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The Budget was bad news for Aim stocks – but the long term looks good

Questor Aim portfolio: low valuations mean there is scope for significant capital gains

Despite a material reduction in inheritance tax relief on Aim shares, the Budget could have been worse for holders of qualifying companies. After all, rumours of the complete abolition of business property relief on Aim-quoted firms abounded in the weeks leading up to the Statement.
The Chancellor, though, decided to halve rather than end inheritance tax relief on Aim shares. This means the effective death duty rate on qualifying Aim shares that are held for at least two years is 20pc. While this remains substantially below the standard tax rate of 40pc, it is nevertheless much higher than the previous figure of 0pc.
As a result of this change, it would be wholly unsurprising if demand for Aim-quoted companies declines to at least some extent. This could be tempered by a continuation of their relative appeal from an inheritance tax standpoint.
Indeed, with pensions being subject to inheritance tax from 2027 onwards, any individual with wealth to pass on to their dependents has a seemingly ever-shrinking list of tax-efficient vehicles from which to choose.
However, in Questor’s view, the most significant aspect of the Budget for Aim stocks was its likely impact on the UK economy’s growth prospects. Given that Aim-quoted firms typically have a UK bias compared with larger companies, they are likely to be greatly impacted by the prospect of a slower pace of interest rate cuts resulting from the Chancellor’s decision to vastly increase spending.
The return of “tax and spend” should generate a higher rate of inflation, meaning that the Bank of England could be forced to adopt a more cautious stance when it comes to monetary policy easing.
Indeed, the Office for Budget Responsibility (OBR) expects inflation to rise from its current 1.7pc and subsequently remain above the central bank’s 2pc target until 2029.
While this does not necessarily preclude further interest rate cuts following recent reductions – especially since inflation is forecast to peak at a relatively modest 2.6pc in 2025 – a brisk pace of monetary policy easing that acts as a sizeable tailwind on UK-focused businesses seems somewhat less likely.
This effect, of course, will be compounded by other policies included in the Budget such as changes to employer National Insurance contributions. Given that Aim-quoted firms are by nature relatively small and financially fragile, they could be negatively affected to a far greater extent than their larger peers by higher staff costs.
Furthermore, with the UK economy expected to grow by between 1.5pc and 2pc per annum over the next five years, according to the OBR, the prospects for domestically-focussed firms are rather humdrum in comparison to those with exposure to other economies. This may further reduce demand for Aim stocks, as well as weaken investor sentiment towards the wider UK stock market.
Of course, there are still opportunities for long-term investors to generate high returns from Aim shares. Smaller companies remain grossly undervalued in many instances, with the FTSE Aim All-Share Index trading around 41pc below its level from three years ago. This suggests that wide margins of safety are prevalent, with dirt-cheap valuations often being difficult to justify – even after the Budget.
While interest rates may fall at a slower pace than previously expected, monetary policy easing is nevertheless set to become a feature of the economy over the medium term. This should have a positive impact on company performance and stock market valuations.
Separately, the reduction in inheritance tax relief may not equally affect all Aim stocks.
High-quality firms with impressive growth potential are likely to remain sought after by investors, thereby pushing their prices higher. By contrast, there is likely to be scant reason to hold some of the lower-quality companies quoted on Aim. This could lead to the emergence of a two-tier index, where only firms that appeal for reasons other than inheritance tax relief are in high demand among investors.
As a result, Questor intends to maintain its focus on selecting businesses with solid fundamentals when they trade at attractive prices. Over the long run, we expect this simple strategy to yield relatively high returns for our Aim portfolio.
Ultimately, the UK economy is extremely likely to experience improved growth vis-a-vis its recent past as a relatively modest inflation rate allows gradual interest rate cuts to be implemented.
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