Why Investors Should Always Approach AIM With Caution

London's Alternative Investment Market, or AIM, is one of the City's big success stories of the past decade. After launching in 1995, the market has rapidly become one of the most successful growth markets in the world. Thousands of smaller companies have listed on the market during its existence, and there have been several great success stories.

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For example, fashion retailer Asos, Domino's Pizza and Majestic Wine are three rags-to-riches AIM success stories that are still generating returns for investors today.

However, such successes are rare, and the number of AIM's disasters and total losses significantly exceeds the number of success stories. And this is why investors should always approach AIM with caution.

You see, the requirements to list on it are much less strenuous than the main market. As the London Stock Exchange's Guide To AIM points out, to list on the exchange there are no prescriptive entry criteria such as minimum size, trading history or free float. To join it, all companies have to do is demonstrate their readiness and suitability to join a public market. It's usually the job of the company's appointed nominated adviser (NOMAD) along with a number of other advisors to help it prepare for the listing and support it throughout the admission process.

Access to capital

Aim was designed to help smaller companies gain access to capital, but the lack of trading history required before joining the market means that many companies listed there are highly speculative. Indeed, there are some companies listed that have been in existence for only a year and are still several years away from generating any kind of profit or return for investors.

With this being the case, most companies listed on AIM should be viewed as private equity investments. When experienced investors approach a private equity investment, they never put all their eggs in one basket.They invest with a timeframe of five years or so, conduct incredibly detailed due diligence and run a well-diversified portfolio of companies across many different sectors.

Unfortunately, most private investors don't have time to perform the rigorous analysis that usually comes as part of private equity investing - that's why AIM isn't suitable for a large number of investors.

Long-term performance poor

All you need to do is take a look at the performance of the benchmark FTSE AIM All-Share Index over the past 10 years to see the uphill struggle investors face. Since April 2006, the index has lost 40% of its value, while over the past five years the index is down by 20%. In comparison, the FTSE 250 has risen 44% since the beginning of 2011 and 70% since the beginning of 2006.

Still, AIM has some advantages. Shares traded on the exchange are exempt from the usual 0.5% stamp duty levied on main market equities. Some Aim shares also qualify for business property and inheritance tax relief.

If you do stumble onto a big Aim winner, the returns can be life changing. However, unless you know what you're doing and approach AIM with extreme caution the chances of you picking the next Asos, and not losing everything are extremely slim.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.