Fistful of Dollars: A brave new world or a Wild West town only for gold diggers?
A brave new world or a Wild West town only for gold diggers?
It is hard to make your mind up about AIM, the Alternative Investment Market that has nurtured some big names, but also hosted huge failures.
The market had a strong 2020, outperforming the broader UK equity market by 33 per cent, and its record this year has continued to be good.
Ewan Millar, head of AIM at investment manager Brooks Macdonald, says the market’s success is down to its relatively low exposure to what he calls the ‘old world economy’ – sectors such as oil and gas, mining and heavy industrial businesses.
‘It was these ‘old world’ economy stocks that were hardest hit by the Covid-19 pandemic and lockdowns,’ he explains.
The AIM market has also proved resilient when it comes to paying dividends to shareholders.
Harry Nimmo, co-manager of investment trust Standard Life UK Smaller Companies, is a fan.
He says: ‘AIM is the envy of the world in terms of its depth and scale. It is suitable for nurturing companies from the very small to those with market capitalisations in excess of £1 billion.
‘But it will take many years for some of the outdated, preconceived notions of AIM as a dangerous market to be overtaken by the new reality,’
Where to pan for nuggets of gold
AIM is a huge market with 830 listed stocks so it can be hard to pick winners.
Brooks Macdonald’s Millar says: ‘Businesses which have been able to carve out market leading positions within the niches that they operate – preferably on a global perspective – tend to be the most lucrative companies to invest in.’
There are plenty of household names on AIM such as clothing giant Asos, Fever-Tree Drinks and pollster YouGov.
But there are lesser-known winners such as life science company Abcam, language translation specialist RWS and ID verification company GB Group.
Lee Wild, head of equity strategy at wealth platform Interactive Investor, also likes kettle safety control group Strix, growth consultancy Next Fifteen and engineering infrastructure business Renew Holdings. All fit Millar’s template of niche market leaders.
Wild adds: ‘All three have been brilliant in terms of share price performance, but they also pay dividends to shareholders.’
Smaller companies specialist Gervais Williams, co-manager of Miton UK MicroCap Trust, is a fan of the market.
He says: ‘The prospects of some AIM-listed technology and meditech stocks actively improved during Covid.
‘Going forward, numerous industry bottlenecks are making it harder for businesses to meet customer demand and we fear a squeeze on corporate profits. But at times like this, smaller businesses are often better positioned to dodge the bullets.’
Watch out for the risks and pitfalls
While AIM might have spawned household names, of course it doesn’t follow that every company is a guaranteed success story.
Brooks Macdonald’s Millar says the expansive nature of the index means it is easy for investors to make a mistake. ‘There are many great companies,’ he says.
‘The flipside is that there are some that investors would be wise to avoid.’ Some sectors of AIM are speculative.
Millar warns that oil exploration, loss making biotechnology stocks, and companies working in hydrogen fuel cell production are prone to volatile share prices.
Juliet Schooling Latter, research director at investment platform Chelsea Financial, also counsels that AIM is less regulated than the main London Stock Exchange.
She says: ‘Most of its constituents are smaller, growing companies – typically at an earlier stage in their corporate life than those listed on the main market.
AIM is therefore riskier and won’t appeal to cautious investors.’ She also warns that the market has been artificially boosted by the tax loophole that makes investment in AIM a tool to guard against inheritance tax bills (see box below).
Essentially, if certain (not all) AIM shares are held for at least two years, they are exempt from inheritance tax when the owner dies. She says: ‘If the Government ever changed the rules and took the IHT protection away, this could hit AIM.’
Investment funds to set your sights on
While picking individual stocks on AIM can be lucrative, it is hard to negotiate the large number of them on the market. The heightened risk means it is important not to put all your eggs in one basket.
Ryan Hughes of wealth manager AJ Bell says: ‘There are hundreds of companies to choose from and therefore going down the fund route is sensible.’
Matthew Read, senior analyst at financial research group QuotedData, agrees. He explains: ‘AIM companies tend to have lower financial reporting requirements.
‘This can create a concern for some investors, but it can be counteracted by focusing on AIM-oriented investment trusts which have a strong focus on ESG (environmental, social and corporate governance) issues.’ He says Montanaro UK Smaller Companies is good in this area.
There are no funds exclusively invested in AIM stocks, but many smaller company funds have holdings. Hughes suggests Tellworth UK Smaller Companies managed by Paul Marriage and John Warren – a fund which has around two fifths of its portfolio in AIM stocks.
He adds: ‘Both fund managers are hugely experienced smaller companies’ investors and, crucially, have a deep knowledge of many of the management teams that run AIM listed businesses.’
The £500million fund has three AIM-listed stocks in its top ten holdings; student accommodation developer Watkin Jones, spectacle frame designer Inspecs and flexible office specialist Essensys. The fund is less than three years old. Over the past year it has generated an overall return of 64 per cent.
Jason Hollands, investment expert at Tilney Smith & Williamson, also likes the Tellworth fund – as well as investment trust Henderson Smaller Companies which has almost a third of its assets in AIM shares. Over the past three years, it has rewarded investors with profits of 52 per cent.
‘Even some funds that invest across the UK stock market – backing large, medium sized and smaller companies – have chunky exposure to AIM,’ says Hollands.
He cites investment fund Liontrust Special Situations, which has almost a quarter of its investments in AIM stocks.
Chelsea’s Schooling Latter says that her favourite funds with AIM exposure include Gresham House UK Micro Cap, Marlborough UK Micro Cap Growth and Amati UK Smaller Companies. Respective three year returns are 42 per cent, 65 per cent and 47 per cent.
AIM-focused Venture Capital Trusts are another way to gain access to AIM-traded companies, and can offer investors attractive tax breaks.
Investors who buy new shares in VCTs enjoy 30 per cent up-front tax relief, provided they hold the shares for at least five years. Any dividends and capital gains are also tax-free.
Hollands says: ‘The Government has excluded certain types of business from being eligible for VCT investment.
‘So AIM VCTs only have access to part of the AIM market, not all of the companies on it.’ That doesn’t stop these trusts being popular. Recently, Octopus AIM VCT raised £40million of new money from investors in just 24 days.
However you choose to invest in the AIM market, it is important to understand the risks when investing in lighter regulated companies. You must ensure your AIM investments match your tolerance for risk.
Guard your haul from the taxman
One of the reasons why AIM shares are popular is that they can help to lower inheritance tax bills.
The stocks listed on this market benefit from an allowance introduced in 1976 called Business Property Relief (BPR).
Originally, BPR was meant to ensure that family businesses did not have to be broken up to pay IHT bills, but it now applies to unquoted company investments and companies trading on AIM.
By buying AIM shares, you can keep hold of your wealth and still reduce any IHT bill when you die.
The relief is available after just two years, whereas gifts to family members outside certain allowances only become IHT-free after seven years.
In other words, any qualifying AIM shareholding escapes inheritance tax provided the holder has owned the shares for at least two years.
But AIM shares can be risky and it is not a given they will always have the protected status they have now when it comes to inheritance tax.
Jason Hollands at Tilney Smith & Williamson warns: ‘Not all AIM companies are eligible for such relief and this is something that needs to be assessed by the investor or their portfolio manager. It is not detailed in a set of report and accounts or on a company website.’
Eligibility can change over time, too. He adds: ‘Ultimately, the eligibility of an AIM share for business relief will be tested when the owner has died, at the time of probate.’
While protection from IHT can be useful, it is important to choose AIM shares and AIM oriented funds for their investment potential.