While UK markets have generally enjoyed a move up in the past year, one area that has not benefited is the Alternative Investment Market (Aim), which is down on a year ago. But Paul Mumford, manager of the Cavendish AIM Fund (GB00B0JX3X39), thinks there may be better times ahead.
"The Aim has performed very badly over the past year and has been shunned by investors," he says. "Shares in better-quality companies have often been neglected by investors leaving an interesting opportunity to pick up nuggets at attractive levels for those investors looking for an above average risk/reward. Timing an investment is always difficult, but we feel that the market has a more robust range of companies in it that it did several years ago."
At the height of its most recent popularity in 2007, there were 1,694 companies on Aim, but by the end of 2012 the number had fallen to 1,105. "The financial crisis meant that banks reduced lending to smaller companies causing some to delist from Aim," he adds. "But this means the remaining ones are generally of a better quality than before.
The background situation also helped because banks are now for a number of reasons relaxing their lending policies so that small companies can be supported. Overall, the investment and financial risks are less than they have been and I feel quite positive about Aim in 2013."
The Aim market is well below its peak so valuations are far from demanding. If there is a rotation from bonds to equities among larger institutional investors such as pension funds, although these are too large to invest in Aim shares, the average rating on growth shares will be pushed up. This may drive other investors to Aim for value.
Another possible boost to the market may come if government proposals to allow Aim shares to be held in individual savings accounts (Isas) are enacted, which could mean more investors start to buy into this market.
Getting your timing right is important when exploiting Aim opportunities. Most Aim companies have 31 December year-ends, so their annual and half-year reports tend to come out in the first and third quarter. This means that there is a lack of news flow about them in the second and fourth quarters. Share prices tend to move sharply following trading reports, and broker updates tend to come out after the reports.
But, in general, the Aim market is under-researched so there are more anomalies to exploit than among large-cap and small-cap shares. And if you find the right companies, the results are transformational, adds Mr Mumford. For example, he bought Tullow Oil (TLW), Cairn (CNE) and Premier Oil (PMO) in the 1990s while they were still small, but they are now listed on the FTSE 100 and FTSE 250, respectively.
He thinks some of the oil companies operating in the North Sea are attractive, examples including Faroe Petroleum (FPM) and Valiant Petroleum (VPP). "These have acreage in the Norwegian part of the North Sea and the Norwegian government refunds just under 80 per cent of the drilling costs," he says.
"And I have benefited from a number of acquisitions. Companies such as Shell (RDSB) and BP (BP.) have got to make massive finds to replace what they sell on a daily basis. I bought Nautical Petroleum at around 34p a share and it was taken out at around 454p a share."
Valiant Petroleum is now also subject to a takeover offer
Read more on Valiant Petroleum
Aim also has a number of healthcare companies and these are not necessarily loss-making biotechnology firms. "Alliance Pharma (APH), for example, buys mature drugs from large companies which provide a steady stream of income. Alliance Pharma is a relatively low-risk operation as healthcare will continue to grow and it has global reach."
That said, Mr Mumford does not allocate his portfolio by sector, but by stock-picking, and allocation is a result of this. He is also finding attractive investments in areas including construction, software and support services.
Risk
Aim is much riskier than the main market. "There is no doubt that over the years, companies that have listed on Aim have been of varied quality," says Mr Mumford. "Before investing in shares listed on Aim, it is important to recognise the difference between them and fully-listed companies. Aim-listed companies have higher regulatory risks than those on the main exchange."
Areas he avoids include overseas companies listed on Aim. Exceptions include Bangladesh-based Beximco Pharmaceuticals. "This company supplies developing countries with drugs and the World Health Authority has said it can supply generics without competition from large pharmaceutical companies. It puts this company in a good position and it has been quite profitable. It has an attractive valuation and investment merits."
One of the main ways he mitigates the risk is by having a large spread of companies - the fund has 66 holdings spread across eight sectors. "Whenever I consider a share I look at the loss or profit, and loss generally rules it out," adds Mr Mumford.
He also doesn't like any one holding to account for too much of the fund - nothing accounts for more than 3.4 per cent of the assets. However, if a share performs well, meaning it accounts for a larger proportion of the fund, he won't sell it just because of that.
Reasons to sell include:
■ Something has gone wrong with the company;
■ The share price has got ahead of itself; or
■ He has found something he really wants to buy so needs to sell something.
Last year he sold Avocet Mining (AVM) because its reserves are less than he thought.
"It is important to meet the companies' managements as the information available to the public can be lacking," adds Mr Mumford. "This helps you get a feel for how they might do over the next four or five years. The majority of companies visit me around twice a year so I get specialist information.
"There are a number of up and coming companies which could do well, and hopefully we will see a more favourable banking outlook so they will experience good growth."
