Final Results
Aberforth Smaller Companies Trust plc
Audited Annual Results for the year to 31 December 2019
The following is an extract from the Company's Annual Report and Financial Statements for the year to 31 December 2019. The Annual Report is expected to be posted to shareholders by 4 February 2020. Members of the public may obtain copies from Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its website: www.aberforth.co.uk. A copy will also shortly be available for inspection at the National Storage Mechanism at: www.morningstar.co.uk/uk/NSM.
FINANCIAL HIGHLIGHTS
| Net Asset Value per Ordinary Share Total Return | 26.9% |
| Numis Smaller Companies Index (excluding Investment Companies) Total Return | 25.2% |
| Ordinary Share Price Total Return | 39.8% |
| Total Dividends of 36.00p per Ordinary Share (including a Special Dividend of 4.00p per Ordinary Share) |
INVESTMENT OBJECTIVE
The investment objective of Aberforth Smaller Companies Trust plc (ASCoT) is to achieve a net asset value total return (with dividends reinvested) greater than that of the Numis Smaller Companies Index (excluding Investment Companies) (NSCI (XIC) or benchmark) over the long term.
CHAIRMAN’S STATEMENT TO SHAREHOLDERS
Review of 2019 performance
2019 proved to be a stellar year for global stockmarkets. Trade wars, politics and slowing economic activity, as referred to in my interim report, ran afoul of the old Wall Street adage that bull markets climb a wall of worry.
After a period on the side-lines, the UK stockmarket did participate in the bull run, though it took the fourth quarter’s General Election for investors to reassess UK assets in a broader sense. In particular, small UK quoted companies, in which the Company invests, were significant beneficiaries of this reappraisal.
For the full year, the FTSE 100 Index’s total return was 17.3% and that of the FTSE All-Share Index, which is heavily weighted towards large companies, was 19.2%. The Numis Smaller Companies Index (excluding Investment Companies)(NSCI (XIC)) is the Company’s benchmark. It gave a total return of 25.2%, almost half of which came in the fourth quarter of the year. The Company’s net asset value total return was 26.9%. This encapsulates the Income Statement’s return attributable to equity Shareholders of 332.22p per share (2018: -235.92p), together with the effect of dividends received and re-invested. The share price generated a total return of 39.8% as the discount narrowed towards the end of the year.
The Managers’ Report provides more detail on 2019’s performance and puts it into the context of the three-year continuation vote period.
Dividends
The Board remains committed to a progressive dividend policy. In this context, the Board is pleased to propose a final ordinary dividend of 22.0p per share. Total ordinary dividends of 32.0p per share for 2019 represent a 5.8% increment when compared with 2018.
Since 2015, the Company has paid a special dividend alongside the ordinary dividend, thereby ensuring that the all-important minimum retention test imposed by HMRC is not breached. The Board adopted such a strategy to avoid the pitfalls of allowing non-recurring revenue streams, such as special dividends received from investee companies, to become embedded into the progressive dividend policy.
Accordingly, the Board has declared a special dividend of 4.0p per share alongside the total ordinary dividend of 32.0p per share.
After adjusting for both the final ordinary and special dividends, the Company’s revenue reserves will be 76.1p per share, circa 2.4x the ordinary dividend. Strengthened revenue reserves, and prudent management of the non-recurring revenue streams of recent years, leave the Board optimistic about the sustainability of the progressive dividend policy. The ambition behind this strategy, and perhaps its acid test, will be for the Board to deliver dividend growth through the next downturn.
I would stress that the base level for the Company’s progressive dividend policy is the ordinary dividend, i.e. 32.0p per share which excludes the special dividend.
Continuation Vote
It is the Company’s policy to hold a continuation vote every three years. The Annual General Meeting on 3 March 2020 will see the ninth such vote in its history. The Board views the continuation vote as an important shareholder right and would once again encourage all Shareholders to exercise it.
The backdrop to the ninth continuation vote is a little unusual. The Company’s investment strategy, at the core of which is the Managers’ value investment philosophy, faced further challenges in the three years to 31 December 2019. It is pleasing, therefore, to be reporting on a three year period in which returns were ahead of the benchmark. It is important for the Board to understand the influences on such outcomes. In reaching its recommendation, the Board is comfortable that the value style can recover from its struggles since the financial crisis and that recent performance has been achieved without deviation from that style.
For its recommendation in this upcoming continuation vote, the Board is able to draw on favourable performance data for both the short term record over three years and the long term record over twenty nine years. However, as anyone familiar with the stockmarket knows, and as previous continuation votes highlight, the stars are not always aligned and, particularly when an investment strategy is pursued with discipline, short term performance can disappoint.
The Board therefore seeks to understand other aspects of the Managers’ culture and process that ought to support favourable long term returns, irrespective of short term noise. The partnership structure, the consistent collegiate approach, the level of resource focused on a single asset class, alongside the self-imposed ceiling on assets managed and the meaningful alignment through their shareholdings in the Company have been ever-present since the Company’s formation in 1990. Although difficult to quantify, the Board believes that each facet has contributed to building the impressive investment record and has allowed the Managers to manage succession from its founders without some of the pitfalls seen elsewhere in the industry.
The Board therefore recommends that Shareholders vote in favour of the Company’s continuation.
Gearing
It has been the Company’s policy to use gearing in a tactical manner throughout its 29 year history. The £125m facility with The Royal Bank of Scotland International has a term expiring in June 2020. As has been the case in the past, the facility term dovetails with the three-yearly continuation vote cycle. After the Annual General Meeting, and providing the continuation vote is duly passed, the Board and the Managers would seek to put in place a new facility which would continue to provide the Company with access to liquidity for investment purposes and to fund share buy-backs as and when appropriate. In an at times volatile and less liquid asset class such as small UK quoted companies, having access to immediate funds through a credit facility provides the Managers with enhanced flexibility. During the year, the level of gearing ranged from nil to 2.6%, with an average of 0.7%, and at the year end gearing stood at 0.8% of Total Shareholders’ Funds.
Share buy-back
At the Annual General Meeting in February 2019, the authority to buy back up to 14.99% of the Company’s Ordinary Shares was approved. During the year, 1,047,245 Ordinary Shares (1.2% of the issued share capital) were bought in at a total cost of £12.6m. Consistent with the Board’s stated policy, those Ordinary Shares have been cancelled rather than held in Treasury. The Board continues to believe that, at the margin, buy-backs provide an increase in liquidity for those Shareholders wishing to crystallise their investment and at the same time deliver an economic uplift for those Shareholders wishing to remain invested with the Company. Once again, the Board will be seeking to renew the buy-back authority at the Annual General Meeting on 3 March 2020.
Outlook
In what is my first annual Chairman’s statement, it is pleasing to report on a period of strong absolute returns and, despite challenges to the value investment style, out-performance of the benchmark. Honeymoons do not last forever and more difficult statements lie ahead – as all good stockmarket historians know, the wall of worry has a top.
Some aspects of Brexit are undoubtedly clearer following the General Election in December 2019, but challenges remain as the complex legal and commercial work of agreeing and implementing the UK’s exit from the EU gets under way. For ASCoT, as an investment company, the operational implications of Brexit’s next stages are limited. These next stages are, though, more relevant at the investment level, as the underlying investee companies are affected, to varying degrees, by the adjustment to the new environment.
Nevertheless, there is considerably more clarity today on Brexit than seemed possible even six months ago. This contributed to a much better experience for the value style in the second half of the year. While this could not offset the headwinds of the first half, or indeed of the full continuation vote period, it serves as a useful reminder of how rapidly the mood of the stockmarket can change. There appears ample scope for a further improvement in the value style’s fortunes to judge by the extremity of the portfolio’s relative valuation, with the historical price earnings ratio of 10.0x one third lower than the benchmark’s 14.9x. However, in the years since the financial crisis, value rallies have so far proved to be pauses rather than sustainable reversals. Time will tell if that proves to be the case regarding the second half of 2019.
As the Company moves into its thirtieth year, it has enjoyed a period of strong gains, despite which the portfolio’s valuation remains compelling, as explained in the Managers’ Report. This, together with the decisive election result, gives grounds for optimism, and the ever-present features of the Managers’ offering provide the Board with further confidence.
Finally, the Board very much welcomes the views of Shareholders and is available to talk to you directly. My email address is noted below.
Richard Davidson
Chairman
29 January 2020
richard.davidson@aberforth.co.uk
MANAGERS’ REPORT
Introduction
ASCoT’s net asset value total return in 2019 was 26.9%. This was ahead of the NSCI (XIC)’s 25.2% return and the FTSE All-Share’s 19.2%. The year just ended was also the final year in ASCoT’s latest three-yearly continuation vote cycle. This was a volatile period for equity markets, but the overall performance in this three year period was acceptable, as the table below demonstrates.
| Total returns | 2017 | 2018 | 2019 | Full period |
| ASCoT NAV | +22.1% | -15.4% | +26.9% | +31.0% |
| NSCI (XIC) | +19.5% | -15.3% | +25.2% | +26.6% |
| FTSE All-Share | +13.1% | -9.5% | +19.2% | +22.0% |
| FTSE All-World (US$ terms) | +24.7% | -9.0% | +27.2% | +44.3% |
The volatility of share prices over the three years was influenced by global macro economic and political developments. In 2017, markets were enthused by the prospect of “synchronised global recoveryâ€, though this optimism proved short-lived, as Donald Trump’s trade wars intensified towards the end of 2018. Into 2019, fears of a tariff-induced slowdown were allayed by widespread monetary stimulus, with the Federal Reserve cutting interest rates and further quantitative easing deployed by the European Central Bank. These swings in sentiment were echoed by government bond yields: US ten year yields, which started 2017 at 2.5%, reached almost 3.5% in 2018, before sinking back below 2.0% at the end of 2019.
The UK economy has not been unaffected by these global moves, but their effects have been overshadowed by the all-consuming issue of Brexit. In the face of gnawing uncertainty about the eventual terms of the UK’s divorce from the EU, the economy proved more resilient than might have been expected. However, the steady – if unspectacular – progress since the referendum masks an undoubted opportunity cost, some of which is reflected in the under-performance of UK equities against other stockmarkets as illustrated in the table above. As 2019 drew on, it was notable that the incidence of profit warnings from small UK quoted companies rose – it would seem that uncertainty related to Brexit is catching up with businesses reliant on the domestic economy, while the trade wars are taking their toll on companies more reliant on overseas markets. Nevertheless, the year ended in an encouraging fashion, with apparent progress towards a trade deal between China and the US, alongside a decisive general election result in the UK promising to bring clarity at least to the first stage of the Brexit process.
The influence of the value style on performance
| Relative total returns | 2017 | 2018 | 2019 | Full period |
| Value less growth | -9.6% | -1.4% | -8.1% | -21.5% |
| Source: London Business School | ||||
The Managers are value investors. This means that ASCoT’s net asset value performance is influenced by the performance of the value style, for better or worse. Data from the London Business School allow analysis of the value factor’s performance within the NSCI (XIC). Since ASCoT’s inception in 1990, the index’s value stocks have out-performed its growth stocks by 1.5% per annum; that premium rises to 3.2% over the NSCI (XIC)’s full 64 year history. Adherence to the value style has therefore been beneficial to ASCoT’s returns over its lifetime. However, the growth style has led the way since the financial crisis. As the table above shows, this pre-eminence was evident over the continuation vote period as a whole and in 2019 specifically. ASCoT’s out-performance of the NSCI (XIC) therefore came without help from the style factor – “one against the head†in rugby parlance. There was, though, a noteworthy improvement in value’s fortunes in the second half of 2019 after the particularly poor start to the year noted in the interim report.
There is a relationship between style performance and the low bond yields that have characterised the years since the financial crisis. These low yields, all else being equal, drag down the discount rates used to value other assets. This is of greater benefit to the valuations of those assets whose cash flows are weighted further into the future. In the equity world, such assets are growth stocks. This reasoning tallies with observable trends in the real world: investment horizons have lengthened, cash consumptive business models have succeeded in attracting enormous quantities of capital and many equity portfolios are littered with attempts, quoted or unquoted, to find the next Amazon or Apple. Meanwhile, less glamorous businesses, which are usually sensitive to the economic cycle, are overlooked – their proven ability to weather downturns and to benefit from economic progress is presently much less prized than a disruptive business model that promises growing profits some years in the future.
The Managers’ dedication to value investing has resulted in two features of the portfolio that have been and will continue to be influential on future returns: a significant exposure to the smaller constituents of the NSCI (XIC) and a bias towards companies reliant on the domestic economy. The table below shows the performance of these size and geographical influences within the NSCI (XIC), while the subsequent paragraphs give more detail on each.
| Relative total returns | 2017 | 2018 | 2019 | Full period |
| Smaller smalls less larger smalls* | -2.6% | +1.4% | -13.1% | -13.9% |
| Domestics less overseas | -12.8% | -8.4% | +8.3% | -18.3% |
| *FTSE SmallCap (XIC) - FTSE 250 (XIC) |
- Constituents of the NSCI (XIC) are those stocks within the bottom 10% of the total UK stockmarket by value. This definition means that the market capitalisation of the largest constituent is £1,632m and that the index has a significant overlap with the FTSE 250. Mid caps – or “larger small†companies – represent 61% of the total value of the NSCI (XIC), but just 35% of ASCoT’s portfolio. ASCoT therefore has a relatively high exposure to the NSCI (XIC)’s “smaller small†companies, most of which FTSE includes in its SmallCap and Fledgling indices.
| “Smaller smalls†| “Larger smalls†| |
| ASCoT exposure | 65% | 35% |
| NSCI (XIC) exposure | 39% | 61% |
| Tracked universe EV/EBITA* 2019 | 9.6x | 11.3x |
| Tracked universe profit growth 2019-2021 | 12.6% | 9.6% |
| *EV = Enterprise value; EBITA = earnings before interest, tax and amortisation | ||
The table above demonstrates the reason for ASCoT’s size positioning: “smaller small†companies are both cheaper than their larger peers and are expected to grow more quickly. This is an unusual state of affairs, the most significant reason for which is a general reluctance to assume liquidity risk. The much lower valuations for “smaller smalls†have been evident since the financial crisis, which heightened concern about illiquidity. That concern was further intensified in 2019 by the unfortunate events at Woodford Investment Management and their knock-on effect on other parts of the investment management industry. These developments ensured that the share prices of “smaller small†companies lagged the NSCI (XIC) as a whole in 2019 and over the continuation vote period, which was disadvantageous to ASCoT’s returns. As a consequence of this under-performance, the size discount widened further in the year and valuations of many “smaller small†companies approached distressed levels. This represents opportunity for a closed-ended fund such as ASCoT, though the Managers’ enthusiasm may be tempered by the regulatory reaction to what has come to pass.
- The EU referendum created a further dislocation within the valuation framework of small UK quoted companies, which have a much greater exposure than do large companies to the domestic economy. The share prices of overseas-facing companies out-performed as sterling weakened and boosted their profits through translation gains. Meanwhile, many domestic-facing businesses faced narrowing margins as they had to pay higher sterling prices for goods sourced from outside the UK. ASCoT’s portfolio was well positioned for this divergence, having a relatively high exposure to the overseas component at the time of the referendum. However, the subsequent relative performance of the two components led to more opportunities among the domestics. Portfolio capital therefore flowed from overseas to domestic companies, such that ASCoT’s exposure to the latter at 31 December was 63%, determined by the underlying revenues of the companies. The NSCI (XIC)’s domestic exposure fell to 54% following the annual rebalancing of the index on 1 January. This reflects the rally in share prices of domestic companies towards the end of the year, following which several became too large for continued membership of the NSCI (XIC).
The portfolio’s shift towards domestics was a function of the Managers’ value investment discipline and has been modestly advantageous to returns both in 2019 and the continuation vote period: since the end of the third quarter of 2018, the share prices of domestic companies have performed more strongly than those of their overseas peers. This reflects both the impact of the trade wars on the prospects of the overseas earners and, since the emergence of Boris Johnson’s Brexit deal, building optimism – demonstrated by sterling strength – that a disorderly divorce will be avoided. It should be noted, though, that the nature of the UK’s future relationship with the EU will take time to define and consequently that Brexit risk has not vanished: the trading conditions of small UK quoted companies, particularly those addressing the domestic economy, remain vulnerable to a badly handled Brexit.
These aspects of portfolio positioning – size and geographical exposure – are consequences of the Managers’ adherence to the value investment philosophy. However, unlike that philosophy, they may not be constant features of ASCoT’s portfolio. Over time, basic economic forces will mean that these specific opportunities are arbitraged away. In the case of the geographical bias, the obvious catalyst for such arbitrage is greater clarity on the Brexit process, in which the recent general election result should be helpful. Resolution of the size opportunity may be more distant: while the market will take care of overhangs in individual stocks, the full reaction to Woodford Investment Management’s problems – not least in terms of regulation – has yet to play out. However, it is worth noting that Brexit clarity may encourage more M&A activity within the smaller companies universe. Indeed, with ASCoT receiving bids for five of its holdings in 2019, there was a pick-up in takeovers of NSCI (XIC) constituents in 2019, albeit from a low base: predators were prepared to look through currency risk to the very low underlying valuations. An important caveat is that the standard takeover premium of around 30% may be insufficient for the Managers, given the particularly low valuations of “smaller small†companies.
The day-job – stock selection and portfolio management
| Performance for the twelve months ended 31 December 2019 | Basis points | |
| Attributable to the portfolio of investments, based on mid prices (after transaction costs of 22 basis points) |
188 | |
| Movement in mid to bid price spread | 15 | |
| Cash/gearing | 39 | |
| Purchase of ordinary shares | 14 | |
| Management fee | -77 | |
| Other expenses | -6 | |
| ---- | ||
| Total attribution based on bid prices | 173 | |
| Note: 100 basis points = 1%. Total Attribution is the difference between the total return of the NAV and the Benchmark Index (i.e. NAV = 26.90%; Benchmark Index = 25.17%; difference is 1.73% being 173 basis points). | ||
The previous section focused on the effect of the value investment style on ASCoT’s investment performance in recent years. While the impact of style can be significant – for better over ASCoT’s history though for worse in recent years –the Managers cannot influence it. Where they do have influence and where their daily efforts are concentrated are stock selection and the moulding of stocks into a portfolio. The process underlying these activities has been consistently applied over ASCoT’s 29 year history. There are three main aspects to the process.
- Company analysis is facilitated by splitting the small cap universe by sector: each investment manager looks after a handful of sectors and is charged with identifying opportunities within these. With six or seven experienced investment managers in recent years and 346 companies in total to analyse, the level of resource directed at the investment universe is very high. The investment manager seeks to understand how a company makes its money, its barriers to entry, its vulnerabilities, ESG factors material to valuation, the motivation of its executives and the oversight provided by the chair and non executive directors. Scrutiny of historical results and regular contact with management are important features of the analytical effort. Using the output of the analysis, the investment manager determines a valuation for the company in question. A variety of methodologies and metrics – most commonly the ratio of enterprise value to earnings before interest, tax and amortisation – is utilised, all with the aim of calculating a target price for each stock.
- While analysis is conducted by the individual investment managers within their allocated sectors, buy and sell decisions and portfolio management are a collegiate effort. For a value investor, this part of the process is at one level very straightforward: the aim is to move capital from companies whose share prices are close to their targets into those at a wide discount. The Managers refer to this circulation of capital as the “value rollâ€, which can be a powerful contributor to the investment returns generated by a value manager. The key is to ensure that the valuation determined for each company is close to being correct, more often than not. This is the focus of scrutiny and debate when the investment managers gather for investment meetings.
- The third noteworthy aspect of the process is engagement with the chair and other directors of investee companies, through face-to-face meetings and voting in general meetings, something that ASCoT has done throughout its 29 year history. The value of regular engagement becomes especially clear when investment cases go awry. All companies disappoint their investors’ expectations at some point. The stockmarket’s reaction to such events can be harsh and, in the Managers’ experience, is usually over-done in the short term. The Managers are therefore inclined to view a profit warning as an opportunity to own more of a company at a better price. Additional purchases are not, however, undertaken blindly: the Managers engage with directors if poor governance or capital allocation have contributed to the company’s misstep. The odds of effecting change are improved if Aberforth’s funds collectively own a significant stake - up to 25% in some limited cases – in a company’s issued share capital. While the Managers actively seek to improve investment outcomes through their engagement, they always do so discreetly.
These three features of how the Managers invest have been constantly applied throughout ASCoT’s history. Underpinning the ability to remain true to a process that has proved itself over 29 years is the ownership structure of Aberforth: the business is entirely owned by partners working at the firm. There are no outside shareholders who might encourage a dilution of the value investment style, through exploration of other equity markets or pursuit of an asset-gathering strategy. This would risk being against the interests of investors in existing funds managed by Aberforth. Indeed, the Managers remain committed to a ceiling on the business’s assets under management, specifically 1.5% of the total market capitalisation of the NSCI (XIC) index. The ability to avoid distractions has a beneficial side-effect: it increases the Managers’ confidence to invest in ASCoT to the extent that each has a meaningful personal holding.
The Managers’ consistent investment process, designed to identify and own under-valued small companies, has been thoroughly tested in recent years by the challenges facing the value investment style. These challenges can be so intense that portfolio returns lag those of the NSCI (XIC). However, the process can sometimes overcome these challenges, as was the case in 2019 and, indeed, over the continuation vote period as a whole.
Other portfolio features
The Managers’ investment process gives rise to several noteworthy portfolio characteristics. These are often consequences of the value investment style, two of which – the portfolio’s present biases to “smaller small†companies and to domestically oriented businesses – have already been described. The following paragraphs describe and explain other relevant characteristics.
Turnover
In 2019, portfolio turnover – as defined in the glossary – was 24%. Over the three years of the continuation vote period, it was slightly higher at 26%. These rates of turnover are lower than ASCoT’s long run average of 33%. A return to higher turnover would probably be good news for ASCoT’s investors. This counterintuitive assertion has its explanation in the Managers’ value investment style. If the stockmarket has little interest in ASCoT’s holdings, they are unlikely to see their share prices rise towards the Managers’ price targets. There is therefore no reason for holdings to be sold. On the other hand, were the stockmarket to be seeking out value stocks – typically those domestically oriented “smaller smalls†– the Managers would be inclined to take profits and reinvest the proceeds into still under-valued businesses. This “value roll†would imply good relative returns for ASCoT. The Managers do not, therefore, focus on turnover rates, which are an output of the investment process. Moreover, the average three year holding period implied by a long run turnover rate of 33% masks a more nuanced underlying picture. Of ASCoT’s ten most successful stocks in the continuation vote period, four were held for fewer than three years, while another three were held for more than twelve years. Thus, the Managers are patient and take a long term view – it is just that the stockmarket can be shorter term and offer opportunities to recycle capital more quickly.
Attractive income characteristics
Addressing small UK quoted companies from a value investment perspective tends to bring income advantages, which support the dividend ambition described by the Chairman in his report. First, the NSCI (XIC), whose largest constituent is just over 1% of the index, offers a much more diversified income profile than does the FTSE All-Share, where a handful of high yielding stocks and sectors generate a disproportionate amount of that index’s income. Second, dividend cover is considerably higher in the small cap world: the NSCI (XIC)’s cover at 31 December 2019 was 2.1x, which compares with 1.6x for the FTSE All-Share and with 2.9x for ASCoT’s portfolio. Superior dividend cover, all else being equal, should improve the chances of higher dividend growth. Third, historical evidence suggests that small companies’ dividend growth is higher: since 1955 the growth rate for constituents of the NSCI has been circa 3% per annum in real terms, against just over 1% for large companies. The fourth advantage is more specific to ASCoT: the Managers’ value investment style tends to result in a portfolio with a higher yield than that of the NSCI (XIC) as a whole. At 31 December 2019, ASCoT’s average portfolio yield was 3.4%, which is higher than the benchmark’s 3.2%.
A couple of caveats are necessary. First, real dividend growth from the NSCI (XIC) since 2010 has been over 8% per annum, significantly higher than the 3% long term average and therefore unsustainable. There were signs in 2018 that the underlying rate of progress was moderating and this trend was also evident in 2019. Nevertheless, growth last year was positive and exceeded inflation, despite the economic pressures besetting both domestic and overseas companies.
The second caveat relates to the comments made earlier in this report about very low government bond yields and their implications for investor behaviour in other asset classes. Low bond yields have contributed to “income starvationâ€, which has encouraged investors to look to other assets to plug the gap. Corporate bonds and infrastructure have benefited, as too have equities. The search for yield has resulted in a general lowering of yields across stockmarkets and in the valuations of certain companies being determined more by their yields than by other valuation metrics. As a result of this, the Managers have found yield to be a less reliable indicator of value in recent years and there have been points, albeit not presently, at which ASCoT’s average portfolio yield has been lower than that of the NSCI (XIC).
Low valuations
Other valuation metrics are less ambiguous and ASCoT’s portfolio enjoys the low valuation ratios that one would expect of a portfolio put together by a value investor. The most extreme metric at present is the historical PE ratio. This for ASCoT’s portfolio was 10.0x at 31 December 2019, against 14.9x for the NSCI (XIC). The portfolio’s year end discount of 33% was the widest in ASCoT’s history and compares with a 29 year average of 11%. The wide discount is in effect the culmination of the portfolio’s differentiated positioning in terms of size and geographical exposure described previously in this report.
| Portfolio characteristics | 31 December 2019 | 31 December 2018 | ||
| ASCoT | NSCI (XIC) | ASCoT | NSCI (XIC) | |
| Number of companies | 80 | 346 | 81 | 359 |
| Weighted average market capitalisation | £672m | £883m | £524m | £732m |
| Price earnings (PE) ratio (historic) | 10.0x | 14.9x | 9.6x | 10.9x |
| Dividend yield (historic) | 3.4% | 3.2% | 3.7% | 3.6% |
| Dividend cover | 2.9x | 2.1x | 2.9x | 2.6x |
Moving from a historical metric to forward valuations on the Managers’ preferred ratio, the table below sets out the EV/EBITA numbers for ASCoT and for the “tracked universeâ€, which is 98% by value of the NSCI (XIC) and is made up of those 267 small caps that the Managers follow most closely. The table also shows data for two subsets of the “tracked universeâ€, a collection of 47 growth stocks and the other 220 stocks. It is from this latter group that ASCoT’s portfolio is usually constructed.
| EV/EBITA | 2019 | 2020 | 2021 |
| ASCoT’s portfolio | 10.1x | 9.5x | 8.5x |
| Tracked universe | 11.7x | 11.0x | 9.7x |
| -Growth stocks | 19.2x | 16.3x | 13.5x |
| -The rest | 10.6x | 10.1x | 8.9x |
On the basis of data within the 2020 column, the tracked universe is 17% more expensive than ASCoT’s portfolio, while the subset of growth stocks is on a 72% EV/EBITA premium to the portfolio. While macro economic pressures meant that 2019 was a year of little profit progression within the NSCI (XIC), the ratios above imply a return to growth in 2020 and 2021. The profit estimates underlying this are the Managers’ own and assume that the further stages of Brexit process are not disorderly and that recession for this, or any other, reason is avoided. The lack of profit growth in 2019 across the small cap universe is consistent with an upsurge in profit warnings since the half year, as the Brexit uncertainty since the referendum eventually took its toll and as the trade wars affected the fortunes of overseas facing businesses. It is notable that, for the first time in perhaps ten years, these profit warnings were often greeted by flat or rising share prices. The stockmarket would thus seem to have anticipated bad news, as imminent clarity on the political outlook acted as the catalyst for a change in sentiment towards these companies.
High active share
While ASCoT’s turnover, income profile and portfolio valuation are directly a result of the Managers’ value investment style, active share is distinct. Active share is a measure of how different a portfolio is from an index. It is calculated as half of the sum of the absolute differences between each stock’s weighting in an index and its weighting in the portfolio. A higher active share would indicate that a portfolio has a better chance of performing differently from the index, for better or worse. The Managers target a ratio of at least 70% for ASCoT in relation to the NSCI (XIC) and at the start of January 2020 the ratio was 78%. Active share can be flattered by holding companies that are not constituents of the comparable index. The Managers believe that it is important for investors to know in what part of the stockmarket ASCoT is invested and accordingly there are only limited circumstances in which the portfolio can hold companies that are not in the NSCI (XIC).
Conclusion & outlook
Experience should overcome surprise, but what a difference a year can make! As 2018 drew to a close, pessimism reigned as trade wars clouded the global outlook and the Brexit process was mired in uncertainty. Twelve months on, higher equity markets attest to a rediscovered optimism. The received wisdom is now that Donald Trump will act in a rational fashion to conclude a “great†deal with the Chinese as he enters the election year. At home, one of the extreme political outcomes has been avoided and the expectation in the immediate aftermath of the election was that Boris Johnson, now free of the Brexit hardliners, would use his majority to cultivate a softer form of Brexit. However, events quickly highlighted the risk of such assumptions, as the government sought to make it legally impossible to prolong the transition period beyond December 2020. With a hard Brexit still therefore on the table, sterling and UK equities have been given pause for thought.
The point here is less about the further twists and turns of share prices on the road to the UK’s eventual relationship with the EU, or indeed to the US’s eventual relationship with China – stockmarket gyrations of this sort are inevitable. It is more about the problems of an investment climate in which politics in general and the whims of individual politicians have so great an influence. Faith in the capabilities or good intentions of politicians is no substitute for a system in which the state plays a defined and understood role – whether American or Scandinavian in its reach – and lets other participants in the economy conduct their affairs accordingly. It may be argued that today’s situation is effectively normality, with the exception being the “great moderation†of the two decades or so before the financial crisis. Either way, it might not be unreasonable to expect today’s political uncertainty to be reflected in greater scepticism about the promises made by governments and in the valuations of assets particularly reliant on these promises. And yet, even as fiscal spending seems set to rise, vast swathes of even long-dated government bonds yield close to zero, which allows investment horizons to be generously extended to support the valuations of speculative growth companies.
ASCoT stands in sharp contrast to the boldness implicit in such valuations, with the portfolio’s value metrics more attractive than their 29 year historical averages both in absolute terms and relative to the NSCI (XIC). The opportunity has arisen because of the general reluctance since the financial crisis to embrace economic cyclicality and stockmarket illiquidity. However, as the closing months of 2019 showed, sentiment can turn quickly, while the tentative pick-up in M&A points to how some of the valuation anomalies will be rectified. The timing of such events is impossible to call, so in the meantime the Managers continue to follow their investment process designed to identify attractive investment opportunities, funding positions in these with capital from mature holdings and thus moulding a diversified portfolio of attractively valued smaller companies. That process has worked over ASCoT’s first 29 years and, as the continuation vote period demonstrates, can on occasion overcome extremely hostile conditions for the value investor.
Guided by the Managers’ value investment philosophy, ASCoT is distinguished from the overwhelming majority of small cap investment trusts and open-ended funds, which are reliant on the continued ascendancy of growth stocks. This differentiation ensures the relevance of ASCoT’s proposition and underpins the Managers’ optimism for investment performance in the years ahead.
Aberforth Partners
Managers
29 January 2020
DIRECTORS’ RESPONSIBILITY STATEMENT
Each of the Directors confirms 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;
(b) the Strategic 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; and
(c) the Annual Report, taken as a whole, is fair, balanced and understandable and provides information necessary for Shareholders to assess the Company’s performance, business model and strategy.
On behalf of the Board
Richard Davidson
Chairman
29 January 2020
PRINCIPAL RISKS
The Board carefully considers risks, including emerging risks, faced by the Company and seeks to manage these risks through continual review, evaluation, mitigating controls and taking action as necessary.
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 risks inherent in diversified portfolios of small and large companies. In addition, the Company has a simple capital structure and outsources all the main operational activities to recognised, well-established firms. The Board receives internal control reports from these firms to review the effectiveness of their control frameworks.
The principal risks faced by the Company, together with the approach taken by the Board towards them, have been summarised below. Further information regarding the review process can be found in the Corporate Governance and Audit Committee Reports.
(i) Investment policy/performance risk – the Company’s portfolio is exposed to share price movements owing to the nature of its investment policy and strategy. The performance of the investment portfolio typically differs from the performance of the benchmark and is influenced by stock selection and market related risks including market price and liquidity. The Board’s aim is to achieve the investment objective over the long term by ensuring the investment portfolio is managed appropriately. The Board has outsourced portfolio management to experienced managers with a clearly defined investment philosophy and investment process. The Board receives regular and detailed reports on investment performance including detailed portfolio analysis, risk profile and attribution analysis. Senior representatives of Aberforth Partners attend each Board meeting. Peer group performance is also regularly monitored by the Board. The Board and Managers closely monitor economic and political developments and, in particular, are mindful of the continuing uncertainty following the UK referendum result to leave the EU and other geopolitical issues referred to in the Managers’ Report.
(ii) Share price discount – investment trust shares tend to trade at discounts to their underlying net asset values but a significant share price discount, or related volatility, could reduce shareholder returns and confidence. The Board and the Managers monitor the discount on a daily basis both in absolute terms and relative to ASCoT’s peers. In this context, the Board intends to continue to use the buy-back authority as described in the Directors’ Report.
(iii) Gearing risk – in rising markets, gearing enhances returns; however, in falling markets the gearing effect adversely affects returns to Shareholders. The Board and the Managers consider the gearing strategy and associated risk on a regular basis.
(iv) Reputational risk – the reputation of the Company is important in maintaining the confidence of shareholders. The Board and the Managers monitor external factors outwith the Company’s control affecting the reputation of the Company and/or the key service providers and take action if appropriate.
(v) 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. A breach of Section 1158 of the Corporation Tax Act 2010 could lead to the Company losing investment trust status and, as a consequence, any capital gains would then be subject to capital gains tax. The Board receives quarterly compliance reports from the Secretaries to evidence compliance with rules and regulations, together with information on future developments.
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 2019
(audited)
| For the year ended | For the year ended | |||||
| 31 December 2019 | 31 December 2018 | |||||
| Revenue | Capital | Total | Revenue | Capital | Total | |
| £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | |
| Net gains / (losses) on investments | - | 269,836 | 269,836 | - | (251,019) | (251,019) |
| Investment income | 42,478 | 295 | 42,773 | 46,263 | 3,429 | 49,692 |
| Other income | - | - | - | 7 | - | 7 |
| Investment management fee | (3,326) | (5,543) | (8,869) | (3,777) | (6,295) | (10,072) |
| Portfolio transaction costs | - | (2,595) | (2,595) | - | (2,935) | (2,935) |
| Other expenses | (698) | - | (698) | (742) | - | (742) |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Net return before finance costs | 38,454 | 261,993 | 300,447 | 41,751 | (256,820) | (215,069) |
| and tax | ||||||
| Finance costs | (351) | (586) | (937) | (301) | (501) | (802) |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Return on ordinary activities | 38,103 | 261,407 | 299,510 | 41,450 | (257,321) | (215,871) |
| before tax | ||||||
| Tax on ordinary activities | - | - | - | - | - | - |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Return attributable to | ||||||
| equity shareholders | 38,103 | 261,407 | 299,510 | 41,450 | (257,321) | (215,871) |
| ====== | ======= | ======= | ====== | ======= | ======= | |
| Returns per Ordinary Share (Note 4) | 42.26p | 289.96p | 332.22p | 45.30p | (281.22p) | (235.92p) |
The Board declared on 29 January 2020 a final dividend of 22.00p per Ordinary Share and a special dividend of 4.00p per Ordinary Share. The Board declared on 26 July 2019 an interim dividend of 10.00p per Ordinary Share.
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 year. A Statement of Comprehensive Income is not required as all gains and losses of the Company have been reflected in the above statement.
RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS
For the year ended 31 December 2019
(audited)
| Capital | ||||||
| Share | redemption | Special | Capital | Revenue | ||
| Capital | reserve | reserve | reserve | reserve | Total | |
| £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | |
| Balance as at 31 December 2018 | 906 | 82 | 115,375 | 949,213 | 88,160 | 1,153,736 |
| Return on ordinary activities after taxation | - | - | - | 261,407 | 38,103 | 299,510 |
| Equity dividends paid (Note 3) | - | - | - | - | (34,824) | (34,824) |
| Purchase of Ordinary Shares | (11) | 11 | (12,622) | - | - | (12,622) |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Balance as at 31 December 2019 | 895 | 93 | 102,753 | 1,210,620 | 91,439 | 1,405,800 |
| ====== | ====== | ====== | ====== | ====== | ====== |
For the year ended 31 December 2018
(audited)
| Capital | ||||||
| Share | redemption | Special | Capital | Revenue | ||
| Capital | reserve | reserve | reserve | reserve | Total | |
| £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | |
| Balance as at 31 December 2017 | 930 | 58 | 148,201 | 1,206,534 | 79,919 | 1,435,642 |
| Return on ordinary activities after taxation | - | - | - | (257,321) | 41,450 | (215,871) |
| Equity dividends paid (Note 3) | - | - | - | - | (33,209) | (33,209) |
| Purchase of Ordinary Shares | (24) | 24 | (32,826) | - | - | (32,826) |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Balance as at 31 December 2018 | 906 | 82 | 115,375 | 949,213 | 88,160 | 1,153,736 |
| ====== | ====== | ====== | ====== | ====== | ====== |
BALANCE SHEET
As at 31 December 2019
(audited)
| 31 December | 31 December | |
| 2019 | 2018 | |
| £ 000 | £ 000 | |
| Fixed assets | ||
| Investments at fair value through profit or loss (Note 5) | 1,416,678 | 1,168,165 |
| ---------- | ---------- | |
| Current assets | ||
| Debtors | 2,809 | 3,230 |
| Cash at bank | 187 | 59 |
| ---------- | ---------- | |
| 2,996 | 3,289 | |
| Creditors (amounts falling due within one year) | (13,874) | (309) |
| ---------- | ---------- | |
| Net current (liabilities) / assets | (10,878) | 2,980 |
| ---------- | ---------- | |
| Total Assets less Current Liabilities | 1,405,800 | 1,171,145 |
| Creditors (amounts falling due after more than one year) | - | (17,409) |
| ---------- | ---------- | |
| Total Net Assets | 1,405,800 | 1,153,736 |
| ======= | ======= | |
| Capital and reserves: equity interests | ||
| Called up share capital | 895 | 906 |
| Capital redemption reserve | 93 | 82 |
| Special reserve | 102,753 | 115,375 |
| Capital reserve | 1,210,620 | 949,213 |
| Revenue reserve | 91,439 | 88,160 |
| ---------- | ---------- | |
| Total Shareholders’ Funds | 1,405,800 | 1,153,736 |
| ======= | ======= | |
| Net Asset Value per Ordinary Share (Note 6) | 1,570.15p | 1,273.72p |
CASH FLOW STATEMENT
For the year ended 31 December 2019
(audited)
| 31 December 2019 | 31 December 2018 | |||
| £’000 | £’000 | |||
| Operating activities | ||||
| Net revenue before finance costs and tax | 38,454 | 41,751 | ||
| Scrip dividends received | - | (319) | ||
| Receipt of special dividends taken to capital | 295 | 3,429 | ||
| Investment management fee charged to capital | (5,543) | (6,295) | ||
| Decrease in debtors | 421 | 419 | ||
| Decrease in other creditors | (13) | (21) | ||
| -------- | -------- | |||
| Net cash inflow from operating activities | 33,614 | 38,964 | ||
| ===== | ===== | |||
| Investing activities | ||||
| Purchases of investments | (300,568) | (357,515) | ||
| Sales of investments | 319,296 | 376,211 | ||
| -------- | -------- | |||
| Cash inflow from investment activities | 18,728 | 18,696 | ||
| ===== | ===== | |||
| Financing activities | ||||
| Purchases of Ordinary Shares | (12,622) | (32,826) | ||
| Equity dividends paid | (34,824) | (33,209) | ||
| Interest and fees paid | (1,018) | (609) | ||
| Net (repayment) / drawdown of bank debt facilities (before any costs) |
(3,750) | 8,750 | ||
| -------- | -------- | |||
| Cash outflow from financing activities | (52,214) | (57,894) | ||
| ===== | ===== | |||
| Change in cash during the period | 128 | (234) | ||
| ===== | ===== | |||
| Cash at the start of the period | 59 | 293 | ||
| Cash at the end of the period | 187 | 59 | ||
| ====== | ====== | |||
SUMMARY NOTES TO THE FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Company has presented its financial statements under Financial Reporting Standard 102 (FRS 102) and under the AIC’s Statement of Recommended Practice “Financial Statements of Investment Trust Companies and Venture Capital Trusts (SORP) issued in October 2019, applicable for accounting periods beginning on or after 1 January 2019. The principal accounting policies have been consistently applied throughout the year and the preceding year. The financial statements have been prepared on a going concern basis under the historical cost convention, modified to include the revaluation of the Company’s investments as permitted by FRS 102. The functional and presentation currency is pounds sterling, which is the currency of the environment in which the Company operates.
2. INVESTMENT MANAGEMENT FEE
The Managers, Aberforth Partners LLP, receive an annual management fee, payable quarterly in advance, equal to 0.75% of net assets up to £1 billion, and 0.65% thereafter. The investment management fee has been allocated 62.5% to capital reserve and 37.5% to revenue reserve, in line with the Board’s expected long term split of returns, in the form of capital gains and income respectively, from the investment portfolio of the Company.
3. DIVIDENDS
| Year to 31 December 2019 £000 |
Year to 31 December 2018 £000 |
|
| Amounts recognised as distributions to equity holders in the period: | ||
| Final dividend for the year ended 31 December 2018 of 20.75p (2017: 19.75p) paid on 7 March 2019 | 18,795 | 18,332 |
| Special dividend for the year ended 31 December 2018 of 7.75p (2017: 6.70p) paid on 7 March 2019 | 7,020 | 6,219 |
| Interim dividend for the year ended 31 December 2019 of 10.00p (2018: 9.50p) paid on 30 August 2019 | 9,009 | 8,658 |
| ------------ | ------------ | |
| 34,824 | 33,209 | |
| ------------ | ------------ | |
The 22.00p final (2018: 20.75p) and 4.00p (2018: 7.75p) special dividend for the year ended 31 December 2019 will be paid, subject to shareholder approval, on 6 March 2020. These dividends have not been included as a liability in the financial statements for 2019 or 2018.
4. RETURNS PER ORDINARY SHARE
The returns per Ordinary Share are based on:
| Year to 31 December 2019 | Year to 31 December 2018 | |
| Returns attributable to Ordinary Shareholders | £299,510,000 | (£215,871,000) |
| Weighted average number of shares in issue during the year |
90,154,625 | 91,501,299 |
| Return per Ordinary Share | 332.22p | (235.92p) |
There are no dilutive or potentially dilutive shares in issue.
5. INVESTMENTS AT FAIR VALUE
In accordance with FRS 102 fair value measurements have been classified using the fair value hierarchy:
Level 1 - using unadjusted quoted prices for identical instruments in an active market;
Level 2 - using inputs, other than quoted prices included within Level 1, that are directly or indirectly observable (based on market data); and
Level 3 - using inputs that are unobservable (for which market data is unavailable).
Investments held as fair value through profit or loss
As at 31 December 2019 |
Level 1 £’000 |
Level 2 £’000 |
Level 3 £’000 |
Total £’000 |
||||
| Listed equities | 1,416,678 | - | - | 1,416,678 | ||||
| Unlisted equities | - | - | - | - | ||||
| ------------ | ------------ | ------------ | ------------ | |||||
| Total financial asset investments | 1,416,678 | - | - | 1,416,678 | ||||
| ------------ | ------------ | ------------ | ------------ | |||||
| As at 31 December 2018 | Level 1 £’000 |
Level 2 £’000 |
Level 3 £’000 |
Total £’000 |
| Listed equities | 1,168,165 | - | - | 1,168,165 |
| Unlisted equities | - | - | - | - |
| ------------ | ------------ | ------------ | ------------ | |
| Total financial asset investments | 1,168,165 | - | - | 1,168,165 |
| ------------ | ------------ | ------------ | ------------ |
6. NET ASSET VALUES
The net asset value per share and the net assets attributable to the Ordinary Shares at the year end are calculated in accordance with their entitlements in the Articles of Association and were as follows.
| 31 December 2019 | 31 December 2018 | |
| Net assets attributable | £1,405,800,000 | £1,153,736,000 |
| Ordinary Shares in issue at the end of the year | 89,533,066 | 90,580,311 |
| Net asset value per Ordinary Share | 1,570.15p | 1,273.72p |
7. SHARE CAPITAL
During the year, the Company bought back and cancelled 1,047,245 shares (2018: 2,418,826) at a total cost of £12,622,000 (2018: £32,826,000). During the period 1 January to 29 January 2020, no shares have been bought back.
8. RELATED PARTY TRANSACTIONS
Directors’ fees and their shareholdings are detailed in the Directors’ Remuneration Report contained in the Annual Report. There were no matters requiring disclosure under s412 of the Companies Act 2006.
9. 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 2018, 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 498(2) or (3) of the Companies Act 2006.
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.
The Annual Report is expected to be posted to shareholders by 4 February 2020. Members of the public may obtain copies from Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its website: www.aberforth.co.uk.
CONTACT: Alistair Whyte/Euan Macdonald, Aberforth Partners LLP, 0131 220 0733
Aberforth Partners LLP, Secretaries – 29 January 2020
ANNOUNCEMENT ENDS
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