Shares listed on the Alternative Investment Market are now among the most tax-efficient investments available to investors. Not only do some Aim stocks qualify for business property relief – making them exempt from inheritance tax if they are held for at least two years – they became Isa eligible on 5 August. However, advisers remain cool on their attractions.
Aim stocks held in an Isa will have dividends taxed at 10 per cent and Isa investments are also exempt from capital gains tax. Stamp duty on Aim stocks will also be abolished in April, potentially making Aim even more attractive.
This should all add up to a perfect investment opportunity but Aim shares are speculative, so are higher risk and many advisers say this risk cancels out the benefits for most clients.
The Aim market comprises early stage companies as well as more mature firms that are attracted to the junior market because of its less onerous regulatory requirements.
Direct exposure to individual shares brings another level of risk into portfolio so Aim stocks will not suit everyone, even with the tax advantages of an Isa. A fund that provides exposure to Aim stocks and other smaller companies could be preferable for many investors, but will not provide IHT benefits.
IPFM managing director Luke Gibbon points out that IFAs would have to consider the merits of holding Aim stocks in Isas because of the Retail distribution review, but he beleives many will reject shares in favour of funds. He says: “The benefits of an Isa are normally two-fold. One is that you don’t pay the higher rate of income tax on dividends and the other is exemption from CGT. But Aim stocks don’t tend to pay dividends and many people can manage capital gains tax nowadays within their £10,200 allowance. In fact, if portfolios are managed correctly, investors wouldn’t be paying CGT.”
Holding Aim stocks makes the IHT-free Isa a possibility, but the characteristics of these stocks could be at odds with clients’ investment needs. Hargreaves Lansdown senior investment manager Adrian Lowcock says: “Investors who are retired are going to be looking for income from their Isas, but Aim stocks tend to be high growth, high risk and they don’t usually pay dividends. Investors will most likely add one or two Aim holdings to their Isa portfolios,” he says.
St James’s Place tax and technical director Tony Mudd has reservations about the suitability of Aim stocks for older clients, where IHT is more of a concern. “It is unlikely that a client’s risk profile will get higher as they get older and an Aim portfolio is likely to be higher risk. You could say that the 40 per cent IHT saving in itself lessens the risk, but I’ve never bought that,” he says.
Mudd thinks Aim shares will be popular among people with self-invest Isas but highlights some of the caveats. “There is huge liquidity risk in Aim and if investing in Aim through an Isa becomes popular, quality stocks will be harder to find. They will be bought by professional investors, while stockbrokers and self-select investors will end up with lower quality stocks,” he says.
Bestinvest managing director Jason Hollands says investors who prefer shares rather than funds have a wider universe of stocks to choose from now that they can consider Aim. This type of investor represents a niche part of the stocks and shares Isa market according to Hollands, accounting for around 16 per cent of total assets.
Highlighting the risks of Aim stocks, Hollands says: “It is important to stress that these companies are often higher risk investments than large established businesses, the standards required of companies are less exacting and trading liquidity can be poor, so they will only be suitable for investors who understand the risks involved.”
These risks underline a need for financial advice but access to this appears fraught with difficulty. Specialist investment advice and tax advice is needed and would have to be paid for in a transparent way.
Mudd points out that stockbrokers and specialist small cap investment firms could provide investment advice, but would not advise clients on IHT and other tax issues. One alternative is for clients to do it themselves with no advice but this can be risky. “Not all Aim shares qualify for business relief, which is a problem if you go down the self-select route. Even if investors choose an Aim stock that qualifies for business relief now, they could hold it and upon death it could no longer qualify,” says Mudd.
Miton Group managing director and UK smaller companies manager Gervais Williams says selecting Aim stocks can be profitable for investors who have the ability and the interest. But he warns that the stock-specific risk that generates impressive returns can also work against investors. He says: “You could get three to five wizards and get the IHT benefit, but you could also have bad periods where companies get into financial difficulty. Stock-specific risk can work against you and your portfolio could fall at a faster rate than the market, which would be a concern for investors who are leaving money to future generations.”
Paul Mumford, manager of the Cavendish Aim fund, says Aim shares that qualify for business relief tend to be expensive on the basis that not all Aim shares qualify. “One of the disadvantages of holding individual Aim shares in an Isa is that if something goes wrong, losses cannot be offset against profits elsewhere because an Isa is a tax-free pot. Inevitably something will go wrong but the advantage of a fund which has a spread of investments is that the effect will not be so great,” he says.
Chelsea Financial Services managing director Darius McDermott says there is a lot of research on the internet to help people select their own stocks, but this would be time-consuming. “I personally think most people would be better off with a fund unless they are more than a hobbyist investor. Fund managers have the skill and resources to do the research. Diversification is another reason to go for a fund.”
Gibbon says there are good reasons that IFAs tend to use collectives, rather than choose individual stocks for clients. As a holistic IFA, he does not have the time, knowledge or back-office systems to select and give advice on appropriate Aim holdings. “With clients that have big enough portfolios, I could consider outsourcing to a stockbroker. In my opinion, individuals would need an equity portfolio of around £200,00, with a minimum portfolio of £300,000,” says Gibbon.
Mudd thinks it would be best if advice could be given to clients by their existing advisers, but concedes that the need for both individual stock selection and tax advice presents practical problems. “I think the ability to hold Aim stocks in Isas seemed a good idea at the time but some things haven’t been thought through. Rather than use an Isa, there are other ways of estate planning,” he says.