A challenging year for a market dominated by growth stocks
The Alternative Investment Market, along with broader global indices, has experienced a turbulent final quarter of 2018, posting its weakest quarter in a decade, and the sixth largest quarterly drop on record.
This last decade has seen the AIM transform its size, liquidity and growth profile, as it became the home of some unique assets, many of which, after a number of years of strong performance, have come under significant pressure in recent months.
This index has come a long way
Since launching, the FTSE AIM All Share Index has changed dramatically. It launched on 19 June 1995 with 10 companies valued at a combined £82m. By the end of November 2018, there were 926 businesses listed on the AIM with a combined market capitalisation in excess of £98bn. Compared to the FTSE main market, the AIM does not offer a great deal of dividend income, yet 2018 marked a landmark year in which despite the fall in capital values, the total income generated passed £1bn. This is almost three times the amount distributed in 2012.
At the end of 2009, the index was dominated by the Basic Materials, Oil & Gas and Financials sectors, a theme that had persisted for several years. In aggregate these sectors, which traditionally contain value-oriented equities, represented 59.3% of the entire index. By the end of 2018, however, this number had almost halved to 33.6% as a raft of new entrants performed well, namely Technology, Consumer Goods and Healthcare stocks. The market has become a home for today’s growth businesses with many of the constituent companies expected to grow their revenues and earnings at a fast pace, reflected in higher valuation multiples. ASOS, Fever Tree and Keywords Studios, for example, are amongst the largest members of the index.
This evolution also resulted in a change in the sectoral composition. As the more highly rated growth stocks led the way, coupled with a recovery in equity markets, the price to earnings ratio of the index increased from 12.7x to 22.2x, reflecting a greater growth bias. Many of the companies that caused this shift performed so well that they reached previously unseen market capitalisations, with a handful breaking through the £1bn mark.
Traditional value sectors are unavailable to Inheritance Tax (IHT) investors
Business relief criteria mean that certain sectors are uninvestable to the IHT investor. Business relief is assessed on a stock-by-stock basis, but restrictions on the corporate structure and non-qualifying assets on their balance sheets mean that the Financials, Oil & Gas, and Basic Materials sectors are mostly out of scope. As the high growth companies’ shares have fallen back recently, these more traditional sectors have held up rather better.
Growth companies are leading the decline
The turn of the fourth quarter of 2018 brought US-China trade wars, a 10-year US treasury yield rising over 3.0% in the face of global growth concerns, and weakening Brexit sentiment. Unsurprisingly this confluence of risks had a negative impact on riskier assets, and in particular growth stocks. This has been a feature of global markets, as reflected in the US with a significant performance differential between the NASDAQ, which is dominated by growth companies, and the S&P 500, which is more broadly diversified.
The same trend has been observed in the AIM market. The 10 largest AIM companies at the end of Q3 2018 accounted for over a quarter of the index, and on average had delivered share price growth of 698.6% over the previous 3 years. In the final quarter of the year, the same companies declined in value by 32.9% on average. This decline is almost twice as severe as the remainder of the index. Furthermore, these 10 companies represented 47.1% of the shares traded in the entire index during the course of the quarter.
Sarasin & Partners’ investment process
Sarasin & Partners has a disciplined investment process for AIM portfolios. Initially, uninvestable sectors and smaller illiquid companies, generally those with a market capitalisation of under £100m, are screened out. Then companies are assessed to identify long-term structural growth opportunities, competitive advantage, stronger balance sheets, experienced and typically entrepreneurial management teams. Attractive current or future free cash flow characteristics and progressive dividend prospects are a priority where available. Lastly, the portfolio is constructed by applying a valuation overlay to ensure we only hold the companies that are appropriately priced for the growth on offer.
The larger growth names that are meaningfully represented in AIM portfolios have endured a difficult year, contributing to a 25.5% decline in portfolio values. Despite this fall, however, AIM portfolios have generated longer-term returns in excess of the comparator indices, namely the FTSE AIM All Share Index. The 3 and 5 year net returns for the AIM portfolios are 7.4% and 38.0% respectively, compared to the FTSE AIM All Share Index returns of 21.2% and 7.9%. The AIM has become the home of the UK growth company since its inception, and despite recent share price volatility there are many stocks trading well, able to grow profits at an attractive rate, and whose progress we hope to participate in.
Please note: past performance is no guide to future performance and there is no guarantee that your AIM portfolio’s objective will be achieved.