Turmoil in the US banking system could end up creating an unlikely set of beneficiaries: small-cap technology and biotechnology companies that need to raise cash.
(Bloomberg) — Turmoil in the US banking system could end up creating an unlikely set of beneficiaries: small-cap technology and biotechnology companies that need to raise cash.
The trigger is the rebalancing of the Russell 2000 Index, which is being preliminarily announced on Friday and will take effect on June 23, according to Steve Maletzky, head of capital markets at William Blair.
The index, which focuses on small-capitalization stocks, has a number of regional banks that could see their weights shrink or be removed from the gauge, according to Maletzky. And that would open the opportunity for tech and biotech companies to join the Russell 2000, he said.
Since Russell indexes are widely used as benchmarks for portfolio managers and index funds, members of the gauges have broader institutional ownership and higher levels of inflows into their stocks, which makes them more appealing for capital raising.
“We expect regional banks and banking to be a much smaller percentage of the Russell 2000 going forward,” Maletzky said. “It opens the opportunity for other companies in sectors like biotech and tech to have their weighting in the Russell 2000 increase, and it can be used strategically to improve either access to the capital markets or potential liquidity for private equity and venture capital investors that are already in those stocks.”
Small-cap stocks have been the hardest hit group in the market since the start of 2022 as inflation kicked in and the Federal Reserve started raising rates it rein it in, with the Russell 2000 posting steeper losses the S&P 500 Index, Nasdaq 100 Index and Dow Jones Industrial Average. And the underperformance has become more pronounced this year as tech has taken off and small caps continue to lag.
Biotech stocks have trailed the broader market this year as anxiety about the Fed’s pace of interest rate hikes reduced investors’ risk appetite. In biotech, investors focused on a handful of established names, like Vertex Pharmaceuticals Inc. and Biogen Inc., and avoided smaller, riskier companies, said Matt Maley chief market strategist at Miller Tabak + Co.
Even as the market improves investors still may be reluctant to participate in capital raising for biotech companies. It can be a big risk, considering a typical business model assumes lots of investment in research and development, as well as clinical trials that can last years before a company starts generating cash flow.
“The money is no longer free,” said Sarah Hunt, portfolio manager at Alpine Woods. “It also may be more difficult for biotech companies to find it.”
In 2020 and 2021, before the Fed started raising rates, tech and biotech firms raised an enormous amount of capital. But many of those stocks have traded poorly since then, leaving investors disheartened.
“We went from hope to denial,” said Mark Lehmann, chief executive officer of JMP Group. “Now we’re in an acceptance phase.”
Now, investors have become more realistic, Lehmann said. Going forward, he’s optimistic about the market environment and expects more merger activity and capital formation plans to help spur the biotech and tech sectors.
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