TIDMAFHC TIDMAFHC
ABERFORTH GEARED CAPITAL & INCOME 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. The Annual Report and Accounts will shortly be
available for inspection at the FSA's document viewing facility at 25 The
North Colonnade, Canary Wharf, London E14 5HS.
KEY FEATURES
Total Assets Total Return +39.4%
Net Asset Value of Capital Shares (1) +228.0%
Second Interim Dividend per Income Share 6.7p (unchanged)
Total Dividend per Income Share 12.6p (unchanged)
(1)Capital Shares asset performance assumes Income Shares have a
capital entitlement of 100p each.
The investment objective of Aberforth Geared Capital & Income Trust plc is to
provide Income Shareholders with a high level of income payable half yearly with
the potential for income growth and to provide Capital Shareholders with geared
capital growth.
All data throughout this Annual Report is to, or as at, 31 December 2009 as
applicable, unless otherwise stated.
CHAIRMAN'S STATEMENT TO SHAREHOLDERS
INTRODUCTION
Aberforth Geared Capital & Income Trust (AGCiT) recorded a total return on
total assets of 39.4% during 2009. Over the same period the index that
represents AGCiT's chosen asset class, the RBS Hoare Govett Smaller Companies
Index (Excluding Investment Companies) (HGSC (XIC)), recorded a total return
of 60.7%. The FTSE All-Share Index, representative of larger companies,
showed a total return of 30.1%.
AGCiT's borrowings consist of a long term facility of GBP34.3m that expires on
31 December 2011. A supplementary overdraft facility of GBP4m negotiated in 2004
expired on 31 May 2009 and was not renewed.
Following detailed discussion and consideration during the first quarter of
2009, your Board and Managers resolved to maintain AGCiT's level of borrowings
towards the upper limit of the available facility for the foreseeable future.
This has proven to be beneficial to the Company's asset performance given the
significant rise in the equity market described above. The Net Asset Value of
a Capital Share (assuming 100p prior charge for the Income Share) rose from
91.9p on 31 December 2008 to 301.5p on 31 December 2009 - an increase of
228.0%.
INTEREST RATE SWAP
AGCiT has an interest rate swap that was put in place immediately following
the formation of the Company, as described in the Company's prospectus. The
purpose of the swap was to remove volatility in the interest cost and thus
create greater certainty as to the Company's net income and dividend payments.
The swap matures on 30 September 2011. At 31 December 2009 the swap had a
liability value of GBP1,991,000. The liability value is due to the low level of
the prevailing interest rates compared with the rate at which the swap was
agreed. The movement in the prevailing value of the swap has either been
credited to or charged against the Capital of the Company throughout its life.
Currently the liability value is equivalent to -19.0p per Capital Share. It
has always been the intention to allow this swap arrangement to run until its
maturity at which point it will have a zero value. The maturity date of the
swap is three months ahead of the scheduled wind up date of the Company.
DIVIDENDS
The Directors have approved an unchanged second interim dividend of 6.7p per
Income Share. When taken together with the first interim dividend of 5.9p, the
total dividend declared for the year is 12.6p, the same level as was paid with
respect to 2008. Earnings per Income Share for 2009 were 11.4p and therefore
GBP294,000 (1.2p per Income Share) has been drawn from revenue reserves in order
to maintain the dividend. Following this payment the retained revenue
reserves will be GBP1,166,000, equivalent to 4.75p per Income Share. The second
interim dividend will be paid on 26 February 2010 to Income Shareholders on
the register at the close of business on 5 February 2010. The ex-dividend date
will be 3 February 2010.
PERFORMANCE
The difference between the 60.7% total return of the HGSC (XIC) and the 39.4%
total return on AGCiT's total assets is disappointing but a number of comments
should be noted in relation to the 2009 relative performance. The return of
the HGSC (XIC), and in particular its significant rise since March 2009, was
dominated by a small group of higher risk equities whose common
characteristics include, weak balance sheets owing to high borrowings and the
consequent likely requirement to raise equity finance, pension fund deficits,
and an inability to pay dividends to Shareholders.
Throughout its life AGCiT has eschewed investing in highly leveraged companies
principally because AGCiT's own balance sheet has been consistently highly
leveraged and it was considered inappropriate to double the exposure to
financial leverage.
The lack of dividend payments by a significant proportion of the higher risk
companies that led the market for much of the year rendered them inappropriate
investments for AGCiT.
AGCiT's underlying dividend income declined by an estimated 15% in 2009 -
significantly less than the income reduction experienced by the opportunity
base.
The sustained use of AGCiT's borrowing facilities during 2009 enhanced returns
for Capital Shareholders in a rising equity market. The use of leverage also
enhances income for the Income Shareholders on an ongoing basis.
Consequently, while in 2009 the relative performance of the assets has been
poor, the absolute return, assisted by the consistent use of leverage, has
been satisfactory.
Further and more detailed comments on the performance of the HGSC (XIC) and
the portfolio during 2009 are to be found in the Managers' report.
OUTLOOK
I am pleased to be able to report returns that are much more satisfactory than
those for 2008 and 2007. There remains some uncertainty, particularly in the
UK, as to the continued path of economic and financial recovery. Share prices
of companies in the opportunity base have recovered significantly since March
2009 as the visibility of economic recovery became clearer. Despite this
recovery, your Managers can still identify attractive opportunities at
prevailing stock market valuations. In view of this, it is the intention to
maintain the gearing at or close to its current near maximum level for the
foreseeable future. This is a position that your Board and Managers keep
under constant review particularly as the Company enters the penultimate year
of its planned life.
Alastair C Dempster
Chairman
25 January 2010
MANAGERS' REPORT
PERFORMANCE
The HGSC (XIC)'s total return of 60.7% makes 2009 its best year of absolute
performance in both AGCiT's eight year history and Aberforth Partners' nineteen
year history. AGCiT's total asset total return of 39.4% was some way behind.
However, in absolute terms this ranks as AGCiT's best ever year, which is
important in view of the capital structure and makes a pleasant change from the
declines of 2008. 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 HGSC (XIC) in
2009 before moving on to address the relatively weak returns from AGCiT.
SMALL COMPANIES
The HGSC (XIC)'s rise in 2009 has to be viewed against the background of the
substantial decline of 40.8% in 2008: over the two year period the total return
from the index 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 prior
to 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. 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 AGCiT'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 by the end of the year.
AGCiT'S RELATIVE PERFORMANCE
An understanding of the mechanics of the HGSC (XIC) is a useful starting place
for an explanation of AGCiT's relative under 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 drove a ceiling of GBP1.188bn: in other words, any company with a
market capitalisation of GBP1.188bn or less at 31 December 2009 is a member of the
HGSC (XIC) in 2010. The index 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 index 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 almost two thirds in 2008, which was, of course, what cut them
down to a size that meant inclusion in 2009's HGSC (XIC). 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 AGCiT's relative performance are
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.
Performance Attribution Analysis
For the year ended 31 December 2009
Basis
Points
Stock Selection (1,731)
Sector Selection (419)
------
Attributable to the portfolio of investments (mid-basis) (2,150)
Impact of mid-price to bid-price 71
Gearing/cash 20,855
Management fee (427)
Interest cost (1,456)
Movement in swap valuation 124
Other expenses (295)
------
Total Attribution 16,722
------
Note: 100 basis points = 1%. Total Attribution is the
difference between the total return performance of the
Capital Share net asset value and the HGSC (XIC) (i.e.
Capital Share net asset value = 227.95%; HGSC (XIC) =
60.73%; difference is 167.22% being 16,722 basis points).
The short duration of the downturn and the speed of return to the investment
behaviours that prevailed prior to 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 AGCiT'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 61 holdings but, over the course of the twelve
months, positions were taken in 83 companies. Of those, 18 out-performed, out
of which eight 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 the
60.7% rise of the HGSC (XIC). Three holdings combined sharp share price
declines with top ten positions within the portfolio at the start of the year.
These three thus had a substantial impact on returns.
· Half of the negative impact from Sector Selection can be accounted for by
Nonlife Insurance. 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.
· Prior to 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 nine equity issues.
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 HGSC (XIC). 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: 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.
Moving into 2010, one third of the HGSC (XIC) had no dividend yield.
Given its capital structure and consequent focus on income, AGCiT avoided
the worst of these dividend declines but nevertheless saw its income
decline by over 15% in 2009. With the HGSC (XIC)'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 55% premium. Since this
movement was substantially influenced by the widespread dividend cuts
outwith the portfolio, your managers do not believe that it indicates a
deterioration in quality within the portfolio. Indeed, the implied
dividend cover of the portfolio is, at 2.9x, at its highest ever level.
Moreover, the income profile is not dependent on very high yielding stocks
whose prospects of dividend growth might be considered to be limited, with
82% of the portfolio invested in companies yielding less than 5%.
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 AGCiT HGSC(XIC) AGCiT HGSC(XIC)
Number of Companies 61 448 67 495
Weighted Average Market GBP347m GBP619m GBP249m GBP442m
Capitalisation
Price Earnings Ratio 8.4x 11.2x 6.4x 6.4x
(Historic)
Net Dividend Yield 4.2% 2.7% 6.1% 5.9%
(Historic)
Dividend Cover (Historic) 2.9x 3.3x 2.6x 2.6x
Despite this re-rating, small companies remain at the cheap end of their
valuation range over Aberforth'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 good scope for further re-rating on the assumption
that the recovery is sustained.
Valuations within AGCiT's portfolio are lower. The historical PE moved up
through 2009, from 6.4x to 8.4x, but not as sharply as that of the HGSC (XIC),
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 AGCiT's history. Crucially, in
your managers' opinion, this has not been facilitated by a sacrifice of quality.
The portfolio retains its bias to companies with strong balance sheets, with
over 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. The income profile of the portfolio might offer additional
comfort, with the average dividend yield of 4.2% never better covered by
earnings and significantly higher than that of the HGSC (XIC).
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 AGCiT to maintain
its level of borrowing towards the upper limit of its available facility. This
would be subject to change when absolute valuations move closer to more
appropriate levels. In the meantime, your managers believe that the closure of
these value gaps, in a portfolio of stocks with robust income characteristics,
should put AGCiT in a good position to meet the requirements of both its Income
and Capital Shareholders.
Aberforth Partners LLP
Managers
25 January 2010
DIRECTORS' RESPONSIBILITY STATEMENT
DECLARATION
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 that it faces. A summary of the principal
risks are set out below.
On behalf of the Board
Alastair C Dempster
Chairman
25 January 2010
PRINCIPAL RISKS AND RISK MANAGEMENT
The Company's financial instruments comprise its investment portfolio, cash
balances, borrowing facility, interest rate swap, Income Shares, debtors and
creditors that arise directly from its operations such as sales and purchases
awaiting settlement and accrued income. 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. As the Company's investments consist of
small UK quoted companies, the principal risks facing the Company are market
related and an explanation of these risks and how they are managed is set out
below.
The main risks that the Company faces from its financial instruments are:
(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
The Company has long term borrowing facility amounting to GBP34.3m with the Bank
of Scotland which it utilises on a regular and consistent basis. Interest rate
fluctuations on GBP30m of long term borrowings are managed through an interest
rate swap agreement with Bank of Scotland which produces an effective total
fixed interest rate of 6.47%. Borrowings in excess of GBP30m are not covered by an
interest rate swap agreement and are exposed to fluctuations in UK market
interest rates. If LIBOR and bank base rate had increased by 1% the impact on
profit or loss and therefore Shareholders' equity would have been negative
GBP29,500 (2008: negative GBP19,000). If LIBOR and bank base rate had decreased by
0.5% the impact on profit or loss and therefore Shareholders' equity would have
been positive GBP14,750 (2008: positive GBP9,500). The Company has no exposure to
movements in LIBOR in respect of the GBP30 million referred to above, as it has
been matched with a swap transaction. The calculations are based on the drawn
down loan facility as at the respective Balance Sheet dates which may not be
representative of the actual drawn down loan facility during the year. 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 as at
31 December 2009 was 0.5% (2008: 2%). 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.
(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 the bank debt
facility. The Company's current liabilities all have a remaining contractual
maturity of less than three months with the exception of the Bank of Scotland
long-term 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.
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. Further information on the investment portfolio is set out in the
Managers' Report. No derivative or hedging instruments are utilised to
specifically manage market price risk. If the investment portfolio valuation
fell by 20% at 31 December 2009 the impact on profit or loss and therefore
Shareholders' equity would have been negative GBP18.7m (2008: negative GBP14.2m). If
the investment portfolio valuation rose by 20% at 31 December 2009 the impact on
profit or loss and therefore Shareholders' equity would have been positive
GBP18.7m (2008: positive GBP14.2m). The calculations are based on the portfolio
valuation as at the respective Balance Sheet dates and are not representative of
the year as a whole. The fair value of the financial instruments held as at 31
December 2009 approximately equates to the book value. The fair value of the
Income Shares is based on the quoted market price of 114.25p whilst the book
value reflects the projected final capital entitlement of 100p per Income Share.
The fair value of the interest swap is based on the 1.75 year (2008: 2.75 year)
bid swap rate supplied by the Bank of Scotland. The investment portfolio
consists of listed investments valued at their bid prices, which represents
their fair value. The Company is a split capital investment trust. In the
Directors' opinion the Income Shares and Capital Shares are in aggregate the
true equity of the Company although the Income Shares must be disclosed as a
"financial liability" due to the existence of a contractual obligation on the
Company to repay to Income Shareholders upon liquidation, a pre-determined
amount.
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 provide Income Shareholders with a high level
of income payable half yearly with the potential for income growth and to
provide Capital Shareholders with geared capital growth. The performance of the
investment portfolio may in short periods not achieve this objective. However,
the Board's aim is to achieve the investment objective whilst managing risk by
ensuring the investment portfolio is managed appropriately within the longer
term horizon.
(ii) Investment policy - a risk facing the Company is inappropriate sector and
stock selection leading to a failure in achieving the investment objective. The
Managers have a clearly defined investment philosophy and manage a diversified
portfolio, investing only in shares of companies that are considered capable of
meeting the Company's objective. Furthermore, performance against the index of
the Investment Universe 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 volatility - the Capital Shares can trade at a discount or
premium to their underlying net asset value. The highly geared nature of the
Company makes the share price of the Capital Shares more volatile than other
less highly geared Investment Trusts. The Directors have decided a share buy-in
policy is not appropriate for the Company after taking into account factors such
as the planned wind-up date of the Company and the anticipated natural
dissipation of the Capital Share discount prior to the planned wind-up date.
(iv) Regulatory risk - breach of regulatory rules 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 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 - the Board believes that the Company has a relatively high-
risk profile in the context of the investment trust industry. This belief arises
from the Company employing a significant level of gearing to increase its yield
and to provide the potential for a growing level of dividend income and the
potential for geared capital appreciation. The Board intends that the Company
remain geared throughout its life.
Some mitigating factors in the Company's risk profile include the facts that the
Company:
· has a relatively simple capital structure;
· invests only in a diversified portfolio of small UK quoted companies; and
· outsources all of its 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 that 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 overall risk by holding portfolios of both
small and large companies together. In summary, the Board regularly considers
risks associated with the Company, the measures in place to monitor them and the
possibility of any other risks that may arise.
INVESTMENT PORTFOLIO
Thirty Largest Investments as at 31 December 2009
Valuation % of
No. Company GBP'000 Total Business Activity
1 Greggs 3,753 4.0 Retailer of sandwiches, savouries
and other bakery products
2 Domino Printing 3,452 3.7 Manufacture of industrial
printing equipment
3 Spirax-Sarco 3,331 3.6 Engineering
Engineering
4 Dunelm Group 3,306 3.5 Homewares retailer
5 Robert Wiseman 3,006 3.2 Processing and distribution of
Dairies milk
6 RPC Group 2,994 3.2 Manufacture of rigid plastic
packaging
7 Brown (N.)Group 2,942 3.1 Home shopping catalogue retailer
8 JD Sports Fashion 2,805 3.0 Retailer of sports and leisurewear
9 Delta 2,676 2.9 Galvanising, manganese products
and industrial supplies
10 Spectris 2,638 2.8 Manufacture of precision
instrumentation and controls
Top Ten Investments 30,903 33.0
11 Beazley 2,455 2.6 Lloyds insurer
12 Phoenix IT Group 2,327 2.5 IT services
13 KCOM Group 2,193 2.3 Telecommunications services
14 e2v technologies 2,011 2.2 Manufacture of electronic
components and sub-systems
15 Evolution Group 1,860 2.0 Stockbroker and private client
fund manager
16 Huntsworth 1,855 2.0 International public relations
17 Holidaybreak 1,720 1.8 Holiday, travel and educational
services
18 Keller Group 1,669 1.8 Ground and foundation engineer
19 Microgen 1,655 1.8 Software and related services
20 Regus Group 1,644 1.8 Serviced offices
Top Twenty 50,292 53.8
Investments
21 Hampson Industries 1,602 1.7 Aerospace and automotive
22 Game Group 1,583 1.7 Retailer of pc and video games
23 Smiths News 1,566 1.7 Newspaper distributor
24 Wilmington Group 1,516 1.6 Information and training to the
professional business market
25 UMECO 1,492 1.6 Advance composite materials and
supply chain management
26 Micro Focus 1,460 1.6 Software
International
27 Dialight 1,456 1.6 LED based lighting solutions
28 Shanks Group 1,454 1.6 Waste services
29 office2office 1,430 1.5 Distribution of office products
30 Collins Stewart 1,422 1.4 Stockbroker and private client
fund manager
Top Thirty 65,273 69.8
Investments
Other Investments(31)28,241 30.2
Total 93,514 100.0
Investments
Net Liabilities (59,047)
Liabilities
Total Net Assets 34,467
The Income Statement, Balance Sheet, Reconciliation of Movements in
Shareholders' Funds, and Summary Cash Flow Statement are set out below: -
INCOME STATEMENT
(Audited)
For the year ended 31 December 2009
2009 2008
Revenue Capital Total Revenue Capital Total
GBP'000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
Realised losses on sales - (6,862) (6,862) - (2,378) (2,378)
Increase/(decrease) in fair - 30,700 30,700 - (45,324)(45,324)
value
------ ------- ------- ------ ------- -------
Gains/(losses) on - 23,838 23,838 - (47,702)(47,702)
investments
Dividend income 3,761 150 3,911 4,482 848 5,330
Interest income 31 - 31 89 - 89
Other income 13 - 13 12 - 12
Investment management fee (177) (412) (589) (276) (645) (921)
Other expenses (233) (285) (518) (268) (373) (641)
------ ------- ------- ------ ------- -------
Net return before finance 3,395 23,291 26,686 4,039 (47,872)(43,833)
costs and taxation
Finance costs: interest (602) (1,286) (1,888) (668) (3,317) (3,985)
------ ------- ------- ------ ------- -------
2,793 22,005 24,798 3,371 (51,189)(47,818)
Finance costs on Income (3,087) - (3,087) (3,087) - (3,087)
Shares
------ ------- ------- ------ ------- -------
Return on ordinary (294) 22,005 21,711 284 (51,189)(50,905)
activities before tax
Tax on ordinary activities - - - (2) - (2)
------ ------- ------- ------ ------- -------
Return attributable to (294) 22,005 21,711 282 (51,189)(50,907)
Shareholders
===== ======= ====== ====== ======= =======
Returns per share
Income Share 11.40p - 11.40p 13.75p - 13.75p
------ ------- ------- ------ ------- -------
Capital Share - 209.57p 209.57p - (487.51p)(487.51p)
------ ------- ------- ------ ------- -------
NOTES
1.The total column of this statement is the profit and loss account of the
Company. The supplementary revenue and capital columns are both prepared
under guidance published by the Association of Investment Companies. 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 Income Share are based on net revenue
on ordinary activities before distributions of GBP2.793 million (2008: GBP3.369
million) and on 24.5 million Income Shares (2008: 24.5 million). The
calculations of capital return per Capital Share are based on net capital
profits of GBP22.005 million (2008: losses of GBP51.189 million) and on 10.5
million Capital Shares (2008: 10.5 million).
RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' FUNDS
(Audited)
For the year ended 31 December 2009
Capital
Share redemption Special Capital Revenue
capital reserve reserve reserve reserve Total
GBP 000 GBP 000 GBP 000 GBP 000 GBP 000 GBP 000
Shareholders'
funds as at 31
December 2008 105 50 9,674 (175) 3,102 12,756
Return
attributable to - - - 22,005 (294) 21,711
Shareholders
----- ----- ------ ------ ----- ------
Shareholders'
funds as at 31 105 50 9,674 21,830 2,808 34,467
December 2009
===== ===== ====== ====== ===== ======
For the year ended 31 December 2008
Capital
Share redemption Special Capital Revenue
capital reserve reserve reserve reserve Total
GBP 000 GBP 000 GBP 000 GBP 000 GBP 000 GBP 000
Shareholders'
funds as at 31
December 2007 105 50 9,674 51,014 2,820 63,663
Return
attributable to - - - (51,189) 282 (50,907)
Shareholders
----- ----- ------ ------ ----- ------
Shareholders'
funds as at 31 105 50 9,674 (175) 3,102 12,756
December 2008
===== ===== ====== ====== ===== ======
BALANCE SHEET
(Audited)
As at 31 December 2009
31 31
December December
2009 2008
GBP'000 GBP'000
Fixed Assets: Investments
Investments at fair value through 93,514 70,930
profit or loss
------- -------
Current assets
Debtors 421 448
Cash at bank 1 -
------- -------
422 448
------- -------
Creditors (amounts falling due
within one year)
Bank overdraft - (136)
Amounts due to brokers - (16)
Other creditors (46) (87)
------- -------
(46) (239)
------- -------
Net current assets 376 209
------- -------
Total assets less current 93,890 71,139
liabilities
Creditors (amounts falling due (59,423) (58,383)
after more than one year)
------- -------
TOTAL NET ASSETS 34,467 12,756
====== ======
Capital and reserves: Equity
interests
Called up share capital:
Capital shares 105 105
Reserves:
Capital redemption reserve 50 50
Special reserve 9,674 9,674
Capital reserve 21,830 (175)
Revenue reserve 2,808 3,102
------- -------
TOTAL EQUITY 34,467 12,756
====== ======
Net Asset Values:
- per Capital Share 317.17p 120.16p
- per Income Share (Income 104.75p 100.57p
Shares are classified as
financial liabilities)
NOTE
The Company had 24.5 million Income Shares and 10.5 million
Capital Shares in issue as at 31 December 2009 and 31 December
2008.
SUMMARY CASH FLOW STATEMENT
(Audited)
For the year ended 31 December 2009
2009 2008
GBP'000 GBP'000
CASH FLOW STATEMENT
Net cash inflow from operating 3,233 4,850
activities
------- -------
Taxation paid
Overseas tax suffered - (2)
Returns on investment and
servicing of finance
Dividends paid (3,087) (3,087)
Interest and other finance costs (2,006) (2,222)
paid
------- -------
Net cash outflow from returns
on investment and servicing of (5,093) (5,309)
finance
------- -------
Capital expenditure and
financial investments
Payments to acquire investments (24,392) (31,381)
Receipts from sales of 25,239 31,751
investments
------- -------
Net cash inflow from capital 847 370
expenditure and financial
investments
------- -------
Net cash outflow before (1,013) (91)
financing activities
------- -------
Financing activities
Loans drawn down/(repaid) 1,150 (45)
------- -------
Net cash inflow/(outflow) from 1,150 (45)
financing activities
------- -------
Change in cash during the period 137 (136)
====== ======
Reconciliation of change in cash
to movement in net debt
Change in cash during the period 137 (136)
Loans (drawn down)/repaid (1,150) 45
Change in fair valuation of 120 (1,757)
interest rate swap
Amortisation of issue costs (10) (9)
during the period
------- -------
Change in net debt (903) (1,857)
Opening net debt (58,519) (56,662)
------- -------
Closing net debt (59,422) (58,519)
====== ======
NOTES TO THE FINANCIAL STATEMENTS
1. ACCOUNTING STANDARDS
The financial statements have been prepared in accordance with UK generally
accepted accounting practice (UK GAAP) 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 to 31 December 2008 have been applied
for the year to 31 December 2009.
2. INVESTMENT MANAGEMENT FEE
2009 2008
Revenue Capital Total Revenue Capital Total
GBP'000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
Investment management 177 412 589 276 645 921
fee
====== ====== ====== ======= ====== ======
3. FINANCE COSTS
2009 2008
Revenue Capital Total Revenue Capital Total
GBP'000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
Interest on base rate 20 48 68 84 197 281
loans/overdraft
Interest on LIBOR loans 582 1,358 1,940 584 1,363 1,947
Change in fair - (120) (120) - 1,757 1,757
valuation of interest
rate swap
------ ------ ------ ------- ------ ------
Total interest costs 602 1,286 1,888 668 3,317 3,985
====== ====== ====== ======= ====== ======
2009 2008
Revenue Capital Total Revenue Capital Total
GBP'000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
Second interim dividend 1,642 - 1,642 1,642 - 1,642
for the year ended 31
December 2008 at 6.7p
(2007: 6.7p)
First interim dividend 1,445 - 1,445 1,445 - 1,445
for the year ended 31
December 2009 at 5.9p
(2008: 5.9p)
------ ------ ------ ------- ------ ------
Total distribution 3,087 - 3,087 3,087 - 3,087
costs
====== ====== ====== ======= ====== ======
A second interim dividend for the year to 31 December 2009 of 6.7p will be
paid on 26 February 2010 to Income Shareholders on the register at close of
business on 5 February 2010.
4. RETURNS PER SHARE
2009 2008
Revenue Capital Total Revenue Capital Total
GBP'000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
Return on ordinary (294) 22,005 21,711 282 (51,189) 50,907)
activities
Add back dividends on 3,087 - 3,087 3,087 - 3,087
Income Shares
------ ------ ------ ------- ------ ------
Earnings attributable 2,793 22,005 24,798 3,369 (51,189)(47,820)
to shareholders
====== ====== ====== ======= ====== ======
Number of Income Shares 24.5m - 24.5m -
Number of Capital Shares - 10.5m - 10.5m
Returns per share 11.40p 209.57p 13.75p (487.51p)
5. NET ASSET VALUE PER SHARE
Total net assets have been calculated in accordance with the provisions of
Financial Reporting Standard 4. Income Shares are classified as financial
liabilities and are carried on the balance sheet at their fair value of 100p
each which results in a total fair valuation of the Income Shares of
GBP24,500,000. This valuation does not reflect the rights of the Income Shares
under the Articles of Association on a return of assets. Set out below is a
reconciliation of Capital and Income share net asset values in accordance
with the Articles.
2009 2008
Revenue Capital Total Revenue Capital Total
GBP'000 GBP'000 GBP'000 GBP'000 GBP'000 GBP'000
Net assets per Balance 34,467 - 34,467 12,756 - 12,756
Sheet
Revenue reserve (2,808) 2,808 - (3,102) 3,102 -
Capital entitlement of - 24,500 24,500 - 24,500 24,500
Income Shares as at 31
March 2011
Capital entitlement not 1,644 (1,644) - 2,963 (2,963) -
yet transferred to
Income Shareholders
------ ------ ------ ------- ------ ------
Net assets per Articles 33,303 25,664 58,967 12,617 24,639 37,256
====== ====== ====== ======= ====== ======
Number of Income Shares - 24.5m - 24.5m
Number of Capital Shares 10.5m - 10.5m -
NAV per share 317.17p 104.75p 120.16p 100.57p
6. CREDITORS: AMOUNTS FALLING DUE AFTER MORE THAN ONE YEAR
2009 2008
GBP'000 GBP'000
Loan facility 2,950 1,800
LIBOR loan facility 30,000 30,000
Less: unamortised issue costs (18) (28)
Income shares 24,500 24,500
Interest rate swap 1,991 2,111
--------- ---------
Total 59,423 58,383
======== ========
7. FURTHER INFORMATION
The foregoing do not comprise Statutory Accounts (as defined in section
434(3) of the Companies Act 2006) of the Company. The statutory accounts for
the year to 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: John Evans - Aberforth Partners LLP - 0131 220 0733
Aberforth Partners LLP, Secretaries - 26 January 2010
ANNOUNCEMENT ENDS
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