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Inefficient markets may spell opportunities for small-cap equities

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      By Aidan Farrell, Director of Global Small Cap Equity, Eaton Vance Advisers International Ltd.

      London - Small-cap markets are the best example of why the sheer number of publicly traded stocks is both a blessing and a curse for investors. The blessing is opportunity, the curse is that small caps have fewer research analysts per stock.

      Small Cap Chart

      ¹Source: Factset, as of 12/31/18. Average number of analysts covering each company by market cap. Based on making estimates for companies within the MSCI World All-Cap Index.

      This paucity of analysts leaves small caps with fewer earnings estimates and greater dispersion around those estimates. And, depending on European regulation, the coverage may dissipate further.

      Recent regulation known as the second Markets in Financial Instruments Directive (MiFID)seeks to, among other things, unbundle the availability and cost of research from the execution and cost of trading. This could lead to diminished research spending, as some asset managers will face an additional economic burden. The resulting capacity limitations could further reduce coverage and coverage quality. Though the regulation directly impacts the distribution and trading of financial instruments in the EU, its impact, particularly regarding equity research, will extend globally.

      American and international small-cap markets are ripe for active management and bottom-up research. Active managers can uncover value in a large, less explored universe where greater dispersion of business results means more chances to capitalize on market inefficiencies. Active managers can choose stocks outside of indexes and defensively position a portfolio in down markets.

      Bottom line: Small-cap markets lack sufficient analyst coverage. Skilled active managers have the potential to uncover unique opportunities that could be otherwise overlooked.

      The MSCI ACWI All Cap Index captures large, mid, small and micro cap representation across 23 developed markets countries and large, mid and small cap representation across 24 emerging markets countries.