FE Trustnet reported last week that the AIM market had surged strongly since stocks from the index were made eligible for ISAs last August.
Montanaro, who has been a small cap specialist for decades, says that he has sold out of AIM stocks and fears for investors caught up in the “lobster pot” when this current bullish market reverses.
“People have forgotten bear markets come along,” he said.
“After two years of strong returns, people are becoming complacent.”
“You cannot just buy AIM shares because they have a yield of 8 per cent. You have to go for quality.”
“We don’t invest in AIM,” he added.
“I’m a strong believer AIM is not an institutional market. It’s great on the way up, but you try and get out on the way down.”
“The successes will not compensate you for the harm the disasters will bring you.”
Performance of indices since 5 Aug
Source: FE Analytics
The AIM market has returned 22.57 per cent since the ISA rules were relaxed in August, according to FE Analytics data, well ahead even of the 13.61 per cent made by the FTSE Small Cap index.
Managers tell FE Trustnet that the relaxation of ISA regulations is a key factor, and the market is also benefiting from an increased appetite for risk and a late-cycle push from large caps into small caps.
Figures provided by the London Stock Exchange suggest there has been a huge boost to the AIM market following the rule changes.
Average trading volumes more than doubled between July and August last year, and for the whole year 2013 were up 40 per cent on 2012 thanks to this boost.
Source: FE Analytics
The new regulations mean that investors can invest in AIM shares without paying capital gains or income tax, bringing them into line with those listed on the main market.
The tax situation is about to get even more favourable, with stamp duty to be abolished on AIM shares on 28 April.
Stamp duty is payable at 0.5 per cent when buying £1,000 or more of shares.
Stocks on AIM also qualify for inheritance tax-relief if they are not property or financial companies, which makes investing your ISA in AIM shares extremely appealing from a tax point of view.
However, Montanaro says investors should not invest for tax reasons.
“Politically driven investments are a disaster,” he said.
“If you are investing for tax reasons or political reasons, it is not an investment.”
He says that he personally lost a significant sum investing in the old Business Expansion Scheme which ran from 1983 to 1994 and was replaced by the Enterprise Investment Scheme.
The scheme offered tax breaks for investing in start-ups and early stage companies, working in a similar way to the current EIS and VCT schemes.
It isn’t just retail investors who are buying AIM, however. Many of the top-performing smaller companies funds have benefited from betting heavily on the sector.
For example, R&M Smaller Companies, the top-performing portfolio in the IMA UK Smaller Companies sector in 2013, has 31.9 per cent invested in AIM stocks.
Quindell Portfolio, the second-largest stock on AIM, is among the fund’s top-10 holdings.
CF Miton Smaller Companies, the third-best performer last year, has a whopping 80.5 per cent in AIM; however, its co-manager Gervais Wiliams is a recognised AIM specialist.
Multi-cap income funds have also been boosted by a weighting to AIM in recent months.
PFS Chelverton UK Equity Income, which invests heavily in AIM, was a top decile performer in 2012 and 2013.
Performance of funds vs indices in 2013
Source: FE Analytics
CF Miton Multi Cap Income, another top decile performer and another recent launch from Miton, has 33.2 per cent in AIM.
FE Alpha Manager Giles Hargreave’s Marlborough Micro Cap Growth and Marlborough Nano Cap Growth funds are heavily invested in AIM, while his Marlborough Multi Cap Income fund, run on a day-to-day basis by Siddarth Chand Lall, also holds some AIM stocks.
Montanaro says that his small cap Montanaro Equity Income fund, which is being made available to retail investors, will not invest in AIM.
However, he adds that the number of stocks available on the small cap indices with a decent yield makes it highly desirable to diversify into this area.
He notes that in 2013, 50 per cent of the dividends on the UK market were paid by 10 companies alone, and the current move to diversify into multi cap and small cap income funds makes sense for investors concerned about protecting their income.
