The AIM market is home to a hugely diverse range of companies that provide great potential for earnings growth. The benefits of investing in smaller companies are clear over the longer term, as they can offer significant growth for investors who take advantage of careful stock picking. The figures shown in the chart demonstrate the additional value created by active smaller company managers over the last 18 years. Over this period smaller companies have shone as a result of superior earnings and dividend growth.
The average IMA UK Smaller Companies fund has significantly outperformed both the FTSE All-Share and FTSE Small Cap indices. Performance of indices over 18 yrs
Source: FE Analytics
What are the specific tax benefits that stem from investing in AIM stocks?
There are a number of government initiatives which enable investors in AIM-quoted shares to access tax benefits. These tax incentives are made available to encourage investment in small growth companies, which in turn generate jobs and economic growth. This will subsequently translate into greater revenues for the Treasury, creating a virtuous circle.
Venture Capital Trusts (VCTs)
Investors can invest in some companies on AIM through a VCT. VCTs are investment trusts that offer 30 per cent income tax relief, tax-free dividends and growth provided the shares are held for the minimum five year holding period.
To benefit from these tax advantages, VCTs must invest 70 per cent of their funds in companies with gross assets of less than £15m and fewer than 250 employees.
Enterprise Investment Schemes (EIS)
As with VCTs, investors can access some AIM companies through an EIS. EIS investments offer investors 30 per cent income tax relief and tax-free growth. In addition, EIS investments provide 100 per cent inheritance tax relief (provided the funds remain invested at the time of death) and can be used to defer paying tax on a capital gain that investors may have made outside the EIS. Investors must hold EIS investments for a minimum of three years to qualify for the tax reliefs.
Business Property Relief (BPR)
BPR was extended to AIM companies in 1996. Investors in certain AIM-quoted companies will receive BPR on their shares, which means they will fall outside their estate for inheritance tax purposes. The BPR-qualifying investment must have been held for at least two years at the time of death to qualify. A number of investment managers offer discretionary AIM portfolios of established and profitable growth companies for IHT planning purposes. Not all companies qualify for BPR, so it’s important to know how to select the ones that do.
ISAs
ISA benefits include tax-free dividends and growth. On 5 August 2013, the government introduced new ISA rules to enable shares in AIM-quoted companies to be directly held within an ISA wrapper. This legislation change enables investors who have built up a sizeable ISA portfolio to address IHT planning within their ISA wrapper, and to gain access to exciting growth companies.
Why should investors hold AIM stocks in their ISA?
Including AIM-quoted companies in your ISA will not be suitable for everyone. However, early reports indicate that many investors with a higher risk appetite have already taken advantage of the new rules.
There are more than 24 million ISA savers in the UK, and over 5.6 million of these are 65 or older. We believe elderly investors who are familiar with equity risk and have built up sizeable ISA portfolios over the years will be interested in the opportunity to take advantage of the BPR available on AIM-quoted shares to enable them to do some IHT planning with their ISA.
Earlier this month we launched our own AIM Inheritance Tax ISA in response to demand from advisers and investors for a solution that enabled them to maximise the tax benefits that can be accessed through certain AIM companies. Our ISA provides investors with access to some exciting growth companies, combined with inheritance tax relief for their accumulated ISA savings. Investing through an ISA wrapper is a highly tax-efficient way for investors to access the AIM market.
How risky are AIM stocks really?
AIM will always be subject to investor sentiment swings that affect all equity markets. It is, however, an extremely diverse market, home to a wide variety of companies. At one end of the spectrum it attracts many successful entrepreneurs and disruptive technologies – small growth companies that have the potential to grow into substantial businesses. On the other hand, there are many larger and more established companies quoted on AIM, and these tend to be the focus for our inheritance tax portfolios.
Investments in smaller companies are considered higher risk but they also offer investors great opportunities. What’s more it is an exciting time to be investing in UK smaller companies. Our recent meetings with management teams, particularly those with domestic based businesses, have reinforced the view that there is confidence that the recovery in the UK economy is sustainable. Order books are growing and the pricing pressures that have been present for a number of years have started to reverse, both of which ought to translate into upgrades to profit expectations as we near the end of the year. Through active management and careful stock selection, AIM companies can offer the investor the potential for significant earnings growth.
If you are investing in a smaller company directly, you can complete valuable research by just being aware of your surroundings. Which AIM-quoted companies are people talking about? Which new brands are emerging? Whose shops or bars are full? Talk to customers and get a feel for the underlying success of a small domestic business before it is reflected in the financial performance of the company. The online retailer ASOS is a good example. Most teenage online shoppers knew ASOS would be a success long before City fund managers did.
Richard Power is head of the smaller companies team at Octopus. The team manages over £350m of funds invested in UK smaller companies quoted on the Alternative Investment Market, on behalf of investors in Octopus’ AIM VCTs, AIM inheritance tax portfolios, the Eureka EIS and the CFIC Octopus UK Micro Cap Growth Fund.
