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 But traders complain that the risks are getting higher and the
rewards harder to reap as fewer small companies come to market and
investors throw money at them almost indiscriminately via
index-following exchange traded funds.
The combination of those two factors has cut into what experts call
liquidity - the ability of investors to trade at a desirable price
at any given time.
Traders at Hodges Fund, T. Rowe Price and other investment firms say
the lack of liquidity in small company stocks has forced them to
spread sales over weeks instead of minutes, eat higher trading
costs, buy higher, sell lower and hire their own liquidity
specialists to deal with the challenges. At times, they have been
shut out of shares of companies they wanted to acquire, they say.
Individual investors who buy small-cap mutual funds have been paying
the price, too. Small-cap companies have underperformed large cap
companies over the last six years, an unusual lag during a period of
market expansion, according to data from Morningstar. Yet shares of
small companies are far more expensive, relative to their earnings,
than those of bigger companies. So far this year they are selling at
an 86.2 percent premium over large companies; a 32.7 percent spread
is more typical.
"What you're seeing now are big swings often on no news on small-cap
equities on a daily basis and it's not uncommon for something to
move up 5 or 10 percent on seemingly meaningless news," said Whitney
George, chairman of Sprott USA, an asset management company.
Liquidity in the small-cap end of the stock market has been
deteriorating for years. But two factors have made that worse: With
more startups staying private or selling themselves outright to
larger companies, there are fewer new small company stocks on
exchanges. The authoritative and imprecisely named Wilshire 5000
index, which claims to hold "all U.S. equities with readily
available prices," covers just over 3,700 companies, near its
long-term low.
Meanwhile, investments in index-following mutual funds and exchange
traded funds have exploded. U.S.-listed domestic equity ETFs now sit
on $1.3 trillion in assets; they had $288 billion in 2006. Since
2007, assets have almost quadrupled in small-cap index ETFs, which
often are required to buy or sell stocks in their target index
regardless of price and may be squeezing out other traders. Small
companies with high ETF ownership have lower liquidity than similar
companies without big ETF play, according to a 2014 study by Sophia
Hamm, an assistant professor at Ohio State University.
Since 2008, small-cap stocks have traded at bid-ask spreads eight
times as wide as the spreads of large company stocks, according to
Ana Avramovic, analyst for Credit Suisse Trading Strategy in New
York. Before 2008 they more typically traded at spreads five times
as wide.
Even small trades can create exaggerated price moves and force fund
managers to decide between an undesirable price or a
smaller-than-intended position.
"We go in and we start buying it and within a day or two the stock
moves and runs away from us," said Eric Marshall, research director
at Hodges Capital Management in Dallas. "We want to have a 1 percent
or 2 percent position in that stock and we end up with a
25-basis-point position," he said, meaning 0.25 percent.
[to top of second column] |
Selling when everyone is dumping a stock can be even more fraught.
Stephen Massocca, chief investment officer at Wedbush Equity
Management LLC in San Francisco, says he sometimes does not buy as
much as he would like of a specific company because he fears not
being able to sell it when he wants to. He recently limited a
biotech stock purchase to about half of what he might otherwise buy
because "I wanted a manageable position when it came time to sell"
so he would not get stuck with unsold shares.
Fund companies have turned to more sophisticated strategies to place
their trades - bunching them into earnings reporting season days
when there is more trading than usual and turning to off-exchange
private marketplaces known as "dark pools."
Stuart George, head of equity trading for Delaware Investment, which
manages about $166 billion, said his firm uses "time-slicing" -
spreading trades out throughout a day and sometimes, more than a
day. Some high-volume trades of small cap stocks can take as long as
several weeks, he said.
At T. Rowe Price, trader Chris Carlson said he clumps his small-cap
trades at the end of the day, when liquidity improves as funds have
to settle their accounts and price their portfolios. Nonetheless, he
said he finds himself spending a few more cents per share for many
of his small company trades.
The lack of liquidity and outsized stock moves can be problematic
for the issuing companies as well, according to Tim Quast, president
of Modern Networks IR in Denver, which does data analytics and works
on behalf of public companies.
When low volume whip-saws a company's share price, its treasurer
cannot use the equity market as a barometer of value, or even
attract investors who may stick to stocks with ample trades.
For example, Kevin Mahn, a portfolio manager and chief investment
officer at Hennion & Walsh Asset Management, said that because he
invests only in companies with adequate liquidity, he tends to stay
away from the smallest 700 or so companies in the Russell 2000 small
cap stock index.
"I don't go into the microcap names," he said.
(Reporting by John McCrank and Chuck Mikolajczak; additional
reporting by Trevor Hunnicutt; editing by Linda Stern and Dan
Grebler)
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