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November 18, 1999
Dear Fellow Aggressive Growth Shareholder,
We had a good quarter--up 3.8%. 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 6%. When we can overcome a market
downdraft with positive performance and surpass the S&P 500 by over ten
percentage points, as we did this quarter, I'm very happy.
Something to Celebrate
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Most of you know I hate underperforming any relevant market benchmark over any
time period. While we have been trouncing stock indexes comprised of small and
mid-size stocks for most of the time since the Portfolio inception five years
ago, we were not able to overcome the amazing performance of large U.S.
stocks--until now. This quarter we took back the cumulative lead over the S&P
500 Index (including dividends). This is something only 6% of domestic stock
funds have accomplished over the last five years. We have beaten the S&P 500 in
all four of the last four quarters, and in 15 of the 21 quarters since
inception. Bridgeway Aggressive Growth ranks 7th of 75 aggressive growth funds
over this time period. This is truly something to celebrate.
Performance Summary
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TRANSLATION: Three factors contributed to our positive performance from July
through September: 1) Our 24% exposure to science and technology companies
certainly helped, as technology funds were the only domestic category with
significant positive (+7%) returns for the three month period. 2) We sold
several risky stocks, specifically several large company Internet holdings,
before the market suffered its first significant "correction" of 1999.
Sometimes, what you sell adds as much value as what you buy. 3) Our "focus"
strategy (concentrating more money in two or three companies that I believe
have superior risk and return characteristics) worked well from July through
September.
The table below presents our September quarter, year-to-date, one-year, and
life-to-date financial results according to the formula required by the SEC. I
particularly like the "1 Year" column, which begins just after the horrendous
small-stock correction of 1998.
<TABLE>
<CAPTION>
September Qtr. Year-to-Date 1 Year 5 Year Life-to-Date
7/1/99 01/01/99 10/01/98 10/01/94 8/5/94 to
to 9/30/99 to 9/30/99 to 9/30/99 to 9/30/99(3) 9/30/99(3)
---------- ---------- ---------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Aggressive Growth Portfolio 3.8% 30.3% 80.5% 26.1% 26.5%
S&P 500 Index (large companies)(1) -6.3% 5.4% 27.8% 25.0% 24.6%
Russell 2000 (small companies) (1) -6.2% 2.4% 19.1% 12.4% 13.1%
Lipper Capital Appreciation Funds(2) -3.0% 10.4% 35.4% 18.2% 18.6%
</TABLE>
(1) The Russell 2000 and S&P 500 are unmanaged indexes of small and
large companies, respectively, with dividends reinvested. (2) The
Lipper Capital Appreciation Funds reflect the aggregate record of
more aggressive domestic growth mutual funds as reported by Lipper
Analytical Services, Inc. (3) Periods longer than one year are
annualized. Past performance does not guarantee future returns.
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Detailed Explanation of Quarterly Performance--Technology helped
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TRANSLATION: A handful of technology stocks ensured positive quarterly returns
for the Portfolio. Our largest holding in a telecommunications firm also helped
significantly.
Three of our top four performing stocks were technology stocks. While we had
trimmed back our top large company Internet holdings in the June quarter, we
added two micro-cap Internet companies in July, which helped our performance
significantly. Unify Corporation, which develops software for e-commerce
applications, had been largely left behind in the Internet mania of the last
nine months. This was a company with significant earnings, strong projected
growth, and a price to earnings ratio that was a small fraction of the industry
average. For no reason I could see, the company had declined from a high of $17
1/2 to a price of $11 in less than three months. Our models flashed a very
strong buy signal in July, but we had little room in the Portfolio for an
additional holding. We bought shares equal to about 1 1/2 percent of net
assets, but also used our Portfolio flexibility to acquire stock options in
order to buy Unify calls. (Calls are a contract to purchase shares of a company
at a specified price - here, $10 - for a specified period of time at the option
of the call owner.) We purchased 120 calls, representing 0.4% of net assets at
the time of purchase. Our timing couldn't have been better. The company got a
very favorable write up in the Red Chip Review and received positive press
coverage on a financial news cable network. One large brokerage house also
began accumulating a large position. The stock climbed from $11 to $22.50 at
the end of the quarter. Our stock and calls added more than 2% to our quarterly
return.
A second small-cap Internet stock, Santa Cruz Operation, went up 53% in the
quarter. Pilgrim America Capital Corporation, a mutual fund company we
highlighted last year, rose 47% after Reliastar, an insurance company that owns
the Firstar family of funds, announced a friendly takeover bid. This merger was
completed in October.
Finally, Qualcomm, our largest holding, appreciated 32% and added 3% to our
quarterly return. This is an example of the kind of mid-cap growth company that
has led the market lately. (Actually, with recent appreciation, the company is
now a large-, rather than mid-cap company.) It looks quite "pricey" to me, but
I just keep following our models.
Detailed Explanation of Quarterly Performance--What Didn't Go Well
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Of course, not everything went up during the quarter, and our strong exposure
to retail stocks (19% versus 6% for the S&P 500) hurt our performance
significantly. Children's Place (-34%), The Gap (-24%), Best Buy (-8%), and
Creative Computers (-20%), were a real drag on our performance. American Eagle
Outfitters was our only retail stock that went up during the quarter.
One other stock declining more than 25% during the period was the "discount"
brokerage firm, Charles Schwab. It caused the most damage in dollar terms. The
stock declined 30% before we sold it.
Our ten largest positions continue to reflect considerable diversification,
spanning seven different industries. The retail store industry, which
represents 20.5% of net assets, is the largest industry concentration. All
together, the ten stocks below comprise over half of our Portfolio net assets,
making this a relatively "focused" portfolio. At the end of the September
quarter, the Portfolio held 41 stocks. Qualcomm has become our largest holding,
both by design and by strong appreciation. We trimmed VISX, the largest
position last quarter, to only 3.7% of net assets, when the potential risk of
this holding increased.
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Here are our top ten:
<TABLE>
<CAPTION>
Percent of
Rank Description Industry Net Assets
---- ----------- -------- ----------
<S> <C> <C> <C>
1 Qualcomm Inc. Telecommunications 14.2%
2 IDEC Pharmaceutical Corp. Biotechnology/Drugs 7.8%
3 Arkansas Best Corp. Trucking 5.2%
4 Spiegel Inc. Retail/Services 4.8%
5 CTS Corp. Electronics/Electric 4.5%
6 O'Sullivan Inds. Holdings Inc. Home Furnishings 4.3%
7 Ford Motor Company Automobiles 4.1%
8 JDS Uniphase Corp. Electronics/Electric 3.9%
9 Best Buy Company, Inc. Retail Stores 3.9%
10 Chicos Fashions Inc. Retail Stores 3.7%
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Total 56.4%
</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 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
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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 Aggressive Growth 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 20
of the enclosed prospectus.
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.
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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
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TRANSLATION: Our first five years were quite tax-efficient, especially for an
actively managed fund. 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 Aggressive Growth has a very good record, scoring 94% tax efficiency
over the last five years according to Morningstar. This statistic is the
percentage of total returns that a shareholder would keep after taxes, assuming
the shareholder paid taxes at the maximum rate and held shares in a taxable
account. It excludes taxes incurred when you sell shares of the Portfolio.
Although the Aggressive Growth 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 top 5% of domestic equity funds. I am very proud of this record.
1999 Dividends
In accordance with IRS requirements, the Board of Directors recently voted to
distribute the following dividends for the Aggressive Growth Portfolio for
calendar year 1999:
Ordinary income $ .00
Short-term capital gains $ 2.32
Long-term capital gains $ 1.96
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Total dividends $ 4.28
Based on a recent net asset value per share of $36.73 and year-to-date return
of over 70%, 1999 appears to be another very tax efficient year.
Wall Street Transcript Interview
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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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