The Alternative Investment Market (AIM) can be a fertile hunting ground for investors, but it can also be a minefield. Small, unproven companies are inherently riskier than larger, established companies. As such, investors seek much higher upside on AIM companies.
Whilst AIM shares are not for the fainthearted, they can provide diversification and enhance portfolio performance.
AIM has built a reputation as an attractive marketplace for companies and investors, and a highly tax-efficient one. Qualifying shares listed on AIM are exempt from inheritance tax once they have been held for two years and have been allowed in ISAs since 2013.
Over recent years, investors have been given a further incentive, with the abolition of stamp duty on purchases of AIM stocks. Inevitably this has led to greater demand for shares in quality companies, which works to the advantage of those investors who identify them early.
A less tightly regulated market than the main exchange, AIM provides a lower-cost alternative for growth companies seeking investment.
Over the last twenty years, the AIM All Share index has lagged considerably behind the FTSE 100 and even further behind the FTSE 250. But that’s been improving in recent years. Over a three-year period, the AIM All Share has doubled the return of the FTSE 250 and almost trebled that of the FTSE 100.
What’s more, the returns from successful AIM investments can be truly staggering; each £10,000 investment in ASOS on listing in 2001 would now be worth over £2.24 million, in Numis over £800,000 and more recently in Fevertree on listing in late 2014 would now be worth approximately £222,000.
AIM is truly a stockpicker’s market with a lottery type lure for private investors. The desire to identify fast-growing companies that offer exposure to an emerging trend such as online shopping is why investors keep coming back to AIM. However, skill and judgment must be applied when selecting small companies.
AIM is often seen as an under-researched area of the stock market, meaning those with the necessary resources and experience have the opportunity to identify businesses with strong growth potential long before they appear on the radar of most other investors.
There are many reasons why smaller companies can deliver much higher returns that large companies simply cannot match.
One such reason is that early stage companies have more potential to experience share price booms as they build market share. A small company can expand from serving thousands of customers to millions if the product is marketed correctly and there is customer demand.
As smaller companies become more established, the risk of investment falls alongside the chances of failure. This can lead to a further rally of the share price as more investors are willing to buy. The obvious example would be fund managers. Many funds are simply not allowed to invest in start-ups or early stage companies. But as a company matures and is no longer considered as high risk then this allows fund managers to buy in, hoping to see a continuation of the company’s growth curve. Funds will tend to buy in much larger size than private investors and this could create additional impetus behind the share price.
Below we look at some general good practice rules that fund managers follow when investing for capital growth and whether private investors might benefit from doing the same when selecting AIM companies.
General rules to follow when investing in AIM companies
- Invest and build
Building a diversified range of investments is important in all areas of the market. In the case of AIM companies, many of the best early stage fund managers will invest small amounts initially and then track performance.
For the companies that are growing and the share price is rising, the fund managers will average up. Many of the more aggressive funds will invest up to four times as much when averaging up. Professional investors see building positions on successful investments as a strategy to maximise returns and compensate for non profitable investments.
At the same time, many of the more successful professional investors will be well disciplined and resist the temptation to buy more of a stock because the share price is falling.
- Run winners, cut losers
Investors need to set clear profit and loss prices at the time of investment.
When investing in a stockpickers market like AIM, it is essential to be patient with the successful investments to allow the share price to reach levels that make up for the unsuccessful investments. Keep a close eye on successful investments and if you feel it is a good business, be open to taking some profit and adjusting your profit target to let the remaining investment run.
The flipside is to cut stocks that are losing money. It is tempting to wait for the share price to recover. Sometimes that will happen, but all too often there is a very good reason why the price is falling. Market sentiment on the AIM market can be very strong and a disciplined investor will cut losses early and find a better opportunity.
- Do not lose your money more than once
You may buy a stock for all the right reasons but things go wrong for the company. The share price falls dramatically and the company comes to the market looking for fresh capital to bail it out.
You need to admit that you can be wrong and resist the temptation of averaging down. Having experienced a major setback, in order to then succeed as an investment the company will have to overcome market sentiment as well as turn around its fortunes. It is much better to use your capital to invest in a successful company with a rising share price, remember the trend is your friend.
- A company is only as strong as its management team
Fund managers will invariably have the opportunity to meet companies face-to-face. This is a valuable opportunity to cross-examine the management and to gauge their quality, which is particularly important in small caps.
If unable to meet management, make sure you perform sufficient due diligence to be satisfied the team has the requisite experience and market knowledge to deliver on the company’s growth strategy. The management team must be incentivised correctly and have the right motivations.
For more details on assessing the quality of a management team click HERE
It is also imperative the management team has a track record of being able to raise capital on the markets through both equity and debt. Repeat funding is invariable required by fast, expanding companies and the management will need to know how to tap the various funding options open to AIM listed companies.
- Be selective
Whilst fund managers have many advantages over private investors, they can also be hampered by managing large pools of capital. Managing a £1 billion fund will often lead to over diversifying within a stockpicker’s market.
The key is to find companies that are mispriced. Look at sector comparables but be careful not to fall into the trap of using ratios as a basis of comparison. Many ratios can provide strong indications for established companies with extensive trading history. However, they simply do not apply to smaller companies on the AIM.
Essentially, a mispriced investment means it either it is undervalued when compared to competitors at a similar stage of development or it is more established and hence offers the same expected return for a lower risk.
- Inefficient Market
One benefit of investing in smaller companies as opposed to larger ones is that the actual market can be an inefficient and under-researched. With the changes since Mifid 2, there are likely to be even fewer analysts covering stocks with a market cap of £250m and below. This can present opportunities for investors with strong research skills to identify opportunities that have simply slipped under the radar.
Look for companies where the biggest risk is management execution risk rather than big external factors outside the control of management. For example, if looking at a gold mining stock, make sure it can still succeed even at a significantly reduced gold price.
For investors looking to achieve the stellar returns possible from the AIM market, thorough due diligence and research are key; a good portfolio is as much about the opportunities you reject as those that you buy.
Identify opportunities that match your investment goals and follow a proven strategy in order to bring consistency to your results.
CSS Partners has raised over £170m for entrepreneurial companies since 2001. To learn more about how we enable private investors seeking higher capital growth to invest with confidence in smaller companies click HERE.
The information in this website is provided by CSS Partners LLP. This website has been approved for the purposes of section 21 of the Financial Services and Markets Act by Charles Street Securities Europe LLP (CSSE), which is authorised and regulated by the Financial Conduct Authority. CSS Partners is an appointed representative of CSSE.
Any views or opinions expressed in this blog are those of the author alone, except where specifically stated that they are the views of CSS Partners LLP.