Is small cap liquidity drying up? The UK stockmarket is now almost two years into the MiFID II experiment, which sharply cut equity research budgets. The cost burden moved from clients to management groups, putting downward fee pressure on investment banks and stockbrokers. With few IPOs this year, there has been little opportunity for the City to offset the loss of research revenue. Now it is clear that smaller company performance has suffered most, made worse by the Woodford and Invesco concerns.
In recent years, the FTSE Mid 250 has outperformed the FTSE 100, reflecting the greater growth prospects and dynamism of medium-sized businesses compared with the largest mega-cap FTSE100 companies. Until 2018, smaller companies had shared in this outperformance. The divergence since then is marked, with smaller companies lagging mid-cap by almost 10% over 12 months. Is a rebound likely?
Resolution on UK trade relations should bring back foreign investors. And, if Brexit encourages import substitution, many smaller companies will benefit. However, diminishing quality independent research on these companies, now combines with investor and regulatory concern about liquidity. This may move institutional investors into more liquid areas of the stockmarket. Mid-cap appears to be in the sweet spot in terms of offering liquidity along with growth. But, institutional investors must demonstrate a robust and independent liquidity management process to capture this opportunity. This is easier to achieve in investment firms with capacity limits, allowing them to control exposures and reduce individual company dealing risks.