Swim with the small fry, but don't get in too deep

The Alternative Investment Market offers the chance to put your money on tiddlers that may become titans. But there are dangers, writes Sam Dunn

While many investors wonder when would be a good time to dip their toes tentatively back into the FTSE 100, the bold have already dived in at the deep end - by putting their money into the Alternative Investment Market (AIM).

While many investors wonder when would be a good time to dip their toes tentatively back into the FTSE 100, the bold have already dived in at the deep end - by putting their money into the Alternative Investment Market (AIM).

Unlike the established blue-chip stocks that comprise the FTSE 100, AIM offers investors a punt on hopes of future riches from a pool of some 700 fledgling companies in the UK and overseas.

AIM is only for investors prepared to accept volatility. Its members hope to grow big enough to qualify for the main London Stock Exchange, where they will catch the eye of mainstream investors. Mining company Aquarius Platinum, for example, was floated on AIM in October 1999 at 50p a share. Just days before it moved to the bigger exchange in July last year, its price had edged above £3.

To this end, AIM - run and regulated by the Stock Exchange and including such household names as Majestic Wine, Domino's Pizza and Coffee Republic - offers investors the possibility of getting in on a success story right at the start.

Glen Pratt, manager of the £59m Newton Growth fund, which invests in AIM, says: "There can be gems out there that haven't yet been recognised by the market. When you buy an AIM member, you are trying to buy tomorrow's mid-cap companies at today's [smaller] prices. It is a good hunting ground."

The potential reward, though, comes at a greater risk because the companies can be unknown quantities with short track records. Their fortunes might also be at the mercy of one or two customers. Colin Jackson, director of independent financial adviser (IFA) Baronworth, says: "If you are thinking of investing in equities, you should put only a small amount in AIM. The golden rule is to invest only what you can afford to lose."

You can buy AIM company shares directly through a stockbroker - with advice or on a cheaper execution-only basis - or reduce risk by investing in a managed fund such as the Isis AIM Growth unit trust or the Close Brothers AIM venture capital trust. Or, to spread your risk further, there are funds like Newton Growth that partly invest in AIM.

The disadvantage of a managed fund is that you don't qualify for the same tax breaks offered to people who invest directly in AIM - an incentive designed to help smaller firms that may otherwise struggle for funding. Thanks to tapering capital gains tax relief, higher-rate earners will pay only 10 per cent on profits from their AIM shares, as long as they hold them for at least two years. There is no inheritance tax liability if shares are owned for this period.

Ben Yearsley, investment manager at IFA Hargreaves Lansdown, says: "It's a useful tool in tax planning, and there's no more expense than buying other shares. It's def- initely a higher form of risk, but firms without debt and paying a dividend will add a bit of spice to a portfolio."

AIM companies range in size from multi-million-pound food suppliers to outfits with barely 12 months' working capital, so there are plenty of opportunities to pick up on developments unnoticed by big City investment firms - as long as you do your homework.

Mr Pratt at Newton says: "AIM firms will be under-researched and so, for investors, it's a case of writing off to companies and asking for reports.

"The companies tend to respond and look after their private investors well because they make up a larger part of their shareholder base."

Not every stockbroker will be able to buy and sell AIM stocks, so you may have to hunt one down; go to the Association of Private Client Investment Managers and Stockbrokers' website (www.apcims. co.uk) for help. But watch out for dealing costs. If you are confident enough to use an execution-only broker, an online account will help keep charges down, with each trade typically costing from £10 upwards. A phone-based broker service, with advice, will cost more.

Bear in mind that there may be difficulties when you try to sell your shares, since AIM's relatively small size means it can take longer to find a buyer.

While AIM offers the prospect of big returns, like other markets it has suffered from a lack of investor confidence over the past three years. At the end of July 2000, its index stood at 1,693.2; last Friday it was at 679.8 - some 60 per cent down. This is not far off the Nasdaq 100's 67 per cent slump during the same period and compares unfavourably with a FTSE All-Share (Equity Income and Equity & Bond Income) fall of 27 per cent.

But the idea is that when the economy picks up, smaller firms will be able to react faster to changing circumstances and their share price will recover quickly.

www.londonstockexchange.com/aim