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Myths and Realities of Microcap Investing

Myths and Realities of Microcap Investing. Paul Carter, CFA Point Defiance Capital Management LLC April 23, 2013. Microcaps Often Get a Bad Rap. From SEC’s “Microcap Stock: A Guide for Investors” 1

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Myths and Realities of Microcap Investing

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  1. Myths and Realities of Microcap Investing Paul Carter, CFA Point Defiance Capital Management LLC April 23, 2013

  2. Microcaps Often Get a Bad Rap From SEC’s “Microcap Stock: A Guide for Investors”1 • “Lack of Public Information… information about microcap companies can be extremely difficult to find, making them more vulnerable to investment fraud schemes.” • “Risk…microcap stocks are among the most risky. Many microcap companies tend to be new and have no proven track record. Some of these companies have no assets or operations.” • 1 Source: www.sec.gov/investor/pubs/microcapstock.htm

  3. Definition • MSCI USA Micro Cap Index (932 stocks)1 • Market Cap Range: $2 mm - $564 mm • Median: $73 mm • Russell Microcap Index (1,510 stocks)2 • Market Cap Range: $30 mm - $565 mm • Median: $152 mm • Dow Jones Select MicroCap Index (272 stocks)3 • Market Cap Range: $0.0 – $1.0 billion • Median: $0.3 billion • 1 Source: www.msci.com/resources/factsheets/index_fact_sheet/msci-usa-micro-cap-index.pdf • 2 As at 2012 reconstitution; Source: www.russell.com/indexes/tools-resources/reconstitution/us-capitalization-ranges.asp • 3 Source: www.djindexes.com/mdsidx/downloads/fact_info/Dow_Jones_Select_MicroCap_Index_Fact_Sheet.pdf

  4. Russell Indexes • Source: http://www.russell.com/indexes/documents/US_Indexes_comparison.pdf

  5. Some Common Beliefs about Microcaps • They are a bunch of tech/biotech stocks. • They are companies of low quality. • The costs to trade them are extremely high. • It’s hard to borrow / short these stocks. • If a tree falls in the forest, does anybody hear? • Correlations among microcaps are high.

  6. Sector Diversity • Source: Baseline, Point Defiance Capital Management calculations

  7. Quality of Microcaps • Source: Baseline, Point Defiance Capital Management calculations

  8. Microcaps Are Often Well Known

  9. How Hard are Microcaps to Trade? • Source: Baseline, Point Defiance Capital Management calculations

  10. How Hard are Microcaps to Trade? • Source: Baseline, Point Defiance Capital Management calculations

  11. How Hard are Microcaps to Trade? • Source: Thomson ONE, Point Defiance Capital Management calculations

  12. Short Interest • Source: Baseline, Point Defiance Capital Management calculations

  13. Analyst Coverage • Source: Baseline, Point Defiance Capital Management calculations

  14. Do Microcaps Move? • Source: Baseline, Point Defiance Capital Management calculations

  15. Do Microcaps Move Together? • Source: Baseline, Point Defiance Capital Management calculations

  16. Conclusions about US Microcap Stocks • Lots of opportunities by sector/industry. • Plenty of “good” companies, although the quality range is wide. • Trading costs are significant. • Relatively little competition to short. • News often moves these stocks a great deal. • Correlations among stock returns are low. • Inefficiencies, and therefore opportunity to get an edge, are high.

  17. Thank You Paul Carter, CFA Point Defiance Capital Management LLC April 23, 2013

  18. Investment Management in Microcap The Case For Microcap Dennis Jensen, CFA – Director of Research 4-23-13

  19. Microcap – A Rich Opportunity Inefficiency creates better return opportunity Little institutional attention to Microcap stocks A diversifying space within US Equity (stock specific) Shares some advantages of Private Equity strategies, but avoids some disadvantages Microcap companies are common targets for M&A activity

  20. The Average Manager Outperforms Annualized Active Manager Outperformance Period ending June 30, 2012 Source: Acuitas, Evestment, Russell Investments.

  21. Why Doesn’t Everyone Do It? Large investment managers can’t manage enough money to support infrastructure Large brokers can’t generate trading volume Investors that rely on brokers for research are at a disadvantage “Competitors” end up being insiders, individual investors, local brokers, etc. The bottom line – most institutional investors don’t even try!

  22. Unique considerations for managers Tug-of-war between resources and business viability Efficiency in idea generation and research is critical Far easier to gain an ‘informational’ advantage With power comes responsibility (on your own with research!) Does anyone care? Discovery is powerful Avoiding the ‘garbage’ puts wind at your back DON’T MANAGE TOO MUCH MONEY

  23. Microcap Products with Low Asset Bases Outperform Microcap Universe Performance by AUM 10 years ending June 30, 2012 Source: Acuitas, Evestment, Russell Investments. Annual returns are based on asset level as of the start of each 12 month period beginning June 30.

  24. Discussion

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