Tomorrow’s winners or toxic waste? The rewards and risks of investing in AIM

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16/06/2015
Over the course of its 20 year history, AIM has played host to over 3,000 companies. Some have thrived, while others have vanished.

AIM launched on 19 June 1995 with 10 companies with a combined market cap of £82m. By the end of April 2015 the number of companies was 1,077, with a market cap of £72.611bn.

Here, we look at the rewards and risks of investing in this hugely evolving junior market.

Rewards

The main advantage of the AIM market is that it gives investors the opportunity to back small and often cheap companies, which could end up being tomorrow’s big winners.  As Tom Stevenson, investment director of Fidelity Personal Investing, says, AIM is “an ideal hunting ground for undervalued stock.”

While there have been numerous flops in its two-decade long history, there have also been plenty of success stories. Perhaps its most famous constituent is online fashion retailer ASOS, which listed on AIM in 2001, and is now worth £3.9bn. £1,000 invested in the company then would be worth around £200,000 now.

Other strong performers include luxury brand Mulberry, which listed in 1996. Its shares are up by 494 per cent today. Also, Domino’s Pizza, which listed on AIM in 1999, and is up by over 1000 per cent today.  GW Pharmaceuticals floated in 2001 with a market capitalisation of £174m – today, that figure is £1.6bn.

A number of smaller companies fund managers invest directly in the market. It accounts for 29 per cent of the Standard Life UK Smaller Companies Trust, run by Harry Nimmo, and a significant proportion of his top 20 biggest holdings.

“If you know what to look for, you can find some real winners – often at bargain rates,” he says.

“There’s really nothing else like it in the world.”

Mike Prentis, manager of BlackRock Smaller Companies Trust, believes AIM is the go-to destination for stocks that are highly profitable and cash generative. At present, AIM stocks account for around 40 per cent of his portfolio.

“The joy of AIM is that if you get it right, you will get much more appreciation than you would with a larger company,” he says.

Investing in AIM also comes with attractive tax incentives. AIM holdings are not subject to inheritance tax if held for over two years, can be held in ISAs, and last year became exempt from stamp duty.

Risks

However, there are downsides. When it comes to companies listing, there are few requirements in respect of minimum trading history, market capitalisation or liquidity. Listings also operate on a ‘comply or explain’ basis. This means companies must either follow the rules or explain why the rules don’t apply.

While greater regulatory flexibility makes it easier for smaller companies to list, it also leads to significantly increased investment risks.

Mark Dampier of Hargreaves Lansdown says this creates a breeding ground for questionable listings; he dubs the market “a fad magnet.”

“Whenever there are short-term crazes, new companies in the ‘hot’ sectors flock to AIM, only to tumble spectacularly when the bubble bursts. This is exactly what happened in the dotcom boom 15 years ago, and a few years ago with mining stocks,” he explains.

A more lightweight reporting environment also means there is less information available about companies. As a result, AIM stocks tend to be under-researched and many are simply ignored by analysts.

“If you invest in AIM, you’re wading through toxic waste, hunting for rare gems. It’s a real ‘sex and violence’ market – there are great companies and there are dreadful companies, and there’s little to no middleground. You rarely know which end of the spectrum you’re going to get, either. It really is a lottery,” says Dampier.

AIM has been home to a number of major disasters during its existence, in which investors have lost billions. In 2007, US securities regulator Roel Campos likened AIM to a casino, stating: “I’m concerned that 30 per cent of those that list on AIM are gone in a year.”

His words seemed prophetic the next year, when AIM was plagued by high-profile scandals, and lost 60 per cent of its overall value. More recently, in December 2014 Banc De Binary revealed that 87 AIM listings were members of the ‘90 per cent club’, their shares now worth 10 per cent of their peak value.

In 2011, the RBS HGSC Index Report noted that £100 invested in AIM from its inceptions would have declined to £96 by its 15th birthday. The same invested in the HGSC index would have grown to £298. In April 2015, at the end of the first full tax year in which AIM shares could be held in ISAs, the AIM Allshare had fallen by 17.2 per cent over the year. The 100 biggest AIM stocks fell by 20.4 per cent.

“There have been calls to introduce tracker funds for AIM, which would be crazy – a tracker that effectively invested in every AIM share would almost certainly be a guaranteed loss overall, every year,” Dampier concludes.

Recommendations

For investors drawn to AIM, Dampier recommends using funds to access the market, rather than direct investment.

“The best managers in the field know what to look for, and will almost certainly have access to information that a DIY stockpicker won’t,” he explains.

“An investor benefits from the team’s specialist expertise, and a broadly diversified portfolio that helps manage stock-specific risk.”

Dampier recommends looking for funds run by smaller company specialists such as Giles Hargreave, manager of the AIM-focused Marlborough Special Situations fund. Between 2003 and 2013, the fund produced a return of almost 300 per cent, a total surpassing those offered by many contemporaneous emerging markets and commodities funds.

“If an investors does decide to go the DIY route, I’d recommend an extremely limited exposure to AIM – perhaps no more than 5 per cent of a portfolio,” Dampier adds.

Jason Hollands of Tilney Bestinvest recommends the Unicorn UK Income fund, which focuses on income-generating shares. The fund is currently yielding 4 per cent.

For those who want AIM exposure in a more balanced portfolio, Hollands suggests the Liontrust Special Situations fund. Currently, its portfolio is 38 per cent comprised of smaller companies, 30 per cent mid-caps, and 32 per cent larger companies.

“Despite the high small cap weighting, the fund has been less volatile than the FTSE All Share Index. Much like the Liontrust UK Smaller Companies fund, this fund focuses on companies with strong intellectual capital, distribution channels and brands,” says Hollands.

In a similar vein, Stevenson notes that the Fidelity UK Smaller Companies fund holds offered a varied array of small caps, including AIM stocks.

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