ABERFORTH SMALLER COMPANIES TRUST plc
Audited Final Results for the year to 31 December 2009
The following is an extract from the Company's Annual Report and Accounts for
the year to 31 December 2009. The Annual Report is expected to be posted to
shareholders on 30 January 2010. Members of the public may obtain copies from
Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its
website at www.aberforth.co.uk. This will shortly be available for inspection
at the authority's document viewing facility at 25 The North Colonnade, Canary
Wharf, London, E14 5HS.
FEATURES
Net Asset Value Total Return +44.4%
Benchmark Index Total Return +60.7%
Ordinary Share Price Total Return +59.2%
Dividend maintained at 13p per Share
The objective of Aberforth Smaller Companies Trust plc (ASCoT) is to achieve a
net asset value total return (with dividends reinvested) greater than on the
RBS Hoare Govett Smaller Companies Index (Excluding Investment Companies) over
the long term. ASCoT is managed by Aberforth Partners LLP.
CHAIRMAN'S STATEMENT TO SHAREHOLDERS
Review of 2009 Performance
As noted in my Half Yearly Statement, the first three months of 2009
remained challenging for equity investors as the turmoil afflicting global
economies towards the end of 2008 showed no signs of abating. However,
stock markets then rallied strongly as economies stabilised in response to
unprecedented monetary and fiscal stimulus, and as investors' appetite for
risk returned.
Against this background, ASCoT's net asset value total return for the full
year was 44.4%, the third best in its history. This was well ahead of the
30.1% total return of large companies, as represented by the FTSE All-Share
Index, but was some way behind the 60.7% total return of the RBS Hoare
Govett Smaller Companies Index (Excluding Investment Companies), ASCoT's
investment benchmark.
The Managers' Report provides greater insight into ASCoT's net asset value
performance compared with the benchmark index. In particular, your Board
understands the relatively cautious positioning of the portfolio coming into
2009. Many companies in the investment benchmark were confronted by a
combination of profits reduced by recessionary conditions and highly geared
balance sheets. Dividends suffered and the equity value of these companies
was perilously close to being dictated by their lenders. Positioned to
avoid these exposures, the portfolio was out of step with the stock market's
subsequent rally, which was helped by investors' willingness to refinance
indebted businesses through numerous rights issues.
Gearing
I commented last year that timing "the bottom" of the market with certainty
was near impossible. Employing bank borrowing to gear the portfolio has,
however, been helpful during 2009 as the market recovered.
As reported in my Half Yearly Statement, your Board negotiated terms in July
2009 on a new two year committed facility of £75 million, which replaced the
previous arrangement.
At the year-end approximately £48 million of this facility was utilised.
Your Board reviews the level of gearing regularly with the Managers and is
comfortable that ASCoT has access to sufficient liquidity for both
investment purposes and also to fund share buybacks as and when appropriate.
Share Buy Back Authority
At the Annual General Meeting in March 2009, the authority to buy-in up to
14.99% of ASCoT's Ordinary Shares was renewed. Under that authority 33,000
shares have been bought in to the end of December at a total cost of £0.2
million. All shares bought in have been cancelled rather than held in
treasury.
Your Board will be seeking a renewal of this authority at the Annual General
Meeting to be held on 3 March 2010. The Board keeps under careful review
the circumstances under which the buy-in authority is used in the context of
its overall objective of seeking to sustain a low discount. It will remain
the policy to cancel, rather than hold in treasury, any such shares.
Dividends
Your Board is pleased to declare a second interim dividend, in effect a
final dividend, of 13 pence per share. This results in total dividends for
the year of 19 pence per share, which is the same as the previous year, and
delivers a yield of 3.6% on the year-end share price of 534 pence.
Reflecting the impact of the severe economic downturn and exacerbated by the
credit crunch, portfolio dividend income for the year is approximately 20%
lower than that recorded the previous year. As the Managers' Report
explains, this was nevertheless a considerably better outcome than that
experienced by the benchmark. Whilst the worst is hopefully behind us, a
further modest decline in dividend income in 2010 would not be a surprise.
In this context, your Board does have a degree of flexibility on dividends
given the level of ASCoT's revenue reserves which, after adjusting for
payment of the second interim dividend, amount to 25.3 pence per share.
Your Board is aware of the importance of the income component of the total
return from equities over the long term.
The second interim dividend of 13.0 pence per share will be paid on 26
February 2010 to Shareholders on the register at the close of business on 5
February 2010. The last date for submission of Forms of Election for those
Shareholders wishing to participate in ASCoT's Dividend Reinvestment Plan
(DRiP) is 5 February 2010. Details of the DRiP are available from Aberforth
Partners LLP on request or on their website, www.aberforth.co.uk.
Alternative Investment Fund Managers Directive (AIFMD)
The AIFMD is draft legislation, currently being debated in Europe, which
will regulate the managers of "alternative investment funds". As currently
drafted, UK investment trust companies fall within its scope. Certain of the
draft proposals could have far reaching consequences for ASCoT and the whole
of the investment trust industry in the UK. Your Board and Managers, as
well as the Association of Investment Companies and others, have actively
engaged in lobbying relevant parties to highlight the potential issues and
seek changes to the draft. The outcome remains far from certain and it is
unlikely that the Directive will be finalised before summer 2010.
Summary
Overall, 2009 has been a vintage year for the share prices of UK smaller
companies. However, this performance has to be viewed in context of the
steep declines suffered during the previous two years, with the benchmark
index at the end of 2009 still some 21% below its peak reached in the second
quarter of 2007. Accordingly, the Managers are of the view that UK small
company equities remain attractive from a value perspective despite recent
gains. As is their style, they have constructed the portfolio mindful of
the short term risks of recovery, with stock selection based around sound
fundamentals. Your Board remains confident that the Managers' experience
and this consistency of approach will benefit ASCoT over the long term.
Finally, and as announced in my Half Yearly Statement, I retire from the
Board at the Annual General Meeting in March 2010, when Professor Paul Marsh
will take over the role of Chairman. It has been my privilege to serve on
the Board for fifteen years and to have held the Chair for five of these.
As a shareholder, I will be following the fortunes of the Company closely in
my retirement. In this regard, Paul and his colleagues on the Board have my
full confidence and very best wishes.
David R Shaw
Chairman
26 January 2010
MANAGERS' REPORT
In ASCoT's nineteen year history, 2009 ranks as both the best year of
absolute performance from the HGSC (XIC) and the worst year of relative
performance for ASCoT. Whereas the benchmark's total return was 60.7%, ASCoT
produced a return of 44.4%. This was nevertheless its third best ever annual
return in absolute terms. Large companies meanwhile performed less well,
though the 30.1% total return from the FTSE All-Share stands out in its own
historical context.
The following paragraphs explain the strong performance of the benchmark in
2009 before moving on to address the relative returns from ASCoT.
Small companies
The HGSC (XIC)'s rise in 2009 has to be viewed against the background of the
previous year's substantial decline of 40.8%: over the two year period the
total return from the benchmark has been -4.9%. Entering 2009, the market
was confronted by a recession that was exacerbated by an unprecedented credit
crunch - descent into depression was a widespread concern. Risk aversion,
reflected in equity valuations and stretched credit market spreads, was at
extreme levels in the wake of Lehman's collapse. Governments and central
banks were in the middle of unleashing substantial fiscal and monetary
stimuli, which went on to enter the uncharted territory of quantitative
easing. The climate of uncertainty persisted for much of the first quarter
and was reflected in company results that were characterised by deep cost
cutting and sharp reductions in dividends.
However, in mid March, small company share prices hit their lows for the
year, from which they went on to bounce by 73%. This recovery has been based
on improving fundamentals. The global economy has bottomed and subsequently
started to pick up. A majority of major economies have now exited recession,
with the UK, as yet, a notable exception. As the year progressed, businesses
saw destocking come to an end and the start of tentative restocking in the
latter part of the year. Sustainable demand levels remain unclear, but the
combination of restocking and sharply reduced cost bases promises a period of
good profits growth moving into 2010.
At the same time, the extreme risk aversion of 2008 has eased. Important in
this regard have been the conventional and unconventional activities of
central banks to influence the cost of borrowing. Notwithstanding the banks'
focus on repairing their own balance sheets, this has filtered through
financial markets, bringing many spreads in the credit markets back to levels
that prevailed before the failure of Lehman. Waning risk aversion has also
been evident in equity markets, which have been led upwards by smaller
companies and emerging markets, traditionally considered to be at the riskier
end of equity investment. Though more powerful, the risk rally of 2009 is
thus reminiscent of 2003, when the markets bounced strongly on recovery from
the US's mini-recession at the start of the decade.
A catalyst for this rediscovered appetite for risk was the preparedness of
equity investors to finance the substantial volume of rights issues and
placings from highly geared companies. Within the small company universe,
this flood of re-equitisation started at the end of January, when valuations
were at levels that suggested many UK businesses could go under. While the
banks often retain rather too much influence, the removal of the risk of
imminent failure added longevity to the equity of these geared companies and
justified a re-rating from what were extremely low valuations of historical
earnings.
Indeed, the historically low valuations that characterised the small cap
universe are perhaps the most important way to understand the strong rally
enjoyed by the benchmark. The HGSC (XIC) came into 2009 valued on a
historical PE of 6.4x and a yield of 5.9%, on both measures the cheapest over
ASCoT's history. Clearly, a proportion of this apparent cheapness was
justified by the sharp drops in earnings and dividends that companies went on
to report as the year progressed: the lowest historical PEs were certainly to
be found among those companies that were characterised by the unpleasant
cocktail of falling profits, high debts and pension fund deficits. However,
with the benefit of hindsight, it is clear that these low valuations were
overplaying the risk of descent into depression. The subsequent
stabilisation and even improvement in economic and credit conditions have
therefore provided the basis of a powerful re-rating that took the historical
PE up to 11.2x and the yield down to 2.7% by the end of the year.
ASCoT's relative performance
An understanding of the mechanics of the benchmark, the HGSC (XIC), is a
useful starting place for an explanation of ASCoT's relative performance.
The HGSC (XIC) comprises those companies that make up the bottom 10% of the
market capitalisation of the total UK market, excluding AIM. At the end of
2009, this definition resulted in a ceiling of £1.188bn: in other words, any
company with a market capitalisation of £1.188bn or less at 31 December 2009
is a member of the HGSC (XIC) in 2010. The benchmark is rebalanced just once
a year, on 1 January. Ordinarily, this rebalancing exercise is rather low
key, with turnover of perhaps half a dozen companies. In 2009 it was not
ordinary: 40 companies were relegated to the rebalanced HGSC (XIC). As
described in the interim report, these companies represented a quarter of the
benchmark by value at the start of the year and together enjoyed a total
return of 80% in 2009.
However, the typical `fallen star' exemplified those characteristics that
were shunned in 2008: high debts, falling profits, significant pension
deficits and reduced dividends. So, in aggregate, the share prices of this
group of 40 companies fell by two thirds in 2008, which was, of course, what
cut them down to a size that meant inclusion in 2009's benchmark. Your
managers simulate a rebalanced HGSC (XIC) through the year, so it was not the
case that they were suddenly overwhelmed on 1 January by the surprise
inclusion of 40 new companies: the analytical work on these businesses was
conducted through the second half of 2008.
Rather, the relevance of the `fallen stars' to ASCoT's relative performance
is their typical characteristics previously described: with equity capital
encumbered by substantial debts and pension deficits, this was a riskier than
average group of companies. In contrast, the portfolio came into 2009 with a
defensive orientation: the two strong themes detailed in last year's annual
report were those of robust balance sheets and `being paid to wait' by a
sustainable dividend yield through a downturn of uncertain duration. While
each proved advantageous in 2008, neither helped in 2009: the more rewarding
strategy would have been to pursue those companies that combined cut
dividends and high levels of debt. Thus, your managers were too risk averse
for the investment climate that developed through 2009.
The irony here is that your managers had been investing in anticipation of a
recovery in share prices for some time. In the second half of 2008, the
portfolio was cautiously reoriented towards domestic cyclical sectors and, in
May 2008, ASCoT started to take on gearing for only the third time in its
history. At that point, your managers judged that small company valuations
were already at a level that discounted recession, but preferred to reflect
this in gearing at the trust level across a well diversified portfolio of
small companies, rather than exposing capital to individual highly geared
businesses. That judgement was temporarily called into question by the
collapse of Lehman and the consequent intensification of the credit crunch.
However, given the rebound in share prices, the decision to gear has proved
beneficial in 2009, as is demonstrated in the table below.
PERFORMANCE ATTRIBUTION ANALYSIS
For the year ended to 31 December 2009 Basis
Points
Stock Selection (1,806)
Sector Selection (212)
------
Attributable to the portfolio of investments (2,018)
(calculated on a mid-price basis)
Impact of mid-price to bid-price 82
Purchase of Ordinary Shares 1
Cash/gearing 401
Management fee (91)
Other expenses (10)
-----
Total Attribution based on bid-prices (1,635)
Note: 100 basis points = 1%. Total Attribution is the
difference between the total return of the net asset value and
the Benchmark Index (i.e. net asset value = +44.38%; Benchmark
Index = +60.73%; difference is -16.35% being -1,635 basis
points).
But if it has not been the stabilisation and subsequent improvement in
economic fundamentals, what has surprised your managers? The short duration
of the downturn and the speed of return to the investment behaviours that
prevailed before the credit crunch have been startling.
· During the UK's last recession, in the early 1990s, small company earnings
fell for three consecutive years. In the present downturn, if analysts are
correct, the period of earnings contraction may be confined to just 18 months,
despite the accompanying credit crunch. This itself would be a remarkable
outturn. However, extrapolating from this, the equity valuations of a number of
cyclical businesses are already discounting a rapid return to previous peak
levels of profitability. This seems improbable in view of the structural
challenges, principally significant levels of debt, faced by many economies.
· The equity issues that have resuscitated a number of distressed small
company equities, including a large portion of the `fallen stars', have not
necessarily provided a long term cure. The banks and pension fund trustees
frequently remain very influential, though this influence on the value due to
equity holders might not become manifest until the debt facility next comes up
for renewal, or until the outcome of the next triennial pension review is
revealed.
· The investment strategies that were popular up into the first half of 2008
but that suffered in the second half of that year have returned to favour more
quickly than expected. In particular, commodities have enjoyed a strong
revival, as have businesses exposed to China's secular growth story. There is
evidence that these may be benefiting from a return of carry trade activity,
i.e. borrowing in currencies with low interest rates such as the dollar and
investing in riskier, higher-yielding assets. This plays to concerns that an
element of the monetary authorities' largesse is being diverted directly into
asset markets rather than being passed on through the banking system.
General caution about the speed, rather than the reality, of recovery is
therefore an important factor in understanding ASCoT's relative performance.
This is reflected in the table above, which shows negative contributions from
both stock and sector selection: your managers' risk aversion limited the
amount of capital exposed to those stocks, and indeed sectors, where highly
geared balance sheets were a feature. Below this over-arching theme, there
were other influences at work that provide more colour on the relative
performance.
· The portfolio contained many stocks that performed well in 2009. At the
end of the year, there were 87 holdings but, over the course of the twelve
months, positions were taken in 118 companies. Of those, 43 out-performed, out
of which 15 more than doubled. However, of the doublers, none sat within the
top ten holdings at the start of the year. This in part reflects the speed with
which the market's mood changed in the first quarter in 2009. But it is also
clear that relative performance could have been enhanced by better capital
allocation: attractively valued businesses were identified but could have been
pushed further up the portfolio. On the other hand, any stock that suffered an
absolute fall in price had a significant impact on relative returns against a
benchmark that rose by 60.7%. Four holdings combined sharp share price declines
with top ten positions within the portfolio at the start of the year. These
four thus had a substantial impact on returns. Two of them were constituents of
the Nonlife Insurance sector, which is addressed in the following paragraph.
· The negative impact from Sector Selection can be accounted for by Nonlife
Insurance, with the contributions from other sectors offsetting each other. The
portfolio was over-weight in Nonlife Insurance, with three holdings at the start
of the year. The sector had performed very well in 2008, actually managing to
rise by 15%. However, what were considered positive attributes in 2008 - high
sustainable dividend yields, low price to book valuations and little exposure to
the general economic cycle - came to be perceived as handicaps in 2009 as the
market rediscovered its appetite for risk. The sector therefore under-performed
by a wide margin in 2009, with a return of -7%. This has left its constituents
offering some of the most attractive valuations within the HGSC (XIC), which
argues for maintaining a meaningful exposure to the sector in expectation of
another change in the stockmarket's sentiment.
· Before the onset of the credit crunch and recession, the UK stockmarket
benefited from the phenomenon of de-equitisation: the stock of quoted equity
capital shrank between 2003 and 2007 as new issuance was out-weighed by share
buybacks, dividends and takeover activity boosted by the highly leveraged
techniques of private equity. This provided technical support to equity
valuations, particularly in the small company universe. However, de-
equitisation went into reverse in 2008 as the banks started their rights issues.
This new trend of re-equitisation continued in 2009, with small companies
contributing to substantial equity issuance: almost a fifth of the HGSC (XIC)'s
constituents issued new equity that was equivalent to at least a tenth of their
outstanding equity capital at the start of the year. As already described, the
willingness of shareholders to support these funding exercises made an important
contribution to the ensuing rally in share prices. The discounts of the placing
price to the prevailing market were typically wide and, from the portfolio's
point of view, could provide good opportunities to establish a holding, as long
as the new equity provided sufficient comfort against remaining debt covenants.
In all, the portfolio participated in 23 equity issues, using six of those as
the opportunity to acquire an initial position in the underlying business.
While equity issuance exploded, M&A activity dropped sharply, running at
around one third of its average over the past ten years. This reflected
caution in the face of recession on the part of company boards and the
difficulty in securing debt funding as banks sought to repair their
balance sheets. Reflecting your managers' value investment philosophy,
the portfolio has historically benefited disproportionately from M&A and
indeed had holdings in three of the 14 companies in the HGSC (XIC) that
were acquired in 2009. A return to normal levels of activity in 2010
would be beneficial. There are numerous indications that this might be
the case, with corporate transactions already picking up in the US and
with UK assets, by virtue of lower valuations and the weakness of
sterling, looking vulnerable.
· In terms of dividends, the portfolio out-performed the benchmark. As noted
in the interim report, the current recession has been considerably worse for
dividends than was the previous downturn. At work have been not only the
understandable pressures of recession and troubled lenders, but also the
frustrating influences of fashion and weak advice. Large companies, whose
dividends in aggregate escaped unscathed from the recession of the early 1990s,
have seen a decline of roughly 20% in the present downturn, substantially
reflecting the problems of the banking sector. The experience for small
companies is also worse than last time: the drop of 35-40% over the last 18
months compares with a fall of 20-25%, spread over a three year period, in the
early 1990s.
ASCoT found some protection in its focus on being `paid to wait' for the
upturn. It nevertheless experienced a decline in income of
approximately 20%. With the benchmark's dividends having fallen
further, the portfolio's historical yield relative to that of the HGSC
(XIC) moved up steadily to end the year at a 20% premium. This is close
to its highest level over ASCoT's history. Your managers believe that
over longer time periods, such a yield advantage will benefit the
portfolio's absolute and relative returns. Importantly, it has not been
secured by sacrificing quality. Implied dividend cover rose sharply
through the second half to its highest ever level, ending the year at
3.9x. This compares with a nineteen year average cover of 2.4x. The
income profile is not dependent on very high yielding stocks whose
prospects of dividend growth might be considered to be limited, with 83%
of the portfolio invested in companies yielding less than 5%.
Indeed, 19% of the portfolio at the year end consisted of companies with
no yield, around half of which may be considered structural nil
yielders, i.e. companies whose business models do not support dividend
payments. The other half can be classified as cyclical nil yielders,
i.e. businesses whose profits have suffered in recession and are
currently unable to pay. Moving forward, an important dynamic will be
the return of these cyclical nil yielders to the dividend register as
recovery continues. Other things being equal, this ought to provide a
boost to dividend growth across the portfolio, and indeed the small cap
market, in the medium term. However, whilst this is encouraging for the
medium term, it is not unlikely that a further modest decline in dividend
income in 2010 may occur.
Looking forward
From a macro economic perspective, it is difficult to muster a lot of
optimism at the current time about the world's developed economies.
Policymakers have thus far done a good job in staving off the risk of the
recession spiralling into depression. However, the measures required to
achieve this have essentially been an exercise in moving lumps of debt from
the private to the public sector. The burden of structurally high levels of
debt therefore persists and this has to be worked down over time. It is
reasonable to expect this to place a limit on economic growth over the medium
term. This is particularly relevant to the UK, where the next government
will have to embrace public spending cuts and where the savings rate among
consumers is heading upwards.
With interest rates and government bond yields at their present low levels,
financing high public borrowing is not too demanding. However, there are
threats. Government bond yields have been held down for the time being by
purchases by central banks and, as the year drew to a close, the gilt market
weakened as fears built about the UK's fiscal position. Moreover, scope for
monetary policy error lingers. Thus far, rhetoric from the central banks is
hinting at a bias to keeping rates `lower for longer' in order to reduce the
perceived risk of mistakes made in the 1930s depression. This, however, has
reignited concerns about resurgent inflationary pressure and focused
attention on exit strategies from the current phase of loose monetary policy.
Peering into 2010, it is safe to state that the financial markets' focus of
concerns will continue to oscillate between inflation and deflation.
But there are offsetting factors, principally the increasing contribution to
global economic growth of emerging markets and the relative health of the
corporate sector. Recoveries from recession over the past couple of decades
have typically been led by the US consumer, who has responded in Pavlovian
fashion to interest rate reductions. However, with the US consumer at last
in retrenchment mode and the current account deficit narrowing, the present
recovery has been substantially powered by China and other emerging markets.
And within China, the incremental growth has come not from the export sector,
which is in any case highly dependent on the US consumer, but on internally
generated demand. It would no doubt be better if this demand originated from
the private sector rather than from the state, but the key issue is the fact
of an alternative and autonomous source of growth that eases the process of
adjustment within developed economies.
Meanwhile, in the wake of recession and credit crunch, the corporate sector
in both the UK and US is in surprisingly good shape. Contributing to this
have been the substantial equity issuance seen through 2009, reduced capital
expenditure budgets, and the rapidity with which management teams reacted to
the downturn with cost reductions. The strain has been taken by labour, with
unemployment rates rising to multi year highs in several economies. While
this dynamic curbs the enthusiasm of consumers to spend, it is consistent
with a recovery that might be led initially by profits and then by capital
expenditure. With ample spare capacity, such a scenario might also offer
some comfort regarding inflation.
This relative strength of the corporate sector is evident in the substantial
opportunity base that is the HGSC (XIC), where trading conditions for many
businesses have stabilised and, boosted by tentative restocking, are starting
to pick up. This improvement is reflected in the strong returns from small
companies in 2009 and, as the table below demonstrates, has precipitated a
substantial re-rating: historical PEs moved from 6.4x to 11.2x over the
course of the year.
31 December 2009 31 December 2008
Characteristics ASCoT Benchmark ASCoT Benchmark
Number of Companies 87 448 93 495
Weighted Average Market £368m £619m £259m £442m
Capitalisation
Price Earnings Ratio 8.1x 11.2x 6.0x 6.4x
(Historic)
Net Dividend Yield 3.2% 2.7% 5.3% 5.9%
(Historic)
Dividend Cover (Historic) 3.9x 3.3x 3.1x 2.6x
Despite this re-rating, small companies remain at the cheap end of their
valuation range over ASCoT's history. The average historical PE over the
past 19 years has been 14x and, in the recovery phase of the recession in the
early 1990s, it moved up to 18x. While the structural issues besetting the
UK economy may prevent a return to this level of valuation, there would
nevertheless appear to be plenty of scope for further re-rating on the
assumption that the recovery is sustained.
Valuations within ASCoT's portfolio are lower. The historical PE moved up
through 2009, from 6.0x to 8.1x, but not as sharply as that of the benchmark,
reflecting the lower return and also a more resilient earnings performance
from the portfolio. On both an absolute and relative basis, the portfolio is
offering what is approaching its best value over ASCoT's history. Crucially,
in your managers' opinion, this has not been facilitated by a deterioration
in quality. The portfolio retains its bias to companies with strong balance
sheets, with just under a third invested in businesses with net cash. Such
financial strength affords these companies flexibility to invest, which might
reasonably prove a competitive advantage at a time when banks still appear
reluctant to lend to indebted businesses. Another indication of quality
might be the relative resilience of the portfolio's income performance, which
has helped its yield move from a 10% discount to that of the HGSC (XIC) at
the start of the year to a 20% premium, while retaining a higher dividend
cover.
While not being complacent about the challenges facing the domestic and
global economies, the availability of well financed and attractively valued
businesses, such as those that make up the portfolio, argues strongly for
ASCoT to maintain its gearing. However, the gearing is employed on a
tactical rather than structural basis and it will be withdrawn when absolute
valuations within the portfolio move closer to more appropriate levels. The
closure of these value gaps, enhanced by the gearing, should be the basis for
an improvement in ASCoT's relative performance. The precise timing is as
difficult as ever to call, but some comfort may be drawn from ASCoT's
history: your managers' value investment style has led to phases of weak
relative returns in previous bull markets but returns have improved as the
adjustment in risk appetites comes to an end.
Aberforth Partners LLP
Managers
26 January 2010
DIRECTORS' RESPONSIBILITY STATEMENT
Each of the Directors confirm to the best of their knowledge that:
(a) the financial statements, which have been prepared in accordance with
applicable accounting standards, give a true and fair view of the assets,
liabilities, financial position and profit or loss of the Company; and
(b) the Annual Report includes a fair review of the development and performance
of the business and the position of the Company, together with a description of
the principal risks and uncertainties it faces. A summary of these can be found
below.
On behalf of the Board
David R Shaw
Chairman
26 January 2010
PRINCIPAL RISKS AND RISK MANAGEMENT
The Directors have established an ongoing process for identifying, evaluating
and managing the key risks faced by the Company. This process was in operation
during the year and continues in place up to the date of this report.
The Board believes that the Company has a relatively low risk profile in the
context of the investment trust industry. This belief arises from the fact that
the Company has a simple capital structure; invests only in small UK quoted
companies; has never been exposed to derivatives and does not presently intend
any such exposure; and outsources all the main operational activities to
recognised, well-established firms. Investment in small companies is generally
perceived to carry more risk than investment in large companies. While this is
reasonable when comparing individual companies, it is much less so when
comparing the volatility of returns from diversified portfolios of small and
large companies. The Board believes the Company's portfolio is diversified. In
addition, since returns from small and large companies are not perfectly
correlated, there is an opportunity for investors to reduce risk by holding
portfolios of both small and large companies together.
As the Company's investments consist of small UK quoted companies, the principal
risks facing the Company are market related and include interest rate,
liquidity, credit, and market price risk. An explanation of these risks and how
they are managed are as follows:
(i) Interest rate risk, being the risk that the interest receivable/payable and
the market value of investment holdings may fluctuate because of changes in
market interest rates;
(ii) Liquidity risk is the risk that the Company will encounter difficulty
raising funds to meet its cash commitments as they fall due. Liquidity risk may
result from either the inability to sell financial instruments quickly at their
fair values or from the inability to generate cash inflows as required;
(iii) Credit risk is the risk that a counterparty to a financial instrument will
fail to discharge an obligation or commitment that it has entered into with the
Company; and
(iv) Market price risk, being the risk that the market value of investment
holdings will fluctuate as a result of changes in market prices caused by
factors other than interest rate or currency rate movement.
The Company's financial instruments are all denominated in sterling and
therefore the Company is not directly exposed to any significant currency risk.
However, it is recognised that most investee companies, whilst listed in the UK,
will be exposed to global economic conditions and currency fluctuations.
(i) Interest rate risk
When the Company decides to hold cash balances, all balances are held on
variable rate bank accounts yielding rates of interest linked to bank base rate
which at 31 December 2009 was 0.5% (2008: 2.0%). The Company's policy is to hold
cash in variable rate bank accounts and not usually to invest in fixed rate
securities. The Company's investment portfolio is not directly exposed to
interest rate risk.
The Company has a bank debt facility of £75,000,000 of which £48,250,000 was
drawn down as at 31 December 2009 (2008: debt facility of £80,000,000, of which
£41,174,000 was drawn down as at 31 December 2008).
(ii) Liquidity risk
The Company's assets comprise mainly readily realisable equity securities which,
if necessary, can be sold to meet any funding requirements though short term
funding flexibility can typically be achieved through the use of bank debt
facilities. The Company's current liabilities all have a remaining contractual
maturity of less than three months with the exception of the bank debt facility.
(iii) Credit risk
The Company invests in UK equities traded on the London Stock Exchange and
investment transactions are carried out with a large number of FSA regulated
brokers with trades typically undertaken on a delivery versus payment basis and
on a short settlement period.
Cash at bank is held with reputable banks with acceptable external credit
ratings.
The investment portfolio assets of the Company are held by The Northern Trust
Company, the Company's custodian, in a segregated account. In the event of the
bankruptcy or insolvency of Northern Trust the Company's rights with respect to
the securities held by the custodian may be delayed or limited. The Board
monitors the Company's risk by reviewing Northern Trust's internal control
report.
(iv) Market price risk
The Company's investment portfolio is exposed to market price fluctuations which
are monitored by the investment managers in pursuance of the investment
objective. No derivative or hedging instruments are currently utilised to
specifically manage market price risk. Further information on the investment
portfolio is set out in the Managers' Report. It is not the Managers' policy to
use derivatives to manage portfolio risk.
As at 31 December 2009, all of the Company's financial instruments were included
in the balance sheet at fair value. The fair value approximately equates to the
book value. The investment portfolio consisted of listed investments valued at
their bid price, which represents fair value. Any cash balances, which are held
in variable rate bank accounts, can be withdrawn on demand with no penalty.
Additional risks faced by the Company, together with the approach taken by the
Board towards them, have been summarised as follows:
(i) Investment objective - is to achieve a net asset value total return (with
dividends reinvested) greater than on the RBS Hoare Govett Smaller Companies
Index (Excluding Investment Companies) over the long term. The performance of
the investment portfolio will often not match the performance of the benchmark.
However, the Board's aim is to achieve the investment objective over the long
term whilst managing risk by ensuring the investment portfolio is managed
appropriately. The Corporate Governance Report provides additional information
regarding the various areas considered by the Board.
(ii) Investment policy - a risk facing the Company is inappropriate sector and
stock selection leading to underperformance relative to the benchmark. The
Managers have a clearly defined investment philosophy and manage a diversified
portfolio. Furthermore, performance against the benchmark and the peer group is
regularly monitored by the Board. The Company may also be affected by events or
developments in the economic environment generally, for example inflation or
deflation, recession and movements in interest rates.
(iii) Share price discount - investment trust shares tend to trade at
discounts to their underlying net asset values. The Board and the Managers
monitor the discount on a daily basis.
(iv) Regulatory risk - failure to comply with applicable legal and regulatory
requirements could lead to suspension of the Company's share price listing,
financial penalties or a qualified audit report. Breach of Section 842 could
lead to the Company being subject to capital gains tax. The Board receives
quarterly compliance reports from the Secretaries to monitor compliance with
rules and regulations.
(v) Operational/Financial risk - failure of the Managers' accounting systems
or those of other third party service providers could lead to an inability to
provide accurate reporting and monitoring, or potentially lead to the
misappropriation of assets. The Board reviews regular reports on the internal
controls of the Managers and other key third party providers.
(vi) Gearing risk - in rising markets, the effect of borrowings would be
beneficial but in falling markets the gearing effect would adversely affect
returns to Shareholders.
PORTFOLIO INFORMATION
Thirty Largest Investments
Valuation
as at % of
31 December Total
2009 Net
No Company £'000 Assets Business Activity
1 Bellway 19,445 3.3 Housebuilder
2 Greggs 17,178 2.9 Retailer of sandwiches, savouries
and other bakery products
3 Domino Printing 15,930 2.7 Manufacture of industrial printing
Sciences equipment
4 Micro Focus 15,754 2.7 Software
International
5 Spectris 15,674 2.7 Manufacture of precision
instrumentation and controls
6 JD Sports 14,565 2.5 Retailer of sports and leisurewear
Fashion
7 Dunelm Group 14,505 2.5 Homewares retailer
8 Beazley 14,296 2.4 Lloyds insurer
9 RPC Group 13,686 2.3 Manufacture of rigid plastic
packaging
10 Robert Wiseman 13,524 2.3 Processing and distribution of milk
Dairies
Top Ten Investments 154,557 26.3
11 Huntsworth 13,340 2.3 International public relations
12 Unite Group 12,791 2.2 Property
13 RPS Group 12,384 2.1 Consulting
14 Phoenix IT Group 12,372 2.1 IT services
15 KCOM Group 11,985 2.0 Telecommunications services
16 National 11,881 2.0 Bus and coach services
Express Group
17 Evolution Group 11,544 2.0 Stockbroker and private client fund
manager
18 Regus 11,040 1.9 Serviced offices
19 e2v 10,974 1.9 Manufacture of electronic components
technologies and sub-systems
20 Bodycote 9,788 1.7 Industrial heat treatment
Top Twenty Investments 272,656 46.5
21 Keller Group 9,590 1.6 Ground and foundation engineer
22 Vectura Group 9,322 1.6 Inhaled pharmaceuticals
23 Collins Stewart 9,300 1.6 Stockbroker and private client fund
manager
24 Brown (N.) 9,203 1.6 Home shopping catalogue retailer
Group
25 Pace 9,036 1.5 Design and sourcing of set top boxes
26 Intec Telecom 8,552 1.5 Software and related services
Systems
27 Anite 8,530 1.5 Software
28 Wilmington 8,466 1.4 Information and training to the
Group professional business market
29 Hampson 8,414 1.4 Aerospace and automotive
Industries
30 Delta 8,378 1.4 Galvanising, manganese products and
industrial supplies
Top Thirty Investments 361,447 61.6
Other Investments (57) 270,939 46.1
Total Investments 632,386 107.7
Net Liabilities (45,464) (7.7)
Total Net Assets 586,922 100.0
The Income Statement, Balance Sheet, Reconciliation of Movements in Shareholders' Funds
and summary Cash Flow Statement are set out below:-
INCOME STATEMENT
For the year ended
31 December 2009
(audited)
For the year ended For the year ended
31 December 2009 31 December 2008
Revenue Capital Total Revenue Capital Total
£ 000 £ 000 £ 000 £ 000 £ 000 £ 000
Realised losses on sales - (40,331) (40,331) - (9,027) (9,027)
Increase/(decrease) in - 209,726 209,726 - (297,703)(297,703)
fair value
------ ------- ------- ------ ------- -------
Net gains/(losses) on - 169,395 169,395 - (306,730)(306,730)
investments
Dividend income 19,110 1,183 20,293 23,684 7,387 31,071
Interest income 1 - 1 1,152 - 1,152
Other income 168 - 168 54 - 54
Investment management (1,450) (2,417) (3,867) (1,636) (2,727) (4,363)
fee
Other expenses (437) (2,624) (3,061) (489) (2,880) (3,369)
------ ------- ------- ------ ------- -------
Return on ordinary 17,392 165,537 182,929 22,765 (304,950)(282,185)
activities
before finance costs
and tax
Finance costs (579) (965) (1,544) (526) (877) (1,403)
------ ------- ------- ------ ------- -------
Return on ordinary 16,813 164,572 181,385 22,239 (305,827)(283,588)
activities before tax
Tax on ordinary - - - (16) - (16)
activities
------ ------- ------- ------ ------- -------
Return attributable to
equity shareholders 16,813 164,572 181,385 22,223 (305,827)(283,604)
====== ======= ======= ====== ======= =======
Returns per Ordinary 17.35p 169.84p 187.19p 22.75p (313.12p)(290.37p)
Share
The Board declared on 26 January 2010 a second interim dividend of
13.0p per Ordinary Share (2008 - 13.0p). The Board also declared on 22
July 2009 a first interim dividend of 6.0p per Ordinary Share (2008 interim
dividend of 6.0p).
NOTES
1. The total column of this statement is the profit and loss account of
the Company. All revenue and capital items in the above statement derive from
continuing operations. No operations were acquired or discontinued in the period. A
Statement of Total Recognised Gains and Losses is not required as all gains and
losses of the Company have been reflected in the above statement.
2. The calculations of revenue return per Ordinary Share are based on net revenue
of £16,813,000 (2008 - £22,223,000) and on the weighted average Ordinary Shares
of 96,897,197 (2008 - 97,670,037).
The calculations of capital return per Ordinary Share are based on net capital
gains of £164,572,000 (2008 - net capital losses of £305,827,000)
and on the weighted average Ordinary Shares of 96,897,197 (2008 - 97,670,037).
SUMMARY RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' FUNDS
For the year ended 31 December 2009
(Audited)
2009 2008
£ 000 £ 000
Opening shareholders' funds 424,115 735,021
Return on ordinary activities after 181,385 (283,604)
taxation
Equity dividends paid (18,411) (16,189)
Purchase of Ordinary Shares (167) (11,113)
-------- --------
Closing shareholders' funds 586,922 424,115
======= =======
BALANCE SHEET
As at 31 December 2009
(Audited)
31 December 31 December
2009 2008
£ 000 £ 000
Fixed assets:
Investments at fair value through 632,386 464,427
profit or loss
-------- --------
Current assets
Debtors 2,010 2,278
Cash at bank 362 -
-------- --------
2,372 2,278
Creditors (amounts falling due (148) (42,590)
within one year)
-------- --------
Net current assets/(liabilities) 2,224 (40,312)
-------- --------
Total Assets less Current 634,610 424,115
Liabilities
Creditors (amounts falling due after (47,688) -
more than one year)
-------- --------
Total Net Assets 586,922 424,115
======= =======
Capital and reserves: equity interests
Called up share capital (Ordinary Shares) 969 969
Reserves:
Capital redemption reserve 19 19
Special reserve 186,025 186,192
Capital reserve 362,796 198,224
Revenue reserve 37,113 38,711
-------- --------
Total Shareholders' Funds 586,922 424,115
======= =======
Net Asset Value per Ordinary Share 605.90p 437.68p
SUMMARY CASH FLOW STATEMENT
For the year ended 31 December 2009
(Audited)
For the year ended For the year ended
31 December 2009 31 December 2008
£ 000 £ 000 £ 000 £ 000
Net cash inflow from operating 16,833 31,520
activities
Taxation - (16)
Returns on investment and (2,062) (1,381)
servicing of finance
Capital expenditure and
financial investment
Payments to acquire investments (238,152) (260,020)
Receipts from sales of 235,245 198,007
investments
-------- -------
Net cash outflow from capital
expenditure and financial (2,907) (62,013)
investment
-------- -------
11,864 (31,890)
Equity dividends paid (18,411) (16,189)
-------- -------
(6,547) (48,079)
Financing
Purchase of Ordinary Shares (167) (11,113)
Net drawdown of bank debt 7,076 41,174
facilities (before costs)
-------- -------
Increase/(decrease) in cash 362 (18,018)
======== =======
Reconciliation of net cash flow to
movement in net debt
Increase/(decrease) in cash in the year 362 (18,018)
Net drawdown of bank debt facilities (6,326) (41,174)
Amortised costs in respect of (188) -
the bank debt facility
-------- -------
Change in net debt (6,152) (59,192)
Opening net (debt)/funds (41,174) 18,018
-------- -------
Closing debt (47,326) (41,174)
======== =======
NOTES TO THE FINANCIAL STATEMENTS
1. ACCOUNTING STANDARDS
The financial statements have been prepared under the historical cost
convention, as modified to include the revaluation of investments
and in accordance with applicable accounting standards and the AIC's
Statement of Recommended Practice "Financial Statements of Investment Trust
Companies and Venture Capital Trusts" issued in January 2009.
The total column of the Income Statement is the profit and loss
account of the Company. All revenue and capital items in the Income
Statement are derived from continuing operations. No operations were
acquired or discontinued in the period.
The same accounting policies used for the year ended 31 December 2008
have been applied.
2. INVESTMENT MANAGEMENT FEE
For the year to 31 December 2009 Revenue Capital Total
£ 000 £ 000 £ 000
Investment management fee 1,450 2,417 3,867
VAT refund - - -
------ ------ ------
Total for the year to 31 December 1,450 2,417 3,867
2009
====== ====== ======
For the year to 31 December 2008 Revenue Capital Total
£ 000 £ 000 £ 000
Investment management fee 1,901 3,170 5,071
VAT recovered (265) (443) (708)
------ ------ ------
Total for the year to 31 December 1,636 2,727 4,363
2008
====== ====== ======
The VAT recovered during the year to 31 December 2008 above represents
the repayment of VAT incurred in respect of management fees
paid between 1991 and 1996.
3.DIVIDENDS
Year to Year to
31 December 2009 31 December 2008
£000 £000
Amounts recognised as distributions to
equity holders in the period:
Second interim dividend of 13.0p for the
year ended 31 December 2008 (2007: 10.5p) 12,597 10,375
First interim dividend of 6.00p for the year
ended 31 December 2009 (2008: 6.0p) 5,814 5,814
------ ------
18,411 16,189
====== ======
The second interim dividend for the year ended 31 December 2009 of 13.0p will
be paid on 26 February 2010 to shareholders on the register on 5 February 2010.
4. RETURNS PER ORDINARY SHARE
The returns per Ordinary Share are based on:
Year to Year to
31 December 2009 31 December 2008
£000 £000
Returns attributable to Ordinary Shareholders 181,385 (283,604)
Weighted average number of shares in
issue during the period 96,897,197 97,670,037
5. NET ASSET VALUES
The net assets and the net asset value per share attributable to the Ordinary
Shares at each period end are calculated in accordance with their entitlements
in the Articles of Association and were as follows:
31 December 31 December
2009 2008
£000 £000
Net assets attributable 586,922 424,115
Pence Pence
Net asset value attributable per Ordinary Share 605.90 437.68
As at 31 December 2009, the Company had 96,867,000 Ordinary Shares in issue
(31 December 2008 - 96,900,000). During the year to 31 December 2009, the Company
bought in and cancelled 33,000 shares (2008 - 1,909,788 shares ) at a total cost
of £ 167,000 (2008 - £11,113,000).
6. FURTHER INFORMATION
The foregoing do not constitute statutory accounts (as defined in section 434(3)
of the Companies Act 2006) of the Company. The statutory accounts for the year
ended 31 December 2008, which contained an unqualified Report of the Auditors,
have been lodged with the Registrar of Companies and did not contain a statement
required under section 237(2) or (3) of the Companies Act 1985 (as amended).
Certain statements in this announcement are forward looking statements. By their
nature, forward looking statements involve a number of risks, uncertainties or
assumptions that could cause actual results or events to differ materially from
those expressed or implied by those statements. Forward looking statements
regarding past trends or activities should not be taken as representation that
such trends or activities will continue in the future. Accordingly, undue
reliance should not be placed on forward looking statements.
CONTACT: David Ross/Alistair Whyte, Aberforth Partners LLP, 0131 220 0733
Aberforth Partners LLP, Secretaries - 26 January 2010
ANNOUNCEMENT ENDS