Aiming high in 2011

In the year to December, Aim rose by almost 31 per cent, double the growth of the FTSE 250 at 15 per cent and leagues ahead of the blue-chip FTSE 100 which had grown by just 2.9 per cent by the beginning of December.

Once again this performance proves the adage that smaller companies generally outperform in the early stages of economic recovery. In particular, the strong rebound in the UK economy in the second quarter gave Aim a further boost, as did the surge in commodities prices across the year as a whole. This benefited the resources companies that make up a large proportion of Aim's constituents.

Indeed, as we pointed out several times during 2010, Aim's best resources companies were among the stellar performers of the year. Investors enjoyed handsome returns from shares in companies such as Arian Silver, Chariot Oil & Gas and EnCore Oil. The recovery in the oil price and its subsequent stability prompted a pick-up in exploration activity, which in itself led to some handsome successes with the drillbit – something that always gets investors' attention. This helped companies such as Nautical Petroleum and Cove Energy to end the year well above where they started it.

Prospects for the oil & gas sector for 2011 continue to appear promising. With the oil price now apparently becalmed around the $70-$80 a barrel range, drilling campaigns will continue to dominate. The Falklands will remain one of the key stories for smaller companies investors although recent drilling results from Desire Petroleum, which found more water than oil at its Rachel prospect, may have dampened enthusiasm a little.

Companies to watch that may benefit from continued drilling success include Faroe Petroleum and Chariot Oil & Gas, which is exploring offshore Namibia and is now actively seeking farm-in partners, and Northern Petroleum, whose small share in a recent major potential discovery offshore French Guiana could have a significant bearing on its shares.

The year also saw commodity prices soar ,with gold setting new all-time highs and copper and iron ore regaining most of the value they lost in the recession. This gave a big lift to companies such as Arian Silver, whose shares have risen almost 10-fold, Condor Resources, Berkeley Mineral Resources, Western Coal, Solomon Gold and Vatukoula Gold Mines. The key in this sector in 2011 will be continued success with drilling campaigns which help to prove up resources in the ground, agreements for farm-ins with majors and permitting success. Indeed, European Goldfields' shares could be boosted significantly by the expected award of permits in Greece and Romania early in 2011. Companies to watch on the drilling and improved resources front include Kryso Resources and Chaarat Gold, both of which are proving up gold projects in central Asia.

A further theme to keep an eye on among small-cap resources stocks is uranium. As global demand for uranium grows with the proliferation of nuclear power stations, smaller companies with rights over uranium deposits could find their valuations bid upwards. Players include Kalahari Minerals, Berkeley Resources and Vane Minerals.

But, despite Aim's reputation as a home for resources investors, the list of best-performing shares of 2010 was punctuated with non-resources companies and the best-performing sector was retail, which enjoyed an average rise of 83.5 per cent. It was boosted strongly by a stunning 486 per cent rise in Mulberry's share price and the continued excellent performance of online retailer Asos, whose shares rose by 175 per cent. Further strong retail performers included Walker Greenbank, up 137 per cent, and Colefax and Jacques Vert, both up 80 per cent, as investors piled back into consumer cyclicals in a big way.

Whether this can be repeated in 2011 remains to be seen, especially if the UK consumer shies away from the spending of recent years. Asos appears almost bullet-proof, growing strongly despite the woe the recession visited upon its key demographic of 16-24 years olds and it is now in overseas expansion mode, which is likely to support its high valuation. Mulberry and Walker Greenbank could also continue to benefit from their strong operational performance and positioning as luxury brands, something that has not harmed them at all in recent months.

How Aim compares

Aim has also seen a resurgence in interest in sectors such as technology and renewable energy and sustainability. Technology favourites such as mobile marketing specialist Velti continued to perform well. It added 140 per cent over the year on the back of continued penetration of its mobile marketing service with blue-chip clients. Velit should continue to perform well. Mobile and online technology businesses remain popular in small-cap technology, with applications, content and e-commerce finding favour with investors of late. Penny stocks such as Mobile Streams and MobilityOne more than doubled over the course of 2011 and, a bit higher up the value scale, Bango's shares trebled.

Investors have also plugged into new technological themes such as cloud computing and remote hosting of online services. Growth in these areas benefited Iomart, CSF Group and Forbidden Technologies. CSF also provides data storage capacity in Asia, where demand is growing rapidly.

Another sector that enjoyed a resurgence was the alternative energy sector. Several of its constituents which were trampled underfoot in the rush for the exits in 2008 and 2009 have risen, phoenix-like, from the ashes. Obvious examples include fuel cell specialists AFC Energy and Acta, whose shares have risen 440 per cent and 322 per cent respectively, and Pursuit Dynamics, whose efficient pump technology finally gained traction in 2010, giving its shares a 383 per cent boost. All three have promising pipelines of corporate news well into 2011, which is likely to maintain investor interest and support their share prices.

So, what of 2011? Can Aim shares continue to outperform their larger cousins to such a notable extent? True, it is going to be difficult to match the level of outperformance enjoyed in 2010, and the economic outlook will have a huge bearing on that. Many Aim stocks have enjoyed a resurgence on the back of improving economic sentiment and should that falter, as economic growth looks set to come under increasing pressure in the early months of next year, then smaller companies could feel the pain most acutely.

Aim has also enjoyed a turbo-boost from the surge in commodity prices and this, by common consensus, is unlikely to be repeated in 2011. Admittedly, commodity prices may remain relatively high, which will continue to support exploration and investment in the sector, but returns could level off as inflation creeps into the cost-side of the equation, especially for those companies operating in emerging markets.

In fact, the dominance of resources and emerging markets exposure has led to some investors seeking new themes on Aim. Collins Stewart fund manager Sean O'Flanagan believes that good, old-fashioned UK companies have been left behind.

"I'm investing in UK businesses, I see it as a really interesting area because everyone else has written it off. I'm looking at businesses that had fallen a long way but are well operationally geared," he says. Mr O'Flanagan highlights firms like Lavendon, GB Group, May Gurney and Tikit as quality UK companies who have, until now, been overlooked by many investors.

Mr O'Flanagan thinks Aim's resurgence could still have legs: "These things come in cycles, it tends to last three to four years and we're in year two now, so maybe we've got another year or two. Certainly, we've not seen the large increases in volumes that usually come at the top of the market."

Some companies simply carry on serenely throughout all manner of economic hiccups – Asos being a prime example. It has defied all predictions of a slowdown in spending in its core market at home by expanding overseas. Other consistent performers over recent years include Velti, another company that has plugged into the long-term theme of the growth of the internet globally, which will continue for years to come.

But among those more economically sensitive companies, recruiters such as Staffline and Impellam may find it difficult to replicate their stunning 2010 success in 2011, if the UK economy does indeed begin to falter.

The year just ending was mightily successful for Aim and, following a near-60 per cent rebound in 2009, sealed its recovery from the credit crunch and ensuing recession. Importantly, it also proved that there is life in Aim generally and that it is not driven solely by the ebb and flow of the resources sector.

Should the economy falter significantly in 2011, there will be little Aim can do to avoid the fallout. If we have a more benign slowdown but no lurch back into recession, then smaller companies should continue to perform well. The credit crunch allowed for some badly needed pruning of the market’s dead wood. And the ensuing period of tight credit conditions has encouraged best practice among Aim's survivors, which should stand them in good stead even in the event of an economic relapse.

How Aim sectors performed

How Aim companies performed