Adventurous Investor: Take Aim – but follow the old-fashioned rules

Acouple of weeks back, I received one of those annoying letters from my broker informing me of a corporate action at a company I’d invested in.

Global MENA, a middle-eastern investment fund quoted on the Alternative Investment Market (Aim), had decided it was fed up with pesky, critical western investors and was going to delist. As I tend to spend a lot of time investing in specialist closed-ended funds, I can’t say this was the first time this had happened to me. Too many listed funds on the London market have thrown in the towel in the past year or two – although most extended the courtesy of buying back some shares before scarpering to foreign climes.

After much under-the-breath cursing and rolling of the eyes, I decided to do what I normally do in these circumstances: rather than waiting for the horrible day when the shares vanish into oblivion, I vowed to sell up – but on a day of my own choosing.

In my experience, far too many investors who receive these letters immediately pick up the phone to their brokers. As a result, huge bid-offer spreads open up, destroying whatever profits you might have made.

Quite how any broker can justify a bid offer spread of 20 per cent or more prior to a delisting astonishes me, but the impression is left that the interests of private investors rank somewhere below those of the fund manager’s hairdresser.

That impression was re­inforced after a recent interview with an independent researcher, David O’Hara of Blackthorn Focus, who has been studying the effect of companies leaving Aim.

His conclusion is shocking: in 2009, about a quarter of all the companies on the market delisted in one way or another. A few of those delistings were benign affairs involving takeovers. However, the vast majority involved the destruction of 100 per cent of investors’ capital.

O’Hara makes two additional observations.

First, the way to avoid this catastrophic wealth destruction is to pick companies with a trading history and decent fundamentals. Further evidence for this comes from Elroy Dimson and Paul Marsh’s excellent RBS Hoare Govett Smaller Companies index review, analysing the performance of UK small caps back to 1955.

Last year demonstrated yet again that, in resurgent markets, small caps are the place to be. But attractively valued small caps are an even better place. The index review shows that between 1955 and 2009 “a smaller company value strategy has generated the highest annualised return of 20.5 per cent. Larger value stocks (within the HGSC) have given an annualised return of 18.5 per cent. Growth stocks have had a lower long-term return than either category of value stocks.”

So, if you must buy
small caps on Aim, follow the old-fashioned rules of value investing: look for a decent balance sheet, good cash flow, sound management and decent corporate governance.

Second, O’Hara’s research contains one very positive note: London is not about to lose its status as one of the best places for small caps to list. Although 2009 wasn’t a great year for new listings, O’Hara could only find a tiny number of companies that had chosen to delist in the UK and move to other exchanges.

For me, the key when selecting London-listed small-cap shares is proper corporate governance and good communication between management and investors.

Sadly, I’m not especially hopeful that managers will improve their news flow, which is why I have one last practical suggestion: why don’t we as private investors take matters into our own hands?

At any moment in time, there are a handful of battles going on involving inept managers and brave private shareholders standing up for their rights. Much of this activity ends up on various investor
bulletin boards on the internet. Crucially, though, there’s no single list of shareholder activist battles with forwarding links for more information.

For all I know, there might even be a Global MENA board somewhere!

So, over the next few months, I’m planning to pull together a list of all the current battles so that you can check up on a small-cap company before you invest in it.

In the meantime, if you are involved in such a battle, e-mail me the company name and any relevant web link, and I’ll be sure to include it in my list.

adventurous@ft.com

Audio podcast: Interview

I have recorded a short interview with David O’Hara of Blackthorn Focus about Aim-quoted companies and the way they treat their shareholders. If, like me, you invest in Aim stocks – be they listed funds or trading companies – I heartily recommend listening to O’Hara’s comments. They can only help to improve your due diligence process – especially when it comes to researching the smaller, and possibly flakier, members of the London-listed community. You can listen to my conversation with O’Hara on our website, or download the audio file,as well as other Adventurous Investor audio interviews – including my discussion on “Demographics and Market Timing” with Tim Bond and Michael Dicks of Barclays Capital, and my “China bubble” debate with Dylan Grice of SocGen – at by visiting www.ft.com/moneyshow