Risk and Trading on London's Alternative Investment Market

The Stock Market for Smaller and Growing Companies

J. Board, A. Dufour, Y. Hartavi, C. Sutcliffe

• Publisher: Palgrave Pivot
• Year: 2015
• ISBN:
  9781137361301
• Topic: Commerce
• Subtopic: Services financiers

The alternative investment market (AIM) has seen rapid growth over its 19 years, and has emerged as the market of choice for smaller, newer companies, both in the UK and abroad. However, it has often had a volatile reputation among investors, who have commonly perceived stock in the AIM as more risky than the main market. In this book, a group of leading financial analysts conduct an extensive empirical study to compare the relative volatility of two UK equity markets run by the London Stock Exchange, over a ten year period. They analyse the comparative risks involved in the alternative investment market, the market of growing companies, and the 'main market', the market for more established companies. This book analyses the volatility of the alternative investment market, using a variety of techniques and approaches. It compares the volatility of stocks in the markets, exploring variables such as size, industry, age and market switches. Using refined methods to focus on the difference between the markets, the authors provide a convincing study to challenge the idea that the alternative investment market is higher risk than the main market.

1

Introduction

Abstract: We conduct an extensive empirical study comparing the relative riskiness of two UK equity markets run by the London Stock Exchange: AIM the market for growth companies versus the Main Market, the market for more established companies. AIM has been a considerable success. Even by its survival over 19 years it has succeeded in relation to similar markets in other countries. During that period it has seen rapid growth and has emerged as the market of choice for smaller, newer companies in the UK and increasingly elsewhere. Investors often perceive AIM as riskier than the Main Market for comparable stocks. At a superficial level we find that AIM stocks may seem more risky than comparable Main Market stocks, but as the analysis is refined to ensure that the comparisons focus purely on the effect of being on different markets the difference shrinks and finally disappears. This conclusion concurs with the market practitioner’s view that there is no significant risk differential.

Board, John et al. Risk and Trading on London’s Alternative Investment Market: The Stock Market for Smaller and Growing Companies. Basingstoke: Palgrave Macmillan, 2015. DOI: 10.1057/9781137361301.0005.

The alternative investment market (AIM) has been a considerable success for the London Stock Exchange (LSE). Even by its survival over 19 years it has succeeded in relation to similar markets in other countries. Since its opening in 1995 it has grown steadily to reach 1,100 listed companies with a market value exceeding £76bn by 2014, and it has emerged as the market of choice for smaller, newer companies in the United Kingdom, and increasingly beyond the United Kingdom. This success has come even though recent years have not been kind to most second-tier markets and several have closed. AIM’s success is said to be partly a reflection of its regulatory standards and also because its marketing has targeted a wide range of companies rather than focussing on high-tech companies.

We conducted a study into the continuing perception that AIM remains riskier than corresponding stocks on the LSE’s Main Market (obviously, AIM stocks can be expected to be more risky than blue-chip stocks). A result showing that AIM is not inherently more risky would be useful in addressing this perception. Conversely, if the results show that AIM stocks are indeed more risky, the analysis may help exchanges when considering regulatory and marketing policies and regulators when developing the regulatory infrastructure in a competitive environment with alternative providers of trading services.

2

Activities

Abstract: The research comprises three elements – an interview program, a literature review and an extensive empirical analysis using 11 years of trade data.

Board, John et al. Risk and Trading on London’s Alternative Investment Market: The Stock Market for Smaller and Growing Companies. Basingstoke: Palgrave Macmillan, 2015. DOI: 10.1057/9781137361301.0006.

Three distinct activities were undertaken for this book:

     

   A brief interview programme among selected market participants. The purpose of this is not to gain an exhaustive understanding of the AIM market, but to gain an indication of factors that are relevant in looking at the risk of AIM stocks.

     

   A review of the academic literature relating to smaller company markets. The objective of this review is to summarize existing, related research and to gain insights into the factors that might be relevant in assessing and explaining risk.

     

   An empirical study of the volatility of returns in the two markets. The empirical study is the main element of the research and it is guided by information gathered from the literature and interviews. Our empirical approach is conditioned by our wish to examine the question of ‘perceived’ risk and we therefore undertake a number of analyses of increasing sophistication designed first to identify apparent risk, and then to see whether any apparent risk persists through more sophisticated examination. We therefore look at the following:

(a)		Basic analysis of relative volatility.
(b)		Basic analysis with allowance for size, age and liquidity.
(c)		Regression analyses with multiple variables.
(d)		Analysis of stocks that switched from one market to the other (‘switchers’).
(e)		A more sophisticated analysis of switchers using GARCH procedures and robust volatility estimation.

3

Interviews

Abstract: The interview program suggested four conclusions. First, while AIM has less demanding minimum requirements than the Main Market (for example in terms of free float) the Nominated Advisors (Nomads) almost always insist that new AIM companies exceed minimum standards, and in practice, standards are similar to those of the Main Market. Second, although AIM, in its earlier days may have been more risky, its growth in recent years and the diversity of companies attracted to the market mean that risk is now much lower, and AIM companies are not significantly different in risk terms from comparable companies on the Main Market. Third, age (since admission) of a company is an important factor in determining risk, but after a relatively short time, perhaps two to three years, its importance disappears. Finally, in AIM (and the Main Market) there is a segmentation between larger, investable companies and a non-investable group – typically very small companies. The non-investable portion is high-risk by nature because it is difficult to trade.

Board, John et al. Risk and Trading on London’s Alternative Investment Market: The Stock Market for Smaller and Growing Companies. Basingstoke: Palgrave Macmillan, 2015. DOI: 10.1057/9781137361301.0007.

The short interview programme covered brokers, dealers and fund managers. The interviews (which were conducted in 2005) suggested a number of key factors to consider in the subsequent research:

AIM stocks can informally be divided into two groups: the larger ‘investable’ companies and a non-investable ‘sludge’. The latter is high risk both by nature and because it is very difficult to trade. A similar division exists in the corresponding section of the Main Market.

Age is an important factor, in that stocks which have been listed for less than about three years are seen as riskier. However, there is no difference in risk between stocks of greater age than this.

In practice, nominated advisors (nomads) impose requirements on AIM companies that are as demanding as those imposed on Main Market stocks. Advisors believe that investors and their own reputation would suffer if AIM was perceived as subject to lower requirements. In particular, while the free float requirements are lower on AIM, the nominated advisors require new AIM companies to have the same free float as new Main Market companies.

The end of the lock-in period and the exit of venture capitalists may cause volatility. However, the volatility around these events is mainly a function of a small number of large transactions and is short-lived as it reflects market impact rather than fundamentals.

Historically AIM has been more risky, but this has been compen...

Table of contents

• Cover
• Title
• 1  Introduction
• 2  Activities
• 3  Interviews
• 4  Literature Review
• 5  Empirical Analysis
• 6  Preliminary Data Analysis
• 7  Volatility Estimation
• 8  Basic Analysis of Relative Volatility
• 9  Relative Risk Allowing for Size, Age or Liquidity
• 10  Regression Analyses with Multiple Variables
• 11  Market-Switching Stocks
• 12  GARCH Analysis of Switchers
• 13  Conclusions
• Appendix: Mean of Dummy Variables for all Estimated Regression Models
• Bibliography
• Index