Michael Corbett's Perritt MicroCap Opportunities Fund beat 98 percent of competing U.S. mutual funds during the past five years by buying shares of companies Corbett says are "under-followed, under-loved and under-researched."

Two of Corbett's biggest holdings -- Flanders Corp., a maker of residential and commercial air filters, and Barrett Business Services Inc., a human resources company -- more than tripled in value in the past two years. Both companies are followed by fewer than three analysts.

Companies with stock market values of less than $400 million, such as Flanders and Barrett, are "neglected," Corbett, 39, said from his office in Chicago. "You can find a lot of inefficiencies. That's the appeal."

The $271 million Perritt MicroCap fund rose at an average annual rate of 18.5 percent in the past five years, ranking third among 142 funds that invest in smaller-size companies reporting above-average earnings and revenue growth. In the same period, the Russell 2000 Index climbed an average 4.8 percent and the Standard & Poor's 500-stock index fell 3.6 percent.

The $535 million Wasatch Micro Cap Fund, run by Robert Gardiner and Daniel Chace from Salt Lake City, is the No. 1 performer in its class in the past five years, rising at an annual rate of 22 percent.

Corbett's fund is down 3.1 percent this year. Shares of smaller companies have declined amid higher borrowing costs, as the Federal Reserve has increased its overnight lending rate eight times since June.

"Small caps tend to lag the large caps when the Fed is raising rates," said Steven DeSanctis, director of small-cap strategy at Prudential Equity Group LLC, who has been the top-ranked small-cap strategist in Institutional Investor magazine's survey since 2002. "The cycle is over. Small-cap earnings growth will slow later this year."

Corbett said 2005 may be a "pause in what I think is a decade-long period for smaller and micro stocks to outperform." Shares of Century Casinos Inc., which was among his biggest holdings at the end of March, are down 26 percent this year. The stock closed Friday at $7.22 a share.

The performance of funds such as Perritt Micro prompted Russell Investment Group Inc. to introduce a micro-cap index to track companies with market values of $55 million to $500 million.

"They've had pretty stellar performance and we needed an appropriate benchmark for that group," Kelly Haughton, strategic director of the Russell indexes, said in an interview in New York. Russell is launching the new index this month.

The Perritt fund is the flagship of Perritt Capital Management, which was founded in 1987 by Gerald Perritt. Corbett was hired three years later as an analyst, after graduating with a bachelor's degree in finance from DePaul University in Chicago, where Perritt taught. The two never met there -- Corbett said he learned about the job from the school's recruitment office.

"The best thing I ever did was hire Michael," said Perritt, 62, who has a doctorate in finance and economics from the University of Kentucky in Lexington. "It's been on-the-job training for him. I hire kids out of college because they're eager to learn." The two have collaborated on books and articles about investing.

Corbett's fund owns 100 to 150 stocks. Newpark Resources Inc. of Metairie, La., which provides environmental services to oil companies, was the biggest holding as of March 31, accounting for 1.7 percent of the fund. Its stock ended the week at $6.32 a share. Newpark has a market value of $519 million. Corbett sells stocks when a company's market value reaches $1 billion.

Perritt Micro's second-biggest holding is Flanders. The St. Petersburg, Fla.-based company uses Arm & Hammer baking soda and Lysol Antimicrobial in some of its residential air filter products and markets them using those brand names as well as the Flanders-Precisionaire name. That's one reason the Flanders name isn't better known, Corbett said.

"They're taking market share and expanding into other businesses," he said. The only analyst who follows the stock, Matrix USA's Ivan Feinseth, who covers more than 1,600 companies, has a "strong sell" rating on Flanders.

Shares of Flanders have surged to $9.04 from $2.70 in the past two years. Corbett's third-biggest holding, Barrett Business Services, rose to $14.76 from $2 in the same period. Flanders closed Friday at $8.97 while Barrett ended the week at $14.75.

Barrett, based in Portland, Ore., said in February that 2004 sales jumped almost 60 percent to $195 million. Leonard Lee of Seidler Cos. and Jeff Martin of Roth Capital Partners have "buy" ratings on the stock.

The company will benefit from "a temp business that's improving," Corbett said. U.S. nonfarm employment grew by 78,000 positions in May, the Labor Department's Bureau of Labor Statistics reported Friday.

"We're sticking to our traditional approach, focusing on the smallest of companies," he said. "It's fascinating to meet people who have started businesses out of their basements. It's not a space the general public knows about."

Bloomberg reporters Tracy O'Brien and Demetrios Pasigos contributed to this report.