The aftermath of Brexit, the Liz Truss government and Mini Budget, record-high inflation and rising interest rates left the UK Alternative Investment Market “particularly vulnerable to an increase in interest rates” due to its concentration of richly-valued growth stocks, he noted.
Recent research by UHY Hacker Young mirrored Alster’s analysis, which it found a record low in IPOs on the AIM, with just nine companies floating in the 12 months to March 2023 – an 88% drop from the 74 listings of the previous year.
New listings on AIM reach record low in the last twelve months
Alster said the lack of new issues has been disappointing, especially considering the market has been able to provide funding to smaller companies, which he deemed to be the “engine room of the UK economy”.
He explained: “For all of AIM’s advantages, it has struggled to generate positive returns for investors over recent years. Much as equities – particularly smaller companies – have the ability to grow their earnings to offset inflationary impacts, the scale of policy action has seen investors adopt a ‘risk off’ attitude to markets.”
James Penny, CIO at TAM Asset Management, agreed, noting UK AIM “remains fraught with risks”.
Some of those are specific to the nature of the market itself, but others were related to the economic situation the UK finds itself in, he noted.
“This is largely down to Brexit, which has created structural barriers to the UK’s growth prospects, as well as the ever-increasing dichotomy of UK inflation versus that of other G7 nations,” Penny said. “Of course, these two are very closely linked to one another.”
Beyond the current economic challenges, both CIOs highlighted the discounts smaller companies are trading at, with Alster saying they remain “attractive” and “compelling”.
IPOs in London drop 90% in 2022
When gaining exposure to AIM-listed companies, Adam Carruthers, collectives analyst at Charles Stanley, recommended portfolios which have significant exposure to the AIM market from a bottom-up perspective, such as the BlackRock UK Smaller Companies, which is available as both a trust and an open-ended fund.
“[The fund] buys approximately the bottom 10% of the UK equity market, including AIM (about 40% currently). The approach is very bottom-up and the team are pragmatic growth investors, seeking to buy companies that are undervalued relative to their growth and/or recovery potential,” he said.
“At today’s 13% discount to net asset value, [the BlackRock trust] is certainly an attractive entry point for those of a long-term persuasion.”
On the stocks’ discount, Penny added: “Some might say the price reflects the dire situation the UK is in, and other – more contrarian investors – see the UK as a small but potent small and mid-cap market with some high-quality companies just waiting for the UK, and global, economic situation to stabilise and realise its potential – and thus begin unlocking the interest of the international investment market.
“In our portfolio, we see the UK smaller companies market as a long-term cyclical opportunity that should pay dividends as capital floods back into the country and, as the market begins to price in another full recovery cycle, investors move to take on more risk in their portfolios.”
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Alster echoed Penny’s sentiment, saying the underlying picture for AIM-listed companies is “decidedly more upbeat” as companies’ earnings, balance sheets and supply chains are recovering and normalising post-Covid.
“As confidence recovers, the combination of outstanding companies, compelling valuations and supportive tax incentives should deliver strong returns over time for those willing to dig a little deeper,” he added.
Buy healthcare, avoid banks
Indriatti van Hien, deputy fund manager of the Henderson Smaller Companies trust, argued one of the more favourable sectors within AIM-listed companies was healthcare.
She said the sector can benefit from a “variety of structural growth trends”, while also proving resilient through a market downturn.
She highlighted Advanced Medical Solutions and Benchmark Holdings as case studies on this and the HSCI trust also recently took a position in pharmaceutical services provider Ergomed after its shares “suffered from a sharp de-rating last year”, due to market concerns over tighter funding for biotech companies and a “dramatic” increase in interest rates.
The long-term growth trends for the life science sector should persist, van Hien said, adding she has used the “weakness” in shares to initiate a variety of positions.
But the sector, and the discounts available, needed to be treated with some discretion she said.
The manager said she avoided AIM-listed miners due to “weaker standards of corporate governance”, lack of pricing power and health and safety controls which, coupled with a relative lack of liquidity, precluded “the ability for these stocks to be tactically traded”.
