H&W in the Media

The small cap squeeze: When more money chases fewer companies

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.

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.

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