Paul Carter, CFAPoint Defiance Capital Management LLC April 23, 2013

Myths and Realities of Microcap Investing

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

Microcaps Often Get a Bad Rap

•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.pdf2 As at 2012 reconstitution; Source: www.russell.com/indexes/tools-resources/reconstitution/us-capitalization-ranges.asp3 Source: www.djindexes.com/mdsidx/downloads/fact_info/Dow_Jones_Select_MicroCap_Index_Fact_Sheet.pdf

Definition

Russell 2000® Index 8% of Russell 3000®

Index

Russell Midcap® In-dex

27% of Russell 3000® Index

Russell Top 200® Index

64% of Russell 3000® Index

Russell Microcap® Index <3% of U.S. equity market

Russell Indexes

Source: http://www.russell.com/indexes/documents/US_Indexes_comparison.pdf

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.

Sector Diversity

Source: Baseline, Point Defiance Capital Management calculations

Quality of Microcaps

Source: Baseline, Point Defiance Capital Management calculations

Microcaps Are Often Well Known

How Hard are Microcaps to Trade?

Source: Baseline, Point Defiance Capital Management calculations

How Hard are Microcaps to Trade?

Source: Baseline, Point Defiance Capital Management calculations

How Hard are Microcaps to Trade?

Source: Thomson ONE, Point Defiance Capital Management calculations

Short Interest

Source: Baseline, Point Defiance Capital Management calculations

Analyst Coverage

Source: Baseline, Point Defiance Capital Management calculations

Do Microcaps Move?

Source: Baseline, Point Defiance Capital Management calculations

Do Microcaps Move Together?

Source: Baseline, Point Defiance Capital Management calculations

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.

Paul Carter, CFAPoint Defiance Capital Management LLC April 23, 2013

Thank You

The Case For MicrocapDennis Jensen, CFA – Director of Research4-23-13

Investment Management in Microcap

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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

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The Average Manager Outperforms

Source: Acuitas, Evestment, Russell Investments.

Annualized Active Manager OutperformancePeriod ending June 30, 2012

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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!

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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

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Microcap Products with Low Asset Bases Outperform

Source: Acuitas, Evestment, Russell Investments. Annual returns are based on asset level as of the start of each 12 month period beginning June 30.

Microcap Universe Performance by AUM10 years ending June 30, 2012

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