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Fund name: Pinnacle Value (PVFIX)

Objective: Pinnacle Value seeks long-term capital appreciation by investing in undervalued small- and micro-cap stocks. It might 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.”

Adviser:  Bertolet Capital of New York. Bertolet advises one $10 million account as well as this fund.

Manager: 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.

Opening date: April Fool’s Day, 2003.

Minimum investment: $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 registering; Mr. Deysher notes that the registration fees in some states exceed $1000 while others are only $100. The fund is available through the TD Ameritrade platform.

Expense ratio: 1.49% on assets of $47 million. There is a 1% redemption fee for shares held less than a year.

Comments: What’s the basis for my “Berkshire Hathaway for ultra-micro-caps teaser?”  Five factors brought the comparison to mind.  With Deysher, you get:

  1. 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 33 stocks and his largest holding consumes 7% of the fund. The fund’s prospectus allows for as much as 10% in a single, tiny 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.

  2. 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? $35 million by Morningstar’s calculation (the manager reports that the weighted average is $165 million), and he’s willing to consider companies with a market cap as low as $10 million.  That means his MMC is one-tenth of the MMC for Bridgeway Ultra-small Company (BRUSX), the original fund for companies smaller than micro-caps. To get a sense of Deysher’s style, we can look at his top three holdings:

    ·        Argan Inc., the fund’s top holding at 7% of the portfolio, is a publicly–traded holding company.  It owns a power plant designer, a wiring company, and a nutriceutical manufacturer.  Pinnacle is the only fund which owns shares of Argan.  The stock has doubled in the past year.  It has a market cap of $89 million.

    ·        Conrad Industries, the second holding at 5.5%, designs and builds tugs and barges.  Pinnacle is one of four fund companies which own shares of Conrad.  The second largest holder, at about a third of Pinnacle’s stake, is Royce Micro-cap.  The third-largest holder, Boston Parnters, has one-tenth of Pinnacle’s stake and the fourth, DFA, has a tiny share.  The stock has returned 250% over the past year.  It has a market cap of $108 million.

    ·        WHX Corporation is an OTC-listed holding company for a variety of tiny tech and manufacturing concerns.  It was reorganized under bankruptcy protection in 2005.  Its average trading volume is just over 6000 shares/day and it has no shares at all traded on about one day in three.  Pinnacle holds more shares than any other fund, though several of the Gabelli funds hold shares as well.  It has a market cap of $72 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 MSCI EAFE non-dollar index; that is, from the perspective of statistical regression, the fund acts more like a foreign stock fund than a small cap US one.  (Not to worry – even there the correlation is extremely small.)

  3. 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 offer 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, no.  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 under 50% of the portfolio is in cash right now, providing a substantial war chest in the case of instability in the weeks ahead. Part of those opportunities come when comes “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.

  4. A strong track record. All of this wouldn’t matter if he weren’t successful.  But he is.  The fund has returned 12% through 8/30/2007 and 16.1% annually over the past three years, a top decile performance. As I write, it reports top 1% returns for the week, quarter and year.  That’s accomplished by staying competitive in rising markets and strongly outperforming in falling ones.  His worst-ever quarter was a loss of 0.31% (one-tenth of the loss in Vanguard’s Small Cap Value index for the same period). Pinnacle Value operates with less than half the volatility of its index. 

  5. 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.”

Bottom line: The manager trained with and managed money for twelve years with the nation’s premium small cap investor, Charles Royce.  He seems to have internalized many of the precepts that have made both Mr. Royce and Mr. Buffett successful.  And his fund 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.

Company website: Pinnacle Value Fund

 



September 1, 2007