The Institute for Innovation Development—as part of our ongoing series of interviews exploring unique or innovative viewpoints from active asset managers—recently talked with Michael Corbett, CEO and CIO at Perritt Capital Management, an independent investment advisory firm and manager of three mutual funds with a 25 year commitment and focus on microcap equity management. We asked Michael to share his firm’s singular vantage point and research on the unique nature of the microcap asset class.
Bill Hortz: As a leading expert on microcap equities, what do you see as the most interesting and compelling nature of this universe of companies?
Michael Corbett: While not all microcap equities result in making more than 10 times your money, the microcap universe is one of the best places to find those type of opportunities. Microcap equities are the least researched publicly invested securities. Due to their under-researched and under-followed nature, they tend to be inefficiently priced, which can offer great upside potential for investors. Microcaps represent a formidable crack in the so-called “efficient market theory.” Furthermore, with the entire microcap segment being very small at less than $400 billion (45 percent of the market value of Apple) and a median capitalization of about $400 million, many large institutional investors, as well as equity analysts, tend to shy away from this sector. These two factors very easily distort the risk/return characteristics of individual stocks in this area that can be exploited by active managers who know how to uncover well run companies through intensive independent research and deep knowledge of this space. Research we have done on the microcap area has also determined that portfolios of microcap stocks have a high probability of producing a significant positive alpha.
Hortz: What have you learned about company managements that choose being a microcap public company versus staying private?
Corbett: Believe it or not, there are many publicly traded microcap companies that should be private. We have met several management teams that were convinced many years ago to become a public company, but have executed poorly. Our experience leads us to avoid these management teams. This main fact is why we believe it is imperative to use an active management approach in the microcap space and it requires a reliance on non-traditional investment idea mining. We purchase companies strictly at potentially attractive valuations and strongly believe that great companies are great investments only at great prices. This long-term perspective drives our investment professionals to evaluate management teams in a way that we believe will potentially provide our shareholders the most gain.
Hortz: What is the case for microcap equities as a proxy for private equity?
Corbett: Microcap equities tend to act similarly to private equity, primarily due to their under-researched and illiquid nature. Performance trends in the same direction and they enjoy similar periods of difficulty and success. Management of microcap equity portfolios usually have lower fees and the liquidity is better than that of private equity.
Hortz: Your research in the microcap space makes the case of microcap investing being an intrinsically active versus passive investing approach. Can you further explain that for us?
Corbett: We believe the microcap asset class is better suited for active management. Most of the reason is related to the fact that there are many mismanaged companies in the space and, contrary to popular opinion, not all small companies depend on debt financing. Hence, an index product would capture all companies, including the lower quality companies. An active, ongoing due diligence process helps us to avoid these riskier companies.