The Alternative Investment Market (AIM), the junior market of the London Stock Exchange, is home to ‘hidden gems’ that fund managers with a disciplined stock-picking framework are well placed to unearth.
“Most AIM companies either don’t grow or they fall by the wayside – but within the market there are those hidden gems that do succeed,” said Adrian Lowcock, an investment director at Architas. “AIM investing is risky, but the [potential] rewards are huge.”
Had you invested in online fashion retailer ASOS, the largest AIM stock with a market value of more than £4 billion, you would have made 160 times your investment from trough to peak.
It is the best investment Harry Nimmo has made in his 14 years of managing the Standard Life Investments UK Smaller Companies Trust. He made investors 50 times their money on ASOS during an eight-year holding period from 2006 to 2014, ultimately selling the stock after it grew beyond the Trust’s size range.
“We don’t like any one holding to become more than 5% of the portfolio, so ASOS became a bit big for us and we recycled the money into smaller things,” he said. That spectacular performance has helped the Trust’s ordinary share price grow 285% over the decade to June 2017.
It is at the AIM end of the market that Nimmo is increasingly finding strong investment opportunities. Some 40% of the portfolio is invested in AIM-listed companies, following a significant increase over the past year.
In part, this has been driven by the strong performance of AIM: the index is up more than 15% in the year to date*, while the FTSE 250 is up 9% and the FTSE 100 just 5%.
Moreover, it is reflective of his disciplined stock-picking process. Nimmo recognises that a greater allocation to AIM may seem counterintuitive given his focus on risk management.
“Equity investment is risky and AIM is probably slightly riskier than traditional large cap investing, but these are proper businesses,” said Nimmo.
“Many investors, and indeed our clients, see smaller companies as risky and we try to mitigate that. We prefer to invest in lower-risk smaller companies – companies where we see earnings visibility, strong balance sheets and good cashflow. Many of them pay dividends.”
“Lower risk can mean higher reward; that flies in the face of traditional academic research, but more recent research validates our way of thinking.”
While this approach may mean that the Trust underperforms during strong bull markets, it has proven resilient during more challenging market conditions; for example, the downturn caused by the banking crisis or bursting of the dotcom bubble.
Having previously been very weighted to resources, AIM has evolved to become much more broadly based.
Standard Life Investments UK Smaller Companies Trust has no exposure to oil and gas or mining, and instead has biases towards healthcare, food and drink, software, retailers and sports services.
Increasingly, the Trust’s holdings have an international flavour, again a result of the manager’s clearly defined investment process that encompasses comprehensive screening – Standard Life Investments ‘Matrix’, a quantitative screening tool that is focused on a number of factors including quality, value, growth and momentum – and fundamental research.
Positions he has recently initiated or added to include RWS Group, a patent translation business that has a strong foothold in the US and China; veterinary service provider CVS Group, which is expanding into Holland; Fever-Tree, a producer and exporter of premium drink mixers; chocolatier and cocoa grower Hotel Chocolat; Nichols, whose lead brand Vimto is a favourite in the Middle East during Ramadan; and Accesso, which provides virtual queuing technology and point-of-sale and ticketing software to top attractions around the world.
“This shows the diversity of the AIM market and the scale of some of these UK businesses that are doing well in overseas markets,” said Nimmo. “If successful internationally, the growth potential is massively higher. That’s often what we look to tap into.”
Conversely, recent sells include a handful of UK-focused firms, including Dunelm, Computacentre, Secure Trust Bank and Rightmove.
Despite some clear winners, the broader AIM market has been somewhat disappointing: since its launch in 1995. Launched at 1,000, the FTSE AIM All-Share index stands at 965.70 today – and even that is after a 35% recovery over the past year.
“This is why active managers are essential,” said Lowcock. “It takes a huge amount of work to identify those potential opportunities, but more than that a lot of knowledge to understand what you are looking for, as well as experience to recognise when companies have maximised their potential or perhaps failed to achieve and sell out.”
While you can invest in single AIM stocks in an Isa, Darius McDermott, managing director of Chelsea Financial Services, believes that a good fund manager investing in AIM is a “better bet for most people”. “Good stock-picking and thorough research are necessities,” he added.
Nimmo and his team perform fundamental research to test the conclusion of a stock’s Matrix scores. They also place great emphasis on performing a comprehensive analysis of a company’s market position, as well as meeting its management.
Nimmo is conscious of other factors at play, too. “AIM has benefited handsomely from inheritance tax and capital gains tax advantages over fully listed companies and that’s something the Chancellor could change at any time,” he said. “We keep a weather eye on these idiosyncrasies of tax.”
For further information, please visit our investment trust web site: www.standardlifeuksmallercompaniestrust.com
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