How to profit from Aim via funds and investment trusts

While the Aim index may have not have performed well, investors would have been very happy with the performance of some funds that have substantial exposure to Aim shares.

Stuart Widdowson, manager of Strategic Equity Capital (SEC) investment trust, has found quite a few opportunities on Aim. "The Aim market offers a big choice of companies in a broad universe and the companies tend to grow faster," he says. "Some of them are managed by their founders so the interests are well aligned with investors. There are some real jewels which can offer better quality and growth than fully-listed companies, and some are mispriced. There are also fewer investors chasing Aim shares as some funds won't touch them."

Paul Mumford, manager of the Cavendish Aim Fund (GB00B0JX3Z52), says that while a FTSE 100 share may be covered by 20 brokers, an Aim share might be covered by one or none. He likes their growth potential, in particular those in the oil and gas sector which are out of favour because of the fall in the oil price.

Aim companies are often focused on a disruptive niche and can generate growth even if the overall environment is not great. In healthcare, companies such as Alliance Pharma (APH) have enjoyed strong growth, but this is not expected for large healthcare companies.

Mr Mumford also says the general quality of Aim shares has improved because nominated advisers have become more responsible in terms of which companies they launch on the market, while a number of less attractive companies have delisted or gone bust.

Laura Foll, deputy manager of IC Top 100 Fund Lowland Investment Company (LWI), says that some Aim companies are established, profitable businesses with good opportunities to grow sales and earnings, yet trade at a discount to their larger cap peers.

"Over time some of our best performers in Lowland have come out of Aim, such as Scapa (SCPA) and Johnson Service Group (JSG)," she adds.

Mr Widdowson says Aim excluding resources, financials and loss makers is forecast to generate 19 per cent forward earnings growth for next year, while the FTSE Small-Cap Index excluding resources, financials and loss makers is forecast to generate 3.6 per cent. While the Aim average price earnings ratio (PE) is 17x against 13.5x for the FTSE Small-Cap Index, he believes Aim offers the potential for higher growth at a modestly higher rating.

The FTSE 250 (minus resources, financials and loss makers) meanwhile, in which some smaller companies funds have a substantial portion of their assets, is on forward earnings growth of 7.3 per cent for next year and a 16.6x PE.

In April, Miton UK Micro Cap (MINI) investment trust launched and its manager Gervais Williams plans to invest the majority of its assets in Aim. "The FTSE Aim Index has fallen back by nearly 20 per cent since peaking in March 2014, but many Aim stocks have continued to deliver earnings growth over recent quarters," he says.

Mr Williams adds that Aim is more balanced than the FTSE 350: energy only accounts for 10 per cent of it as opposed to 22 per cent in December 2012.

Jason Hollands, managing director at Tilney Bestinvest, says investors' core UK equity funds are likely to be focused on larger companies so you might want to supplement them with a smaller companies fund. Because of their higher-risk nature these are more suitable for investors with large portfolios and a long-term time horizon. Laith Khalaf, senior analyst at Hargreaves Lansdown, says investors could consider a 10 to 20 per cent weighting to UK smaller companies, and maybe more if they feel adventurous.

Risks of Aim

The quality of companies listed on Aim varies, in part because this market has lighter regulation than the main market. There are fewer shareholder protections than with the main market.

Blue sky stories in hot sectors such as biotech, oils and minerals may have no profits or cash flow, and regularly ask shareholders for more money.

Smaller and weaker companies are more likely to go bust in times of economic difficulty than larger companies. Over 3,000 companies have listed on Aim since its launch but at present there are just over 1,000, and this is not just due to mergers and acquisitions.

Aim company share prices can move sharply on the back of low volumes prompted by company announcements.

Mr Widowson says there is a greater history of Aim companies failing to meet forecasts than main market companies.

Best funds for Aim exposure

No passive funds or exchange traded funds (ETFs) offer exposure to the Aim market. So you need to choose an actively managed open-ended fund or investment trust.

OPEN-ENDED OPTIONS

Mr Hollands recommends AXA Framlington UK Smaller Companies Fund (GB00B7MMLM18) which has 32 per cent of its assets in Aim. This has performed strongly putting it among the top five performing funds out of more than 50 in the Investment Association (IA) UK Smaller Companies sector over one, three and five years. The fund's Aim holdings include Clinigen Group (CLIN), Redcentric (RCN), Scapa Group (SCPA) and Restore (RST).

He also recommends Franklin UK Smaller Companies Fund (GB00B7FFF708) which is among the top 10 performing funds in the IA UK Smaller Companies sector over one and three years, and has about 32 per cent of its assets in Aim. The fund's Aim holdings include Scapa Group (SCPA) and Restore (RST), Gooch & Housego (GHH) and Patisserie Holdings (CAKE).

Mr Hollands also likes Fidelity UK Smaller Companies Fund (GB00B7VNMB18) which is the top performer in the IA UK Smaller Companies sector over five years, and third over three. It has about a fifth of its assets in Aim, including top 10 holding LXB Retail Properties (LXB).

Mr Lowcock recommends Marlborough UK Micro Cap Growth Fund (GB00B02TPH60), which we also count among our IC Top 100 Funds. It has 88 per cent of its assets in Aim shares. It is among the top 10 performers in the IA UK Smaller Companies sector over five years, but has not done so well over one and three.

It has about 250 holdings and none of these account for more than 2 per cent of the portfolio. Its Aim investments include top ten holdings NAHL Group (NAH) Clinigen Group (CLIN), Redcentric (RCN), Next Fifteen Communications Group (NFC), Eckoh (ECK), Staffline Group (STAF), Cello Group (CLL) and GB Group (GBG).

The fund's manager Giles Hargreave says that during May holdings that did well included Pure Wafer (PUR), which doubled thanks to a much higher insurance claim than expected, while Staffline rose on the election result and Patisserie on good numbers and roll out prospects. He added to the latter.

The fund also took part in fund raisings by including Aim listed Parkmead (PMG), Lombard Risk (LRM) and Johnson Service Group (JSG). A new position was also added: Aim listed EasyHotel (EZH).

Total cumulative return performance of recommended funds

Source: Morningstar as at 11 June 2015

Investment trust options

Investment trusts can be a good way to access assets that are set to rise, as you can sometimes benefit from both a rise in the price of the underlying assets and the investment trust's share price. Because they do not have inflows and outflows like open-ended funds they can take a long-term time horizon which is necessary with smaller companies, and assets that are hard to buy and sell.

Strong performers among investment trusts that have Aim market exposure include IC Top 100 Fund BlackRock Smaller Companies Trust (BRSC). This has 29 per cent of its assets in Aim and is on a 10 per cent discount to NAV, albeit tighter than its 12 month average of 12.7 per cent.

Fund manager Mike Prentis who also runs BlackRockThrogmorton Trust (THRG) says: "Generally we like well run, market leading businesses which have strong records of earnings growth and cash generation and have strong balance sheets. We like companies whose main source of growth has been organic. This has allowed us to make investments in companies such as CVS Group (CVSG), the veterinary surgeries business, Restore (RST), the document storage business, and Advanced Medical Solutions (AMS), the leading provider of wound care and closure products.

Bonding tape manufacturer Scapa has rewarded investors

"Aim is often associated with resources and technology companies and we do selectively invest in these. We have owned shares in Gemfields (GEM), which mines emeralds and rubies, and meet our tests in terms of management quality, market leadership and profitability. Within the technology space we have investments in companies such as EMIS (EMIS), SQS (SQS) and First Derivatives (FDP). There have been some excellent initial public offerings on Aim, FeverTree Drinks (FEVR) being one that has served us well in recent months."

Other strong performing investment trusts with significant exposure to Aim include Henderson Opportunities (HOT) which has 34 per cent of its assets in this market and is run by highly regarded manager James Henderson, who also runs IC Top 100 Fund Lowland (LWI) which has 10 per cent of its assets in Aim.

Henderson Opportunities is on a discount to NAV of about 8.5 per cent, slightly wider than its 12 month average of 7 per cent, while Lowland is on a discount of 4 per cent, wider than its 12 month average of 2.7 per cent.

Investment trusts with most exposure to Aim - share price total return on £100

Source: Association of Investment Companies (AIC) as at 31 May 2015, *Morningstar.