Investment Comment: Taking Aim with your Isa investments

AT THE beginning of this week, the government removed an unpopular restriction on Individual Savings Accounts (Isas). Now, for the first time, investors with the confidence to select individual shares for their stocks and shares Isa are able to invest in companies listed on the junior Alternative Investment Market (Aim).

Preventing investors from putting Aim shares in an ISA was always an anomaly, because there was no such restriction on holding them in a Self-Invested Personal Pension (Sipp). An investor could get the same tax advantages by simply putting the same shares in their pension.

Aim has always been popular with do-it-yourself stocks and shares investors. It provides an opportunity to get in on the ground floor, catching young dynamic growth stocks at an early stage in their development. The potential rewards are high, but that can mean higher risks too.

Those risks were the main reason the government held back from supporting Aim with the Isa tax break. Since the financial crisis, however, the government has been keen to ensure that small and medium-sized companies have sufficient access to funding. It sees Aim investors as a potential source of working capital.

So now we are able to invest in companies like Majestic Wine, Asos, Gulf Keystone Petroleum and many other less well-known Aim stocks in our Isas. Can is not the same as should, though. So what are the pros and cons of the new rules?

First, the latest move actually makes Aim shares one of the most tax-advantaged of all investments. In most cases, they are already exempt from inheritance tax. From next year, they will also be exempted from stamp duty. And the new rules now add income tax and capital gains tax exemptions to the list of benefits.

So there are good tax reasons to consider putting Aim shares in your Isa; but what might the downside be? The principal concern is that the listing requirements for Aim shares are more lenient than for companies on the main market. For example, Aim-listed companies don’t have to demonstrate such a long track record of audited results. That makes Aim an attractive market for young, unproven companies.

Aim has also tended to attract a fair proportion of small companies in the riskier technology or natural resources areas of the market.

Interestingly, the inability to hold single Aim stocks within an Isa has not stopped investors gaining an exposure to the alternative market in a tax-efficient way. That’s because smaller company funds holding Aim stocks have always been eligible to be held in an Isa. For many investors, perhaps most, this might still be the best way to gain access to Aim.

The need for careful stock selection is made clear by the performance of the Aim market, which has been quite volatile and over the long run (since 2000) disappointing. Since the market bottomed in March 2009, for example, Aim has outperformed the FTSE 100, but it has been a rollercoaster ride. In the early stages of the market rally, Aim outperformed by a wide margin but its exposure to underperforming natural resources stocks has, in the past couple of years, seen it fall short.

It was a similar story during the financial crisis. Aim outperformed in the good years leading up to the crisis, but 2008 was a shocker for Aim investors – and the market lost around two thirds that year.

It is good news that investors are being given the opportunity to invest in Aim stocks in a tax-efficient way. But if they choose to do so, they should make sure they have their eyes wide open.

Tom Stevenson is an investment director at Fidelity Worldwide Investment.