Manager Commentary-Archive-Deleted

Manager Commentary, 1st Quarter 2010

Q: How has acquisition activity in the micro-cap space changed this year?

A: Acquisition activity within the micro-cap space has become extremely robust over the past quarter. Through the first 16 weeks of 2010, we had 8 stocks acquired in the Perritt Emerging Opportunities Fund and 5 stocks acquired in the Perritt MicroCap Opportunities Fund (see detail in table on page 3). The number of companies that were bought out represents 5.4% and 4.7% of the entire portfolios, respectively. That level of merger and acquisition activity in one quarter is impressive: historically, buyout activity has averaged about 5% of portfolio assets during a calendar year.  One trend that we have witnessed in the recent acquisition activity is that smaller companies are being purchased by public companies as opposed to private equity. Faced with low interest rates, management teams of acquiring companies are potentially receiving pressure from boards and shareholders to find better opportunities to utilize their cash. The result has often been the purchasing of profitable, small companies. On the other side of the equation, we have seen in most instances the companies being acquired have a considerable amount of insider ownership. This is significant because insider owners with a large voting stake can push a decision through if needed, and due to the likelihood that taxes may be higher next year, business owners have a motivation to sell their companies now. Added together, we believe that the conditions facing the management teams of acquiring companies and those of companies targeted for purchase have created an environment for acquisition activity in the microcap universe where “the stars are aligned.” This can certainly be a boon to microcap investors: buy-out premiums can be significant; two examples of companies bought out of our portfolios last quarter, Zareba and Global Med, were purchased for premiums of100% and 80%, respectively.

Performance as of 3/31/10*

Q: In conversations with small company managers, are you hearing a different tone over the past few quarters?

A: For businesses related to consumer spending (a sector that we remain underweight in), the general discussion continues to be that although sales have been decent, it feels to businesses that they are just restocking shelves. An area where we are beginning to see more concrete growth however is in companies related to business services. A major focus for managers of all companies seems to be related to finding ways to increase productivity. This is not surprising given that many businesses cut their workforce significantly and now need to find ways to do the same amount of work with less people. Our conversations with small company management relate to valuations because the big question that all investors are asking is, “when will the revenue growth start to kick in?” While we are not sure about business related to consumer spending, we do have higher confidence in industries related to business services in terms of revenue growth, as mentioned previously. What we have seen and heard from management of these types of companies tells us that they should see growth of revenue, earnings, and lower P/E ratio’s if prices remain stable. A final note on valuations is that although P/E ratios have certainly climbed, they were doing so from severely depressed levels. In our opinion, the P/E ratios of 15 to 16 where the Funds stand now, while well higher than we experienced during the March 2009 lows, are not egregious relative to any metrics.

Acquisition Activity, Jan 1 – Apr 15, 2010*

Q: Discuss attribution analysis – What happened?

A: Our attribution analysis shows that in the first quarter of 2010 stock selection added significant value to the performance of The MicroCap Opportunities Fund. Our selection within the Health Care and Information Technology industries were particularly strong, and our relative overweight to those industries contributed to our returns. However, our underweighting in other industries versus the Russell 2000 Index, primarily in financials, caused the Fund to underperform the bench- mark. Although the individual financial companies that we invested in did perform as well as the financial holdings of the benchmark, our large underweight to the sector led to a smaller return overall.  Our attribution analysis shows that in the first quarter of 2010 an underweight in financials hurt performance of the Emerging Opportunities Fund in a similar manner as described for the MicroCap Opportunities Fund. However, stock selection in the Emerging Opportunities Fund contributed more than 7% to our overall performance during the quarter. Much of this contribution was related to the acquisition activity discussed earlier.