Building a defensive portfolio of Aim shares

It is seen by most investors as comprised of small growth companies often speculative, frequently volatile and occasionally dodgy. Although there is a great deal of truth to this view, it is far from the whole story.

Investors are increasingly using Aim as a way of accessing the inheritance tax (IHT) mitigation benefits of business property relief (BPR).

BPR allows an investor in certain Aim stocks to receive 100 per cent relief from IHT if they have held qualifying investments for at least two years at the time of death. Additionally, Aim stocks can now be held in an Isa, meaning investors can keep the tax benefits of an Isa during their lifetime while mitigating IHT on death.

Strong companies

An investor seeking this benefit is unlikely to be of an age and risk profile to invest in risky growth stocks. So can you build a defensive portfolio of Aim shares? Firstly Aim companies are not as small as you might imagine. The Aim comprises 1,091 companies and of these 309 have market capitalisations in excess of £50m and 19 are valued at more than £500m.

Secondly there are a number of strong Aim-listed companies that have long histories, established business models and strong management teams.

These are often companies with significant family shareholdings that have chosen to move from the main market to Aim in part to benefit from BPR.

So how does one choose a portfolio of defensive stocks? There are a number of key considerations which can be divided into a three-stage selection process. Firstly, look for quality companies. These are companies with strong margins, high returns and which can turn their profits into cash. Importantly these companies should have strong balance sheets with minimal net debt, or even better, net cash. Next, look at valuations to avoid overpaying, even for quality companies.

Inflation hedge

Finally, look for a company that will grow over time to protect against the effect of inflation.

Avoiding companies that might cost a chunk of your invested capital is just as important a part of the process. An advisable approach is to avoid speculative companies in the oil, mining and technology sectors that are both loss making and cash consuming. Investors also need to steer clear of highly acquisitive companies or those with aggressive new business models.

Finally, if investing for BPR purposes, the investor has to know the relevant tax rules as not all Aim stocks qualify for the relief.

An investor should build a portfolio of roughly 20 stocks across a range of industry sectors to limit any potential risk. In addition, if the investor is looking for BPR, if they unintentionally invest in a stock that does not qualify for IHT relief, the impact will be limited to that holding.

Investing in smaller companies may be risky, but with some care you can build a portfolio of defensive Aim stocks – though careful and constant monitoring of each position will be required.

Justin Waine is investment director at Puma Investments

KEY DETAILS

HMRC guidance says that business relief is available at either 100 per cent or 50 per cent in certain circumstances on some of an estate’s business assets, which can be passed on either while the owner is still alive or as part of the will.

You can get 100 per cent business relief on:

• A business or interest in a business.

• Shares in an unlisted company.

You can get 50 per cent business relief on:

• Shares controlling more than 50 per cent of the voting rights in a listed company.

• Land, buildings or machinery owned by the deceased and used in a business they were a partner in or controlled.

• Land, buildings or machinery used in the business and held in a trust that it has the right to benefit from.

However, the guidance states: “You can only get relief if the deceased owned the business or asset for at least two years before they died.”