Investing in the Alternative Investment Market (AIM)

A Daily Reckoning Special Report

By Tom Bulford

A new report, ‘From Local to Global – The Rise of AIM as a Stock Market for Growing Companies,’ has attempted to answer one of most pressing questions for this junior market. Should investors go anywhere near it?

To most observers, myself included, the answer to this question has always been ‘Yes, but only if you are very careful and know what you are doing.’ Because as the report accepts ‘AIM is often described as a stock picker’s market’ – which is simply another way of saying that overall, on balance, at the end of the day, and when all is said and done, the market in toto has not given investors anything like the rewards that they deserve for getting involved with high risk shares in small companies.

Investing in the AIM: a comparison of returns

Over the last decade the stark fact is that over the last decade while the All Share index has delivered a respectable annual return of 7% and the FTSE 100 of 6%, AIM has managed a feeble 1%. This, conventional wisdom has it, is the wrong way round. Investing in small companies is supposed to be risky, so the return over time should be higher.

The report comes from the London School of Economics but was commissioned by the London Stock Exchange. This might explain its dubious attempt to come up with a more flattering figure for the market’s performance.

Having excused the miserable long term return on the basis that it was distorted by the dot-com boom and bust, the authors then say that ‘another way of assessing returns is through an analysis of after-market performance of new admissions…’ Taking only those shares that have been admitted to AIM since December 2000, the report calculates that the three hundred and thirty three that have been around for three years have by this stage delivered a total return of 84%, equivalent to about 23% per year.

This is no more than a highly selective use of statistics. The majority of new issues that have a three year record came to AIM in the dark days of the 2001-2 bear market and have since enjoyed the general rally of the market. But this performance calculation also raises other tricky questions. If new issues have done so well, how come the overall performance of AIM has been so poor? The answer must be that there is a long tail of companies that came to AIM before December 2000 that are basically going nowhere.

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Investing in the AIM: the types of companies involved

The report hints at the cause of this. Over five hundred of the companies traded on AIM have a market value under £10m. At this level they struggle to meet the costs of being public companies, let alone to get any serious attention from analysts or fund managers. They are though still constituents of AIM, and rather than exclude them from the index calculation in a bogus attempt to make the return look better, a way needs to be found of dealing with these minnows, many of which have simply failed to execute their original business plan and are now casting around for a reason to exist.

Too many of these companies are allowed to reinvent themselves through deal-making or to stagger on with a series of fresh capital raisings. This protects the jobs of their directors and the fees of their City advisers, but rarely does anything for shareholders.

Investing in the AIM: lower volatility than London’s Main Market

More encouragement for AIM investors comes from the sections on Liquidity and Volatility. AIM, remember, is perceived as a market that rewards those prepared to tolerate illiquid stocks and wild price gyrations. In fact liquidity is improving and volatility is lower than that of London’s Main Market. Taking as a measure of liquidity turnover, i.e. the total monthly volume as a percentage of the number of shares outstanding, AIM’s turnover last year was 35%, a respectable figure that compares well with other junior markets overseas. But the real surprise is the measure of volatility, defined as the standard deviation of returns.

Over the last five years AIM has been considerably less volatile than the All-Share or FTSE100 index. AIM has seen an average volatility of 9% per annum, compared to 15% for the latter markets. So rather than being a safe and steady market that can deliver sleepless nights to widows and orphans, the Main Market has been turned into a gambling den for hedge funds, while the progress of AIM more closely reflects the performance of its constituent companies.

This is quite a turn up. The conclusion is that for low risk, low returns go to AIM. For high risk, high returns go for the blue chips. How long will it take before conventional wisdom catches up with this extraordinary reversal?

First published on Tue 29 Jan, 2008

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