This month AIM (the ‘Alternative Investment Market’), the London Stock Exchange’s market for small, growth companies, reaches its 20-year anniversary, so it is worth reflecting on the features of AIM as well as revisiting the broader case for UK smaller companies.
By way of background, AIM was launched in June 1995, essentially replacing its predecessor, the Unlisted Securities Market (USM), as an exchange with considerably less onerous regulatory requirements than the Main Market and lower costs for companies seeking a listing. For example whereas the Main Market requires companies to have traded for at least three years to be listed and for at least 25% of the shares to be traded as ‘free float’, AIM has no such rules and the standards of disclosure are much less rigorous.
Overall this makes AIM - currently home to around 1,100 companies - a higher-risk market than the Main stock exchange as it includes companies whose shares are very illiquid and where information flow is not as regular as a Main Market stock. But in its favour, AIM has certain perks. For example, many AIM companies qualify for Business Property Relief once held for two years, meaning that they become exempt from an investors estate for the purposes of Inheritance Tax.
And in recent years, further steps have been taken to support the market, with AIM shares becoming eligible investments for ISAs and the removal of stamp duty on AIM share purchases, a cost buyers of Main Market shares must still incur.
There are other advantages for both certain companies on AIM, as well as investors, through accessing AIM companies via Venture Capital Trusts and the Enterprise Investment Scheme. A subset of AIM companies that meet detailed rules on their size and activities are eligible to receive funding through VCTs and EIS. For investors in these schemes, this brings certain benefits including a 30% Income Tax credit (providing the investment is held for at least five years in the case of VCTs and three years under an EIS), as well as tax-free returns. In the case of an EIS, there is also the scope for Capital Gains Tax deferral and loss relief.
The risks of AIM should not be dismissed though and are apparent from the fact that while it is estimated that some 3,500 companies have raised money on AIM over the past 20 years, according to the London Stock Exchange, there are only around 1,100 companies on the exchange today. Where did half of the companies who raised money go?
While some of these will have been absorbed in successful mergers and acquisitions, or taken private again, AIM has also had plenty of flops. And although numerous academic studies covering the long-term trends across markets from around the globe have proven a return premia from smaller companies compared to larger companies (see below one such example), this has not thus far been reflected in the performance of AIM.
Global small-cap premia from 2000-2014:
Indeed the graph below shows the 20-year relative performance of the FTSE AIM All Share Index, versus both the FTSE Small-Cap Index of smaller companies listed on the Main Market, as well as the giants of the FTSE 100 Index.
Most investors in pooled products - funds and investment companies - will have gained exposure through broader UK smaller company investment funds or via a handful of specialist AIM-investment porfolios. The latter includes one OEIC (Cavendish AIM, managed by veteran small-cap manager Paul Mumford) and a cluster of AIM-focused VCTs. Notably, all of these have done better than the FTSE AIM All-Share Index (and that’s not including the additional boost of the Income Tax relief received on VCT investments), a sign perhaps that when navigating shark infested waters, success is as much about avoiding the disasters as cherry picking winners. Of course there are no guarantees and past performance is not a guide to future performance.
It is in many ways ironic that while active management appears to be more successful the further you go down the market-cap spectrum, where companies are less researched and there is more scope for a diligent manager to uncover hidden gems, much of the financial services industry has moved in the opposite direction.
Stockbroking firms have morphed into global investment banks, focused on researching and trading large companies that might appeal to an international client base, while the rise of passive investment strategies means exposure to UK smaller companies is virtually absent from many portfolios despite the fact that numerically these companies represent most of the opportunity set. In theory this ongoing neglect of smaller company shares should mean that those active managers who are still prepared to fish in the small-cap pond, should be able to add value through being selective.
With that in mind, a few ways to invest into UK smaller companies include:
- Through a UK smaller companies OEIC fund. But try picking a fund that isn’t too large and potentially negatively impacted in the manager’s ability to select from a wide universe of stocks. Funds worth considering include the £116 million AXA Framlington UK Smaller Companies fund (30% invested in AIM), the £282 million Fidelity UK Smaller Companies fund (21% in AIM) and the £149 million Franklin UK Smaller Companies fund (32% in AIM).
- Through a UK smaller companies investment trust. The advantage of a closed end structure means these vehicles can hold less liquid stocks. For example, the Standard Life UK Smaller Companies Investment Trust holds around 29% in AIM, whereas the open-ended fund also managed by Harry Nimmo is actually predominantly (57%) invested in mid-caps, not smaller companies.
- Through an AIM VCT. There are a handful of strong teams operating in this space including Unicorn and Hargreave Hale. Investing in newly created VCT shares has the benefit of attracting a 30% income tax credit and here opportunities to do so are seasonable. Right now, one with capacity and open until the end of July is the Amati VCT offer.
- Invest in a UK multi-cap fund. You don’t need to invest in a dedicated smaller companies fund to get exposure to the smaller company or AIM stocks, as the secret to success for some of the best-performing UK equity fund managers is that they are prepared to invest right across the UK stock market, typically with a hefty slug of small and mid-cap companies compared to the FTSE All Share Index. For example, the Liontrust Special Situations fund currently has around 38% in smaller companies.
Finally, it is worth asking: is this a good time to invest in smaller companies?
The chart below shows that on a Price/Earnings valuation basis, having stood at quite a premium to large and mid-cap stocks through 2012 and 2013, smaller company valuations now look reasonable. The one caveat is that this discount in part reflects a shift in sentiment towards bigger, more liquid companies as investors have grown more cautious about the outlook for investment markets generally – but for the genuine long-term investor, this may present a potential buying opportunity.