If your AIM is true, then back tomorrow's stars

Jenne Mannion asks if investors should join the party as the junior market has its 10th birthday

It's about to blow out the candles on its cake, and many investors may want to wish it a happy birthday. Celebrating a 10th anniversary on 19 June is the Alternative Investment Market (AIM), the junior market run by the London Stock Exchange and home to more than 1,500 small, young companies.

It's about to blow out the candles on its cake, and many investors may want to wish it a happy birthday. Celebrating a 10th anniversary on 19 June is the Alternative Investment Market (AIM), the junior market run by the London Stock Exchange and home to more than 1,500 small, young companies.

AIM replaced the Unlisted Securities Market in 1995 and, although initially associated with poor quality, high-risk stocks, it has become a rich hunting ground for people seeking investment opportunities.

Richard Plackett, manager of the Merrill Lynch UK Smaller Companies fund, which invests in firms listed on AIM, says the market has grown up in the past decade and is now home to many high-calibre companies.

"It used to be associated with loss-making technology businesses, but the picture nowadays is very different," he says. "We can find many quality stocks that meet our criteria of good management, [being] strong in their market, [having] healthy balance sheets and generating a lot of cash."

Many household names are listed on AIM. They include the Monsoon and Mulberry fashion groups; football clubs Birmingham City, Charlton Athletic, Sheffield United and Tottenham Hotspur; and the Domino's pizza chain.

For investors prepared to allocate a small part of their portfolio to AIM firms, the junior stock market offers the potential of getting in at the start of a growth story, says Paul Ilott of independent financial adviser (IFA) Bates Investment Services. However, he adds, there are also risks.

"Many AIM companies have relatively short histories and don't always have diverse business models. In some cases, this means that their fortunes are tied to the success of a single product.

"Also, they tend to have smaller market share and less experienced management [when compared with larger companies].

"This makes them more risky," Mr Ilott continues, "but potentially more rewarding as well because their size could multiply several times if they are successful."

There are two main ways to tap into the fledgling firms that could turn into the giant companies of the future.

First, you can buy the individual shares direct through a stockbroker, like any other type of share. However, holding just one or a handful of shares is a high-risk strategy as any losses will have a far bigger impact on your overall finances - especially if you don't have many other investments.

But there are two big tax advantages to buying, and holding, stocks listed on the junior market.

"If you hold any AIM company for more than two years, their value lies outside your estate for inheritance tax [IHT] purposes [40 per cent on any estate worth more than £275,000]," says Mitch Hopkinson of IFA M2 Financial. This is due to business property relief, which is also applicable to ordinary investments.

"The IHT relief should never be the only reason to hold AIM shares, as these can fall as well as rise in value," adds Mr Hopkinson. "Yet the ability to save 40 per cent IHT tax should certainly be weighed up when considering these companies."

AIM shares also qualify as a business asset when it comes to capital gains tax (CGT), says Mr Ilott. This means that they enjoy high "taper" relief - where you pay less tax if they're held for a certain time.

"If you hang on to AIM shares for more than two years, the profit chargeable to CGT is reduced by 75 per cent," he says. "Fully listed shares do not have the same advantage."

But small investors may have no tax to pay at all. Say you backed a company going great guns and made a £10,000 profit over at least two years. When you came to sell your shares, you would in theory face a CGT bill of £2,500. But thanks to the annual CGT allowance of £8,500, there would be nothing to pay.

An alternative approach is to invest in AIM-listed companies via a UK smaller companies fund - and you can use your tax-free £7,000 individual savings allowance to do so.

Many fund managers hold a large amount of AIM-listed shares because they have found good investment opportunities.

For instance, AIM stocks account for half the portfolios of Marlborough Special Situations, Rensburg UK MicroCap Growth and New Star Select Opportunities. UBS UK Smaller Companies and First State UK Smaller Companies hold 54 and 65 per cent respectively in AIM shares.

Meanwhile, the Close Beacon fund is completely invested in AIM firms.

Smaller firms in general offer many advantages, says Mr Ilott. "One bonus is that interest rates appear to have peaked, so the cost of borrowing, which generally has a big effect on the profit margins of smaller businesses, will fall."

Meanwhile, he adds, corporate balance sheets are generally much healthier. This means that, as the economy is expected to slow, larger companies will be under pressure to use their strong cashflows to fund mer- gers and acquisitions in order to maintain earnings.

"The most likely beneficiaries of takeover activity - which generally results in a higher share price - are smaller and medium-sized companies."