White Paper: Activist International Equities Investing Series

Anatomy of the Small-Cap Anomaly

Mapping valuation differences potentially responsible for the
small cap anomaly in developed European and Asian stock
markets.

Marcel Houtzager CFA, Peter Zaldivar CFA, Aditya Eachempati,

Vipul Badjatya, and Nikhil Rastogi

May 2010

Special Thanks to Rodrigo Garcia-Uribe

ANATOMY OF THE SMALL-CAP ANOMALY Copyright 2010 by Kabouter Management LLC.

All rights reserved. Printed in

the United States of America. No part of this document may be used or reproduced in any manner whatsoever
without written permission except in the case of brief quotations embodied in critical articles and reviews. For
information address Kabouter Management LLC, 1 East Wacker Drive, Suite 2505, Chicago, IL 60601

Table of Contents

Executive Summary......................................................................................................................... 2
Introduction .................................................................................................................................... 2
Summary of Prior Research ............................................................................................................ 3
Methodology................................................................................................................................... 5
Results ............................................................................................................................................. 6
Possible causes of observed valuation anomalies ........................................................................ 10
Further Research........................................................................................................................... 11

Executive Summary
A large body of research exists on the question of market efficiency and the Capital Asset
Pricing Model ("CAPM"). Numerous apparent exceptions to the CAPM have been observed,
with the risk adjusted outperformance of small-cap stocks over large-cap stocks being the most
commonly cited anomaly. The bulk of the research to date on this topic has found excess
returns for stocks below a certain size threshold. In this paper, the authors analyze valuations
in a number of developed markets in Europe and Asia across the market cap spectrum. While
CAPM would lead one to expect a gradual decline in valuations as one looks at smaller and
smaller stocks, the research in this paper shows that valuations do not correlate with company
size in a smooth fashion and that there is a kink point below which companies become
cheaper faster than the CAPM would predict. The authors posit that the valuation anomaly
described by these kink points could help explain the existence of the small-cap performance
anomaly, and that the institutional behavior that probably creates these kink points is difficult
to change, which could help explain why the small cap anomaly has persisted, despite ample
information on the topic.

Introduction
During our 19 years as active managers investing in developed international stock markets
(world ex-US), we have observed, along with many of our competitors, that smaller companies
often appear to be undervalued relative to their larger brethren, even on a risk-adjusted basis.
We have also observed that as such smaller companies grow, either organically, or by
acquisition, the undervaluation often disappears. This often results in strong investment
performance, as the companies share prices appreciate at the combined rate of their earnings
per share growth and the growth in their earnings multiples.
Based on these observations, our hypotheses are 1) that institutional investors ignore stocks
below a certain size and liquidity threshold, thereby creating a systematic valuation anomaly
(and opportunities for patient managers willing to invest the time and energy required to invest
in smaller companies), and 2) that this valuation anomaly, and its eventual correction as
companies grow out of it, may help explain the well documented small-cap performance
anomaly to the CAPM. By investigating and describing key aspects of the valuation anomaly,
we therefore hope to contribute to an improved understanding of the small-cap performance
anomaly, and to lay the groundwork for further efforts to understand the linkage between the
two.

Anatomy of the Small-cap Anomaly

Summary of Prior Research
Prior research on topics relating to the small-cap effect show a number of interesting findings,
specifically:
1. The smallest stocks outperformed the largest stocks in developed markets;
2. Less liquid stocks outperformed more liquid stocks, and this effect is likely separate
from the size effect;
3. Stocks with less analyst coverage reacted more slowly to news, particularly bad news,
than stocks with more coverage, indicating a less efficient market for those stocks; and
4. Institutional investors have shown a preference for larger, more liquid stocks -- possibly
to maximize exposure to their best ideas, as well as to realize the benefits of scale. This
preference is acknowledged by a staunch defender of the efficient market theory.
Therefore, there is evidence not only that smaller, less liquid, less followed stocks outperform
larger, more liquid, more followed stocks, but that this might be caused by institutional investor
behavior.
Bauman, Conover and Mitchell showed in their 1998 study of stocks in Europe, Australia and
Far East ("EAFE") developed markets that stocks in their lowest market capitalization quartile,
averaging $46.6 million, far outperformed stocks in the highest market capitalization quartile,
averaging $2.5 billion by 22.0% to 10.8% between 1986 and 1996.1 The difference was most
pronounced for the quartile of smallest stocks, with the quartile of the second smallest stocks
returned 13.6% and the quartile of second largest stocks returned 11.1%. Fama and French
found similar results in their study of US stocks between 1963 and 2005, with the smallest
stocks again experiencing the most anomalous higher returns.2 Earlier studies in the 1980s and
1990s had similar findings.
Keene and Peterson found evidence that liquidity has had an impact on portfolio returns,
separate from company size and valuation.3 They analyzed 54 US stock portfolios between July
1963 and December 2002, and found that both size and liquidity had an impact on returns.
They also concluded that the two factors likely had independent impacts.

W. Scott Bauman, C. Mitchell Conover and Robert E. Miller, "Growth versus Value and Large-Cap versus SmallCap stocks in International Markets", Financial Analysts Journal, Vol. 54, No. 2 (Mar - Apr., 1998), pp. 75-89
2

Eugene F. Fama and Kenneth R. French, "Dissecting Anomalies", The Journal of Finance, Vol. LXIII, No. 4 (August
2008), pp. 1653-1678
3

Marvin A. Keene and David R. Peterson, "The Importance of Liquidity as a Factor in Asset Pricing", The Journal of
Financial Research, Vol. XXX, No. 1 (Spring 2007), pp. 91-109

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Anatomy of the Small-cap Anomaly

Hong, Lim and Stein also found a relationship between analyst coverage and market efficiency,
particularly for smaller-cap stocks.4 They found a 60% greater benefit to momentum investing
from smaller stocks in the tertile with the least coverage compared to stocks of basically the
same size in the tertile with the most coverage, using a universe of US stocks between 1976 and
1996. Specifically they found that prices for stocks with lesser coverage did not react as quickly
to bad news as did those with more coverage, while the reaction times for good news was
more similar. They hypothesized that companies with little analyst following, and investment
managers who owned their shares, made efforts to publicize good news, while they had little
incentive to spread bad news for those companies.
Barberis and Thaler hypothesize that anomalous pricing of smaller cap stocks may be the result
of the paucity of arbitrage opportunities in this universe caused by larger trading costs and
lower liquidity.5
Pollet and Wilson found evidence that as mutual funds grow, their managers tend to add to
existing positions, and only seek new investment ideas in order to address liquidity constraints. 6
They hypothesize that there may be two reasons for this behavior:
1. Managers prefer to maximize exposure to their best ideas; and
2. Managers enjoy greater returns to scale with fewer positions.
Malkiel questioned the validity of the small-cap effect, positing that the results were skewed by
survivorship bias.7 But, he also pointed out that
"From the mid-1980s through the decade of the 1990s, there has been no gain from
holding smaller stocks. Indeed in most markets, larger capitalization stocks
produced larger rates of return. It may be that the growing institutionalization of
the market led portfolio managers to prefer larger companies with more liquidity to
smaller companies where it would be difficult to liquidate significant blocks of stock."

Harrison Hong, Terrence Lim and Jeffrey C. Stein, "Bad News Travels Slowly: Size, Analyst Coverage and the
Profitability of Momentum Strategies", The Journal of Finance, Vol. LV, No. 1 (February 2000), pp. 265-195
5

Nicholas Barberis and Richard Thaler, "A Survey of Behavioral Finance", Handbook of the Economics of Finance,
edited by George Constantinides, Milt Harris and Rene Stulz (2002)
6

Joshua M. Pollet and Mungo Wilson, "How Does Size Affect Mutual Fund Behavior"?, The Journal of Finance, Vol.
LXIII, No. 6 (December 2008), pp. 2941-2968
7

Burton G. Malkiel, "The Efficient Market Hypothesis and its Critics", The Journal of Economic Perspectives, Vol. 17,
No. 1 (Winter 2003), pp. 59-82

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Anatomy of the Small-cap Anomaly

Therefore although Malkiel questioned the existence of the small-cap effect, he does seem to
believe in the institutionalized preference for larger-cap stocks. He also seems to believe that
this preference is more relevant than in past years.
Therefore the research seems to indicate some evidence that smaller, less liquid stocks are less
desirable to large institutional fund managers, and that this may have an impact on their
valuations and their returns.

Methodology
In our November 2009 study, we analyzed stock valuations across the market cap spectrum in
seven regions in Europe and Asia where the Kabouter Fund LLC ("the Fund") is active:

Scandinavia -- Sweden, Denmark, Finland, Norway and Iceland

Western Europe -- France, Belgium, Netherlands, Luxembourg and Ireland
Central Europe -- Germany, Austria and Switzerland
Southern Europe -- Portugal, Italy, Greece and Spain
United Kingdom
Japan
Asia Ex-Japan -- Hong Kong, Singapore, Australia and New Zealand

We first graphed valuations against market capitalization. The CAPM would predict that this
relationship should be relatively smooth. Smaller and smaller companies are on average, more
and more risky (at the extreme small end of the spectrum, the majority of startups fail and at
the extreme large end of the spectrum the majority of mega caps do not), and the CAPM
therefore predicts that, ceteris paribus, the relationship between size and valuation should be
smooth and upward sloping as companies get larger. Any kinks in this relationship would
therefore have to be considered anomalous.
Secondly, we tried to further analyze the valuation differences between companies of different
sizes by adjusting for the quality of those companies and the volatility of their stock prices, and
in this manner attempted to isolate the portion of the valuation anomaly that is more likely
created by institutional bias alone. To remove quality and volatility differences between
companies from the equation as much as possible, we therefore took the following four steps:
1. We compared valuation metrics (price/book, price/earnings and EV/EBITDA) across a
number of ranges of market capitalizations in each market -- Under $100 million, $100
million to $250 million, $250 million to $500 million, $500 million to $1 billion, $1 billion
to $5 billion, $5 billion to $10 billion, and above $10 billion;

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Anatomy of the Small-cap Anomaly

2. We examined the differences in quality of the companies across these ranges of market
capitalizations using fundamental metrics -- return on equity, return on capital -- and
proprietary metrics: "K1", which incorporates factors including earnings per share
growth, capital structure, earnings stability and return on capital and "K2", which
considers the price volatility of stocks;
3. We examined the sensitivity of valuation metrics to differences in the quality of the
stocks using the above metrics;
4. We used the findings in the first three steps to arrive at a quality-adjusted comparison
of valuations across the ranges of market capitalizations listed above.
During our research we considered over 12,000 companies in developed markets in Europe and
Asia. For each market, the Kink Point was defined was deemed to occur where we observed a
sudden decline in the pricing level between market cap ranges.
Risk-adjusted price to book = price to book ratio K2,
where K2 a Kabouter proprietary measure of total risk in the stock, i.e. Fundamental Risk
plus Stock Price Volatility. It is calculated as:
K2, = K1/360 day standard deviation of stock price
where K1 a Kabouter proprietary measure of fundamental risk in the stock, i.e.
Fundamental Risk plus Stock Price Volatility. It is calculated as:
K1 = 20%* Correlation of basic EPS + 25%*ROC + 25%*Last 5 year EPS growth before
extraordinary income + 30%* Altman Z Score

Results
Our research consistently showed the presence of Kink Points below which valuations, as
measured by Price to Book Ratio dropped off steeply. This is illustrated in Exhibit 1 using data
from November 2009 for Kabouter's "Asia Ex-Japan Region", which includes Hong Kong,
Singapore, Australia and New Zealand.

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Anatomy of the Small-cap Anomaly

Exhibit 1
Kink Points -- Asia Ex-Japan
Includes Hong Kong, Singapore, Australia and New Zealand
As of November 2009
(in US Dollars)

Kink Points
3.0
2.43

2.5

Price
to
Book

2.0
1.55

1.5

1.23
1.04

1.0
0.39

0
Less than
$250 million to $500 million $1 billion to
to $1 billion $3 billion
$250 million $500 million

$3 billion to $5 billion to
$5 billion
$10 billion

Market Capitalization
Source: Bloomberg; Kabouter Management LLC

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More than
$10 billion

Anatomy of the Small-cap Anomaly

We also found the valuation anomaly exists even after adjusting for company quality (see
Exhibit 2 where the quality and risk-adjusted Price-to-Book Ratio is also kinked).

Exhibit 2
Kink Points -- Asia Ex-Japan
Includes Hong Kong, Singapore, Australia and New Zealand
As of November 2009
(in US Dollars)

Kink Point
3.0
2.43

2.5

Price
to
Book

2.23

2.30

2.06

2.0

1.58
1.30
1.19

1.5

1.55

1.23
1.04

1.0

0.48
0.39

0
$250 million to $500 million $1 billion to
Less than
to $1 billion $3 billion
$250 million $500 million

$3 billion to $5 billion to
$5 billion
$10 billion

Market Capitalization
Actual Price to Book
Predicted Price to Book (Using Kabouter risk estimator)
Source: Bloomberg; Kabouter Management LLC

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More than
$10 billion

Anatomy of the Small-cap Anomaly

We found Kink Points in most developed European and Asian stock markets in the $250 million
to $5 billion range. This may indicate that smaller-cap stocks remain systematically
underfollowed by institutional investors across markets, which we think could be an important
aspect this aspect of the anatomy of the small cap anomaly (see Exhibit 3).

Exhibit 3
Kink Points by Region
As of November 2009
(in US Dollars)
Region

Countries

Number of
Companies

Kink Point
Price to Book below this point
drops more steeply:

Scandinavia

Sweden, Denmark,
Finland, Norway,
Iceland

1,050

$500 million

Western Europe

France, Belgium,
Netherlands,
Luxembourg, Ireland

1,195

$250 million

Central Europe

Germany, Austria,
Switzerland

1,488

$250 million and $1 billion

Southern Europe

Portugal, Italy,
Greece, Spain

United Kingdom

UK

1,727

$1 billion

Japan

Japan

2,327

$250 million

Asia Ex-Japan

Hong Kong, Singapore,

Australia, New
Zealand

3,528

$500 million

743

12,058
Source: Bloomberg; Kabouter Management LLC

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$500 million

Anatomy of the Small-cap Anomaly

The kink points for other regions are illustrated in Exhibits 4 through 9. It is interesting to note
that in certain markets, such as Scandinavia, Central Europe and the UK, there is a Kink Point at
the larger end of the spectrum, whereby Mega-cap stocks over $10 billion are actually
undervalued relative to Large-cap stocks in the $5 billion to $10 billion range.

Possible causes of observed valuation anomalies

In our regular discussions with portfolio managers, buy side analysts, sell side analysts, brokers,
and clients we have often found the following phenomena:
1. Managers wish their funds to be scalable to at least $2 billion - $5 billion, in order to
meet their personal earnings objectives, given the typically high opportunity cost of
their time;
2. They wish their funds to be relatively concentrated so that each stock has a meaningful
impact on fund returns. This means that they typically wish to have no more than 50100 stocks in their portfolios. In a 100 stock portfolio, each stock accounts for an
average of 1% of the fund's returns;
3. Therefore, many managers limit themselves to investing in stocks in which they can
potentially invest at least $30 million - $50 million;
4. Most managers do not wish to take more than a 5%-7% stake in companies in which
they invest, since larger positions would be difficult to trade in and out of and hence
illiquid. As a result, they are limited to considering stocks with a minimum market cap
of $250 million to $1 billion -- the range in which Kink Points are frequently found;
5. Brokers and sell-side analysts, correctly gauging their large clients' lesser interest in
smaller stocks, give them far less coverage. Our research shows that non-US small-cap
stocks in developed markets are covered by an average of two analysts, compared to 11
analysts for Mid-Cap stocks and 25 analysts for Large-cap stocks in these same markets;
6. Smaller companies, responding to the lack of interest from large fund managers and
brokers, invest less in investor relations efforts, and furthermore tailor these efforts to
local investors and those personally familiar with their company;
7. Of the more than 20,000 stocks in developed non-US markets, only a small minority are
large-cap stocks. Consequently, an intrepid investor wishing to analyze non-US smallercap stocks must navigate an enormous, foggy sea of tens of thousands of stocks, little
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Anatomy of the Small-cap Anomaly

sell-side coverage, and companies unaccustomed to dealing with overseas investors, or
even to speaking any language other than their own.
While the specific numbers described here vary somewhat from market to market, we have
observed this dynamic across all developed world markets.

Further Research
It would be interesting to see how the data changes over time. Also, it might be productive to
find ways to document how smaller companies are "re-rated" as they move up to mid-cap and
large-cap status such that re-rating theory can be shown to be responsible for a meaningful
portion of the small-cap performance anomaly. One way to examine this might be to follow
those mid-cap and large-cap stocks that were publicly traded when their size was below the
Kink Point in their region, and examine whether they were re-rated as they grew.
Another possible topic for further research might be to examine the causes for the Kink Point at
the larger end of the scale, whereby mega-cap stocks are undervalued relative to large-cap
stocks in certain markets. We believe these Kink Points may also be caused by institutional
behavior, specifically by the behavior of hedge fund and other active managers who find that
their clients are somewhat reluctant to pay more than index fund fees for strategies that use
mega caps. Tracking the correlation between the emergence of the mega-cap discount in these
markets and the hedge fund boom might be interesting.
Finally, this paper dealt with specific developed markets in Europe and Asia. It might be
interesting to repeat the study in the USA, Canada and even in emerging and frontier markets.

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Anatomy of the Small-cap Anomaly

Exhibit 4
Kink Points -- Scandinavia
Includes Sweden, Denmark, Finland, Norway and Iceland
As of November 2009
(in US Dollars)

Kink Points
2.5

2.24

2.0

Price
to
Book

1.92

1.73
1.61

1.5
1.35

1.61

1.39
1.30
1.33

1.0

1.23

1.39

1.16

0.85

0.5
0.74

0
Less than
$250 million to $500 million $1 billion to
to $1 billion $3 billion
$250 million $500 million

$3 billion to $5 billion to
$5 billion
$10 billion

Market Capitalization
Actual Price to Book
Predicted Price to Book (Using Kabouter risk estimator)
Source: Bloomberg; Kabouter Management LLC

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More than
$10 billion

Anatomy of the Small-cap Anomaly

Exhibit 6
Kink Points -- Western Europe
Includes France, Belgium, Netherlands, Ireland and Luxembourg
As of November 2009
(in US Dollars)

Kink Point
2.0
1.40

1.5

Price
to
Book

1.34

1.32

1.34

1.29
0.93

1.0

1.36

1.08

1.09
1.09

1.06

0.95
0.61

0.5
0.51

0
Less than
$250 million to $500 million $1 billion to
to $1 billion $3 billion
$250 million $500 million

$3 billion to $5 billion to
$5 billion
$10 billion

Market Capitalization

Actual Price to Book

Predicted Price to Book (Using Kabouter risk estimator)
Source: Bloomberg; Kabouter Management LLC

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More than
$10 billion

Anatomy of the Small-cap Anomaly

Exhibit 7
Kink Points -- Central Europe
Includes Germany, Austria and Switzerland
As of November 2009
(in US Dollars)

Kink Point
2.2
1.92

1.7

Price
to
Book

1.45
1.26

1.2

1.27

1.23

1.11

0.7

1.67

1.27

1.20

0.91

0.41

0.35

0.30

0.28

0.2
0

Less than
$250 million to $500 million $1 billion to
to $1 billion $3 billion
$250 million $500 million

$3 billion to $5 billion to
$5 billion
$10 billion

Market Capitalization

Actual Price to Book

Predicted Price to Book (Using Kabouter risk estimator)
Source: Bloomberg; Kabouter Management LLC

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More than
$10 billion

Anatomy of the Small-cap Anomaly

Exhibit 8
Kink Points -- Southern Europe
Includes Portugal, Italy, Spain and Greece
As of November 2009
(in US Dollars)

Kink Points
1.5

1.41

1.40
1.22

1.41

1.2

Price
to
Book

1.14
0.88

0.9

1.01
0.74

0.76
0.52

0.6

0.57
0.28

0.3

0.44

0.22

0
$3 billion to
Market Capitalization

Less than
$250 million to $500 million $1 billion to
to $1 billion $3 billion
$250 million $500 million

Actual Price to Book

Predicted Price to Book (Using Kabouter risk estimator)
Source: Bloomberg; Kabouter Management LLC

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$5 billion

$5 billion to
$10 billion

More than
$10 billion

Anatomy of the Small-cap Anomaly

Exhibit 9
Kink Points -- United Kingdom
As of November 2009
(in US Dollars)

Kink Point

2.5
2.5

2.21
2.08

2.0
2.0

Price
to
Book

2.04

1.88

2.04
1.76

1.5
1.5

1.36

1.56

1.50

1.0
1.0

0.94
1.07
0.90
0.49

0.5
0.5

0.38

00.0
$250 million to $500 million $1 billion to
Less than
to $1 billion $3 billion
$250 million $500 million

$3 billion to $5 billion to
$5 billion
$10 billion

Actual Price to Book

Predicted Price to Book (Using Kabouter risk estimator)
Source: Bloomberg; Kabouter Management LLC

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More than
$10 billion

Anatomy of the Small-cap Anomaly

Exhibit 10
Kink Points -- Japan
As of November 2009
(in US Dollars)

Kink Points
0.6
0.48
0.49

0.5

Price
to
Book

0.41

0.38
0.41

0.32
0.29

0.27

0.4

0.30

0.23
0.28

0.28
0.20

0.3

0.15

0.2
0
$250 million to $500 million $1 billion to
Less than
to $1 billion $3 billion
$250 million $500 million

$3 billion to $5 billion to
$5 billion
$10 billion

Market Capitalization
Actual Price to Book
Predicted Price to Book (Using Kabouter risk estimator)
Source: Bloomberg; Kabouter Management LLC

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More than
$10 billion

Anatomy of the Small-cap Anomaly

About Kabouter Management LLC
Kabouter Management LLC was founded in 2003 by Marcel Houtzager and Peter Zaldivar.
Kabouter invests in a portfolio of under-researched non-US micro to mid-cap equities with a
prospect for growth and eventual institutional discovery. Kabouter companies are
characterized by low leverage, a successful operating history, a recession-resistant business
model, and a high degree of management ownership. The focus is on micro-cap companies -which are among the least researched by major investment firms -- thereby enabling
professional investors to add value through creative and diligent research, and in some cases,
friendly advice. Messrs. Houtzager and Zaldivar previously managed non-US smaller cap
portfolios for seven years while at Wanger Asset Management. These portfolios reached over
$1 billion in assets. Kabouter's supportive and sophisticated investor base includes professional
money managers, entrepreneurs, family offices and foundations. In addition to the Kabouter
Fund LLC, the firm manages a separate account which also focuses on under-researched non-US
equities. As of 2009 year-end, Kabouter had approximately $180 million in assets under
management.

Contact:
Linda Choi
Chief Operating Officer
Kabouter Management LLC
1 East Wacker Drive, Suite 2505
Chicago, IL 60606
Tel: (1-312) 546-3091
Fax: (1-312) 546-4260
E-mail: linda@kabouterfund.com

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Anatomy of the Small-cap Anomaly

Certain Risk Factors:
Before considering an investment in the Kabouter Fund, please read the Risk Factors of this
presentation and please review the Confidential Private Offering Memorandum of the Kabouter
Fund available from Kabouter Management, LLC, upon request.
Before investing in the Kabouter Fund, you should carefully review the Confidential Private
Offering Memorandum and, to the extent you consider it appropriate, consult with your
independent professional advisor in evaluating the merits and risks of acquiring an interest in
the fund. Although the risks are described in further detail in the funds Confidential Private
Offering Memorandum, in reviewing this presentation, you should consider the following risks:
An investment in a hedge fund is considered speculative and entails substantial risks. There can
be no assurance that the investment objectives of the Kabouter Fund, including its risk
management and diversification goals, will be achieved and results may vary substantially over
time.
While the Kabouter Fund may be considered similar to an investment company, the fund is not
required to register nor is it registered as such under the Investment Company Act of 1940 in
reliance upon an exclusion available to privately offered investment companies. Accordingly,
the provisions of the Investment Company Act and other securities laws, which provide certain
regulatory safeguards to investors, are not applicable to the fund or to the Manager of the
fund.
The Kabouter Fund is chiefly dependent on the efforts of Mr. Zaldivar and Mr. Houtzager. If Mr.
Zaldivar or Mr. Houtzager become unavailable to the Manager, the Manager may lose its ability
to sustain the funds operations.
Interests in the Kabouter Fund are subject to restrictions on transferability and resale and may
not be transferred or resold to another person except under limited circumstances. Also, unlike
a mutual fund, an interest in the fund cannot be redeemed on a daily basis but is subject to
lock-up periods and substantial illiquidity. Access to capital is prohibited for one year after each
investment and subject to a 4% redemption fee until the second anniversary of each
investment, and thereafter capital may be withdrawn only upon 60 days written notice at the
end of each quarter. Investors should be aware that they will be required to bear the financial
risks of an investment in the fund for an indefinite period of time.
The Kabouter Fund may employ investment techniques such as margin transactions, short
sales, option transactions and forward and futures contracts, which practices can, in certain
circumstances, maximize an adverse impact to the funds portfolio.

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Anatomy of the Small-cap Anomaly

The Kabouter Funds portfolio is sensitive to global market, economic, social and political
conditions that could result in dramatic decreases in value.
The Kabouter Fund invests in companies that are smaller and less well-known than larger, more
widely held companies. Small companies tend to be more vulnerable to adverse developments
than larger companies. Small companies may have limited product lines, markets, or financial
resources, or they may depend on less seasoned management. Their securities may trade
infrequently and in limited volumes. As a result, the prices of these securities may fluctuate
more than the prices of securities of larger, more widely traded companies. Also, there may be
less publicly available information about small companies or less market interest in their
securities as compared with larger companies, and it may take longer for the prices of these
securities to reflect the full value of their issuers earnings potential or assets.
The Kabouter Fund invests in non-U.S. companies that involve special risks not usually
associated with investing in U.S. securities. Some of these risks include expropriation and
nationalization, confiscatory taxation, difficulty of repatriating funds, social, political and
economic instability and adverse diplomatic developments. In addition, there may be lower
quality information available about non-U.S. companies, and foreign markets may not provide
the same protections available in the U.S.
The Kabouter Fund may invest in securities of companies in emerging markets that are subject
to risks due to inexperience of financial intermediaries, lack of modern technology, lack of a
sufficient capital base to expand operations and social and political instability.
The Kabouter Fund may invest in restricted securities as an alternative investment strategy if
there exist opportunities to enhance the funds position. Restricted securities are subject to
legal or other restrictions on transfer. No liquid market exists for restricted securities. The
market prices, if any, for such securities tend to be more volatile, and the fund may not be able
to sell them when it desires to do so or to realize what it perceives to be their fair value in the
event of a sale. As a result, calculating the fair market value of the funds holdings may be
difficult.
The Kabouter Fund will incur substantial brokerage and transactional costs typically greater
than the costs of transacting in U.S. securities that must be overcome for the fund to generate
profits.
Past performance does not guarantee future returns. The possibility for gains is accompanied
by the possibility of loss.

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