<PAGE>
Montgomery Variable Series:
Growth Fund
Annual Report
December 31, 1998
[OWL ARTWORK APPEARS HERE]
Invest Wisely.(R)
THE MONTGOMERY FUNDS/SM/
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights
December 31, 1998
- --------------------------------------------------------------------------------
Investment Review
Q: HOW DID THE FUND PERFORM DURING THE SIX MONTHS ENDED DECEMBER 31, 1998?
A: Although the Fund enjoyed strong performance over the final three months
of the year, returning 18.65%, it underperformed the S&P 500 Index, which
returned 21.30%. Disappointingly, the Fund's fourth-quarter gain was also
not enough to offset its third-quarter loss. As a result, for the six
months ended December 31, 1998, the Fund returned -5.12% versus a return
of 9.35% for the S&P 500.
Q: WHAT FACTORS CONTRIBUTED TO THE FUND'S PERFORMANCE?
A: The narrowness of the U.S. market in both the third and fourth quarters
did not favor the Variable Series: Growth Fund's strategy. Our investment
approach considers not only expected growth potential but also attractive
valuations. We continued to focus on this disciplined approach, seeking
companies in the midst of positive fundamental change, with both
improving earnings growth and reasonable valuations. This resulted in a
portfolio that was concentrated in more cycle-sensitive and smaller-cap
names than the benchmark. Over the second half of the year, the market's
large-cap stocks outperformed midsized stocks. This was true during the
steep third-quarter market correction, when small and mid-sized stocks
lost value disproportionately to large-caps. In the fourth quarter, the
outperformance of a relatively small number of large-cap and Internet
issues masked much weaker returns in small-caps and cyclicals. In fact,
the stocks of just seven companies-including Microsoft, Intel, Dell and
Cisco-accounted for 77% of S+P 500's gains in 1998.
Q: DID YOU MAKE ANY CHANGES TO THE VARIABLE SERIES: GROWTH FUND'S PORTFOLIO
OVER THE SECOND HALF OF THE YEAR?
A: During the third-quarter market correction, we added a number of
companies with positive long-term fundamentals, capitalizing on their
attractive valuations. Capital One Financial (1.9% of assets as of
12/31/98) and Nokia (1.3% of assets as of 12/31/98) are two good examples
of companies that fit this criteria and represent the strategy of the
Fund. Capital One Financial is a technology-based credit-card issuer
which, in our opinion, is well positioned to grow at favorable rates.
Nokia is best known for cellular phones and related transmission
equipment. The company is gaining market share in an industry already
experiencing impressive growth rates. We see a bright future for Nokia
based on its
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 periods
ended 12/31/98
MONTGOMERY VARIABLE SERIES: GROWTH FUND
Since inception (2/9/96).............. 19.73%
One Year.............................. 2.93%
S&P 500 Index/1/
Since 1/31/96......................... 27.63%
One Year.............................. 28.60%
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:
Growth Fund S&P 500 Index/1/ Lipper Growth Funds Average/2/
<S> <C> <C> <C>
2/9/96 $10,000 $10,000 $10,000
2/96 $10,040 $10,093 $10,235
3/96 $10,437 $10,190 $10,318
4/96 $11,081 $10,340 $10,659
5/96 $11,766 $10,607 $10,943
6/96 $11,508 $10,647 $10,793
7/96 $11,002 $10,177 $10,154
8/96 $11,448 $10,392 $10,510
9/96 $11,954 $10,976 $11,123
10/96 $12,272 $11,279 $11,216
11/96 $12,817 $12,131 $11,911
12/96 $12,722 $11,890 $11,732
1/97 $13,166 $12,633 $12,352
2/97 $13,125 $12,732 $12,201
3/97 $12,671 $12,210 $11,633
4/97 $13,145 $12,938 $12,100
5/97 $14,229 $13,729 $12,973
6/97 $14,807 $14,339 $13,475
7/97 $16,354 $15,480 $14,619
8/97 $16,179 $14,613 $14,120
9/97 $17,066 $15,413 $14,907
10/97 $16,458 $14,899 $14,340
11/97 $16,499 $15,588 $14,588
12/97 $16,357 $15,856 $14,736
1/98 $15,956 $16,031 $14,822
2/98 $17,495 $17,187 $15,952
3/98 $18,416 $18,066 $16,657
4/98 $18,622 $18,251 $16,860
5/98 $17,972 $17,938 $16,377
6/98 $17,744 $18,666 $16,979
7/98 $16,769 $18,468 $16,580
8/98 $13,821 $15,800 $13,842
9/98 $14,189 $16,813 $14,675
10/98 $15,490 $18,179 $15,712
11/98 $16,400 $19,280 $16,682
12/98 $16,836 $20,390 $18,055
</TABLE>
- -------------------------
/1/ The Standard & Poor's 500 Index is composed of 500 widely held common
stocks listed on the NYSE, AMEX, and OTC market.
/2/ The Lipper Growth Funds universe consists of 601 funds.
1
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights (continued)
December 31, 1998
- -------------------------------------------------------------------------------
management's ability to exploit the tremendous growth potential in the
wireless communications market. Both of these companies were sold down
heavily during the third quarter.
Our discipline also dictates that we trim portfolio holdings when they reach
the upper levels of the growth and valuation characteristics we look for. This
resulted in a decision to sell our holdings in both Ascend and Texas
Instruments during the fourth quarter. We continue to see opportunities in
smaller and cycle-sensitive names, where the valuations are more reasonable.
Q: HOW WAS THE FUND POSITIONED AT THE END OF THE FOURTH QUARTER?
A: At the end of the year, the Fund remained fully invested and well
diversified across a broad spectrum of industries. Bearing in mind that
we follow a bottom-up investment approach, our company selections resulted
in the Fund being overweighted versus the S&P 500 Index in basic
industries, business services, capital goods and transportation. We are
currently underweight versus the index in consumer non-durables, financial
services, health care and public utilities.
Q: WHAT IS YOUR OUTLOOK FOR THE U.S. STOCK MARKET IN 1999?
A: Looking forward, economic data continues to forecast strength. Low levels
of unemployment, benign inflation and stable to falling interest rates
continue to fuel consumption, the main engine of economic growth. In view
of this, we anticipate continued, albeit more moderate, economic expansion
through 1999. Expectations are for 2.5 to 3% growth with modest inflation.
At the same time, consensus expectations are for modest corporate earnings
growth of approximately 4% in 1999. The implication of these earnings
growth expectations is price-to-earnings multiples of 26 times 1999
earnings if the S&P 500 Index reaches a level of 1250.
We believe these numbers suggest that we are overdue for a period when
rates of return from stocks regress to the average. After an extraordinary
16-year period of 18% annualized returns, we expect several years in which
stock returns come in somewhat below the historical average.
Q: IS THIS LIKELY TO PRESENT THE FUND WITH SOME INTERESTING OPPORTUNITIES?
A: In our view the market outlook for the coming year favors the Fund's
fundamental approach to investment, over the indexing approach that has
been so successful in the 1998 market. We expect to see a broadening
interest in the market, and the Fund may benefit from this trend. Our stock
selection approach has identified some very interesting companies that we
believe offer promising long-term growth prospects that are currently
trading at attractive valuations. The Fund is well positioned to take
advantage of the returns that these may generate should the market
recognize their potential.
2
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights (continued)
December 31, 1998
- -------------------------------------------------------------------------------
TOP FIVE INDUSTRIES AS OF 12/31/98
(AS A PERCENTAGE OF NET ASSETS)
Telecommunications Equipment............ 8.5%
Paper................................... 7.0
Railroad................................ 4.5
Clothing/Shoe/Accessory Stores.......... 4.5
Major Chemicals......................... 3.8
TOP TEN HOLDINGS AS OF 12/31/98
(AS A PERCENTAGE OF NET ASSETS)
General Motors Corporation.............. 3.4%
Nordstrom, Inc.......................... 3.2
Dow Chemical Company.................... 3.1
Golden West Financial Corporation....... 3.1
Comverse Technology, Inc................ 3.0
Donnelley (R.R.) & Sons Company......... 2.9
Manitowoc Company, Inc.................. 2.8
Avid Technology, Inc.................... 2.7
Amerada Hess Corporation................ 2.6
Canadian National Railway Company....... 2.6
3
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights (continued)
December 31, 1998
COMMON STOCKS-95.0% VALUE
SHARES (NOTE 1)
ADVERTISING - 2.2%
8,900 Snyder Communications, Inc. $300,375
--------
AIR FREIGHT/DELIVERY SERVICES - 2.6%
3,850 FDX Corporation 342,650
--------
ALUMINUM - 2.4%
4,350 Aluminum Company of America (Alcoa) 324,347
--------
APPAREL - 0.7%
2,050 VF Corporation 96,094
--------
BUILDING PRODUCTS - 1.0%
4,850 Masco Corporation 139,438
--------
CLOTHING/SHOE/ACCESSORY STORES - 4.5%
12,400 Nordstrom, Inc. 430,900
5,900 TJX Companies, Inc. 171,100
--------
602,000
--------
COMPUTER SOFTWARE - 3.6%
15,600 Avid Technology, Inc. 365,622
16,800 Sybase, Inc. 124,163
--------
489,785
--------
CONSTRUCTION/AGRICULTURE EQUIPMENT/TRUCKS - 3.6%
8,500 Manitowoc Company, Inc. 377,189
2,500 PACCAR, Inc. 102,500
--------
479,689
--------
CONSUMER ELECTRONICS/APPLIANCES - 1.1%
2,600 Whirlpool Corporation 143,975
--------
CONTRACT DRILLING - 0.4%
6,900 R&B Falcon Corporation + 52,613
--------
DISCOUNT STORES - 1.2%
2,900 Dayton Hudson Corporation 157,325
--------
DIVERSIFIED ELECTRONIC PRODUCTS - 1.5%
1,150 Matsushita Electric Industrial Company, Ltd., ADR 200,675
--------
DIVERSIFIED MANUFACTURE - 1.4%
2,550 Tyco International Ltd. 192,366
--------
ELECTRONIC DATA PROCESSING - 1.0%
8,500 Data General Corporation 139,719
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
4
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights (continued)
December 31, 1998
COMMON STOCKS-(continued) VALUE
SHARES (NOTE 1)
--------
ELECTRONIC DATA PROCESSING SERVICES - 3.2%
2,100 Computer Sciences Corporation $135,319
5,850 Electronic Data Systems Corporation 293,963
--------
429,282
--------
ELECTRICAL PRODUCTS - 2.3%
9,450 Raychem Corporation 305,353
--------
ENVIRONMENTAL SERVICES - 1.0%
6,900 Republic Services Inc., Class A + 127,219
--------
FINANCIAL COMPANIES - 1.9%
2,200 Capital One Financial Corporation 253,000
--------
FOOD DISTRIBUTORS - 1.2%
15,650 Fleming Companies, Inc. 162,367
--------
HOTELS/RESORTS - 1.0%
9,500 Host Marriott Corporation 131,218
--------
INDUSTRIAL MACHINERY/COMPONENTS - 1.1%
4,000 Applied Power Inc., Class A 151,000
--------
INTEGRATED OIL COMPANIES - 2.6%
7,100 Amerada Hess Corporation 353,225
--------
MAJOR BANKS - 0.9%
2,097 BankAmerica Corporation 126,082
--------
MAJOR CHEMICALS - 3.8%
4,550 Dow Chemical Company 413,766
2,100 Eastman Chemical Company 93,975
--------
507,741
--------
MANAGED HEALTH CARE - 1.6%
12,700 First Health Group Corporation + 209,947
--------
MEDICAL SPECIALTIES - 1.6%
3,600 Bausch & Lomb, Inc. 216,000
--------
MOTOR VEHICLES - 3.4%
6,450 General Motors Corporation 461,981
--------
MOVIES/ENTERTAINMENT - 2.8%
8,200 Fox Entertainment Group, Inc., Class A + 206,538
2,700 Time Warner, Inc. 167,569
--------
374,107
--------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
5
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights (continued)
December 31, 1998
COMMON STOCKS-(continued) VALUE
SHARES (NOTE 1)
MULTI-SECTOR COMPANIES - 1.2%
1,700 Loews Corporation $167,025
--------
OIL AND GAS PRODUCTION - 1.7%
24,650 Union Pacific Resources Group, Inc. 223,391
--------
OILFIELD SERVICES/EQUIPMENT - 1.4%
4,050 Schlumberger Ltd. 186,806
--------
OTHER CONSUMER SERVICES - 0.6%
4,294 Cendant Corporation 81,854
--------
OTHER METALS AND MINERALS - 1.0%
3,000 Rio Tinto PLC, Sponsored ADR 135,375
--------
PACKAGED FOODS - 1.3%
5,900 Dole Foods Company, Inc. 177,000
--------
PACKAGED GOODS/COSMETICS - 1.2%
1,950 Unilever N.V., ADR 161,728
--------
PAPER - 7.0%
10,100 Boise Cascade Corporation 313,100
5,000 Chesapeake Corporation 184,375
7,100 International Paper Company 318,169
4,900 Westvaco Corporation 131,381
--------
947,025
--------
PRINTING/FORMS - 3.6%
8,800 Donnelley (R.R.) & Sons Company 385,550
3,400 World Color Press, Inc. + 103,488
--------
489,038
--------
RAILROAD - 4.5%
6,800 Canadian National Railway Company 352,750
5,700 Union Pacific Corporation 256,856
--------
609,606
--------
REAL ESTATE INVESTMENT TRUST - 0.1%
950 Crestline Capital Corporation + 13,894
--------
SAVINGS AND LOAN ASSOCIATIONS - 3.1%
4,500 Golden West Financial Corporation 412,594
--------
SPECIALTY CHEMICALS - 1.3%
5,450 Nalco Chemical Company 168,950
--------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
6
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Highlights (continued)
December 31, 1998
COMMON STOCKS-(continued) VALUE
SHARES (NOTE 1)
SPECIALTY STEEL - 1.0%
3,950 Carpenter Technology Corporation $ 134,053
TELECOMMUNICATIONS EQUIPMENT - 8.5%
20,150 Aspect Telecommunications Corporation 351,365
5,635 Comverse Technology, Inc. + 399,909
3,450 Motorola, Inc. 210,666
1,500 Nokia Corporation, Sponsored ADR 180,656
----------
1,142,596
----------
TRUCKING - 1.9%
9,150 Swift Transportation Company, Inc. + 254,484
----------
TOTAL COMMON STOCKS (COST $11,898,377 ) 12,774,992
----------
REPURCHASE AGREEMENT - 4.6% (COST $617,000)
PRINCIPAL AMOUNT
$617,000 Agreement with Prudential Securities,
5.15% dated 12/31/98, to be repurchased at
$617,353, on 01/04/99, collateralized by
$629,340 market value of U.S. government
securities, having various maturities and
various interest rates. 617,000
-----------
TOTAL INVESTMENTS (COST $12,515,377*) 99.6% 13,391,992
OTHER ASSETS AND LIABILITIES (NET) 0.4 59,643
----- -----------
NET ASSETS 100.0% $13,451,635
===== ===========
- -------------------
* Aggregate cost for federal tax purposes is $12,556,718
+ Non-income producing security.
ABBREVIATION:
ADR American Depositary Receipt
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
7
<PAGE>
Montgomery Variable Series: Growth Fund
Portfolio Investments (continued)
December 31, 1998
<TABLE>
<CAPTION>
ASSETS:
<S> <C>
Investments in securities, at value
(Identified cost $12,515,377) (Note 1)
Securities............................................................................. $12,774,992
Repurchase agreements.................................................................. 617,000
-----------
Total investments...................................................................... 13,391,992
Cash........................................................................................ 718
Receivables:
Shares of beneficial interest sold..................................................... 96,431
Dividends.............................................................................. 27,588
Expenses absorbed by Manager (Note 2).................................................. 2,238
Interest............................................................................... 88
Miscellaneous.......................................................................... 2,673
Other Assets:
Deferred organization costs (Note 1)................................................... 27,226
-----------
Total Assets................................................................................ 13,548,954
-----------
LIABILITIES:
Payables:
Investment securities purchased......................... $ 49,728
Professional fees....................................... 24,889
Shares of beneficial interest redeemed.................. 15,343
Trustees' fees and expenses (Note 2).................... 3,705
Other accrued liabilities and expenses.................. 3,654
-----------
Total Liabilities........................................................................... 97,319
NET ASSETS.................................................................................. $13,451,635
===========
NET ASSETS CONSIST OF:
Undistributed net investment income................................................. $ 26,825
Accumulated net realized gain on securities sold.................................... 132,498
Net unrealized appreciation of investments.......................................... 876,615
Shares of beneficial interest....................................................... 8,742
Additional paid-in capital.......................................................... 12,406,955
-----------
NET ASSETS.................................................................................. $13,451,635
===========
Net Asset Value, offering and redemption price per share
($13,451,635/874,235 shares of beneficial interest outstanding)............................. $ 15.39
===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
8
<PAGE>
Montgomery Variable Series: Growth Fund
Statement of Operations
For the Year Ended December 31, 1998
<TABLE>
<CAPTION>
<S> <C>
NET INVESTMENT INCOME
Dividends (Net of foreign withholding taxes of $980).............................................. $ 166,874
Interest.......................................................................................... 90,948
-----------
Total Investment Income........................................................................... 257,822
EXPENSES:
Management fee (Note 2)................................................. $ 143,412
Professional fees....................................................... 18,002
Amortization of organization expenses (Note 1).......................... 12,410
Trustees' fees and expenses (Note 2).................................... 7,702
Custodian fees.......................................................... 3,585
Printing fees........................................................... 2,500
Other................................................................... 10,533
----------
Total Expenses.................................................................................... 198,144
Fees deferred and expenses absorbed by Manager (Note 2)........................................... (21,017)
-----------
NET EXPENSES...................................................................................... 177,127
-----------
NET INVESTMENT INCOME............................................................................. 80,695
-----------
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
(NOTES 1 AND 3):
Net realized gain on investments during the year.......................................... 197,527
Net unrealized depreciation of investments during the year................................ (87,985)
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS................................................... 109,542
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS............................................. $ 190,237
===========
</TABLE>
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Year Ended 12/31/97
Ended 12/31/98 For the Year
-------------- --------------
<S> <C> <C>
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS:
Net investment income.......................................................... $ 80,695 $ 124,367
Net realized gain on investments during the year............................... 197,527 431,903
Net unrealized appreciation/(depreciation) of investments during the year...... (87,985) 825,450
----------- -----------
Net increase in net assets resulting from operations........................... 190,237 1,381,720
DISTRIBUTIONS TO SHAREHOLDERS:
Distributions from net investment income....................................... (53,870) (123,377)
Distributions from net realized gains on investments (68,399) (443,288)
BENEFICIAL INTEREST TRANSACTIONS:
Net increase from beneficial interest transactions (Note 4).................... 786,288 9,655,629
----------- -----------
Net increase in net assets..................................................... 854,256 10,470,684
NET ASSETS:
Beginning of year.............................................................. 12,597,379 2,126,695
----------- -----------
End of year.................................................................... $13,451,635 $12,597,379
=========== ===========
Undistributed net investment income........................................... $ 26,870 $ 1,035
=========== ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
9
<PAGE>
Montgomery Variable Series: Growth Fund
Statement of Financial Highlights
December 31, 1998
Selected Per Share Data for the Year or Period Ended:
<TABLE>
<CAPTION>
12/31/98 12/31/97 12/31/96*
-------- -------- --------
<S> <C> <C> <C>
Net asset value-beginning of year............................................. $ 15.09 $ 12.33 $ 10.08
----------- --------- -----------
Net investment income......................................................... 0.09 0.16 0.15
Net realized and unrealized gain on investments............................... 0.35 3.35 2.59
----------- --------- -----------
Net increase in net assets resulting from investment operations............... 0.44 3.51 2.74
Distributions to Shareholders:
Distributions from net investment income................................. (0.06) (0.16) (0.15)
Distributions from net realized gains on investments..................... (0.08) (0.59) (0.34)
----------- --------- -----------
Total Distributions...................................................... (0.14) (0.75) (0.49)
----------- --------- -----------
Net asset value-end of year................................................... $ 15.39 $ 15.09 $ 12.33
=========== ========= ===========
Total return**................................................................ 2.93% 28.57% 27.22%
=========== ========= ===========
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of year (in 000's)............................................ $ 13,452 $ 12,597 $ 2,127
Ratio of net investment income to average net assets.......................... 0.57% 1.74% 2.55%+
Ratio of operating expenses to average net assets, including
interest expense......................................................... 1.25% 0.35% 0.01%+
Ratio of operating expenses to average net assets, excluding
interest expense......................................................... 1.25% 0.34% -
Portfolio turnover rate....................................................... 57% 53% 78%
Net investment income/(loss) before deferral of fees and absorption of
expenses by Manager......................................................... $ 0.07 $ 0.01 $ (0.27)
Operating expense ratio before deferral of fees and absorption of
expenses by Manager, including interest expense............................. 1.40% 1.97% 6.98%+
</TABLE>
- -----------------
* Montgomery Variable Series: Growth Fund commenced operations on February 9,
1996.
** Total return represents aggregate total return for the periods indicated.
+ Annualized.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
10
<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.
Information presented in these financial statements pertains to the
Montgomery Variable Series: Growth Fund (the "Fund"). The Montgomery
Variable Series: Emerging Markets Fund and the Montgomery Variable Series:
Small Cap Opportunities Fund are presented under separate covers.
1. SIGNIFICANT ACCOUNTING POLICIES:
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts and disclosures in the
financial statements. Actual results could differ 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.
Permanent differences incurred during the year ended December 31,
1998, resulting from differences in book and tax accounting have been
reclassified at year end to reflect a decrease undistributed net
investment income by $990 and increase accumulated net realized gain
on securities sold by $990.
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 the
supervision of the Board of Trustees, reviews the value of the
collateral and the creditworthiness of those banks and dealers with
which the Fund enters into repurchase agreements to evaluate potential
risks. The Fund may also participate on an individual or joint basis
in tri-party repurchase agreements which involve a counterparty and a
custodian bank.
11
<PAGE>
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.
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. ORGANIZATION COSTS
Expenses incurred in connection with the organization of the Fund
are amortized on a straight-line basis over a period of sixty months
from commencement of operations.
g. 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 $500 Million Next $500 Million Over $1 Billion
------------------ ----------------- ---------------
1.00% 0.90% 0.80%
</TABLE>
The Manager has agreed to reduce some or all of its management fee
or absorb the Fund's expenses if necessary to keep the Fund's annual
operating expenses, exclusive of interest or taxes, at or below 1.25%
of the average daily net assets of the Fund. Any reductions or
absorptions made for the Fund by the Manager of its fees are subject
to recovery within the following three years provided the Fund is
able to effect such reimbursement and remain in compliance with
applicable expense limitations. For the year ended December 31, 1998,
the Manager deferred fees of $21,017 and absorbed no expenses. As of
December 31, 1998, the deferred management fees and absorbed expenses
subject to recoupment are $209,945.
b. Certain officers and Trustees of the Trust are, with respect to
the Trust's Manager, "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.
12
<PAGE>
Montgomery Variable Series: Growth Fund
Notes to Financial Statements (continued)
3. SECURITIES TRANSACTIONS:
a. The aggregate amount of purchases and sales of investment
securities, other than short-term securities, for the year ended
December 31, 1998, were $9,495,257 and $7,049,756 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 $2,072,865 and $1,237,591 respectively.
c. Under an unsecured Revolving Credit Agreement with DeutscheBank (New
York), the Montgomery Variable Series: Growth Fund, along with other
funds of The Montgomery Funds, 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 year ended December 31, 1998, there were
no borrowings under this agreement.
4. TRANSACTIONS IN SHARES OF BENEFICIAL INTEREST:
The Trust has authorized an unlimited number of shares of beneficial
interest which have a par value of $0.01. Transactions in shares of
beneficial interest for the periods indicated below were:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1998 December 31, 1997
Shares Amount Shares Amount
<S> <C> <C> <C> <C>
Shares Sold 683,115 $10,396,707 1,117,506 $15,968,560
Issued as Reinvestment of Dividends 8,317 122,269 38,314 566,665
Shares Redeemed (652,075) (9,732,688) (493,401) (6,879,596)
------- --------- ------- ----------
Net Increase 39,357 $786,288 662,419 $9,655,629
======= ========= ======= ==========
</TABLE>
At December 31, 1998, shareholders with ownership of 10% or greater
included two shareholders comprising ownership of 71.14% of the total
aggregate shares outstanding.
14
13
<PAGE>
Report of Independent Accountants
To the Trustees and Shareholders of the Montgomery Variable Series: Growth 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: Growth
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 for the year then ended, and the changes in its net assets and the
financial highlights for each of the two years in the period then ended 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 audits. We
conducted our audits 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
audits, which included confirmation of investments at December 31, 1998 by
correspondence with the custodian and brokers, provide a reasonable basis for
the opinion expressed above. The financial statements of Montgomery Variable
Series: Growth Fund for the period from February 9, 1996 (commencement of
operations) through December 31, 1996 were audited by other independent
accountants whose report dated January 31, 1997 expressed an unqualified opinion
on those statements.
PRICEWATERHOUSECOOPERS LLP
SAN FRANCISCO, CA
FEBRUARY 12, 1999
14
<PAGE>
TAX INFORMATION
FISCAL YEAR ENDED DECEMBER 31, 1998
The amounts of long-term capital gains paid for the fiscal year ended
December 31, 1998, were as follows:
Montgomery Variable Series: Growth Fund............................ $23,28
Of the distribution made by the Fund, the corresponding percentage
represents the amount of the distribution which will qualify for the
dividends received deduction available to corporate shareholders:
Montgomery Variable Series: Growth Fund............................ 100%
15
