Pinnacle Value (PVFIX)
Pinnacle Value seeks long-term capital appreciation by investing in small- and micro-cap stocks that it believes trade at a discount to underlying earnings power or asset values. It might also invest in companies undergoing unpleasant corporate events (companies beginning a turnaround, spin-offs, reorganizations, broken IPOs) as well as illiquid investments. It also buys convertible bonds and preferred stocks which provide current income plus upside potential embedded in their convertibility. The fund can also use shorts and options for hedging. The manager writes that “while our structure is a mutual fund, our attitude is partnership and we built in maximum flexibility to manage the portfolios in good markets and bad.”
Bertolet Capital of New York. Bertolet advises one $10 million account as well as this fund.
John Deysher, Bertolet’s founder and president. From 1990 to 2002 Mr. Deysher was a research analyst and portfolio manager for Royce & Associates. Before that he managed equity and income portfolios at Kidder Peabody for individuals and small institutions. The fund added an equities analyst, Mike Walters, in January 2011.
Manager’s Investment in the fund
In excess of $1,000,000, making him the fund’s largest shareholder. He also owns the fund’s advisor.
April Fool’s Day, 2003.
$2500 for regular accounts and $1500 for IRAs. The fund is currently available in 25 states, though – as with other small funds – the manager is willing to register in additional states as demand warrants. A key variable is the economic viability of registered; Mr. Deysher notes that the registration fees in some states exceed $1000 while others are only $100. The fund is available through TD Ameritrade, Fidelity, Schwab, Vanguard and other platforms.
1.47% on assets of $47 million. Some sources report a slightly higher ratio, but that’s based on the fund’s ownership of a number of closed-end and exchange-traded funds. There is a 1% redemption fee for shares held less than a year.
Could you imagine a “Berkshire Hathaway for ultra-micro-caps”? Five factors bring the comparison to mind. With Deysher, you’re got:
- a Buffett devotee. This is one of very few funds that provides a link to Berkshire Hathaway on its homepage and which describes Mr. Buffett’s reports as a source of ideas for companies small enough to fit the portfolio.
Like Mr. Buffett, Mr. Deysher practices high commitment investing and expects it of the companies he invests in. His portfolio holds only 47 stocks and his largest holding consumes 4% of the fund. The fund’s prospectus allows for as much as 10% in a single name. One of the key criteria for selecting stocks for the portfolio is high insider ownership, because, he argues, that personal investment makes them “pay more attention to capital allocation and not do dumb things just to satisfy Wall Street.”
Also like Buffett, he invests in businesses that he can understand and companies which practice very conservative accounting and have strong balance sheets. That excludes many financial and tech names from consideration.
- a willingness to go against the crowd. Deysher invests in companies so small that, in some instances, no other fund has even noticed them. He owns companies with trade on exchanges, but also bulletin board and pink sheet stocks. As a result, his median market cap (MMC) is incredibly low. How low?
The average market cap is under $250 million, 10thlowest of the 2300 domestic stock funds that Morningstar tracks, and he’s willing to consider companies with a market cap as low as $10 million.
Deysher acquires these shares through both open-market and private placements. He seems intensely aware of the need to do fantastic original research on these firms and to proceed carefully so as not to upset the often-thin market for their shares.
One interesting measure of his independence is Morningstar’s calculation of his “best fit” index. Morningstar runs regressions to try to figure out what a fund “acts like.” Vanguard’s Small Value Index acts like, well, an index – it tracks the Russell 2000 Value almost perfectly. Pinnacle acts like, well, nothing else. Its “best fit” index is the Russell Mid-Cap Value index which tracks firms 22 times larger than those in Pinnacle. When last I checked, the closest surrogate was the MSCI EAFE non-dollar index. That is, from the perspective of statistical regression, the fund acted more like a foreign stock fund than a small cap US one. (Not to worry – even there the correlation was extremely small.)
- a patient, cash-rich investor. Like Mr. Buffett, Mr. Deysher sort of likes financial panic. He’s only willing to buy stocks that have been deeply discounted, and panics often provide such opportunities. “Volatility,” he says, “is our friend.” Since his friend has visited so often, I asked whether he had gone on a buying spree. The answer was, yes, on a limited basis. Even after the instability of the past months, most small caps still carry an unattractive premium to the price he’s willing to pay. There are “not a lot of bargains out there.” He does allow, however, that we’re getting within 5 – 10% of some interesting buying opportunities for his fund.
And he does have the resources to go shopping. Just over 42% of the portfolio is in cash (as of mid-October, 2011). While that is well down from the 53% it held at the end of the first quarter of 2011, it still provides a substantial war chest in the case of instability in the months ahead. Part of those opportunities come when stocks “go dark,” that is they deregister with the SEC and delist from NASDAQ. At that point, there’s often a sharp price drop which can provide a valuable entry point for watchful investors.
- a strong track record. All of this wouldn’t matter if he weren’t successful. But he is. The fund has returned 3.9% annually over the past five years (as of 9/30/2011), while its average peer lost 1.4%. As of that same date, it earned top 1% returns for the past month, three months, six months and year-to-date, with top 2% returns for the past year and for the trailing five years. That’s accomplished by staying competitive in rising markets and strongly outperforming in falling ones. During the market meltdown from October 2007 to March 2009, Pinnacle lost 25% while his peers lost over 50%. While his peers roared ahead in the junk-driven rally in 2009 and early 2010, they still trail Pinnacle badly from the start of the meltdown to now (i.e., October 2011). That reflects the general pattern: by any measure of volatility, Pinnacle has about one-third of the downside risk experienced by its peers.
- a substantial stake in the fund’s outcome. As is often the case, Mr. Deysher is his own largest shareholder. Beyond that, though, he receives no salary, bonus or deferred compensation. All of his income comes from Bertolet’s profits. And he has committed to investing all of those profits into shares of the fund.
He has, in addition, committed to closing the fund as soon as money becomes a problem. His argument, often repeated, is pretty clear: “We expect to close the fund at some point. We don’t know if we will close it at $100 million or $500 million, but we won’t dilute the quality of investment ideas just to grow assets.”
Over the past few years, Mr. Deysher experimented with adding some additional elements to the portfolio. Those included a modest bond exposure and short positions on a growth index, both achieved with ETFs. He also added some international exposure when he bought closed-end funds that were selling at a “crazy” discount to their own NAVs.
Quick note on CEF pricing: CEFs have both a net asset value (the amount a single share of the fund is worth, based on the minute-to-minute value of all the stocks in the portfolio) and a market value (the amount that a single share of the fund is worth, based on what it’s selling for at that moment. In a panicked market, there can be huge disconnects between those two prices. Those disconnects sometimes allow investors to buy $100 in stock for $60. Folks who purchase such deeply discounted shares can pocket substantial profits even if the market continues to fall.
Mr. Deysher reports that the bond ETF purchase was about a break even proposition, but that the short ETFs have been sold to generate tax losses. He pledges to avoid both “inverse and long-macro bets” in the future, but notes that the CEFs have been very profitable. While those positions have been pared back, he’s open to repeating that investment should the opportunity again present itself.
The manager trained with and managed money for twelve years with the nation’s premium small cap investor, Chuck Royce. He seems to have internalized many of the precepts that have made both Mr. Royce and Mr. Buffett successful.
Pinnacle Value offers several compelling advantages over better known rivals: the ability to take meaningful positions in the smallest of the small, a willingness to concentrate and the ability to hedge.
Many smart people hold two beliefs in tension about small cap investing: (1) it’s a powerful tool in the long term and (2) it may have come too far too fast. If you share those concerns, Pinnacle may offer you a logical entry point – Mr. Deysher shares your concerns, he has his eye on good companies that will become attractive investments should their price fall, and he’s got the cash to move when it’s time. In the interim, the cash pile offers modest returns through the interest it earns and considerable downside cushion.
© Mutual Fund Observer, 2011. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact [email protected].