2010 In Review: Looking Back on A Year in the Small Cap Sector

AIM had a rough ride during 2009, suffering from a wave of de-listings and a significant fall in new money raised. To the end of October 2010, however, the number of companies de-listing from AIM had fallen by 28 per cent, compared with the same period last year, while new money raised is up from £579.7m to £863.18m. But how has AIM’s recovery impacted other markets and how well is London’s junior market serving small cap companies and their investors? 

Not surprisingly, given the drop in the number of de-listings, secondary markets have seen fewer companies join from AIM, with private firms now making up the majority of new admissions. As for the main market, a new government, spending reviews and bank bail-outs have all contributed to a turbulent year. Amid the ups and downs, the steady recovery of AIM has been welcomed, with seven companies moving up to the main market from AIM so far this year. 

Liquidity remains a real concern

However, the story isn’t so rosy for the majority of UK-listed small cap companies, for whom liquidity and market visibility remain a real concern. With market-makers widening spreads in the wake of the credit crunch and mainstream media attention focused on larger companies, 2010 has seen many small caps struggle to communicate with their investors and improve market exposure, while their shares remain inaccessible and illiquid.

Furthermore, institutional investors are unable to invest in small caps due to size and liquidity restrictions, while the regulatory and information environment makes it difficult for private investors to invest.

One organisation committed to helping small caps escape the liquidity trap is the Small Cap Network, a newly-formed industry working group. Small Cap Network member and co-founder of Stockopedia, David Brickell, says: “Although small caps have outperformed large caps, this wasn’t the case in recent years and, as a result, a lot of institutional money has been lost from the sector.

“This has left retail investors to provide the balance of liquidity but the market structure isn’t well set up for this. Retail investors often lack access to fundamental analysis and broker research, which has unfortunately led to the rise of speculation and short-term trading strategies”.

A state of overprotection

The attitude of policy makers has arguably compounded the problem. Amid understandable concerns about miss-selling, it seems to have been forgotten that the equity markets were originally designed to enable companies to raise finance effectively, in an environment that allowed investors to find those companies and vice versa.

A number of commentators believe we now exist in a state of overprotection of retail investors and overregulation of smaller companies, which is crippling many small caps and driving others away from the markets. There are approximately 100,000 SMEs in this country and less than 2000 of those are listed. That’s a relatively poor share for the public markets.

While some may argue that illiquidity is inevitable for small caps, they would do well to look at the Australian and Toronto exchanges, where listed SMEs thrive thanks to a more buccaneering spirit. The Canadian regulatory environment doesn’t prevent private client brokers from promoting stocks to the retail audience, in the way that is increasingly the case here. Nor is the tax environment for AIM companies as supportive as it could be.

Investors respond to incentives and the fact investors are unable to hold AIM shares in ISAs doesn’t help towards providing the increased retail investor liquidity that is badly needed by smallcaps.

Hope for UK small caps

Despite the doom and gloom, there is some hope for the UK’s smaller companies. Many believe the forlorn state of the small cap market is due to the credit bubble favouring large caps, so institutional interest may return. Furthermore, the government has emphasised the importance of SMEs in its recovery plans with its recent Green Paper, Financing a Private Sector Recovery, suggesting the equity markets is a key route to resolving the funding gap for SMEs. Finally, an increasing number of UK small caps are also looking to dual-trade their shares on an order-driven market like Sharemark alongside a quote driven system – to help further raise liquidity and provide them with an additional route to settlement.

Let’s hope such measures ensure the UK’s small caps and their investors enjoy as much of a reversal in fortune in 2011 as AIM did in 2010.