By Yang Huiwen

THE market selldown has caused many smaller firms with fast-shrinking market values to drop off the radar screens of institutional investors.
Some of these big investors are required to adhere to mandates that effectively bar them from investing in a firm when its market value, or market capitalisation, drops below a certain level.

Small caps have been generally more battered than their larger counterparts. As a general indication, the FTSE ST Small Cap Index has slumped over 65per cent since reaching its 52-week high last Dec31.

By comparison, the main benchmark Straits Times Index (STI) of 30blue-chip firms is down about 48per cent.

While the ongoing crisis has definitely made the valuations of most stocks much more attractive, institutional funds - depending on the type of fund and its objectives - typically have mandates that restrict them from investing below a certain market cap.

There is often some leeway built into the mandates, but even then, at a certain level, the funds would usually have to sell into the market, say market experts.

As a result, the crisis has reduced the number of companies that institutional funds will consider investing in, said CIMB-GK head of research Kenneth Ng.

Some fund managers may choose to focus more on trading values than on market cap, he said.

For example, some bigger funds invest only in stocks with a daily turnover of between US$3million (S$4.3million) and US$5million a day, while smaller funds may have their benchmark set at above US$1million a day.

'Investors with big-size portfolios can't realistically buy into companies that are too small, as they may not be liquid enough,' said Lion Capital chief executive officer Daniel Chan.

This lack of liquidity is exacerbated by the fact that more retail investors are opting to sink their money into increasingly affordable, battered blue chips.

'Some of the large caps have fallen so much that retail investors have shifted their money from small caps to blue chips,' said Phillips Securities deputy head of research Brandon Ng.

'Large-cap stocks tend to have better liquidity and less risk than small and mid caps.'

In the current climate, investors are concerned about safety and survival, and the fear is that some stocks might go belly-up, he added.

Some funds that focus on investing in quality Asian stocks used to consider only companies with over US$1billion in market cap. With the slump in stock prices, this figure has now been revised downwards to about US$500million, which is still a high barrier to entry for many small and mid caps.

However, this bodes well for funds that have been created specially to invest in small- and mid-cap stocks.

'An incredible amount of value has come into this space at the moment,' said Mr Sam Hanbury, a co-portfolio manager for DWS Asian Small/Mid Cap Fund and managing director at Deutsche Asset Management.

His fund looks at Asian stocks excluding Japan that have a market cap of between US$50million and US$2billion.

'What we've seen is a huge fall (in stock prices) and it has brought a lot of stocks into our universe, including blue chips, which we did not consider investing in before,' he said, citing Wheelock Properties and Venture Corp as examples.

'Investors have sold down these stocks so much that a tiny bit of buying will drive up share prices as well,' said Mr Hanbury.

However, 'stock picking is important, because some will recover and some will not', he said. Among the things to look out for are the firm's cash-generating ability, its debt levels and its price-to-book ratio.

A lack of analyst coverage of a company can also see a firm slowly slip out of investors' fields of vision.

Research houses are becoming more selective regarding the types of companies they choose to cover, as teams of analysts have shrunk across the industry in general, leading to manpower constraints, said CIMB's Mr Ng.

He added that some companies are also dropped if they have been less than honest in providing guidance or information when these are requested.

To enhance a stock's appeal to institutional investors, some firms resort to a share consolidation, also known as a reverse stock split, whereby several shares are consolidated into one.

For example, shares in South Korean bulk carrier STX Pan Ocean rose over 45per cent within a week after it completed a 10-to-one share consolidation to increase the value of each share.

Abterra, a supply chain manager of coking coal and iron ore, has also proposed consolidating every 20 existing shares into one share.

This move may 'increase market interest and activity in the shares, and generally make the shares more attractive to investors, including institutional investors, thus providing a more diverse shareholder base', the firm said in a statement to the stock exchange.

This article was first published in The Straits Times on December 22, 2008.