Aim for profits: big potential in UK small caps
UK small caps on the Aim junior market have been in the doldrums for years. That could be about to change, says David Prosser
Aim, the London Stock Exchange's market for smaller or growing companies, is in the doldrums. Hit by negative sentiment towards UK small caps, plus tax reforms that have reduced the attractiveness of many Aim stocks, London's junior stock market has struggled to keep its head above water. The FTSE Aim 100 index, which charts the share-price performance of the largest companies on the market, currently stands at around 3,650. That compares with a peak of almost 6,550 in September 2021.
In fact, the malaise goes back even further. Looking across the whole of Aim, returns over the past ten years are near zero, compared with a 60% gain from the FTSE All-Share index over the same period. And it's not only investors who feel disenchanted; far fewer companies now see a compelling case to list their shares on Aim. In 2007, some 1,700 businesses had Aim quotes, while today the figure is barely above 600.
For all that, “I remain an Aim bull,” says Alex Game, a fund manager in the Economic Advantage team at Liontrust. “We like to back businesses with high levels of founder and manager ownership. These are entrepreneurial companies focused on [growth] and many of them are high-quality businesses, in market leading positions with well-capitalised balance sheets.”
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“There's also a diversification angle,” adds Eustace Santa Barbara, co-manager of the IFSL Marlborough Special Situations, UK Micro-Cap Growth, Multi-Cap Growth and Nano-Cap Growth funds. “We're now seeing… the potential perils of holding just a handful of household-name, mega-cap businesses that dominate their indexes and can leave investors at the mercy of market shocks.”
Aim is under domestic pressure
To decide whether you share such optimism, you must first understand why Aim has underperformed in recent times. That is partly explained by the difficult macro environment the UK has faced, with ongoing challenges such as elevated inflation, driven by higher food and energy prices, depressed domestic demand amid the cost-of-living crisis, and political instability. Smaller companies, which tend to have less international activity, are more exposed to these domestic pressures.
It is also a reflection of the bias in the smaller companies sector towards growth stocks. These are companies where investors are betting on the long-term prospects of the business, rather than performance right now. When interest rates rise – and the rapid climb from a base rate of near zero five years ago to above 5% was unprecedented – investors tend to avoid such stocks. They calculate they will need much higher returns to compensate them as they wait for jam tomorrow.
Such worries have prompted a flight of capital. Funds investing in UK small caps have seen withdrawals of £6.1 billion, according to analysis by Hargreaves Lansdown. Most of that cash has gone overseas. Aim, moreover, is at the sharp end of this perfect storm. It's home to many of the smallest listed companies in the UK and features a disproportionate number of growth stocks. No wonder investors have steered clear. That said, Aim has also been hit by problems specific to it.
Above all, the decision by the government in its first budget in 2024 to reduce the value of a key tax incentive for Aim investors has had a significant impact. Many Aim shares qualify for Business Property Relief (BPR), a tax break intended to encourage investment in small businesses – by entrepreneurs starting their own companies, but also by investors backing the ventures. Until April, BPR meant that once you had held qualifying Aim shares for two years, there would be no inheritance tax (IHT) to pay on the assets following your death. This was a powerful incentive to consider Aim stocks, particularly since they can be held inside an individual savings account (ISA), sheltering them from all tax charges on income and capital growth.
Since April, however, BPR has fallen from 100% to 50%. This means the value of Aim shares bequeathed to your heirs could now attract an IHT charge, assuming your estate is valued above the £325,000 threshold at which the tax becomes payable. The rate charged would be 20%, rather than the usual 40%, but the tax bill could still be significant. Importantly, the change applies both to any new investments you make on Aim and to Aim assets you already hold. This has seen some investors opt to sell out – the Tax Efficient Review says investors in specialist Aim portfolio services have sold roughly £170 million worth of shares this year, around 10% of the value of assets held in these services overall. Such sales represent a brake on Aim's potential, even before you factor in reduced future demand for stocks now the IHT tax break is no longer so attractive.
Aim shares are going cheap
Other Aim-specific concerns include something of a dearth of exciting new businesses coming to the market. In today's investment environment, there are more sources of growth capital available to early-stage businesses than when Aim launched 30 years ago. The plentiful supply of venture capital, private equity and even debt finance means companies don't necessarily need to jump through the administrative and regulatory hoops required for a stock market listing to raise money. Corporate governance concerns still worry some potential Aim investors, too. The point of a junior market is to enable less mature companies to secure a public listing even if they are not ready to meet all the requirements of a traditional stock exchange. The London Stock Exchange therefore imposes fewer responsibilities on would-be Aim businesses. Unfortunately, this light-touch approach also increases the potential for governance failures and criminality. The LSE has periodically tightened the rules, but scandals at firms such as Langbar International, Globo and African Minerals continue to cast a long shadow.
All of which explains why Aim has struggled. But as Game points out, the market has been through difficult periods before – and then bounced back. “Aim does go through these spells and right now we're at the nadir of the market,” he says. “But performance is cyclical: throughout its history, there have also been times when Aim has performed really well.”
Santa Barbara adds: “It's easy to claim Aim's glory days are long gone, but it's impossible to argue with Aim's proven track record as an engine of growth. The founding principle of the market – to provide the most promising smaller companies with access to capital and ongoing finance – still applies.”
It's certainly possible to make the case that Aim now looks very cheap. Valuations of UK small caps generally look attractive. The price/earnings ratio on the FTSE Small Cap index is currently 10.6, compared with 15.0 for the FTSE 100 index of large companies, for example. Comparative data for Aim is not available, given issues such as the lack of revenues and profits at some businesses, but many stocks are on low valuations by all historical comparisons. “Private equity has been acquiring Aim companies at quite a pace, suggesting sophisticated investors believe many of these businesses are fundamentally undervalued,” says Jonathan Moyes, head of research at investment platform Wealth Club. What the market needs, then, is a catalyst for a change of sentiment. Investors need a reason to look at Aim afresh – and to decide whether those valuations now represent opportunity. One such catalyst could be lower interest rates. The Bank of England's Monetary Policy Committee cut rates six times during 2024 and 2025 and was widely expected to make further cuts before the Iran war saw energy prices spike.
That prompted the MPC to step back from cuts, but a decisive end to the crisis could prompt looser monetary policy. It helps that early expectations of an inflation spike have so far proved overly-pessimistic.
Another potential game changer would be an influx of new companies that excites investors to return to the market. Initial public offerings (IPOs) have been in short supply on all markets in recent times, but more private companies do now appear to be thinking about going public. That includes potential new entrants to Aim, adds Moyes. “Companies raised around £3.3 billion in the first seven months of 2026, compared with just £1.6bn during the whole of 2024,” he points out. “A significant proportion of this year's fundraising came from one very large transaction, and that activity has been driven by secondary raises rather than new listings; nevertheless, capital is flowing again.”
The LSE is trying to do its bit. It has already unveiled plans aimed at reducing the costs of listing on Aim and at making it easier to raise capital. Greater political stability, particularly once the fiscal and monetary plans of the Andy Burnham-led government become clearer following next month's Budget, could also support an increase in Aim IPOs. Aim may not need seismic shifts in sentiment to change the direction of travel. The market for shares in many Aim companies is illiquid – there are fewer buyers and sellers – so even small shifts in mood can have a significant impact. This is one reason why Aim has often proved volatile, but that can work in investors' favour as well as against.
Aim is a stock-picker's market
One other important point is that Aim investors don't need the whole market to change gear – just the companies in which they are interested. Investment experts agree Aim is an active stock-pickers' market. It's natural to focus on the performance of the market overall, but the qualities of individual firms vary enormously; the dispersion of returns at a stock-specific level is much wider than on other markets. The focus on flat returns over ten years overlooks individual success stories. Indeed, says Game, “Aim has probably generated more ten-baggers than most other developed markets.” Recent examples include healthcare software company Craneware, which joined Aim almost 20 years ago and has since delivered total returns of around 1,500% – an annualised return of about 16%. Defence technology business Cohort has generated annualised returns of roughly 14% over the same period.
Mortgage Advice Bureau is another example. It moved to the main market earlier this year having listed on Aim in 2014. Over its 12 years on Aim, the business returned more than 400%, or roughly 15% a year.
None of which is to suggest Aim, as a market in general, is guaranteed to rebound from its current lows. And there is certainly plenty of scepticism. “The problem in the UK is that very few investors are interested in smaller companies – and even fewer are interested in the spicier end of small cap that Aim represents,” says Ben Yearsley, a director of Fairview Investing. “Some exciting IPOs in the small-cap space might help, but companies are staying private for longer; and while there have been Aim floats, managers who invest in the market say quality has often been lacking.”
The counter argument is that in an improving interest-rate environment and a market where IPO activity seems to be picking up, IHT reforms could clear the decks for a new conversation about the merits of Aim. “Tax relief was never enough on its own to sustain a healthy market,” argues Moyes. “If valuations start to recover, investors will be coming for the investment story first, with a bit of inheritance tax relief as the icing on the cake, rather than the other way round.”
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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.