Why Do Brokerages Only Provide Research Reports For Large Companies?

One of the common problems I see in today’s investing environment, and which I feel is getting progressively worse, is that many brokerages only cover companies which are large and established. This results in reports being published only of such companies while the bulk of the smaller, mid-sized companies are neglected.

There are situations where a large blue-chip company have around eight analysts covering the stock, with the majority of them having the same opinion and stating the same set of facts. This diverts manpower, time and resources away from the promising but smaller companies which are continually under the radar. Let’s explore some reasons why this trend seems here to stay, unless something can be done to urgently address it.

Lack Of Liquidity

The smaller companies listed on the exchange usually suffer from a dearth of trading liquidity due to both a lack of interest and promotion. Many retail investors prefer to purchase shares in more liquid companies as this means it is easier to purchase and to exit, and the bid-ask spread is also tighter.

Brokerages thrive on commissions and fees generated by higher trading volumes. Thus, there is no incentive for them to write on companies which have low liquidity as it would be seen as a waste of manpower and resources.

Reduced Budget, Less Resources

The brokerage industry landscape is also altering due to the introduction of a new regulation known as MiFid II by the European Union, where transactions and research now have to be “unbundled” and cannot be offered together.

This means that brokerages have to charge clients separately for research reports. Many clients have baulked at paying what they see as high levels of fees for sub-standard research material. As a result of such reduced budgets from clients and lower demand for research, brokerages also have less resources and money to devote to covering a wider range of companies.

A Vicious Cycle

By now, it would be clear that the lack of coverage of smaller companies is a result of a vicious cycle. With reduced budgets, brokerages have fewer reasons to initiate research on smaller companies. Without research coverage, less retail investors would read about the merits of such companies, thus deepening the neglect. The woeful neglect results in ever lower liquidity which then further discourages the brokerages from covering such companies.

Independent Research Outfits

There are not many solutions for this malady, but one I can think of is for more independent research outfits to spring up and start to initiate coverage on good quality but neglected small companies. As interest gets piqued, more liquidity will flow in and generate a virtuous cycle for the companies.

A piece of good news is that the Monetary Authority of Singapore has also recently announced the launch of an S$75 million grant for Equity Market Singapore (known as GEMS) on February 14 2019, which includes funds for research talent and research initiatives. It remains to be seen how useful these initiatives may be. But in the meantime, research coverage is likely to continue to be limited to mainly the larger, liquid companies.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.