Aim for profits: UK small caps may be ready to turn a corner

Shares in smaller UK companies have languished on the Aim junior market for years. James Mackreides believes that may soon change.

Aim, the London Stock Exchange market for smaller and growing companies, is struggling. UK small caps have fallen out of favour, while tax reforms have made many Aim stocks less appealing. The junior market has been under pressure for some time. The FTSE Aim 100, which tracks the share prices of Aim's largest companies, is now around 3,650 - well below its peak of nearly 6,550 in September 2021.

The problem runs deeper than that. Across AIM as a whole, investors have earned almost nothing over the past decade, while the FTSE All-Share has risen by 60%. Companies have grown just as wary: in 2007, roughly 1,700 businesses were listed on AIM; today, barely more than 600 remain.

Despite the concerns, Alex Game, a fund manager on Liontrust's Economic Advantage team, says, "I remain an Aim bull. We prefer businesses where founders and managers own a substantial stake. They tend to be entrepreneurial, growth-focused companies; many are high-quality firms with leading market positions and well-capitalised balance sheets."

"There's a diversification angle too," says Eustace Santa Barbara, who co-manages the IFSL Marlborough Special Situations, UK Micro-Cap Growth, Multi-Cap Growth and Nano-Cap Growth funds. Investors may now be seeing the danger of relying on only a few familiar mega-cap companies: because those businesses dominate their indexes, a market shock can leave portfolios exposed.

Aim faces pressure at home

Aim's weak recent performance makes the optimism harder to judge. The UK economy has been dealing with high inflation, pushed up by food and energy costs, while the cost-of-living crisis has held back domestic demand and political instability has added further strain. Smaller companies often do more of their business at home, leaving them especially exposed to these pressures.

It also reflects the small-company sector's tilt toward growth stocks - businesses investors buy for their future prospects rather than their current results. Rising interest rates make those bets less attractive. The increase from a base rate near zero five years ago to above 5% was unprecedented, and investors began demanding much higher eventual returns to justify waiting for profits that may only arrive later.

Those fears have driven investors to pull money out. Hargreaves Lansdown analysis puts withdrawals from UK small-cap funds at 6.1 billion, with most of the money moving abroad. Aim has felt the shock particularly hard: it hosts many of Britain's smallest listed companies and an unusually large share of growth stocks. Investors have therefore kept their distance. The market also faces problems of its own.

The government's first 2024 budget weakened a major tax incentive for Aim investors, and the change has had a marked effect. Many Aim shares qualify for Business Property Relief (BPR), which was designed to encourage investment in small companies - both from entrepreneurs setting up businesses and from people who fund them. Before April, anyone who held qualifying Aim shares for at least two years could pass them on after death without an inheritance tax (IHT) bill. That made Aim stocks especially attractive because they could also be held in an individual savings account (ISA), shielding income and capital gains from tax.

Since April, BPR has dropped from 100% to 50%. As a result, Aim shares left to your heirs may now face an IHT charge if your estate exceeds the 325,000 threshold. The rate is 20%, half the usual 40%, but the bill could still be substantial. The rule covers both new Aim investments and assets you already own. Some investors have decided to leave. The Tax Efficient Review reports that people invested in specialist Aim portfolio services have sold about 170 million of shares this year - roughly 10% of the total assets held by those services. That selling puts a limit on Aim's growth, before accounting for the weaker future demand for shares now that the IHT tax break has become less appealing.

Aim shares are going cheap

Aim faces another problem: too few compelling new companies are choosing to list. Early-stage businesses now have far more ways to raise growth capital than they did when Aim launched 30 years ago. Venture capital, private equity and debt funding can provide the money they need without forcing them through the administrative and regulatory demands of a stock-market listing. Corporate governance also puts off some potential Aim investors. A junior market exists to give less mature companies access to public markets before they can satisfy every requirement of a traditional exchange, so the London Stock Exchange places fewer obligations on companies seeking an Aim listing. Unfortunately, this hands-off approach also leaves more room for regulatory failures and criminal activity. The LSE has tightened its rules from time to time, yet scandals involving Langbar International, Globo and African Minerals still hang over the exchange.
That helps explain Aim's troubles. Game points out that this is not the first rough spell the market has endured; it has recovered before. "Aim does go through these spells, and right now we're at the nadir of the market," he says. "But performance is cyclical. At other points in its history, Aim has performed really well."

Santa Barbara adds: "Some may say Aim's best days are behind it, but its record as a source of growth is hard to dispute. Its founding purpose - to give promising smaller companies access to capital and continued funding - still holds."

There's a credible argument that Aim has become very cheap. UK small-cap valuations look low generally: the FTSE Small Cap index trades at 10.6 times earnings, against 15.0 times for the FTSE 100. Aim is harder to compare because some of its companies have little or no revenue or profit, but plenty of shares still look inexpensive against their own history. "Private equity has been acquiring Aim companies at quite a pace, suggesting sophisticated investors believe many of these businesses are fundamentally undervalued," says Jonathan Moyes, head of research at investment platform Wealth Club. The market now needs something to shift sentiment and make investors reassess whether these prices reflect genuine opportunity. Falling interest rates could provide that trigger. The Bank of England's Monetary Policy Committee lowered interest rates six times in 2024 and 2025. Further reductions were widely expected, until the war in Iran sent energy prices sharply higher.
The MPC paused its rate cuts as a result. If the crisis ends decisively, though, monetary policy could loosen. Early fears of a sharp rise in inflation have also failed to materialize, which helps.

A surge of new listings could bring investors back to the market. IPOs have been scarce across the board, but more private companies now seem willing to consider going public, including possible additions to Aim, Moyes says. Companies raised about 3.3 billion in the first seven months of 2026, compared with only 1.6bn throughout 2024. One very large deal accounted for a sizeable share of this year's fundraising, and most of the activity came from secondary raises rather than new listings. Even so, capital is beginning to move again.

The LSE is taking steps of its own. It has announced plans to cut the cost of listing on Aim and make raising capital less difficult. A steadier political climate could help too, especially once the Andy Burnham-led government sets out its fiscal and monetary plans after next month's Budget. Aim may not require a dramatic change in sentiment to reverse its current course. Shares in many Aim-listed companies trade thinly, with relatively few buyers and sellers, so even a modest shift in mood can move prices sharply. That helps explain the market's frequent volatility - and why it can reward investors as well as punish them.

Aim rewards careful stock selection

Aim investors do not need the entire market to improve. They only need the companies they own to perform well. Investment experts generally describe Aim as a market for active stock-pickers: although headline figures draw attention to the market's overall performance, individual businesses can produce very different results, with stock-level returns spread far more widely than in other markets. That is why a decade of flat returns tells only part of the story. As Game puts it, "Aim has probably generated more ten-baggers than most other developed markets." Craneware, the healthcare software company, joined Aim almost 20 years ago and has since produced total returns of around 1,500%, equivalent to an annualised return of about 16%. Defence technology business Cohort has delivered roughly 14% a year over the same period.

Mortgage Advice Bureau offers another example. After listing on Aim in 2014, it moved to the main market earlier this year. During its 12 years on Aim, investors gained more than 400% - about 15% annually.

That does not mean Aim, as a market, will recover from its current lows. Plenty of investors remain doubtful. Ben Yearsley, a director at Fairview Investing, says the UK has little appetite for smaller companies, especially the riskier end of the small-cap market represented by Aim. A few compelling small-cap IPOs could help, he adds, but companies are remaining private for longer. Aim has still attracted new listings, though fund managers investing there often say the quality has been poor.

The counterargument is that rising interest rates and signs of a recovering IPO market could give IHT reform a chance to reopen the debate over Aim's merits. "Tax relief was never enough by itself to sustain a healthy market," says Moyes. "If valuations begin to recover, investors will come for the investment case first. Inheritance tax relief will be an added bonus, not the main reason."