Institutional and retail investors will have access to more sharebroking research on small and mid-cap Australian Securities Exchange (ASX)-listed companies, with the ASX this week starting its 12-month Equity Research Scheme trial and committing $1 million to the initiative.
Poor research coverage of stocks outside the top 200 is a growing problem for Australian investors.
More sharebroking firms have reduced their coverage of small-cap stocks since the global financial crisis (GFC) to cut costs.
Lower liquidity in small stocks, less corporate activity and the heavy concentration of large-cap stocks (by value) on the ASX has made small-cap research increasingly uneconomic.
A lack of quality independent research coverage has made it harder for ASX-listed companies to raise their profile in Australian and offshore investment communities, raise capital and improve liquidity in their shares.
In turn, this has made it harder for institutional investors seeking more ideas on emerging companies and better liquidity in small-cap stocks.
Waning research on small-cap companies has been a problem in the United States since the GFC. It is thought a lack of initial public offerings in the US is partly because sharebroking firms have cut back their research on small companies.
Although a step in the right direction, the ASX Equity Research Scheme will not solve a problem that has existed for years.
The exchange has such a 'long tail' of small companies; about 92 per cent of ASX-listed companies are capitalised below $1 billion.
Just over 60 per cent of stocks are capitalised at less than $50 million because of the high volume of resource stocks.
If the trial succeeds, funding for the ASX Equity Research Scheme could be expanded to provide up to $10 million in funding annually, with the scheme's full cost spread across all ASX-listed companies in addition to an ongoing base of $1 million from the ASX.
The real upside for broking firms is the potential corporate activity that comes from this additional research, rather than the small amount of funding for each stock covered.
The scheme has three tiers. The most significant is an institutional report for companies capitalised between $200 million and $1 billion.
The ASX has selected six investment banks to participate in this tier in the 12-month trial: Credit Suisse Equities, Deutsche Bank, JP Morgan, Macquarie Securities, Merrill Lynch Equities and UBS Securities Australia.
They have collectively chosen 22 companies and will publish three standard institutional reports on them.
The second tier (by company size) is the retail report for companies capitalised between $50 million and $200 million.
The ASX chose 10 licensed research providers to produce three standard retail research reports with analysis and commentary on about 30 small-cap stocks.
The third tier is a research brief for companies capitalised at less than $50 million.
Investor Weekly publisher Morningstar Australia will produce a company snapshot for all 1179 eligible companies, which will be updated daily and available on the ASX website.
The Equity Research Scheme looks like a win-win for investors, who will have access to more research, and for sharebrokers, who will receive extra funding to produce it.
The biggest losers may well be sharebroking firms that already produce considerable small-cap research, and small-cap Australian share funds that have benefited from less small-cap research and thus more pricing anomalies in small stocks.
Extra research on about 50 small and mid-cap stocks (capitalised above $50 million) is unlikely to worry small-cap fund managers too much, and some may benefit from it.
But it does mean some of the market's more promising companies will have higher-quality broking firms investigating them and producing their research for a wider audience, meaning small-cap managers will have to work even harder to uncover the most promising small-cap stocks first.
Tony Featherstone is a consulting editor for ASX e-newsletters.
