Portfolio Adviser • Portfolio Adviser March 2019 • Adverse Effect Of Mifid II On Analyst Research Divides Industry

● Sell-side survey reveals fund managers are unhappy with the effect of Mifid II on analyst research

● Buyside community bites back by saying small companies do not have 'divine right' to be covered

What’s the story? Members of the buyside community have criticised the findings of a sellside survey that revealed discontent among fund managers over the effect of Mifid II on analyst research. They claim the industry was ‘over-brokered’ and that small-cap companies ‘don’t have a divine right to be covered’.

According to the Peel Hunt report, a majority of the fund managers surveyed said Mifid II had a ‘detrimental’ effect on research quality and demand, and liquidity for small and midcap stocks. Two-thirds said less research was being produced in the small and mid-cap space.

“The unintended consequences of Mifid II we have seen so far are just the beginning,” warned Steven Fine, chief executive of Peel Hunt.

But the investment industry is not unanimous in its criticism of the rules requiring research costs to be unbundled.

“There was always too much sell-side research,” said Dan Brocklebank, Orbis Investment Advisory director. “Too much of it was focused on short-term news flow and was of little value.”

Brocklebank is not alone in his defence of the EU directive, which came into effect on 3 January 2018.

PA viewpoint It is more likely that medium-sized companies will suffer the most if analyst resources are diverted to covering FTSE 100 companies and other large-cap stocks.

On the sell-side, second-tier banks and brokerages have been hit hard by Mifid II, while independent economic research houses could also be squeezed. Buy-side firms could face even more pressure to trim their research lists if volatility continues.

What the industry thinks Daniel Godfrey, ex-chief executive of the Investment Association, said “it’s a bit rich” for the industry to be complaining about having to pay for its own research when the FCA gave them ample opportunity to address problems with the old system.

Godfrey thinks the fact the industry has responded by buying half as much as they used to is telling.

“If research has value you should be willing to pay for it out of your fee or by telling clients why they should pay for it,” according to Godfrey. “If it doesn’t add value, it should disappear.”

Seven Investment Management senior portfolio manager Peter Sleep, said: “Small companies don’t have a divine right to be covered,” noting many were not followed by analysts pre-Mifid II.

“It was always the case that coverage was focused on largecap firms at the expense of small and Aim-listed entities; Mifid just made it worse,” claimed Gavin Fielding, editorial director at Fundscape.

“Realistically, research will be focused where it is most profitable, at large caps and interesting growth sectors.”

Jason Hollands managing director of Tilney says: “When parts of the market are under- researched it creates challenges and opportunities.

“As chunks of the stock universe become under-researched or progressively ignored, this is going to impair market efficiency, undermining the price discovery process.”

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