Mifid II is set to have an “unintended consequence” on smaller company investments this year as the new regulation could lead to reduced coverage of quoted firms of this size.
Specialist asset manager Livingbridge warned this would be one of the biggest issues for UK smaller companies in 2018 after Mifid II comes into force today (3 January).
Mifid II is designed to offer greater protection for investors and inject more transparency into investing in all asset classes across European fund houses, including how asset managers pay for the research they use to make investment decisions.
Until now, asset managers received research, including written reports and phone calls with analysts, for free, although the cost of this service was built into trading fees, which are usually paid by fund managers’ clients.
For the first time, fund managers will have to budget separately for research and trading costs
Ken Wotton, fund manager at Livingbridge Equity Funds, said: “While the wider ambition for Mifid II should be applauded, an unintended consequence could be reduced coverage of smaller quoted companies as asset managers source significantly less research from banks and brokers.”
He noted that in areas where there was limited analyst coverage there was already less data and insight available to investors looking to invest in smaller quoted companies.
“There are some asset managers who are very reliant on the research produced by sell-side analysts to maintain their knowledge of particular stocks and sectors,” he observed.
Mr Wotton suggested with less pre-packaged insight and research available in the future, investors in smaller quoted companies would need “to consider how best to access potential returns from growth companies, while mitigating the associated risks”.
Elsewhere in 2018, Livingbridge forecast the vulnerability of momentum stocks could have a significant bearing on the outlook for small UK firms this year, following a period in which many high growth small-cap stocks have delivered stellar share price performance, “driving small company indices and Aim as a whole to outperform the wider market”.
“These high momentum stocks are typically high quality businesses with large potential markets but where the valuations are now discounting almost flawless execution for many years.
“However, we see these momentum stocks as being vulnerable to a material de-rating for even the smallest slip up in delivery or during periods of market volatility as is possible towards the tail-end of 2018,” he warned.
He added: “We consider it’s important that investors back businesses that aren’t dependent on momentum tailwinds or are subject to threats from macro events.”
Livingbridge also pointed to high levels of UK corporate activity which Mr Wotton said would be maintained up until the deadline for leaving the European Union in early 2019.
He explained: “The IPO market in London has been strong due to a combination of attractive valuations and investor appetite for new opportunities, particularly in the smaller companies segment. Demand for companies offering rapid growth or an attractive dividend yield remains strong.
“We’re expecting significant levels of corporate activity in the first half of 2018 as management teams and investors take advantage of the current window of opportunity ahead of the March 2019 Brexit deadline.”
Patrick Connolly, certified financial planner at Chase de Vere, acknowledged that UK smaller company investments face a number of challenges in 2018, "especially if economic growth is muted or if concerns about the implications of Brexit increase".
But he also pointed out that nobody knows what the future holds or how investments will react.
"The market as a whole may be affected by reduced research coverage because of Mifid II, corporate activity levels or by a re-rating of stocks," he said.
"However, even if these concerns materialise, investors should be taking a long-term approach and there are still likely to be opportunities for good quality smaller company fund managers to invest in companies with strong growth prospects over the medium to long term."
Read more about what advisers should expect from Mifid II here and bank 40 minutes of structured CPD.
eleanor.duncan@ft.com
