[Texas Capital Value Funds logo]
Dear Fellow Shareholder,
Stock markets around the world have declined over the
last few months. While our market decline shouldnt
be a shock, as we have discussed the possibility in
many of our quarterly letters, we understand it is no
fun. This is when it is important to keep perspective.
Following are some of the questions we have received
from clients.
If you knew the market was going to go down, why
didnt you sell, and wait until prices were cheaper?
We would if we could. Unfortunately, knowing the
market may decline at some point in the future has no
usefulness unless one knows exactly when. And since
the when is unknowable, the best we can do is buy
when we find good companies at value prices.
Remember that stock returns are generally compressed
into very short bursts followed by long periods of
modest returns. Statistically, those short bursts of big
returns occur only 2%-7% of the time. With stocks,
you have to stay in to win.
How far will stocks fall?
Periodically, the market averages will fall 10%-35%
from their peaks. The Russell 2000 Index, which most
closely resembles the list of stocks from which we
choose, has fallen 31% from its peak on April 21, 1998
through today. Were almost certainly a lot closer to
the bottom than we are to the top of the market.
Why should I be in small stocks?
In the words of the bank robber Willie Sutton, because
thats where the money is. Small-cap stocks have
provided superior long-term returns over large-caps.
From January 1926 to December 1994, small stocks
earned nearly 2% more each year than large-caps.
Style also makes a difference. Small-cap value, the
style in which your portfolio is managed, has almost
doubled the cumulative return of small growth from
June 1979 through June 30, 1998, according to
Wilshire Associates $1 grew to $32.46 in small value
stocks, and $17.62 in small growth stocks. In the long-
term, small value stocks are essential to any portfolio.
We think there is a good short-term justification too.
Over the 1969-73 period in which the Nifty 50
dominated, small stocks cumulatively underperformed
large stocks by 46.1%, much as they have
underperformed the Nifty 50 for the last five years.
(See chart on back.) In the subsequent five years, small
stocks trounced large stocks, providing a cumulative
return of 124.8% versus 13.2% for large stocks.
Unusual? Not according to Professor Marc Reinganum.
Like the tides, small and large stocks have shown an
almost certain tendency to reverse leads. When small
stocks lead for five years, large stocks will lead for the
next five years and vice versa. With small stocks
underperforming by the greatest margin since 1926,
overweighting smaller stocks makes sense as they
should produce stellar returns in the next five years.
The impetus for the tide shift is that smaller companies
are considerably cheaper and growing faster than their
larger brethren. The Russell 2000 companies have
beaten the S&P 500 in earnings growth for five
quarters in a row, according to Claudia Mott of
Prudential. Yet smaller companies are trading at much
cheaper P/E and P/BV ratios.
Is now a good time to increase my investment?
The goal of any investor is to buy when the prices are
low. Right now, your fund is trading at even cheaper
ratios than the cheapest index, the small-cap index.
Since inception through June 30, 1998, a period of
small-cap underperformance, your fund has
outperformed the S&P 500, and dwarfed the returns of
most other small-cap funds. There is no reason why it
cannot continue to do so when the market turns around.
Certainly, the markets are difficult, and may stay so for
some time. There is nothing new or unusual in this.
Were investing your funds along with our funds no
differently than we always have in good quality,
undervalued stocks. Its a strategy that has been
rewarded and will be rewarded again.
In difficult times, the supreme investor virtues are
courage and patience. We feel fortunate that our
shareholder group is strong on both.
Respectfully submitted,
Mark A. Coffelt, CFA
[small stock graph]
Dating back to 1926, every five-year period of small cap
underperformance was followed by significant periods of small cap
outperformance. The last five years has been the greatest period
of underperformance on record. Today, small caps' superior
earnings growth and low valuations lead us to conclude that we
are about to witness a historic era of small cap outperformance.
Data from "Predicting Size Effect Reversals" by Marc R. Reinganum
as published in Small Cap Stocks
PERFORMANCE* INCEPTION VALUATIONS* P/E P/B
P/CF
by Klein/Lederman. Comparison is between the largest market cap
decile and decile 5, corresponding S&P
500 INDEX 30.5%
roughly to the S&P 500 Index and Small Cap stocks of less than $1
billion in market cap. Data beyond TCVGX
34.2%
1991 reflects the Wilshire Large Growth v. Small Value Indices
for the 5 years ending June 30, 1998.
RUSSELL 2000 18.4% TCVGX 10.2x 1.7x 9.7x
Returns are historical and include change in share price and
reinvestment of dividends and capital gains.
*Inception for the Value & Growth Portfolio was November 6,
1995. Performance is through June 30, 1998. Including the
Past performance cannot guarantee future results. Return and
share price will fluctuate, and redemption
maximum sales charges, the annualized return for the Fund
would be 32.4%. Valuations are as of August 31, 1998.
value may be more or less than original cost. For more complete
information, including sales charges
While the reversals of large stocks and small stocks has
been consistent over time, there can be no guarantee such
and expenses, call for a Prospectus. Read it carefully before
you invest or send money. a reversal
will occur in the next five years.
