I attended a conference recently and heard an analogy regarding the Ice Hockey player, Wayne Gretzky. Widely regarded as the greatest to have played the game. He was neither the strongest nor the fastest, both vital attributes in a physical sport, but he could read the game better than anyone. His famous quote, “I skate to where the puck is going, not where it has been,” is sage advice for investors as well, and after a long period of poor performance for small companies, is now the time to get ahead of the puck?

Formerly known as the Alternative Investment Market, AIM was created by the LSE to help smaller companies raise capital for growth. Most (but not all) qualify for Business Relief after being held for 2 years, meaning that shares held for that period are exempt from Inheritance tax. The benefits to an investor are twofold; the reduction of 40% IHT from one’s estate, and the chance to participate in the upside of smaller companies with high growth potential.

The nature of these companies mean that this is an inherently riskier environment in which to invest and is not suitable for everyone, but the long-term capital appreciation can be significant. These risks can be mitigated by stock selection and a thorough due diligence process. For example, the Investec AIM IHT planner will only invest in companies with a strong balance sheet, experienced management, and 5 years of trading history.

There is no denying that smaller companies are currently out of favour. Whilst all equity markets were affected by the rapid interest rate hiking cycle of recent years, to combat inflation, small caps have been hit particularly hard. They tend to have much higher proportion of costs in labour, relative to other expenses, so wage inflation has a greater impact on profitability, and they also have to pay more for their debt, due to their risk. Consequently, higher rates are particularly difficult for them.

Often the greatest opportunity comes when pessimism is highest, and missing the best performing days, which often come in the midst of bear markets, can have a significant impact on long term performance. Using the US small cap index, the Russell 2500; $10,000 invested in 1990 grew to $343,119 by 2023, however without the 10 best performing days, it would have only reached $158,544¹.

The market is expecting rate cuts this year which could potentially be the catalyst for optimism returning to the small cap market. Even if the expectations are overly optimistic, it is an opportune time for a new investor, who has not had to suffer the drawdowns of recent years, to enter the market to try and catch those best performing days.

The higher risk nature of investing in smaller companies, which offers higher potential returns, combined with the extreme pessimism over small caps in recent years, could well mean that AIM will outperform the broader market in the medium term - and for anyone investing for IHT purposes they are potentially already 40% better off.

¹ T Rowe Price US Smaller companies fund - March 2024 update

The value of investments can go down as well as up and you may not get back the full amount invested. Your capital is at risk.

The AIM portfolio is a higher risk, long-term investment; we recommend that you seek advice prior to investing. The tax relief available on AIM company shares is subject to certain criteria which may be subject to change in the future.

To contact or read more about Jack Roper, visit his biography here.

Important information

It is advisable to seek independent financial advice from a tax specialist before making financial decisions. Tax treatment depends on the individual circumstances of each client and may be subject to change in future. All statements concerning tax treatment are based upon our understanding of current tax law and HMRC practice and can be subject to change.

The information contained in this article does not constitute a personal recommendation and the investment or investment services referred to may not be suitable for all investors. Any opinion or estimate expressed in this publication is Investec Wealth & Investment (UK)’s current opinion as of the date of this article and is subject to change without notice. The value of investments and any income from them is not guaranteed and may go down as well as up; you may get back less than the amount invested. Past performance is not an indication of future performance.