Small cap returns outperformed big caps by 5 % every year from 2005 to 2015 . Yet now , some players on the buy-side are gravely concerned about the future of mid- and small-cap equities . With the rise of private equity , is the market under threat of a slow demise ? When Microsoft went public in 1986 , the company ’ s market capitalisation was just $ 500 million . When Facebook went public in 2012 , its market cap was $ 100 billion . This discrepancy has led buyside observers to question whether the small-cap market is dying out . According to Anthony Godonis , senior equity trader at Aberdeen Asset Management , the key issue may be how the buy-side adapts to the new environment . “ It used to be the case that you ’ d start by going to a broker , but that ’ s hardly ever the case now ,” said Godonis . “ The bank sales trader may not be the most experienced person . If the order is overshopped , it creates impact . We should start electronically . Instead of relying on blocks from the sell side , try the pools .” The problem , Godonis says , is that when the buy side goes to the broker , it moves the stock significantly . One solution to this problem is to use dark pools to reduce the market impact . Aberdeen Asset Management experienced lower market impact on trades that were executed electronically . But even then , the role of services provided by brokers can be an issue . “ It ’ s the routing that ’ s the problem ,” added Godonis . “ Too much routing to a particular venue for example , will alert the HFTs where we are .” Old assumptions no-longer hold true either . Traditionally , many asset managers had grown used to the bundling of research and payments for execution . This used to mean firms that provided a good service in one area , such as research , were assumed to be competent in the other , i . e . execution . Yet this is now not necessarily the case . “ Trading research providers used to be high quality trading shops ,” said Godonis . “ It ’ s not the case anymore . Great research doesn ’ t mean you should necessarily trade with the same broker .” Unbundling is reducing costs , but at the same time , sell-side data costs are increasing . Aberdeen Asset Management reports that the sell side has not increased its charges to take account of that rise ; instead , brokers are absorbing it by cutting costs internally . Meanwhile , buyside broker lists are shrinking as buy-side firms themselves downsize their trading desks . There are concerns on the buy side about what impact all this cost-cutting activity this will have on the viability of sell-side services . “ You can ’ t keep driving commissions down and expect the same quality of service from the sell side ,” said Godonis . “ Eventually we will reach a point where there ’ s going to have to be a new understanding , which says that if you want small and mid cap liquidity , you are going to have to pay for it .” This is particularly important from a bestexecution standpoint , because Godonis reports the brokers that tend to pay the most for market data tend to deliver the best results in terms of minimising market impact . In addition , the emphasis on cost-cutting means that some smaller brokers white-label smart order routing technology from larger firms , but in that case the buy-side trader may end up paying a larger fee than if they had just gone to the original broker behind the technology . It is always worth checking this first when using a local broker , he says . The quality of sell-side research is another problem for the buy side , since Godonis feels that it is not always of the highest quality . The issue is exacerbated by the low levels of revenue available for the sell side in this area and the consolidation of broker lists . Some analysts are crossing over to the buy side , he says – a strategy which may make sense , given that he believes the active managers that will prosper are the ones that do the research themselves . A related problem is the scarcity of block liquidity . “ We ’ ve tried many times to incentivise brokers to offer larger sizes , but often we ’ ve found the market moves against you ,” he added . “ It ’ s hard to incentivise them to offer blocks . On the exchange side , the lit markets are OK because of all the passive trading . The exchanges own the auctions , so it ’ s doubtful they will push for many changes .” This leaves the question of where to turn for liquidity . Aberdeen Asset Management supports IEX , the US alternative trading platform that recently became an exchange . IEX is best known for its system of “ speed bumps ” – random delays that are intended to prevent HFTs from gaining an advantage over other participants . The decision of US regulator the SEC to grant the venue exchange status was controversial . The main opposition to IEX ’ s application to become an exchange was based on the argument that no other exchange is permitted to introduce speed bumps , thus giving IEX a potential unfair advantage . Nasdaq has threatened legal action over the decision . However , the venue has gained popularity among the buy side . One of the factors in favour of IEX is buy-side frustration with HFT . Most asset managers will acknowledge these days that not all HFT is bad , but many still find it frustrating they are making profits from the market when they have no interest in holding stocks for more than a few seconds or less . Long-only asset managers are typically holding stocks that are deciding people ’ s pensions over a period of 20 years or more . “ IEX has instituted fairness in the exchange ,” said Godonis . “ The tools they have make sense . They educated a lot of people . This has pushed the regulators to look at the issues again . I think it ’ s changing things . IEX is doing things that feel right . And they ’ re eating someone ’ s revenue – you can see that from the level of furore they ’ ve generated in certain parts of the market . I think that ’ s a good thing .” Perhaps the most pertinent question now is what happens if IEX can get into the big listings business , Godonis suggests . “ Competition is good and I ’ m sure that IEX would provide a lot more disclosure versus other exchanges .” However , the listings business may have serious problems that even a new platform might struggle with . One of the issues is the lack of public market confidence . The growth in private equity means that companies don ’ t necessarily need to go public . At the same time , the very fact that there is the alternative of private equity means that there is less money in the market . “ They feel they are better off making use of private equity . I don ’ t know what exchanges can do about that ,” said Godonis .
20 www . buysideintel . com August 2016