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Take Aim at small firms

The small company effect is the widely reported phenomenon which records that small company share prices perform well both absolutely and relatively in the first quarter of a calendar year. It has been noted for many years, particularly in relation to analysis of the Hoare Govett smaller companies index.

Is it too rosy a view of the stockmarket to suggest that the small company effect will be alive and kicking this year? I don&#39t think so.

Needless to say, it has not been a feature of the UK stockmarket in the last two years. However, 2003 could be very different.

In what has become, temporarily, a backwater of the stockmarket, namely the Alternative Investment Mar-ket, there lurk some prizes worth catching early. Aim is the market which the London Stock Exchange has created for smaller, growing companies. It allows those companies to raise funds and to grow with perhaps less fuss than applies on the LSE&#39s full list.

Don&#39t think though that Aim is lightly regulated. It isn&#39t. What it does have as a major difference are some tax incentives for investors. Some of these tax breaks have been around as long as Aim itself, which started in 1995.

The sceptic will not believe of their existence and expect a catch. That, though, would not be the correct attitude. The area is complex and, of course, changes. However, that is not a catch. Indeed, the first Aim company tax relief has been changed and subsumed into EIS arrangements. A number of companies run schemes investing in Aim companies, which now defer capital gains from the taxman or capture other reliefs.

Did you know that suitable Aim company shares held for two years fall totally outside the estate at death and the taxman&#39s net? This means a portion of an investor&#39s estate is free from tax – and not just the sum originally invested, but any gain on it too.

Similarly, investors can invest in a portfolio of appropriate Aim shares and, if they are sold after two years, the gain on them is subject to only 10 per cent capital gains tax. Repeat the exercise and you have an interesting way of accumulating a nest egg for the future.

By investment in particular Aim companies existing capital gains tax can be deferred and new ones made to be taxed at advantageous rates, which can even be nil. Most of these reliefs, but not all, require investment into small com-panies, which meet Inland Revenue defined criteria.

Investing in Aim does not require any bravery beyond investment generally. You may not feel like investing in anything except a good cocktail on a tropical beach right now but Aim has some wonderful opportunities on a par with lots of cocktails and potentially without that after-effect, which brings me back to the small company effect.

Investing in small and gro-wing companies is a test of patience, even in cases of outright success. Many professionals take a three to fiveyear view of these positions so individual investors also need generally to be patient.

But one factor, which has driven Aim share prices so low recently, has been the loss of patience among institutional investors which have regarded the time that these investments take to come to maturity as too long and too risky in prevailing stockmarket conditions.

As a result, many Aim prices are at unprecedentedly low levels – not because their trading results merit that, nor because their market is going to stop growing nor because the economy is going to slap them in the face, but because big institutions have taken decisions for their own particular reasons, to sell small company shares.

In the present stockmarket conditions, all this has meant that sellers have outnumbered buyers. It has also meant that buyers can, to a large extent, dictate the price at which shares are traded – and they have done so. There have been some interesting prices struck over the last few months, which will appear to be fantastic bargains in the next few months.

When many warn of the continuing risk of equity investment, it may seem absurd to advocate investment in small companies. But many great investors analyse situations and back their judgement at times when much popular opinion would suggest their analysis was wrong? It was uncomfortable being a value investor at the end of the dotcom bubble.

However, making investments is not about riding a particular wave or hoping that a bubble does not deflate. It is about analysing situations and resisting the temptation to gamble. It is about backing your long-term judgements. So should you invest in Aim now?

Well, yes, Aim companies are generally characterised by being small, among quoted companies and by being growing companies. In a low interest and low GDP growth environment, small companies which can grow are an attractive investment class. Back in the 1950s and early 1960s, when similar conditions prevailed, small companies earned a price premium for their shares.

At present, small companies are not attracting much institutional investment for a variety of structural reasons. Aim is therefore full of bargains from which the specialist funds can benefit their shareholders.

If that is the case, it would seem that now is the right time to invest in Aim, on the basis that time is measured in a few years not a few weeks, although it is probably wise to invest via funds and portfolio services.

Rises and falls on a daily basis, particularly at present, can be caused by numerous factors that reflect stockmarket conditions. Only the longer-term trend needs concern a longer-term investor. Looking back in two or three years, we will see that 2002 was a time when bargains existed.

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