Imagine if a year ago you had invested in one of the many indices which track the share price performance of different-sized companies listed on the London market. Which one would you have chosen? Would it have been the blue chip FTSE 100? Maybe the mid cap FTSE 250? What about the All-Share? Perhaps the Small Cap? Would you have considered the AIM index? And which do you reckon has risen the most over the past year?
It might surprise you that in fact the AIM index, representing all the stocks on the junior arm of the Stock Exchange, has easily outperformed the rest, posting an impressive 85% rise since the middle of last November. During the same period, the FTSE 100 has only gone up about 20%. Meanwhile the mid cap 250 has moved ahead 26% and the Small Cap has improved 28%. Invest in an All-Share tracker and you would only be sitting on a 21% gain.
By comparison AIM's 85% jump is quite staggering. You might be wondering how this has happened, and how you can invest in these stocks growing at such a fantastic rate. Well, first of all I have to shatter your illusions and tell you that, as with most small cap indices, no investment manager currently runs an index fund which tracks the performance of the Alternative Investment Market (AIM's official title). This would be far too complicated to achieve. Why? Well, size matters in index tracking.
Size Matters
Some of the more than 300 companies listed on AIM are incredibly tiny, worth less than £1m. A company of this size accounts for an infinitesimal proportion, just one ten thousandth, of the whole index. The junior market as a whole is worth only £8.56 billion. That is roughly the same size, by market value, as the 36th largest company in the FTSE 100, financial services group Legal & General (LSE: LGEN).
To try and gain exposure to all these companies would prove a nigh impossible and fruitless task. It would also be incredibly expensive. Some of the smaller stocks are rarely traded, or to use Wise terminology "illiquid". Most also command an incredibly wide spread between the price you can buy them at from brokers and the price you can sell them at, back to the same brokers, later on. Only 65 companies traded on AIM are worth more than £30m. The Fool reckons this is the minimum size a company should be for you to consider investing in it to avoid the problems just mentioned. Such stocks will be easier to buy at reasonable prices.
160 AIM stocks have a market cap above £10m. That means over half of the 333 companies currently on AIM are valued at less than £10m. Some of these tiddlers are worth under £1m, several at just a few hundred thousand pounds. Do not touch these at all. Ignore the promises that many brokers wishing to sell such stocks tell you about the "big deals just around the corner". This line has probably been spun many times before just so that these brokers can offload this unwanted stock onto mugs who, unFoolishly, have not done their research properly.
Be particularly wary of those companies with share prices of less than 50p. Even if the brokers selling such stocks charge a reasonably small commission, you will lose out heavily when you deal in such shares, because the spread between the buying and selling price will be gargantuan. Take a stock like small cleaning outfit Sira Business Services(LSE: SIB). This is currently quoted at 10p. But remember this is the mid-price set at a point in between the prices brokers are prepared to buy and sell the shares at.
For instance if you wanted to buy shares in Sira today you would in fact have to pay 11p, which is 10% higher than the mid-price. That is a massive mark-up. Similarly if you already held these shares you will only be able to sell them at 9p, 10% lower than the mid-price. Again, brokers stand to make quite a packet on this transaction. So always think of the share price in terms of the spread between the sell and buy prices quoted. In Wise speak this is known as the bid and offer spread. In the case of Sira it is 9p to 11p.
Compare this with more easily traded shares such as oil group BP Amoco(LSE: BPA) in the FTSE 100. Mid-prices here are often calculated in halfpennies. At the time of writing BP's mid price is 635.5p. This is because brokers will sell you the stock at 636p and buy it from you at 635p. There is only a halfpenny spread on either side of the mid price. This equates to just 0.07% on each side. Thus the spread is less than a hundredth that of some illiquid AIM shares, like Sira.
That's the health warning finished about avoiding the disasters, which could damage your wealth. But it's an important and Foolish message to remember. With that in mind, now we can go forward and explore why AIM has exploded over the past year.
Aiming Sky High - Part One Aiming Sky High - Part Two
