11
Dividends and Distributions 11
Taxation 12
General Information 12
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.
Financial Highlights
Selected Per-Share Data and Ratios
<TABLE>
The following financial information for the period ended December 31,
1997, was audited by Price Waterhouse LLP, whose report, dated February 11,
1998, appears in the 1997 Annual Report of the Fund. The information for the
period ended December 31, 1996, was audited by other independent accountants
whose report is not included herein.
- --------------------------------------------------------------------------------
1
<PAGE>
Montgomery Variable Series: International Small Cap Fund
- --------------------------------------------------------------------------------
<CAPTION>
MONTGOMERY VARIABLE SERIES:
INTERNATIONAL SMALL CAP FUND
----------------------------
Selected Per-Share Data for the Period Ended December 31: 1997 1996(a)
<S> <C> <C>
Net asset value--beginning of period $ 10.67 $ 10.00
- -------------------------------------------------------------------------------------------------------------------
Net investment income 0.22 0.05
Net realized and unrealized gain/(loss) on investments (0.78) 0.68
- -------------------------------------------------------------------------------------------------------------------
Net increase/(decrease) in net assets resulting from investment
operations (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 $ 8.29 $ 10.67
========== =======
- -------------------------------------------------------------------------------------------------------------------
Total return * (5.10)% 7.23%
======= =======
- -------------------------------------------------------------------------------------------------------------------
Ratios to Average Net Assets/Supplemental Data:
- -------------------------------------------------------------------------------------------------------------------
Net assets, end of period (in 000's) $ 2,063 $ 1,107
- -------------------------------------------------------------------------------------------------------------------
Ratio of net investment income to average net assets 2.15% 2.03%+
- -------------------------------------------------------------------------------------------------------------------
Ratio of operating expenses to average net assets 0.00% 0.00%+
- -------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate 176% 12%
- -------------------------------------------------------------------------------------------------------------------
Average commission rate paid++ $ 0.0139 $ 0.0059
- -------------------------------------------------------------------------------------------------------------------
Net investment loss before deferral of fees and
absorption of expenses by Manager $ (0.17) $ (0.11)
- -------------------------------------------------------------------------------------------------------------------
Operating expense ratio before deferral of fees and
absorption of expenses by Manager 3.50% 6.30%+
- -------------------------------------------------------------------------------------------------------------------
<FN>
(a) The Montgomery Variable Series: International Small Cap Fund commenced
operations on September 30, 1996.
* Total return represents aggregate total return for the periods
indicated.
+ Annualized.
++ Average commission rate paid per share of securities purchased and sold
by the Fund.
</FN>
</TABLE>
The Fund's Investment Objective and Policies
The Fund's investment objectives and general investment policies are described
below. Specific portfolio securities that may be purchased by the Fund are
described in "Portfolio Securities." Specific investment practices are described
in "Other Investment Practices" and certain risks associated with investments in
the Fund are described in those sections as well as in "Risk Considerations."
o Montgomery Variable Series: International Small Cap Fund
The investment objective of the International Small Cap Fund is capital
appreciation which, under normal conditions, it seeks by investing at least 65%
of its total assets in equity securities of companies outside the United States
having total market capitalizations of less than $1 billion. The Fund generally
invests the remaining 35% of its total assets in a similar manner but may invest
those assets in equity securities of U.S. companies, in companies having market
capitalizations of $1 billion or more, or in debt securities, including up to 5%
of its total assets in debt securities rated below investment grade. See
"Portfolio Securities," "Risk Considerations" and the Appendix in the Statement
of Additional Information.
This Fund targets companies with potential for above average, long-term growth
in sales and earnings on a sustained basis with securities reasonably priced at
the time of purchase, in the Manager's opinion, compared with the potential for
capital appreciation. In evaluating investments, the Fund considers a number of
factors, including a company's per-share sales and earnings growth; return on
capital; balance sheet; financial and accounting policies; overall financial
strength; industry sector; competitive advantages and disadvantages; research,
product development and marketing; new technologies or services; pricing
flexibility; quality of management; and general operating characteristics.
This Fund may invest substantially in securities denominated in one or more
foreign currencies. Under normal conditions, it invests in at least four
different countries outside the United States, but no country may represent more
than 40% of the Fund's net assets. Furthermore, countries that are regarded as
"emerging markets" countries by the World Bank or International Finance
Corporation are each limited to 25% of the
- --------------------------------------------------------------------------------
2
<PAGE>
Montgomery Variable Series: International Small Cap Fund
- --------------------------------------------------------------------------------
Fund's net assets. The Manager uses its financial expertise and research
capabilities in markets throughout the world in attempting to identify those
countries, currencies and companies providing the greatest potential for
long-term growth. See "Risk Considerations."
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) as well as 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 a U.S 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. For purposes of allocating the Fund's investments, the Manager
regards convertible securities as a form of equity security.
Securities Warrants
The Fund may invest up to 5% of its net assets in warrants. Typically, a warrant
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. A warrant not exercised or disposed of by its
expiration date expires worthless.
Privatizations
The Fund believes that foreign governmental programs of selling interests in
government-owned or -controlled enterprises ("privatizations") may represent
opportunities for significant capital appreciation, and the Fund may invest in
privatizations. The ability of U.S. entities, such as the Fund, to participate
in privatizations may be limited by local law, or the terms for participation
may be less advantageous than for local investors. There can be no assurance
that privatization programs will be successful.
Special Situations
The Fund believes that carefully selected investments in joint ventures,
cooperatives, partnerships, private placements, unlisted securities and similar
vehicles (collectively, "special situations") could enhance its capital
appreciation potential. This Fund may also invest in certain types of vehicles
or derivative securities that represent indirect investments in foreign markets
or securities in which it is impracticable for the Fund to invest directly.
Investments in special situations may be illiquid, as determined by the Manager
based on criteria approved by the Board of Trustees. The Fund does not invest
more than 15% of its net assets in illiquid investments, including special
situations.
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.
Because of restrictions on direct investment by U.S. entities in certain
countries, other investment companies may provide the most practical or only way
for the Fund to invest in certain markets. 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 of 1940 ("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.
- --------------------------------------------------------------------------------
3
<PAGE>
Montgomery Variable Series: International Small Cap Fund
- --------------------------------------------------------------------------------
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 purchase debt securities that complement its objective of capital
appreciation, through anticipated favorable changes in relative foreign exchange
rates, in relative interest rate levels or in the creditworthiness of issuers.
In selecting debt securities, the Manager seeks out good credits and analyzes
interest rate trends and specific developments that may affect individual
issuers. As an operating policy that may be changed by the Board of Trustees,
the Fund will not invest more than 5% of its total assets in debt securities
rated lower than BBB by S&P, Baa by Moody's or BBB by Fitch, or in unrated debt
securities deemed to be of comparable quality by the Manager using guidelines
approved by the Board of Trustees. Subject to this limitation, the Fund may
invest in any debt security, including securities in default. After its purchase
by the Fund, a debt security may cease to be rated or its rating may be reduced
below that required for purchase by the Fund. A security downgraded below the
minimum level may be retained if determined by the Manager and by the Board to
be in the best interests of the Fund. See "Risk Considerations."
In addition to traditional corporate, government and supranational debt
securities, the Fund may invest in external (i.e., to foreign lenders) debt
obligations issued by the governments, governmental entities and companies of
emerging markets countries.
The percentage distribution between equity and debt will vary from country to
country based on anticipated trends in inflation and interest rates; expected
rates of economic and corporate profits growth; changes in government policy;
stability, solvency and expected trends of government finances; and conditions
of the balance of payments and terms of trade.
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, whereas 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. The U.S. government does not guarantee the net
asset value of the Fund's shares, however. 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.
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, a 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 an agreed-upon rate of return not determined by the coupon rate on the
underlying security. Under the Investment Company Act,
- --------------------------------------------------------------------------------
4
<PAGE>
Montgomery Variable Series: International Small Cap Fund
- --------------------------------------------------------------------------------
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 or equity securities ("collateral assets"). 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 10% of the
value of its total assets.
Reverse Repurchase Agreements
The Fund may enter into reverse repurchase agreements. In a reverse repurchase
agreement, the Fund sells to a financial institution a security that it holds
and agrees to repurchase the same security at an agreed-upon price and date.
Although reverse repurchase agreements are fully collateralized with collateral
assets, the Fund aggregates such transactions with its bank borrowings in
applying its borrowing limits. See the Statement of Additional Information for
further information.
Leverage
The Fund may leverage its portfolio in an effort to increase total return.
Although leverage creates an opportunity for increased income and gain, it also
creates special risk considerations. For example, leveraging may magnify changes
in the net asset value of the Fund's shares and in the yield on its portfolio.
Although the principal of such borrowings will be fixed, the Fund's assets may
change in value while the borrowing is outstanding. Leveraging creates interest
expenses that can exceed the income from the assets retained.
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 collateral assets in an
amount at least equal to the current market value of the loaned securities, plus
accrued interest. 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 fail financially.
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.
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. At the time a Fund enters into a transaction on a
when-issued or forward commitment basis, it supports its obligation with
collateral assets equal to the value of the when-issued or forward commitment
securities and causes the collateral 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"): forward currency exchange contracts, stock
options, currency options, and stock and 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 (the "Board") has adopted
derivative guidelines that require the Board to review each new type of
derivative 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.
- --------------------------------------------------------------------------------
5
<PAGE>
Montgomery Variable Series: International Small Cap Fund
- --------------------------------------------------------------------------------
Hedging transactions involve certain risks. Although 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.
Forward Currency Contracts. A forward currency contract is individually
negotiated and privately traded by currency traders and their customers and
creates an obligation to purchase or sell a specific currency for an agreed-upon
price at a future date. The Fund normally conducts its foreign-currency exchange
transactions either on a spot (i.e., cash) basis at the spot rate in the
foreign-currency exchange market at the time of the transaction, or through
entering into forward contracts to purchase or sell foreign currencies at a
future date. The Fund generally does not enter into forward contracts with terms
greater than one year.
The Fund generally enters into forward contracts only under two circumstances.
First, if the Fund enters into a contract for the purchase or sale of a security
denominated in a foreign currency, it may desire to "lock in" the U.S. dollar
price of the security by entering into a forward contract to buy the amount of a
foreign currency needed to settle the transaction. Second, if the Manager
believes that the currency of a particular foreign country will substantially
rise or fall against the U.S. dollar, it may enter into a forward contract to
buy or sell the currency approximating the value of some or all of the Fund's
portfolio securities denominated in such currency. Although forward contracts
are used primarily to protect the Fund from adverse currency movements, they
involve the risk that currency movements will not be accurately predicted.
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 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 industrywide 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. The Fund may purchase and sell equity index
futures contracts like S&P 500 Index futures contracts. The S&P 500 Index
futures contract (or other similar equity futures contract) is an agreement to
purchase or sell the cash value of the S&P 500 Index (or other applicable basket
of securities) at a specified date and price. The Fund may sell an equity index
futures contract (i.e., enter into a futures contract to sell a basket of the
securities underlying the index) in an attempt to hedge against an anticipated
market decline. Conversely, the Fund may purchase an equity index futures
contract (i.e., enter into a futures contract to purchase a basket of securities
underlying the index) in an attempt to hedge against any increase in the value
of securities it anticipates purchasing. In addition, the Fund may also purchase
and sell put and call options on futures contracts. The Fund will have
collateral 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 option 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
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6
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Montgomery Variable Series: International Small Cap Fund
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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.
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 objective 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 markups and other
transaction costs and may result in the recognition of capital gains that may be
distributed to shareholders. See "Financial Highlights" for portfolio turnover
information. Portfolio turnover in excess of 100% is considered high and
increases such costs. Even when portfolio turnover exceeds 100%, however, 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.
Risk Considerations
Foreign Securities
Shareholders should understand that all investments involve risk and there can
be no guarantee against loss resulting from an investment in the Fund. 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. The Fund may invest in securities of companies domiciled in, and in
markets of, so-called "emerging markets countries." These investments may be
subject to higher risks than investments in more-developed countries.
Foreign investments involve the possibility of expropriation, nationalization or
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 investments. In addition, there is often less publicly available
information about foreign issuers than those in the United States. 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. 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.
Brokerage commissions, fees for custodial services, and other costs relating to
investments by the Fund in other countries are generally greater than in the
United States. Foreign markets have different clearance and settlement
procedures from the United States, and certain markets have experienced times
when settlements did not keep pace with the volume of securities transactions
which resulted in settlement difficulty. The inability of the Fund to make
intended security purchases due to settlement difficulty could cause the Fund to
miss attractive investment opportunities. Inability to sell a portfolio security
due to settlement problems could result in loss to the Fund if the value of the
portfolio security declined, or
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Montgomery Variable Series: International Small Cap Fund
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result in claims against the Fund if it had entered into a contract to sell the
security. In certain countries, there is less government supervision and
regulation of business and industry practices, stock exchanges, brokers and
listed companies than in the United States. The securities markets of many of
the countries in which the Fund may invest may also be smaller, less liquid, and
subject to greater price volatility than those in the United States.
Because certain 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. A change in the value of a foreign currency
against the U.S. dollar results in a corresponding change in the U.S. dollar
value of the Fund's securities denominated in that currency. Such changes also
affect the Fund's income and distributions to shareholders. The Fund may be
affected either favorably or unfavorably by changes in the relative rates of
exchange among the currencies of different nations, and the Fund may therefore
engage in foreign-currency hedging strategies. Such strategies, however, involve
certain transaction costs and investment risks, including dependence on the
Manager's ability to predict movements in exchange rates.
Some countries in which the Fund may invest also may have fixed or managed
currencies that are not freely convertible at market rates into the U.S. dollar.
Certain currencies may not be internationally traded. A number of these
currencies have experienced a steady devaluation relative to the U.S. dollar,
and such devaluations in the currencies may have a detrimental impact on the
Fund.
Many countries in which the Fund may invest have experienced substantial, and in
some periods extremely high, rates of inflation for many years. Inflation and
rapid fluctuation in inflation rates have had and may continue to have negative
effects on certain economies and securities markets. Moreover, the economies of
some countries may differ favorably or unfavorably from the U.S. economy in such
respects as rate of growth of gross domestic product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments.
Certain countries also limit the amount of foreign capital that can be invested
in their markets and local companies, creating a "foreign premium" on capital
investments available to foreign investors such as the Fund. The Fund may pay a
"foreign premium" to establish an investment position which it cannot later
recoup because of changes in the country's foreign-investment laws.
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.
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.
Lower-Quality Debt
The Fund is authorized to invest in medium-quality (rated or equivalent to BBB
by S&P or Fitch's or Baa by Moody's) and in limited amounts of high-risk,
lower-quality debt securities (i.e., securities rated below BBB or Baa) or, if
unrated, deemed to be of equivalent investment quality as determined by the
Manager. Medium-quality debt securities have speculative characteristics, and
changes in economic conditions or other circumstances are more likely to lead to
a weakened capacity to make principal and interest payments than with
higher-grade debt securities.
As an operating policy, which may be changed by the Board of Trustees without
shareholder approval, the Fund does not invest more than 5% of its total assets
in debt securities rated lower than BBB by S&P or Baa by Moody's or, if unrated,
deemed to be of comparable quality as determined by the Manager using guidelines
approved by the Board. The Board may consider a change in this operating policy
if, in its judgment, economic conditions change such that a higher level of
investment in high-risk, lower-quality debt securities would be consistent with
the interests of the Fund and its shareholders. Unrated debt securities are not
necessarily of lower quality than rated securities, but they may not be
attractive to as many buyers. Regardless of rating levels, all debt securities
considered for purchase (whether rated or unrated) are analyzed by the Manager
to determine, to the extent reasonably possible, that the planned investment is
sound. From time to time, the Fund may purchase defaulted debt securities if, in
the opinion of the Manager, the issuer may resume interest payments in the near
future.
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8
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Montgomery Variable Series: International Small Cap Fund
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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
changes. 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 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.
Equity Swaps
The Fund may invest in equity swaps. Equity swaps are derivatives that allow the
parties to exchange the dividend income or other components of return on an
equity investment (e.g., a group of equity securities or an index) for a
component of return on another non-equity or equity investment. The value of
equity swaps can be very volatile. To the extent the Manager does not accurately
analyze and predict the potential relative fluctuation of the components swapped
with another party, the Fund may suffer a loss. The value of some components of
an equity swap (like the dividends on a common stock) may also be sensitive to
changes in interest rates. Furthermore, during the period a swap is outstanding,
the Fund may suffer a loss if the counterparty defaults.
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, LLC, is the Funds' Manager. The Manager, a Delaware
limited liability company, is a subsidiary of Commerzbank AG ("Commerzbank").
The Manager was formed in February 1997 as an investment adviser registered as
such with the SEC under the Investment Advisers Act of 1940, as amended. It
advises private accounts as well as the Funds. Commerzbank, one of the largest
publicly held commercial banks in Germany, had total assets of approximately
$288 billion as of December 31, 1997. Commerzbank and its affiliates had more
than $92 billion in assets under management as of October 31, 1997.
Commerzbank's asset management operations involve more than 1,000 employees in
13 countries worldwide.
On July 31, 1997, Montgomery Asset Management, L.P., the former manager of the
Funds, completed the sale of substantially all of its assets to the Manager. At
a special meeting of shareholders on June 23, 1997, the shareholders of each
Fund approved a new Investment Management Agreement with the Manager, effective
July 31, 1997, for an initial two-year period.
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9
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Montgomery Variable Series: International Small Cap Fund
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Portfolio Managers
Montgomery Variable Series: International Small Cap Fund
Oscar A. Castro, CFA, is a senior portfolio manager and principal. Before
joining the Manager, he was vice president and 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, he was deputy portfolio manager and analyst at Templeton International.
John D. Boich, CFA, is a senior portfolio manager and principal. From 1990 to
1993, he was vice president and portfolio manager at The Boston Company
Institutional Investors Inc. From 1989 to 1990, he was the founder and
co-manager of The 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.
Management Fees and Other Expenses
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.
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
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10
<PAGE>
Montgomery Variable Series: International Small Cap Fund
- --------------------------------------------------------------------------------
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 International Small Cap Fund at or below one and one-half of one percent
(1.50%) of its average net assets. The Manager also may voluntarily reduce
additional amounts and/or reimburse the Fund for its expenses to increase the
return to the Fund's investors. The Manager may terminate these voluntary
reductions and/or reimbursements at any time. Any reductions made by the Manager
in its fees and any reimbursements by the Manager of Fund expenses are subject
to reimbursement by the Fund within the subsequent three years, provided the
Fund is able to effect such reimbursement and remain in compliance with
applicable expense limitations. The Manager generally seeks reimbursement for
the oldest reductions before payment by the Fund of fees and expenses for the
current year.
In addition, the Manager may elect to absorb operating expenses that the Fund is
obligated to pay in order to increase the return to the Fund's shareholders. To
the extent 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, out of its own funds, also may compensate persons who
distribute the Fund's shares as well as other service providers of shareholder
and administrative services. The Manager may also sponsor seminars and education
programs on the Fund for financial intermediaries and shareholders.
The Manager considers a number of factors in determining which brokers or
dealers to use for the Fund's portfolio transactions. 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.
Management Fee
Average Daily Net Assets (Annual Rate)
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Montgomery Variable Series:
International Small Cap Fund First $250 million 1.25%
More than $250 million 1.00%
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11
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Montgomery Variable Series: International Small Cap Fund
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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 the Fund's cutoff
time on each day that the NYSE is open for trading. Generally, this is 4:00 p.m.
eastern time or earlier when trading closes earlier. 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 that
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 in the Fund's calculation of
its net asset value unless the Manager, under the 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 of
Trustees. Currently, the Fund intends to distribute according to the following
schedule:
Income Dividends Capital Gains
---------------- -------------
Montgomery Variable Declared and paid Declared and paid
Series: in the last in the last
International Small quarter of each quarter of each
Cap Fund year* 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
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Montgomery Variable Series: International Small Cap Fund
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the distribution, net of any subsequent market fluctuations. For example, assume
that on December 31, the International Small Cap Fund declared a dividend in the
amount of $0.50 per share. If the International Small Cap 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 has elected and intends to continue 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 pertaining to the timing of
distributions. If the Fund is unable to meet certain requirements of the Code,
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, $0.01 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 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. Although 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.
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. 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.
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.
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Montgomery Variable Series: International Small Cap Fund
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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 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 Paul,
Hastings, Janofsky & Walker LLP, 345 California Street, San Francisco,
California 94104.
-----------------------
No salesperson, 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.
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14
<PAGE>
Rule 497(e)
33-84450 and 811-8782
THE MONTGOMERY FUNDS III
Supplement dated April 30, 1998, to:
Prospectus for the
Montgomery Variable Series: Small Cap Opportunities Fund
dated April 30, 1998
Effective April 30, 1998, the Manager has agreed to waive its entire management
fee until either May 1, 1999, or such time as the Fund's net assets reach $10
million whichever occurs earlier. In the event that the Fund's net assets reach
$10 million before April 1, 1999, shareholders will be given at least 30 days'
notice before the Manager terminates such waivers.
<PAGE>
Rule 497(e)
33-84450 and 811-8782
The Montgomery Variable Series: Small Cap Opportunities Fund
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Montgomery Variable Series:
Small Cap Opportunities Fund
The Montgomery Funds III
101 California Street
San Francisco, California 94111
(800) 572-FUND (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 policyholders, 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, LLC (the "Manager"), a
subsidiary of Commerzbank AG. 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 ensured.
This prospectus sets forth concisely the information about the Fund that a
prospective investor should know before investing in an Account or a subaccount
of an Account that invests in the Fund or, in the case of a qualified pension or
retirement plan, investing directly in the Fund. Please read it and retain it
for future reference. A Statement of Additional Information dated April 30,
1998, as may be revised, has been filed with the Securities and Exchange
Commission (the "SEC"), is incorporated by this reference and is available
without charge by calling (800) 572-FUND (3863) or the insurance company whose
Account invests in the Fund.
Prospectus
April 30, 1998
TABLE OF CONTENTS
The Fund's Investment Objective and Policies 2
Portfolio Securities 2
Other Investment Practices 3
Risk Considerations 6
Management of the Fund 7
How to Invest in the Fund 8
How to Redeem an Investment in the Fund 8
Exchange Privileges and Restrictions 9
How Net Asset Value Is Determined 9
Dividends and Distributions 9
Taxation 9
General Information 10
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 Montgomery Variable Series: Small Cap Opportunities Fund
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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." Specific investment practices are described
in "Other Investment Practices" and certain risks associated with investments in
the Fund are described in those sections as well as in "Risk Considerations."
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 and in investment-grade debt securities
and foreign companies. 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 Small Cap Opportunities Fund seeks growth at a reasonable value, identifying
companies with sound fundamental values and potential for substantial growth.
The Fund selects its investments based on a combination of quantitative
screening techniques and fundamental analysis. The Fund initially identifies a
universe of investment candidates by screening companies based on changes in
rates of growth and valuation ratios such as price to sales, price to earnings
and price to cash flows. Through this process the Fund seeks to identify rapidly
growing companies with reasonable valuations and accelerating growth rates, or
having low valuations and initial signs of growth. The Fund then subjects these
companies to a rigorous fundamental analysis focusing on balance sheets and
income statements; company visits and discussions with management; contact with
industry specialists and industry analysts; and review of the competitive
environments.
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 a United States 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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The Montgomery Variable Series: Small Cap Opportunities Fund
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Securities Warrants
The Fund may invest up to 5% of its net assets in warrants. Typically, a warrant
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. 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 of 1940 ("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 and government 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, whereas 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 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
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The Montgomery Variable Series: Small Cap Opportunities Fund
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credit, U.S. government securities or other high-grade liquid debt or equity
securities ("collateral assets"). 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 10% 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 collateral assets in an
amount at least equal to the current market value of the loaned securities, plus
accrued interest. 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 fail financially.
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.
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. At the time a Fund enters into a transaction on a
when-issued or forward commitment basis, it supports its obligation with
collateral assets equal to the value of the when-issued or forward commitment
securities and causes the collateral 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 (the "Board") 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. Although 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 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
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The Montgomery Variable Series: Small Cap Opportunities Fund
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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 industrywide 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. The Fund may purchase and sell equity index
futures contracts like S&P 500 Index futures contracts. The S&P 500 Index
futures contract (or other similar equity futures contract) is an agreement to
purchase or sell the cash value of the S&P 500 Index (or other applicable basket
of securities) at a specified date and price. The Fund may sell an equity index
futures contract (i.e., enter into a futures contract to sell a basket of the
securities underlying the index) in an attempt to hedge against an anticipated
market decline. Conversely, the Fund may purchase an equity index futures
contract (i.e., enter into a futures contract to purchase a basket of securities
underlying the index) in an attempt to hedge against any increase in the value
of securities it anticipates purchasing. In addition, the Fund may also purchase
and sell put and call options on futures contracts. The Fund will have
collateral assets equal to the purchase price of the portfolio securities
represented by the underlying 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.
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 markups, 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%. Even when portfolio turnover exceeds 100%, however, 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.
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The Montgomery Variable Series: Small Cap Opportunities Fund
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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
United States. 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.
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
changes. 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 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.
Equity Swaps
The Fund may invest in equity swaps. Equity swaps are derivatives that allow the
parties to exchange the dividend income or other components of return on an
equity investment (e.g., a group of equity securities or an index) for a
component of return on another nonequity or equity investment. The value of
equity swaps can be very volatile. To the extent the Manager does not accurately
analyze and predict the potential relative fluctuation of the components swapped
with another party, the Fund may suffer a loss. The value of some components of
an equity swap (like the dividends on a common stock) may also be sensitive to
changes in interest rates. Furthermore, during the period a swap is outstanding,
the Fund may suffer a loss if the counterparty defaults.
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
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The Montgomery Variable Series: Small Cap Opportunities Fund
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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, LLC, is the Funds' Manager. The Manager, a Delaware
limited liability company, is a subsidiary of Commerzbank AG ("Commerzbank").
The Manager was formed in February 1997 as an investment adviser registered as
such with the SEC under the Investment Advisers Act of 1940, as amended. It
advises private accounts as well as the Funds. Commerzbank, one of the largest
publicly held commercial banks in Germany, had total assets of approximately
$288 billion as of December 31, 1997. Commerzbank and its affiliates had more
than $92 billion in assets under management as of October 31, 1997.
Commerzbank's asset management operations involve more than 1,000 employees in
13 countries worldwide.
On July 31, 1997, Montgomery Asset Management, L.P., the former manager of the
Funds, completed the sale of substantially all of its assets to the Manager. At
a special meeting of shareholders on June 23, 1997, the shareholders of each
Fund approved a new Investment Management Agreement with the Manager, effective
July 31, 1997, for an initial two-year period.
Portfolio Managers
Montgomery Variable Series: Small Cap Opportunities Fund
The Small Cap Opportunities Fund is managed by the growth equity team. Key
members of that team are Roger W. Honour, Andrew Pratt and Kathryn M. Peters.
Roger W. Honour is a senior portfolio manager and principal. 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.
Andrew G. Pratt, CFA, is a portfolio manager and principal. 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.
Kathryn M. Peters is a portfolio manager and principal. From 1993 to 1995, Ms.
Peters was an associate in the investment banking division of Donaldson, Lufkin
& Jenrette in New York where she 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 buyout group of Marine Midland Bank.
Management Fees and Other Expenses
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.
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
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The Montgomery Variable Series: Small Cap Opportunities Fund
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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 and/or reimburse the Fund for its expenses to increase the
return to the Fund's investors. The Manager may terminate these voluntary
reductions and/or reimbursements at any time. Any reductions made by the Manager
in its fees and any reimbursements by the Manager of Fund expenses are subject
to reimbursement by the Fund within the subsequent three years, provided the
Fund is able to effect such reimbursement and remain in compliance with
applicable expense limitations. The Manager generally seeks reimbursement for
the oldest reductions before payment by the Fund fees and of expenses for the
current year.
In addition, the Manager may elect to absorb operating expenses that the Fund is
obligated to pay in order to increase the return to the Fund's shareholders. To
the extent 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, out of its own funds, also may compensate persons who
distribute the Fund's shares as well as other service providers of shareholder
and administrative services. The Manager may also sponsor seminars and education
programs on the Fund for financial intermediaries and shareholders.
The Manager considers a number of factors in determining which brokers or
dealers to use for the Fund's portfolio transactions. 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.
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.
Management Fee
Average Daily Net Assets (Annual Rate)
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Montgomery Variable Series:
Small Cap Opportunities Fund First $200 million 1.20 %
Next $300 million 1.10 %
Over $500 million 1.00 %
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8
<PAGE>
The Montgomery Variable Series: Small Cap Opportunities Fund
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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 the Fund's cutoff
time on each day that the NYSE is open for trading. Generally, this is 4:00 p.m.
eastern time or earlier when trading closes earlier. 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 that
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:
Income Dividends Capital Gains
---------------- -------------
Montgomery Variable Declared and paid Declared and paid
Series: Small Cap in the last in the last
Opportunities Fund quarter of each quarter of each
year* 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
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9
<PAGE>
The Montgomery Variable Series: Small Cap Opportunities Fund
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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 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. Although 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.
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. At least 30 days' 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 a
representation of what an investor's total return may be in any future period.
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10
<PAGE>
The Montgomery Variable Series: Small Cap Opportunities Fund
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Legal Opinion
The validity of the shares offered by this prospectus will be passed on by Paul,
Hastings, Janofsky & Walker LLP, 345 California Street, San Francisco,
California 94104.
------------------------
No salesperson, 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.
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11
<PAGE>
Rule 497(e)
33-84450 and 811-8782
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
(800) 232-2197
Statement Of Additional Information
April 30, 1998
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, LLC (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 and Montgomery Variable Series: Small Cap
Opportunities Fund, each dated April 30, 1998, 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.
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<PAGE>
TABLE OF CONTENTS
THE TRUST......................................................................3
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS................................3
RISK FACTORS..................................................................15
INVESTMENT RESTRICTIONS.......................................................17
DISTRIBUTIONS AND TAX INFORMATION.............................................20
TRUSTEES AND OFFICERS.........................................................25
INVESTMENT MANAGEMENT AND OTHER SERVICES......................................29
EXECUTION OF PORTFOLIO TRANSACTIONS...........................................31
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION................................34
DETERMINATION OF NET ASSET VALUE..............................................35
PRINCIPAL UNDERWRITER.........................................................37
PERFORMANCE INFORMATION.......................................................38
GENERAL INFORMATION...........................................................41
FINANCIAL STATEMENTS..........................................................43
Appendix......................................................................44
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<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, $0.01
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 each Fund are described in
detail in its Prospectus. The following discussion supplements the discussion in
the Prospectuses.
Each Fund is a 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. To the extent allowed in its Prospectus, a Fund
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 a Fund's investment policies, a Funds' investments in
ADRs, EDRs and similar instruments will be deemed to be investments in the
equity securities representing the securities of foreign issuers into which they
may be converted.
Other Investment Companies. To the extent allowed by its Prospectus, a
Fund may invest in securities issued by other investment companies. Those
investment companies must invest in securities in which the Fund can invest in a
manner consistent with the Fund's investment objective and policies. Applicable
provisions of the Investment Company Act require that a Fund limit its
investments so that, as determined immediately after a securities purchase is
made: (a) not more than 10% of the value of a Fund's total assets will be
invested in the aggregate in securities of investment companies as a group; and
(b) either (i) a Fund and affiliated persons of that Fund not own together more
than 3% of the total outstanding shares of any one investment company at the
time of purchase (and that all shares of the investment company held by that
Fund in excess of 1% of the company's total outstanding shares be deemed
illiquid), or (ii) a 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
B-3
<PAGE>
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 Fund bears directly
in connection with its own operations.
U.S. Government Securities. Generally, the value of U.S. Government
securities held by these Funds will fluctuate inversely with interest rates.
U.S. Government securities in which these 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, a Fund 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
that Fund.
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 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
B-4
<PAGE>
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
mortgage loan 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
To the extent allowed in its Prospectus, a Fund may invest in debt
securities that are rated below BBB by Standard & Poor's Corporation ("S&P"),
Baa by Moody's Investors Service, Inc. ("Moody's") 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, a Fund will invest no more than
5% of its 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.
The market value of debt securities generally varies in response to changes in
interest rates and the financial condition of each issuer.
B-5
<PAGE>
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 a Fund 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 a Fund 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 that Fund.
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 a Funds to
achieve its investment objectives may, to the extent it invests in low-rated
debt securities, be more dependent upon such credit analysis than would be the
case if that Fund 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, a Fund 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, a Fund,
to the extent allowed in its Prospectus, 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. The Fund also may conduct its foreign currency exchange transactions on a
spot (i.e., cash) basis at the spot rate prevailing in the foreign currency
exchange market.
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<PAGE>
To the extent allowed in its Prospectus, a Fund also may purchase other
types of options and futures and may, in the future, write covered options, as
described below and in its Prospectus.
Forward Contracts. To the extent allowed in its Prospectus, a 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.
A Fund may enter into a forward contract, for example, when it enters
into a contract for the purchase or sale of a security denominated in a foreign
currency or is expecting a dividend or interest payment in order to "lock in"
the U.S. dollar price of a security, dividend or interest payment. 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 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 its commitments will be held aside or
segregated to be used to pay for the commitments. 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 them, and the ability of a Fund to utilize
forward contracts 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 entered into such contracts. A
Fund 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, a
Fund, to the extent allowed in its Prospectus, may purchase and sell various
kinds of futures contracts and options on futures contracts. The Fund 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.
These Funds have filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the CFTC and the National
Futures 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
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<PAGE>
Exchange Act, the notice of eligibility included the representation that these
Funds will use futures contracts and related options for bona fide hedging
purposes within the meaning of CFTC regulations, provided that a Fund 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 that 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%.
These 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 these Funds or
which they expect to purchase. These 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 these Funds are traded on
U.S. exchanges or boards of trade 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 these Funds'
futures contracts on securities or currencies will usually be liquidated in this
manner, a Fund may 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, these 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 these Funds propose to acquire. For example, when
interest rates are rising or securities prices are falling, a Fund can seek,
through the sale of futures contracts, to offset a decline in the value of its
current portfolio securities. When rates are falling or prices are rising, a
Fund, 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 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
such futures contracts, the Manager will attempt to estimate the extent of this
difference in
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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 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 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 is dependent upon a liquid market.
Loss from investing in futures transactions by a Fund 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. To the extent
allowed in its Prospectus, a Fund may purchase put and call options on
securities in which is has invested, on foreign currencies represented in its
portfolios and on any securities index based in whole or in part on securities
in which that Fund may invest. A Fund 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 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.
To the extent allowed in its Prospectus, a Fund may purchase and sell
options traded on U.S. and foreign exchanges. Although a Fund 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 its options in order to realize any
profit and would incur transaction costs upon the purchase or sale of the
underlying securities.
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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, they may, in the
future, write (i.e., sell) covered put and call options on securities,
securities indices, and currencies in which they 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 a price decline of the underlying security. 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 (above the option exercise
price) in the underlying security. In addition, a Fund's ability to sell the
underlying security is limited while the option is in effect unless that Fund
effects a closing purchase transaction.
Each Fund also may write covered put options that give the holder of
the option the right to sell the underlying security to the Fund 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" put options it has written, a Fund
will cause its custodian to segregate cash, cash equivalents, U.S. Government
securities or other liquid equity or debt securities with at least the value of
the exercise price of the put options. A Fund will not write put options if the
aggregate value of the obligations underlying the put options exceeds 25% of
that Fund's total assets.
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 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. To the extent allowed in its Prospectus, a Fund
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
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price. The repurchase price is generally higher than the purchase price, the
difference being interest income to that Fund. Alternatively, the purchase and
repurchase prices may be the same, with interest at a stated rate due to a Fund
together with the repurchase price on the date of repurchase. In either case,
the income to a 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,
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.
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. A Fund may not 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, 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. As such, 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.
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The Funds may participate in one or more joint accounts with each other
and other series of the Trust that invest in repurchase agreements
collateralized, subject to their investment policies, either by (i) 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 in no event have a duration
of more than seven days.
Reverse Repurchase Agreements. To the extent allowed in its Prospectus,
a Fund may enter into reverse repurchase agreements, as set forth in the
Prospectus. A Fund 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 and 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 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.
Dollar Roll Transactions. To the extent allowed in its Prospectus, a
Fund may enter into dollar roll transactions. A dollar roll transaction involves
a sale by a Fund of a security to a financial institution concurrently with an
agreement by that Fund to purchase a similar security from the institution at a
later date at an agreed-upon price. The securities that are repurchased will
bear the same interest rate as those sold, but generally will be collateralized
by different pools of mortgages with different prepayment histories than those
sold. During the period between the sale and repurchase, a Fund will not be
entitled to receive interest and principal payments on the securities sold.
Proceeds of the sale will be invested in additional portfolio securities of that
Fund, and the income from these investments, together with any additional fee
income received on the sale, may or may not generate income for that Fund
exceeding the yield on the securities sold.
At the time a Fund enters into a dollar roll transaction, it causes its
custodian to segregate liquid assets such as cash, U.S. Government securities or
other liquid equity or debt securities having a value equal to the purchase
price for the similar security (including accrued interest) and subsequently
marks the assets to market daily to ensure that full collateralization is
maintained.
Lending of Portfolio Securities. To the extent allowed in its
Prospectus, a Fund may lend its portfolio securities in order to generate
additional income. Such loans may be made to broker-
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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 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. A Fund 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 a Fund or the borrower at any time. Upon such termination, that
Fund is 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.
When-Issued and Forward Commitment Securities. To the extent allowed in
its Prospectus, a Fund 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 with a value equal in value to commitments for when-issued or delayed
delivery securities. The segregated securities either will 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.
To the extent allowed in its Prospectus, a Fund may seek to hedge
investments or to realize additional gains through forward commitments to sell
high-grade liquid debt securities it does not own at the time it enters into the
commitments. Such forward commitments effectively constitute a form of short
sale. To complete such a transaction, the Fund must obtain the security which it
has made a commitment to deliver. If the Fund does not have cash available to
purchase the security it is obligated to deliver, it may be required to
liquidate securities in its portfolio at
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either a gain or a loss, or borrow cash under a reverse repurchase or other
short-term arrangement, thus incurring an additional expense. In addition, the
Fund may incur a loss as a result of this type of forward commitment if the
price of the security increases between the date the Fund enters into the
forward commitment and the date on which it must purchase the security it is
committed to deliver. The Fund will realize a gain from this type of forward
commitment if the security declines in price between those dates. The amount of
any gain will be reduced, and the amount of any loss increased, by the amount of
the interest or other transaction expenses the Fund may be required to pay in
connection with this type of forward commitment. Whenever this Fund engages in
this type of transaction, it will segregate assets as discussed above.
Illiquid Securities. To the extent allowed in its Prospectus, a Fund
may invest 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 that 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.
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
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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,
however, could adversely affect the marketability of such portfolio securities
and result in a Fund's inability to dispose of such securities promptly or at
favorable prices.
The Board 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.
RISK FACTORS
The following describes certain risks involved with investing in the
Funds.
Foreign Securities
Investors in Funds that may, as allowed by their Prospectus, invest in
foreign securities 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 United States. Foreign companies are often not subject to uniform
accounting, auditing and financial reporting standards, and auditing practices
and requirements often may not be 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
To the extent allowed in its Prospectus, a Fund may invest in
securities of companies domiciled in, and in markets of, so-called "emerging
market countries." These investments may be subject to potentially higher risks
than investments in developed countries. These risks include (i) volatile
social, political, and economic conditions; (ii) the small current size of the
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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 which may restrict these 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
Funds, to the extent allowed in the Prospectus, that buy and sell
foreign currencies endeavor to do so 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 which 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 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 portfolio position
which is intended to be protected is imperfect, the desired protection may not
be obtained, and a Fund may be exposed to risk of financial loss.
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Perfect correlation between a Fund's hedging positions and 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 that Fund would be invested in such issuer. There
are no limitations with respect to the remaining 25% of that
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 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.)
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5. Buy or sell real estate or commodities or commodity contracts;
however, each Fund, to the extent not otherwise prohibited in
the Prospectus or this Statement of Additional 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, each 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 that
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, each 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 each Fund from (a) making any permitted borrowings,
mortgages or pledges, or (b) entering into permissible
repurchase and dollar roll transactions.
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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 each Fund's
total assets. (This is an operating policy which may
be changed without shareholder approval.)
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 that Fund's net assets. Included
in such amount, but not to exceed 2% of the value of that
Fund's net assets, may be warrants which are not listed on the
New York Stock Exchange or American Stock Exchange. Warrants
acquired by that 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 that 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
that 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
which may be changed without shareholder vote, these restrictions may be amended
upon approval by the Board and notice to shareholders.
B-19
<PAGE>
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 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 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 the eight previous taxable years), although a distribution
from capital gains, will be distributed to shareholders with and as a part of
dividends giving rise to ordinary income. 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 the eight previous
taxable years) will be distributed and treated as long-term capital gains in the
hands of the shareholders regardless of the length of time that Fund's shares
may have been held by the shareholders.
Any dividend or distribution per share 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.
Dividends and other distributions will be reinvested in additional
shares of the applicable Fund unless the shareholder has otherwise indicated.
Investors have the right to change their elections with respect to the
reinvestment of dividends and distributions by notifying the Transfer Agent in
writing, but any such change will be effective only as to dividends and other
distributions for which the record date is seven or more business days after the
Transfer Agent has received the written request.
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
B-20
<PAGE>
regarding the source of its income, the diversification of its assets, and the
timing of its distributions. Each Fund that has filed a tax return has so
qualified and elected in prior tax years. 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 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, each 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) for taxable years beginning or before August 5, 1997, 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 that 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 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.
Distributions of net investment income and net realized capital gains
by a Fund will be taxable to shareholders whether made in cash or reinvested in
shares. In determining amounts of net realized capital gains to be distributed,
any capital loss carryovers from the eight prior taxable years will be applied
against capital gains. Shareholders receiving distributions in the form of
additional shares will have a cost basis for federal income tax purposes in each
share so received equal to the net asset value of a share of a Fund on the
reinvestment date. Fund distributions also will be included in individual and
corporate shareholders' income on which the alternative minimum tax may be
imposed.
The Funds or any securities dealer effecting a redemption of the Funds'
shares by a shareholder will be required to file information reports with the
IRS with respect to distributions and payments made to the shareholder. In
addition, the Funds will be required to withhold federal income tax at the rate
of 31% on taxable dividends, redemptions and other payments made to accounts of
individual or other non-exempt shareholders who have not furnished their correct
taxpayer identification numbers and made certain required certifications on the
Account
B-21
<PAGE>
Application Form or with respect to which a Fund or the securities dealer has
been notified by the IRS that the number furnished is incorrect or that the
account is otherwise subject to withholding.
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.
A Fund may receive dividend distributions from U.S. corporations. To
the extent that a Fund receives such dividends and distributes them to its
shareholders, and meets certain other requirements of the Code, corporate
shareholders of the Fund may be entitled to the "dividends received" deduction.
Availability of the deduction is subject to certain holding period and
debt-financing limitations.
If more than 50% in value of the total assets of a Fund at the end of
its fiscal year is invested in stock or other securities of foreign
corporations, that Fund may elect to pass through to its shareholders the pro
rata share of all foreign income taxes paid by that Fund. If this election is
made, shareholders will be (i) required to include in their gross income their
pro rata share of any foreign income taxes paid by that Fund, and (ii) entitled
either to deduct their share of such foreign taxes in computing their taxable
income or to claim a credit for such taxes against their U.S. income tax,
subject to certain limitations under the Code, including certain holding period
requirements. In this case, shareholders will be informed in writing by that
Fund at the end of each calendar year regarding the availability of any credits
on and the amount of foreign source income (including or excluding foreign
income taxes paid by that Fund) to be included in their income tax returns. If
50% or less in value of that Fund's total assets at the end of its fiscal year
are invested in stock or other securities of foreign corporations, that Fund
will not be entitled under the Code to pass through to its shareholders their
pro rata share of the foreign income taxes paid by that Fund. In this case,
these taxes will be taken as a deduction by that Fund
A Fund may be subject to foreign withholding taxes on dividends and
interest earned with respect to securities of foreign corporations. A Fund may
invest up to 10% of its total assets in the stock of foreign investment
companies. Such companies are likely to 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 these Funds derive from
PFIC stock may be subject to a non-deductible federal income tax at the Fund
level. In some cases, a 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. A Fund will endeavor to limit its 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, a Fund may incur the PFIC tax in
some instances.
B-22
<PAGE>
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 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,
B-23
<PAGE>
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.
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 that 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 that Fund generally will be capital
gain or loss.
Any security, option or other position entered into or held by a Fund
that substantially diminishes that Fund's risk of loss from any other position
held by that 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 a 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 a
Fund that may mitigate the effects of the straddle rules.
B-24
<PAGE>
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 will be treated 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.
Redemptions and exchanges of shares of a Fund will result in gains or
losses for tax purposes to the extent of the difference between the proceeds and
the shareholder's adjusted tax basis for the shares. Any loss realized upon the
redemption or exchange of shares within six months from their date of purchase
will be treated as a long-term capital loss to the extent of distributions of
long-term capital gain dividends with respect to such shares during such
six-month period. All or a portion of a loss realized upon the redemption of
shares of a Fund may be disallowed to the extent shares of that Fund are
purchased (including shares acquired by means of reinvested dividends) within 30
days before or after such redemption.
Distributions and redemptions may be subject to state and local income
taxes, and the treatment thereof may differ from the federal income tax
treatment. Foreign taxes may apply to non-U.S. investors.
The above discussion and the related discussion in the Prospectus are
not intended to be complete discussions of all applicable federal tax
consequences of an investment in the Funds. The law firm of Paul, Hastings,
Janofsky & Walker LLP has expressed no opinion in respect thereof. Nonresident
aliens and foreign persons are subject to different tax rules, and may be
subject to withholding of up to 30% on certain payments received from the Funds.
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 Funds.
TRUSTEES AND OFFICERS
The Trustees of the Trust are responsible for the overall management of
the Funds, including general supervision and review of their investment
activities. The officers (the Trust as well as two affiliated Trusts, The
Montgomery Funds and The Montgomery Funds II, have the same officers), who
administer the Funds' daily operations, are appointed by the Board of
B-25
<PAGE>
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:
Karen Jacoppo-Wood, Vice President and Assistant Secretary (Age 30)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Ms. Jacoppo-Wood is
the Assistant Vice President of FDI and an officer of certain investment
companies advised or administered by Morgan, Waterhouse, RCM and Harris or their
respective affiliates. From June 1994 to January 1996, Ms. Jacoppo-Wood was a
Manager, SEC Registration, Scudder, Stevens & Clark, Inc. From 1988 to May 1994,
Ms. Jacoppo-Wood was a Senior Paralegal at The Boston Company Advisers, Inc.
(TBCA)
Christopher J. Kelley, Vice President and Assistant Secretary (Age 32)
60 State Street, Suite 300, Boston, Massachusetts 02109. Mr. Kelley is the Vice
President and Associate General Counsel of FDI and Premier Mutual, and an
officer of certain investment companies advised or administered by Morgan,
Waterhouse and Harris or their respective affiliates. From April 1994 to July
1996, Mr. Kelley was Assistant Counsel at Forum Financial Group. From 1992 to
1994, Mr. Kelley was employed by Putnam Investments in Legal and Compliance
capacities. Prior to 1992, Mr. Kelley attended Boston College Law School, from
which he graduated in May 1992.
Mary A. Nelson, Vice President and Assistant Treasurer (Age 33)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Ms. Nelson is the Vice
President and Manager of Treasury Services and Administration of FDI and Premier
Mutual, and an officer of certain investment companies advised or administered
by Morgan, Dreyfus, Waterhouse, RCM and Harris or their respective affiliates.
From 1989 to 1994 Ms. Nelson was Assistant Vice President and Client Manager for
The Boston Company, Inc.
Gary S. MacDonald, Vice President and Assistant Treasurer (Age 32)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Mr. MacDonald is the
Vice President of FDI with which he has been associated since November 1996. He
also is an officer of certain investment companies advised or administered by
RCM. From September 1992 to November 1996 he was Vice President of Bay. Banks
Investment Management/Bay Bank Financial Services; and from April 1989 to
September 1992 he was an Analyst at Wellington Management Company.
B-26
<PAGE>
Marie E. Connolly, Vice President and Assistant Treasurer (Age 40)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Ms. Connolly is the
President, Chief Executive Officer, Chief Compliance Officer and Director of FDI
and Premier Mutual, and an officer of certain investment companies advised or
administered by Morgan and Dreyfus or their respective affiliates. From December
1991 to July 1994, Ms. Connolly was President and Chief Compliance Officer of
FDI. Prior to December 1991, Ms. Connolly served as Vice President and
Controller, and later Senior Vice President of TBCA.
Douglas C. Conroy, Vice President and Assistant Treasurer (Age 28)
60 State Street, Suite 130, Boston, Massachusetts 02109. Mr. Conroy is the
Assistant Vice President and Manager of Treasury Services and Administration of
FDI and an officer of certain investment companies advised or administered by
Morgan and Dreyfus or their respective affiliates. Prior to April 1997, Mr.
Conroy was Supervisor of Treasury Services and Administration of FDI. From April
1993 to January 1995, Mr. Conroy was a Senior Fund Accountant for Investors Bank
& Trust Company. From December 1991 to March 1993, Mr. Conroy was employed as a
Fund Accountant at The Boston Company, Inc.
Joseph F. Tower, III, Vice President and Assistant Treasurer (Age 35)
60 State Street, Suite 1300, Boston, Massachusetts 02109. Mr. Tower is the
Executive Vice President, Treasurer and Chief Financial Officer, Chief
Administrative Officer and Director of FDI; Senior Vice President, Treasurer and
Chief Financial Officer, Chief Administrative Officer and Director of Premier
Mutual, and an officer of certain investment companies advised or administered
by Morgan, Dreyfus and Waterhouse or their respective affiliates. Prior to April
1997, Mr. Tower was Senior Vice President, Treasurer and Chief Financial
Officer, Chief Administrative Officer and Director of FDI. From July 1988 to
November 1993, Mr. Tower was Financial Manager of The Boston Company, Inc.
John A. Farnsworth, Trustee (Age 55)
One California Street, Suite 1950, San Francisco, California 94111. Mr.
Farnsworth is a partner off 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.,
and 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.
B-27
<PAGE>
Andrew Cox, Trustee (Age 53)
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 48)
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.
R. Stephen Doyle, Chairman of the Board of Trustees (Age 56).*
101 California Street, San Francisco, California 94111.R. Stephen Doyle, the
founder of Montgomery Asset Management, began his career in the financial
services industry in 1974. Before starting Montgomery Asset Management in 1990,
Mr. Doyle was a General partner and member of the Management Committee at
Montgomery Securities with specific responsibility for private placements and
venture capital. Prior to joining Montgomery Securities, Mr. Doyle was at E. F.
Hutton & Co. as a Vice President with responsibility for both retail and
institutional accounts. Mr. Doyle was also with Connecticut General Insurance,
where he served as a Consultant to New York Stock Exchange Member Firms in the
area of financial planning.
<TABLE>
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. However, those officers and
Trustees who are officers or partners of the Manager or the Distributor may
receive remuneration indirectly because the Manager will receive a management
fee from the Funds and Funds Distributor, Inc., will receive commissions for
executing portfolio transactions for the Funds. The Trustees who are not
affiliated with the Manager or the Distributor receive an annual retainer and
fees and expenses for each regular Board meeting attended. The aggregate
compensation paid by each Trust to each of the Trustees during the fiscal year
ended December 31, 1997, and the aggregate compensation paid to each of the
Trustees during the fiscal year ended December 31, 1997 by all of the registered
investment companies to which the Manager provides investment advisory services,
are set forth below.
- ------------
* Trustee deemed an "interested person" of the Funds as defined in the
Investment Company Act.
B-28
<PAGE>
<CAPTION>
NAME OF TRUSTEE AGGREGATE COMPENSATION PENSION OR RETIREMENT TOTAL COMPENSATION FROM THE
FROM THE MONTGOMERY FUNDS BENEFITS ACCRUED AS PART OF TRUSTS AND FUND COMPLEX (2
III FUND EXPENSES* ADDITIONAL TRUSTS)
------------------------- --------------------------- --------------------------
<S> <C> <C> <C>
R. Stephen Doyle 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
Investment Management Services. As stated in each Prospectus,
investment management services are provided to the Funds by Montgomery Asset
Management, LLC (the "Manager"), pursuant to an Investment Management Agreement
between the Manager and The Montgomery Funds dated July 31, 1997 (the
"Agreement").
The Agreement is in effect with respect to each Fund for two years
after the Fund's inclusion in the Trust's Agreement (on or around its beginning
of public operations) and then continue for each Fund for periods not exceeding
one year so long as such continuation is approved at least annually by (1) the
Board or the vote of a majority of the outstanding shares of that Fund, and (2)
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, each Fund pays the Manager
a management fee (accrued daily but paid when requested by the Manager) based
upon the average daily net assets of the Fund at the following annual rates:
FUND AVERAGE DAILY NET ASSETS ANNUAL RATE
- ---- ------------------------ -----------
First $500 million 1.00%
Growth Fund Next $500 million 0.90%
Over $1 billion 0.80%
First $250 million 1.25%
Emerging Markets Fund Over $250 million 1.00%
First $250 million 1.25%
International Small Cap Fund Over $250 million 1.00%
First $200 million 1.20%
Small Cap Opportunities Fund Next $300 million 1.10%
Over $500 million 1.00%
B-29
<PAGE>
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,
expenses incurred in connection with any merger or reorganization or
extraordinary expenses such as litigation.
The Agreement was approved with respect to the Funds by the Board 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. The Manager's ability to request reimbursement is subject to various
conditions. First, any reimbursement is subject to a Fund's ability to effect
such reimbursement and remain in compliance with applicable expense limitations
in place at that time. Second, the Manager must specifically request the
reimbursement from the Board. Third, the Board must approve such reimbursement
as appropriate and not inconsistent with the best interests of the Fund and the
shareholders at the time such reimbursement is requested. Because of these
substantial contingencies, the potential reimbursements will be accounted for as
contingent liabilities that are not recordable on the balance sheet of a Fund
until collection is probable; but the full amount of the potential liability
will appear footnote to each Fund's financial statements. At such time as it
appears probable that a Fund is able to effect such reimbursement, that the
Manager intends to seek such reimbursement and that the Board has or is likely
to approve the payment of such reimbursement, the amount of the reimbursement
will be accrued as an expense of that Fund 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,
1997 1996 1995
---- ---- ----
Growth Fund* $ 0 $ 0 $ 0
Emerging Markets Fund* $ 1,201,496 $ 19,504 NA
International Small Cap Fund* $ 0 $ 0 NA
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FUND YEAR OR PERIOD ENDED DECEMBER 31,
1997 1996 1995
---- ---- ----
Small Cap Opportunities Fund* NA 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.
The Distributor. The Distributor may provide certain administrative
services to the Funds on behalf of the Manager. The Distributor 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 the Distributor with those of the Funds, and may restrict the
ability of the Distributor to provide services to the Funds.
The Custodian. Morgan Stanley Trust Company 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 in
accordance with delegation instructions approved by the Board 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 on 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 the Funds and which broker-dealers are eligible to execute
the Fund's portfolio transactions, subject to the instructions of, and review
by, that Fund and its Board. Purchases and sales of securities within the U.S.
other than on a
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<PAGE>
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 Emerging Markets Fund and the International Small Cap Fund
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 a 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.
Provided the Trust's officers are satisfied that the Funds are
receiving the most favorable price and execution available, the Manager may also
consider the sale of the Funds' shares as a factor in the selection of
broker-dealers to execute their portfolio transactions. The placement of
portfolio transactions with broker-dealers who sell shares of the Funds is
subject to rules adopted by the National Association of Securities Dealers, Inc.
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
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<PAGE>
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 that 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 that Fund or assist the
Manager in carrying out its responsibilities to that Fund. The standard of
reasonableness is to be measured in light of the Manager's overall
responsibilities to the Funds. The Board 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 a 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 that security
is thinly traded or is 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, a Fund 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 that 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, a Funds' transactions are bunched with the
transactions for other client accounts. It is recognized that in some cases this
system could have a detrimental effect on the price or value of the security
insofar as that 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.
The Manager's sell discipline for investments 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
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<PAGE>
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.
For each Fund, 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.
For the year ended December 31, 1997, the Funds' total securities
transactions generated commissions of $888,899, of which $90 was paid to
Montgomery Securities. For the year ended December 31, 1996, the Funds' total
securities transactions generated commissions of $125,421, of which $9 was paid
to Montgomery Securities. Throughout 1996 and through July 31, 1997, Montgomery
Securities was affiliated with the Funds through its ownership of Montgomery
Asset Management L.P., the former Manager of the Funds.
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 the Funds. However, 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 Funds 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 its Funds' shares, and (ii) reject purchase orders in
whole or in part when in the judgment of the Manager or the Distributor such
suspension or rejection is in the best interest of a Fund.
When in the judgment of the Manager it is in the best interests of a
Fund, an investor may purchase shares of that Fund by tendering payment in kind
in the form of securities, provided that any such tendered securities are
readily marketable (e.g., the Funds will not acquire restricted securities),
their acquisition is consistent with that Fund's investment objective and
policies, and the tendered securities are otherwise acceptable to that Fund's
Manager. Such securities are acquired by that Fund only for the purpose of
investment and not for resale. For the purposes of sales of shares of that Fund
for such securities, the tendered securities shall be valued at the identical
time and in the identical manner that the portfolio securities of that Fund are
valued for the purpose of calculating the net asset value of that Fund's shares.
A shareholder who purchases shares of a Fund by tendering payment for the shares
in the form of other securities may be required to recognize gain or loss for
income tax purposes on the difference, if any, between the adjusted basis of the
securities tendered to the Fund and the purchase price of the Fund's shares
acquired by the shareholder.
Payments to shareholders for shares of a Fund redeemed directly from
that Fund will be made as promptly as possible but no later than three days
after receipt by the Transfer Agent of
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<PAGE>
the written request in proper form, with the appropriate documentation as stated
in the Prospectus, except that a Fund may suspend the right of redemption or
postpone the date of payment during any period when (i) 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; (ii) 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 (iii) for such other
period as the SEC may permit for the protection of the Fund's shareholders.
The Funds intend to pay cash (U.S. dollars) for all shares redeemed,
but, under abnormal conditions that make payment in cash unwise, the Funds may
make payment partly in their portfolio securities with a current amortized cost
or market value, as appropriate, equal to the redemption price. Although the
Funds do not anticipate that they will make any part of a redemption payment in
securities, if such payment were made, an investor may incur brokerage costs in
converting such securities to cash. The Trusts have elected to be governed by
the provisions of Rule 18f-1 under the Investment Company Act, which require
that the Funds pay in cash all requests for redemption by any shareholder of
record limited in amount, however, during any 90-day period to the lesser of
$250,000 or 1% of the value of the Trust's net assets at the beginning of such
period.
The value of shares on redemption or repurchase may be more or less
than the investor'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 a 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 that 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., eastern time,
(or earlier when trading closes earlier) on each day the NYSE is open for
trading. It is expected that the NYSE will be closed on Saturdays and Sundays
and for New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas. The
national bank holidays, in addition to New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas, include, New Years Day, Good Friday, Columbus Day, Veteran's Day and
Christmas. The Funds may, but do not expect to, determine the net asset values
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
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<PAGE>
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 that will not be reflected in the computation of that Fund's net asset
value unless the Board 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.
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. Securities that are traded on more than
one exchange 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.
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, or at fair value as determined in good faith by procedures approved by
the Board. 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
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<PAGE>
price cannot be used, futures contracts will be valued at their fair market
value as determined by or under the direction of the Board.
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. The Board 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 currency into U.S. dollars, the
Board 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 in
good faith deems appropriate to reflect their fair value.
PRINCIPAL UNDERWRITER
The Distributor acts as the Funds' principal underwriter in a
continuous public offering of the Funds' shares. The Distributor is currently
registered as a broker-dealer with the SEC and in all 50 states, is a member of
most of the principal securities exchanges in the U.S., and is a member of the
National Association of Securities Dealers, Inc. The Underwriting Agreement
between each Fund and the Distributor is in effect for each Fund for the same
periods as the Agreements, and shall continue in effect thereafter for periods
not exceeding one year if approved at least annually by (i) the appropriate
Board or the vote of a majority of the outstanding securities of that Fund (as
defined in the Investment Company Act), and (ii) a majority of the Trustees who
are not interested persons of any such party, in each case by a vote cast in
person at a meeting called for the purpose of voting on such approval. The
Underwriting Agreement with respect to each Fund may be terminated without
penalty by the parties thereto upon 60 days' written notice and is automatically
terminated in the event of its assignment as
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<PAGE>
defined in the Investment Company Act. There are no underwriting commissions
paid with respect to sales of the Funds' shares.
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. A 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:
ERV - P
-------
P
Where: P = a hypothetical initial payment of $1,000.
ERV = Ending Redeemable Value of a hypothetical
$1,000 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.
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<PAGE>
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. Investors
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 YEAR INCEPTION*
ENDED THROUGH
DECEMBER 31, 1997 DECEMBER 31, 1997
----------------- -----------------
Growth Fund 28.57% 29.72%
International Small Cap Fund -5.10% 1.41%
Emerging Markets Fund -0.58% 3.18%
Small Cap Opportunities Fund** N/A N/A
* 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; and International Small Cap Fund,
September 30, 1996.
** The Small Cap Opportunities Fund has not, as of the date of this
Statement of Additional Information, commenced operations.
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, 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
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<PAGE>
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, an investor 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 mutual fund ranking services like Lipper Analytical Services, Inc.,
VARDS, and Morningstar, Inc.
Investors should note that the investment results of the Funds will
fluctuate over time, and any presentation of a Funds' total return for any
period should not be considered as a representation of what an investment may
earn or what a investor'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, consensus estimates, Datastream, Micropal, 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. The Funds may, by way of
further example, present a region as possessing the fastest growing economies
and may also present projected gross domestic product (GDP) for selected
economies.
Research. The Manager has developed its own tradition of intensive
research and has made intensive research one of the important characteristics of
the Montgomery Funds 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.
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<PAGE>
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.
From time to time, advertising and sales materials for the Montgomery
Funds may include biographical information about portfolio managers as well as
commentary by portfolio managers regarding investment strategy, asset growth,
current or past economic, political or financial conditions that may be of
interest to investors.
Also, from time to time, the Manager may refer to its quality and size,
including references to its total assets under management (as of December 31,
1997, over $10 billion for retail and institutional investors) and total
shareholders invested in the Funds (as of December 31, 1997, around 315,000).
GENERAL INFORMATION
Investors 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.
Expenses incurred in connection with the establishment and registration of
shares of each of the other funds constituting Trusts as separate series of the
Trusts have been assumed by each respective Fund. The expenses incurred in
connection with the establishment and registration of shares of the Funds as
separate series of the Trusts have been assumed by the respective Funds and are
being amortized over a period of five years commencing with their respective
dates of inception. The Manager has agreed, to the extent necessary, to advance
the organizational expenses incurred by certain Funds and will be reimbursed for
such expenses after commencement of those Funds' operations. Investors
purchasing shares of a Fund bear such expenses only as they are amortized daily
against that Funds' investment income.
As noted above, Morgan Stanley Trust Company (the "Custodian") acts as
custodian of the securities and other assets of the Funds. The Custodian does
not participate in decisions relating to the purchase and sale of securities by
the Funds.
Investors Fiduciary Trust Company, 127 West 10th Street, Kansas City,
Missouri 64105, is the Funds' Master Transfer Agent. The Master Transfer Agent
has delegated certain transfer agent functions to DST Systems, Inc., P.O. Box
419073, Kansas City, Missouri 64141-6073, the Funds' Transfer and Dividend
Disbursing Agent.
Price Waterhouse LLP, 555 California Street, San Francisco, California
94104, are the independent auditors for the Funds.
The validity of shares offered hereby will be passed on by Paul,
Hastings, Janofsky & Walker LLP, 345 California Street, San Francisco,
California 94104.
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Among the Board's powers enumerated in the Agreement and 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 March 31, 1998, 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 ADDRESS OF RECORD OWNER NUMBER OF PERCENT
SHARES OWNED OF SHARES
------------ ---------
Growth Fund
Great West Life & Annuity Insurance Co. 625,998.016 67.59
Benefits Corp Equities, Inc.
8515 East Orchard Road
Englewood, CO 80111
Fortis Benefits Insurance Company 97,516.842 10.53
500 Bielenberg Drive
Woodbury, Minnesota 55125
Providian Corporation 76,456.850 8.26
400 West Market Street
Louisville, Kentucky 40202
Canada Life Assurance Co. 75,513.620 8.15
Investment Division
300 university Ave
Toronto, Ontario M5G1R8
International Small Cap Fund
Great West Life & Annuity Insurance Co. 350,528.168 99.90
Benefits Corp Equities, Inc.
8515 East Orchard Road
Englewood, CO 80111
Emerging Markets Fund
American Skandia Life Assurance Corporation 9,871,841.260 90.35
1 Corporate Drive
P.O. Box 883
Shelton, Connecticut 08484-0883
As of March 31, 1998, the Trustees and Officers of the Trust, as a
group, owned less than 1% of the outstanding shares of each Fund.
The Trust is registered with the SEC as a non-diversified management
investment company, although each Fund is a diversified series of the Trust.
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
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<PAGE>
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, 1997, 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, 1997 (the "Report"), are incorporated
herein by reference to the Reports.
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APPENDIX
Description ratings for Standard & Poor's Ratings Group ("S&P");
Moody's Investors Service, Inc., ("Moody's"), Fitch Investors Service, L.P.
("Fitch") and Duff & Phelps Credit Rating Co. ("Duff & Phelps").
Standard & Poor's Rating Group
Bond Ratings
AAA Bonds rated AAA have the highest rating assigned by S&P.
Capacity to pay interest and repay principal is extremely
strong.
AA Bonds rated AA have a very strong capacity to pay interest and
repay principal and differ from the highest rated issues only
in small degree.
A Bonds rated A have a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the
adverse effects of changes in circumstances and economic
conditions than obligations in higher-rated categories.
BBB Bonds rated BBB are regarded as having an adequate capacity to
pay interest and repay principal. Whereas they normally
exhibit adequate protection parameters, adverse economic
conditions or changing circumstances are more likely to lead
to a weakened capacity to pay interest and repay principal for
bonds in this category than for bonds in higher rated
categories.
BB Bonds rated BB have less near-term vulnerability to default
than other speculative grade debt. However, they face major
ongoing uncertainties or exposure to adverse business,
financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal
payments.
B Bonds rated B have a greater vulnerability to default but
presently have the capacity to meet interest payments and
principal repayments. Adverse business, financial or economic
conditions would likely impair capacity or willingness to pay
interest and repay principal.
CCC Bonds rated CCC have a current identifiable vulnerability to
default and are dependent upon favorable business, financial
and economic conditions to meet timely payments of interest
and repayment of principal. In the event of adverse business,
financial or economic conditions, they are not likely to have
the capacity to pay interest and repay principal.
CC The rating CC is typically applied to debt subordinated to
senior debt which is assigned an actual or implied CCC rating.
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C The rating C is typically applied to debt subordinated to
senior debt which is assigned an actual or implied CCC- debt
rating.
D Bonds rated D are in default, and payment of interest and/or
repayment of principal is in arrears.
S&P's letter ratings may be modified by the addition of a plus
(+) or a minus (-) sign designation, which is used to show relative
standing within the major rating categories, except in the AAA (Prime
Grade) category.
Commercial Paper Ratings
An S&P commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no
more than 365 days. Issues assigned an A rating are regarded as having
the greatest capacity for timely payment. Issues in this category are
delineated with the numbers 1, 2 and 3 to indicate the relative degree
of safety.
A-1 This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those
issues determined to possess overwhelming safety
characteristics are denoted with a plus (+) designation.
A-2 Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as high
as for issues designated A-1.
A-3 Issues carrying this designation have a satisfactory capacity
for timely payment. They are, however, somewhat more
vulnerable to the adverse effects of changes in circumstances
than obligations carrying the higher designations.
B Issues carrying this designation are regarded as having only
speculative capacity for timely payment.
C This designation is assigned to short-term obligations with
doubtful capacity for payment.
D Issues carrying this designation are in default, and payment
of interest and/or repayment of principal is in arrears.
Moody's Investors Service, Inc.
Bond Ratings
Aaa Bonds which are rated Aaa are judged to be of the best
quality. They carry the smallest degree of investment risk and
generally are referred to as "gilt edge." 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,
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<PAGE>
such changes as can be visualized are most 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
generally are 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 in 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 speculative
elements; their future cannot be considered as well assured.
Often the protection of interest and principal payments may be
very moderate and, therefore, not well safeguarded during both
good and bad times in the future.
Uncertainty of position characterizes bonds in this class.
B Bonds which are rated B generally lack the characteristics of
a 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 present obligations which are
speculative in a high degree. Such issues are often in default
or have other marked shortcomings.
C Bonds which are rated C 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.
Moody's applies the numerical modifiers 1, 2 and 3 to show relative
standing within the major rating categories, except in the Aaa category
and in the categories below B. The modifier 1 indicates a ranking for
the security in the higher end of a rating category; the
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<PAGE>
modifier 2 indicates a mid-range ranking; and the modifier 3 indicates
a ranking in the lower end of a rating category.
Commercial Paper Ratings
The rating Prime-1 (P-1) is the highest commercial paper
rating assigned by Moody's. Issuers of P-1 paper must have a superior
capacity for repayment of short-term promissory obligations, and
ordinarily will be evidenced by leading market positions in well
established industries, high rates of return on funds employed,
conservative capitalization structures with moderate reliance on debt
and ample asset protection, broad margins in earnings coverage of fixed
financial charges and high internal cash generation, and well
established access to a range of financial markets and assured sources
of alternate liquidity.
Issuers (or related supporting institutions) rated Prime-2 (P-2) have a
strong capacity for repayment of short-term promissory obligations.
This ordinarily will be evidenced by many of the characteristics cited
above but to a lesser degree. Earnings trends and coverage ratios,
while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
Issuers (or related supporting institutions) rated Prime-3 (P-3) have
an acceptable capacity for repayment of short-term promissory
obligations. The effect of industry characteristics and market
composition may be more pronounced. Variability in earnings and
profitability may result in changes in the level of debt protection
measurements and the requirements for relatively high financial
leverage. Adequate alternate liquidity is maintained.
Issuers (or related supporting institutions) rated Not Prime do not
fall within any of the Prime rating categories.
Fitch Investors Service, L.P.
Bond Ratings
The ratings represent Fitch's assessment of the issuer's ability to
meet the obligations of a specific debt issue or class of debt. The
ratings take into consideration special features of the issue, its
relationship to other obligations of the issuer, the current financial
condition and operative performance of the issuer and of any guarantor,
as well as the political and economic environment that might affect the
issuer's future financial strength and credit quality.
AAA Bonds rated AAA are considered to be investment grade and of
the highest credit quality. The obligor has an exceptionally
strong ability to pay interest and repay principal, which is
unlikely to be affected by reasonably foreseeable events.
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AA Bonds rated AA are considered to be investment grade and of
very high credit quality. The obligor's ability to pay
interest and repay principal is very strong, although not
quite as strong as bonds rated AAA. Because bonds rated in the
AAA and AA categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these
issuers is generally rated F-1+.
A Bonds rated A are considered to be investment grade and of
high credit quality. The obligor's ability to pay interest and
repay principal is considered to be strong, but may be more
vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB Bonds rated BBB are considered to be investment grade and of
satisfactory credit 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 have an adverse impact on these
bonds and, therefore, impair timely payment. The likelihood
that the ratings of these bonds will fall below investment
grade is higher than for bonds with higher ratings.
BB Bonds rated BB are considered speculative. The obligor's
ability to pay interest and repay principal may be affected
over time by adverse economic changes. However, business and
financial alternatives can be identified which could assist
the obligor in satisfying its debt service requirements.
B Bonds rated B are considered highly speculative. While bonds
in this class are currently meeting debt service requirements,
the probability of continued timely payment of principal and
interest reflects the obligor's limited margin of safety and
the need for reasonable business and economic activity
throughout the life of the issue.
CCC Bonds rated CCC have certain identifiable characteristics,
which, if not remedied, may lead to default. The ability to
meet obligations requires an advantageous business and
economic environment.
CC Bonds rated CC are minimally protected. Default in payment of
interest and/or principal seems probable over time.
C Bonds rated C are in imminent default in payment of interest
or principal.
DDD, DD and D Bonds rated DDD, DD and D are in actual default of
interest and/or principal payments. Such bonds are extremely
speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of
the obligor. DDD represents the highest potential for recovery
on these bonds and D represents the lowest potential for
recovery.
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Plus (+) and minus (-) signs are used with a rating symbol to indicate
the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the AAA category covering 12-36
months.
Short-Term Ratings
Fitch's short-term ratings apply to debt obligations that are payable
on demand or have original maturities of up to three years, including
commercial paper, certificates of deposit, medium-term notes, and
municipal and investment notes.
Although the credit analysis is similar to Fitch's bond rating
analysis, the short-term rating places greater emphasis than bond
ratings on the existence of liquidity necessary to meet the issuer's
obligations in a timely manner.
F-1+ Exceptionally strong credit quality. Issues assigned this
rating are regarded as having the strongest degree of
assurance for timely payment.
F-1 Very strong credit quality. Issues assigned this rating
reflect an assurance of timely payment only slightly less in
degree than issues rated F-1+.
F-2 Good credit quality. Issues carrying this rating have a
satisfactory degree of assurance for timely payments, but the
margin of safety is not as great as the F-l+ and F-1
categories.
F-3 Fair credit quality. Issues assigned this rating have
characteristics suggesting that the degree of assurance for
timely payment is adequate; however, near-term adverse changes
could cause these securities to be rated below investment
grade.
F-S Weak credit quality. Issues assigned this rating have
characteristics suggesting a minimal degree of assurance for
timely payment and are vulnerable to near-term adverse changes
in financial and economic conditions.
D Default. Issues assigned this rating are in actual or imminent
payment default.
Duff & Phelps Credit Rating Co.
Bond Ratings
AAA Bonds rated AAA are considered highest credit quality. The
risk factors are negligible, being only slightly more than for
risk-free U.S. Treasury debt.
AA Bonds rated AA are considered high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from
time to time because of economic conditions.
A Bonds rated A have protection factors which are average but
adequate. However, risk factors are more variable and greater
in periods of economic stress.
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<PAGE>
BBB Bonds rated BBB are considered to have below average
protection factors but still considered sufficient for prudent
investment. There may be considerable variability in risk for
bonds in this category during economic cycles.
BB Bonds rated BB are below investment grade but are deemed by
Duff as likely to meet obligations when due. Present or
prospective financial protection factors fluctuate according
to industry conditions or company fortunes. Overall quality
may move up or down frequently within the category.
B Bonds rated B are below investment grade and possess the risk
that obligations will not be met when due. Financial
protection factors will fluctuate widely according to economic
cycles, industry conditions and/or company fortunes. Potential
exists for frequent changes in quality rating within this
category or into a higher or lower quality rating grade.
CCC Bonds rated CCC are well below investment grade securities.
Such bonds may be in default or have considerable uncertainty
as to timely payment of interest, preferred dividends and/or
principal. Protection factors are narrow and risk can be
substantial with unfavorable economic or industry conditions
and/or with unfavorable company developments.
DD Defaulted debt obligations. Issuer has failed to meet
scheduled principal and/or interest payments.
Plus (+) and minus (-) signs are used with a rating symbol (except AAA)
to indicate the relative position of a credit within the rating
category.
Commercial Paper Ratings
Duff-1 The rating Duff-1 is the highest commercial paper rating
assigned by Duff. Paper rated Duff-1 is regarded as having
very high certainty of timely payment with excellent liquidity
factors which are supported by ample asset protection. Risk
factors are minor.
Duff-2 Paper rated Duff-2 is regarded as having good certainty of
timely payment, good access to capital markets and sound
liquidity factors and company fundamentals. Risk factors are
small.
Duff-3 Paper rated Duff-3 is regarded as having satisfactory
liquidity and other protection factors. Risk factors are
larger and subject to more variation. Nevertheless, timely
payment is expected.
Duff-4 Paper rated Duff-4 is regarded as having speculative
investment characteristics. Liquidity is not sufficient to
insure against disruption in debt service. Operating factors
and market access may be subject to a high degree of
variation.
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Duff-5 Paper rated Duff-5 is in default. The issuer has failed to
meet scheduled principal and/or interest payments.
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