The Times: Watchdog’s rules 'depress investment in smaller companies': “Many recent City scandals have centred on large blue chip companies, such as Shell, traditionally regarded as “safe”. (ShellNews.net)
By ELIZABETH JUDGE
September 02, 2004
THE chief City watchdog has been accused of depressing investment in smaller quoted companies by exaggerating risks associated with firms outside the main FTSE markets. Business groups led by the Quoted Companies Alliance (QCA), which represents companies outside the FTSE 350, are calling for the Financial Services Authority to alter its rules to emphasise that the dangers associated with investing in a company are not determined solely by size. The small business lobby says that the FSA’ s “suitability” rules are deterring brokers from recommending smaller stocks.
In a meeting with the watchdog this month, they will call for the FSA to define more clearly in its handbook the risks associated with smaller firms, to encourage the promotion of smaller-cap stocks and to end the “knee-jerk” reaction that investors are better off steering clear of them.
Andrew Smith, chairman of the QCA, says: “The unintended consequence of this FSA guidance is a distortion in the market. There seems to be an assumption across the board that smaller-cap companies are always higher risk when, in reality, some of the bigger AIM-listed companies are more liquid, more stable and a better buy than companies on the main list.”
The FSA points out that there is nothing in the rules to prohibit brokers from recommending smaller companies.
But small business groups argue that the wording of the rules within the “advising and selling” and “suitability” sections of the official FSA Handbook means that brokers are so wary of being caught out by the watchdog or of voiding their professional indemnity cover that they interpret the rules conservatively.
Angela Knight, chief executive of the Association of Private Client Investment Managers, said: “The FSA guidance is a factor in the level of investment in small-cap stocks but it is one of several factors behind this, including the liquidity problem.”
Though the guidance was introduced several years ago, its damaging impact has only gradually become apparent.
There is also better evidence now to disprove the assumption that small-cap stocks are more risky. A ten-year study by three academics at London Business School, Triumph of the Optimists, reveals that small-cap companies have outperformed the market by almost three times since 1955 and micro-caps by ten times.
Many recent City scandals have centred on large blue chip companies, such as Shell, traditionally regarded as “safe”.
The promotion of smaller-cap companies by private client managers is also important, business groups argue, in the light of the sustained downward trend in the numbers of pension funds, investment trusts and other institutional investors putting money into them.
In 1996 £7 billion was invested in smaller quoted companies. If interest had remained at that level, institutional investment should have been £5 billion higher than the £12.3 billion put into small stocks at the end of 2001 — the most recent data collected.
The NAPF, the leading lobby group representing investment fund managers had pledged to help the cause of smaller quoted firms by producing a booklet together with the QCA. But it has since claimed that its strategy has changed and that the book would not fit in with its new policy.