<PAGE>
Montgomery Variable Series:
Small Cap Opportunities Fund
Annual Report
December 31, 1998
[OWL ARTWORK APPEARS HERE]
Invest Wisely.(R)
THE MONTGOMERY FUNDS/SM/
<PAGE>
Montgomery Variable Series: Small Cap Opportunities Fund
Portfolio Highlights
December 31, 1998
- --------------------------------------------------------------------------------
Investment Review
Q: HOW DID THE FUND PERFORM FOR THE PERIOD ENDED DECEMBER 31, 1998?
A: As investors tended to shy away from investments they perceived to be too
risky, the roller-coaster market fluctuations of the second half of 1998
afforded a very poor environment for the small-cap market. The effect of
negative investor sentiment was magnified considerably, as small-cap
issues tended to be relatively illiquid.
Against this difficult market backdrop, the Montgomery Variable Series:
Small Cap Opportunities Fund was up 20.2% in comparison to the benchmark
Russell 2000 Index gain of 16.3% for the fourth quarter. This end-of-year
outperformance was not enough, however, to offset losses experienced
during the third quarter. For the volatile six-month period ended December
31, 1998, both the Variable Series: Small Cap Opportunities Fund and the
benchmark Russell 2000 reported negative figures: -7.0% and -7.1%,
respectively.
Q: DID THE COMPOSITION OF THE FUND CHANGE IN RESPONSE TO THE VOLATILE MARKET
CONDITIONS?
A: The Fund's strategy does not involve market timing or making sector bets.
Our focus is on fundamentally sound companies trading at attractive
valuations. Nevertheless, because deteriorating business conditions in
certain small-cap market segments resulted in a shrinking set of
attractive companies with improving fundamentals, the composition of the
Fund did change somewhat over the second half of the year.
As a result of our individual company analysis, the Fund's portfolio allocations
to energy, technology, consumer services and health care were reduced, and we
increased portfolio weightings in consumer non-durables, transportation, and
materials and processing. Relative to the Russell 2000, the Fund ended the year
overweight in materials and business services and underweight in finance, health
care and capital goods. Most of the portfolio revisions were minor.
Q: WHAT DO YOU CONSIDER TO BE THE MOST INTERESTING OPPORTUNITIES FOR SMALL-
CAP INVESTORS IN 1999?
A: Current fundamentals favor specific small-cap technology companies that
serve fast-growing markets. For example, fundamentals in the wireless
Portfolio Management
Roger W. Honour
.................. Senior Portfolio Manager
Kathryn M. Peters
.................. Portfolio Manager
Andrew Pratt, CFA
.................. Portfolio Manager
Fund Performance
Average annual total returns for the period
ended 12/31/98
MONTGOMERY VARIABLE SERIES:
SMALL CAP OPPORTUNITIES FUND
Since inception (5/1/98)............ -7.20%
Russell 2000 Index/1/
Since 5/1/98........................ -11.94%
Past performance is no guarantee of future
results. Net asset value, investment return
and principal value will fluctuate so that
shares, when redeemed, may be worth more or
less than their original cost.
<TABLE>
<CAPTION>
Montgomery Variable Series:
Small Cap Opportunities Fund Russell 2000 Index/1/ Lipper Small Cap Funds Average/2/
<S> <C> <C> <C>
5/1/98 $ 10,000 $10,000 $10,000
5/98 $ 9,390 $ 9,461 $ 9,437
6/98 $ 9,980 $ 9,481 $ 9,509
7/98 $ 9,050 $ 8,714 $ 8,826
8/98 $ 7,200 $ 7,022 $ 7,061
9/98 $ 7,720 $ 7,571 $ 7,466
10/98 $ 7,860 $ 7,880 $ 7,768
11/98 $ 8,460 $ 8,293 $ 8,269
12/98 $ 9,280 $ 8,806 $ 8,885
</TABLE>
- ---------------
/1/ The Russell 2000 Index is a capitalization-weighted total return index that
includes the smallest 2,000 companies within the Russell 3000 Index.
/2/ The Lipper Small Cap Funds universe consists of 678 funds.
1
<PAGE>
Montgomery Variable Series: Small Cap Opportunities Fund
Portfolio Highlights (continued)
December 31, 1998
- -------------------------------------------------------------------------------
communications and data networking areas remain solid, driven in large
part by new cellular subscriber growth and the expansion of the Internet.
As plays on these trends, the Fund owns positions in Actel Corp. (2.8% of
assets as of 12/31/98) and Comverse Technology (3.3% of assets as of
12/31/98). Actel sells specialty semiconductors to a variety of markets
including data communications; Comverse Technology makes equipment to
provide network-based voice-mail and other services to both the wireless
and wireline markets.
At the same time, we are keeping a close watch on the energy sector, which
is extremely depressed right now. In particular, an imbalance of supply
versus demand has resulted in low prices for the oil industry.
We believe that if global economies start to improve in 1999, oil stocks
could recover, piquing investor interest once again. Given the depressed
nature of oil stocks in general, we believe even a small improvement in
fundamentals could lead to some big returns. In anticipation of
opportunities going forward, we are vigilantly monitoring this area.
Q: WHAT'S YOUR OUTLOOK FOR SMALL-CAP STOCKS IN THE COMING YEAR?
A: We are cautiously optimistic about the prospects for the small-cap sector.
Although the U.S. economy is widely expected to slow, high rates of
employment, low interest rates and a benign inflation environment should
help unpin moderate economic growth. In our opinion this may prove a net
positive for the more domestically focused small-cap sector. Against this
backdrop is the idea that small-cap growth stocks may be able to deliver
stronger earnings growth versus the expected slower growth of large-caps
in 1999. Moreover, we believe that the outlook for large-cap companies'
earnings growth suggests that the market is overdue for a period when
rates of return for this sector regress to the average of 10% per annum
from the extraordinary 18% annualized returns of the past 16 years.
Historically, such an out come has led to the outperformance of the small-
cap sector.
- ---------------
There are risks associated with investing in small-cap companies, which tend to
be more volatile and less liquid than stocks of large companies, including the
increased risks of price fluctuations.
2
<PAGE>
Montgomery Variable Series: Small Cap Opportunities Fund
Portfolio Highlights Investments (continued)
December 31, 1998
- -------------------------------------------------------------------------------
TOP FIVE INDUSTRIES AS OF 12/31/98
(AS A PERCENTAGE OF TOTAL NET ASSETS)
Diversified Commercial Services.................. 15.7%
Electronic Data Processing Services.............. 8.4
Telecommunications Equipment..................... 4.7
Computer Software................................ 4.6
Homebuilding..................................... 3.9
TOP TEN HOLDINGS AS OF 12/31/98
(AS A PERCENTAGE OF TOTAL NET ASSETS)
Catalina Marketing Corporation................... 4.2%
Acxiom Corporation............................... 4.1
Tetra Tech., Inc................................. 3.9
Kronos, Inc...................................... 3.7
Education Management Corporation................. 3.6
Synopsis, Inc.................................... 3.6
Orthodontic Centers of America Inc............... 3.5
HA-LO Industries, Inc............................ 3.3
Comverse Technology, Inc......................... 3.3
TMP Worldwide, Inc............................... 3.1
3
<PAGE>
Montgomery Variable Series: Small Cap Opportunities Fund
Portfolio Investments
December 31, 1998
COMMON STOCKS--95.3% VALUE
SHARES (NOTE 1)
ADVERTISING - 3.1%
1,400 TMP Worldwide, Inc. $ $ 59,588
--------
APPAREL - 1.1%
1,000 Jones Apparel Group, Inc. + 22,063
--------
BROADCASTING - 1.5%
700 Metro Networks, Inc. + 29,794
--------
BUILDING PRODUCTS - 3.2%
3,200 Interface, Inc. 29,700
1,300 TJ International, Inc. 33,394
--------
63,094
--------
CATALOG/SPECIALTY DISTRIBUTION - 0.7%
1,000 Coldwater Creek, Inc. + 13,875
--------
CLOTHING/SHOE/ACCESSORY STORES - 2.0%
1,250 The Men's Wearhouse Inc. + 39,375
--------
COMPUTER SOFTWARE - 4.6%
1,500 Manugistics Group, Inc. + 18,703
1,300 Synopsis, Inc. + 70,443
--------
89,146
--------
CONSTRUCTION/AGRICULTURAL EQUIPMENT/TRUCKS - 1.6%
700 Manitowoc Company, Inc. 31,063
--------
CONTAINERS/PACKAGING - 2.3%
1,900 Ivex Packaging Corporation + 44,175
--------
DIVERSIFIED COMMERCIAL SERVICES - 15.7%
700 AptarGroup, Inc. 19,644
1,800 BA Merchant Services, Inc. + 36,225
1,000 Caribiner International, Inc. + 9,125
1,200 Catalina Marketing Corporation + 82,050
600 Fair Isaac & Company, Inc. 27,713
1,700 HA-LO Industries, Inc. + 63,963
1,900 Interim Services, Inc. + 44,411
644 Nova Corporation 22,339
--------
305,470
--------
ELECTRONIC DATA PROCESSING SERVICES - 8.4%
2,600 Acxiom Corporation + 80,437
1,500 Analysts International Corporation 28,969
2,000 Computer Task Group, Inc. 54,250
--------
163,656
--------
ENVIRONMENTAL SERVICES - 3.9%
2,800 Tetra Tech, Inc. 75,513
--------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
4
<PAGE>
Montgomery Variable Series: Small Cap Opportunities Fund
Portfolio Investments (continued)
December 31, 1998
<TABLE>
<CAPTION>
COMMON STOCKS--95.3% VALUE
SHARES (NOTE 1)
<S> <C> <C>
HOME FURNISHINGS - 1.3%
600 Ethan Allen Interiors, Inc. $24,600
--------
HOMEBUILDING - 3.9%
1,200 Champion Enterprises, Inc. + 32,850
1,500 Kaufman & Broad Home Corporation 43,125
--------
75,975
--------
INVESTMENT MANAGERS - 1.4%
1,200 Waddell & Reed Financial Inc., Class A 28,425
--------
MANAGED HEALTH CARE - 1.1%
1,050 Sierra Health Services. + 22,115
--------
MEDICAL/NURSING SERVICES - 3.5%
3,500 Orthodontic Centers of America, Inc. + 68,030
--------
MEDICAL SPECIALTIES - 0.9%
800 Cooper Companies, Inc. + 16,550
--------
MILITARY/GOVERNMENT/TECHNICAL - 1.5%
1,600 SBS Technologies, Inc. + 29,050
--------
OFFICE/PLANT AUTOMATION - 3.7%
1,600 Kronos, Inc. + 71,150
--------
OTHER CONSUMER SERVICES - 3.6%
3,000 Education Management Corporation + 70,594
--------
OTHER SPECIALTY STORES - 1.4%
700 Regis Corporation 27,978
--------
PACKAGE GOODS/COSMETICS - 1.7%
2,100 Playtex Products, Inc. + 33,731
--------
PAINTS/COATINGS - 2.3%
1,700 Ferro Corporation 44,200
--------
PRECISION INSTRUMENTS - 2.7%
600 Waters Corporation + 52,350
--------
PRINTING/FORMS - 2.1%
1,000 Big Flower Holdings, Inc. + 22,063
600 World Color Press, Inc. + 18,262
--------
40,325
--------
PROPERTY-CASUALTY INSURERS - 1.4%
800 Berkley (WR) Corporation 27,000
--------
RECREATIONAL PRODUCTS/TOYS - 2.2%
1,200 Action Performance Companies, Inc. + 42,375
--------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
5
<PAGE>
Montgomery Variable Series: Small Cap Opportunities Fund
Portfolio Investments (continued)
December 31, 1998
<TABLE>
<CAPTION>
COMMON STOCKS (continued) VALUE
SHARES (NOTE 1)
<C> <S> <C>
SAVINGS AND LOAN ASSOCIATIONS - 1.8%
1,500 Commercial Federal Corporation $34,781
--------
SEMICONDUCTORS - 2.8%
2,700 Actel Corporation. + 54,338
--------
SPECIALTY STEEL - 0.8%
450 Carpenter Technology Corporation 15,272
--------
TELECOMMUNICATIONS EQUIPMENT - 4.7%
1,600 Aspect Telecommunications Corporation 27,900
900 Comverse Technology Inc. + 63,872
--------
91,772
--------
TRUCKING - 2.4%
1,600 US Freightways Corporation 46,600
--------
TOTAL COMMON STOCKS (COST $1,764,562) 1,854,023
---------
REPURCHASE AGREEMENTS--7.4%
PRINCIPAL AMOUNT
$95,000 Agreement with Greenwich Capital Markets,
Tri-Party, 5.15% dated 12/31/98, to be repurchased
at $95,054, on 01/04/99, collateralized by $96,900
market value of US government securities, having
various maturities and various interest rates 95,000
--------
50,000 Agreement with Prudential Securities, 5.15% dated
12/31/98, to be repurchased at $50,029, on 01/04/99,
collateralized by $51,000 market value of US government
securities, having various maturities and various
interest rates 50,000
--------
TOTAL REPURCHASE AGREEMENTS (COST $145,000) 145,000
--------
TOTAL INVESTMENTS (COST $1,909,562*) 102.7% 1,999,023
OTHER ASSETS AND LIABILITIES (NET) (2.7) (53,420)
----- ----------
NET ASSETS 100.0% $1,945,603
===== ==========
</TABLE>
- --------------
* Aggregate cost for federal tax purposes was $1,923,406.
+ Non-income producing security.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
6
<PAGE>
Montgomery Variable Series: Small Cap Opportunities Fund
Statement of Assets and Liabilities
December 31, 1998
<TABLE>
<CAPTION>
<S> <C>
ASSETS:
Investments in securities, at value
(Identified cost $1,909,562)(Note 1)
Securities..................................................... $1,854,023
Repurchase agreements.......................................... 145,000
----------
Total investments.............................................. 1,999,023
Cash................................................................ 68
Receivables:
Investment securities sold..................................... 4,223
Dividends...................................................... 387
Interest....................................................... 21
Total Assets........................................................ 2,003,722
LIABILITIES:
Payables:
Investment securities purchased............... $ 19,342
Management fee (Note 2)....................... 16,439
Professional fees............................. 13,158
Trustees' fees and expenses (Note 2).......... 3,314
Custodian fees................................ 1,198
Other accrued liabilities and expenses........ 4,668
---------
Total Liabilities................................................... 58,119
----------
NET ASSETS.......................................................... $1,945,603
==========
NET ASSETS consist of:
Distributions in excess of net investment income............... $ (7,526)
Accumulated net realized loss on securities sold............... (217,717)
Net unrealized appreciation of investments,.................... 89,461
Shares of beneficial interest.................................. 2,097
Additional paid-in capital..................................... 2,079,288
----------
NET ASSETS.......................................................... $1,945,603
----------
Net Asset Value, offering and redemption price per share
($1,945,603 divided by 209,748 shares of beneficial interest
outstanding)........................................................ $ 9.28
----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
7
<PAGE>
Montgomery Variable Series: Small Cap Opportunities Fund
Statement of Operations
For the Period Ended December 31, 1998*
<TABLE>
<CAPTION>
<S> <C>
INVESTMENT INCOME:
Interest................................................................ $ 7,347
Dividends............................................................... 2,821
Total Investment Income................................................. 10,168
EXPENSES:
Management fee (Note 2)........................... $ 14,153
Professional fees................................. 15,440
Trustees' fees and expenses (Note 2).............. 5,169
Custodian fees.................................... 2,895
Other............................................. 6,094
----------
TOTAL EXPENSES.......................................................... 43,751
Fees deferred and expenses absorbed by Manager (Note 2)................. (26,057)
----------
NET EXPENSES............................................................ 17,694
----------
NET INVESTMENT LOSS..................................................... (7,526)
----------
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
(NOTES 1 AND 3):
Net realized loss on investments during the period................ (217,717)
Net unrealized appreciation of investments during the period...... 89,461
----------
NET REALIZED AND UNREALIZED LOSS ON INVESTMENTS......................... (128,256)
----------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS.................... $ (135,782)
==========
STATEMENT OF CHANGES IN NET ASSETS
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS:
Net investment loss..................................................... $ (7,526)
Net realized loss on investments during the period...................... (217,717)
Net unrealized appreciation of investments during the period............ 89,461
----------
Net decrease in net assets resulting from operations.................... (135,782)
BENEFICIAL INTEREST TRANSACTIONS:
Net increase from beneficial interest transactions (Note 4)............. 81,385
----------
Net decrease in net assets.............................................. (54,397)
NET ASSETS:
Beginning of period..................................................... 2,000,000
----------
End of period........................................................... $1,945,603
==========
Distributions in excess of net investment income........................ $ (7,526)
==========
</TABLE>
- --------------
* Montgomery Variable Series: Small Cap Opportunities Fund commenced operations
on May 1, 1998.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
8
<PAGE>
Montgomery Variable Series: Small Cap Opportunities Fund
Financial Highlights
Selected Per Share Data for the Period Ended:
<TABLE>
<CAPTION>
12/31/98*
----------
<S> <C>
Net asset value--beginning of period..................................... $ 10.00
----------
Net investment loss...................................................... (0.04)
Net realized and unrealized loss on investments.......................... (0.68)
----------
Net decrease in net assets resulting from investment operations.......... (0.72)
----------
Net asset valueend of period............................................. $ 9.28
==========
Total return**........................................................... (7.20)%
==========
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's)..................................... $ 1,946
Ratio of net investment loss to average net assets....................... (0.64)%+
Ratio of operating expenses to average net assets........................ 1.50%+
Portfolio turnover rate.................................................. 82%
Net investment loss before deferral of fees and absorption of
expenses by Manager.................................................. $ (0.16)
Operating expense ratio before deferral of fees and absorption of
expenses by Manager.................................................. 3.71%+
</TABLE>
- --------------
* Montgomery Variable Series: Small Cap Opportunities Fund commenced operations
on May 1, 1998.
** Total return represents aggregate total return for the period indicated.
+ Annualized.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
9
<PAGE>
The Montgomery Funds III
Notes to Financial Statements
The Montgomery Funds III (the "Trust") is registered under the Investment
Company Act of 1940, as amended (the "1940 Act"), as a diversified, open-
end management investment company and was organized as a Delaware business
trust on August 24, 1994. As of December 31, 1998, the Trust had three
series, the Montgomery Variable Series: Growth Fund, the Montgomery
Variable Series: Emerging Markets Fund and the Montgomery Variable Series:
Small Cap Opportunities Fund. On December 31, 1998, the Montgomery Variable
Series: International Small Cap Fund (previously a series of the Trust)
returned paid-in capital to shareholders thus liquidating the fund.
Montgomery Variable Series: Small Cap Opportunities Fund commenced
operations on May 1, 1998 with an initial funding of $2,000,000 and 200,000
shares. Information presented in these financial statements pertains to the
Montgomery Variable Series: Small Cap Opportunities Fund (the "Fund"). The
Montgomery Variable Series: Growth Fund and the Montgomery Variable Series:
Emerging Markets Fund are presented under separate covers.
1. SIGNIFICANT ACCOUNTING POLICIES:
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the
financial statements. Actual results could differ from those estimates. The
following is a summary of significant accounting policies.
a. PORTFOLIO VALUATION
The Fund's securities are valued using current market valuations:
either the last reported sales price or, lacking any reported sales,
and in the case of fixed income securities, the mean between the
closing bid and asked prices. Securities for which market quotations
are not readily available (including restricted securities which are
subject to limitations as to their sale) are valued at fair value by
management as determined in good faith by or under the supervision of
the Trust in accordance with methods which are authorized by the
Trust's Board of Trustees. Short term debt obligations with remaining
maturities in excess of 60 days are valued at current market prices,
as discussed above. Short-term securities with maturities of 60 days
or less are carried at amortized cost, which approximates market
value.
b. DIVIDENDS AND DISTRIBUTIONS
Dividends from net investment income, if any, are declared and paid
at least annually. Distributions of net realized capital gains
(including net short-term capital gains) are distributed no less
frequently than annually. Additional distributions of net investment
income and capital gains for the Fund may be made in order to avoid
the application of a 4% non-deductible excise tax on certain
undistributed amounts of ordinary income and capital gains. Income
distributions and capital gain distributions are determined in
accordance with income tax regulations which may differ from
generally accepted accounting principles. These differences are
primarily due to differing treatments of income and gains on various
investment securities held by the Fund, timing differences and
differing characterizations of distributions made by the Fund.
c. REPURCHASE AGREEMENTS
The Fund may engage in repurchase agreement transactions individually
or jointly through a joint repurchase account with other series of
the Trust and affiliated registered investment companies pursuant to
a joint repurchase agreement. Under the terms of a typical repurchase
agreement, the Fund takes possession of a government debt obligation
as collateral. The Fund also agrees with the counterparty to allow
the counterparty to repurchase, and the Fund to resell the obligation
at a specified date and price, thereby determining the yield during
the Fund's holding period. This arrangement results in a fixed rate
of return that is not subject to market fluctuations during the
Fund's holding period. The value of the collateral is at least equal
at all times to the total amount of the repurchase obligations,
including interest. In the event of counterparty default, the Fund
has the right to use the collateral to offset losses incurred. There
could be potential loss to the Fund in the event the Fund is delayed
or prevented from exercising its rights to dispose of the collateral
securities, including the risk of a possible decline in the value of
the underlying securities during the period while the Fund seeks to
assert its rights. The Fund's investment manager, acting under the
supervision of the Board of Trustees, reviews the value of the
collateral and the creditworthiness of those banks and dealers with
which the Fund enters into repurchase agreements to evaluate
potential risks. The Fund may also participate on an individual or
joint basis in tri-party repurchase agreements which involve a
counterparty and a custodian bank.
d. SECURITIES TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are recorded on a trade-date basis. Realized
gain and loss from securities transactions are computed on the
specific identified cost basis of the securities sold. Dividend
income is recognized on the ex-dividend date. Interest income,
including accretion/amortization of premium/discount on short-term
investments, is recognized on an accrual basis.
10
<PAGE>
The Montgomery Funds III
Notes to Financial Statements (continued)
e. FEDERAL INCOME TAXES
The Fund has elected and qualified and it is the intention of the
Fund to continue to qualify as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"), by complying with the applicable requirements of the Code,
and by making distributions of taxable income to shareholders
sufficient to relieve the Fund from all or substantially all federal
income taxes. Accordingly, no provision for federal income taxes is
required.
f. EXPENSES
General expenses of the Trust are allocated to the Fund based upon
relative net assets. Operating expenses directly attributable to the
Fund are charged to the Fund's operations.
2. MANAGEMENT FEES AND OTHER TRANSACTIONS WITH AFFILIATES:
a. Montgomery Asset Management, LLC is the Fund's Manager (the
"Manager"). The Manager, a Delaware limited liability company, is an
investment adviser registered with the Securities and Exchange
Commission under the Investment Advisers Act of 1940, as amended (the
"Advisers Act"). The Manager is a subsidiary of Commerzbank AG.
Pursuant to the investment management agreement (the "Agreement"),
the Manager provides the Fund with advice on buying and selling
securities, manages the investments of the Fund including the
placement of orders for portfolio transactions, furnishes the Fund
with office space and certain administrative services, and provides
the personnel needed by the Trust with respect to the Manager's
responsibilities under the Agreement. As compensation, the Fund pays
the Manager a monthly management fee (accrued daily) at the following
annual rates based upon the average daily net assets of the Fund:
<TABLE>
<S> <C> <C>
First $200 Million Next $300 Million Over $500 Million
------------------ ----------------- -----------------
1.20% 1.10% 1.00%
</TABLE>
The Manager has agreed to reduce some or all of its management fee or
absorb the Fund expenses if necessary to keep the Fund's annual
operating expenses, exclusive of interest or taxes, at or below 1.50%
of the average daily net assets of the Fund. Any reductions or
absorptions made for the Fund by the Manager of its fees are subject
to recovery within the following three years provided the Fund is
able to effect such reimbursement and remain in compliance with
applicable expense limitations. For the period ended December 31,
1998, the Manager deferred fees of $14,153 and absorbed expenses of
$11,904. As of December 31, 1998, the deferred management fees and
absorbed expenses subject to recoupment are $26,057.
b. Certain officers and Trustees of the Trust are, with respect to the
Trust's Managers, "affiliated persons" as defined in the 1940 Act.
Each Trustee who is not an "affiliated person" receives an annual
retainer and quarterly meeting fees totalling $55,000 per annum, as
well as reimbursement for expenses, for services as a Trustee of all
three Trusts advised by the Manager ($5,000 of which will be
allocated to the Montgomery Funds III).
MAM Securities, LLC ("MAM Securities") serves as the Fund's transfer agent.
3. SECURITIES TRANSACTIONS:
a. The aggregate amount of purchases and sales of investment securities,
other than short-term securities, for the period ended December 31,
1998, were $3,150,671 and $1,168,392, respectively.
b. At December 31, 1998, aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost and
aggregate gross unrealized depreciation for all securities in which
there was an excess of tax cost over value for federal income tax
purposes were $238,177 and $162,560 respectively.
c. Under an unsecured Revolving Credit Agreement with DeutscheBank (New
York), the Montgomery Variable Series: Small Cap Opportunities Fund,
along with other funds of The Montgomery Funds, The Montgomery Funds
II and The Montgomery Funds III, may for one year starting August 13,
1998, borrow (consistent with applicable law and its investment
policies) up to 10% of its net asset value, provided that the
aggregate principal amount of outstanding loans under the agreement
to all Funds does not exceed $175,000,000. The Fund pays its pro-rata
share of the quarterly commitment fee of 0.08% per annum of the
unutilized credit line balance. For the period ended December 31,
1998, there were no borrowings under this agreement.
11
<PAGE>
The Montgomery Funds III
Notes to Financial Statements (continued)
4. TRANSACTIONS IN SHARES OF BENEFICIAL INTEREST:
The Trust has authorized an unlimited number of shares of beneficial
interest which have a par value of $0.01. Transactions in shares of
beneficial interest for the period indicated below were:
<TABLE>
<CAPTION>
PERIOD ENDED
DECEMBER 31, 1998*
SHARES AMOUNT
<S> <C> <C>
Shares Sold 13,660 $114,412
Shares Redeemed (3,912) (33,027)
------ --------
Net Increase 9,748 $ 81,385
====== ========
</TABLE>
At December 31, 1998, shareholders with ownership of 10% or greater
included one shareholder, comprising ownership of 100% of the total
aggregate shares outstanding.
5. CAPITAL LOSS CARRYFORWARD:
At December 31, 1998, the Fund had available for Federal income tax
purposes unused capital losses of $203,873 expiring in 2006.
- ---------------
* Montgomery Variable Series: Small Cap Opportunities Fund commenced operations
on May 1, 1998, with initial funding of $2,000,000 and 200,000 shares.
12
<PAGE>
Report of Independent Accountants
To the Trustees and Shareholders of the Montgomery Variable Series: Small Cap
Opportunities Fund
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Montgomery Variable Series: Small
Cap Opportunities Fund (one of the portfolios constituting The Montgomery Funds
III, and hereafter referred to as the "Fund") at December 31, 1998, and the
results of its operations, the changes in its net assets and the financial
highlights for the period May 1 to December 31, 1998, in conformity with
generally accepted accounting principles. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit, which included
confirmation of investments at December 31, 1998 by correspondence with the
custodian and brokers, provides a reasonable basis for the opinion expressed
above.
PRICEWATERHOUSECOOPERS LLP
SAN FRANCISCO, CA
FEBRUARY 12, 1999
13
