What challenges do small caps face?
In our global survey of the investment community in Q4 2019, we asked both the buy side and the sell side what the particular challenges are for investing in small-cap companies. The question was open comment, allowing respondents to answer in any way they wished. These comments were then categorized to give a broader picture of the challenges faced in small-cap investment.
Liquidity
The most common issue to be raised is liquidity, with three in 10 respondents mentioning it. Quite simply, investors are concerned about having money tied up in small-cap companies, whether they can get enough investment in the first place and whether they can readily get out of that position when needed.
Liquidity is the issue mentioned most by both buy-side and sell-side respondents, although it is more commonly cited by the sell side: more than four in 10 sell-siders mention liquidity, compared with a quarter of buy-siders.
Information
The lack of information and insufficient communication and disclosure is the next most commonly mentioned issue. Investors often feel there is not enough data on small-cap companies for them to make an informed investment decision. They are also concerned about the lack of transparency at small caps and whether these companies are able to regularly provide investors with the information they need.
Information issues are more of a concern for the buy side than the sell side: 23 percent of buy-siders mention these issues, compared with 13 percent of sell-siders.
Governance
The third-most commonly cited issue is governance. This includes aspects of the way small-cap companies are run, including quality of senior management. Governance is mentioned by 19 percent of respondents. It is more commonly mentioned by the buy side than the sell side, being identified by 21 percent of buy-siders and 13 percent of sell-siders.
Coverage
As identified elsewhere in this report, sell-side analyst coverage for small-cap companies is considerably lower than coverage for companies of other cap sizes. This is reflected in the view of the investment community, with 15 percent of respondents citing it as their key challenge in small-cap investment. Rather predictably, the sell side does not see a lack of analyst coverage for small caps as a key issue, but the buy side does, with 19 percent of buy-side respondents mentioning it.
Moreover, lack of analyst coverage can be considered in the wider issue of lack of information. Respondents who mention analyst coverage or lack of information generally amount to 35 percent, more than the 30 percent who mention liquidity. Seen this way, lack of information, either from the sell side or elsewhere, is the major challenge facing small-cap investment.
Volatility
Volatility is another issue that concerns the investment community regarding small-cap companies. This time it is the sell side that is more concerned, with 17 percent citing it as an issue, compared with just 7 percent of buy-siders.
Other issues
The other issues mentioned by the investment community as challenges to investing in small caps include the lack of resources available to such companies to have an effective IR operation, trading issues such as ETFs and the lack of index availability for small caps. The lack of information around ESG is mentioned by a small number (7 percent) of investors while a few specifically cite the impact of Mifid II as being detrimental to small-cap investment.
Comments
