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November 18, 1999
Dear Ultra-Small Company Shareholder,
We had a good September quarter--up 3.0%. While not exciting in absolute terms,
it is quite strong in light of the fact that the broader market averages of
both large and small stocks were down over 5%. When we can overcome a market
downdraft with positive performance and surpass our primary (CRSP) benchmark by
over eight percentage points, as we did this quarter, I'm very happy.
Working our way back: The figure in the upper right hand corner of this page
indicates that we are about half of the way back to our all-time high (dividend
adjusted) price of $20.58. It has been one year since the ultra-small market
low on October 6. The average time ultra-small stocks (as an asset class) have
taken to return to the former peak after a correction is six months, based on
market data from 1926-98. The longest recovery period has been three and a half
years. We are still "pluggin' away" at this goal, and it's slower than I'd
like--but we have been making steady progress in the last four quarters.
The following table presents our September quarter, one-year, five-year and
life-to-date financial results according to the formula required by the SEC.
<TABLE>
<CAPTION>
Sept. Qtr. 1 Year 5 Years Life-to-Date
7/1/99 10/01/98 10/1/94 to 8/5/94 to
to 9/30/99 to 9/30/99 9/30/99(4) 9/30/99(4)
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Ultra-Small Company Portfolio 3.0% 21.0% 16.7% 16.6%
Lipper Small-Cap Stock Funds (1) -2.7% 27.7% 16.2% 15.1%
Russell 2000 (small companies) (2) -6.2% 19.1% 12.4% 13.1%
CRSP Cap-Based Portfolio 10 Index (3) -5.3% 23.2% 11.5% 12.3%
</TABLE>
(1) The Lipper Small-Cap Stock Funds is an index of small-company funds
compiled by Lipper Analytical Service, Inc. (2) The Russell 2000 Index is an
unmanaged index of small companies (with dividends reinvested). It is the
most widely tracked index among small company funds, but it is comprised
of companies roughly 10 times larger than those of the CRSP Index and the
Bridgeway Ultra-Small Company Portfolio. (3) The CRSP Cap-Based Portfolio 10
Index is an unmanaged index of over 2400 of the smallest publicly traded
U.S. stocks (with dividends reinvested) as reported by the Center for
Research on Security Prices. (4) Periods longer than a year are annualized.
Past performance does not guarantee future returns.
Detailed Explanation of Quarterly Performance--The Movers and the Shakers
- -------------------------------------------------------------------------
TRANSLATION: A handful of technology stocks and a handful of stocks across
other industries "took off" in the September quarter, ensuring overall positive
returns for the Portfolio. Several of these were from among our largest
positions at the beginning of the quarter.
Eleven stocks appreciated more than 50% during the quarter, adding nicely to
our performance:
<TABLE>
<CAPTION>
Gain & Loss Industry % Gain
----------- -------- ------
<S> <C> <C> <C>
1 Clayton Williams Energy Energy/Oil 131.6%
2 United Shipping & Technology Transportation/Air Courier 100.0%
3 Santa Cruz Operations Data Processing/Software 82.8%
4 Performance Technologies, Inc. Data Processing/Hardware 68.2%
5 Unify Corp. Data Processing/Software 66.7%
6 Interpore International Machinery/Medical Equip. 60.6%
7 Turner Corp. Building 60.3%
8 Kensey Nash Corp. Machinery/Medical Equip. 58.2%
9 Gentner Communications Electronics/Electric 56.1%
10 Comtech Telecommunications Corp. Telecommunications 51.8%
11 Prosoft Training.com Services 51.2%
</TABLE>
<PAGE> 2
Technology certainly made a contribution to our performance. However, the
Portfolio is not specifically a "tech" fund, and a number of other sectors are
represented on the list. Two companies, Unify and Performance Technologies,
were among our top ten holdings at the beginning of the quarter, so these gains
really made a difference.
Clayton Williams enjoyed a nice recovery as oil prices came back during the
quarter. United Shipping & Technology, a tiny company with fast growing
revenues, appears to be approaching its first quarterly profit. This company
makes and operates self-service shipping kiosks. Santa Cruz and Unify both
enjoyed the second "Internet wave," which carried up a number of smaller
software firms.
Of course, not all of our stocks went up in the recent quarter. Two stocks
declined more than 50%:
Rank Company Industry % Decline
---- ------- -------- ---------
1 Alta Gold Co Mining -60.0%
2 McLaren Automotive Group Automobiles -51.3%
Alta Gold has suffered from the severe downturn in gold prices. There is some
question whether the company will survive. This is the only company that we
have held continuously since our first fiscal year, five years ago. McLaren
Automotive develops and markets automobile components and accessories.
Development expenses have outstripped revenues, causing the firm to
significantly increase its debt load.
Detailed Explanation of Fiscal Year Performance--Value Stocks Continue to
Trail in Performance
- -------------------------------------------------------------------------
TRANSLATION: Value stocks, those priced cheaply relative to some financial
measures of worth, continue to do poorly, based on September quarter returns.
This poor performance runs counter to the long-term historical trend and puts
our Portfolio at a significant disadvantage. Fortunately, we had enough
"winning" stocks to overcome this handicap.
You may recall from our annual report that recent history has not been kind to
smaller stocks (and especially ultra-small ones) or to value stocks. The market
was not particularly kind to domestic companies of any size in the most recent
quarter, but it was particularly unkind to stocks on the value end of the
spectrum. Since these are the staple of our Portfolio, we really overcame a
significant handicap to bring in a return of +3.0%. These are the average
quarterly returns of domestic equity funds by style box according to
Morningstar:
Value Growth
Large ----------- ----------- -----------
| | | | | |
| -9.1% | | -5.9% | | -3.1% |
| | | | | |
----------- ----------- -----------
| | | | | |
| -9.8% | | -7.4% | | -0.7% |
| | | | | |
----------- ----------- -----------
| | | | | |
| -7.2% | | -5.1% | | 0.9% |
| | | | | |
Small ----------- ----------- -----------
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 128 stocks. I have continued to pare the number
of stocks from 160 a year ago. Here are the top ten:
<TABLE>
<CAPTION>
Rank Description Industry % of Net Assets
---- ----------- -------- ---------------
<S> <C> <C> <C>
1 Unify Corp. Data Processing/Software 4.6%
2 Pilgrim America Capital Corp Finance 4.0%
3 Performance Technologies, Inc. Data Processing/Hardware 4.0%
4 Catherines Stores Corp. Retail Stores 3.8%
5 Braun's Fashions Corp. Retail Stores 3.5%
6 SCP Pool Corp. Leisure-Amusement 2.9%
7 Home Products International, Inc. Housewares 2.8%
8 Santa Cruz Operation Data Processing/Software 2.7%
9 Gilat Communications Telecommunications 2.5%
10 Vari L Company, Inc. Electronics/Electric 2.2%
----
Total 33.0%
</TABLE>
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Each of the stocks on this list has appreciated significantly. I briefly
discussed Unify in our annual report and will devote more space to this
interesting company next quarter. Pilgrim America Capital Corporation, a mutual
fund company we highlighted last year, rose 47%. It was the target of a
friendly take over bid by Reliastar, an insurance company that owns the Firstar
family of funds. The merger was completed in October. I'll miss this company.
It's an industry I understand pretty well. As manager of a no-load fund family,
I loved reaping the profits from their loads.
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 a holding applies only as of the quarter end,
September 30, 1999; security positions can and do change thereafter.
New Prospectus
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TRANSLATION: Each year we print and mail to shareholders an updated prospectus
in compliance with federal securities laws. This year, our format has changed
dramatically in accordance with an effort to simplify mutual fund prospectuses
and make them more readable. We are interested in whether you think it is an
improvement. Please drop us a note, call or email if you have an opinion or an
idea.
Enclosed is our updated prospectus, which is also our first "Plain English"
prospectus. The "Plain English" approach is an effort by the Securities and
Exchange Commission to take much of the "legalese" out of prospectuses and to
make them more "friendly" for people who may not have training in investments.
Bridgeway welcomed this new initiative. However, in order to maintain
accordance with SEC guidelines, we had to omit or restructure much of the
additional information on items that we wanted to include. In the final
analysis, we decided to discuss some of these items in our quarterly letters,
rather than in the prospectus itself. In this report we will highlight the two
subjects: distribution expenses and the tax efficiency of our Portfolio.
Distribution Cost--or I hate high expenses
- ------------------------------------------
TRANSLATION: Bridgeway Fund shareholders pay no distribution expenses. They
never have. This cost is borne by the Adviser, Bridgeway Capital Management,
according to our contract. Any change in this policy would require a vote by
Fund shareholders.
On October 15, 1996, shareholders approved a 12b-1 distribution plan, whereby
the Fund serves as its own distributor; however, the Adviser, Bridgeway Capital
Management, continues to pay all of the distribution expenses. Distribution
costs are expenses related to selling the Fund. Since Bridgeway does
essentially no advertising, our distribution costs consist primarily of mailing
materials to people who request information about the funds. For instance, if a
non-shareholder friend of yours calls the "800" number at Bridgeway and asks
for a prospectus, the phone expense, personnel expense, prospectus cost,
envelope, any other enclosures, and postage are all expenses of the Adviser,
not the Ultra-Small Company Portfolio. A majority of mutual funds pay at least
a portion of the distribution costs from the fund itself. Bridgeway's policy is
in line with our focus on cost efficiency. You may remember that our four
business values are integrity, performance, cost, and service.
You may be wondering why I am raising this topic now. It is to avoid any
confusion about the presentation of annual expenses in the fee table on page 6
of the enclosed prospectus.
3
<PAGE> 4
Since the inception of our Portfolio, even before shareholder approval of the
12b-1 Plan, the Adviser has paid all distribution expenses directly from its
own capital and profits. The Fund's management contract with its adviser,
Bridgeway Capital Management, clearly states that the adviser pays distribution
expenses. Therefore, they are not shareholder expenses, and we have previously
excluded distribution expenses from our fee table. The SEC has taken the view
that since distribution expenses are expenses of the Fund, even though they may
not be paid by the Fund, they must be presented in the fee table. The expenses
are then "backed out" in the line labeled simply "Fee Waiver." The new SEC
rules for plain English do not allow flexibility with the fee table
presentation. We can neither add that the "fee waiver" includes distribution
expense, nor can we include a footnote to the table to that effect. We disclose
it later on page 35 of the prospectus. My concern is that I don't want anyone
to think we reneged on our commitment in 1996 never to charge a 12b-1 fee
without shareholder approval.
Tax Efficiency
- --------------
TRANSLATION: Notwithstanding last year, which was tax inefficient in the
extreme, our first five years put us in the middle of the pack with respect to
tax efficiency among domestic equity funds. Tax efficiency means that you pay a
smaller portion of your Portfolio returns to Uncle Sam. However, this is
irrelevant if you hold your shares in an IRA or other tax-deferred account.
On October 31, Bridgeway became the first mutual fund, to my knowledge, to
highlight the relative tax efficiency of each of our portfolios in a separate
section of its prospectus (see page 38). For an actively managed portfolio,
Bridgeway Ultra-Small Company has an OK, not great, long-term record. If you
owned this Portfolio over the last five years in a taxable account and paid the
maximum tax rate, you would have kept 84% of the Portfolio returns. (If you
live in "Taxachusetts" or another tax heavy-state, you keep less.) This measure
of tax efficiency considers tax on distributions only; it excludes taxes
incurred when you sell shares of the Portfolio. Although the Ultra-Small
Company Portfolio is not specifically a tax-managed Portfolio, we do make
decisions to minimize taxes when we feel it would not hurt our overall
Portfolio returns. Our five-year tax efficiency record ranks in the 53rd
percentile among domestic equity funds according to Morningstar.
1999 Dividends
- --------------
Our tax efficiency in 1999 will be better. There will be no distributions in
1999.
Wall Street Transcript Interview
- --------------------------------
On October 4, the Wall Street Transcript, a magazine for investment
professionals, published an interview with me on Bridgeway's strategies and
portfolios, including this one. Copies are too expensive to distribute with
this letter (sorry), but you can see the article in full on our web site at
www.bridgewayfund.com/910wall.htm.
Conclusion
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As always, we appreciate your feedback. We take it seriously and discuss it at
our weekly staff meetings. Please keep your ideas coming.
Sincerely,
/S/ JOHN MONTGOMERY
John Montgomery
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