Investments 

Mifid to push down value of small caps

Mifid to push down value of small caps

The Mifid II rule on the cost of research will lead to smaller company shares performing poorly over the long term, according to Steven Fine, chief executive of broker Peel Hunt.

The Mifid II rule requires firms to disclose to clients how much they are charging for research.

Previously brokers would supply research on companies to fund managers for free, and in exchange they would receive stock broking commissions to buy or sell shares on behalf of the fund.

But the Mifid rules took the view that this was not in the client's best interest so fund houses were forbidden from accepting free research and must now report to the client how much they are paying for the research.

Ultimately, a wide range of asset management firms chose to absorb the cost of research themselves, rather than charge clients for it.

Speaking at an event in the House of Parliament, Mr Fine said the impact of this has been a decline in demand for such research.

He said broker firms have responded to this by "asking an analyst who has maybe covered, say, the retail sector for years and is very good at it, to now also cover the leisure and media sectors, where he has less experience, this means the research is of poorer quality.

"But in time, the impact is likely to be less research is produced on smaller companies, and that will lead to smaller company share prices falling."

Mr Fine said the impact is particularly felt by smaller companies as fund managers tend to have a greater volume of publicly available information about larger businesses, and so are less reliant on research notes.

Judith MacKenzie, a UK smaller companies fund manager at Downing, said she has already noticed a negative impact on the valuations at which smaller companies trade, as a direct result of the Mifid rules.

She said: "We have seen companies issue profit upgrades, in one case a company issued four profit upgrades, and the shares haven’t really moved upwards as they should, because there are fewer buyers in the market for these shares as a result of the Mifid rules."

Ms MacKenzie added: "It’s not just a case of liquidity, smaller companies will become less profitable.

"We have already seen companies having to put on road shows for private investors in order to drum up interest, and in order to get research about themselves out there they are having to pay for it themselves, they never had to do that in the past. And [they] generally have to spend more on investor relations, and all of that reduces profitability."

Gervais Williams, manager of a range of smaller company funds at Miton said: "What has happened so far is that the lower quality research has left the market, it isn’t being provided anymore because it doesn’t really have an economic value.