Perritt Emerging Opportunities Fund (PREOX)

By Ian Wyatt, MutualsAdvisor.com | PREOX | Aug 08, 2007 | comment

By Ian Wyatt, Editor-in-Chief

 Amy Buttell Crane, Research Analyst

Fund Type: Small Value

Expense Ratio: 1.67%

Min. Investment: $1,000

Web: http://www.perrittmutualfunds.com

Top 3 Holdings:

MFRI Inc. 1.5%

Medtox Scientific Inc. 1.29%

North American Galvanizing and Coatings 1.3%

Micro-cap stocks aren’t even on the radar screen for most individual investors who consider this equity class far too risky. But when they’re available in a diversified portfolio that stresses growth at a reasonable price in the form of the Perritt Emerging Opportunities Fund, it might be worth expanding your radar screen.

On the verge of celebrating its third birthday, the fund was founded to complement its sibling, Perritt Microcap Fund, which is currently closed to new investors. Perritt Microcap has an outstanding long-term track record – on an average annual return basis, it has returned 14.59% for the 10-year period, 20.75% for the five-year period and 17.82% for the threeyear period.

While the Microcap portfolio focuses on companies with a market capitalization of $250 to $500 million, the Emerging Opportunities downsizes that even further, trolling for companies with market caps from $10 million to $350 million. As of June 30, the fund returned 25.82% for the past year on an average annual return basis; returns for the first six months of 2007 were 18.72%.

Manager Michael Corbett describes these companies as “nano-cap” and strives to keep the fund’s average market capitalization below $100 million. Corbett and his three analysts use a combination of a quantitative and fundamental approach to sorting through the 3,000 companies that make up the fund’s investment universe. This process seeks companies with above average revenue and earnings per share growth, a low level of long-term debt, a high percentage of insider ownership, expanding profit margins, capable management, a clean balance sheet and reasonable price-to-earnings and price-to-sales ratios relative to their long-term growth prospects.

Because most of the companies in the fund’s investment universe aren’t followed by major brokerage analysts, Corbett has developed relationships with a network of two dozen regional brokers who feed him and his analysts research ideas; he also pays research firms to assist him in mining for suitable companies. Internally, the research team scans company SEC filings, runs screens and examines earnings releases and newswires toward this effort.

Stock selection is generally sector-neutral. However, if one sector consumes 20% to 30% of the portfolio, management takes notice and considers cutting back. In terms of segments, management favors the technology (21.27%), consumer discretionary (19.68%) industrials (18.35%) and health care (11.44%) sectors.

Under certain conditions, the fund will invest assets in micro-cap exchange traded funds in a stop-gap effort to keep cash invested within the fund’s investment mandate. The fund has used Powershares Microcap and iShares Russell Microcap in the past, but sells those shares as soon as it has the opportunity to invest in the types of individual companies it prefers.

To manage risk within the fund’s mandate, management spreads its assets among 100 to 150 different companies. When one company soaks up more than 3% of the fund assets, Corbett begins to trim the position back so as not to assume too much single-company risk.

Besides selling to eliminate sector and company risk, a company that grows beyond the identified market-cap universe of the fund is usually sold to conform to the fund’s mandate. In addition, positions are sold when they become overvalued, which management identifies as selling at a PE ratio of 1.5 to 2 times their growth rate.

Because of the fund’s nano-cap strategy, companies in the portfolio are frequently buy-out targets, where the fund will receive either cash or stock in the acquiring company. Management will also sell when a position fails to perform as expected; while management won’t sell on a quarterly earnings disappointment, if a company fails to execute its strategy, it will be a candidate for sale.

Unlike most micro-cap funds, this fund has a buy-and-hold strategy. Under ideal conditions, management prefers to hold companies for three to five years. The fund’s portfolio turnover rate of 26.7% reflects that philosophy. This turnover rate is substantially lower than its peer group average of 70.83%.

In an effort to preserve the fund’s ability to pursue its strategy, Corbett has announced his intention to close the fund at $100 to $110 million in assets. However, assets as of June 30 were already $125 million, according to fund data-tracker Morningstar, over Corbett’s limit.

As assets have grown, the fund has cut its expense ratio from an initial rate of 2.22% to 1.67% in January. Both Corbett and fund company president Gerald Perritt, Ph.D., invested the initial seed money to start this fund and continue to invest their personal assets in both of the fund family’s funds.

If you’re interested in this young micro-cap fund, move fast. Corbett’s success as a stock picker depends on keeping his funds small in terms of assets and if the past is any guide, he won’t hesitate to close this fund when he thinks it’s time.

 This article is from the report, "MutualAdvisors.com, Top 10 Mutual Funds from 2008." Click here for the latest report!

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