The Alternative Investment Market (AIM) has staged a spectacular comeback this year, bouncing 42 per cent since mid-March and leaving other UK indices in its wake.

Admittedly, the rebound followed one of the most difficult periods for the London Stock Exchange’s market for small and growing businesses. Once described as the “most successful growth market in the world”, AIM lost 70 per cent of its value in the previous two years.

The number of companies listing on AIM, the lifeblood of any fast-growing market, dried to a trickle. Only £4 billion was raised last year as the economy took a turn for the worse and investors shunned AIM’s high-risk shares. In 2007 £16 billion had been raised.

To make matters worse, several of the most high-profile AIM shares, including Hardy Amies, the Queen’s tailor, went bust, further damaging the market’s reputation.

This caused sleepless nights for thousands of investors who piled into AIM to take advantage of the tax breaks offered by the junior market. Most AIM shares become free of inheritance tax (IHT) if you hold them for two years, but this is of little use if heavy losses eclipse the tax benefits. Now the market’s recent jump has prompted some market-watchers to ask whether it is time to take a chance on AIM again.

Mike Lenhoff, market strategist at Brewin Dolphin, the stockbroker, says: “If you think, as we do, that the huge collective effort on the part of policymakers is likely to help to reflate the global economy, then an exposure to smaller companies is desirable. They tend to outperform during the earlier stages of an expansionary phase of the economic cycle.”

Small, growing businesses often beat their larger rivals in an expanding economy, because they can grow much faster than the heavyweights. Hopes of an end to the recession, which has encouraged investors to plough money back into the riskier, smaller end of the stock market, lies behind AIM’s recent success.

Since the start of the year AIM has risen by 33 per cent. In comparison, the FTSE small-cap index, the smallest 4 per cent of the all-share index, has climbed 19 per cent; the FTSE Mid 250 has risen 13 per cent; and the FTSE 100 index of Britain’s biggest stocks has fallen 5 per cent.

However, while there is still uncertainty about whether the economy is truly improving, many commentators remain cautious. Their fears seemed to be confirmed this week as shares fell across the globe after gloomy assessments of the world economy from the European Central Bank, the World Bank and the Organisation for Economic Co-operation and Development.

Even at the best of times shares on the junior market can be highly volatile, so it is no place for the risk-averse. With research and advice hard to come by, even experienced investors with good stock-picking skills can find it difficult to spot the winners and avoid the losers.

David Kuo, director of The Motley Fool, the financial website, says: “There are undoubtedly some attractive investment opportunities on AIM. However, the vast number of companies it now contains makes finding them extremely hard.”

If shares went into freefall again, AIM investors could find themselves trapped with no hope of exiting.

Paul Hutton, of Black Swan Capital Wealth Management, says: “One of the main issues for investors is the illiquid nature of many AIM-listed companies and funds. What may appear a good investment may not be worth the paper it’s written on if you can’t sell on the shares.”

Some market-watchers are expecting a shake-out of the market because businesses already listed on AIM are finding it difficult to raise funds. Two fifths of those with a capitalisation below £5 million are considering delisting, according to a survey by Smith & Williamson (S&W), the accountancy and investment group.

John Cowie, head of AIM at S&W, says: “Only the very best opportunities are attracting the attention of the AIM investment community, so equity fundraising is tough. With the banks’ reluctance to lend, acquisitive AIM companies no longer have access to the borrowing they need to make an acquisition economic.”

If some of the riskier companies that are likely to have the least access to finance opt for a delisting, that could make the market more attractive to new investors. However, for existing investors, delisting does have its downsides (see case study).

For some investors, the chance to make quick profits outweighs the risks. For others, the tax breaks are the main draw. AIM shares are classed as business assets, which is why many become free from IHT once you have held them for two years.

But if you are buying AIM shares for the tax breaks, take care, because some companies — such as property and finance companies — do not qualify. You also have to invest in the shares directly because the IHT perk is not normally available to funds.

However, if you do not want to choose the shares yourself, many fund managers and stockbrokers — including Octopus, Brewin Dolphin, Collins Stewart, Rensburg Sheppards and Smith & Williamson — will select a portfolio on your behalf If you are not interested in the tax breaks, the easiest way to invest is via a fund, where your money is pooled with that of other investors to buy a portfolio of stocks. The risk is then reduced because it is spread.

Mick Gilligan, of Killik & Co, the stockbroker, says: “Our preferred fund for investing in AIM would be Marlborough UK Micro Cap Growth. It has done incredibly well, beating the FTSE all-share since launch, which is remarkable given its focus on very small companies.”

The fund has returned 38 per cent since October 2004, compared with a decrease of 7 per cent in the FTSE all-share, according to Morningstar, the fund data company.

Still afloat after a decade of highs and lows

Steve Markus, a professional investor from Chesterfield, Derbyshire, has invested in AIM for more than a decade. During that time he has experienced the highs and lows of investing in smaller companies.

The 49-year-old, pictured with his Jack Russell, Sid, says: “The market is riskier, but when things go your way, you tend to see larger and quicker gains than you would on the main market.”

One of his recent successes has been Cape, the energy services group. He bought its shares for 22p in March and now they are worth more than 170p.

However, AIM can also have its downsides. “I bought shares in Touchstone Group, a software company, a year and a half ago for 135p,” he explains. “Now it is worth less than 15p.

“Touchstone says that it is considering delisting and, at the current low price, it looks like a great time for the company to buy out investors and go private. However, it could leave shareholders like me out of pocket.”

Despite the risks he remains enthusiastic about investing in the market, saying: “It has been tricky over the past couple of years, but even when the market as a whole was falling, you could still do well by picking the right shares.

“I always make sure that I have cash available in case I spot an attractive opportunity. Over the past few months there have been plenty to choose from.”

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