Small caps look to build on solid year

AIM’s 1,063 members have a total market cap of around £73 billion compared to the 982 firms which make up the £2.1 trillion Main Market. That’s a 3.3% weighting toward AIM, a figure which can act as a benchmark for assessing whether a multi-cap fund is suitable for an investor’s risk appetite or not. Anything above that, the investor will need a higher tolerance for risk (and a willingness and ability to suffer portfolio losses). If that is the case they could even look to dedicated small-cap funds. Again, the weighting of small caps in the equity portion of a portfolio can be measured against that 3.3% benchmark to gauge whether an investor is within their comfort zone or not.

There are plenty of actively-managed funds from which to choose. According to Morningstar there are over 40 actively managed OEICs which target small-caps (although some reach as far as the FTSE 250) and 18 investment trusts which operate in the same space.

Best performing UK small cap OEICs over the last five years

Source: Morningstar, for UK Small Cap Equity category.

Where more than one class of fund features only the best performer is listed.

NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

Best performing UK small cap investment companies over the last five years

Source: Morningstar, for UK Smaller Companies category.

Where more than one class of fund features only the best performer is listed.

NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

However, fans of passive funds are less well served. There are far fewer choices and ongoing charge figures are less competitive, perhaps owing to issues which reflect the asset class' underlying liquidity. Morningstar lists one small-cap ETF,  iShares MSCI UK Small Cap, which comes with the ticker of CUKS.

Roller-coaster ride

The AIM 100 index may have its detractors, but the junior index can point to a 9.9% gain so far in 2015, enough to leave the FTSE Small Cap and the FTSE 250 in its wake, let alone the FTSE 100, which is still down for the year.

AIM has outperformed in 2015

Source: Thomson Reuters Datastream

NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

Despite this solid performance, AIM has offered relatively few fireworks in its twentieth year, unless you include the corporate governance fiasco that was financial services software provider Quindell, whose share price shot up and then fizzled out amid questions over its accounting practices, management’s share dealings and a string of acquisitions. The forty-six firms who had joined AIM by the end of September compares to the 118 who did so in 2014 and the platform is on track to welcome its second-lowest number of new entrants ever, beating only 2009’s 36.

AIM has welcomed relatively few new entrants in 2015

Source: London Stock Exchange

This relative paucity of new opportunities could work in investors’ favour. It suggests fund managers are being picky about IPOs and only letting the cream join the ranks of public companies. Some degree of risk aversion may also mean the market suits buyers rather than sellers, so any new deals may be priced more attractively.

In addition, AIM-based corporate governance accidents such as Quindell and Naibu of this world should not obscure what the London Stock Exchange’s junior platform has to offer. According to consensus analyst forecasts, 71 of the AIM 100’s index’s members are expected by the analyst consensus to be profitable in 2016 and 55 are forecast to pay a dividend, even if the overall yield of 1.4% is on the skinny side. 

Doubters will nevertheless counter that the AIM 100’s aggregate profit profile is too volatile for comfort. The huge rebound forecast for 2016 looks interesting but is very dependent on Quindell getting its act together, a handful of tech and telecoms stocks breaking into the black and the 10  member oil stocks substantially reducing their losses. Moreover, £34.8 billion of market cap for £780 million in net profit in 2015 and £1.3 billion in 2016 (according to aggregated consensus analysts’ forecasts) put the AIM 100 on more than 26 times earnings for next year, a rating which means at least a chunk of the constituents’ growth potential is already baked into the cake.

AIM 100 index is expected to report a huge increase in profits in 2016

Source: Digital Look, analyst consensus

NOTE: Past performance is not a guide to future performance and some investments need to be held for the long term.

That high-octane combination may suit some investors and not others, again making the case for using that 3.3% weighting as a handy benchmark for AIM (or small-cap) exposure within an equity portfolio. Risk-tolerant portfolio builders may be happy to go above that, risk-averse ones may prefer to sit below it, or even have no exposure at all, depending on their overall strategy, target returns and time horizon.

Russ Mould

AJ Bell Investment Director