There might be a simple reason for this. Aim stocks are like lottery tickets; they offer the small chance of massive gains. And investors tend to pay too much for such upside potential with the result that Aim stocks, on average, disappoint. Investors over-estimate the number of shares like Plethora (up 800 per cent in the last 12 months) and under-estimate the number like Touchstone Gold (down 94 per cent).
You might think this just confirms that Aim is useless. Not necessarily. The index does have its use, as an indicator of sentiment and hence as a predictor of returns.
The idea here is that because Aim stocks are even harder to value accurately than main market ones, they are more sensitive to changes in investors’ optimism or pessimism. And when investors are optimistic, they are often too optimistic with the result that share prices subsequently fall. Equally, when they are pessimistic they might be too gloomy and so prices subsequently rise.
To test this, we first need to adjust the ratio of Aim to the All-Share index to correct for its long-term downtrend since the 1990s; if we don’t do this it will seem as if sentiment steadily deteriorates every year, which would be odd. Doing this shows a few phases of high sentiment - most obviously at the peak of the tech bubble but also in the mid-00s - and some of low: during the financial crises of 1998 and 2008 and after the tech crash in 2002-03.
And here’s the thing. There’s a strong negative correlation (0.56 since December 1995) between this index of sentiment and subsequent annual changes in Aim. For example, Aim did well after sentiment was low in late 1998, 2003 and late 2008, but badly after sentiment was high in 2000, 2007 and early 2011.
What’s more, there’s also a negative correlation, albeit a weaker one, between this indicator of sentiment and subsequent annual changes in the All-Share index. Mainline stocks also tend to do badly after Aim has been high relative to the All-Share index and well after it has been low.
Herein lies some goodish news. Aim’s latest fall means that this indicator of sentiment is now slightly negative. Past relationships imply that this points to decent returns on Aim and mainline stocks in the next 12 months, with Aim slightly outperforming.
Now, this is not a huge buy signal; sentiment is only slightly below its long-term average and there is of course statistical noise in this relationship. Nevertheless, this suggests we shouldn’t be pessimistic about either main market or Aim returns over the next 12 months.
