Investing in small cap stocks and the AIM market

Small cap stocks, such as those listed on the AIM market, can offer potentially high returns as part of an investment portfolio. However, with potential high reward comes increased risk so it’s important to understand what’s involved.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results

There comes a point in every investor’s life when you feel ready to start exploring opportunities away from the mainstream. Maybe you are tired of the current low-rate environment, or maybe you just want to diversify away from portfolio stalwarts such as blue-chip stocks and corporate bonds.

Whatever the case, it’s worth looking at small cap stocks and the Alternative Investment Market (AIM). Smaller companies have potentially big growth prospects, and therefore can potentially deliver high returns. They are also more likely to raise money by selling stocks, as opposed to larger corporates, which tend to fundraise by issuing bonds. Furthermore, by investing in a small start up you can be a part of an exciting growth story which could pay dividends in the not-so-distant future. Major UK brands such as Domino’s Pizza, food wholesaler Booker Group, and self-storage company Big Yellow all started out on AIM before graduating to the main market of the London Stock Exchange and being included in the FTSE 250 index.

However, before you take the plunge and start investing in small cap stocks and the AIM, there are a few things you should bear in mind.

  1. Risk

Investing in small cap stocks can be a high-risk, high-reward environment, no matter how careful you are with your allocations. For every small cap success story, there are dozens of failures, and when small companies fail, their investors can lose everything.

Cover your risk by spreading your investments across a range of different stocks, rather than choosing just one or two. An AIM-focused exchange traded fund (ETF) will track the whole market’s performance at once, so you can benefit from the overall growth of these smaller companies, and minimise any losses. For instance, between 28 September 2012 and 28 September 2017, the top 100 companies in the AIM index returned more than 29% overall, despite some periods of extreme volatility and a number of high-profile company collapses.

  1. Check ISA eligibility

When the AIM market does well, it does very well. Fulcrum Utility Services has seen its share price double over the past two years2 while online retailer ASOS has been hailed the 'king of the AIM market' thanks to its meteoric rise, earning double digit returns for its investors on a regular basis.

By investing through a Stocks and Shares ISA you can keep any returns that you make, without having to worry about capital gains tax. However, don’t assume that all your stocks and shares investments are ISA eligible. While most small caps and AIM ETFs are ISA-complaint, it is always worth checking (and double-checking) before you invest.   

  1. Set a maximum on your small cap investments

Alternative investments should always form a small part of your portfolio, never the whole amount. These are unpredictable investments which can either net big returns, or cost you your capital.

Decide from the outset how much you want to invest, either as a percentage of your overall portfolio or as a fixed amount. Stick with these limits, at least until you are ready to spend some time doing a full revaluation of your investments.

  1. Choose a range of stocks and sectors

It is never a good idea to pin all your hopes on one or two stocks, or even one sector. Many investors were burned by the oil price rout of 2016, which had a devastating effect on small oil exploration companies and the AIM’s oil and gas sector. Likewise, the falling price of iron ore forced the £2 billion AIM firm African Minerals into insolvency4 in 2015.

By choosing a range of different stocks and sectors you can shield your investment from this sort of sector-specific volatility

  1. Be sensible

It’s always tempting to take on more risks with small cap and AIM investments, especially if you’ve had a run of good returns. However, no investor can afford to be complacent when it comes to the small cap market.

Spend some time educating yourself about the risks and opportunities in the UK’s small cap stocks and the AIM market. Maintain a variety of different stocks and shares in your portfolio at all times, and consider investing through an AIM or small caps-focused ETF, which will keep your trading costs down and offer instant portfolio diversification.

And finally, remember that stock performance changes over time, and so does your risk profile. What works for you today might not work in a year, so it’s important to keep constantly reviewing your portfolio over time so that you can adapt to any changes in the market in a timely manner.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.