What you need to know about investing in AIM shares

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.

Five things you need to know about AIM shares 

There are five things you should know about AIM:

1. The AIM market has its own large-cap indices, including an AIM 100.

2. The performance of the Top 100 is good in recent years.

3. The range of companies is much broader than you may think.

4. When it goes right, it really goes right.

5. More fund managers are covering the AIM market, giving investors plenty of options.

How does AIM stack up?

The AIM 100 lists the top 100 stocks on the junior market by market capitalisation, in the same way that the FTSE 100 reflects the biggest companies listed in London.

Some of the stocks are indeed large with ASOS and Fevertree, both worth billions, occupying the top two spots. According to the latest FTSE AIM factsheet, they contribute over 7 per cent and 6 per cent of the weighting in the index respectively.

This is comparable to HSBC and Royal Dutch Shell A, which dominate the FTSE 100 index.

However, while you may imagine that the AIM index is dominated by those at the top, with a long tail of much smaller companies, in fact the AIM 100 is actually less concentrated than the FTSE 100. The top 10 AIM stocks’ weighting is currently 36.9 per cent, compared to an equivalent top 10 weighting of 44.2 per cent for the FTSE 100.

How has AIM performed? 

Despite a hiccup in 2014, AIM stocks have performed well versus their larger counterparts in recent years.

To the end of May, the five-year annualised total return for the AIM 100 is 12.5 per cent, versus 7.1 per cent for the FTSE 100.

Although volatility remains slightly higher for AIM shares, the difference may be less that expected, with the AIM 5-year volatility figure being 12.1, compared to an equivalent measure of 10.6 for the FTSE 100.

Previously thought of as the preserve of mining companies and other high-risk sectors, it may come as a surprise to find that AIM shares are more mainstream than you think.

The top three Supersectors in the AIM 100 are Financial Services, Retail and Industrial Goods & Services. 

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. 

 

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.