FUND VIEW: Betting on smallest stocks pushes Perritt fund past peers
NEW YORK, Dec 13 (Reuters) - With a nearly 50 percent gain in his portfolio for the year, fund manager Michael Corbett might be expected to coast into January. Instead, he has been taking advantage of the recent stock market selloff to add new positions.
This aggressive move reflects Corbett's foot-on-the-pedal investing style. In his $99 million Perritt Ultra MicroCap fund , he only buys shares of what he calls "the smallest of the small" - risky, tiny companies that he believes will give him the biggest gains.
Typically, their market values are below $100 million, and they may trade on the over-the-counter market rather than on a major exchange.
"If one of my analysts says that he thinks there's a 30 percent upside to a company, I'm not interested," Corbett says. "I'm interested in finding the five baggers," which Wall Street calls a stock that appreciates to more than five times its purchase price.
So far, that shoot-for-the-moon strategy has been working. Corbett's year-to-date performance is the best among small-cap value funds tracked by Morningstar. Over the last five years, it has returned an annualized 27.4 percent, putting it in the top 7 percent of the 257 funds in his category.
Those large gains can mask a feast-or-famine track record, however. The fund finished 2010 with 39 percent gain, putting it in the top 2 percent of its peers. But it followed that performance by losing 13.4 percent in 2011 and falling behind its peer average by 4.2 percentage points in 2012, putting it in the bottom quarter for both years, according to Morningstar.
"When this fund gets it right, it really gets it right," says Todd Rosenbluth, head of mutual fund research at S&P CapitalIQ. "But when small-caps struggle, this fund is going to feel it."
Corbett says investors should judge microcap stocks, which do not trade nearly as often as their large company counterparts, by their three-to-five-year performance because their short-term share movements can be exaggerated by the lack of liquidity.
"You can get killed in this marketplace very easily," he says.
To find additions to his portfolio, Corbett starts by screening for the smallest 10 percent of companies in terms of market value. Then he judges each company on nine attributes, such as whether its margins are improving, its cash flow is positive, and its debt as a percentage of sales is declining.
If a company meets at least five of those metrics, he meets with its executives to judge whether they are competent. He estimates that he holds three such meetings a week in his Chicago office.
There are few sectors or business lines that Corbett will not invest in, although he says he rarely buys biotech shares.
"It's hard to pass the screen when you don't have any revenue or earnings," he says. He also tends to pass on financial companies because their potential gains generally are not large enough to excite him.
Corbett has been paring down his stakes in top performers like Addus Homecare Corp, which is up 275 percent for the year.
Instead, he is moving more of his portfolio into what he calls "super-nichey" technology companies like USA Technologies Inc, which trades on Nasdaq and has a market value of $60 million. Its main line of revenue is software that allows someone to use a credit card at a vending machine or laundromat.
Besides a contract to service Coca-Cola Co vending machines, the company signed a contract in June to expand its payment service with Setomatic Systems, giving it a larger footprint in the $5 billion laundromat industry.
USA Technologies, which is up just 1.5 percent for the year to date, trades at about $1.75, but Corbett expects it to rise to $4 to $6 in the next couple of years.
He has also been adding to his position in Datalink Corp , a $230 million market cap company that manages corporate servers and networks. Its shares are up 18 percent for the year, compared with a gain of about 30 percent for the Russell 2000 index of small-cap companies.
A strategy of buying competitors should push Datalink's earnings and margins higher, Corbett says.
His biggest worry in 2014 is his fund's popularity. As his assets under management rise, Corbett says it becomes harder to invest in tiny companies without taking becoming a major shareholder. As a result, he expects to close his fund to new accounts when his assets rise to about $150 million.
Corbett filed paperwork with the U.S. Securities Exchange Commission earlier this week to introduce a new fund that will focus on small-caps with market values of between $100 million and $3 billion, he says. It will probably begin trading in March, he says.
Investors who want to buy into the Ultra MicroCap fund before its official close should be prepared for high fees. The fund charges $1.85 per $100 invested, a level that Morningstar considers expensive.
(Reporting by David Randall; Editing by Linda Stern and Lisa Von Ahn)