Annual Financial Report
KEYSTONE INVESTMENT TRUST PLC
ANNUAL FINANCIAL REPORT ANNOUNCEMENT
FOR THE YEAR ENDED 30 SEPTEMBER 2018
FINANCIAL INFORMATION AND PERFORMANCE STATISTICS
Performance Statistics
| 2018 % CHANGE |
2017 % CHANGE |
|||
| Total Return(1)(3) (dividends reinvested) | ||||
| Net asset value (NAV)(2) | 0.0 | +7.8 | ||
| Share price | +0.8 | +3.2 | ||
| FTSE All-Share Index(4) | +5.9 | +11.9 | ||
| AT 30 SEPTEMBER 2018 |
AT 30 SEPTEMBER 2017 |
% CHANGE |
||
| Capital Statistics | ||||
| Net assets (£’000) | 266,146 | 275,387 | –3.4 | |
| NAV(2)(3) per share | 1,921.7p | 1,979.9p | –2.9 | |
| Share price(1) | 1,685.0p | 1,730.0p | –2.6 | |
| FTSE All-Share Index(1)(4) | 4,127.9p | 4,049.9 | +1.9 | |
| Discount(3) of share price to NAV(2) per share | 12.3% | 12.6% | ||
| Gearing from borrowings(3) – gross | 12.0% | 11.6% | ||
| Gearing from borrowings(3) – net | 11.6% | 6.6% | ||
| FOR THE YEAR TO 30 SEPTEMBER | ||||
| 2018 | 2017 | |||
| Revenue Statistics | ||||
| Net revenue available for ordinary shareholders (£’000) | 7,552 | 8,316 | ||
| Revenue return per ordinary share | 55.90p | 61.50p | –9.1 | |
| Dividends per ordinary share – first interim | 18.00p | 18.00p | ||
| Dividends per ordinary share – second interim | 38.00p | 37.00p | ||
| 56.00p | 55.00p | +1.8 | ||
| Dividends per ordinary share – special | 1.75p | 4.70p | ||
| Dividends per ordinary share – total | 57.75p | 59.70p | ||
| Ongoing charges(3): | ||||
| Excluding performance fee | 0.54% | 0.61% | ||
| Performance fee | 0.00% | 0.00% | ||
(1) Source: Refinitiv (Thomson Reuters).
(2) Figures with debt at fair value.
(3) Defined in the Glossary of Terms and Alternative Performance Measures on page 66.
(4) The benchmark index of the Company.
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CHAIRMAN’S STATEMENT
Performance
The total return to shareholders over the year to 30 September 2018 was 0.8%, based on the share price. It is disappointing that this was again behind our benchmark, the FTSE All-Share Index, which posted a total return of 5.9%. The total return on the underlying net asset value (NAV) per share was 0.0% with debt at fair value.
The three year performance now lags significantly behind our benchmark, with NAV total return performance of 13.3% compared with 38.4% for the FTSE All-Share Index, and the Board recognises that this will be very disappointing for shareholders.
The Manager’s Report section of the Strategic Report provides a review of market and portfolio performance during the year and the portfolio manager’s view of the outlook. Overall, market conditions have been challenging and have not favoured the Company’s UK focus and the portfolio manager’s valuation driven approach. Although there were some strong performances from holdings in the portfolio, these were offset by others where stock specific factors had a significant negative impact, such as N Brown, TP ICAP, McBride and Barclays. In addition, being underweight in commodity stocks adversely affected the Company’s performance relative to the benchmark. However, the Board continues to support the portfolio manager’s convictions about investing in well-positioned and attractively valued companies and the portfolio’s tilt towards UK domestic cyclicals in anticipation of a change in market sentiment post Brexit.
The weighted average discount of the investment companies in the UK All Companies sector narrowed marginally but remained wide through the year. It was 9.5% at 30 September 2018 compared with 9.7% at 30 September 2017 (source: JP Morgan Cazenove). The average discount at which the Company’s ordinary shares traded relative to their underlying NAV (with debt at fair value) over the past year widened to 11.4%, from 10.6% last year. At the year end the share price stood at a discount of 12.3% to the NAV (debt at fair value), a slight improvement from 30 September 2017.
Revenue and Dividends
The revenue return after tax for the year was 55.9p per ordinary share, down from last year’s 61.5p per share. The portfolio’s overall yield has moderated a little following its realignment last year, with a few of the higher yielding stocks having been sold or reduced. The more significant changes in this respect included the sales of pharmaceuticals Roche and Novartis and the reduction in tobacco holdings following the merger of British American Tobacco and Reynolds American. This was compounded by a significant reduction this year in special dividends received. Market expectations for future revenue returns from companies in the portfolio are positive.
The Board has declared a second interim dividend, in lieu of a final, of 38p per share (2017: 37p), with a small element funded from revenue reserve, giving a total dividend for the year of 56p per share (2017: 55p). This equates to a yield of 3.3% at 30 September 2018, which compares favourably with the UK All Companies sector average of 2.0% (source: JP Morgan Cazenove), and also extends the Company’s record of either increasing or maintaining the level of ordinary dividends each year since 1976. The dividend will be paid on 21 December 2018 to shareholders on the register on 30 November 2018.
Special dividends received from investee companies have continued to decline, as I have cautioned in my statements in the past few years. These dividends totalled £236,000, the equivalent of 1.75p per share, this year (2017: £643,000; 4.7p). Although the amount is modest, the Board has decided again to pass this on to shareholders as a special dividend of 1.75p (2017: 4.7p). The special dividend will be paid at the same time as the second interim dividend.
The Board
After serving on the Board for over 15 years, eight of these as Chairman, I will retire at the conclusion of the forthcoming annual general meeting. After due consideration of the composition of the Board and the Company’s ongoing succession plan, the Directors agreed that Karen Brade, who was appointed to the Board on 18 January 2018, should be appointed as the Company’s new Chairman. The Board believes that her broad investment experience in a range of sectors and markets and as a non-executive director provide her with the appropriate skills to lead the Company. I wish her, the Board and the Company every success for the future.
Gearing
The Board takes responsibility for the Company’s gearing strategy and sets parameters within which the Manager operates. The Board reviews the limit to which the Manager may gear the portfolio at every Board meeting. During the course of the year the Board granted the Manager greater latitude, increasing, in stages, the level of net gearing that can be used from 7.5% to 15% of net assets. The Manager has discretion on where to set the portfolio’s exposure subject to the limits set by the Board. At the year-end net gearing stood at 11.6% compared with 6.6% a year ago. The Company has fixed borrowing in the form of long-term debentures that amount to £32 million, and has also arranged with The Bank of New York Mellon an overdraft facility of up to £15 million that can be used for investment purposes. The net gearing of the Company is determined by the extent to which borrowings are invested.
Fraud Warning
As mentioned in the Company’s 2018 half year report, the Board reiterates its message to investors to remain vigilant of unsolicited telephone calls and correspondence from people purporting to be connected to the Company and offering services not related to the Company’s actual business. These people do not work for either the Company or Invesco, and are seeking fraudulently to extract payments. The Company and Invesco would never contact shareholders or members of the public in this way, or require any type of upfront payment. If you suspect you have been approached by fraudsters, please contact the FCA Consumer Helpline on 0800 111 6768 and Action Fraud on 0300 123 2040. Further details on reporting frauds, or attempted frauds, can be found on page 64.
Outlook
As it has throughout the year, the Board continues to monitor investment performance closely and, with advice and guidance from the Company’s corporate broker, Numis, to consider distribution and other initiatives that could help to improve the demand for and liquidity of the shares, and hence the discount at which they trade. Although the outlook for the UK remains uncertain, not least because of Brexit, the Board is confident that James Goldstone, employing his differentiated investment approach anchored in value, has positioned the portfolio to generate worthwhile returns over time and enable the Company to fulfil its investment objective to provide shareholders with long-term growth of capital.
AGM
The Notice of the AGM of the Company is on pages 60 to 63 and a summary of the resolutions is set out in the Directors’ Report on pages 58 and 59. The AGM will be held on 22 January 2019 at
43-45 Portman Square, London W1H 6LY at 11.00am and shareholders are cordially invited to attend.
The Board has carefully considered all the resolutions proposed in the Notice and, in their opinion, consider them to be in the interests of the shareholders as a whole. The Directors and the portfolio manager, James Goldstone, will be available at the meeting to answer shareholders’ questions.
Beatrice Hollond
Chairman
26 November 2018
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STRATEGIC Report
for the year ended 30 September 2018
Business Review
Keystone Investment Trust plc is an investment company holding investments with a market value in excess of £290 million and its investment objective is set out below. The strategy the Board follows to achieve that objective is to set investment policy and risk guidelines, together with investment limits, and to monitor how they are applied. These are also set out below.
The business model adopted by the Company to achieve its objective has been to contract the services of Invesco Fund Managers Limited (the ‘Manager’) to manage the portfolio in accordance with the Board’s strategy and under its oversight. The Manager also provides company secretarial, marketing and general administration services. The portfolio manager responsible for the day-to-day management of the portfolio is James Goldstone.
All administrative support is provided by third parties under the oversight of the Board. In addition to the management and administrative functions of the Manager, the Company has contractual arrangements with Link Asset Services as registrar and The Bank of New York Mellon (International) Limited (BNYMIL) as depositary and custodian. BNYMIL became the depositary following novation of the depositary agreement from BNY Mellon Trust & Depositary (UK) Limited on 1 December 2017. The transfer has had no substantive effect on the services received by the Company. BNYMIL is also the Company’s bank.
Investment Objective and Policy
Investment Objective
The Company’s objective is to provide shareholders with long-term growth of capital, mainly from UK investments.
Investment Policy and Risk
The portfolio is invested by the Manager so as to maximise exposure to the most attractive sectors and stocks within the UK stock market and, within the limits set out below, internationally. The Manager does not set out to manage the risk characteristics of the portfolio relative to the benchmark index and the investment process will result in potentially very significant over or underweight positions in individual sectors versus the benchmark.
The Manager controls stock-specific and sector risk by ensuring that the portfolio is always appropriately diversified. In depth, continual analysis of the fundamentals of investee companies allows the portfolio manager to assess the financial risks associated with any particular stock. The portfolio is typically made up of 50 to 80 stocks. If a stock is not considered to be a good investment, then the Company will not own it, irrespective of its weight in the index.
Investment Limits
The Board has prescribed the following limits on the investment policy, all of which are at time of investment unless otherwise stated:
– no single equity investment in a UK listed company may exceed 12.5% of gross assets;
– the Company will not invest more than 15% of its assets in other listed investment companies;
– the Company will not invest more than £12 million in bonds, with a maximum of £1.5 million in any issue;
– the Company will normally not invest more than 5% of gross assets in unquoted investments;
– the Company will not normally invest more than 15% of its equity investments in companies that are not UK listed and incorporated; and
– borrowing may be used by the Company to create gearing within limits determined by the Board.
Gearing Policy
The Board takes responsibility for the Company’s gearing strategy and sets parameters within which the Manager operates. The Company has fixed borrowing, in the form of long-term debentures that amount to £32 million, and also has an uncommitted overdraft facility from BNYMIL of up to £15 million that can be used for investment purposes. The net gearing of the Company is determined by the extent to which borrowings are invested. The Board reviews the limit to which the Manager may gear the portfolio at every Board meeting. During the course of the year the Board granted the Manager greater latitude on gearing, increasing, in stages, the level of net gearing that can be used from 7.5% to 15% of net assets. The Manager has discretion as to how much borrowing is utilised within the limits set by the Board. At the year end net gearing stood at 11.6%.
Foreign Exchange
The Company has some non-sterling denominated investments and is therefore subject to foreign exchange risk. The Board monitors foreign currency exposure and takes a view, from time to time, on whether foreign currency exposure should be hedged. During the year, the Board had prescribed that all currency exposure should be hedged other than US dollar and Swiss franc. Since the year end the Board has determined that Canadian dollars will also not be hedged.
Performance
Delivery of shareholder value is achieved through outperformance of the relevant benchmark.
The Board reviews performance by reference to a number of Key Performance Indicators that include the following:
• net asset value (NAV) and share price total return compared with benchmark and peer group performance;
• share price premium/discount relative to the net asset value;
• dividends; and
• ongoing charges.
The Company’s NAV and share price total returns for the year to 30 September 2018 were 0.0% and 0.8% respectively, both of which were less than the total return of the Company’s benchmark, the FTSE All-Share Index, of 5.9%. The Manager’s Report on pages 12 to 15 provides commentary on the reasons for the performance.
As a result of the Company’s NAV total return underperformance against the benchmark, no performance fee has been earned for the year.
A table of the returns for the last ten years, together with a graph, can be found on page 3.
Peer group performance is monitored by comparing the Company with the 14 investment companies making up the UK All Companies sector. As at 30 September 2018, in NAV total return terms, the Company was ranked 12th in its sector over one year, 12th over three years and 8th over 5 years (source: JPMorgan Cazenove). The Board also compares the Company to a bespoke list of investment companies which the Board considers to be its nearest peers.
The Company’s shares traded at a discount relative to NAV (with debt at fair value) through the year, as shown in the following graph. The discount at the year end was 12.3%.
Although the board has the authority to buy back shares, it has preferred not to do so. The Board believes that there is mixed evidence on whether buybacks will actually close the discount if an investment style is out of favour. The Board is cognisant that the Company’s shares are likely to trade on a relatively wide discount until there is more certainty around the macro backdrop and in particular the UK's exit from the European Union.
With advice and guidance from the Company’s corporate broker, Numis, the Board continues to consider distribution and other initiatives that could help to improve the demand for and liquidity of the shares, and hence the discount at which they trade.
Dividends form a key component of the total return to shareholders. The income from the portfolio and potential level of dividend payable is reviewed at every board meeting. The Board’s Dividend Payment Policy is for the Directors to declare two dividends in respect of each accounting year, with a payment in each of the second and fourth calendar quarters. Additional special dividends may be declared, at the discretion of the Directors.
A first interim dividend of 18p (2017:18p) per share was paid on 15 June 2018 and a second interim dividend of 38p (2017: 37p) per share has been declared, which is payable on 21 December 2018 to shareholders on the register at 30 November 2018. These give a total ordinary dividend for the year of 56p compared with 55p for the previous year. The Board has also declared a special dividend of 1.75p (2017: 4.7p) to be paid at the same time as the second interim dividend. The dividend history of the Company over the last ten years is shown in the table on page 3.
The ongoing charge is the industry measure of the Company’s operating costs as a percentage of net asset value. The expenses of the Company are reviewed at every board meeting, with the aim of managing costs incurred and their impact on performance. The ongoing charges figure for the past year was 0.54%, compared with 0.61% for the year to 30 September 2017. No performance fee was payable in respect of either year. The ten year record of ongoing charges is shown on page 3.
Financial Position
At 30 September 2018, the Company’s net assets were valued at £266 million (2017: £275 million). These comprised a portfolio of mainly equity investments and net current assets.
At this and the previous year end, the Company’s ordinary shares were geared by borrowings in the form of two issues of long-term debentures, totalling £32 million nominal. Their weighted average interest rate was 6.77% for both years. The Company also had £0.25 million of 5% cumulative preference shares in issue.
In addition, the Company has an uncommitted overdraft facility of up to £15 million with an interest rate of 0.75% over base rate. No amounts were drawn down at the year end (2017: none).
Outlook and Future Trends
The main trends and factors likely to affect the future development, performance and position of the Company’s business can be found in the Manager’s Report section of this Strategic Report. Further details as to the risks affecting the Company are set out below under ‘Principal Risks and Uncertainties’.
Principal Risks and Uncertainties
The Audit Committee regularly undertakes a robust assessment of the risks the Company faces, on behalf of the Board (see Audit Committee Report on pages 21 to 23).
The following are considered to be the most significant risks to the Company and to shareholders in relation to their investment in the Company. Further details of risks and risk management policies as they relate to the financial assets and liabilities of the Company are detailed in note 16 to the financial statements.
Investment Objective
There is no guarantee that the Company’s strategy and business model will be successful in achieving its investment objective.
The Board monitors the performance of the Company and has established guidelines to ensure that the approved investment policy is pursued by the Manager.
Market Risk
The majority of the Company’s investments are traded on the London Stock Exchange. The principal risk for investors in the Company is of a significant fall in stock markets and/or a prolonged period of decline in the markets relative to other forms of investment. The value of investments held within the portfolio is influenced by many factors including the general health of the UK economy, interest rates, inflation, government policies, industry conditions, political events, tax laws, environmental laws and investor sentiment. The portfolio manager has summarised in the Manager’s Report section of this Strategic Report particular factors affecting the performance of markets in the year and his view of those most pertinent to the outlook for the portfolio. Such factors are out of the control of the Board and the Manager and may give rise to high levels of volatility in the prices of investments held by the Company, although the use or elimination of gearing may modify the impact on shareholder return.
Investment Risk
An inherent risk of investment is that the stocks selected for the portfolio do not perform well.
The investment process employed by the Manager combines top down assessment of economic and market conditions with stock selection. Fundamental analysis forms the basis of the Company’s stock selection process, with an emphasis on sound balance sheets, good cash flows, the ability to pay and sustain dividends, good asset bases and market conditions. The process is complemented by constant assessment of market valuations. It is important to have a sense of a company’s realistic valuation which, to some extent, will be independent of the price at which it trades in the market. Overall, the investment process aims to achieve absolute returns through a genuinely active stock selection approach. This can therefore result in a portfolio which looks substantially different from the benchmark index.
Risk management is an integral part of the investment management process. The Manager effectively controls risk by ensuring that the Company’s portfolio is always appropriately diversified. Continual analysis of all holdings gives the Manager a thorough understanding of financial risks associated with them.
The portfolio of investments held at 30 September 2018 is set out on pages 16 and 17.
Past performance of the Company is not necessarily indicative of future performance.
Shares
Shareholders are exposed to certain risks in addition to risks applying to the Company itself.
The ordinary shares of the Company may trade at a premium or discount to its NAV. The Board monitors the price of the Company’s shares in relation to their NAV and the premium/discount at which they trade.
The value of an investment in the Company and the income derived from that investment may go down as well as up and an investor may not get back the amount invested.
While it is the intention of the Directors to pay dividends to ordinary shareholders twice a year, the ability to do so will depend upon the level of income received from securities and the timing of receipt of such income by the Company. Accordingly, the amount of the dividends paid to ordinary shareholders may fluctuate. Any change in the tax or accounting treatment of dividends or other investment income received by the Company may also affect the level of dividend paid.
The Directors seek powers to issue and buy back the Company’s shares each year, which can be used to help manage the level of discount. The Board also monitors the level of revenue available for distribution at each Board meeting.
Gearing
Gearing levels may change from time to time in accordance with the Manager’s and the Board’s assessment of risk and reward. Whilst the use of borrowings by the Company should enhance total return where the return on the Company’s underlying securities is rising and exceeds the cost of borrowing, it will have the opposite effect where the underlying return is falling. The Board and the Manager regularly review gearing and will continue to monitor the level closely over the year ahead. The maximum gearing limit currently authorised by the Board is 15% of net assets. As at 30 September 2018, net gearing from borrowings stood at 11.6% (2017: 6.6%).
Reliance on the Manager and Other Service Providers
The Company has no employees and the Directors have all been appointed on a non-executive basis. The Company is therefore reliant upon the performance of third party service providers for its executive function. In particular, the Manager performs services that are integral to the operation of the Company and the custodian appointed by the depositary holds assets on its behalf. Failure by any service provider to carry out its obligations to the Company in accordance with the terms of its appointment could have a materially detrimental impact on the operation of the Company and could affect the ability of the Company to pursue its investment policy successfully.
The Company has limited direct exposure to cyber risk. However, the Company’s operations or reputation could be affected if any of its service providers suffered a major cyber security breach. The Board monitors the preparedness of its service providers in this regard and is satisfied that the risk is given due priority.
The Manager may be exposed to reputational risks. In particular, the Manager may be exposed to the risk that litigation, misconduct, operational failures, negative publicity and press speculation, whether or not it is valid, will harm its reputation. Any damage to the reputation of the Manager could result in potential counterparties and third parties being unwilling to deal with the Manager and by extension the Company. This could have an adverse impact on the ability of the Company to pursue its investment policy successfully.
The Company’s main service providers are listed on page 65. The Board monitors the services provided to the Company, informally at every Board meeting and formally at least annually.
Regulatory
The Company is subject to various laws and regulations by virtue of its status as a public limited company, as an investment trust and as an alternative investment fund. A loss of investment trust status could lead to the Company being subject to capital gains tax on the profits arising from the sale of its investments. A serious breach of other regulatory rules might lead to suspension from the Stock Exchange. Other control failures, either by the Manager or another of the Company’s service providers, might result in operational or reputational problems, erroneous disclosures or loss of assets through fraud, as well as breaches of regulations.
The Manager reviews the level of compliance with tax and other regulatory financial requirements on a daily basis. All transactions, income and expenditure are reported to the Board. The Board regularly considers all risks, the measures in place to control them and the possibility of any other risks that could arise. The Board ensures that satisfactory assurances are received from service providers. The Manager’s Compliance Officer produces regular reports for review by the Company’s Audit Committee.
Viability Statement
The Company is a collective investment vehicle rather than a commercial business venture and is designed and managed for long term investment. The Company’s investment objective clearly sets this out. Long term for this purpose is considered by the Directors to be at least five years and accordingly they have assessed the Company’s viability over that period. However, the life of the Company is not intended to be limited to that or any other period.
In assessing the viability of the Company the Directors considered the Company’s current position, the principal risks to which it is exposed and their potential impact on its future development and prospects. The most significant of these are shareholder dissatisfaction arising from failure to meet the Company’s investment objective, through poor investment performance or because the investment policy is no longer appropriate to the prevailing market conditions, and contributory market and investment risks. The Board also took into account the capabilities of the Manager and the varying market conditions experienced, which have effectively stress tested the Company over many years through different and difficult market cycles.
In terms of financial risks to viability, save for the limited value ascribed to unquoted investments, the Company’s portfolio is readily realisable and many times the value of its short term liabilities and annual operating costs. The Company also has long term debt obligations comprising two debentures. The smaller debenture, £7 million, falls due in 2020 and the larger, £25 million, in 2023. In aggregate this long term debt amounts to 10.7% of total assets less current liabilities, so the principal is more than nine times covered and the risk that interest obligations will not be met is negligible.
Based on the above, and assuming there is no significant adverse change to the regulatory environment and tax treatment of UK investment trusts, the Directors have a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the five year period of assessment.
Board Responsibilities
As set out in the Directors’ Report on page 53 the Directors have a statutory duty to promote the success of the Company, whilst also having regard to certain broader matters, including the need to engage with employees, suppliers, customers and others, and to have regard to their interests (s172 Companies Act 2006). However, the Company has no employees and no customers in the traditional sense. In accordance with the Company’s nature as an investment trust the Board’s principal concern has been, and continues to be, the interests of the Company’s shareholders taken as a whole. Notwithstanding this, the Board has a responsible governance culture and also has due regard for broader matters so far as they apply. In particular, the Board engages with the Manager at every Board meeting, reviews its relationships with other service providers at least annually and monitors compliance with the Company’s obligations to debt holders.
Board Diversity
The Company’s policy on diversity is set out on page 52. The Nomination Committee considers diversity, including the balance of skills, knowledge, gender and experience, amongst other factors, when reviewing the composition of the Board and appointing new directors but does not consider it appropriate to establish targets or quotas in this regard. At the date of this report, the Board comprises six non-executive directors of whom three, including the Chairman, are women thereby constituting 50% female representation. The Chairman will retire at the forthcoming AGM, after which this ratio will decrease to 40%. Summary biographical details of the Directors are set out on page 18. The Company has no employees.
Social and Environmental Matters
As an investment company operating as an investment trust, with no employees, property or activities outside investment, environmental policy has limited application. The Manager considers various factors when evaluating potential investments. A company’s policy towards the environment and social responsibility, including with regard to human rights, is considered as part of the overall assessment of risk and suitability for the portfolio. The Manager applies the United Nations Principles for Responsible Investment.
The Company is an investment vehicle and does not provide goods or services in the normal course of its business, or have customers. Accordingly, the Directors consider that the Company is not required to make any slavery or human trafficking statement under the Modern Slavery Act 2015.
Stewardship
The Board considers that the Company has a responsibility as a shareholder towards ensuring that high standards of corporate governance are maintained by the companies in which it invests. The Company’s stewardship functions have been delegated to the Manager, who exercises the Company’s voting rights and reports back to the Board. The Manager has adopted a clear and considered policy towards its responsibility as a shareholder on behalf of the Company. As part of this policy, the Manager takes steps to satisfy itself about the extent to which the companies in which it invests look after shareholders’ value and comply with local recommendations and practices, such as the UK Corporate Governance Code. A copy of the Manager’s Policy on Corporate Governance and Stewardship can be found at www.invesco.co.uk.
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MANAGER’S REPORT
Market Review
In the twelve month period to 30 September 2018 the FTSE All-Share Index provided a single-digit total return of 5.9%. However, headline data masks underlying periods of volatility, most notably in the central six months of the period.
In November 2017 the Bank of England’s Monetary Policy Committee (MPC) voted to implement the UK’s first interest rate rise in a decade, raising the central bank’s base rate to 0.5%. Economic data continued to provide mixed signals around the outlook for UK GDP growth, leading to speculation around if, and when, a further rate rise would be implemented; this would ultimately come later in 2018.
UK equity markets rallied through December 2017 and into the new year, against a backdrop of rising commodity prices, strengthening global economic growth and a raft of new US tax legislation, headlined by a major cut in corporation tax from the Trump administration. Oil and industrial metal prices rallied, particularly copper, supporting outperformance in the oil & gas and mining sectors. However, performance faltered in mid January with UK equity markets selling off sharply in response to upward revisions to US interest rate expectations and a corresponding increase in government bond yields.
Renewed sterling strength in the first quarter of 2018 weighed on the returns of the UK equity market’s many international constituents. Additionally, the unseasonable storms and snow brought by the “Beast from the East†at the end of the first quarter of 2018 resulted in lower than expected economic growth for the period, as consumers and construction workers remained at home. As a result, the Bank of England decided against implementing a very widely expected second 0.25% increase in base rates.
UK equity markets reached a high in late May before drifting downwards for the latter months of the period under review. Market sentiment was driven by the threat and reality of global trade tensions, as well as the ongoing political uncertainty at home. Sterling continued to act as a barometer for the perceived success of the UK and European Union’s (EU) Brexit negotiations, as the likelihood of a deal or no deal scenario continued to dominate headlines. Sterling peaked in mid April at US$1.43 before weakening to US$1.26 in August.
Growth in real incomes, allied to the extended hot summer, the football World Cup and a Royal Wedding provided a boost to consumer spending in the second quarter. Data showed that unemployment fell to less than 4% during the period, the lowest figures on record, whilst job vacancies reached an all time high. Meanwhile the UK government granted the largest public sector pay rise in more than a decade, as the 1% cap on pay increases was lifted for teachers, soldiers, police and prison officers, as well as for NHS doctors and dentists.
The MPC voted unanimously in August 2018 to raise interest rates by a further 0.25% to 0.75%. The increase was widely anticipated as higher energy prices and weaker sterling had kept CPI inflation above the 2% target for some time and wage growth had built steadily and exceeded economists’ expectations. The weakness in growth during the second quarter of 2018 had become recognised as temporary and weather induced, and the Committee appeared keen to build some additional flexibility to pare back interest rates should it be deemed necessary once the terms of the UK’s exit from the European Union are known.
Towards the end of the twelve month review period the EU’s rejection of the UK Government’s Chequers plan led to further volatility in the value of Sterling as fears heightened around a no-deal outcome. Sterling ended the period at US$1.30.
Oil prices rose over the 12 month period from US$56 per barrel in October 2017 to more than US$82 per barrel in September 2018 on concerns around lower OPEC(1) production and looming US sanctions on Iran, which were compounded by production shortfalls in Venezuela.
Portfolio Activity
During the 12 month period new investments were made in Tesco, Royal Bank of Scotland, Amigo, Rolls-Royce, Phoenix Spree Deutschland, MJ Gleeson, Bushveld Minerals, CVS, Endeavour Mining, On the Beach, Capita, Future and Dairy Crest. Meanwhile the portfolio’s holdings in Lloyds, Shire, BTG, SAGA, Rentokil, Hiscox, BAE Systems, Electra Private Equity and Real Estate Investors were sold.
Portfolio Performance Review
The period covered by this report has been a challenging one. The Company’s net asset value, including reinvested dividends, was flat over the year, returning neither gain nor loss, compared with a total return of 5.9% by the FTSE All-Share Index.
The underperformance has two main sources. The first is an increasingly difficult market backdrop for a valuation-driven approach. Recent years have seen an ever-greater premium attached to companies globally that are perceived to be capable of delivering growth and reliability of earnings such that the relative valuation of growth stocks to value stocks has widened to historically extreme levels. In a UK market context this phenomenon has been compounded by anxiety around Brexit that has resulted in the valuation of domestically focused businesses (and especially financials), the potential losers in a bad Brexit outcome, compressing to unusually low levels for a non-recessionary environment. In the light of such relative valuations, the portfolio is overweight domestic value and underweight international growth and resources, and this has hurt performance.
The second source of underperformance is a series of sharp share price corrections following operational disappointments from a handful of companies in which the portfolio is invested.
The largest detractor over the twelve-month period, in both relative and absolute terms, was N Brown. Shares in the online outsize clothing retailer were weak throughout the period, against what has proven to be a particularly difficult environment for the retail sector. The company issued a trading update in January 2018, provoking fears that reduced margins would impact full year results and when those results were released in April they were below analyst estimates. These challenges, coupled with disappointing footfall and a steady decline in the value of the shares led to action by the new Chairman, first announcing the closure of their high street stores and then taking the decision to change the Chief Executive. This renewed focus on the company’s online operation is being supported and the stock is still held.
The share price of TP ICAP, an inter-dealer financial derivatives broker, weakened after a disappointing trading update in March 2018. The share price then fell very sharply at the beginning of July as the company cut its cost savings target for the year and parted company with its Chief Executive. Whilst the outlook has certainly deteriorated, the dramatic decline in the share price looks overstated and so the position has been maintained.
Shares in consumer goods company McBride fell sharply in January on the release of a disappointing trading update. The update cited cost challenges, including raw materials, labour market pressures and transportation costs, which had impacted the Group's first half profit performance and saw analysts cut their forecasts for future profits. Notwithstanding the share price performance, this business has been significantly improved by the current management team and its dominant market position remains attractive. Whilst it operates in a competitive sector, many of the issues impacting recent performance are likely to prove transitory. Shares were added to the position opportunistically at lower price levels.
Barclays, the portfolio’s largest holding, also detracted from returns. The share price posted a positive return for the first half of the period but traded lower in the second quarter of 2018 as falling bond yields and fears of fallout from political turmoil in Italy weighed on sentiment towards the global banking sector and fears around Brexit weighed on the UK banks in particular. The shares fell further in the third quarter, despite the bank reporting higher-than-expected net operating income for the first half of 2018. The portfolio’s significant weighting reflects conviction that the stock market’s low valuation of Barclays implies an overly pessimistic assessment of the company’s earnings outlook and capital generation – and therefore of the potential for the company to return capital to shareholders.
The portfolio has two holdings in the oil & gas sector, namely BP and Royal Dutch Shell, and together they provided the largest absolute positive contributions to the year’s return. The oil majors’ shares rose throughout the period, helped by the higher oil price environment. Whilst the portfolio has a significant exposure to the sector, it is still underweight relative to the FTSE All-Share Index, and correspondingly failed to benefit to the same extent as the index.
Performance was also supported by a number of holdings in the financial sector, including AJ Bell and Sigma Capital. Unquoted investment platform AJ Bell provided a positive contribution and confirmed its intention to IPO by the end of 2018. Specialist fund manager Sigma Capital’s share price performed strongly throughout the period. In particular, the market responded positively to a statement released in February that PRS REIT, the residential real estate investment trust that Sigma manages, had successfully raised an additional £250 million via a placing. This additional capital increases the revenue that Sigma earns for developing and managing the assets. There is significant growth potential for PRS REIT, which is also held in the portfolio. With this dual exposure the portfolio can benefit from PRS REIT’s future income generation potential together with the long-term capital growth opportunities presented by Sigma Capital as the investment manager.
The portfolio’s holdings in Bushveld Minerals and Gamma Communications also provided notable contributions to returns. Shares in Gamma, a telecommunications services provider, traded strongly throughout the period, making gains on the release of results for the first half of 2018, which showed an improved growth outlook buoyed by contract wins and an expanded pipeline.
Meanwhile AIM-listed vanadium producer Bushveld Minerals was bolstered in the latter half of the period by news that the company had acquired a further 21.22% stake in Strategic Minerals Corporation (SMC). SMC is the majority owner of Vametco, Bushveld’s South African vanadium mine, of which the company now owns 76% (the residual having been transferred under South Africa’s Black empowerment rules). With vanadium showing the strongest performance of all industrial metals this year to date and the supply demand outlook still compelling, the position has been maintained.
However, the portfolio’s exposure to the mining sector was not positive overall. Whilst the sector as a whole provided a positive return to the market, this portfolio has no exposure to large-cap diversified miners, only to gold miners. Two of those names, Acacia Mining and Randgold Resources were a drag on the portfolio’s return. Shares in the Tanzania-based gold miner Acacia Mining had already fallen substantially in early 2017 following a tax dispute with the Tanzanian government that prevented the export of gold in concentrate from the country. Barrick Gold, which owns 64% of the company, is negotiating on Acacia’s behalf but the outcome remains uncertain and the shares have remained weak accordingly. Meanwhile, the share price of Randgold Resources also performed poorly throughout the period, driven by concerns around tax hikes affecting operations in the Democratic Republic of Congo. The share price of both Acacia Mining and Randgold Resources rallied into the period end on news of a proposed merger between Barrick Gold and Randgold Resources. However, gains were insufficient to offset the losses incurred earlier in the period.
Outlook
As I have written in the past, my investment process is very bottom-up. I have assembled a portfolio of shares, chosen on their own merits but against the backdrop of some broad top-down assumptions. The assumptions I made and wrote about a year ago were that:
– UK disposable income would move into growth territory as CPI fell and wage inflation accelerated. That would be a tailwind for domestic consumption. This has now happened and provides a powerful impetus to UK consumption growth.
– The risk to UK base rates and market rates of interest was clearly to the upside. The MPC has since raised rates twice and the 10 year gilt yield is 0.3% higher than a year ago.
– Geopolitical uncertainty was at an uncomfortable level and presented risks both to global markets and to the global economy. This has certainly worsened as trade relations have deteriorated. In theory this provides a headwind to exports and to the earnings of businesses in export or trade-dependent sectors.
– Valuation disparities were at extreme levels with US technology company shares looking particularly over-valued. Should those valuations compress, there was a risk of contagion into elevated share prices of growth companies in unrelated sectors in all regions. A number of these US shares have now de-rated and at the time of writing some of the most highly valued UK listed growth stocks are also coming under pressure.
– After years of monetary largesse, the withdrawal of stimulus via interest rate rises and quantitative tightening (QT) posed risks to the global economy and to stock markets. With the US Federal Reserve still pushing rates higher and global central banks now implementing a net reversal of quantitative easing, there is an increasing sense of unease that monetary policy may now pose a risk to global growth and therefore to stock market valuations.
– Brexit negotiations would bring volatility to UK equities, but in time this would be seen to have presented unusually attractive investment opportunities.
The global and domestic macro environment therefore looks broadly in line with my expectations. Unfortunately, the wild card that Brexit represents has become the dominant factor in the UK stock market and with negotiations heading for a perhaps predictably late and fraught conclusion, this has weighed heavily on domestically focused shares, as illustrated in the chart below. Many of the stocks I had already considered to be attractively valued, especially financials, have therefore remained under pressure, shunned by international and domestic investors alike despite a constructive if unspectacular economy. In this process of falling out of favour, these shares have exhibited the negative price momentum that sees them excluded from or shorted by quantitative strategies whose flows have increasingly defined the shape of markets in recent years. This somewhat circular phenomenon is still in full effect.
At the time of writing (in November) in advance of the supposed late November deadline for a Brexit deal to have been settled, and four months before Brexit itself, it is too early to judge whether this volatility brought about by Brexit has indeed presented “unusually attractive investment opportunitiesâ€.
The fundamentals of the vast majority of domestic holdings remain intact. For now at least the UK consumer still appears robust and on the basis that Brexit does not bring about the recession that is widely priced in, the opportunity to own these companies at or close to post-financial crisis valuation lows still looks extremely attractive. In a number of cases I have therefore taken the opportunity of share price weakness to add to positions. At the same time, to reflect the totality of the risks the wider market and the portfolio faces (trade frictions escalating, Italy, Iran, US fiscal weakness, risk to the US dollar’s reserve currency status, Chinese credit to name but a few), I have increased the weighting in gold equities. I am hopeful that the modest average valuation of the bulk of the holdings and the defensive characteristics of gold will combine to produce a portfolio with compelling risk/reward characteristics in the forthcoming period.
James Goldstone, Portfolio Manager
The Strategic Report was approved by the Board of Directors on 26 November 2018.
Invesco Asset Management Limited
Company Secretary
.
STRATEGIC REPORT
INVESTMENTS IN ORDER OF VALUATION
AT 30 SEPTEMBER 2018
UK listed ordinary shares unless stated otherwise
| Investments | |||||
| ISSUER | SECTOR | MARKET VALUE £’000 |
% OF PORTFOLIO |
||
| Barclays | Banks | 13,160 | 4.4 | ||
| BP | Oil & Gas Producers | 12,915 | 4.4 | ||
| Coats | General Industrials | 9,160 | 3.1 | ||
| Tesco | Food & Drug Retailers | 9,055 | 3.1 | ||
| Royal Dutch Shell – B shares | Oil & Gas Producers | 8,967 | 3.0 | ||
| Next | General Retailers | 8,949 | 3.0 | ||
| British American Tobacco | Tobacco | 7,755 | 2.6 | ||
| Royal Bank of Scotland | Banks | 7,606 | 2.6 | ||
| Babcock International | Support Services | 7,510 | 2.5 | ||
| A J BellUQ | Financial Services | 7,068 | 2.4 | ||
| Top Ten Investments | 92,145 | 31.1 | |||
| RELX | Media | 5,413 | 1.8 | ||
| Rolls-Royce | Aerospace & Defence | 5,376 | 1.8 | ||
| BT | Fixed Line Telecommunications | 5,355 | 1.8 | ||
| Legal & General | Life Insurance | 5,257 | 1.8 | ||
| Melrose Industries | Construction & Materials | 5,032 | 1.7 | ||
| Aviva | Life Insurance | 4,955 | 1.7 | ||
| Amigo | Financial Services | 4,928 | 1.7 | ||
| JD Sports Fashion | General Retailers | 4,892 | 1.6 | ||
| Sigma Capital | Financial Services | 4,814 | 1.6 | ||
| McBride | Household Goods & Home Construction | 4,718 | 1.6 | ||
| Top Twenty Investments | 142,885 | 48.2 | |||
| Summit Germany | Real Estate Investment & Services | 4,559 | 1.5 | ||
| XPS Pensions | Financial Services | 4,385 | 1.5 | ||
| Phoenix Spree Deutschland | Real Estate Investment & Services | 4,313 | 1.5 | ||
| BCA Marketplace | Financial Services | 4,236 | 1.4 | ||
| Victoria | Household Goods & Home Construction | 4,213 | 1.4 | ||
| Hollywood Bowl | Travel & Leisure | 4,190 | 1.4 | ||
| Imperial Brands | Tobacco | 3,755 | 1.3 | ||
| Oxford Sciences InnovationUQ | Financial Services | 3,746 | 1.3 | ||
| Derwent London | Real Estate Investment Trusts | 3,716 | 1.3 | ||
| Motif Bio | Pharmaceuticals & Biotechnology | 2,330 | 1.2 | ||
| – ADR | 1,202 | ||||
| – ADR warrants 9 Nov 2021 | 174 | ||||
| Top Thirty Investments | 183,704 | 62.0 | |||
| MJ Gleeson | Household Goods & Home Construction | 3,528 | 1.2 | ||
| PRS REIT | Real Estate Investment Trusts | 3,340 | 1.1 | ||
| Bushveld Minerals | Mining | 3,308 | 1.1 | ||
| Chesnara | Life Insurance | 3,288 | 1.1 | ||
| Endeavour Mining | Mining | 3,258 | 1.1 | ||
| CVS | General Retailers | 3,206 | 1.1 | ||
| Harworth | Real Estate Investment & Services | 3,160 | 1.1 | ||
| PureTech Health | Pharmaceuticals & Biotechnology | 2,987 | 1.0 | ||
| On the Beach | Travel & Leisure | 2,983 | 1.0 | ||
| easyJet | Travel & Leisure | 2,973 | 1.0 | ||
| Top Forty Investments | 215,735 | 72.8 | |||
| Secure Trust Bank | Banks | 2,944 | 1.0 | ||
| Capita | Support Services | 2,908 | 1.0 | ||
| N Brown | General Retailers | 2,889 | 1.0 | ||
| HomeServe | Support Services | 2,781 | 0.9 | ||
| P2P Global Investments | Equity Investment Instruments | 2,777 | 0.9 | ||
| Future | Media | 2,777 | 0.9 | ||
| Dairy Crest | Food Producers | 2,766 | 0.9 | ||
| Inmarsat | Mobile Telecommunications | 2,742 | 0.9 | ||
| Drax | Electricity | 2,733 | 0.9 | ||
| Ultra Electronics | Aerospace & Defence | 2,653 | 0.9 | ||
| Top Fifty Investments | 243,705 | 82.1 | |||
| Randgold Resources | Mining | 2,634 | 0.9 | ||
| Micro Focus | Software & Computer Services | 2,622 | 0.9 | ||
| Plus500 | Financial Services | 2,592 | 0.9 | ||
| Balfour Beatty | Construction & Materials | 2,545 | 0.9 | ||
| Cairn Homes | Household Goods & Home Construction | 2,484 | 0.8 | ||
| Agnico Eagle Mines | Mining | ||||
| – Canadian common stock | 2,482 | 0.8 | |||
| Newmont Mining | Mining | ||||
| – US Common Stock | 2,445 | 0.8 | |||
| Provident Financial | Financial Services | 2,440 | 0.8 | ||
| Horizon Discovery | Pharmaceuticals & Biotechnology | 2,338 | 0.8 | ||
| Hadrian’s Wall Secured Investments | Equity Investment Instruments | 2,240 | 0.8 | ||
| Top Sixty Investments | 268,527 | 90.5 | |||
| Mears | Support Services | 2,164 | 0.7 | ||
| Standard Life Aberdeen | Financial Services | 2,134 | 0.7 | ||
| TP ICAP | Financial Services | 2,112 | 0.7 | ||
| Ashtead | Support Services | 2,107 | 0.7 | ||
| Cranswick | Food Producers | 2,023 | 0.7 | ||
| Sherborne | Financial Services | 1,933 | 0.7 | ||
| Acacia Mining | Mining | 1,926 | 0.7 | ||
| TruFin | Financial Services | 1,893 | 0.6 | ||
| Alpha Financial Software | Software & Computer Services | 1,738 | 0.6 | ||
| Tungsten | Financial Services | 1,457 | 0.5 | ||
| Top Seventy Investments | 288,014 | 97.1 | |||
| Marwyn Value Investors | Equity Investment Instruments | 1,390 | 0.5 | ||
| Diurnal | Pharmaceuticals & Biotechnology | 1,323 | 0.4 | ||
| Hibernia REIT | Real Estate Investment Trusts | 1,296 | 0.4 | ||
| IP Group | Financial Services | 981 | 0.3 | ||
| Silence Therapeutics | Pharmaceuticals & Biotechnology | 969 | 0.3 | ||
| Safestyle UK | General Retailers | 795 | 0.3 | ||
| Debenhams | General Retailers | 630 | 0.2 | ||
| Gamma Communications | Mobile Telecommunications | 618 | 0.2 | ||
| Realm Therapeutics | Health Care Equipment & Services | 218 | 0.1 | ||
| NexeonUQ | Electronic & Electrical Equipment | 165 | 0.1 | ||
| Top Eighty Investments | 296,399 | 99.9 | |||
| The Local Shopping REIT | Real Estate Investment Trusts | 105 | 0.1 | ||
| Barclays Bank – Nuclear Power Notes 28 Feb 2019NR | Non-Equity Investment Instruments | 98 | — | ||
| EurovestechUQ | Financial Services | 47 | — | ||
| HaloSource | Chemicals | 10 | — | ||
| – Regulation S | 9 | ||||
| Jaguar Health – US indemnity sharesUQ | Pharmaceuticals & Biotechnology | 12 | — | ||
| XTL Biopharmaceuticals – ADR | Pharmaceuticals & Biotechnology | 8 | — | ||
| Lombard Medical – US Common Stock | Health Care Equipment & Services | 4 | — | ||
| Total Investments (87) | 296,692 | 100.0 | |||
NR: Non-rated.
UQ: Unquoted investment.
ADR: American Depositary Receipt.
.
STATEMENT OF DIRECTORS’ RESPONSIBILITIES
IN RESPECT OF THE PREPARATION OF FINANCIAL STATEMENTS
The Directors are responsible for ensuring that the annual financial report is prepared in accordance with applicable law and regulations.
Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have elected to prepare financial statements in accordance with UK Accounting Standards, including FRS 102 ‘The Financial Reporting Standard applicable in UK and Republic of Ireland’. Under company law, the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the net return of the Company for that period.
In preparing these financial statements, the Directors are required to:
• select suitable accounting policies and then apply them consistently;
• make judgments and accounting estimates that are reasonable and prudent;
• state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and
• prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business.
The Directors are responsible for keeping adequate accounting records which are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and which enable them to ensure that the financial statements comply with company law. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
Under applicable law and regulations, the Directors are also responsible for preparing a Strategic Report, a Corporate Governance Statement, a Directors’ Remuneration Report and a Directors’ Report that comply with that law and those regulations.
The Directors of the Company, whose names are shown on page 18 of this Report, each confirm to the best of their knowledge that:
• the financial statements, prepared in accordance with United Kingdom accounting standards on a going concern basis, give a true and fair view of the assets, liabilities, financial position and net return of the Company;
• the annual financial 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
• they consider that the annual financial report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position and performance, business model and strategy.
Beatrice Hollond
Chairman
Signed on behalf of the Board of Directors
26 November 2018
.
INCOME STATEMENT
FOR THE YEAR ENDED 30 SEPTEMBER
| 2018 | 2017 | ||||||
| NOTES | REVENUE £’000 |
CAPITAL £’000 |
TOTAL £’000 |
REVENUE £’000 |
CAPITAL £’000 |
TOTAL £’000 |
|
| (Losses)/gains on investments | 9 | — | (8,653) | (8,653) | — | 10,197 | 10,197 |
| Foreign exchange losses | — | (166) | (166) | — | (292) | (292) | |
| Income | 2 | 8,806 | 2,499 | 11,305 | 9,703 | 2,648 | 12,351 |
| Investment management fees and performance-related fees | 3 | (261) | (785) | (1,046) | (301) | (901) | (1,202) |
| Other expenses | 4 | (408) | — | (408) | (401) | — | (401) |
| Net return before finance costs and taxation | 8,137 | (7,105) | 1,032 | 9,001 | 11,652 | 20,653 | |
| Finance costs | 5 | (564) | (1,655) | (2,219) | (561) | (1,647) | (2,208) |
| Return on ordinary activities before taxation | 7,573 | (8,760) | (1,187) | 8,440 | 10,005 | 18,445 | |
| Tax on ordinary activities | 6 | (21) | — | (21) | (124) | — | (124) |
| Return on ordinary activities after taxation for the financial year | 7,552 | (8,760) | (1,208) | 8,316 | 10,005 | 18,321 | |
| Return per ordinary share | |||||||
| Basic | 7 | 55.9p | (64.8)p | (8.9)p | 61.5p | 74.0p | 135.5p |
The total column of this statement represents the Company’s profit and loss account, prepared in accordance with UK Accounting Standards. The return after taxation is the total comprehensive income and therefore no additional statement of comprehensive income is presented. The supplementary revenue and capital columns are presented for information purposes in accordance with the Statement of Recommended Practice issued by the Association of Investment Companies. All items in the above statement derive from continuing operations of the Company. No operations were acquired or discontinued in the year.
STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 30 SEPTEMBER
| CALLED UP REDEMPTION RESERVE £’000 |
CAPITAL RESERVE £’000 |
CAPITAL REVENUE TOTAL £’000 |
CAPITAL RESERVE £’000 |
SHARE PREMIUM RESERVE £’000 |
SHARE RESERVE TOTAL £’000 |
|
| At 30 September 2016 | 6,760 | 3,449 | 466 | 243,643 | 10,629 | 264,947 |
| Dividends paid – note 8 | — | — | — | — | (7,881) | (7,881) |
| Net return on ordinary activities | — | — | — | 10,005 | 8,316 | 18,321 |
| At 30 September 2017 | 6,760 | 3,449 | 466 | 253,648 | 11,064 | 275,387 |
| Dividends paid – note 8 | — | — | — | — | (8,033) | (8,033) |
| Net return on ordinary activities | — | — | — | (8,760) | 7,552 | (1,208) |
| At 30 September 2018 | 6,760 | 3,449 | 466 | 244,888 | 10,583 | 266,146 |
.
BALANCE SHEET
AT 30 SEPTEMBER
| 2018 | 2017 | ||
| NOTES | £’000 | £’000 | |
| Fixed assets | |||
| Investments held at fair value through profit or loss | 9 | 296,692 | 294,778 |
| Current assets | |||
| Debtors | 10 | 1,663 | 733 |
| Cash and cash equivalents | 1,078 | 13,755 | |
| 2,741 | 14,488 | ||
| Creditors: amounts falling due within one year | 11 | (1,250) | (1,876) |
| Net current assets | 1,491 | 12,612 | |
| Total assets less current liabilities | 298,183 | 307,390 | |
| Creditors: amounts falling due after more than one year | 12 | (32,037) | (32,003) |
| Net assets | 266,146 | 275,387 | |
| Capital and reserves | |||
| Called up share capital | 13 | 6,760 | 6,760 |
| Share premium | 14 | 3,449 | 3,449 |
| Capital redemption reserve | 14 | 466 | 466 |
| Capital reserve | 14 | 244,888 | 253,648 |
| Revenue reserve | 14 | 10,583 | 11,064 |
| Shareholders’ funds | 266,146 | 275,387 | |
| Net asset value per ordinary share – basic | |||
| – debt at par | 15 | 1,968.7p | 2,037.1p |
| – debt at fair value | 15 | 1,921.7p | 1,979.9p |
The financial statements on pages 34 to 50 were approved and authorised for issue by the Board of Directors on 26 November 2018.
Signed on behalf of the Board of Directors
Beatrice Hollond
Chairman
.
CASH FLOW STATEMENT
FOR THE YEAR ENDED 30 SEPTEMBER
| NOTES | 2018 £’000 |
2017 £’000 |
|
| Cash flow from operating activities | |||
| Net return before finance costs and taxation | 1,032 | 20,653 | |
| Tax on overseas income | 6 | (21) | (124) |
| Adjustments for: | |||
| Purchase of investments | (111,227) | (157,332) | |
| Sale of investments | 99,172 | 155,617 | |
| (12,055) | (1,715) | ||
| Scrip dividends | (114) | (26) | |
| Losses/(gains) on investments | 8,653 | (10,197) | |
| Net cash movement from derivative instruments – currency hedges | 87 | (157) | |
| Decrease/(increase) in debtors | 8 | (67) | |
| Decrease in creditors | (12) | (151) | |
| Net cash (outflow)/inflow from operating activities | (2,422) | 8,216 | |
| Cash flow from financing activities | |||
| Interest paid on overdraft | (8) | - | |
| Interest paid on debenture stocks | (2,165) | (2,165) | |
| Preference dividends paid | (12) | (12) | |
| Net equity dividends paid | 8 | (8,070) | (7,881) |
| Net cash outflow from financing activities | (10,255) | (10,058) | |
| Net decrease in cash and cash equivalents | (12,677) | (1,842) | |
| Cash and cash equivalents at start of the year | 13,755 | 15,597 | |
| Cash and cash equivalents at the end of the year | 1,078 | 13,755 | |
| Reconciliation of cash and cash equivalents to | |||
| the Balance Sheet is as follows: | |||
| Cash at custodian | 1,078 | 1,605 | |
| Short-Term Investment Company (Global Series) plc, money market fund | — | 12,150 | |
| Cash and cash equivalents | 1,078 | 13,755 | |
| Cash flow from operating activities includes: | |||
| Interest received | 172 | 176 | |
| Dividends received | 10,933 | 9,232 |
.
NOTES TO THE FINANCIAL STATEMENTS
1. Accounting Policies
Accounting policies describe the Company’s approach to recognising and measuring transactions during the year and the position of the Company at the year end.
A summary of the principal accounting policies adopted by the Company is set out below.
(a) Basis of Preparation
(i) Accounting Standards applied
The financial statements have been prepared in accordance with applicable United Kingdom Accounting Standards and applicable law (UK Generally Accepted Accounting Practice (UK GAAP)) and with the Statement of Recommended Practice Financial Statements of Investment Trust Companies and Venture Capital Trusts, issued by the Association of Investment Companies in November 2014 (SORP) and updated in February 2018. The financial statements are issued on a going concern basis.
(ii) Functional and presentation currency
The financial statements are presented in Sterling, which is the Company’s functional and presentation currency and the currency in which the Company’s share capital and expenses, as well as a majority of its assets and liabilities, are denominated.
(b) Financial Instruments
The Company has chosen to apply the provisions of sections 11 and 12 of FRS102 in full in respect of the financial instruments.
(i) Recognition of financial assets and financial liabilities
The Company recognises financial assets and financial liabilities when the Company becomes a party to the contractual provisions of the instrument. The Company will offset financial assets and financial liabilities if the Company has a legally enforceable right to set off the recognised amounts and interests and intends to settle on a net basis.
(ii) Derecognition of financial assets
The Company derecognises a financial asset when the contractual rights to the cash flows from the asset expire or it transfers the rights to receive the contractual cash flows on the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred. Any interest in the transferred financial asset that is created or retained by the Company is recognised as an asset.
(iii) Derecognition of financial liabilities
The Company derecognises financial liabilities when its obligations are discharged, cancelled or expired.
(iv) Trade date accounting
Purchases and sales of financial assets are recognised on trade date, being the date on which the Company commits to purchase or sell the assets.
(v) Classification and measurement of financial assets and financial liabilities
Financial assets
The Company’s investments are classified as held at fair value through profit or loss as the investments are managed and their performance evaluated on a fair value basis in accordance with a documented investment strategy, and this is also the basis on which investment information is provided internally to the Board.
Financial assets held at fair value through profit or loss are initially recognised at fair value, which is taken to be their cost, with transaction costs expensed as part of gains and losses on investments in the income statement, and are subsequently valued at fair value.
Fair value for investments that are actively traded in organised financial markets is determined by reference to stock exchange quoted bid prices at the balance sheet date. For investments that are not actively traded or where active stock exchange quoted bid prices are not available, fair value is determined by reference to a variety of valuation techniques including broker quotes and price modelling. Where there is no active market, unlisted/illiquid investments are valued by the Directors at fair value based on recommendations from Invesco’s European Unquoted Pricing Committee, which in turn is guided by the International Private Equity and Venture Capital Valuation Guidelines issued in 2015, using valuation techniques such as earnings multiples, recent arm’s length transactions, net assets and milestones attained.
(v) Classification and measurement of financial assets and financial liabilities (continued)
Financial liabilities
Financial liabilities, including borrowings, are initially measured at fair value, net of transaction costs and are subsequently measured at amortised cost using the effective interest method.
(c) Amounts recognised in Capital Reserves
The following are included in the income statement and recognised in capital: realised gains or losses on sales of investments; realised gains or losses on foreign currency and any forward currency contracts; management fees and finance costs allocated to capital; and other capital charges, and unrealised increases or decreases in the valuation of investments at the year end (including the related foreign exchange gains and losses).
(d) Cash and cash equivalents
Cash and cash equivalents may comprise cash (including short term deposits which are readily convertible to a known amount of cash and are subject to an insignificant risk of change in value) as well as cash equivalents, including money market funds. Investments are regarded as cash equivalents if they meet all of the following criteria: highly liquid investments held in the Company’s base currency that are readily convertible to a known amount of cash, are subject to an insignificant risk of change in value and provide a return no greater than the rate of a three-month high quality government bond.
(e) Income
Dividend income arises from equity investments held and is recognised on the date investments are marked ‘ex-dividend’. Where the Company elects to receive dividends in the form of additional shares rather than cash, the equivalent to the cash dividend is recognised as income in the revenue account and any excess in the value of the shares received over the amount of the cash dividend is recognised in capital reserve. Special dividends are taken to income unless they arise from a return of capital, when they are allocated to capital in the income statement. Interest income arising from fixed income securities and cash is recognised in the income statement using the effective interest method. Deposit interest and underwriting commission receivable are taken into account on an accruals basis.
(f) Management and Performance-related fees
Investment management fees are recognised on an accruals basis and are charged 75% to capital and 25% to revenue. This is 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.
Performance-related fees are calculated as detailed in the Directors’ Report and are charged wholly to capital as they arise mainly from capital returns on the investment portfolio.
(g) Expenses and Finance costs
Expenses are recognised on an accruals basis and finance costs are recognised using the effective interest method, with the debentures being held at amortised cost. The finance costs of debt are allocated 75% to capital and 25% to revenue for the reasons outlined in (f) above. The 5% cumulative preference shares are classified as a liability and therefore the dividends payable on these shares are classified as finance costs and charged to revenue in the income statement.
(h) Hedging
Forward currency contracts entered into for hedging purposes are valued at the appropriate forward exchange rate ruling at the balance sheet date. Profits or losses on the closure or revaluation of positions are included in capital.
(i) Foreign Currency Translation
Transactions in foreign currency, whether of a revenue or capital nature, are translated to Sterling at the rates of exchange ruling on the dates of such transactions. Foreign currency assets and liabilities are translated to Sterling at the rates of exchange ruling at the balance sheet date. Any gains or losses, whether realised or unrealised, are taken to capital or to revenue, depending on whether the gain or loss is of a capital or revenue nature. All gains and losses are recognised in the income statement.
(j) Taxation
Foreign dividends that suffer withholding tax at source are shown gross, with the corresponding tax charge in the income statement.
Deferred taxation is recognised in respect of all timing differences that have originated but not reversed at the balance sheet date where transactions or events that result in an obligation to pay more tax or a right to pay less tax in the future have occurred. Timing differences are differences between the Company’s taxable profits and its results as stated in the financial statements. Deferred taxation assets are recognised where, in the opinion of the Directors, it is more likely than not that these amounts will be realised in future periods.
A deferred tax asset has not been recognised in respect of surplus management expenses and losses on loan relationships, as the Company is unlikely to have sufficient future taxable revenue to offset against these.
(k) Dividends Payable
Dividends are not recognised in the financial statements unless there is an obligation to pay at the balance sheet date.
2. Income
This note shows the income generated from the portfolio (investment assets) of the Company and income received from any other source.
| 2018 £’000 |
2017 £’000 |
|
| Income from investments | ||
| UK dividends | ||
| – Ordinary dividends | 7,522 | 7,388 |
| – Special dividends | 236 | 643 |
| Overseas dividends | ||
| – Ordinary dividends | 716 | 1,402 |
| Scrip dividends | 114 | 26 |
| Income from interest distribution | 171 | 194 |
| 8,759 | 9,653 | |
| Other income | ||
| Deposit interest | 1 | — |
| Underwriting commission | — | 1 |
| Other | 46 | 49 |
| 47 | 50 | |
| Total income | 8,806 | 9,703 |
Special dividends of £2,499,000 (2017: £2,648,000) have been recognised in capital.
3. Investment Management and Performance-related Fees
This note shows the fees paid to the Manager. These are made up of the management fee payable quarterly and a performance-related fee calculated annually. The latter is only payable when the portfolio outperforms the benchmark index plus its hurdle, which is +1.25% per annum.
| 2018 | 2017 | |||||
| REVENUE | CAPITAL | TOTAL | REVENUE | CAPITAL | TOTAL | |
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |
| Investment management fee | 261 | 785 | 1,046 | 301 | 901 | 1,202 |
| Performance-related fee | — | — | — | — | — | — |
| 261 | 785 | 1,046 | 301 | 901 | 1,202 | |
Details of the management agreement are disclosed in the Directors’ Report.
The performance-related fee is due if the Company’s annualised total return over the previous three years is greater than the annualised return of the FTSE All-Share (Total Return) Index over the same period, plus the hurdle.
At 30 September 2018, an investment management fee of £256,000 (2017: £261,000) has been accrued in respect of the three months to 30 September 2018. There was no performance-related fee provision for the year (2017: £nil).
4. Other Expenses
The other expenses of the Company are presented below.
| 2018 £’000 |
2017 £’000 |
|
| Directors’ fees | 125 | 111 |
| Fees payable to the Company's auditor in relation to: | ||
| – the statutory audit of the financial statements | 26 | 26 |
| Other expenses | 257 | 264 |
| 408 | 401 |
The Director's Remuneration Report provides further information on Directors’ fees.
Fees payable to the Company’s auditor are shown excluding VAT which is included in other expenses. Other expenses includes £7,700 (2017: £6,000) of employer’s National Insurance on Directors’ fees. As at 30 September 2018, the amount outstanding on Directors’ fees and employer’s National Insurance was £10,100 (2017: £7,700).
5. Finance Costs
Finance costs arise on any borrowing that the Company has, with the main borrowing being the £32 million of Debenture stocks (see note 12) and an uncommitted bank overdraft facility (see note 11).
| 2018 | 2017 | |||||
| REVENUE | CAPITAL | TOTAL | REVENUE | CAPITAL | TOTAL | |
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |
| Interest payable on borrowings repayable not by instalment: | ||||||
| Interest payable on bank borrowings | 2 | 6 | 8 | — | — | — |
| Debenture stock repayable in 2 to 3 years | 136 | 407 | 543 | — | — | — |
| Debenture stock repayable after 3 years | 414 | 1,242 | 1,656 | 549 | 1,647 | 2,196 |
| 552 | 1,655 | 2,207 | 549 | 1,647 | 2,196 | |
| Dividends on 5% cumulative preference shares | 12 | — | 12 | 12 | — | 12 |
| 564 | 1,655 | 2,219 | 561 | 1,647 | 2,208 | |
6. Tax on ordinary activities
As an investment trust, the Company pays no tax on capital gains and as the Company principally invests in UK assets, it has little overseas tax. This note shows details of the tax charge and why no deferred tax is required to provide for tax that is expected to arise in the future due to differences in accounting and tax bases.
(a) Current Tax Charge
| 2018 REVENUE £’000 |
2017 REVENUE £’000 |
||
| Overseas tax | 21 | 124 |
(b) Reconciliation of Current Tax Charge
| 2018 £’000 |
2017 £’000 |
||
| Total return on ordinary activities before taxation | (1,187) | 18,445 | |
| UK Corporation Tax effective rate of 19% (2017: 19.5%) | (226) | 3,597 | |
| Effect of : | |||
| – Losses/(gains) on investments | 1,644 | (1,988) | |
| – Loss on foreign exchange movements | 32 | 57 | |
| – UK dividends which are not taxable | (1,931) | (2,030) | |
| – Overseas dividends which are non-taxable | (141) | (264) | |
| – Overseas tax | 21 | 124 | |
| – Non-taxable scrip dividends | (22) | (5) | |
| – Disallowed expenses | 2 | 3 | |
| – Excess of management expenses over taxable income | 642 | 630 | |
| Current tax charge for the year | 21 | 124 |
(c) Factors that may Affect Future Tax Changes
The Company has excess expenses of £75,291,000 (2017: £71,913,000) that are available to offset future taxable revenue. A deferred tax asset of £12,800,000 measured at the standard corporation tax rate of 17% (2017: £12,225,000 at 17%), has not been recognised in respect of these expenses since the Directors believe that there will be no taxable profits in the future against which the deferred tax assets can be offset.
7. Return per Ordinary Share
Basic return per share is the amount of gain (or loss) generated for the financial year divided by the number of ordinary shares in issue. The calculation is based on the weighted average number of shares in issue during the year.
Basic revenue, capital and total return per ordinary share is based on each of the returns on ordinary activities after taxation and on 13,518,799 (2017: 13,518,799) shares being the number of ordinary shares in issue throughout the year.
8. Dividends
Dividends represent the return of income less expenses to shareholders. Dividends are paid as an amount per ordinary share held.
| 2018 £’000 |
2017 £’000 |
|
| Dividends on equity shares paid and recognised in the year: | ||
| Second interim dividend for 2017 of 37p per ordinary share (2016: 35p) | 5,002 | 4,732 |
| Special dividend for 2017 of 4.7p per ordinary share (2016: 5.3p) | 635 | 716 |
| First interim dividend for 2018 of 18p per ordinary share (2017: 18p) | 2,433 | 2,433 |
| 8,070 | 7,881 | |
| Return of unclaimed dividends from previous years | (37) | — |
| 8,033 | 7,881 |
| 2018 | 2017 | |
| £’000 | £’000 | |
| Dividends on equity shares payable in respect of the year: | ||
| First interim paid 18p per ordinary share (2017: 18p) | 2,433 | 2,433 |
| Second interim dividend of 38p per ordinary share (2017: 37p) | 5,137 | 5,002 |
| 7,570 | 7,435 | |
| Special dividend of 1.75p per ordinary share (2017: 4.7p) | 237 | 635 |
| 7,807 | 8,070 |
9. Investments
The portfolio is made up primarily of investments which are listed, i.e. traded on a recognised stock exchange (including AIM), and some unlisted investments. Gains and losses are either:
– realised, usually arising when investments are sold; or
– unrealised, being the difference from cost on those investments still held at the year end.
(a) Analysis of Investments by Listing Status
| 2018 £’000 |
2017 £’000 |
||
| Investments listed on a recognised stock exchange | 285,654 | 285,298 | |
| Unlisted investments | 11,038 | 9,480 | |
| 296,692 | 294,778 |
(b) Analysis of Investment Gains and Losses
| 2018 | 2017 | ||||
| LISTED | UNLISTED | TOTAL | TOTAL | ||
| £’000 | £’000 | £’000 | £’000 | ||
| Opening book cost | 269,085 | 8,535 | 277,620 | 213,594 | |
| Opening investment holding gains | 16,213 | 945 | 17,158 | 68,241 | |
| Opening valuation | 285,298 | 9,480 | 294,778 | 281,835 | |
| Movements in year: | |||||
| Purchases at cost | 110,727 | — | 110,727 | 158,148 | |
| Sales – proceeds | (100,004) | (156) | (100,160) | (155,402) | |
| Sales – realised gains | 15,191 | 156 | 15,347 | 61,280 | |
| Transfer between listed and unlisted during the year | (89) | 89 | — | — | |
| Movement in investment holding gains | (25,469) | 1,469 | (24,000) | (51,083) | |
| Closing valuation | 285,654 | 11,038 | 296,692 | 294,778 | |
| Closing book cost | 294,910 | 8,624 | 303,534 | 277,620 | |
| Closing investment holding (losses)/gains | (9,256) | 2,414 | (6,842) | 17,158 | |
| Closing valuation | 285,654 | 11,038 | 296,692 | 294,778 | |
| Net realised gains based on historical cost | 15,191 | 156 | 15,347 | 61,280 | |
| Movement in investment holding gains in year | (25,469) | 1,469 | (24,000) | (51,083) | |
| (Losses)/gains on investments | (10,278) | 1,625 | (8,653) | 10,197 | |
(c) Transaction Costs
Transaction costs on purchases of £410,000 (2017: £837,000) and on sales of £72,000 (2017: £194,000) are included within gains and losses on investments in the income statement.
10. Debtors
Debtors are amounts which are due to the Company, such as income which has been earned (accrued) but not yet received and monies receivable from brokers for investments sold.
| 2018 £’000 |
2017 £’000 |
||
| Amounts due from brokers | 988 | — | |
| Unrealised profit on forward currency contracts | 70 | 157 | |
| Prepayments and accrued income | 293 | 291 | |
| Unclaimed dividends from previous years recoverable | 37 | — | |
| Overseas withholding tax recoverable | 275 | 267 | |
| Income tax recoverable | — | 18 | |
| 1,663 | 733 |
11. Creditors: amounts falling due within one year
Creditors are amounts which must be paid by the Company, and include any amounts due to brokers for the purchase of investments or amounts owed to suppliers, such as the Manager and auditor, and bank overdraft.
| 2018 £’000 |
2017 £’000 |
|
| Amounts due to brokers | 195 | 809 |
| Accruals | 1,055 | 1,067 |
| 1,250 | 1,876 |
The Company has an uncommitted bank overdraft facility of up to £15 million, renewable on 20 September 2019. Interest payable on the facility is 0.75% over base rate. The covenant under the facility requires total assets not to fall below £100 million.
12. Creditors: amounts falling due after more than one year
Long term creditors consist of £32 million of debentures and a small issue of preference shares. These form the principal borrowings of the Company and the fixed interest that the Company pays is reported under note 5 ‘Finance Costs’.
| 2018 £’000 |
2017 £’000 |
|
| Debenture Stock: | ||
| 7.75% redeemable 1 October 2020 | 7,000 | 7,000 |
| 6.5% redeemable 27 April 2023 | 24,968 | 24,968 |
| 31,968 | 31,968 | |
| Discount and issue expenses on debenture stock | (181) | (215) |
| 31,787 | 31,753 | |
| 5% cumulative preference shares of £1 each | 250 | 250 |
| 32,037 | 32,003 |
The debentures rank pari passu with each other, and ahead of shareholders, and are secured by floating charge over the assets of the Company.
The debenture stocks both pay interest twice a year; the 7.75% Debenture Stock 2020 for the six months ended 31 March and 30 September, and the 6.5% Debenture Stock 2023 for the six months to 27 April and 27 October. Both debenture stocks generally make the payments in April and October. The preference shares dividend is paid bi-annually in March and September.
13. Called up share capital
Ordinary share capital represents the total number of shares in issue, for which dividends accrue.
| 2018 | 2017 | |||
| NUMBER | £’000 | NUMBER | £’000 | |
| Allotted, called-up and fully paid: | ||||
| Ordinary shares of 50p each | 13,518,799 | 6,760 | 13,518,799 | 6,760 |
The ordinary shares are fully participating and on a poll carry one vote per £1 nominal held.
No shares were issued or bought back during the year (2017: nil).
14. Reserves
This note explains the different reserves that have arisen over the years. The aggregate of the reserves and share capital (see previous note) make up total shareholders’ funds.
The share premium comprises the net proceeds received by the Company following the issue of shares, after deduction of the nominal amount of 50 pence and any applicable issue costs. The capital redemption reserve maintains the equity share capital arising from the buy back and cancellation of shares; it, and the share premium, are non-distributable.
The capital reserve includes the investment holding gains/(losses), being the difference between cost and market value at the balance sheet date. It also includes cumulative realised gains/(losses). Capital investment gains and losses are shown in note 9(b) and form part of the capital reserve. Share buy backs can be funded from the capital reserve.
The revenue reserve shows the net revenue retained after payment of dividends. The revenue and capital reserves are distributable by way of dividend.
15. Net Asset Value
The Company’s total net assets (total assets less total liabilities) are often termed shareholders’ funds and are converted into net asset value per ordinary share by dividing by the number of shares in issue.
The following shows the shareholders' funds and net asset value (NAV) in pence per share, together with a reconciliation of NAV with debt at par to NAV with debt at fair value. The difference in the NAVs arises from the valuation of the debenture stocks and preference shares. The number of shares in issue at the year end is shown in note 13.
| 2018 | 2017 | |||
| SHAREHOLDERS’ FUNDS £’000 |
NAV PER SHARE PENCE |
SHAREHOLDERS’ FUNDS £’000 |
NAV PER SHARE PENCE |
|
| NAV – debt at par | 266,146 | 1,968.7 | 275,387 | 2,037.1 |
| Add: debt at par, after amortised costs (note 12) | 32,037 | 237.0 | 32,003 | 236.7 |
| Less: debt at fair value (note 17) | (38,392) | (284.0) | (39,728) | (293.9) |
| NAV – debt at fair value | 259,791 | 1,921.7 | 267,662 | 1,979.9 |
Only the basic NAV is shown. There is no dilution in this or the previous year.
16. Financial Instruments
Financial instruments comprise the Company’s investment portfolio, derivative instruments (if any) as well as its cash, and any borrowings, debtors and creditors. This note sets out the Company’s financial instruments and the risks related to them.
The Company’s financial instruments comprise its investment portfolio (as shown on pages 16 and 17), derivatives, cash, borrowings, debtors and creditors that arise directly from its operations such as sales and purchases awaiting settlement and accrued income. The accounting policies in note 1 include criteria for the recognition and the basis of measurement applied for financial instruments. Note 1 also includes the basis on which income and expenses arising from financial assets and liabilities are recognised and measured. The Company did not have any exposure to derivatives during the year (2017: none), apart from the use of forward currency contracts to hedge the Euro and Canadian dollar exposure.
The principal risks that an investment company faces in its portfolio management activities are set out below:
Market risk – arising from fluctuations in the fair value or future cash flows of a financial instrument because of changes in market prices. Market risk comprises three types of risk: currency risk, interest rate risk and other price risk:
Currency risk – arising from fluctuations in the fair value or future cash flows of a financial instrument because of changes in foreign exchange rates;
Interest rate risk – arising from fluctuations in the fair value or future cash flows of a financial instrument because of changes in market interest rates; and
Other price risk – arising from fluctuations in the fair value or future cash flows of a financial instrument for reasons other than changes in foreign exchange rates or market interest rates.
Liquidity risk – arising from any difficulty in meeting obligations associated with financial liabilities.
Credit risk – arising from financial loss for a company where the other party to a financial instrument fails to discharge an obligation.
Risk Management Policies and Procedures
The Directors have delegated to the Manager the responsibility for the day-to-day investment activities of the Company as more fully described in the Directors’ Report.
An investment company invests in equities and other investments for the long term so as to meet its investment objective and policies. In pursuing its investment objective, the Company is exposed to a variety of risks that could result in either a reduction in the Company’s net assets or a reduction of the profits available for distribution by way of dividends.
The risks applicable to the Company and the policies the Company used to manage these risks for the two years under review follow.
Market risk
The Company’s Manager assesses the Company's exposure when making each investment decision, and monitors the overall level of market risk on the whole of the investment portfolio on an ongoing basis. The Board meets at least quarterly to assess risk and review investment performance, as disclosed under Board Responsibilities on page 53. No derivatives or hedging instruments are utilised to manage market risk. Borrowings are used to enhance returns, however, this increases the Company's exposure to market risk and volatility.
Currency risk
The majority of the Company’s assets, liabilities and income are denominated in Sterling. There is some exposure to US dollars, Swiss francs, Canadian dollars and the Euro. The latter two currencies were hedged by the use of forward currency contracts.
Management of the currency risk
The Manager monitors the Company’s exposure to foreign currencies daily and reports to the Board on a regular basis.
Forward currency contracts can be used to limit the Company’s exposure to anticipated future changes in exchange rates which are also used to achieve the portfolio characteristics that assist the Company in meeting its investment objective and policies. All contracts are limited to currencies and amounts commensurate with asset exposure to those currencies.
Income denominated in foreign currencies is converted to Sterling on receipt. The Company does not use financial instruments to mitigate the currency exposure in the period between the time that income is included in the financial statements and its receipt.
Currency exposure
The fair values of the Company’s monetary items that had currency exposure at 30 September are shown below. Where the Company’s equity investments (which are not monetary items) are priced in a foreign currency, they have been included separately in the analysis so as to show the overall level of exposure.
| 30 SEPTEMBER 2018 | ||||
| CANADIAN DOLLAR £’000 |
EURO £’000 |
SWISS FRANC £’000 |
US DOLLAR £’000 |
|
| Debtors (due from brokers and dividends) | — | 1 | 272 | 35 |
| Forward currency contracts | (3,126) | (8,525) | — | — |
| Foreign currency exposure on net monetary items | (3,126) | (8,524) | 272 | 35 |
| Investments at fair value through profit or loss that are equities | 3,258 | 8,340 | — | 6,326 |
| Total net foreign currency exposure | 132 | (184) | 272 | 6,361 |
| 30 SEPTEMBER 2017 | ||||
| CANADIAN DOLLAR £’000 |
EURO £’000 |
SWISS FRANC £’000 |
US DOLLAR £’000 |
|
| Debtors (due from brokers and dividends) | — | — | 267 | — |
| Forward currency contracts | — | (10,674) | — | — |
| Foreign currency exposure on net monetary items | — | (10,674) | 267 | — |
| Investments at fair value through profit or loss that are equities | — | 10,794 | 2,672 | 1,708 |
| Total net foreign currency exposure | — | 120 | 2,939 | 1,708 |
The above amounts may not be representative of the exposure to risk during the year, because the levels of foreign currency exposure may change significantly throughout each year.
Currency sensitivity
The table below illustrates the sensitivity of net assets and of net return after taxation for the year using the exchange rates shown below. It is based on the Company’s monetary foreign currency financial instruments held at each balance sheet date and takes account of forward foreign exchange contracts that offset the effects of changes in currency exchange rate.
| 2018 | 2017 | |
| £/Canadian Dollar | ±2.6% | n/a |
| £/Euro | ±0.9% | ±2.6% |
| £/Swiss franc | ±2.2% | ±1.8% |
| £/US dollar | ±3.0% | ±2.7% |
The above percentages have been determined based on the market volatility in the year, using the standard deviation of Sterling’s daily fluctuation to the relevant foreign currencies against the mean during the year.
If Sterling were to weaken against the Canadian dollar, Euro, US dollar or Swiss franc to this extent, this would have the following effect:
| 30 SEPTEMBER 2018 | ||||
| CANADIAN DOLLAR £’000 |
EURO £’000 |
SWISS FRANC £’000 |
US DOLLAR £’000 |
|
| Income statement – return after taxation | ||||
| Revenue return | — | — | 6 | 3 |
| Capital return | 3 | (2) | — | 190 |
| Total return after taxation for the year | 3 | (2) | 6 | 193 |
| Effect on net asset value | 0.0% | 0.0% | 0.0% | 0.1% |
| 30 SEPTEMBER 2017 | |||||
| CANADIAN DOLLAR £’000 |
EURO £’000 |
SWISS FRANC £’000 |
US DOLLAR £’000 |
||
| Income statement - return after taxation | |||||
| Revenue return | — | 1 | 13 | 10 | |
| Capital return | — | 3 | 48 | 46 | |
| Total return after taxation for the year | — | 4 | 61 | 56 | |
| Effect on net asset value | — | 0.0% | 0.0% | 0.0% | |
If Sterling were to strengthen against the Canadian dollar, Euro, US dollar or Swiss franc to the same extent, the effect would be the exact opposite.
In the opinion of the Directors, the above sensitivity analysis is not representative of the year as a whole, since the level of exposure may change frequently as part of the currency risk management process of the Company.
Interest rate risk
Interest rate movements may affect the level of income receivable on cash deposits and the interest payable on the variable rate borrowings. When the Company has cash balances, they are held on variable rate bank accounts yielding rates of interest dependent on the base rate of the custodian. The Company has an uncommitted overdraft facility of up to £15 million available for investment and settlement purposes, details are shown in note 11. Use of the overdraft has been infrequent over the two years being reported on and at the year end none was drawn down (2017: none).
At the balance sheet date the Company had structural debt comprising £32 million of debenture stocks and £250,000 of 5% cumulative preference shares. The interest rates on the debenture stocks and preference shares are fixed and details are shown in notes 5 and 12.
The Company’s portfolio is substantially invested in equities which are not directly exposed to interest rate risk.
Other price risk
Other price risk (i.e. changes in market prices other than those arising from interest rate risk or currency risk) may affect the value of the equity investments, and it is the business of the Manager to manage the portfolio to achieve the best returns.
Management of other price risk
The Directors manage the market price risks inherent in the investment portfolio by meeting regularly to monitor on a formal basis the Manager’s compliance with the Company’s stated objectives and policies and to review investment performance.
The Company’s portfolio is the result of the Manager’s investment process and as a result is not correlated with the Company's benchmark or the market in which the Company invests. The value of the portfolio will not move in line with the market but will move as a result of the performance of the company shares within the portfolio.
Based on the equity portfolio value of £296,692,000 (2017: £294,778,000), if the value of the portfolio rose or fell by 1% at the balance sheet date, the net return after tax for the year and net assets would increase or decrease by £2.97 million (2017: £2.95 million) respectively; in calculating these amounts no adjustment has been made for other variables including management fees.
Liquidity risk
Liquidity risk is minimised as the majority of the Company’s investments are readily realisable securities which can be sold to meet funding commitments if necessary. In addition, the bank overdraft facility provides for additional funding flexibility. No special arrangements have been made in connection with the liquidity of any of the Company’s assets.
Liquidity risk exposure
The contractual maturities of the financial liabilities at the year end, based on the earliest date on which payment can be required, are as follows:
| 2018 | 2017 | |||||||
| LESS THAN THREE MONTHS £’000 |
THREE TO TWELVE MONTHS £’000 |
MORE THAN ONE YEAR £’000 |
TOTAL £’000 |
LESS THAN THREE MONTHS £’000 |
THREE TO TWELVE MONTHS £’000 |
MORE THAN ONE YEAR £’000 |
TOTAL £’000 | |
| Debenture stocks | — | — | 31,968 | 31,968 | — | — | 31,968 | 31,968 |
| Interest on debenture stocks | 811 | 1,354 | 7,035 | 9,200 | 811 | 1,354 | 9,200 | 11,365 |
| Amounts due to brokers | 195 | — | — | 195 | 809 | — | — | 809 |
| Other creditors and accruals | 351 | — | — | 351 | 364 | — | — | 364 |
| 1,357 | 1,354 | 39,003 | 41,714 | 1,984 | 1,354 | 41,168 | 44,506 | |
The 5% cumulative preference shares do not have a fixed repayment date and are, as a result, not shown in the above table. Details are shown in note 12 of the financial statements.
Credit risk
Credit risk encompasses the failure by counterparties to deliver securities which the Company has paid for, or to pay for securities which the Company has delivered, and cash balances. Counterparty risk is minimised by using only approved and appropriately regulated counterparties. During the year cash balances were limited to a maximum of either £10 or £15 million with any one deposit taker and 10% of gross assets for holdings in the Short-Term Investments Company (Global Series) plc (STIC), which invests in high quality sterling denominated money market investments such as commercial paper, certificates of deposit, time deposits and asset-backed commercial paper. Since the year end the limit of cash that can be placed with STIC has been increased to 12.5%, with other deposit takers limited to 6% of gross assets. Only deposit takers approved by the Board are used.
The portfolio may be adversely affected if the custodian of the Company’s assets suffers insolvency or other financial difficulties. The risk associated with failure of the custodian is mitigated by the appointment of a depositary. The depositary is ultimately responsible for safekeeping of the Company’s assets and is strictly liable for the recovery of financial instruments in the event of loss. As part of the Board’s risk management and control monitoring, the Board reviews the custodian’s annual control report and the Manager’s management of the relationship with the custodian.
17. Fair Value
The fair values of the financial assets and financial liabilities, other than debentures and preference shares, are either carried in the balance sheet at their fair value (investments), or the balance sheet amount is a reasonable approximation of fair value (due from brokers, dividends receivable, accrued income, due to brokers, accruals, cash at bank and overdraft).
Fair Value Hierarchy Disclosures
Nearly all of the Company’s portfolio of investments are in the Level 1 category as defined in FRS 102 as amended for fair value hierarchy disclosures (March 2016). The three levels set out in FRS102 follow:
Level 1 – The unadjusted quoted price in an active market for identical assets or liabilities that the entity can access at the measurement date.
Level 2 – Inputs other than quoted prices included within Level 1 that are observable (i.e. developed using market data) for the asset or liability, either directly or indirectly.
Level 3 – Inputs are unobservable (i.e. for which market data is unavailable) for the asset or liability.
Categorisation within the hierarchy is determined on the basis of the lowest level input that is significant to the fair value measurement of each relevant asset/liability. The valuation techniques used by the Company are explained in the accounting policies note.
| 2018 | 2017 | |||||||
| LEVEL 1 | LEVEL 2 | LEVEL 3 | TOTAL | LEVEL 1 | LEVEL 2 | LEVEL 3 | TOTAL | |
| £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | £’000 | |
| Financial assets designated at fair value through profit or loss: | ||||||||
| Quoted investments: | ||||||||
| Equities | 285,480 | — | — | 285,480 | 285,095 | — | — | 285,095 |
| Other securities | — | 174 | — | 174 | — | 203 | — | 203 |
| Unquoted investments: | ||||||||
| Equities | — | — | 11,038 | 11,038 | — | — | 9,480 | 9,480 |
| Derivative financial instruments: | ||||||||
| Currency hedges | — | 70 | — | 70 | — | 157 | — | 157 |
| Total for financial assets | 285,480 | 244 | 11,038 | 296,762 | 285,095 | 360 | 9,480 | 294,935 |
Barclays Bank – Nuclear Power Notes 28 Feb 2019, was transferred to Level 1 (2017: Level 2) during the year following increased market activity in this holding. The fair value of this holding at the year end was £98,000 (2017: £1,000).
With regard to unobservable inputs used in the valuation of unquoted investments, there are no reasonably possible alternative assumptions which would produce a material change to the Company’s net asset value.
The book cost and fair value of the debentures and the preference shares based on the offer value at the balance sheet date follow.
| BOOK VALUE 2018 £’000 |
FAIR VALUE 2018 £’000 |
BOOK VALUE 2017 £’000 |
FAIR VALUE 2017 £’000 |
|
| Debentures payable in less than 5 years: | ||||
| 7.75% Debenture Stock 2020 | 7,000 | 7,946 | 7,000 | 8,286 |
| Debentures repayable in more than 5 years: | ||||
| 6.5% Debenture Stock 2023 | 24,968 | 30,200 | 24,968 | 31,218 |
| Discount on issue of debentures | (181) | — | (215) | — |
| 31,787 | 38,146 | 31,753 | 39,504 | |
| 5% Cumulative preference shares of £1 each | 250 | 246 | 250 | 224 |
| 32,037 | 38,392 | 32,003 | 39,728 |
18. Capital Management
The Company’s capital, or equity, is represented by its net assets which are managed to achieve the Company’s investment objective set out on page 6.
The Company’s total capital employed at 30 September 2018 was £298,183,000 (2017: £307,390,000) comprising borrowings of £32,037,000 (2017: £32,003,000) and equity share capital and other reserves of £266,146,000 (2017: £275,387,000).
The Company’s total capital employed is managed to achieve the Company’s investment objective and policy as set out on page 6, including that borrowings may be used to provide gearing of the equity portfolio. At the balance sheet date, net gearing was 11.6% (2017: 6.6%). The Company’s policies and processes for managing capital are unchanged from the preceding year.
The main risks to the Company’s investments are shown in the Strategic Report under the ‘Principal Risks and Uncertainties’ section on pages 8 to 9. These also explain that the Company is able to gear and that gearing will amplify the effect on equity of changes in the value of the portfolio.
The Board can also manage the capital structure directly since it has taken the powers, which it is seeking to renew, to issue and buy back shares and it also determines dividend payments.
The Company is subject to externally imposed capital requirements with respect to the obligation and ability to pay dividends by section 1159 Corporation Tax Act 2010 and by the Companies Act 2006, respectively, and with respect to the availability of the overdraft facility, by the terms imposed by the custodian. The Board regularly monitors, and has complied with, the externally imposed capital requirements. This is unchanged from the prior year.
Borrowings comprise debenture stocks, preference shares and an uncommitted bank overdraft facility, details of which are contained in note 12.
19. Contingencies, Guarantees and Financial Commitments
Contingencies or guarantees that the Company will or has given would be disclosed in this note if any existed. Likewise any commitments, being those amounts that the Company is contractually required to pay in the future as long as the other party meets their obligations.
There were no contingencies, guarantees or other financial commitments of the Company at the year end (2017: £nil).
20. Related Party Transactions and Transactions with the Manager
A related party is a company or individual who has direct or indirect control or influence over the Company. Under accounting standards, the Manager is not a related party.
Under UK GAAP, the Company has identified the Directors as related parties. The Directors’ remuneration and interests have been disclosed on pages 25 and 26 with additional disclosure in note 4. No other related parties have been identified.
Details of the Manager’s services and fees are disclosed in the Directors’ Report on pages 55 and 56 and in note 3.
21. Post Balance Sheet Events
Any significant events that occurred after the Company’s financial year end but before the signing of the Balance Sheet will be shown here.
There are no significant events after the end of the reporting period requiring disclosure.
The financial information set out above does not constitute the Company’s statutory accounts for the year ended 30 September 2018. The financial information for the year ended 30 September 2017 is derived from the statutory accounts for 2017, which have been delivered to the Registrar of Companies. The 2017 accounts were audited and the audit report was unqualified, did not include a reference to any matters to which the auditor drew attention by way of emphasis without qualifying the report and did not contain a statement under section 498 of the Companies Act 2006. The statutory accounts for the year ended 30 September 2018 have been finalised and audited but have not yet been delivered to the Registrar of Companies.
The audited annual financial report will be available to shareholders shortly. Copies may be obtained during normal business hours from the Company’s administration office, 2nd Floor, 43-45 Portman Square, London W1H 6LY and are available via the Company’s section of the Manager’s website at www.invesco.co.uk/keystone .
The Annual General Meeting will be held on 22 January 2019 at 11.00am at 43-45 Portman Square, London, W1H 6LY.
By order of the Board
Invesco Asset Management Limited
26 November 2018
Contact:
Shilla Pindoria 0203 753 1000
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