London’s Alternative Market performed poorly during its first 20 years – but investors can no longer afford to ignore its 1,254 companies, says Max King.
Two years ago, the 20th anniversary of London’s Alternative Investment Market (Aim) was marked with cynicism. During those 20 years, Aim had grown from just ten companies to 1,100, but the annualised return on the index was a feeble –1.6%. The FTSE Aim All-Share index had fallen by 27% over the period, while the main market index had gained 85%.
Professional investors, unable to invest and unwilling to do the research, looked on with disdain at what the Financial Times described as “20 years of few winners and many losers”. Yet today, things look very different. Aim recovered from a poor first half in 2016 to return 16% overall. This year, the index had risen by 22% by mid-October. Moreover, there are encouraging signs that this is not the flash-in-the-pan seen several times before – but the start of a sustained move higher.
A brief history of Aim
Aim was the successor to the Unlisted Securities Market, which was launched by the London Stock Exchange (LSE) in 1980. As with its predecessor, companies listing on Aim do not need the three-year trading record required for a full listing, nor are they required to float at least 25% of their shares. Regulatory requirements are lighter, which makes it cheaper to secure and maintain a listing. The LSE sees it as a market for smaller, growing companies that will hopefully upgrade to a full listing after a few years of successful trading. And to encourage further investment in small firms, the government offers tax benefits.
Money invested directly in Aim stocks is exempt from inheritance tax (otherwise levied at 40%) as long as they have been held for two years (although note that there are anti-avoidance provisions that exclude Aim-listed investment funds, property companies and cash shells). Venture capital trust (VCT) and enterprise investment scheme (EIS) funds, which offer income-tax advantages and exemption from capital-gains tax, can also invest in Aim stocks.
This, says Paul Mumford, manager of the £68m Cavendish Aim Fund, “has encouraged a lot of people looking for inheritance-tax shelters to invest”. Many private wealth managers now have specialist teams to help their clients do so. This has even led to “some companies moving down to Aim rather than up to it, while many Aim companies have been reluctant to move up”.
Unfortunately though, “Aim has historically been vulnerable to a boom/bust cycle”. The index peaked at nearly three times its current level in early 2000; at 15% higher than at present in early 2005; and at not much below current levels in early 2011. On each occasion, Aim fell back sharply. Colin Hughes, a small-cap fund manager at Janus Henderson, explains the background. “In the tech boom, companies found it easy to raise money on the back of a fag packet despite no revenues and a questionable business model. These were found out in the 2000/2001 tech crash.”
Then, in 2005, “came the boom in natural resources and roughly the same thing happened”. A few years later, “68 Chinese-based companies listed on Aim, of which only a handful have survived”. Mumford adds that Aim has had more than its fair share of “fraud, dishonesty, mismanagement and poor business plans, while, in some cases, banks cruelly withdrew their support or the taxman took extreme measures to obtain payment of overdue taxes”.
Painful losses and epic gains
The list of Aim casualties is certainly a long one. Oilexco reached a market value of more than £2bn, moved to a full listing in 2007, and went bust two years later. African Minerals also reached a market value of £2bn before going bust in 2015. Quindell, whose activities spanned insurance and legal claims, reached a market value of £2.7bn but – now renamed Watchstone – is valued at barely £50m. In 2015 Professors Elroy Dimson and Paul Marsh of the London Business School noted that investors had lost money on 72% of the 2,877 companies that had ever listed on Aim, losing at least 95% of their money in more than 30% of them.
Yet underneath all that, says Hughes, “a steady drip of good companies were emerging”. Prominent among these was Asos, the online fashion retailer. This listed in 2001 and saw its share price rise from just a few pence to £75 a go, at which point it had a larger market value than Marks & Spencer. The shares now trade at £55, but with a market value approaching £5bn, it is still Aim’s largest company.
If it had a full listing, it would be in the FTSE 100. More recent successes include the soft-drinks company Fever-Tree, whose share price has multiplied nearly 15-fold since its listing in 2014. The shares of Keywords Studios, which provides services for video-game developers, have multiplied tenfold in value since it listed in 2014, and those of Blue Prism, the robotic process-automation software company, have multiplied tenfold since 2016.
Moreover, says Hughes, “the winners have kept on winning and are not moving to the main market, so have had a bigger impact on the index. Also, established smaller companies such as Young’s Brewery, Scapa and Johnson Services have moved to Aim while solid, sensible businesses such as Majestic Wine have always been on Aim.”
Of course, “there are still disasters,” he adds, “due to charlatans and businesses that have become obsolete, but the abuse is not as bad as it was. Regulation is slowly getting tougher, but this is a good thing as it should cut out the worst quality.” In short, Hughes is optimistic: “we are still seeing interesting, highly differentiated businesses with strong growth potential floating on Aim. There is a virtuous circle of good performance leading to a better perception of the market.”
You can’t ignore the small
This has led to some smaller-companies funds raising their exposure to Aim. The £320m Standard Life UK Smaller Companies Trust (LSE: SLS), for example, has raised its limit from 25% to 50%. Manager Harry Nimmo says that “there are more ‘proper’ companies on Aim that make profits than there were five years ago, while the number of companies in the top 50 that pay dividends has risen from eight to 34.
The decline in the significance of the commodity sectors coupled with a crop of strong new issues has led to a much more broadly based sector exposure within the Aim market focused on growing and developing sectors and businesses.”
Mumford is also positive. “The outlook is good,” he says, “with quality initial public offerings (IPOs – public listings) in the pipeline and many existing companies that are attractive. Entrepreneurialism is definitely not dead in the UK and Aim provides entrepreneurs with capital so that they don’t need to prostrate themselves before the banks.”
If you are looking for the inheritance-tax advantages of Aim, you will need to invest directly, perhaps using one of the many advisory services available. Others can use a fund. Either way, the benefit of diversification across a broad portfolio in a market where share prices both soar and collapse is clear. Most of the smaller-companies funds have sizable allocations, although Aberforth still avoids Aim and the allocation of the Henderson Smaller Companies Trust is only 16%. However, Henderson Opportunities Trust (LSE: HOT) – of which I am a director – is more than 50% invested in Aim.
Its shares trade on a discount to net asset value of 17%. Meanwhile, Mumford’s fund, which has risen by 170% since launch in 2005 against an Aim index that has fallen, is one of a small number of Aim specialists. Don’t be put off by the record of the first 20 years – these companies, now numbering 1,254, can no longer be safely ignored by any investor.