In some ways, the focus on companies with no analyst coverage is an unintended consequence of the index investing boom. Approximately 42 percent of all assets in stock funds are now in passive funds that track indexes, up from 24 percent in 2010, according to the Investment Company Institute.
With fewer investors buying and selling individual stocks, brokerage firms have been forced to cut research staffs, which had long supplied information about small companies in hopes of generating trading commissions.
Over the last 12 months, brokers such as BB&T, Nomura, and Avondale have shut down whole research divisions, leaving a hole in information that is unlikely to be filled quickly. BCA Research, an independent Montreal-based firm, estimates the total number of analyst reports being produced will fall by at least 20 percent as investment banks reshape operations to adapt to the popularity of indexing.
“Portfolio managers are increasingly relying on algorithms to track any changes in a stock, not a human doing a report," said Evan Pondel, president of Los Angeles-based investor relations firm PondelWilkinson Inc.
Overlooked Buys
Portfolio managers who conduct their own research into uncovered small-cap stocks say that it provides a greater justification for annual fees that are often far higher than passive funds.
Laird Bieger, a portfolio manager at New York-based Baron Funds, said he began meeting with executives at Impinj Inc , a maker of radio frequency identification devices with $1 billion market cap, when there were no sell-side analysts covering the firm. Five analysts now cover the company, whose shares are up nearly 40 percent year-to-date.
"This is something that is way below other people's radars and at a point in their growth cycle when they are the most open to meeting with us," he said. Once companies reach market values of $3 billion and above, they typically have much more formalized investor-relations teams that block access to executives.
Eric Marshall, a fund manager at Dallas-based Hodges Capital, said he is looking at uncovered companies in out-of-favor industries such as industrials and financials to find mispriced stocks. He owns shares of Hallmark Financial Services Inc., an insurance company with a market value of $203 million, in part because it is "virtually unheard of," he said. Shares of the company are down 4.2 percent this year.
This article was provided by Reuters.