The first quarter of 2018 was remarkable in several ways. We saw record highs in equity markets, but also a fierce resurgence in volatility. To some degree, the first quarter was a Jekyll and Hyde type of period. The first half of the quarter was characterized by a low volatility, momentum driven, continuation of the themes that carried 2017. While the second half of the quarter brought in a new regime, with explosive volatility, a refocusing of investors attention on fundamentals, and new leadership in the market. The rest of our commentary this quarter will help explain how the Perritt MicroCap Opportunities Fund (“the fund”) performed during these two distinct market environments, and the reasons behind that performance.

As an active manager, the fund has a less than 1.0 correlation to its benchmark as of 3/31/18. This is driven by distinct sector weight differences, weighting of individual stocks in the portfolio, and stylistic investment differences from the composition of the benchmark. The fund has regularly experienced significant positive and negative deltas in performance relative to the benchmark.

Below is a chart of the rolling delta of trailing 12-month performance between the fund and the Russell Microcap Index (“the benchmark”) as of 3/31/2018:

Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling 800-331-8936.

We find the 12-month rolling performance delta, from the 6/30/2000 inception through 3/31/2018, to be a highly mean reverting series. The average 12-month performance delta since the inception of the benchmark data (6/30/2000) is +2.3%, reflecting our long-term outperformance. The standard deviation is 7.2%, which indicates that there can be periods where we significantly outperform or underperform.

On a trailing 12-month basis, our performance relative to the benchmark Russell Microcap Index during the first quarter of 2018 reached -10.83%. This represented -1.8 standard deviations from our mean rolling 12-month performance since 2001. An extreme that lies in the bottom 98th percentile of relative 12-month returns. This was an outcome we were quite unpleased with, but one we understood to be an extreme, and yet, also not unprecedented. After being participants in the U.S. Microcap equity market for nearly 30 years, we understand cycles, even extremes ones, come and go. Historically however, +/- 1.5 standard deviations has been a reliable inflection point for mean reversion of our relative performance.

In the final analysis, we believe a confluence of market factors led to this recent period of underperformance, which hit a nadir in the middle of the first quarter of 2018. We trace the sources of this underperformance to the following factors: 1) disproportionate share of market gains being produced by narrow segments of the market, which we do not participate in, 2) outperformance of larger markets capitalization names within the index, vs. the sub-$500mm market capitalization segment we target, 3) stylistic headwinds, namely growth outperforming value, and 4) larger errors of commission than our historical average. It was our belief that many of these factors are reliably mean reverting. And thus, we expected performance to rebound from the February lows. Which it did in the second half of Q1, wonderfully.

We expect our performance to continue to positively and significantly mean revert. Despite the cyclically of underperformance and outperformance periods, the fund has outperformed its benchmark since inception.

Drivers of Recent Underperformance

1. Concentration of benchmark performance in Healthcare (Biotech/Pharma) and Technology (Internet Software/Software):

Below is the Russell Microcap Index attribution from 3/7/2017-3/7/2018. This period captures the trailing 12-month period ending at the low point of our recent underperformance cycle.

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