Fleeting AIM is the Wild West for some – but brave chance to strike gold

Fistful of Dollars: A Brave New World or a Wild West City Just for Gold Miners?

A brave new world or a city in the Wild West just for prospectors? It’s hard to make a decision about AIM, the alternative investment market that has nurtured some big names, but also seen major failures.

The market had a strong 2020, outperforming the broader UK stock market by 33 percent, and the record this year remains strong.

Ewan Millar, head of AIM at investment manager Brooks Macdonald, says the market’s success is due to its relatively low exposure to what he calls the “old world economy”: sectors such as oil and gas, mining and heavy industrials. “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 fund Standard Life UK Smaller Companies, is a fan. He says: ‘AIM is the envy of the world in terms of depth and scale. It is suitable for nurturing companies from very small to companies with market capitalizations over £1 billion. But it will be many years before some of the outdated preconceptions of AIM as a dangerous market are overtaken by the new reality.”

Where to pan for gold nuggets?

AIM is a huge market with 830 publicly traded stocks, so picking winners can be difficult. Brooks Macdonald’s Millar says, “Companies that have managed to gain market leadership within the niches they operate in, preferably from a global perspective, tend to be the most lucrative companies to invest in.”

There are plenty of well-known 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, translation specialist RWS and ID verification company GB Group.

Lee Wild, head of equity strategy at the wealth platform Interactive Investor, also likes security monitoring group Strix, growth consulting firm Next Fifteen and tech infrastructure firm Renew Holdings. They all fit Millar’s template of niche market leaders.

Wild adds: “All three are brilliant in terms of share price performance, but they also pay dividends to shareholders.”

Gervais Williams, specialist in smaller companies, 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 have actively improved during Covid. Going forward, numerous industry bottlenecks will make it more difficult for companies to meet customer demand and we fear that corporate profits will come under pressure. But in times like these, smaller companies are often better positioned to dodge the bullets.’

Beware of the risks and pitfalls

While AIM may have spawned household names, it doesn’t follow that every business is a guaranteed success story.

Brooks Macdonald’s Millar says the index’s expansive nature means investors can easily make a mistake. “There are many large companies,” he says. “The downside is that there are some that investors should avoid.” Some sectors of AIM are speculative. Millar warns that oil exploration, loss-making biotechnology stocks and companies active in the production of hydrogen fuel cells are sensitive to volatile stock prices.

Juliet Schooling Latter, director of research at investment platform Chelsea Financial, also advises that AIM is less regulated than the major London Stock Exchange.

She says: “Most members are smaller, growing companies – usually at an earlier stage in their business life than those listed on the main market. AIM is therefore riskier and will not appeal to cautious investors.’ She also warns that the market has been artificially stimulated by the tax loophole, which makes investing in AIM a tool to guard against attacks on inheritance taxes (see box below). 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 changes the rules and removes IHT protection, it could affect AIM.”

Mutual funds to set your sights on

While choosing individual stocks on AIM can be lucrative, it is difficult to negotiate the sheer number of them in the market. Due to the increased risk, it is important not to put all your eggs in one basket.

Ryan Hughes of asset manager AJ Bell says, “There are hundreds of companies to choose from, so it makes sense to go the fund route.” Matthew Read, senior analyst at financial research group QuotedData, agrees. He explains: ‘AIM companies tend to have lower financial reporting requirements. This may be a concern for some investors, but can be countered by focusing on AIM-oriented investment trusts that 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 invested solely in AIM stocks, but many smaller corporate funds have stakes. Hughes suggests Tellworth UK Smaller Companies managed by Paul Marriage and John Warren – a fund that has about two-fifths of its portfolio in AIM stocks.

He adds, “Both fund managers are highly experienced investors in smaller companies and, crucially, have a deep understanding of many of the management teams leading publicly traded AIM companies.”

The £500m fund has three AIM-listed stocks in the top ten holdings; student housing provider 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 percent.

Jason Hollands, an investment expert at Tilney Smith & Williamson, also likes the Tellworth fund, as well as the Henderson Smaller Companies investment fund, which has nearly a third of its assets in AIM stocks. Over the past three years, it has rewarded investors with a 52 percent gain.

‘Even some funds that invest in the UK stock market and support large, medium and smaller companies have a large exposure to AIM,’ says Hollands. He cites investment fund Liontrust Special Situations, which has almost a quarter of its investments in AIM shares.

Chelsea’s Schooling Latter says her favorite funds with AIM exposure are Gresham House UK Micro Cap, Marlborough UK Micro Cap Growth and Amati UK Smaller Companies. Three-year returns are respectively 42 percent, 65 percent and 47 percent.

AIM-focused Venture Capital Trusts are another way to access AIM-traded companies and can offer investors attractive tax benefits.

Investors who purchase new shares in VCTs enjoy a 30 percent upfront tax credit, provided they have owned the shares for at least five years. Any dividends and capital gains are also tax free.

Hollands: ‘The government has excluded certain types of companies from being eligible for VCT investment. AIM VCTs therefore only have access to part of the AIM market, not all companies on it.’ That doesn’t stop these trusts from being popular. Recently, Octopus AIM VCT raised £40m in new money from investors in just 24 days.

However you choose to invest in the AIM market, it is important to understand the risks involved in investing in lighter regulated companies. You need to make sure your AIM investments match your risk tolerance.

Protect your loot from the tax authorities

One of the reasons AIM stocks are popular is that they can help lower estate taxes.

Shares listed on this market benefit from a provision introduced in 1976 called Business Property Relief (BPR). Originally, BPR was intended to ensure that family businesses did not have to be broken up to pay IHT bills, but it now applies to privately held corporate investments and companies trading on AIM.

Buying AIM stock allows you to keep your assets and still lower the IHT bill when you die. The exemption is already available after two years, while gifts to relatives 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 stocks can be risky and it’s not a given that they will always have the protected status they now have when it comes to estate taxes. Jason Hollands of Tilney Smith & Williamson cautions: “Not all AIM companies qualify for such an exemption and this should be assessed by the investor or their portfolio manager. It will not be detailed in a series of reports and accounts or on a company website.”

Eligibility may also change over time. He adds: “Ultimately, the eligibility of an AIM stock for business assistance will be tested when the owner is deceased, at the time of probate.”

While protection against IHT can be helpful, it is important to choose AIM stocks and AIM-oriented funds for their investment potential.

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