AIM stocks once struck fear into many mainstream investors, believing the market was full of small mining companies whose volatility wasn’t worth the ensuing sleepless nights.
But, while Alternative Investment Market shares are still not for the faint hearted, they can provide diversification and potentially enhance portfolio performance.
Here, Rebecca O’Keeffe, head of investment at Interactive Investor, explains what you need to know about the small company stock market.
Fast online fashion shop ASOS has long been one of the darlings of the AIM market
This compares with the FTSE 100 where Oil & Gas, Banks and Personal and Household Goods occupy the top three spots.
The benefit of AIM shares is that if you get it right, it really can improve your portfolio.
The best AIM performer over the last five years is carpets and floorcoverings manufacturer Victoria, which does not fit into the typical image of a high growth AIM company.
New management came into the company and they are undertaking a buy and build strategy aimed at making Victoria one of the biggest floorcoverings companies in Europe. The share price is now close to 20 times higher than it was five years ago.
Watch out for survivorship bias
When talking about performance, there is always the thought of survivorship bias and how that impacts relative performance.
Survivorship bias is the idea that when stocks fall out of an index the subsequent index return is flattered by having jettisoned poor performers.
In the case of groups of investments where you do not count the companies that failed to survive, conveniently forgetting they ever existed, then this can flatter performance even more, but the AIM 100 index includes all previous constituents’ performance, in exactly the same way as the FTSE 100.
The big gaps between the winners and the losers
Substantial numbers of investors like trading AIM shares as the market can provide frequent trading opportunities. The difference between the winners and the losers is huge.
Best performers in AIM 100 over one year
Frontier Developments 308%
Plus500 Ltd 197%
Griffin Mining 193%
Source: ii, data to 31 May 2018
Worst performers in AIM 100 over one year
Faron Pharmaceuticals OY -85%
Xeros Technology Group -63%
Telit Communications -50%
Source: ii, data to 31 May 2018
Consider an AIM fund or investment trust instead
For longer term investors, the risks associated with individual shares might not be so appealing. So what options are there for those who want to obtain exposure to AIM shares without the individual company risks?
The AIM index is more difficult to replicate than the FTSE 100, which has numerous low-cost passive options such as ETFs and tracker funds.
This may be because some of the constituents are more illiquid, hence bid-offer spreads on smaller companies tend to be higher than large cap stocks, making it more difficult to track smaller companies effectively.
Currently, there are no tracker options available for the AIM 100. However, this is where the active fund management industry gets to earn their fees.
Many funds within the UK smaller company sector invest in AIM shares. These microcap and AIM funds do the filtering for you, and some of them have done very well over the past five years, appearing at the top of investment tables, outperforming rivals who don’t invest as heavily in the junior sector.
The top three performing funds in the UK smaller companies sector embrace the range and diversity of smaller UK companies, including AIM stocks.
To put these funds’ performance into context, the average return of a FTSE 100 tracker fund over the same time period is 43.9 per cent.
AIM shares are ultra-high risk, but potentially come with high rewards. As such, they can provide additional variety and diversification to a broader investment portfolio. The AIM market has matured, and long-term investors who have so far shied away from it may want to give AIM another look.
Top performing UK smaller company funds over five years
TB Amati UK Smaller Companies 163%
TM Cavendish AIM 160%
LF Livingbridge UK Micro Cap 159%
Source: ii, data to 31 May 2018