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Quarterly Report for the Period ending 9/30/2000
October 25, 2000
Dear Fellow Ultra-Small Company Shareholder,
We churned out a stellar 9.4% return in the September quarter. I am quite
pleased.
Our quarterly return approaches the 11% average annual return of the broader
stock market over the last seven decades. We beat our primary market benchmark
(the CRSP Index of similar size companies) by nine percent and the Russell 2000
Index of small companies by more than eight percent. Our Portfolio ranked 14th
of 63 "micro-cap" funds in the quarter, 19th of 63 funds over the last year, and
3rd of 28 over the last five years based on data from Morningstar. Relative to
all small-cap funds, we ranked 54th of 753 (quarter), 171st of 723 (one-year),
and 63rd of 319 (five-year). Our tiny company size focus helped us in the last
quarter and year, but hurt us (relative to other funds) in the five-year period
before that.
Performance Summary
TRANSLATION: Finally, investing in small companies (relative to the large ones)
is starting to pay off.
The table below presents our September quarter, one-year, five-year and
life-to-date financial results according to the formula required by the SEC.
<TABLE>
<CAPTION>
September Qtr. 1 Year 5 Year Life-to-Date
7/1/00 10/1/99 10/1/95 8/5/94
to 9/30/00(4) to 9/30/00 to 9/30/00(5) to 9/30/00(5)
-------------- ---------- ------------- -------------
<S> <C> <C> <C> <C>
Ultra-Small Company Portfolio 9.4% 53.9% 21.8% 22.0%
Lipper Small-Cap Stock Funds(1) 3.4% 43.0% 15.1% 18.3%
Russell 2000 (small companies)(2) 1.1% 23.4% 12.4% 14.7%
CRSP Cap-Based Portfolio 10 Index(3) 0.0% 27.9% 11.1% 14.3%
</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 roughly 2000 of the
smallest publicly traded U.S. stocks (with dividends reinvested) as
reported by the Center for Research on Security Prices. (4) Periods less
than one year are not annualized. (5) Periods longer than one year are
annualized. Past performance does not guarantee future returns.
Detailed Explanation of Quarterly Performance
TRANSLATION: Our top-performing stocks spanned a number of industries and most
sectors of the economy. This was a "stock picker's" quarter, and our models
passed the test.
Fifteen of our companies appreciated more than 50% in the September quarter.
What is most remarkable is that these companies represent twelve different and
disparate industries.
While most smaller Internet company stock prices got "slammed" in the quarter
(including one on our biggest declining list below), Worldport Communications
nearly tripled in price. The company sold substantially all of its global
telecommunications carrier business and is focused on becoming the European
provider of complex and custom web-hosting services. This seems like a rather
risky strategic shift to me, but the models like the company, so I've enjoyed
the ride--so far.
<TABLE>
<CAPTION>
Rank Description Industry % Gain
---- ----------- -------- --------
<S> <C> <C> <C>
1 Worldport Communications Inc. Internet 194.9%
2 Amsurg Corp. Healthcare-Services 160.5%
</TABLE>
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<TABLE>
<S> <C> <C> <C>
3 Bell Microproducts Inc. Distribution/Wholesale 155.1%
4 ASI Solutions Inc. Commercial Services 122.4%
5 North American Scientific Healthcare-Products 77.0%
6 Ashworth Inc. Apparel 76.2%
7 Meritage Corporation Home Builders 70.8%
8 Engle Homes Inc. Home Builders 62.7%
9 KCS Energy Inc. Oil & Gas Producers 59.1%
10 Christopher & Banks Corporation Retail 59.0%
11 Foilmark Inc. Machinery-Diversified 56.9%
12 McNaughton Apparel Group Inc. Apparel 56.0%
13 TRC Cos. Inc. Environmental Control 54.3%
14 Gadzooks Inc. Retail 54.0%
15 Meridian Medical Technology Inc. Pharmaceuticals 53.3%
</TABLE>
The list below provides a nice case study about things that can go wrong with a
company. Unify was a company that made a lot of money for us in 1999. We
purchased a large number of shares at an average price of $5.44 (split
adjusted). Fortunately, we had sold over three-quarters of our original shares
at an average price of $31.81 between November and February. Unfortunately, the
remaining shares, as well as some additional shares we purchased at an average
price of $1.03 are all "under water." So what happened to make such a wild ride?
The company announced a need to restate earnings this summer, the CEO suffered a
heart attack, and the stock has been de-listed pending new financial statements.
The company announced that it would file new financial statements by October 31
and then missed the deadline. With ultra-small stocks, when things get bad, they
can get really bad. We think this one will either make us quite a bit more
money--or will go out of business altogether.
Here's the full list of our poorest performing stocks for the quarter:
<TABLE>
<CAPTION>
Rank Description Industry % Gain
---- ----------- -------- -------
<S> <C> <C> <C>
1 PC Service Source Inc. Distribution/Wholesale -93.3%
2 Transcoastal Marine Services Commercial Services -84.0%
3 Vari-L Company Inc. Telecommunications -78.5%
4 Unify Corp. Software -72.4%
5 Inspire Insurance Solutions Inc. Software -62.5%
6 Home Products International Inc. Household Products/Wares -59.7%
7 CD&L Inc. Transportation -58.3%
</TABLE>
Top Ten Holdings
The following list will give you a flavor for the diversity of our Portfolio.
Our top ten holdings represent seven different industries. Christopher & Banks
came to represent 9.2% of the Portfolio through very strong appreciation (see
#10 on the top-performing list above). This was after we trimmed the position
back in late August and then again in September. Feels like trimming kudzu.
Here are the top ten:
<TABLE>
<CAPTION>
Percent of
Rank Description Industry Net Assets
---- ----------- -------- ----------
<S> <C> <C> <C>
1 Christopher & Banks Corporation Retail 9.2%
2 SCP Pool Corp. Distribution/Wholesale 3.9%
3 Bell Microproducts Inc. Distribution/Wholesale 3.1%
4 HOT Topic Inc. Retail 2.7%
5 TTI Team Telecom International Ltd. Telecommunications 2.7%
6 Aaon Inc. Building Materials 2.7%
7 Bellwether Exploration Co. Oil & Gas Producers 2.6%
8 Green Mountain Coffee Inc. Food 2.5%
9 Gadzooks Inc. Retail 2.3%
10 McNaughton Apparel Group Inc. Apparel 2.2%
-----
Total 33.7%
</TABLE>
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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, 2000;
security positions can and do change thereafter.
Investment Philosophy: "Don't Look"
TRANSLATION: When thinking about the stock market, one of my long-held rules of
thumb is "if it doesn't affect a decision I will make, I don't look." This saves
me a lot of time and helps me focus on the important aspects of my job, like
seeking to discover the next great company.
The industry rule of thumb: track your investments and the stock market closely
so you will know when to bail out or add more. Unless you are a new shareholder,
you probably know that Bridgeway doesn't believe in market timing. Most of the
TV programming and evening news reports about the market are just so much
entertainment. It's probably the worst place to go to gather information you
might use in making an investment decision. When people ask me what the market
is going to do (in the next week, month, or year), I usually ask, "Why do you
care?"
That may seem like an unusual non-answer to a question that affects the account
value of each shareholder and the revenues of our firm. But as a contrarian, if
I had to make an investment decision based on a news story, I'd do the opposite
of whatever is being suggested. Better yet, I'd simply get a long-term plan, put
it in place, and ignore the "noise." The people who have made the most money
with our portfolios are the ones who made an early investment and just let it
ride. A friend of mine, who is not a wealthy man, was the first shareholder on
the date of inception. Each $1,000 he invested on August 5, 1994 was worth
$3,400 at the end of September. That's nice appreciation, but it still doesn't
answer the relevant question, which is, "How much will it be worth on the day he
retires and needs to start spending it?" That's the only really relevant
question, because the account values in between are "just so much noise." (A
side note on my friend: Yes, he is significantly wealthier "on paper" than when
he started. From a broader standpoint, he is actually an incredibly wealthy man;
you just can't measure it in dollars.)
Since Bridgeway's position is that predicting the market is a fruitless
exercise, my rule of thumb: if it doesn't affect a decision you make, don't
look. Most investors waste a lot of time tracking historical events that cannot
be used to make good current decisions. I frequently go home without knowing if
the market was up or down that day. There are three computer screens in my
office and none of them carry the market indexes. I seek market information at
three times: 1) when I am helping work a trade, 2) when I review fund accounting
statements, and 3) when I review fund performance, for example, for this letter.
In a more ideal world, I would only look quarterly or annually.
So if you find yourself looking up our net asset value in the paper every day
and getting nervous, think about whether our rule of thumb would work for you.
It would thrill me to think that one shareholder read this, put the newspaper
(or this letter!) down, and spent the extra time with their child, parent, or
friend.
How does a Growth Fund Become a Value Fund?
Please note: This section doesn't have to do with the Ultra-Small Company
Portfolio directly. The purpose of this section is simply to indicate one reason
that I think the outlook for this "value slanted" Portfolio is strong. In
addition, it highlights some interesting "shifting ground" within the mutual
fund and investment industries.
TRANSLATION: Answer to the question above: When everyone else dumps value stocks
to buy even faster growing growth stocks. The market has been so enamored with
growth stocks over the last three years that my intuition (and in this case,
also my models) say it is a good time to make sure you have some exposure to
cheaper "value" stocks.
After more than five years (1994 through mid 1999) of the most dramatic
appreciation of large company stocks relative to small ones in the last seven
decades, large company stocks as a group are very pricey.
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Very small company stocks, on the other hand, still appear quite cheap by most
benchmarks of value. For example, the average PE (price to earnings ratio) of
the S&P 500 Index of large companies is 35, almost twice that of Bridgeway
Ultra-Small Company Portfolio.
Not long ago, we got a call from a prospective shareholder about our Ultra-Large
35 Index Portfolio. The caller wanted to know why Morningstar listed the fund as
a value fund. With a PE of 36 and a three-year earnings growth rate of 18.5% on
June 30, I considered this portfolio to be much more of a growth fund than value
fund on an absolute basis. I was puzzled. Morningstar had previously listed it
as a "blend" fund, which I thought was accurate since it does own both growth
and value companies. It looked plenty expensive to me. After looking into it, I
discovered that while the Ultra-Large 35 Index Portfolio had "stayed still,"
that is, held the same stocks as previously, more and more portfolio managers
had "thrown in the towel" on value stocks and joined the growth bandwagon, which
had dominated for several years. Since Morningstar's designation is relative to
other funds, the Ultra-Large 35 Index Portfolio actually showed up in their
rankings as a value fund. This caused me to ask the question, "When is a value
fund (according to Morningstar) really a growth fund (based on classical
benchmarks)?"
As a contrarian, this just looks like one more shred of evidence supporting the
view that now might be a good time to own some cheaper value stocks.
Value Investing Makes a Comeback?
TRANSLATION: More evidence that cheaper valued ("value") stocks might be the
place to have some of your holdings: They lead the pack among U.S. companies
year-to-date. We think they still have quite a way to go (relative to more
pricey large stocks). We'll see.
The table below presents rather dramatically the recent comeback of
value-oriented small stocks. The market leaders for the last few years were the
largest, fastest growing stocks. This year, most of them have been "under
water," while the cheapest-valued small stocks are performing nicely. I think
this bodes well for our Portfolio. We'll see. The following table presents
recent year-to-date total return of funds by category, according to Morningstar.
Value ------------ Growth
Large
------------------------------------
| 1.6% | -3.4% | -7.0%
| ------------------------------------
| 10.0% | 10.1% | 0%
| ------------------------------------
| 13.0% | 6.9% | 1.1%
------------------------------------
Small
Conclusion
As always, we appreciate your feedback. We take it seriously and discuss it at
our weekly staff meetings. As a result of a recent shareholder suggestion, we
are adding a line at the top of page one to let you know if this is an annual,
semi-annual, or quarterly report and for what time period. Please keep your
ideas coming.
Sincerely,
/s/ John Montgomery
John Montgomery
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