A YEAR after shares in fledgling firms became eligible for Isas there are concerns that the opportunity to shelter more cash from the taxman is blinding ordinary investors to the risk of heavy losses.
Shares in companies listed on the Alternative Investment Market (Aim) became eligible for inclusion in tax-efficient Isas under changes that took effect last August.
Aim is London’s junior stock market and contains the smallest and therefore many of the more high-risk listed companies.
There were 1,104 firms listed on Aim as of June, up from 1,087 prior to their inclusion in Isas. Among the Aim-listed stocks are 27 Scottish companies including Celtic FC, Bowleven, Cupid, Rangers FC, Scotgold Resources and IndigoVision.
The Isa move boosted the tax appeal of Aim shares, which already provided shelter against inheritance tax (IHT) – as they attract business property relief, which exempts Aim shares from IHT when they’re held for two years or more – and capital gains tax.
Earlier this year they became exempt from the 0.5 per cent stamp duty on share purchases, before last month’s increase in the annual tax-free Isa allowance to £15,000 sent the amount of money invested in Aim shares by private investors to a new high.
Most brokers and fund platforms have reported a surge of interest in Aim shares over the past year. One platform, Interactive Investor, has seen Aim trading increase by 43 per cent since last August.
The enhanced tax advantages have proved a powerful lure, said Gregor Munro, financial planner at Johnston Carmichael Wealth.
“Because Isa investments are potentially subject to IHT, investors can switch some of their existing portfolios into Aim-qualifying investments, saving them 40 per cent tax if held for at least two years. It also means that the investor retains control of the asset whilst still providing IHT relief.”
But while many investors have been swayed by the tax benefits, there are fears that some have piled into Aim shares unaware of the danger of losses.
While the small companies on Aim can offer potential for rapid growth, their size and the lack of research carried out on them makes them a high-risk investment.
That means Aim shares are best suited to experienced investors who are aware of the risks and able to absorb potentially significant losses.
“While investing in smaller companies can generate a tax break, people need to be cautious and in most cases it would only be advisable for a small proportion of their overall portfolio,” said Munro.
“This market may have matured greatly in recent years but Aim still has to be considered high risk.”
Performance over the past year has been mixed, with Aim markets producing strong returns before hitting turbulence in the quarter ending in June.
The FTSE Aim All Share is up 7 per cent over the past year but fell 7.5 per cent over that quarter. The Aim UK 50 and the Aim UK 100 were down by 15.5 and 11.4 per cent respectively in the three months to the end of June, according to accountants and business advisers BDO. By contrast, the main FTSE index is up 13 per cent since last August.
“Historically Aim has disappointed many investors and it has been far more volatile. During the past five years of market recovery, the FTSE has certainly been a much safer option for investors,” said Munro.
Investors diving into Aim were told by a leading fund manager earlier this year that they were at risk of enormous losses when markets turn negative. Charles Montanaro, who runs the Montanaro European Smaller Companies fund, said he no longer invested in Aim and claimed that two years of bullish markets had made investors complacent.
But their considerable tax efficiency means there is a place for Aim stocks in the Isa portfolios of investors who know what they’re getting into.
“It would be advisable to work with a professional investment management firm and a financial adviser to choose a well-managed portfolio in this market, rather than try to pick a small number of qualifying investments yourself, as you need to be sure that they maintain their Aim status going forward,” said Munro.
Investors can get exposure to Aim through the growing number of funds with holdings in the market, including the Cavendish Aim, the Marlborough UK Micro-Cap Growth and the CF Miton UK Smaller Companies. But while these can typically be held in Isas, they don’t offer the IHT-exemption that comes with holding Aim shares directly.