The quantitative results of the former, produced jointly with Argus Vickers, differed slightly from the ONS study, although they both came to the same over-riding conclusions; namely that overseas investors dominate the main market in the UK, while retail investors are wielding ever-greater influence on market liquidity.
The latter conclusion may seem slightly counter-intuitive to some, but perhaps there is now more room to manoeuvre because of the vast sums of capital pouring in to private markets from institutional investors. In a low interest rate environment, private equity, venture capital and private debt must seem more lucrative options, particularly if you want to make a quick buck. Not only have we witnessed a significant decline in new listings, but there are more publicly traded companies opting to go private.
Help is at hand. The ONS survey reveals that retail investors account for around a fifth of all shareholdings in the main market outside of the FTSE 100 benchmark, but that they have a disproportionate impact on market liquidity. Put simply, the share price of most listed companies is determined by relatively small trades. The overwhelming majority of trades completed on the Main Market and Aim come in below the £10,000 mark. Indeed, about two-thirds of all the companies trading on Aim have an average trade size of less than £5,000, while 46 per cent of Main Market constituents operate on that basis.
And while the two surveys give differing estimates for the percentage share of the overall market held by private investors, with an upper estimate of 13.5 per cent, both surveys point to continued growth over the five years through to 2019.
Analysts at Hardman & Co make the point that the potential impact of the retail investor on market liquidity has come into sharper focus following the collapse of the Woodford Equity Income Fund. Risk management in this area centres on the number of days it would take to completely liquidate a given investment portfolio. Illiquidity proved to be a major headache for Woodford investors, but all financial markets are exposed because of insufficient churn. The sub-prime financial crisis provides a case in point. Investment banks were essentially required to hold large amounts of low-grade debt on their books for much longer than they would normally anticipate.
The Financial Conduct Authority (FCA) admitted that the Woodford debacle showed that many investors either underplayed, or were simply unaware of the risks associated with investments in unquoted companies, although Neil Woodford got around the statutory 10 per cent limit on unquoted securities by listing some of the holdings on Guernsey’s stock exchange.
It’s hard to justify the fund’s actions, although some analysts have argued that problems over market liquidity have become more likely in the wake of the global financial crisis, as banks have become less likely to act as market makers because of the tighter capital controls imposed by regulators. This poses a further risk to fund managers as there are fewer large-scale market participants to absorb liquidity demand when markets turn bearish.
Markets aren’t quite irredeemable just yet and, Woodford aside, it’s gratifying to note the influence of private investors among our readership on secondary markets and, by extension, price discovery. But retail investors must also be confident that a company they’re considering for their own portfolios can readily convert their assets into cash if circumstances dictate? As a first step, most investors usually start by dividing a company’s current assets by its current liabilities; the resultant working capital ratio gives a basic appraisal of a company’s ability to back its liabilities with assets including cash, inventory and equities – the higher the measure the better. The next step would be to look at how many times a company can meet its current debts with cash generated at the operating level. If the resultant ratio is moving up over time, it suggests a positive outcome. If a given company scores poorly on liquidity metrics it could suggest that its ability to grow or even stand still could be comprised if it is unable to allocate capital towards R&D or productive assets.
