Are AIM Listed Companies Ripe With Opportunities?

Asset prices fully reflect all information. Right? At least this is what the well-established efficient-market hypothesis theory holds – the implication being that it is impossible to earn high returns consistently in financial markets.

However, small cap companies, particularly AIM listed companies, are typically under-researched, and as a result, suffer the greatest valuation inefficiencies. This has been exacerbated by the introduction of MiFID II this year, which now requires the cost of research to be unbundled from other services sold by brokers, further reducing access to quality investment research.

Institutional investment is nearly absent in small/micro-cap stocks, but this provides an exciting opportunity for the private investors following them. According to Gervais Williams, portfolio manager at Miton Group, there is a large inflow of institutional capital in AIM’s future.

He sees small companies are able to buck the economic trend and grow even when global world growth is stalling. They are often more streamlined, and have better balance sheets, providing stronger dividend growth as a result.

The companies listed on AIM also provide the opportunity for diversification across many different sectors, including mining, oil and gas, technology, biotech, pharmaceuticals, media, consumer goods and more.

One of the unique characteristics of AIM listed small caps, is that they can be selected to be geographically diversified – being an international growth market, they are not limited to business within the UK, with a large proportion of them have operations internationally. 

If smaller companies become the best performing area of the market going forward, institutions will spend the next decade injecting money, thereby pushing up prices and returns.

Additionally, recent weakness in the pound may prove to be a contributor to institutional demand heading in the direction of the AIM market. 

“There’s a lot of pent-up demand among central banks and sovereign wealth funds for the pound as it’s liquid, offers positive yields and has an attractive valuation,” said Mansoor Mohi-uddin, head of foreign-exchange strategy at NatWest. “The U.K. is one of the few major economies, including Canada and Switzerland, that welcome foreign investments on a big scale.”

Thanks to of central bank quantitative easing, large companies have been able to access credit very cheaply, and as a result have become heavily geared. Large amounts of corporate debt is a growing concern, and has increased the risk that large companies’ underlying business fundamentals will no longer be able to support the same growth in dividend payments. 

Furthermore, large companies are more correlated with global growth, and their dividends may be potentially vulnerable at the time of the next global recession. Alarmingly, dividend cover is already beginning to fall. 

Cheap debt, record levels of capital for private equity investors, the need for legacy businesses to adopt new technologies and improving economic conditions in Europe has driven high levels of M&A activity, to the benefit of small cap companies who are potential acquisition targets.

Blake Hiltabrand, head of merger arbitrage research and senior portfolio manager at UBS, notes, “There has been an increase in small- and mid-sized transactions, providing a universe of diverse opportunities to capitalize on deals across industry sectors and regions.”

“Historically, merger arbitrage was one of the most popular strategies of bank proprietary trading desks, dwarfing individual hedge funds in the space.” 

He added: “In 2011, the Volcker Rule banned proprietary trading, eliminating the largest buyer of merger deals from the market. Facing this wall of supply are fewer arbitrage dollars intermediating the market, which has resulted in more attractive pricing, wider deal spreads, and potentially higher returns for investors” 

Although small cap companies can often be somewhat illiquid, making it harder to exit investments at an attractive price, several companies have been able to achieve rapid growth via cash offers for significant acquisition premiums, allowing shareholders attractive exits. 

Rapid growth can take many different forms: striking high grade mineral intersections, drilling into exceptionally large oil reserves, patenting transformative pharmaceutical research or producing innovative technology, AIM listed companies provide highly attractive opportunities for private investors.

However, it is the focus on sustained organic growth and strong business fundamentals that provides the significantly larger upside growth potential that exists in small cap stocks. 

Institutions and private investors alike are following AIM listed companies very closely, and for good reason.