Perritt Capital Management specializes in “ultra micro” stocks, with market capitalizations of roughly $250 million and below.
Yet since 2005, the buyside firm based in Chicago has built up a specialty in large trades, not small.
Block trades now account for 35 percent of its total volume. Its average block trade: 25,000 shares. And that pushes the average for all its trades to 15,000 shares, according to its director of research and equity analyst George Metrou.
Perritt does this, as well, without relying on electronic markets that specialize in large blocks, such as the Liquidnet dark pool.
Instead, the firm operates in what might be considered the old-fashioned way: It has built up a network of 40-45 brokers across the country that it trusts and relies on to send it indications of interest every day in stocks that it holds positions in. And then, it responds. In “voice negotiations.’’ That is to say, phone calls.
Here are the building blocks it uses to trade in large blocks, effectively.
1.Publish the portfolio, for all to see.
The firm manages two main funds, with roughly $400 million in assets between them:
Perritt MicroCap Opportunities Strategy Fund (PRCGX), which invests in companies that are listed in the bottom 20% of major stock exchanges as ranked by market capitalization. Initial investments have a market capitalization between $50 and $500 million.
Perritt Ultra MicroCap Strategy Fund (PREOX), which invests in companies that are listed in the bottom 10% of the major stock exchanges as ranked by market capitalization. The initial investments are in firms with a market capitalization below $300 million.
At any given time, the firm holds roughly 150 “unique positions.” The holdings are disclosed in 13F filings with the Securities and Exchange Commission, every quarter. Only a handful of other names draw interest, which can be communicated directly to the broker network.
The firm expects that any broker that plans on doing repeat business with it will familiarize itself with those positions. Because those are the stocks in which it will entertain propositions to buy or sell large blocks. Changes in positions – turnover in holdings – at Perritt is only about 30% a year.
2.Adhere to the 100:1 rule.
Perritt asks its network of brokers to send indications of interest every day, consistently.
But it doesn’t send out indications of interest, itself, very often. The ratio of incoming IOIs to outgoing is about 100 to 1.
“We have worked to make the ratio of inbound indications and outbound indications on natural liquidity highly in our favor,” Metrou said. “We want for opportunities to arise and be presented to us to respond to.’’
Each morning, its investment team reviews a half dozen to a dozen indications of interest that come in from its network.
And responds only when it makes sense. Perhaps once or twice a week
“We’re more of a passive responder,’’ asserts Metrou.
3.Leverage the human factor.
Because it gathers indications of indication through its own group of trusted brokers, you could say Perritt runs its own dark pool.
It gathers information about market interest on its own. But does not disclose its own intent.
Until it calls back and negotiates a deal, person to person.
“So much of our order flow is handled with voice-negotiated block trading,” Metrou said. “That personal relationship is very virtual. Building that trust, getting to know someone quite well.”
When you put computers in, you lose that human interaction, in his view.
4.Make it clear to brokers that consistency matters.
The top 10 brokers in Perritt’s network get 75% of its business. “those are the guys who get it,’’ Metrou said. “they understand how I am trying to go about this.”
How to get there?
Be consistent. Keep the faith.
The more often you send indications of interest to Perritt, the greater the chances of a cross. Pure and simple, said Metrou.
“The more often you indicate to me,’’ he said, “your odds of getting a cross go up.’’
High frequency, in this context, matters. And breeds results.
5.Identify ghosts.
Trust, sure.
But if you get an indication of interest, watch like an eagle to see if the fill actually happens.
“If I respond and say I am willing to sell that security,’’ he said, “the frequency of falling down on a trade is very low.”
It’s one of the oldest rules in the book. But if the indication isn’t real, then trust is misplaced.
The broker that sent the false indication gets put on probation.
And if it happens again, dropped from the network.
“The handful of times where you have somebody fall down on a trade, those guys get kicked out of the network. They’re no longer allowed to trade,’’ he said.
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The end result?
Relationships you can bank on. “Shorthand communication” that says, ‘’hey, handle this one like that other one” and the broker knows what you’re talking about.
“Everyone needs to trust everyone else,’’ he said.
No need for algorithms.
The human mind, in a world driven by automation and sliced in the norm to 200-share transactions, can handle the task more neatly.
