Manager Commentary-Archive-Deleted

Manager Commentary, 4th Quarter 2010

Q: Attribution Analysis: What Happened in 2010?

A: The Perritt Funds ended the year with strong performance as the Perritt MicroCap Opportunities Fund returned 26.52% and the Perritt Emerging Opportunities Fund returned 39.02% for investors during the full year of 2010. Our attribution analysis shows that while stock selection had a positive effect on both funds, the selection effect was most pronounced in the Emerging Opportunities Fund. The Emerging Opportunities Fund (PREOX) attribution analysis shows that the top ten holdings of the portfolio contributed approximately 15% to the return. Much of this return was due to a large number of companies that were bought out by larger companies. In fact, 10 of 148 (6.8%) holdings in the portfolio were acquired. Another contributor to the Fund’s strong performance was our investment in the technology sector. Technology companies owned by the Fund returned over 50% during the year. At the same time, the Fund was overweight in the technology sector relative to its benchmark.

Average Annualized Performance as of 12/31/10*

Cumulative Total Return Since March 9, 2009 Market Low*

The MicroCap Opportunities Fund (PRCGX) attribution analysis shows that the top ten holdings of the portfolio contributed approximately 11% to the return, also partly due to a record high amount of acquisition activity. During the year, 12 of 132 (9.0%) holdings in the portfolio were acquired. The Fund’s strongest performing sector was Health Care. During the year, health care related companies owned by the Fund returned over 60%. We remain optimistic about the future opportunities for microcap health care companies as the retirement of baby-boomers is just beginning. It appears that other investors would agree with us, as four of the ten companies acquired from the portfolio in 2010 were related to healthcare.

Q: Why was turnover ratio so much higher in 2010?

B: Turnover in the MicroCap Fund for the fiscal year 2010 was 41.5%, a significantly higher level than in previous years. During the past five years, the Fund averaged under 30% turnover annually. Most of the 2010 turnover was related to the record number of companies bought out of the portfolio. We are proud of our historically low turnover because it shows that we are long-term investors, which is a critical part of our investment philosophy. In the event of a buyout, the amount of time that we own a company is not always as long as we might have planned. However, acquisition activity can be rewarding for both the premium we receive and as evidence that our investment process is working to find undervalued, flourishingcompanies. Turnover in the Emerging Opportunities Fund for the Fiscal year 2010 was 29.1%, which is in line with historical turnover.

Q: How have small cap stocks performed during inflationary environments?

A: Conventional wisdom is that equities won’t perform well in an inflationary environment because profits are eroded by rising costs. However, analysis of small- and large-cap performance during the last two major inflationary periods offers a different conclusion. In fact, equities have historically performed well in inflationary environments, and small cap equities have shown the strongest performance (as seen in the tables on following page). The reason that small companies can outperform in an inflationary environment may be related to pricing power. Quality small companies have niche products and niche businesses, and they can respond quickly to changing market conditions. Small companies with niche products and services have the ability to quickly raise prices, and the consumer will be willing to pay those prices. Historically, equity prices have fallen at the onset of an inflationary environment. However, for small companies especially, over time inflation leads to greater margins and larger profits, which ultimately can lead to higher stock prices.