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April 15, 1999
Dear Fellow Micro-Cap Limited Shareholder,
Overall Summary
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In the March quarter the Portfolio gave up a portion of its fine December
quarter performance; it was down 12.6%. This was worse than our quarterly
benchmarks, all of which were also in negative territory. Fiscal year-to-date
we are down 6.0%, 8.6% better than the CRSP 9 Index of most similarly sized
companies. Over the last year (the closest period for which I have data) only
13% of domestic stock mutual funds have outperformed the market index of most
similarly sized companies by 8.5%. I hate to see an absolute negative return as
much as any shareholder, but our cumulative return relative to the market is
not too shabby.
Micro-cap stocks have lagged large stocks by one of the largest amounts on
record during the period since inception - not the environment in which I would
expect this Portfolio to excel. We are overdue for a micro-cap dominated
quarter. If volatility is part of the nature of micro-cap stocks (and it is),
we have seen more than our fair share the first year in existence. I'm looking
forward to a turnaround in market leadership.
Performance Summary
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Company size continues to be the primary determinant of performance in 1999.
Bridgeway's two large company portfolios were up 6% and 9% (ahead of their
market benchmarks) while our small company portfolios were all under water by a
significant margin. Details of our performance are presented in the next
section. The table below presents our quarterly and life-to-date performance
relative to three benchmarks.
March Qtr. Life-to-Date
1/1/99 to 6/30/98 to
3/31/99 3/31/99
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Micro-Cap Limited Portfolio -12.6% -6.0%
Lipper Small-Cap Stock Funds* -5.7% -10.7%
Russell 2000 (small growth stocks)* -5.8% -12.3%
CRSP Cap-Based Portfolio 9 Index* -7.9% -14.6%
*The Lipper Small Cap Stock Funds is an index of small-cap funds compiled by
Lipper Analytical Services, Inc. The Russell 2000 is an unmanaged index of
small stocks, with dividends reinvested. The CRSP Cap-Based Portfolio 9 Index
is an unmanaged index of 892 micro-cap companies compiled by the Center for
Research in Security Prices, with dividends reinvested. Past performance does
not guarantee future returns.
** The March quarter and life-to-date periods are not annualized.
Detailed Explanation of Performance - The Movers and the Shaken
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Translation: The decline in our Portfolio stocks was broad-based. It spanned
all sectors and each of our quantitative models. Surprisingly, our technology
stocks, which did so well in the December quarter, gave up substantial ground
in the current quarter.
Of 50 stocks we owned during the quarter, ten declined more than 25%. The worst
eight of these were all in the computer hardware, software, and service
industries. Our worst performing companies were:
<TABLE>
<CAPTION>
Rank Description Industry % Decline
---- ----------- -------- ---------
<S> <C> <C> <C>
1 Summit Design Inc. Data Processing-Software -63.1%
2 Inso Inc. Data Processing-Software -62.6%
3 Neomagic Corp Data Processing-Hardware -55.1%
4 DA Consulting Group Data Processing-Services -54.9%
5 Merisel Inc. Data Processing-Distribution -43.4%
6 Health Management Systems Data Processing-Services -39.7%
7 Ansys Inc. Data Processing-Software -37.5%
8 Media Arts Group Housewares -36.0%
9 American Physician Partners Services -35.5%
10 Amtran Air Transport -30.0%
</TABLE>
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Summit Design is an example of the frustration that I experienced in the first
quarter. When Dell Computers (a very large company which is not held in our
portfolio) came out with an earnings report meeting Wall Street expectations
but indicating some softness in sales growth, the stock declined about 20% from
its peak, but still finished the quarter up 12%. When Summit Design reported
earnings 20% above Wall Street estimates, but indicated some softness in sales,
the stock price declined 32% in one day, and ended the quarter down 63%. The
company has no debt and has cash equal to 58% of the current stock price. Cash
levels climbed significantly during the quarter. Analysts believe the company
will grow 30% per year over the next five years, but the stock is trading for
3.4 times next year earnings. Sure, I'm somewhat concerned by the short-term
prospects of slowing sales growth, but this is ridiculous. By comparison, Dell
has a bit more (but insignificant) debt and cash equal to 2% of its stock
price. Analysts believe the company will grow at about the same rate as Summit
Design in the next five years, but the stock is trading for 39 times earnings.
All else being equal (OK, all else is never equal), Dell is trading at a level
which is more than ten times as rich as Summit. Something's wrong here. Over
time, Wall Street tends to sort out these inequities, and I expect (not
predict) that our Portfolio will benefit in the sorting.
As large-cap technology companies trounced small-cap technology, the same was
true with Internet companies. The larger Internet companies in our Aggressive
Growth Portfolio soared. Of seven companies which rose more than 50% in that
portfolio, four were related to the Internet. Of our four micro-cap companies
with significant Internet exposure, two of them had negative returns and none
had exciting returns. The only major difference between these companies is
size. While historically the market has rewarded investors of micro-cap stocks
with better returns over longer timeframes, this was not true in the current
quarter.
Not all of our stocks suffered the carnage of those above. Four of our stocks
gained more than 20%:
<TABLE>
<CAPTION>
Rank Description Industry % Gain
---- ----------- -------- ------
<S> <C> <C> <C>
1 Forward Air Corp. Transportation/Freight 40.0%
2 Power Integrations Electronics/Electric 26.7%
3 Armor Holdings Inc. Machinery 24.2%
4 OSHAP Technologies Ltd. Furniture 21.6%
</TABLE>
Forward Air is an example of a company that is doing everything right, and it
has just taken Wall Street a while to figure it out. The stock price steadily
declined in the March quarter of 1998 along with the rest of the micro-cap
market, even though the company fundamentals were strong. Then, in October, the
company took the bold step of splitting its slower growth trucking business
apart from its faster growth service targeted to air carriers. (Forward Air is
the faster growing company; we sold Landair, the other one.) At first, Wall
Street just didn't know how to value the two new companies, since there was
little historical data of the separate companies. We continued to hold, and
Wall Street finally came around. The company split "2 for 1" (distributed an
additional share for each prior one held) in March. Earnings are accelerating,
and the company has beaten analysists' estimates each quarter since breaking
into separate companies.
Top Ten Holdings
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The following list will give you a flavor for the diversity and level of
concentration of our Portfolio. We rarely put more than 4% of Portfolio net
assets in any one company. I usually start to trim them when the company grows
above 5% through appreciation. At the end of the quarter the Portfolio held 41
stocks. Our top ten holdings on March 31 were:
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<TABLE>
<CAPTION>
Rank Description Industry % Net Assets
---- ----------- -------- ------------
<S> <C> <C> <C>
1 Power Integrations, Inc. Electronics/Electric 5.6%
2 Salton/Maxim House Electronics/Electric 5.2%
3 Creative Computers, Inc. Retail Stores 5.2%
4 Children's Place Retail Stores, Inc. Retail Stores 4.3%
5 Forward Air Corp. Transportation/Freight 4.0%
6 Innotrac Corp. Services 4.0%
7 O'Sullivan Industries Home Furnishings 3.9%
8 Pilgrim America Capital Corp. Finance 3.7%
9 Advanced Digital Information Data Processing-Hardware 3.6%
10 Arkansas Best Group Trucking 3.6%
----
Total 43.0%
</TABLE>
Disclaimer
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The following is a reminder from the friendly folks at your fund who worry
about liability. The views expressed here are exclusively those of Fund
management. They are not meant as investment advice. Any favorable (or
unfavorable) description of trends or holdings applies only as of the quarter
end, March 31, 1999, unless otherwise stated; security positions can and do
change thereafter.
Performance trends discussed here are historical and may not be repeated in the
future.
New Web Site at Bridgewayfund.com
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Our new web site will have its debut on May 1. As one shareholder put it, "It's
time to the enter the twentieth century; the twenty-first century is only
around the corner." We decided to wait until we could program it and support it
internally. I hope you'll find it substantive and useful. The next time you
speak to David, let him know what you think - or you can e-mail him at
[email protected]. There are several ways you might use the site. First,
we will publish our future shareholder letters on the site as soon as they are
available. Click on "Micro-Cap Limited" and then the most current report. This
will probably be much faster than waiting for "snail-mail," particularly if you
hold our shares through a fund marketplace. Second, you may have a question for
us after hours and prefer this medium to answering machines. I'm sure you'll
have other ideas. Please pass them on to us!
Morningstar
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Micro-Cap Limited Portfolio was recently a featured fund in Morningstar's
flagship publication. We thought you might be interested in what an outside
source is saying about us, so we're enclosing a copy.
Conclusion
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I recently clipped an editorial from an industry publication called Investment
News about shareholder reports:
The object should be to give the customer what he or she wants and
needs. For too long the mutual fund industry has provided its
customers with reports that have met its own needs.
Please let us know about your ideas. We occasionally get correspondence or
phone calls with suggested ideas, criticisms, or praise. We take them very
seriously, share them at our weekly staff meetings and continue to make
improvements as a result.
Sincerely,
/s/ JOHN MONTGOMERY
John Montgomery
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