Managers of UK small-cap equity funds fear the full force of recent MiFID II research rule changes have yet to hit the sector, including a further reduction in coverage and a negative impact on research quality.
MiFID II, which came into force in January 2018, requires buy-side firms to pay separately for "substantive", value-added research they receive from brokers, otherwise this would amount to an inducement to trade.
The introduction of the new rules has already seen asset managers reduce the amount of research and number of brokers they are using, which in turn has prompted analysts to start leaving brokers in their droves.
Prior to the introduction of MiFID II, there had also been warnings the small-cap space, which was already relatively under-researched compared to large-cap peers, could be particularly badly hit as it would see coverage fall away even further.
In response, a number of small-cap managers have told Investment Week they have been building out their own internal research capabilities, while committing more time and resources to meeting directly with companies in which they invest.
Phil Harris, manager of EdenTree's UK Equity Growth fund, said the "degradation of small-cap research" has already taken place, but "we are at the early stages" of reduced coverage and research quality.
He added: "It is going to be this results season, coming up in September, when you are going to see the first effects of MiFID II and the degradation of research.
"Small cap has always been an under-researched part of the market and always will be, but it is going to be exacerbated by this."
Harris added his fund had reduced the number of brokers it was using prior to MiFID II's introduction in order to handle the associated cost pressures and had boosted its internal research capabilities to compensate.
Meanwhile, another UK smaller companies manager who did not want to be named agreed the upcoming reporting season could provide insight into the long-term impact of the new rules.
He explained: "In the small-cap space, you only get one, maybe two, notes a year. So you almost have to wait for a reporting
Ken Wotton, lead fund manager at Livingbridge Equity funds, including its UK micro-cap and multi-cap income products, said while it is still "too early to gauge" the impact of MiFID II on small-cap research, he believes eventually more brokers will set about "reducing the number of analysts they have and focussing on the sectors where they have particularly strong teams".
Wotton expects that in the next 12 to 18 months, brokers will have begun to adapt their models further, "pulling out of sectors or reducing their coverage of certain areas of the market".