Half-year Report
Aberforth Smaller Companies Trust plc
Audited Annual Results for the year to 31 December 2017
The following is an extract from the Company's Annual Report and Financial Statements for the year to 31 December 2017. The Annual Report is expected to be posted to shareholders on or before 1 February 2018. 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 Total Return | +22.1% |
| Numis Smaller Companies Index (Excl. Investment Companies) Total Return | +19.5% |
| Ordinary Share Price Total Return | +22.6% |
| Total Dividends increased to 35.50p per Ordinary Share (including a Special Dividend of 6.70p per Ordinary Share) |
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. ASCoT is managed by Aberforth Partners LLP.
CHAIRMAN’S STATEMENT TO SHAREHOLDERS
Review of 2017 performance
Confounding many a sceptic, 2017 proved to be a positive year for returns from UK smaller companies. The FTSE 100 Index gave a total return of 11.9%, while the return of the FTSE All-Share Index, which is heavily weighted towards large companies, was 13.1%. By comparison, the Numis Smaller Companies Index excluding Investment Companies (NSCI (XIC)), the Company’s benchmark, produced a return of 19.5%. The Company’s net asset value total return was 22.1%, which reflects the return attributable to equity shareholders of 279.32p per Ordinary Share (2016: 65.82p), together with the effect of dividends received by them and reinvested. The share price generated a total return of 22.6%.
The Managers’ Report expands in more detail on 2017’s performance.
Dividends
The Board remains committed to a progressive dividend policy. In this context, the Board is pleased to propose a final ordinary dividend of 19.75p. Total ordinary dividends of 28.80p for 2017 represent a 5.3% increment when compared with 2016 and a level 51.6% above the 19.0p that was declared for 2010 in the immediate aftermath of the financial crisis.
I have included 2010 dividend levels and subsequent growth to attempt to bring some context to what has undoubtedly been a golden period for dividends from small UK quoted companies. To put this period into a historical context, long run data from the London Business School for the NSCI (XIC) would suggest dividends since 1955 have grown at 2.7% per annum in real terms.
In 2015 and 2016, alongside the ordinary dividend declared, the Company also paid a special dividend of 2.75p each year, thereby ensuring that the all-important minimum retention test imposed by HMRC was passed. The Board adopted such a strategy to avoid the pitfalls of allowing non-recurring revenue streams to become embedded into the progressive dividend policy, especially since special dividends and non-recurring distributions have been more prevalent following the financial crisis.
In 2017, the Company was once again a beneficiary of special dividends and, in particular, the decision from one of our investee companies to declare five dividends in 2017. This year, the Board will declare a special dividend of 6.70p per share alongside the total ordinary dividend of 28.80p to ensure the retention test is met.
The revenue return for the year was 41.59p (2016: 36.93p) per Ordinary Share. After adjusting for both the final ordinary and special dividends, the Company’s revenue reserves will be 59.5p per share, circa 2.1x the ordinary dividend; in 2010, revenue reserves were circa 1.3x the ordinary dividend. Strengthened revenue reserves, and prudent management of the non-recurring revenue streams of recent years, leave the Board optimistic that a progressive dividend policy can be delivered to Shareholders. 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 re-iterate my comments from previous years that the base level for the Company’s progressive dividend policy in 2018 is on the total ordinary dividend of 28.80p, i.e. excluding the special dividend.
Share buy-in
At the Annual General Meeting in March 2017, the authority to buy in up to 14.99% of the Company’s Ordinary Shares was approved. During the year, 1,404,155 Ordinary Shares (1.5% of the issued share capital) were bought in at a total cost of £18.1m. Consistent with the Board’s stated policy, those Ordinary Shares have been cancelled rather than held in Treasury. Once again, the Board will be seeking to renew the buy-in authority at the Annual General Meeting on 1 March 2018.
Within the broader Investment Companies universe, the UK Smaller Companies sub-sector has languished in rating terms, with discounts stuck in the low to mid-teen range. Currently, uncertainty about Brexit and politics appear to be trumping both economics and underlying corporate profitability. Against such a backdrop, 2017 witnessed a higher level of buy-ins than in previous years. At the margin, buy-ins provide an increase in liquidity for those Shareholders seeking to crystallise their investment and at the same time deliver an economic uplift for those Shareholders wishing to remain invested with the Company.
Gearing
It has been the Company’s policy to use gearing in a tactical manner throughout its 27 year history. The £125m facility with The Royal Bank of Scotland 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. The facility continues to provide the Company with access to liquidity for investment purposes and to fund share buy-ins as and when appropriate. In an illiquid, and at times volatile, asset class such as small UK quoted companies, having access to immediate funds through a credit facility provides the Managers with enhanced flexibility.
Board changes
David Jeffcoat, who has been a Director since July 2009 and Chairman of the Audit Committee since 2011, will not be standing for re-election at the forthcoming Annual General Meeting. David has made a great contribution to the Board, and his colleagues and the Managers will miss his incisive questioning. Shareholders can be grateful for his contribution over the past nine years. The Board wishes him all the very best for the future. A recruitment process, being run by the Board, is well advanced.
Outlook
Since becoming Chairman in October 2014, my January statement to Shareholders has regularly referred to the uncertain political environment. In this relatively short period, the Company has operated against a backdrop of two referendums and two general elections. Regrettably, 2018 feels like more of the same as a minority government seeks to make progress with the Brexit negotiations.
In economic terms, the environment has been more conducive as, despite a slowing UK economy, we have witnessed an acceleration and synchronisation of global growth – indeed, one might regard the biggest fear as being the extent of the consensus about the supportive conditions for further progress. Around the world, we have seen several central banks shift gears and raise interest rates. In financial markets, this has fuelled the debate between inflation and deflation to which I referred in last year’s statement. As a consequence, the tension between equity and bond valuations remains at the forefront of asset allocators’ minds. As with political uncertainties, I would envisage such tensions to be resolved over several years but their significance should not be underestimated for investment managers such as Aberforth Partners who follow a value investing style.
Over the past 12 months, the Company has produced a good result despite difficult conditions for the value investing style. As an asset class, small UK quoted companies have perhaps missed out, owing to politics and Brexit, on the sort of re-rating witnessed in the broader financial markets. As represented by the NSCI (XIC), they look to be selling at around a 34% price/earnings discount to their larger brethren. Since the Company’s formation in 1990, only the period during and in the aftermath of the Long Term Credit Management crisis in 1998 has this discount been meaningfully wider. Driven by the Managers’ value investing style, the Company’s portfolio provides additional valuation support.
There seems always to be the opportunity to comment on regulation, although in many years I resist the temptation. This year, however, sees the noteworthy introduction of the Key Information Document under the Packaged Retail and Insurance-based Investment Products Regulation. While this regulation is undoubtedly well intended, I share the concerns expressed by others that it may be some time before these rules achieve their intended objective, not least until the same rules apply consistently to open ended funds. I look forward to the year when no comment on the regulatory environment is possible.
The Board looks forward with cautious optimism, cognisant of the uncertain times prevailing but reassured by the consistency of approach and professionalism of the Managers.
Finally, the Board very much welcomes the views of Shareholders and we are available to talk to you directly. My email address is noted below and I extend my thanks to those of you who have been in touch with me over the past year.
Paul Trickett
Chairman
26 January 2018
paul.trickett@aberforth.co.uk
MANAGERS’ REPORT
Introduction
ASCoT rode the wave of rising equity valuations around the world in 2017 and delivered a strong performance in both absolute and relative terms. Its NAV total return was 22.1%, which may be compared with 19.5% for its benchmark, the NSCI (XIC), and with 13.1% for the FTSE All-Share index, which is a gauge of the performance of larger companies.
All of ASCoT’s relative gains were secured in the first half of the year: as the year progressed, conditions became more hostile to the value investor, details of which are provided in the Investment Performance section of this report. That the value style should have encountered such headwinds is at one level surprising. One of the most notable developments of 2017 was the synchronisation of economic recovery around the globe, with all major economies enjoying GDP growth for the first time since the financial crisis. While the rate of progress of the US economy eased, tax reform offers the prospect of renewed impetus. Meanwhile, Chinese activity benefited from a bout of stimulus and, perhaps more significantly, the Eurozone returned to growth as the impact of quantitative easing was finally felt. The broad trend of improvement was seized upon promptly by the equity markets and has been termed the “reflation tradeâ€.
Its sustainability was, however, brought into question by the words and actions of the world’s central banks, apparently keen to display their inflation-fighting credentials. Three interest rate rises in the US have been accompanied by commentary on how and when the Federal Reserve’s balance sheet, bloated by quantitative easing, might be run down. To date, the Eurozone has seen no action but plenty of rhetoric, while the UK has witnessed its first interest rate rise for ten years. It is to be hoped that the central banks are not too focused on fighting yesterday’s war and that they have judged the risks of runaway economic activity and inflation accurately. In this regard, a bit more nervousness on the part of government bond markets might have been encouraging: yields in 2017 were essentially unchanged and thus remain at extremely low levels in a historical context. The behaviour of bond investors suggests that the “reflation trade†is merely another of those false dawns to have punctuated the period since the financial crisis and that underlying economic issues of debt and demographics are so intractable as to condemn the world to very low rates of economic growth for years to come.
Such prospects are some of the factors contributing to the emergence of reactionary populism around the globe, though, again, bond investors appear little concerned by the inflationary effects of populist policies. To be fair, a useful test-case of populism, the UK’s EU referendum, has hardly been a cause of concern for bond markets. There was no implosion in the immediate aftermath of the vote, but the second order effects of sterling’s devaluation are now permeating the economy: inflation is picking up, real wages are coming back under pressure and to this extent the outlook for real growth is deteriorating. Though GDP growth forecasts should be taken with a pinch of salt, the trajectory that has taken the UK from the fastest growing G7 nation in 2014 to the slowest in 2017 is hardly encouraging. Meanwhile, the government is in a difficult position, undermined by the outcome of the general election, riven ideologically by differing views on the EU and inevitably focused on divorce negotiations.
Against this complicated background, investment in small UK quoted companies in 2017 was remarkably
straightforward. Leaving aside for now a small number of highly valued growth stocks, the most important issue was the split of exposure to those companies earning their profits overseas and those that rely on the domestic economy. To have had a lot of the former, which benefited from the weak pound and saw their profits expand to historically high levels, was a significant boost to investment returns. ASCoT was a beneficiary and its experience is described in the Investment Performance section of this report.
Investment Performance
ASCoT’s NAV total return in 2017 was 22.1%; the NSCI (XIC)’s was 19.5%. The table below analyses the difference between these two figures, while the subsequent paragraphs provide more detail on how ASCoT’s performance was achieved.
| For the 12 months ended 31 December 2017 | Basis points |
| Stock selection | 412 |
| Sector selection | (70) |
| ----- | |
| Attributable to the portfolio of investments, based on mid prices | 342 |
| (after transaction costs of 22 basis points) | |
| Movement in mid to bid price spread | (47) |
| Cash/gearing | 25 |
| Purchase of Ordinary Shares | 23 |
| Management fee | (79) |
| Other expenses | (6) |
| ----- | |
| Total attribution based on bid prices | 258 |
| ----- |
Note: 100 basis points = 1%. Total Attribution is the difference between the total return of the NAV and the Benchmark Index (i.e. NAV = 22.08%; Benchmark Index = 19.50%; difference is 2.58% being 258 basis points).
Style
The dynamics behind the “reflation trade†of 2017 should have been conducive to a strong relative performance from the value style. While this was indeed the case in the early months of the year, the growth style fought back as government bond yields failed to respond. For the year as a whole, analysis of data from both the London Business School (LBS) and Style Research points to significant headwinds for the value style; indeed, the LBS model suggests it was the ninth worst year since 1955. In this context, ASCoT’s positive relative performance might be considered so surprising as to call into question the Managers’ dedication to value investment. However, two other factors – size and sectors described below – offered mitigation and some strong individual stock selection numbers, as illustrated in the table above, helped the portfolio’s performance exceed that of the benchmark. The experience of 2017 also usefully illustrates the difference of approach between the third-party models and Aberforth in determining value: the former use only price to book, while the Managers’ methodology encompasses other valuation metrics, notably the ratio of enterprise value to earnings before interest, tax and amortisation. Nevertheless, the chance of ASCoT overcoming a repeat of such adverse conditions for the value style is not high.
Size
The size factor within the NSCI (XIC) was a slight boost to ASCoT’s returns in 2017. The NSCI (XIC) represents the bottom tenth of the UK stockmarket by value and includes companies with market capitalisations up to around £1.5 billion. It thus overlaps with the FTSE 250 index. At the start of 2017 this overlap represented 62% of the value of the NSCI (XIC). In 2017, the performance of the FTSE 250 stocks within the NSCI (XIC), its larger constituents, was very slightly behind that of its smaller constituents. This was to ASCoT’s advantage, albeit to a modest degree, since 59% of its portfolio was invested in “smaller small†companies at the start of the 2017. The reason for this disposition is the valuation premium accorded to larger companies and set out in the Valuation section of this report. While the superior returns from “smaller smalls†reduced their valuation advantage in 2017, it remains wide and with the bottom-up prospects for these businesses still positive, the portfolio enters 2018 in a familiar shape with regard to size.
Sectors
The crucial sector issue in 2017 was the divergent performance of overseas and domestic companies. As noted above, relative performance was improved by a comparatively high exposure to those companies earning their money outside the UK. At the start of the year, 47% of the aggregate sales of ASCoT’s portfolio holdings was generated overseas, more than the 41% for the NSCI (XIC). As a gauge of the benefit afforded by this positioning, the NSCI (XIC) may be divided into groups of sectors determined by where these sectors earn their money and the performance of these groups may be compared. The overseas group enjoyed a total return of 32% in 2017, whereas the domestic group’s return was 19%. Sterling’s weakness after the EU referendum explains the gap: the overseas group benefited from the translation of profits at more favourable exchange rates and almost two thirds of the companies therein have seen profit expectations for 2017 raised since the referendum; in contrast, the domestic group has had to contend with the impact of sterling on inflation and real wages, so that only one third of its companies has enjoyed higher estimates.
The net effect has been a widening valuation premium of overseas exposed companies to domestics, even though sterling itself was unchanged on a trade weighted basis in 2017. At the margin, this has motivated the Managers to bias purchases through the latter part of the year to the domestics, always taking into account the likelihood of more challenging trading conditions in the UK economy. However, experience suggests that the stockmarket is prone to overreact and when strong businesses with a domestic bias but attractive financial characteristics and defendable market positions are significantly de-rated the Managers are willing to commit capital. So far, this re-orientation of the portfolio, which is consistent with the application of a value investment philosophy, has been modest, with the portfolio at the start of 2018 still generating 46% of its aggregate sales from overseas.
Stocks
In 2017’s challenging environment for the value style, the portfolio’s exposure to “smaller small†companies and to overseas earners offered some mitigation. However, stock selection also played an important role, as the table at the top of this section makes clear. In last year’s Managers’ Report, it was argued that “for ASCoT to generate superior returns for its shareholders, getting more investment decisions right than wrong … probably does the jobâ€. While over time the Managers’ investment approach and experience can hopefully ensure that this deceptively unambitious target is met, it is fair to state that good fortune played a part in the high stock contribution in 2017. Despite an uptick in profit warnings across the stockmarket as the year progressed, ASCoT encountered few serious declines in share prices and, on the other hand, saw its patience rewarded with unusually large rises in the valuations of some of the long-standing holdings into which capital had been fed steadily over time.
Additionally, the stockmarket offered several opportunities to take advantage of the de-ratings of previously inherently strong but highly valued businesses whose trading difficulties had precipitated substantial share price falls. While holdings in these businesses were taken with a five year investment horizon, in some cases the actual holding period proved much shorter as trading improved and the stockmarket chose once again to re-rate the prospects of the company in question. When the stockmarket will yield such opportunities in the future is uncertain. What is certain is that there will be years in which, despite the consistent application of the value investment philosophy through a seasoned investment process, stock selection will prove as unrewarding as it was rewarding in 2017.
Corporate activity
With 17 bids for NSCI (XIC) constituents completed or outstanding at the end of the year, M&A activity in 2017 was at a similar level to that of 2016. Both these years undershot the 27 deals that took place in 2015 and it is tempting to attribute some of the slowdown since then to the uncertainties stemming from the EU referendum, even though the weakness of sterling ought to add to the appeal of UK assets to overseas buyers. Of the 17 bid situations, ASCoT held six, though in three cases the announcement of the approach and thus the boost to the share prices came at the end of 2016. Overall, M&A was a very small boost to returns in 2017.
The number of initial public offerings in 2017 was 21, which represents a modest rise on the previous year. ASCoT does not often participate in IPOs but did take part in two of the 2017 deals. In both cases, the Managers judged that the valuation offered sufficient compensation for the informational advantage usually enjoyed by the private equity sellers of the businesses.
Balance sheets
For much of the last ten years, the small UK quoted company universe has been characterised by strong and
strengthening balance sheets, which inevitably reflected the impact of the financial crisis on the thinking of company directors. In the last three years, however, there have been indications of less caution. In the case of ASCoT’s portfolio, this is manifest in the proportion of the portfolio that is invested in companies with net cash on their balance sheets, which has declined from 35% in 2014 to 21% at the end of 2017. For the Managers, this development is on balance positive, since it is driven by more investment, returns of surplus cash and, though not to be welcomed in every case, acquisitions. Clearly, however, higher leverage brings risks, particularly if it coincides with an economic downturn. Comfort may be derived from the portfolio’s bias to businesses with less than two times leverage (net debt divided by earnings before interest, tax, depreciation and amortisation), which was almost 75% at the end of 2017. Those with higher leverage ratios tend to be property companies, though the portfolio always has some exposure to more highly indebted businesses where the potential upside justifies the additional risk.
Income
The table below splits the portfolio’s holdings into categories that are determined by each company’s most recent dividend announcement. The profile is familiar from similar analyses in recent years: a small minority of dividend cutters, the persistence of several nil payers and a bias to companies that most recently increased their dividends. The “Other†category includes companies that have returned to the dividend register or that have paid dividends for the first time and that therefore do not have a meaningful comparative payment in the previous year.
| Down | Nil payers | No change | Increase | Other |
| 7 | 13 | 22 | 41 | 3 |
The portfolio’s dividend experience reflects what remains a buoyant backdrop for dividends across the universe of small UK quoted companies. Robust balance sheets and dividend cover of 2.8x for the portfolio, are supportive of further increases, though it would seem likely that the rate of dividend growth across the NSCI (XIC) is moderating from the low double digits of recent years to mid to high single digits. However, in comparison with inflation, this degree of progress remains well above the 62 year average real dividend growth from smaller companies of 2.7%.
Turnover
Portfolio turnover in 2017 was 22%, which is up from 17% in 2016. It is often the case that headline turnover is
influenced by situations in which ASCoT is effectively required to sell, notably through an M&A approach or when an investee company grows too large for continued inclusion in the NSCI (XIC). Adjusting for these, underlying turnover in 2017 was 17%, compared with 12% in 2016. This increase was correlated with the improvement in investment performance. Consistent with their value investment philosophy, the Managers strive to rotate capital from holdings that have performed well and are close to their target valuations into companies with depressed valuations and greater upside. This basic dynamic ought to benefit returns, but it can only be put into action if the broad stockmarket is inclined to re-rate ASCoT’s holdings, as was the case in 2017.
Active share
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 end of December the ratio was 77% (2016:76%).
Valuations
The strength of equity markets in 2017 has seen valuations rise and, as the table below sets out, the universe of small UK quoted companies has participated in this trend. The 14.3x PE of the NSCI (XIC) at the end of December was 6% above its average since 1990 of 13.5x, while the 12.5x PE of ASCoT’s portfolio was 4% above its 12.0x long term average. While neither the asset class nor the portfolio is significantly above normal, the same cannot be claimed of large companies. The historical PE of the FTSE All-Share at the end of 2017 was 21.7x, which is 42% above its average since 1990. This PE reflects the implicit expectation of strong profit growth from large companies in coming months, helped by the translation of overseas profits at lower sterling exchange rates, by the restructuring undertaken in recent times by resources companies and by the effect of rising commodity prices on these companies’ profits.
| Characteristics | 31 December 2017 | 31 December 2016 | ||
| ASCoT | NSCI (XIC) | ASCoT | NSCI (XIC) | |
| Number of companies | 86 | 350 | 87 | 349 |
| Weighted average market capitalisation | £712m | £878m | £617m | £800m |
| Price earnings ratio or PE (historic) | 12.5x | 14.3x | 11.3x | 12.5x |
| Dividend yield (historic) | 2.9% | 2.8% | 3.0% | 2.8% |
| Dividend cover | 2.8x | 2.5x | 3.0x | 2.9x |
The following table sets out the forward valuations of ASCoT’s portfolio and the tracked universe, which is the set of stocks covered closely by the Managers and represents 97% by value of the NSCI (XIC). The valuation metric – the ratio of enterprise value to earnings before interest, tax and amortisation (EV/EBITA) – is the one favoured by the Managers. As should be expected of a portfolio put together in accordance with a value investment philosophy, ASCoT’s holdings are cheaper than the tracked universe as a whole and much cheaper than a subset of 44 growth stocks: at the end of December, the premium of the growth stocks to the portfolio was 74% on the basis of 2018 estimates.
| EV/EBITA | 2017 | 2018 | 2019 |
| ASCoT | 12.1x | 10.4x | 9.0x |
| Tracked universe (285 stocks) | 14.2x | 12.8x | 11.3x |
| - 44 growth stocks | 21.8x | 18.1x | 16.0x |
| - 241 other stocks | 13.2x | 12.0x | 10.6x |
The final valuation table highlights a valuation anomaly that has persisted for several years. Despite the superior returns from “smaller small†companies in 2017, the lowest valuations in the UK stockmarket are still accorded to the smallest companies and, as a consequence, ASCoT’s exposure to those companies is higher than that of the NSCI (XIC) as a whole. In the Managers’ experience, the present relationship is unusual: in the years before the financial crisis, the superior growth of “smaller small†companies tended to be rewarded by higher valuations. However, many investors are today nervous about illiquidity and are reluctant to commit to the stockmarket’s smaller denizens. ASCoT’s status as a closed end fund allows it to take a longer term view, a strategy that paid off in 2017.
| Market capitalisation range: | >£100m | £100-250m | £250-500m | £500-750m | >£750m |
| Portfolio weight | 3% | 15% | 25% | 22% | 35% |
| Tracked universe weight | 1% | 5% | 18% | 15% | 61% |
| Tracked universe 2018 EV/EBITA | 7.4x | 10.3x | 11.4x | 12.2x | 13.9x |
Conclusion & outlook
In broad terms, today’s universe of small UK quoted companies can be split into three groups, a framework that has been useful for the majority of time since the financial crisis.
• The first comprises secular growth companies, whose valuations benefit from the low discount rates that encourage investors to extend their investment horizons well beyond historical norms. Decent memories are now required of the last time that capital became effectively costless for growth companies during the TMT boom. This is not to deny the existence of some truly outstanding business franchises among the technology behemoths of the US and China or even, indeed, within the NSCI (XIC). However, experience suggests that capital does not remain costless indefinitely, that many growth businesses are being valued as if they are the next Amazon and that few businesses succeed in retaining high stockmarket valuations for extended periods.
• The second group comprises companies whose growth is low but dependable and that tend to pay out a large proportion of their profits as dividends. Before the financial crisis these would have been described pejoratively as “dull†or “ersatz bonds†and, condemned to low valuations, might have fitted into a value portfolio. However, since the advent of quantitative easing with its suppressive effect on bond yields, the increasingly desperate search for income has seen them re-rated to high valuations.
• The final group is everything else – the rump of companies that are lowly valued, typically cyclical, often reliant on the domestic economy, sometimes illiquid and thus uncomfortable for many investors to own. None of these characteristics means that these are all poor businesses that face an existential threat. Some will undoubtedly fall victim to the forces of disruption and these are to be avoided, unless prevailing valuations exaggerate the rate of decline and offer an opportunity for investment. However, many members of this group boast defendable market positions, volatile but good returns on capital through the cycle and the opportunity to grow though not necessarily year-in-year-out. For better or worse, these are the typical holdings of a small cap value fund just now.
An implication of this characterisation is that the big-picture issues of macroeconomics, government bond yields and politics are at present disproportionately influential on the valuations of the three groups that make up the universe of small UK quoted companies. The uncertainties stemming from the EU referendum play a part, but the more significant influence remains the extraordinary monetary policies that anchor bond yields in many parts of the world at very low levels. As long as this continues to be the case, issues specific to individual businesses are likely to play a secondary role in determining ASCoT’s returns, though the experience of 2017 suggests that stock selection can make a difference with the help of some good fortune.
So what might move the world’s major bond markets? A year ago, a reasonable response, though one that appeared unlikely to come to pass, might have mentioned a bout of synchronised global growth accompanied by higher inflation, tax cuts for the world’s largest economy and monetary tightening. And yet government bond markets are unyielding. Perhaps in the face of a decades-long bull market in bonds, which has only intensified since the financial crisis, more convincing evidence is required and perhaps 2017’s “reflation trade†will be condemned to the same fate as 2013’s “great rotationâ€. Financial markets certainly remain set up for more of the same: corporate bond spreads are extremely narrow, equity markets are led by a small number of beneficiaries of low rates and, to judge by the world of small UK quoted companies, funds tend to be heavily biased to those favourite stocks. With its commitment to value investment, ASCoT continues to stand apart and in doing so is arguably as relevant as at any point in its 27 year history.
Aberforth Partners LLP
Managers
26 January 2018
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
Paul Trickett
Chairman
26 January 2018
PRINCIPAL RISKS AND RISK MANAGEMENT
The Board carefully considers 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 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 will typically differ from the performance of the benchmark and will be influenced by 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.
(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. The Board intends to continue to buy in shares as stated in the Chairman’s Statement.
(iii) Gearing risk – in rising markets, gearing will enhance returns; however, in falling markets the gearing effect will adversely affect returns to Shareholders. The Board and the Managers consider the gearing strategy and associated risk on a regular basis.
(iv) Reputational risk – 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 Board also closely monitors political developments and, in particular, is mindful of the uncertainty following the UK referendum result to leave the EU.
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 2017
(audited)
| For the year ended | For the year ended | |||||
| 31 December 2017 | 31 December 2016 | |||||
| Revenue | Capital | Total | Revenue | Capital | Total | |
| £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | |
| Net gains on investments | - | 232,376 | 232,376 | - | 29,674 | 29,674 |
| Investment income | 43,676 | - | 43,676 | 39,027 | 5,229 | 44,256 |
| Other income | 1 | - | 1 | 46 | - | 46 |
| Investment management fee | (3,615) | (6,026) | (9,641) | (3,111) | (5,185) | (8,296) |
| Portfolio transaction costs | - | (2,651) | (2,651) | - | (1,925) | (1,925) |
| Other expenses | (750) | - | (750) | (689) | - | (689) |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Net return before finance costs and tax | 39,312 | 223,699 | 263,011 | 35,273 | 27,793 | 63,066 |
| Finance costs | (249) | (415) | (664) | (254) | (424) | (678) |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Return on ordinary activities | 39,063 | 223,284 | 262,347 | 35,019 | 27,369 | 62,388 |
| before tax | ||||||
| Tax on ordinary activities | - | - | - | (36) | - | (36) |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Return attributable to | ||||||
| equity shareholders | 39,063 | 223,284 | 262,347 | 34,983 | 27,369 | 62,352 |
| ====== | ======= | ======= | ====== | ======= | ======= | |
| Returns per Ordinary Share | 41.59p | 237.73p | 279.32p | 36.93p | 28.89p | 65.82p |
The Board declared on 26 January 2018 a final dividend of 19.75p per Ordinary Share and a special dividend of 6.70p per Ordinary Share. The Board also declared on 27 July 2017 an interim dividend of 9.05p 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 2017
(audited)
| Capital | ||||||
| Share | redemption | Special | Capital | Revenue | ||
| Capital | reserve | reserve | reserve | reserve | Total | |
| £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | |
| Balance as at 31 December 2016 | 944 | 44 | 166,343 | 983,250 | 69,647 | 1,220,228 |
| Return on ordinary activities after taxation | - | - | - | 223,284 | 39,063 | 262,347 |
| Equity dividends paid | - | - | - | - | (28,791) | (28,791) |
| Purchase of Ordinary Shares | (14) | 14 | (18,142) | - | - | (18,142) |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Balance as at 31 December 2017 | 930 | 58 | 148,201 | 1,206,534 | 79,919 | 1,435,642 |
| ====== | ====== | ====== | ====== | ====== | ====== |
For the year ended 31 December 2016
(audited)
| Capital | ||||||
| Share | redemption | Special | Capital | Revenue | ||
| Capital | reserve | reserve | reserve | reserve | Total | |
| £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | £ 000 | |
| Balance as at 31 December 2015 | 950 | 38 | 172,625 | 955,881 | 62,385 | 1,191,879 |
| Return on ordinary activities after taxation | - | - | - | 27,369 | 34,983 | 62,352 |
| Equity dividends paid | - | - | - | - | (27,721) | (27,721) |
| Purchase of Ordinary Shares | (6) | 6 | (6,282) | - | - | (6,282) |
| -------- | -------- | -------- | -------- | -------- | -------- | |
| Balance as at 31 December 2016 | 944 | 44 | 166,343 | 983,250 | 69,647 | 1,220,228 |
| ====== | ====== | ====== | ====== | ====== | ====== |
BALANCE SHEET
As at 31 December 2017
(audited)
| 31 December | 31 December | |
| 2017 | 2016 | |
| £ 000 | £ 000 | |
| Fixed assets | ||
| Investments at fair value through profit or loss | 1,440,496 | 1,253,247 |
| ---------- | ---------- | |
| Current assets | ||
| Debtors | 3,649 | 2,881 |
| Cash at bank | 293 | 241 |
| ---------- | ---------- | |
| 3,942 | 3,122 | |
| Creditors (amounts falling due within one year) | (199) | (36,141) |
| ---------- | ---------- | |
| Net current assets/(liabilities) | 3,743 | (33,019) |
| ---------- | ---------- | |
| Total Assets less Current Liabilities | 1,444,239 | 1,220,228 |
| Creditors (amounts falling due after more than one year) | (8,597) | - |
| ---------- | ---------- | |
| Total Net Assets | 1,435,642 | 1,220,228 |
| ======= | ======= | |
| Capital and reserves: equity interests | ||
| Called up share capital | 930 | 944 |
| Capital redemption reserve | 58 | 44 |
| Special reserve | 148,201 | 166,343 |
| Capital reserve | 1,206,534 | 983,250 |
| Revenue reserve | 79,919 | 69,647 |
| ---------- | ---------- | |
| Total Shareholders’ Funds | 1,435,642 | 1,220,228 |
| ======= | ======= | |
| Net Asset Value per Ordinary Share | 1,543.72p | 1,292.57p |
CASH FLOW STATEMENT
For the year ended 31 December 2017
(audited)
| 31 December 2017 | 31 December 2016 | |||
| £’000 | £’000 | |||
| Operating activities | ||||
| Net revenue before finance costs and tax | 39,312 | 35,273 | ||
| Tax recovered | - | 23 | ||
| Receipt of special dividends taken to capital | - | 5,229 | ||
| Investment management fee charged to capital | (6,026) | (5,185) | ||
| Increase in debtors | (768) | (215) | ||
| Decrease in other creditors | (17) | (40) | ||
| -------- | -------- | |||
| Net cash inflow from operating activities | 32,501 | 35,085 | ||
| ===== | ===== | |||
| Investment activities | ||||
| Purchases of investments | (301,163) | (231,112) | ||
| Sales of investments | 343,405 | 201,136 | ||
| -------- | -------- | |||
| Cash inflow/(outflow) from investment activities | 42,242 | (29,976) | ||
| ===== | ===== | |||
| Financing activities | ||||
| Purchase of Ordinary Shares | (18,142) | (6,282) | ||
| Equity dividends paid | (28,791) | (27,721) | ||
| Interest and fees paid | (758) | (640) | ||
| Net (repayment)/drawdown of bank debt facilities (before any costs) |
(27,000) | 28,750 | ||
| -------- | -------- | |||
| Cash outflow from financing activities | (74,691) | (5,893) | ||
| ===== | ===== | |||
| Change in cash during the period | 52 | (784) | ||
| ===== | ===== | |||
| Cash at the start of the period | 241 | 1,025 | ||
| Cash at the end of the period | 293 | 241 | ||
| ====== | ====== | |||
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 2014, updated in January 2017. 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. DIVIDENDS
| Year to 31 December 2017 £000 |
Year to 31 December 2016 £000 |
|
| Amounts recognised as distributions to equity holders in the period: | ||
| Final dividend for the year ended 31 December 2016 of 18.75p (2015: 17.85p) paid on 3 March 2017 | 17,696 | 16,962 |
| Special dividend for the year ended 31 December 2016 of 2.75p (2015: 2.75p) paid on 3 March 2017 | 2,595 | 2,613 |
| Interim dividend for the year ended 31 December 2017 of 9.05p (2016: 8.60p) paid on 24 August 2017 | 8,500 | 8,146 |
| ------------ | ------------ | |
| 28,791 | 27,721 | |
| ------------ | ------------ | |
The 6.70p special and 19.75p final dividend for the year ended 31 December 2017 will be paid, subject to shareholder approval, on 6 March 2018. These dividends have not been included as a liability in these financial statements.
3. RETURNS PER ORDINARY SHARE
The returns per Ordinary Share are based on:
| Year to 31 December 2017 | Year to 31 December 2016 | |
| Returns attributable to Ordinary Shareholders | £ 262,347,000 | £ 62,352,000 |
| Weighted average number of shares in issue during the year |
93,923,545 | 94,730,414 |
| Return per Ordinary Share | 279.32p | 65.82p |
There are no dilutive or potentially dilutive shares in issue.
4. 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 2017 |
Level 1 £’000 |
Level 2 £’000 |
Level 3 £’000 |
Total £’000 |
||||
| Listed equities | 1,440,496 | - | - | 1,440,496 | ||||
| Unlisted equities | - | - | - | - | ||||
| ------------ | ------------ | ------------ | ------------ | |||||
| Total financial asset investments | 1,440,496 | - | - | 1,440,496 | ||||
| ------------ | ------------ | ------------ | ------------ | |||||
| As at 31 December 2016 | Level 1 £’000 |
Level 2 £’000 |
Level 3 £’000 |
Total £’000 |
| Listed equities | 1,253,247 | - | - | 1,253,247 |
| Unlisted equities | - | - | - | - |
| ------------ | ------------ | ------------ | ------------ | |
| Total financial asset investments | 1,253,247 | - | - | 1,253,247 |
| ------------ | ------------ | ------------ | ------------ |
5. 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 2017 | 31 December 2016 | |
| Net assets attributable | £1,435,642,000 | £1,220,228,000 |
| Ordinary Shares in issue at the end of the year | 92,999,137 | 94,403,292 |
| Net asset value per Ordinary Share | 1,543.72p | 1,292.57p |
6. SHARE CAPITAL
During the year, the Company bought in and cancelled 1,404,155 shares (2016: 620,500) at a total cost of £18,142,000 (2016: £6,282,000). During the period 1 January to 26 January 2018, the Company bought in and subsequently cancelled 67,000 shares at a cost of £912,000.
7. 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.
8. 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 2016, 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 on 1 February 2018. 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 – 26 January 2018
ANNOUNCEMENT ENDS
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