Q: Going with the tax advantaged approach, since the fund has performed so well in the last five years, you had to sell to offset gains, yet the turnover rate is a relatively low 55. A: One of the characteristics of stocks this small is that they are extremely volatile. In any one year, a much higher percentage of ultra small stocks have the ability to either quadruple in price on some fundamental measure like revenues, or go completely out of business. So, both of those two things are true and do happen among the 1,800 stocks in our investing universe. What that means is we invest in a sampling of the stock market index that we track, which is the Center for Research in Security Prices Half Based Portfolio 10 Index. If that sounds like some academician named it, that's exactly true. It's from the University of Chicago's Center on Research. This particular index is defined exactly as we defined ultra small companies -- companies the size of the smallest 10% on the New York Stock Exchange. Q: That is a broad measure of performance from extremely small companies. A: Let’s say you're making some medical equipment case and you own 0.05% of the market. You wake up a year later. Your sales force has done well and there's something unique about your product and now you own 0.2% of the market. You're still hard to show up on the radar screen with the big guys, but you've quadrupled your revenues and your stock price takes off. On the opposite side, you've got a company that goes through some financial distress. These tiny companies don't have the resources of a General Electric or a Microsoft. IBM we've seen go through several difficult periods, but they've got enough financial resources and management expertise; they're going to figure out something to do in the market place. Their stock price may go down but the likelihood of them going out of business next year is pretty close to zero. That's not true across the board in ultra small stocks. They are smaller and sometimes more entrepreneurial. But even in a bull market, you'll always be able to find some that have gone down a lot. Obviously you don't want to have a lot of those in your portfolio. Q: You say in the April shareholder letter that you basically turn your back on any Wall Street research. You simply rely on the computer models in the shop. How can you refuse to listen to them? A: In the current environment, what we've learned about some of the worst analysts giving recommendations and on the other end writing emails saying the opposite is really horrible. When it comes to picking stocks, we only engage in an activity where we think we have a leg up on the market. When you are reading someone else's research, other people are reading that, too, so where's the advantage? If you look at the performance of people chasing this research, it ranks consistently below the market indexes. Q: What gives you this edge? A: We stick to what we do well. In the case of Ultra Small Company Tax Advantage, it offers people an avenue; an opportunity to invest in an asset class. For someone with a long-term view and a pretty strong stomach for volatility, it’s an excellent choice. Q: Do you worry about security? A: We've had some substantial conversations about the issues of security and discussion. We're in a responsibly secure building. We use password protection on sensitive files and are increasing ways to try and beat the hackers. We’re about to take a large step on the security of the system overall. A few years back we weren't able to afford it, but we're spending some significant resources in trying to protect the integrity of our modeling process and software. Q: Prior to the creation of Bridgeway 10 years ago, what moved you to the quantitative investment style? A: I think it dates back to the late 1970s when I was a graduate student at MIT. I was in an engineering program that didn't have anything to do with investments, but I learned a lot about statistics and quantitative and large computer modeling. I was in the transportation field and went back and got an MBA from Harvard Business School in 1983 and 1985. It was there that I began to think about applying quantitative methods to investing. There were certain things that I saw in some of the courses that I took that led me to believe these were fairly clear applications of quantitative theory. And, I started coming up with some ways to do it and did that as a hobby. I started investing on my own in 1985 and over the next six years was significantly more successful than I had anticipated. I started thinking about leaving the transportation field and starting a mutual fund company. So, really that's where it came from. Q: In looking at the fund's five-year performance, it's enough to raise eyebrows to those that wonder why ""breathtakingly small"" stocks have done so well in a bear market. A: I don't know whether I discovered it or it discovered me. The 1990s was a remarkable period and the period from late 1999 until now has been just as remarkable but in a different way. From 1994 through the first three quarters of 1999, we had the most extended, most dramatic out performance of large-cap stocks in the last seven and a half decades -- since before World War II and even the Great Depression. Q: Your statistics are obviously telling you that. A: That's right. One of the things that we do with our models when we design a new mutual fund, is we want to know how it's likely to perform over longer periods of time, particularly in down markets. There is a lot of data on ultra small companies as an asset class going back to 1926. We studied all of that data intensively. We came to market in 1997. That was a little bit early because we were still in the middle of a huge large-cap bull market. Q: Large-cap stocks were soaring but small-cap stocks were boring during that brief period. The S&P 500 posted annual gains of 20% or better. A: In 1998, the only calendar year this portfolio had a negative return was the same year the S&P 500 was up 28.5%. We underperformed the S&P 500 and the large-cap index by a full 30% our first full calendar year out with this fund. Q: There was a bear market in small-cap stocks from April 1998 until October 1998 when the Federal Reserve announced a surprise rate cut. A: That was the exact time frame. I remember the first week of October. It is pretty well burnt into my memory. Q: More than 1,500 NASDAQ stocks hit new lows the same day that month. A: When large caps are doing better than small caps, typically ultra small cap stocks are going to look worse. When small caps are doing well, typically our portfolio is going to do better. We're kind of on the tail end of that size whip. So, when the market for small caps is going up, you can normally expect that we're going to be up farther. That's part of what's really happened. The spring wound tighter and tighter as large caps went up out of proportion to everything else. Technology and the dot-com burst. When the professionals had to unwind, the first things they could sell to raise money fast were their very large-cap holdings. Q: Although speculators like to chase hot stories on individual small companies, this fund is made up of over 400 stocks. Those big gainers sometimes get lost in the mix. A: We don't have time to keep up with the details on 400 companies. There is some work that goes in to match the financial characteristics of our underlying index. We’re always buying and selling. We do tax-loss harvesting. We're continually trying to bring our portfolio back into line with the financial characteristics and industry representation of the underlying index. There are several value-added activities that I would argue are true about this portfolio. We offer access to an asset class that no one else does. Part of that has to do with the unusual cost structure of our advisory firm which allowed us to offer a portfolio on very small stocks. Q: That leads to the question of what are you buying today? A: We're out there buying a large number of companies. The other value activity is the tax-advantage management. I'm very proud of the fact that Bridgeway in six years has yet to distribute a capital gain. This is the closest thing to an IRA you could come up with in a taxable account. We're very aggressive at pursuing our strategy to never pay a capital gain. Q: These stocks normally don't pay dividends? A: In the structure of a mutual fund company our expense ratio is about 70 basis points. It will be close to 75 basis points for the fiscal year. Our assets are up enough that we expect it to be falling into next fiscal year. That will offset the dividend yield on these stocks. In a normal year, we expect those to equal and not to distribute a dividend either. It should be one of a tax-efficient portfolio. Q: How does this computer model figure out tomorrow? A: It doesn’t. The last bit of value activity our modeling involves is not picking the winners; it's to try to statistically stay away from a smaller percentage of companies that go right out of business. What's really interesting about its math is you can make as big a difference in the average annual return in your portfolio, probably by avoiding the worst stocks and by including the best stocks. It’s the kind of secret ingredient in what I would argue is a passively managed portfolio. Q: The staff is privy to sensitive information. Do you worry about the security risk when one leaves? A: We do have a non-compete and non-disclosure agreement. We just don't want to be in a position where one day we’re competing with somebody who used to be at Bridgeway and who is buying the same shares of stock at the same time. The other thing we do is have an employee stock ownership plan. We try to give a strong financial incentive for people to want to make Bridgeway successful and stay with the firm. We really reward people for longevity. We also hire for stability. The final thing is integrity. There are four business values: ethics, investment performance, friendly service, and the last thing is if you have a great enough place to work, people won't want to leave.