Aim funds to benefit from 'huge fillip'

The government has announced that it plans to scrap stamp duty on shares traded on Aim from April 2014, and is consulting on allowing Aim shares to be held in individual savings accounts (Isas). It is anticipated that these two changes may increase investor interest in Aim.

"This will surely be a huge fillip for Aim-traded smaller companies," said Mark Williams, product line manager at asset manager Octopus Investments. "The measure will help promote liquidity [the ability to buy and sell shares] and reduces the cost of equity funding for smaller companies, which can only be a good thing."

Aim is under-researched and under-brokered, which provides great opportunities - if you have the time and research capacity. Because of this, and the risks of this market, it could be better to invest in Aim via a fund, run by a dedicated investment team who devote all their working hours to picking the right shares. A fund also holds tens or hundreds of shares, so one blow-up is not going to have a disastrous effect on the overall return, which is very relevant in a high-risk area.

Shares within a fund do not incur capital gains tax (CGT) when traded, although investors accessing Aim shares within a unit trust or investment trust do not benefit from inheritance tax relief as is the case with some Aim shares held directly for two years.

"Several managers run funds that have a bias or focus to Aim shares," says Adrian Lowcock, senior investment manager at Hargreaves Lansdown. "These funds are already available inside an Isa. The portfolio is also likely to be more diversified so investors will not be relying on the performance of just a few individual shares."

There are not many dedicated Aim funds but one good option is Cavendish AIM Fund (GB00B0JX3X39). Fund manager Paul Mumford said: "The Aim market has performed very badly over the last year and been shunned by investors. 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 ratio. The financial crisis meant that banks reduced lending to smaller companies causing some to delist from Aim. But this means the remaining ones are generally of a better quality than before.

"Valuations are far from demanding and if there is a rotation from bonds to equities among larger institutional investors such as pension funds, the average rating on growth shares will be pushed up and may drive other investors to Aim for value."

Read the full interview with Paul Mumford

Most of the unit trusts and investment trusts that offer exposure to Aim are not fully invested in this market, which can help reduce volatility and risk, and boost returns as they select from a wider pool, while having some of the benefit of Aim.

Marlborough UK Micro Cap Growth (GB00B02TPH60) is an IC Top 100 Fund that give investors diversified exposure to Aim and small caps. Managed by Giles Hargreaves, it has 74 per cent invested in Aim shares. "Giles Hargreaves is an exceptional stock-picker, looking at a company's potential rather than the wider economy. His track record has been brilliant and the fund has returned 21 per cent in 2012 and 590 per cent over the last 10 years, while the FTSE Aim index has returned 2.8 per cent and 43.9 per cent respectively," said Mr Lowcock.

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Alternatively, try Cazenove UK Smaller Companies fund (GB0007219362). "Cazenove UK Smaller Companies fund has 39.29 per cent invested in Aim shares and returned 36.6 per cent in 2012 and 397.2 per cent over the last 10 years," added Mr Lowcock.

Top 10 funds that offer exposure to AIM

Source: Morningstar, *Hargreaves Lansdown

Performance data as at at 12 April 2013

Top 10 performing IMA UK Smaller Companies funds over five years

Source: Morningstar

Performance data as at 12 April 2013

Investment trusts can be a good way to access assets that are set to rise, as you can benefit from both a rise in the price of the underlying assets and the investment trust's share price, but as with open-ended funds the best performing smaller companies trusts are not necessarily the ones with most exposure to AIM.

Long-term strong performers which give exposure to Aim shares include IC Top 100 Funds Standard Life UK Smaller Companies (SLS) and BlackRock Smaller Companies Investment Trust (BRSC), as well as Throgmorton Trust (THRG).

Investment trusts which offer exposure to Aim

VCTs for Aim exposure

A number of venture capital trusts (VCTs) invest in Aim shares. These are listed funds like investment trusts but offer a number of tax reliefs because they invest in early-stage and potentially risky companies, such as you might find on Aim. The reliefs include 30 per cent income tax relief if you hold the shares for five years and tax-free dividends, and when you dispose of VCT shares you do not incur capital gains.

Aim VCT performance had been held back due to rules that did not allow them to invest their qualifying money (70 per cent of their assets) in companies with gross assets of more than £7m and more than 50 employees, putting many companies beyond their reach. However, these limits have been increased to companies with assets of up to £15m and up to 250 employees, giving a broader universe to choose from. Some Aim VCTs, such as the Amati and Hargreave Hale vehicles, had already been accessing larger companies with money raised before April 2006, before the £7m and 50 employee restrictions came in.

This is still not as wide a choice as for a smaller company fund or investment trust that can invest in any Aim shares it likes. Funds and investment trust also do not only have to buy shares at initial public offering or top up like a VCT. And you can buy and sell your holding when you want in a unit trust or Oeic, while ability to trade shares is typically easier with investment trusts than VCTs.

But your returns with a VCT get a head start in that you have a 30 per cent tax break and may have an untaxed dividend stream.

VCTs are high-risk investments which advisers suggest you do not use unless you have used up your other tax allowances first, namely Isas, pension and CGT allowance. If you have used these and have a large and diversified portfolio, then you could invest a small part of it into VCTs, maybe up to 10 per cent. VCTs are generally suitable for higher-rate tax payers with a long-term time horizon.

Of the Aim VCTs open to investment, Hargreave Hale VCT 1 & VCT 2 have made good returns, while broker Bestinvest rates Amati 1 & 2 VCT as four star on the grounds that they are run by capable fund managers who know their market well.

Read more on VCTs

Open AIM VCTs

Source: Tax Efficient Review

Aim risks

While the Aim market offers the opportunity for high growth it is also very high risk. So investing in Aim shares is more suitable for those with large portfolios and a long-term time horizon. If you are an adventurous investor you could have up to 15 per cent of your assets in smaller companies, with up to 5 per cent in Aim.

Aim companies are often higher risk than large established businesses because:

■ the standards required of companies to list on this market are less exacting and trading liquidity can be poor, which can exacerbate market falls;

■ share prices can move sharply on the back of low volumes prompted by company announcements;

■ companies issuing Aim shares tend to be smaller, so their shares are more volatile than their larger-cap counterparts. Add into the mix the prevalence of new companies on Aim and the risk of failure can be relatively high;

■ mining, oil and gas companies account for a significant part of the Aim index, so the overall return can follow the fortunes of these areas;

■ picking the right Aim companies takes a tremendous amount of research and insider knowledge. Fund managers say it is important to meet the companies' management teams as the information available to the public can be lacking.