Morningstar Advisor - April/May 2010 - 55

Corbett subscribes to the cockroach theory, a version of which says poor capital expenditures are like the prolific insects—where there’s one, there are bound to be many more.

after launching a series of investment newsletters in 1983, including The Mutual Fund Letter. But some subscribers wanted Perritt to run their money instead of just giving advice, so in 1987 he founded Perritt Investments (now Perritt Capital Management), a wholly owned subsidiary of his newsletter firm. Soon after, he began managing private client accounts, constructing different asset-allocation portfolios using mutual funds. In 1988, Perritt used his own money to seed Perritt Capital Growth, a micro-cap mutual fund that changed its name to Perritt Micro Cap Opportunities PRCGX in 1997. Perritt had long been intrigued with academic research showing that small companies had historically outperformed large companies on a riskadjusted basis. One of his newsletters, Investment Horizons, was even dedicated to small-cap stocks. In some ways, Perritt was one of the pioneers of micro-cap investing. Only a handful of micro-cap funds that launched in the 1980s are still around today. Despite the fund’s initial woes, Perritt continued building his investment business, counting family, friends, and former newsletter subscribers as his clients. In 1990, he hired DePaul graduate Corbett to help him with his newsletters. The job gave Corbett valuable training, allowing him to interview renowned managers such as Ralph Wanger of Columbia Acorn and Preston Athey of T. Rowe Price Small-Cap Value PRSVX. Eventually, Corbett assumed more responsibility and became a research analyst. When Perritt decided to move to Florida in 1996, Corbett, a Chicagoan born and bred, declined offers to follow him. Instead, Corbett

became comanager and started picking stocks for the first time, collaborating with Perritt via telephone.
After the Bubble

The New York Times helped the fund exceed $100 million. The fund was on the map.
Planting New Seeds

Corbett made the jump to lead manager at an inauspicious time for the fund—during the late-1990s tech bubble. It was the firm’s low point, but the transition gave the fund a chance at a fresh start. Corbett still believed that investing in financially sound microcap companies at reasonable prices would work over the long run, but he tweaked the process to better account for company-specific risk. He increased the number of holdings in the portfolio to 100 from 60 and capped positions at 3% of assets, regardless of how much he liked a stock. He also formalized a nine-step research process to grade companies and took a stricter approach to selling stocks that ran up in price, a topic on which he and Perritt occasionally disagreed. As the tech bubble burst, the fund turned a corner. It made money in 2000 and started attracting interest from investors after landing at the top of the small-blend category from 2001 to 2003. Some of the inflows were from fickle retail investors who poured money in after the fund’s big gains in 2001 and yanked it out after a modest return of 0.46% in 2002. The hot money aggravated Corbett, so he pushed for a 2% redemption fee on withdrawals made within the first 90 days. At the same time, Corbett decided to pursue investors through advisors and institutions, which had historically composed just one fifth of the fund’s assets. (Today, they make up more than half of the fund’s assets.) In 2003, a big investment from an advisor pushed assets past the $50 million mark, and a feature story in

With the fund thriving, Corbett worked with the board to launch a new fund in mid-2004. Perritt Emerging Opportunities PREOX invests in even smaller companies, which Corbett likes because of their high growth potential and their relative obscurity in the investing world. Today, Perritt Emerging Opportunities’ average market cap is just $53 million, the smallest in Morningstar’s database. By contrast, the average market cap for Perritt Micro Cap Opportunities is $200 million, and the Russell 2000 Index’s is $766 million. Corbett tries to mitigate the risks of micro-cap investing with independent research. He spends much of his time poring over financial statements and meeting with companies’ management teams to make sure they’re being responsible with capital. Corbett subscribes to the cockroach theory, a version of which says poor capital expenditures are like the prolific insects—where there’s one, there are bound to be many more. A small apparel company the fund owned in the late 1990s bought a Learjet as the stock’s price ran up. Red flags like that can prompt Corbett to sell a stock. In retrospect, he says he should have sold the apparel maker sooner because its share price dropped. Companies with glitzy headquarters aren’t appealing investment candidates to Corbett, so it’s no surprise that Perritt Capital’s own offices in downtown Chicago are pretty basic. Corbett has a private office, but his three analysts, hired in 2004 and 2005, sit in cubicles outside his door. Matthew Brackmann and George Metrou started right out of college,

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Morningstar Advisor - April/May 2010

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