Going 'micro' for maximum gains

Two years ago, after managing a small-cap institutional fund for First Austin Capital Management, Inc., in Texas, Brian Bares started his own firm, investing exclusively in micro caps, the smallest of small-cap firms.

Investing for friends and family, he developed a track record running Bares Capital Management that led Money Manager Review to name him the top-performing private small-cap equity manager in the US for 2001 – up 68 percent for the year.

Mr. Bares hopes to ride the relative recent strength of small-cap firms with his Bares Micro-Cap fund.

With just $1 million under management so far, the fund has recently been opened to institutional investors as well as wealthy individuals. In a rough second quarter for the market, it fared better than most – down just 1.78 percent. For the year to date, the fund is up more than 22 percent.

Bares's target firms: companies with market capitalizations under $200 million. These, he told the Monitor, offer the largest playing field, the greatest value gaps, and the best opportunities for growth.

What's unique about your strategy?

We run a concentrated micro-cap strategy, holding between 10 and 20 stocks in our total portfolio. There are a lot of concentrated strategies and there are a lot of micro-cap strategies around, but very few venture into that realm.

If we can concentrate our funds in the best investment ideas in the portfolio, we think the performance will reflect that over time.

The obvious downside is that with fewer positions in the portfolio, you're statistically [as likely] to underperform as outperform. But the risk to a lot of managers isn't necessarily in the positions [they] own, it's in the positions [they] don't own, vis-à-vis their benchmark index.

By being concentrated, we can eliminate a lot of the land mines that are out there in the micro-cap universe, and there are a lot. A very large percentage of the stocks in the micro-cap universe are companies going out of business, overly speculative companies that have never made a dime in profits.

What is it you like about the micro-cap universe?

There's no following the Street in micro caps. There's relatively little in the way of investment-bank research [or] analyst coverage. There's relatively little in the way of large institutional portfolio managers paying attention to these stocks.

Therefore, you have a lot of intrinsic "value gaps" out there that are specifically the result of lack of attention.

The other thing that not a lot of people talk about is that companies under $200 million in market cap, which is our ceiling, represent 60 percent of the "investable" stock market, according to Market Guide.

If you've got approximately 10,000 companies on the exchanges, you're looking at 6,000-plus in terms of potential investment. The playing field is just so much larger. Think about the guys who are running $50 billion-$100 billion funds – they essentially have 500 selections where we have 6,000.

How do you avoid the so-called land mines?

We start with the investable universe and whittle that down to a universe of 1,000 to 2,000 companies by essentially taking out all the companies that are under $10 million.

From there, we eliminate companies that are overly speculative. These may be companies ... in natural resources/mining/minerals where we think that through our research efforts we couldn't add any value to the investment process. I don't invest outside what Warren Buffett called his "circle of competence."

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