This article originally appeared in the Weekend Read.
Away from the biggest names on the FTSE there’s a corner of the market that investors love and fear in equal measure.
The Alternative Investment Market (AIM) has its die-hard fans, who scour the FTSE AIM All Share index in search of small cap winners.
But for every staunch supporter there’s a trembling investor sitting with a strong tea, promising themselves they’ll never go near it again.
There aren’t many other indices that provoke such polemic responses but is that more of a reflection on us as investors, or is it genuinely an investment madhouse?
Let’s have a look at what AIM actually is.
Launched in 1995 as London’s junior market, AIM started out with 10 companies valued at £82m. Today, AIM is home to around 850 companies with a combined market cap of £104bn, so says the London Stock Exchange.
It’s usually small companies aiming to IPO that consider AIM instead of the main market.
Part of the reason is that listing your company’s shares on AIM comes with lighter-touch regulations than bigger bourses, meaning smaller or earlier-stage firms can see it as a less daunting way to come to the stock market.
An easy way to spot the differences is to look at the admission criteria for AIM and its bigger cousin.
Some of the main ones are included here. This isn’t an exhaustive list but it does illustrate the more relaxed requirements that younger or smaller firms can find attractive.
Well, when you have less rigorous entry requirements, naturally a lot of investors start wondering why the firms on there didn’t want to meet the standards of the main market.
That risks missing the point though. The whole idea of AIM is to provide a route to market for firms either not ready, or put off by all the paperwork and tight regulation needed for the big leagues.
A big difference in that sense is the role of the nominated adviser (street name: nomad) in AIM firms.
Nomads are essentially corporate finance advisors, (usually small investment banks) that AIM companies have to keep on board so there is always someone making sure they’re sticking to the market rule book.
The thing is, there have been a few cases of these nomads dropping the ball. To be fair to them, a lot of the headaches start with the firms themselves and the nomads find out the problems too late.
A good example is Chinese food additive business Sorbic. In 2015 its chief exec, Wang Yan Ting, took the company’s corporate seals, business licences and some cash hostage and refused to hand them over. He lost his job, the nomad resigned and Sorbic shares were delisted from AIM.
So, while a lot of investors are quick to put the blame on nomads in times of trouble, company management should really be the first place we look.
We’ve all seen corporate scandals right up and down the cap scale - it just seems to happen more often and more explosively among small companies with less oversight.
The point here is that looser regulation has its pros and cons, and investors should be aware of them before jumping in.
After all that, you might be wondering why on earth anyone would voluntarily get caught up in such a risky, and often speculative, part of the market.
A lot of it has to do with the growth potential on offer, if you know where to look.
Smaller and early stage companies inherently carry more risk because they often don’t have the wide revenue streams, diversified business models and overall stability of their larger and more established cousins.
That can mean developments in the business can have huge impacts, both positive and negative, on share prices. Expanding into a new market or having a new product take off might be positive for a FTSE 100 company but it can be life-changing for an AIM firm.
Novacyt is a good case study here.
The medical diagnostics firm develops pathogen testing kits for the medical, life science, and food industries, so 2020 was its time to shine.
The likes of Astrazeneca saw a good lift in share price for its vaccine efforts. But Novacyt’s Covid-19 rapid testing kit rollout sent its price into the stratosphere.
After plummeting in value over 2019, the firm’s shares have now returned over 400% in the past three years.
That’s not to say every AIM firm will perform like that, but the possibility is one reason a lot of investors stick around despite the flags that scare others off.
More broadly, the small cap index has given investors a few more reasons to have a look at the market minnows over the past few years.
Over five years, the AIM All Share index has returned around 93% against a return of 40% for the broader FTSE All Share.
Hone in on the AIM 100 (the biggest fish in the small pond) and the difference is even more noticeable. The index has returned just short of 100% against 33% for the FTSE 100.
Looking at that, it’s tempting to think about shifting a big part of your portfolio into AIM but, as we’ve discussed, behind those returns comes a huge dollop of risk. All that past performance is no guarantee of future returns anyway.
What it does demonstrate more recently is the real V-shaped recovery the AIM 100 has seen since market lows in March 2020.
The FTSE, which is more international, lagged in comparison. That’s because smaller companies tend to serve the UK economy more, and make more of their revenue streams from local customers.
Hopes of a UK economic recovery have benefited domestic-focused firms and the further down the cap scale you go, the more likely you are to find businesses serving their home country.
In fact, only about 23% of FTSE 100 company revenues are derived from the UK. Move down into the FTSE 250 and that number jumps to 41%.
That last point is an important one. The gap between the winners and losers on AIM can be extreme so investors need to do their homework.
Keeping up to date with such a volatile index can end up feeling like a part-time hobby. But if there was ever a market that needed your attention this is it.
Their stellar rises are testament to what good companies on AIM can achieve. But investors looking for the next breakout star would do well to remember some of the less glamorous tales.
A lowlight in the past few years was the collapse of high street bakery company Patisserie Valerie in 2019.
Having listed on AIM in 2013 and funding its own growth through the firm’s cash flow, the chain was seemingly doing quite well. It was even paying a dividend - a rare sight on AIM.
But, the cake and coffee group plunged from a value of £580m to zero in less than four months after it emerged its accounts were basically a work of fiction.
The firm said it had uncovered “thousands of false entries into the company’s ledgers” and that “the misstatement of accounts was extensive, involving very significant manipulation of the balance sheet and profit and loss accounts.”
So, that’s the good and the bad taken care of, and it tends to be the small miners that fit somewhere in between. Like Jekyll & Hyde, they can be as ugly as they are beautiful.
Junior miners tend to scavenge around forgotten drill sites or try to exploit shallow reservoirs where they can. It’s cheaper, sometimes the infrastructure is already there, and as they’re small themselves they don’t need a once-in-a-lifetime find to get them into profit.
There’s a huge amount of jeopardy here though. Sometimes it all clicks into place and the market gets excited like in the cases of Greatland Gold, Eurasia Mining, Kodal Minerals and, more recently, Orosur.
But then there are the drawn out cases like Ascent Resources. Battles with the Slovenian government, regular boardroom changes and strategy changes, broken equipment - Ascent has seen the lot. And all the while shareholders have been asked to kindly provide more money to keep the lights on.
If there is a sector typifying just how hit and miss AIM can be, mining is it.
Big names like Boohoo and Fever-Tree have hopefully laid to rest the view that the whole AIM index is just one big gamble. It isn’t.
But it does require a certain type of stock picker. One that’s willing to roll up their sleeves and get stuck into the financial statements. Looser regulations mean there are fewer safeguards in that respect, and fewer professional analysts doing it for you.
For that extra legwork, you could find yourself holding a genuinely valuable opportunity that a lot of others haven’t seen yet. To get there though, you’ll probably have to separate the wheat from the chaff for a while.
AIM is far from the wild west older investors seem to think it is. Caution and a keen eye for detail are essential to make sure you don’t get caught up in another Patisserie Valerie and hopefully back the next big success story among the market minnows.
What's your take on AIM? Are you mad about small caps or do you stick to the big leagues? Let us know on the community forum:
Past performance is not a reliable indicator of future returns.
Source: FE, as at 6 Jul 2021. Basis: bid-bid in local currency terms with income reinvested.
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