The Problems With Spread Dealing on Aim

There’s no doubt that these are thrilling times. And as a small cap investor, I’m very excited about the future. You see, sooner or later, the markets are going to respond positively to all the bail-outs and rate cuts governments are passing. When they do, certain small cap shares could be leading the charge higher.

Over the past few months, I’ve been making a nice long list of shares that are I believe are due for a recovery. I’ve been sharing these with readers of Red Hot Penny Shares. I believe these shares could rally when the credit crunch passes. If you’d like to get all my latest ideas, take a look at my “Leinster Profit Secret” report that I mention below.

Meantime, here’s something I’ve found that I think you’ll be interested in. If you ever thought that the dealing spreads on small caps were a little steep, read on…

One might have thought that presiding over the Alternative Investment Market (‘AIM’), the ‘most successful growth market in the world’, would ensure a fat living down at the London Stock Exchange. But not fat enough, I am afraid, to prevent it from charging £650 to attend a one-day conference.

Scheduled for 4 November, the AIM Conference 2008 – ‘Putting Your Business on An International Platform’ (whatever that means) is clearly intended only for the ears of those professionals whose employers will stump up the price of the ticket. This is a shame because if a few private investors were there, they might ask some of the questions that desperately need to be answered but are notable by their absence from the agenda.

With topics such as ‘Cleantech – the next big sector?’, ‘AIM as an Internationally Recognised Growth Market’ and ‘AIM Internationalisation – Plans for Expansion and Global Challenges,’ you would think that the market is going from strength to strength.

The LSE needs to deal with the exodus from AIM

But this is far from the truth. Many small companies that have their shares traded on AIM are tired of paying annual fees of £175,000 for the privilege, and with their shares grossly undervalued and barely traded they see little benefit from the experience.

Many are now voting with their feet. Investors are fed up too, for much the same reasons. But far from addressing these critical problems of the here and now, the agenda for this conference suggests that the LSE is only interested in inducing even more companies from home and abroad to share this dismal experience.

If you wonder why, the answer is obvious – because every new company that joins AIM pays handsome fees to the City fraternity. So the LSE panders to the City’s self-interest, but is doing nothing for the private investor. This is foolish and short-sighted. Too many AIM shares are rarely traded. The vast majority of their shares are with institutional fund managers who are basically long-term holders, so the share price is determined by infrequent trades and a small volume of trading can have a disproportionate impact.

This is not something that the LSE should ignore. Companies need to see their share prices traded at a fair level if they are to be able to achieve one of the supposed benefits of a stock market listing, namely the chance to raise equity capital.

The LSE’s answer thus far has been to appoint approved firms to write extra research reports on AIM-listed companies. But this will not help. Lack of information is not the problem. In fact, thanks to the vast improvement in the quality of information on company web-sites, far more information is available than ever before.

Two ways to attract more private investors

A much better solution to the problem of mis-pricing would be to actively encourage private investors to participate in AIM. Cutting the cost of an interesting AIM conference from £650 to, shall we say, £10 would be a start. (I note, by the way, that the conference is sponsored by the likes of PWC, which could easily afford to pay for the whole thing). But much better would be to address two problems that really deter private investors. These are short-selling and dealing spreads.

I have written before that short-selling should be banned. I have received many dissenting responses but frankly none of them has convinced me. And short-selling certainly has one damaging effect, because it hardens the impression that the Stock Market has been hi-jacked by professional traders and this understandably deters private investors.

But what private investors are also concerned about is the dealing spread. If a share price is quoted at 8p-10p, then private investors are quite capable of working out that no sooner have they bought a share than they are 20% down on the deal. Of course, although picking the right penny share can lead to gains of much more than this, high dealing spreads can put investors off, and all the more so when they find that they can only deal in a handful of shares at the quoted price.

What we have on AIM is a trading system based on traditional market-makers whose job is to offer to buy and sell shares to investors at all times, ensuring that there is always a market. By having more than one market-maker for each stock there is supposed to be an element of competition, leading to narrow dealing spreads and a hunger to do business.

In practise this is simply not working. The market-makers behave no better than inexperienced private investors, running scared at the first sign of trouble, and virtually shutting up shop. Because trading volumes are low they are unwilling to take stock on their books or risk going short, and this simply makes the matter worse and creates a vicious circle.

This is more than just an irritation. As I have said above, if the market is not pricing shares correctly then it will cease to be a place where companies can raise equity capital. And let us not forget also that much share trading is not necessarily the enactment of a bullish or bearish view, but simply part of the every day business of financial management. Take for example a charity that is bequeathed a list of AIM stocks – how unsatisfactory is it if it cannot readily sell them at a fair price?

How you can vote against sky-high dealing spreads Now I have come across an initiative to tackle this problem and you can find it on www.killthespread.com. The idea behind this campaign is that AIM should move away from a trading system that relies on market makers to one that gives potential buyers and sellers direct access to the market.

This already happens in Canada and Australia, where shareholders can indicate their desired trades and then transact business directly with one another. At the very least this reduces the cost of the market-makers’ dealing spread. It can also ensure that share prices are determined by knowing buyers and sellers rather than arbitrary mark-ups and mark-downs by the market- makers. Such a system would help both investors and AIM-listed companies. And it might do something to stem the exodus from AIM – something that is far more pertinent today than any of the LSE’s ambitions to expand the market yet further.

I have signed up to the www.killthespread.com campaign and if you are interested in dealing in small company shares at a fair price then I suggest that you do the same.

Tom Bulford
for The Penny Sleuth

P.S. Revealed: The "Leinster Profit Secret" - learn how £2,000 became £216,000... Click here today.

P.S. If you want to follow the tales of a small company investor, and uncover the hidden gems of the stock market, then sign up for the Penny Sleuth e-letter. It won’t cost you a penny…

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The Problems With Spread Dealing on Aim

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