Small-cap managers have been searching the alternative investment market for growth opportunities, arguing its reputation as a volatile and trendy listing space is misleading.
Although the Aim market now has more than 40 per cent of its constituents in the resources sector – similar to its high-tech weighting during the 1999 boom – managers believe there are plenty of other opportunities to be found there.
The boost funds seem to get from exposure to the Aim market is highlighted by the fact that many of the top-performing funds in the IMA UK smaller companies sector all have substantial weightings in this area.
All five of the top performers in the UK smaller companies sector over three years to March 10, have varying levels of Aim exposure: SF t1ps smaller companies growth (85 per cent) Close special situations (more than 50 per cent), Fidelity UK opportunities (22 (per cent) and Investec UK smaller companies (37 per cent). Close Beacon investment, which is specifically an Aim-based portfolio, ranks fourth.
However, while the top performers may invest in what some consider to be a volatile part of the market, many of the funds have quite low relative volatility scores.
For instance, over the three years to March 10, Liontrust UK smaller companies ranks ninth out of 58 peers in the IMA sector based on gains of more than 52 per cent. Manager Anthony Cross currently has more than 60 per cent of his portfolio invested in the Aim market and yet the fund has the lowest volatility score in the IMA peer group, according to Financial Express data.
Unicorn UK smaller companies has the second lowest volatility score in the sector and ranks 15th in the peer group, based on returns before charges of 41.94 per cent. It has 48 per cent exposure to Aim companies.
While Aim holdings in a small-cap fund may not be unusual, such high weightings may surprise some advisers. This is particularly so as most funds do not specifically list their exposure to this market in their fund factsheets.
Whether or not this is deliberate, there is no denying some investors view the Aim market in a less than positive way.
Managers say one reason for this is based on what happened during the technology boom and again right before the credit crisis. Many companies involved in the latest hot or trendy investment area of the moment rush to list on Aim as it is easier than the main market. When sentiment on that trend changes, the whole index falls spectacularly.
The assumption many have towards this market is not completely wrong and managers who invest there agree there are plenty of speculative companies on Aim. Peter Walls, who runs Unicorn’s Aim-based VCT, notes the market has seen its share of trends and disasters. By its very nature, the market will always be volatile, he says. “But as a long-term investor, there are great opportunities. It is a great way for smaller companies to get on the ladder.”
It is also important not to get too distracted by the reputation of the whole market. Cross says there is also a large number of profitable, established, ordinary companies just grinding out returns. “I like the Aim market but you do have to be very careful. I prefer profitable, established companies with UK headquarters and with UK directors, subject to UK law.”
His preference for companies outside the dominant Aim sectors means that when the market fell by 70 per cent in 2008, the Liontrust portfolio was not badly impacted, despite its large weighting. During 2008, the Liontrust fund ranked third in the IMA sector, falling around 27 per cent.
Judging the Aim market as risky as a whole is an oversimplification, Cross says. “As with any markets, you hunt for certain types of businesses and you will find good ones.”
While a significant portion of Aim currently consists of junior miners, oil explorers and other resource-based firms, Cross, Walls and Close special situations and Beacon manager Deryck Noble-Nesbitt all prefer the less fashionabe options that can also be found. Cross holds firms such as international PR company Next Fifteen Communications as well as RWS, which deals with patent translations and searches. One of the successful holdings in Unicorn’s small-cap fund has been in Abcam, a debt-free and cash-generative company that manufactures and distributes research-grade antibodies.
But what of the market’s reputation for failures and blowups? Certainly, the numbers of companies leaving Aim prove there remain plenty of potential potholes for investors. At its peak in December 2007, the number of companies on Aim was 1,694, dropping to less than 1,300 by the end of 2009 and it has been reported 2010 saw some 157 further departures.
Walls, who looks to the venture-capital side of Aim, says his VCT has experienced on average one blowup a year since its launch in the 2001/02 tax year. He says: “We have had failures but by the same token we have also had outstanding successes that phenomenally outweigh those failures.”
The recent strong run of smaller companies across the spectrum may have something to do with the popularity of Aim at the moment and brings with it the question of possible overvaluation in this area. However, managers say, as with the main market, there are many overlooked stocks providing opportunity.
Walls puts the average price/ earnings ratio of holdings in his VCT at 12 times, which he sees as not too demanding in the context of the main market. Cross agrees that valuations are not too stretched in the areas in which he is investing and the growth rates he is expecting are on par with main list small caps – around 10-15 per cent a year. Cross also says liquidity is no more of an issue for Aim holdings as for main-listed small caps.
With an overriding reputation for housing speculative stocks, perhaps it is best to start considering the Aim market in two parts – the good side and the bad. That way, high exposures in this market will not be met with too much cynicism and wariness – and maybe then more companies will start openly listing Aim weightings on their fund factsheets.