Liquidity – shrinking when it’s most needed

 
A review of liquidity in London since 2016 By Keith Hiscock, Yingheng Chen 
 
 

Summary

• Liquidity is the lifeblood of equity markets. 
• Following the events at the Woodford Equity Income Fund (WEIF) in 2019, professional investors, increasingly, focus on liquidity when making investment decisions. 
• However, this paper shows that liquidity declined significantly between 2016 and 2022. Our work demonstrates that, in 2016, the total value traded of trading companies listed on the London Stock Exchange (i.e., excluding investment companies and financials) was 60.6% of their average market capitalisation in that year. By 2022, that percentage had fallen to 44.3%. 
• Thorough analysis shows this decline is common to the Main Market and AIM, to nine out of 11 of the market capitalisation size bands we have analysed and to nine out of 11 super sectors. 
• In some respects, the impact of this decline is more significant for small and mid-cap companies. That is because institutional investors will consider how many pounds million can be easily invested, rather than the percentage traded, when deciding on investments. Thus, as percentage liquidity falls, an increasing number of smaller companies will fall below a minimum threshold. 
• We have worked with Winterflood Securities, a major market participant, to reach a deeper understanding of the role of retail investors in liquidity today, via the Retail Service Provider network. 
• We consider the consequences of falling liquidity and outline some suggestions to help company management teams improve liquidity in their shares. 
• Finally, we briefly consider whether the proposals from the Treasury will improve liquidity. 

Liquidity – good or bad?

 
The London equity market is under a particular spotlight at the moment, and many commentators worry whether its global significance is threatened. Participants are concerned about issues such as the decline in IPOs, the ‘loss’ of IPOs to Wall Street, the shrinking number of quoted companies, listing rules, and the availability of research. 

This report seeks to understand another fundamental aspect of healthy markets about which participants are concerned – liquidity. Indeed, it is difficult to describe an exchange as a market if it rarely trades.  

This paper seeks to answer the question of what has really happened to liquidity. We also consider ways that companies can improve liquidity in their own shares and, with the help of a leading market player, put more colour on the impact of retail investors, which, many believe, is at least part of the answer to the liquidity shortage. 

What is liquidity?

 
 
The Oxford English Dictionary defines liquidity as “the availability of liquid assets to a market or company”, with liquid assets being “a high volume of activity in a market”. In short, liquidity is the lifeblood of markets and measuring it over time is a way of gauging a market’s health. 
 

 
By Hardman & Co, in collaboration with Winterflood Securities 
 
Read the full report here >