Fund manager Ketan Patel is preparing for Mifid II research rules to drive market inefficiencies in the small and mid-cap segment as companies become under researched.
The EU regulation is set to come into force at the start of 2018 and will require firms to separate research and execution costs. More than a quarter of fund firms expect research budgets to rise due to the change and more than a fifth plan to charge clients an extra research fee.
Patel, who co-manages the Amity UK fund, argues brokers will be biased towards large-cap clients.
“They’ll be focusing on companies for which they have broker responsibilities, but what that means is that you’ll get huge coverage of the large cap, but on the mid cap and especially the small cap in the UK it will just go very, very, very low.”
Stock pickers will have more opportunity to deliver outperformance by doing their own research, Patel says.
But Patel warns that despite the opportunities for stock pickers, Mifid II will create complications at a business level for small fund houses.
“If you’re a Blackrock or a Fidelity it’s not a problem. The smaller fund managers are going to have to have a really big decision-making process here. Do you build your own entire research function, rely less on broker research?”
EdenTree, which has AUM of just £2.5bn, started bolstering its headcount 18 months ago in preparation for Mifid, says Patel.
“It’s almost reverting back to how it was 20 or 25 years ago, when I joined there were 20-plus analysts on the buy side. It was rolled down a little bit because there was so much broker research coming in and it was fairly cheap.”
Jason Broomer, head of investment at Square Mile, agrees that small or mid caps could end up under researched and markets could become less efficient as a result.
“External research will probably focus on larger cap names where there will be greater demand. There will undoubtedly be a niche market for small cap research providers, but the provision of this research is unlikely to be as prevalent as it is today nor disseminated as widely as it currently is.”
Neptune head of UK equities Mark Martin says he’s “reasonably confident” Mifid II research rules will be good for active managers.
“It would be more of a risk if markets suddenly plummet at the same time Mifid II comes through when research analysts everywhere are laid off. Then maybe there is a risk for FTSE 250 exposure, because no one’s got any interest in even looking at these companies.
“For as long the UK continues to be a fairly financial economy and people are interested in stock markets then I think there will be a sufficient level of interest in the mid caps.”
Neptune doesn’t currently have plans to extend its headcount ahead of Mifid II.