<PAGE> 1
April 15, 1999
Dear Fellow Ultra-Small Company Shareholder,
Overall Summary
- ---------------
The quarterly picture: Small-company, value-oriented funds saw a significant
downturn in the March quarter, and ours was in the middle of the pack - down
9.9%. This really hurts, as the popularly quoted large company indexes were up
7.0% (Dow Jones Industrial Average) and 5.0% (S&P 500) and Bridgeway's own
large-cap portfolios were above their benchmarks in positive territory. The
(outrageously priced) recent market darlings - Internet and mega-large
technology stocks passed us by.
The mid-term picture: We still rank number one of the fifteen funds with a
median market capitalization of less than $120 million (twice our size) over
the last three years. Since inception, we have beaten the market benchmark
closest in size by a compound average of 4.8% per year. Less than 5% of
domestic mutual funds have accomplished this over the last five years (the
closest period for which I have data). Of course, since larger companies have
run counter to the long-term trend by outperforming small companies during this
period, our absolute returns have lagged many funds.
The long-term picture: Including the worst five-year period relative to large
stocks on record (March 1994 through March 1999), ultra-small companies have
still outperformed large ones by 2.7% per year according to data from the
Center for Research in Security Prices. That's a big difference over time.
The really short-term picture: OK, I don't attach much importance to a one-year
record, much less a one-week record. But if you're looking for recent hope for
a market which favors our stocks, we just had the best small-cap and
value-stock week relative to large and growth companies that we've seen in more
than a year.
Outlook: With the downturn of the most recent quarter, some of our stocks are
starting to look ridiculously inexpensive to me again as they did last October.
According to our models, we own a large number of very inexpensive companies by
historical standards. I'm not changing anything about our portfolio orientation
or my own heavy exposure to ultra-small companies. We practice extreme
discipline in this regard at Bridgeway. I continue to believe our ultra-small
focus will have its "day in the sun" again, in line with longer-term historical
returns. As always, this doesn't mean that the next price move of ultra-small
stocks is necessarily up. Cheap stocks can always get cheaper.
Performance Summary
- -------------------
Company size continues to be the primary determinant of performance in 1999,
and it continues to run counter to the long-term historical trend. Over the
twelve-month period through March, very large stocks (those the size of the top
10% of the New York Stock Exchange) outperformed ultra-small ones by 46%, the
largest amount since the Great Depression. On top of that, growth-oriented
small stocks outperformed value-oriented small stocks by a great margin--about
14%. Since our portfolio invests in some of the smallest and currently most
value-oriented companies around, it really got caught in the cross-hairs of
these two trends.
Bridgeway's own portfolios reflect the divergence of the broader market. Our
two large company portfolios were up 6% and 9% (ahead of their market
benchmarks), our Aggressive Growth Portfolio was up 9% due to some exposure to
large company technology and Internet stocks, while our small company
portfolios (Ultra-Small Company, Micro-Cap Limited, and Ultra-Small Index) were
all under water significantly. Year-to-date through the date of this letter,
our Ultra-Small Company Portfolio leads our other two portfolios focused on
very small companies. Details of our performance are
<PAGE> 2
presented in the next section. The table below presents our quarterly and
life-to-date performance relative to three benchmarks.
<TABLE>
<CAPTION>
March Qtr. One Year Life-to-Date
1/1/99 4/1/98 8/5/94 to
to 3/31/99 to 3/31/99 3/31/99**
---------- ---------- ------------
<S> <C> <C> <C>
Ultra-Small Company Portfolio -9.9% -32.0% 14.9%
Lipper Small-Cap Stock Funds* -5.7% -15.3% 15.1%
Russell 2000 (small growth stocks)* -5.4% -16.3% 12.6%
CRSP Cap-Based Portfolio 10 Index* -6.0% -24.3% 10.1%
</TABLE>
*The Lipper Small-Cap Stock Funds is an index of small company 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 10 Index
is an unmanaged index of 2,655 ultra-small companies compiled by the Center for
Research in Security Prices, with dividends reinvested. Past performance does
not guarantee future returns.
** Life-to-date returns are annualized; the March quarter period is not
annualized.
Detailed Explanation of Performance - Value Funds Lag Badly
- -----------------------------------------------------------
Translation: In the current quarter, being invested in very small stocks didn't
help our performance; nor did being invested in companies with relatively low
valuations. (Growth-oriented companies have strong sales and/or earnings
growth; value-oriented companies sell at prices in the market which are
relatively inexpensive compared to some financial measures of worth.) Recent
trends of large company and growth dominance run counter to long-term
historical averages. Large companies have been outperforming small ones for
five years running now, the longest such run in the last seven decades. But
growth company dominance is a more recent phenomenon. Our value orientation
helped Ultra-Small Company Portfolio beat the average performance of all size
companies in 1996 and 1997. In 1998 and the first quarter of 1999, however, it
has been an additional drag. Based on history, these counter-historical trends
don't last forever. I'm very much looking forward to a shift in market
"leadership" toward our companies.
Morningstar's style box below presents clearly the dominance of large and
growth-oriented companies in the March quarter. The trailing one-year numbers
would present a very similar story. Within the small company value funds,
Bridgeway Ultra-Small Company Portfolio is among the smallest 10% in median
market capitalization and among the most value-oriented of funds. Although our
Portfolio has models with differing styles, most have some variable for value.
In the current environment, this has pushed our portfolio more strongly into
the value end of the spectrum. As the box below indicates, this position hasn't
been favorable:
March Quarter Total Returns for 3,541 Domestic Equity Funds
-----------------------------------------------------------
Value -------------------------- Growth
Large
| -------------|------------|-------------
| | |
| 0.9% | 3.6% | 7.9%
| | |
| -------------|------------|-------------
| -------------|------------|-------------
| | |
| -2.3% | -1.6% | 3.7%
| | |
| -------------|------------|-------------
| -------------|------------|-------------
| | |
| -9.4% | -6.9% | -2.0%
| | |
| -------------|------------|-------------
Small
In the current quarter, our value orientation has affected our performance
almost as much as our small company focus. Recent press articles have started
to highlight this phenomenon. A headline in the New
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York Times March quarter mutual fund review asked, "What's Killing the Value
Managers?" An article a few days later in Investor's Business Daily asks,
"Value Funds Are Down, But Are They Out?"
Another way to look at performance of value-oriented versus growth-oriented
mutual funds is presented in the table below. The first row of data presents
our calendar year performance. The second row indicates the degree to which
small company value funds have outperformed growth funds in each of the last
six years. (I would prefer to present this data on the basis of market indexes,
but this kind of data is expensive to buy and time-intensive to create; fund
data serves as a good proxy.) The third row indicates the amount by which
Ultra-Small Company Portfolio has outperformed the CRSP Index of ultra-small
companies.
Annual Performance
------------------
<TABLE>
<CAPTION>
1994* 1995 1996 1997 1998 1999*
----- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Bridgeway Ultra-Small Co. (2.7%) 39.8% 29.7% 38.0% (13.1%) (9.9%)
Value Funds minus Growth Funds (2.8%) (11.0%) 3.8% 10.9% (12.8%) (7.4%)
Ultra-Small Co. minus CRSP 10 (1.8%) 9.5% 12.8% 15.9% (2.0%) (3.9%)
</TABLE>
*Partial years.
What I notice from this table is that in each year that value funds
outperformed growth funds, we trounced the CRSP Index of ultra-small companies.
In each period that growth beat value, we underperformed the CRSP Index, but by
a relatively small margin. The exception is 1995, when we beat the CRSP Index
by a large margin in spite of it being a growth dominated year. If you believe,
as I do, that a value orientation prevails in the long-term, this would portend
good things for our Portfolio.
Detailed Explanation of Performance - The Movers and the Shaken
- ---------------------------------------------------------------
Translation: The decline in our Portfolio stocks was broad based. It spanned
all sectors and each of our quantitative models.
Seven of our stocks declined more than 50%. These were distributed among a
number of different industries, but most surprising is the fact that three were
in the technology sector, the same sector that did so well among the largest
company stocks. Our worst performing companies were:
<TABLE>
<CAPTION>
Rank Description Industry % Decline
---- ----------- -------- ---------
<S> <C> <C> <C>
1 Int'l Management Assoc. Data Processing-software -63.8%
2 Advocat Inc. Health Care Facilities -56.8%
3 Natural Alternatives Inc. Drugs-Generic and OTC -55.7%
4 DA Consulting Group Data Processing-Services -54.9%
5 Alta Gold Mining -53.1%
6 Baldwin Technology Co. Graphic Arts -51.1%
7 Brightstar Info. Technol. Data Processing-Services -50.8%
</TABLE>
Each of these companies announced some bad news during the quarter such as a
turnaround in sales, declining gold prices, a charge against prior or future
earnings, or potential liability. Normally, this kind of announcement would
result in a 10-30% decline in the price of a stock. In the current environment,
these companies were pounded mercilessly.
Of course not all of our stocks suffered the carnage of those above. Six of our
stocks gained more than 50%:
<TABLE>
<CAPTION>
Rank Description Industry % Gain
---- ----------- -------- ------
<S> <C> <C> <C>
1 4 Kids Entertainment, Inc. Services 160.2%
2 I-Flow Corp. Medical equipment/Supplies 141.1%
3 Frontier Airlines Airlines 105.2%
4 U-Ship Services 81.7%
5 Unify Corp. Data Processing 73.9%
6 ASHA Corporation Automobiles 63.2%
</TABLE>
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<PAGE> 4
The two lists of stocks demonstrate one of the favorable characteristics of
ultra-small stocks. A stock can't decline more than 100%, but it can rise
significantly more than 100%, which three of our stocks did. Unfortunately, the
majority of our stocks were in negative territory. We think the financial
health of the vast majority of these stocks is strong. We're waiting for a
"friendlier" market environment.
Top Ten Holdings
The following list will give you a flavor of the diversity of our Portfolio. We
rarely put more than 3% of Portfolio net assets in any one company. I usually
start to trim them if the company grows much above this level. At the end of
the quarter the Portfolio held 146 stocks. Our top ten holdings on March 31
were:
<TABLE>
<CAPTION>
Rank Description Industry % Net Assets
---- ----------- -------- ------------
<S> <C> <C> <C>
1 Creative Computers, Inc. Retail Stores 4.1%
2 Triathalon Broadcasting Co. Broadcasting 3.4%
3 Unify Corp. Data Processing 3.1%
4 Pilgrim America Capital Corp. Finance 2.9%
5 Gilat Communications Telecommunications 2.6%
6 Home Products International, Inc. Housewares 2.6%
7 Jos. A. Bank Clothiers, Inc. Retail Stores 2.3%
8 Catherines Stores Corp. Retail Stores 2.2%
9 SCP Pool Corp Leisure-Amusement 1.8%
10 TTI Team Telecom International Ltd. Telecommunications 1.8%
-----
Total 26.5%
</TABLE>
What's strange to me as I look at this list is that the same industry
representations in our Aggressive Growth Portfolio in larger companies earned
some phenomenal returns there. For example, the fundamental strength of the
retail store companies on the list above is every bit as strong as Best Buy,
our largest holding in Aggressive Growth. But Best Buy had a 70% return in the
March quarter while Jos. A Banks declined 23%. Wall Street doesn't have to make
sense, and sometimes it just doesn't.
Disclaimer
- ----------
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.
A Ten Step Approach
- -------------------
When a fund declines 31% in a twelve month period, it's appropriate to ask, "Is
this investment style out of favor or is there something wrong at the fund?" I
hope I've adequately addressed the first part of this question, and now I'd
like to address the second half. I recently read an article, "Ten Signs Your
Fund May Be in Trouble," at Smartmoney.com. I thought it was an insightful
article, and that addressing each of the ten points with respect to the
Ultra-Small Company Portfolio would be a worthy exercise. According to the
article, you may have trouble if:
1. Your fund manager picks up and leaves. I've been managing this Portfolio
almost five years now, a year longer than the mutual fund industry
average. I own a majority interest in Bridgeway Capital Management, Inc.,
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<PAGE> 5
the adviser to Bridgeway Fund, so I don't have a compelling interest to
jump ship to another firm. The independent fund directors have the legal
right to replace the adviser, but this is extremely unlikely when we're
beating the long-term benchmark of equal size by a significant margin. I
hope to retire in this job. I'm 43. I really enjoy working at Bridgeway.
2. There's a dramatic shift in investment strategy. The last major change
I've made in the Portfolio was in June 1995, when I jettisoned one of
five models. This value model, which worked fine for mid-size companies,
was identifying too many ultra-small companies headed right out of
existence. I highlighted a more minor change in the October 1998
shareholder letter concerning "turning off the pump" of one model during
down markets. We turned the model "off" for the first time in the March
1999 quarter, which helped our performance. I am very disciplined in
following the models. I don't try to second-guess statistics.
3. Your fund's expense structure or ratio changes. If the expense structure
or ratio of a fund changes dramatically, it could signal a fundamental
change in the fund's strategy or management. Our portfolio expense
structure has not changed in the last two years. There has been no change
in strategy or management. Our expense ratio, which was starting to fall
nicely to 1.67% in Fiscal Year 1998, has climbed back to the maximum 2.0%
this year. (The Portfolio expenses are actually less, but are spread over
a smaller base resulting in the higher ratio.) We still have an expense
ratio goal of 1.25% when assets reach $55 million. We still have no loads
and no 12b-1 fee.
4. Your fund grows too big for its own good. We closed our Portfolio to new
investors at half the level of any non-Bridgeway closed fund in
existence. We like to stay "nimble," able to buy and sell stocks more
easily than other larger funds. According to the article, "Smaller is
always better in small-cap funds." We agree, and we did something about
it.
5. Shareholders start jumping ship faster than passengers on the Titanic.
The vast majority of our shareholders have not panicked. Relative to our
ability to raise cash, redemptions have been insignificant.
6. There's more turnover in your portfolio than in the Clinton
administration. Since our investment strategy has remained unchanged, our
turnover has also remained unchanged.
7. Your fund's performance is in the top 1%. Not lately, at least on a
short-term basis. Actually this point is worth considering given our
history. How could big returns be bad? "Superlative performance probably
means the manager is taking a different approach. . . . Therefore,
investors should be prepared for periods of underperformance as well,
since these funds are usually more concentrated in a particular sector or
stock. Investors who stick with these managers for long periods of time
are usually satisfied, Lipper adds, but these are not funds for those
with weak stomachs."
We don't concentrate our investments in a few stocks, industries, or
regions, but we're very concentrated in ultra-small stocks--100%! I'm not
satisfied with any periods of underperformance relative to our benchmark
of similar size. However, there are periods when large beats small, or
growth beats value, and we're less likely to beat the more widely
publicized benchmarks in these periods.
8. Your fund takes you overseas unwillingly or unknowingly. We continue to
have minor exposure overseas. We typically have less than 5% of assets in
foreign stocks, and all of these trade on American exchanges.
9. Your fund starts taking more risks. Our strategy and level of risk have
not changed. We don't do anything with derivatives or leverage. Our
short-term volatility is high due to the asset class we are in. We
believe our long-term inflation risk, however, is very low.
10. Your fund isn't what it claims to be. Our median market capitalization is
right about in the middle of ultra-small stocks. We have always been what
the name of our portfolio indicates, and as long as I'm manager this will
never change. (Actually, it would take a vote of shareholders to change
even if I wanted it to.)
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<PAGE> 6
I hope you get the idea that I believe our stocks have been very much out of
favor in the last year, but that there is nothing wrong at Bridgeway Fund. We
have more breadth and more well-trained staff than at any time in our history.
While I can't predict the timing of a turnaround in ultra-small stocks,
historically downturns have been relatively short-lived. I believe we have a
bright long-term future.
New Web Site at Bridgewayfund.com
- ---------------------------------
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 just
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 "Ultra-Small Company" 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!
Conclusion
- ----------
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
Graph: On the top right hand corner of the letter there is a graph showing the
highest and lowest prices (adjusted for Dividends and Capital Gains) for
Ultra-Small Company Portfolio. The highest price, $20.58, occurred on 4/22/98.
The lowest, $10.42, occurred on 10/8/98. As of 3/31/99 the price for
Ultra-Small Company Portfolio was $13.25.
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