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 “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

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

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

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

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

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

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!

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

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.

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