It has long been known that AIM stocks offer a large incentive to investors, particularly for their enormous capital growth potential. They also present the opportunity for the investor to get in early before the companies reach their full potential. However, does this make it superior to the main market, or do its drawbacks amount to more than the advantages it brings?
Since the introduction of AIM stocks to tax-efficient ISAs last August, there stands the question of whether adding small-cap equities is beneficial to savers and investors. Over time, particular shares on the smaller market have shown far greater capital growth than is usually observed on the FTSE 100. A prime example of this would be to look back at the online clothes retailer; ASOS. In August 2003 the shares were trading at a mere 3.5 pence – by January 2014 the shares had risen to over 7,000 pence each. In other words, for every pound invested, you’d have £2,000. Whilst ASOS may be an extraordinary case, it is not uncommon to see extremely bullish AIM equities which rise by 50% in a single day. This is the remarkable aspect of the Alternative Investment Market.
Enhanced growth prospects come at considerable cost.
Whilst said capital growth potential is a great benefit of the smaller market, there are many drawbacks that come with it. The first is the enormous spreads; these can be up to 50% of the share price when looking at some of the lowest priced stocks. This means without even taking fees into account, one would have to have to achieve a 50% return to simply break-even on their investment; which eradicates a large amount of short-term speculation on the market. The reason for the large spreads is due to the illiquid nature of AIM; there is simply not the same volume of buyers and sellers as there is with the larger-cap equities, meaning the market makers would typically struggle to redistribute the shares, thus they demand higher spreads to compensate. Another significant drawback of small cap equities is that they are generally not viable for large investors – ruling out the majority of institutional investors from participating in the market. This is because funds often invest larger sums than the total market capitalisations of many AIM-listed companies, meaning they would influence the price so much that it would simply not be profitable. Even if purchased gradually, holding all of the publicly-traded equity of a company is very high risk move that few institutional investors would choose to take.
Another major drawback to AIM is that dividends are much less common, and virtually unheard of across the low valued penny stocks. Needless to say, for a company to be priced very low, it is usually because it is high risk, and typically a high risk company will not be generating significant profits, if any – let alone enough to pay dividends. Aside from these drawbacks, there is also the issue that AIM stocks are simply higher risk from a number of factors, such as lack of capital and lack of a loyal customer base. Naturally, with higher expected returns, we would assume higher risk – which is by no means untrue with the smaller market.
If we look at the performance of the FTSE AIM Index (FTAI) over the latest recession, the index lost nearly 70% of its value from that of a year before. By comparison, the FTSE 100 suffered a much lesser decline of 45% across the same period. Since then, we can also see that the main market has recovered to above its pre-recession level, yet the FTAI is still 35% down. Typically the smaller, high risk equities will suffer greatest in times of declining investor confidence, as they are deemed too risky an asset to hold capital in and will often be substituted for less risky equities – or securities from entirely different asset classes; such as government bonds.
Whilst AIM does offer terrific growth prospects, one should consider the likeliness of picking a winner and should also note that around 100 companies are delisted from AIM each year. Less onerous regulation and populated with a large amount of high risk equities; AIM is perhaps best left to the risk-seeking small investor, and is by no means an all-out replacement for those seeking relatively defensive investment – as is the case with a large proportion of retail and institutional investors.