Annual Financial Report

Montanaro UK Smaller Companies Investment Trust PLC Annual Financial Report 2011 The full Annual Report and Accounts 2011 can be found on the Company's website www.montanarouksmaller.co.uk. Investment Objective MUSCIT's investment objective is capital appreciation through investing in small quoted companies listed on the London Stock Exchange or traded on the Alternative Investment Market ("AIM") and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding Investment Companies) Index ("SmallCap"). No unquoted investments are permitted. Highlights for the year ended 31 March 2011 Results ● NAV +39% £141m ● Gross assets +40% £157m ● Share price +52% £119m* ● FTSE SmallCap Index +12%** * Market capitalisation. ** Excluding Investment Companies. Year to Year to 31 March 31 March 2011 2010 Revenue return on ordinary 2,516 2,296 activities (£000) Movement in capital reserve 38,413 36,704 (£000) Revenue return per Ordinary 7.51p 6.86p share Dividend per Ordinary share 6.76p 6.20p* Total return per Ordinary 122.26p 116.50p share As at As at 31 March 31 March 2011 2010 Ordinary share price 355.00p 234.00p NAV per Ordinary share 421.65p 302.59p * Includes 3p interim dividend paid December 2009. Chairman's Statement Background I am pleased to present the 16th annual report of MUSCIT, which was launched in March 1995. In 1996, the initial investment of £25 million was increased in size through a £30 million "C" share issue. Net assets now stand at £141 million. An investment trust is an attractive vehicle for shareholders to invest in quoted UK "smaller" companies, which are less well researched and more illiquid than larger, blue chip companies. Performance In the year to 31 March 2011, the NAV of MUSCIT increased by 39% to 421.65p in comparison with a 12% rise in the SmallCap. Since launch, the NAV of MUSCIT has increased by 320% in comparison with a gain of 55% by the SmallCap, outperforming by 265%. Discount The discount of MUSCIT's share price to NAV stood at 16% on 31 March 2011 in comparison with a weighted sector average of 14% (source: Close Wins Investment Trusts). Share Buy Backs The Board is responsible for share buy backs which are undertaken at arm's length from the Manager. No shares were bought back during the year. Holding Shares in Treasury Since December 2003, investment trusts have had the right to buy back shares and hold them in Treasury for re-issue at a later date. This has the benefit of improving liquidity as well as retaining the opportunity to enhance the NAV. The Board has actively and carefully considered the use of Treasury shares and has been among the industry's pioneers. Our policy is to ensure that shareholders receive a tangible benefit above and beyond an enhanced ability to manage the liquidity of the shares of MUSCIT. Shares held in Treasury will only be re-issued at a lower discount than when they were originally purchased and to produce a positive absolute return. Shares not re-issued will be cancelled within one year from purchase. As at 31 March 2011 no shares were held in Treasury. Gearing The Board reviews the level of gearing considered appropriate for the Company in discussion with the Manager. One of the benefits of investment trusts is the ability to hold prudent levels of gearing which can enhance investment returns. The Board has agreed to limit borrowings to 25% of shareholders' funds. Throughout the year the Company had a £15 million facility with ING Bank. At 31 March 2011, £15 million was drawn down at an interest rate of 1.29%. During the year, Net Gearing ranged from 6.7% to 13.8%. At 31 March 2011, gearing was 9.3% (debt as a % of gross assets) and 10.3% (debt as a % of net assets). Dividends MUSCIT's primary focus is on capital growth rather than income. The Board proposes a final dividend of 6.76p per Ordinary share payable on 12 August 2011 to shareholders on the register at the close of business on 1 July 2011. Corporate Governance The Directors have reviewed the recommendations of the AIC Code on Corporate Governance (the "AIC Code") and have implemented procedures where appropriate, such as an annual evaluation of the Board's performance. MUSCIT has complied with the AIC Code throughout the year except where compliance would be inappropriate given the size and nature of the Company. Full disclosure of MUSCIT's compliance with the AIC Code is included in the Directors' Report. The Manager has signed up to the Stewardship Code and will be publishing its voting records on their website. The use of an internal audit function is not considered necessary given the inherent segregation of duties and internal controls. Directors It was with great sadness that we record the death of Laurie Petar, who died in July 2010; he is sorely missed. Roger Cuming remains as Senior Director and Kathryn Matthews became chairman of the Remuneration Committee and the Nomination Committee. Michael Moule was appointed chairman of the Management Engagement Committee and remains chairman of the Audit Committee. Chairman's Comment Economists are generally reasonably confident about the outlook for the global economy over the next two years expecting moderate growth. This comes from continued strength in the emerging world and ever more expansionary policies in the United States. In Europe, the strength of central and northern countries will more than offset the deflationary forces at play within Portugal, Italy, Ireland, Greece and Spain, the so-called PIIGS. Germany, which produces around a quarter of the output in Europe, is China's fifth largest trade partner and can barely keep up with demand. In the UK, deficit reduction efforts are bearing fruit and the Olympic Games should give a boost to the economy although growth is slow and uneven. In 2008, many small companies, which typically are more flexible and dynamic with more entrepreneurial management, were quick to cut costs in the face of difficult times. Smaller companies are leaner and meaner than ever today, have recovered well and are generating record levels of cash and profits. Over the past 30 years there have been four periods in the UK when corporate profits fell as a result of recession. Typically earnings declined by 25% - 35% over two or three years. Recovery periods lasted 5 - 8 years. Therefore, if history is any guide, several years of recovery in earnings lie ahead. 2011 will be a year for stockpickers. UK SmallCap offers a huge choice of over 2,000 often under researched companies which may grow faster due to their size and give investors higher returns. Typically they are niche businesses with high barriers to entry, pricing power and more motivated management often with large stakes in their own businesses. This is an asset class that allows a Fund Manager with a large, dedicated research team and a few grey hairs to add significant value for shareholders. The exceptional returns over the past two years, while unlikely to be repeated, demonstrate why most investors should include UK SmallCap in their portfolios. UK SmallCap generates attractive returns for investors at times of economic and earnings recovery which augurs well for the next few years. The Montanaro team has had a spectacular year and thoroughly deserves the performance fee awarded to them. This is the first time the capped performance fee has been awarded since the year ended 31 March 2007. The Board, on behalf of the shareholders offers its congratulations - keep it up! David Gamble Chairman 17 June 2011 Manager's Report Market Cap by Value of Holding Value of Holding Percentage £0-50m 1% £50-£100m 1% £100-£200m 20% £200-£300m 20% £300-£600m 28% >£600m 30% 100% Manager's Review 2010/2011 was another good year for investors in UK SmallCap with the FTSE SmallCap (ex Investment Companies) Index increasing by 12% and the RBS Hoare Govett Small Companies Index ("RBS HGSC") by 18%. In comparison, the 39% rise in the NAV of the Fund and the 52% rise in the MUSCIT share price are pleasing. In football parlance this was a year of "two halves". It was a year when the market oscillated between chasing risk and avoiding risk. This was particularly evident in the first half with stock market indices fluctuating by as much as 15%. The first half was dominated by concerns over euro-area sovereign risks with Portugal, Italy, Ireland, Greece and Spain (the "PIIGS") all seeing bond yields rise sharply. To add insult to injury, Eyjafjallajökull erupted covering Europe with Icelandic volcanic ash. This led to the cancellation of flights across most of Europe. Much of the summer saw the equity market range bound. With better macro economic data in the second half of the year and a second round of Quantitative Easing (QE2) in the United States, UK SmallCap enjoyed a gain of 15% with particular strength leading up to Christmas. During last year, growth stocks - our investment focus - outperformed value stocks significantly. Momentum investing was also a successful investment strategy (buying the "winners" of the previous year). Given Montanaro's long term investment horizons, this was helpful. Finally, a number of core holdings such Chloride, Scott Wilson and Dana Petroleum were taken over at a substantial premium. Outlook Montanaro believe that we are less than half-way through a major equity Bull Market which started in April 2009 when we first turned positive again. After a severe Bear Market such as we saw in 2007-2008, Bull Markets historically have lasted on average 5 - 6 years and SmallCap outperformed by 7% p.a. Market valuations are attractive and below average (notably 10% cheaper than Emerging Market equities and US equities). We expect a significant increase in take-overs in 2011 as cash-rich buyers look at external growth to accelerate recent earnings growth. At the peak of the last cycle Montanaro benefited from the take-over of twenty holdings. SmallCap looks under-valued based on price/book measures. Private equity may well make a comeback and compete with trade buyers for targets, many of which will be small companies, bidding up prices. Whilst this should help sentiment, as always there are two sides to every story. We also expect an increase in profit warnings this year. Economic conditions remain challenging and it becomes ever harder to exceed expectations as the cycle matures. Companies on high valuations that disappoint will be severely punished. This is one reason why Montanaro invest in the highest quality companies at attractive valuations. In addition, a large number of companies may be floated on the Stock Market this year which could absorb some of the cash held by investors. They will need to be of a high quality to succeed. We also see a trend of gradually rising inflation and interest rates. The challenges of the PIIGS have not been resolved and are likely to lead to further speculation about the future of the euro. Such concerns are likely to lead to greater stock market volatility than recently. Currently, UK SmallCap is under-owned (everyone has bought bonds and Emerging Markets) and unloved (who wants to buy the UK and Europe in the middle of a PIIGS crisis?), but it is the contrarian investor who makes the money. Montanaro expect UK SmallCap to continue to outperform both MidCap and LargeCap this year. With a bit of luck and hard work, we hope to do better once again. Montanaro Asset Management Limited 17 June 2011 Ten Largest Holdings as at 31 March 2011 Dialight PLC- Electronic and Electrical Equipment Applied LED technology (energy saving, improved safety and easy disposal) for industrial and commercial uses including obstruction lighting, traffic and rail signalling. £5.01m 3.3% £237m Value Portfolio Market Cap Brammer PLC- Support Services A pan-European technical distributor of power transmission components. £4.75m 3.1% £316m Value Portfolio Market Cap SDL PLC - Software and Computer Services Provider of software and services for managing content and language translation. £4.55m 3.0% £508m Value Portfolio Market Cap NCC Group PLC - Software and Computer Services A provider of escrow solutions, assurance testing and consultancy. £4.52m 2.9% £193m Value Portfolio Market Cap Domino Printing Sciences PLC - Electronic and Electrical Equipment An international group providing total coding and printing solutions to a wide portfolio of market sectors. £4.48m 2.9% £698m Value Portfolio Market Cap Fenner PLC - Industrial Engineering A world leader in reinforced polymer technology. £4.32m 2.8% £692m Value Portfolio Market Cap Brooks Macdonald Group PLC - General Financials Integrated private client asset management and financial services company. £4.24m 2.8% £120m Value Portfolio Market Cap Devro PLC - Food Producers Producers of manufactured casings for the food industry, supplying a wide range of products and technical support to manufacturers of sausages, salami hams and other cooked meats. £4.24m 2.8% £464m Value Portfolio Market Cap Victrex PLC - Chemicals Manufacturer of high performance polyaryletherketones. £4.09m 2.7% £1,130m Value Portfolio Market Cap James Fisher & Sons PLC- Industrial Transportation Provider of specialist marine support services and operator of tankships around UK coastal waters. £4.01m 2.6% £259m Value Portfolio Market Cap Investment Portfolio as at 31 March 2011 Value % of Market Cap Holding Sector £000 portfolio £m Dialight Electronic and Electrical 5,007 3.3 237 Equipment Brammer Support Services 4,752 3.1 316 SDL Software and Computer 4,550 3.0 508 Services NCC Group Software and Computer 4,524 2.9 193 Services Domino Printing Sciences Electronic and Electrical 4,477 2.9 698 Equipment Fenner Industrial Engineering 4,320 2.8 692 Brooks Macdonald Group General Financials 4,237 2.8 120 Devro Food Producers 4,237 2.8 464 Victrex Chemicals 4,092 2.7 1,130 James Fisher Industrial Transportation 4,014 2.6 259 Renishaw Electronic and Electrical 3,926 2.5 1,099 Equipment Shaftesbury Real Estate/Real Estate 3,667 2.4 1,183 Investment Trusts Latchways Support Services 3,629 2.4 115 Ocean Wilsons Holdings Industrial Transportation 3,524 2.3 401 Premier Oil Oil and Gas Producers 3,489 2.3 2,321 Consort Medical Health Care Equipment and 3,441 2.2 164 Services Domino's Pizza Travel and Leisure 3,423 2.2 687 Helical Bar Real Estate/Real Estate 3,385 2.2 320 Investment Trusts RPS Group Support Services 3,207 2.1 465 Immunodiagnostics Health Care Equipment and 3,169 2.1 234 Services Twenty Largest Holdings 79,070 51.6 WSP Group Support Services 3,165 2.1 232 Ricardo Support Services 3,155 2.1 173 Dignity General Retailers 3,132 2.0 381 Chemring Group Aerospace and Defence 3,112 2.0 1,223 Genus Pharmaceuticals and 3,092 2.0 566 Biotechnology Abcam Pharmaceuticals and 3,054 2.0 682 Biotechnology Dechra Pharmaceuticals Pharmaceuticals and 3,023 2.0 335 Biotechnology Croda International Chemicals 3,020 2.0 2,304 AG Barr Beverages 2,878 1.9 479 Carclo Chemicals 2,835 1.8 174 Mears Group Support Services 2,803 1.8 207 Brewin Dolphin General Financials 2,775 1.8 389 Aveva Group Software and Computer 2,737 1.8 1,098 Services Enquest Oil and Gas Producers 2,726 1.8 1,094 Severfield-Rowen Industrial Engineering 2,716 1.8 237 Primary Health Properties Real Estate/Real Estate 2,568 1.7 219 Investment Trusts Clarkson Industrial Transportation 2,560 1.7 243 Albemarle & Bond Holdings General Financials 2,446 1.6 171 Booker Group Food and Drug Retailers 2,438 1.6 923 M.P. Evans Group Food Producers 2,322 1.5 230 Microgen Software and Computer 2,273 1.5 113 Services Group NBT Software and Computer 1,908 1.2 105 Services Wilmington Group Media 1,825 1.2 123 James Halstead Construction and Materials 1,672 1.1 470 Kewill Software and Computer 1,643 1.1 85 Services Marshalls Construction and Materials 1,569 1.0 225 Aquarius Platinum Mining 1,555 1.0 1,625 Oxford Instruments Electronic and Electrical 1,218 0.8 351 Equipment Encore Oil Oil and Gas Producers 1,210 0.8 322 Fidessa Group Software and Computer 1,025 0.7 641 Services Stanley Gibbons General Retailers 982 0.6 39 DTZ Holdings Real Estate/Real Estate 668 0.4 76 Investment Trusts Total Portfolio 153,175 100.0 Analysis of Investment Portfolio by Industrial or Commercial Sector as at 31 March 2011 Sector % of portfolio % of SmallCap Oil and Gas Producers 4.9 2.1 Alternative Energy - 1.4 Oil and Gas 4.9 3.5 Chemicals 6.5 0.7 Industrial Metals - 0.4 Mining 1.0 2.8 Basic Materials 7.5 3.9 Construction and Materials 2.1 4.3 Aerospace and Defence 2.0 1.2 General Industrials - 0.3 Electronic and Electrical Equipment 9.5 6.1 Industrial Engineering 4.6 3.4 Industrial Transportation 6.6 3.1 Support Services 13.6 16.0 Industrials 38.4 34.4 Beverages 1.9 - Food Producers 4.3 3.5 Household Goods - 2.3 Leisure Goods - 0.6 Consumer Goods 6.2 6.4 Health Care Equipment and Services 4.3 1.1 Pharmaceuticals and Biotechnology 6.0 4.2 Health Care 10.3 5.3 Food and Drug Retailers 1.6 0.9 General Retailers 2.6 4.5 Media 1.2 6.0 Travel and Leisure 2.2 4.7 Consumer Services 7.6 16.1 Fixed Line Telecommunications - 2.2 Telecommunications - 2.2 Non-life Insurance - 2.7 Life Insurance - 1.5 Real Estate and Investment Services 2.6 10.4 Real Estate Investment Trusts 4.1 3.6 General Financials 6.2 3.8 Financials 12.9 22.0 Software and Computer Services 12.2 4.0 Technology Hardware and Equipment - 2.2 Technology 12.2 6.2 Total 100.0 100.0 The investment portfolio comprises 52 listed UK equity holdings including 10 holdings totalling £23,438,000 (representing 15.3% of the portfolio) traded on the Alternative Investment Market ("AIM"). Board of Directors David Gamble - Chairman Roger Cuming Kathryn Matthews - Appointed 1 April 2010 Michael Moule Business Review The Business Review has been prepared in accordance with the Companies Act 2006 and should be read in conjunction with the Chairman's statement and the Manager's Report. Introduction The purpose of the Business Review is to provide an overview of the business of the Company by: • Analysing development and performance using appropriate key performance indicators ("KPIs"). • Outlining the principal risks and uncertainties affecting the Company. • Describing how the Company manages these risks. • Explaining the future business plans of the Company. • Setting out the Company's environmental, social and ethical policy. • Providing information about persons with whom the Company has contractual or other arrangements which are essential to the business of the Company. • Outlining the main trends and factors likely to affect the future development, performance and position of the Company's business. Review of the DEVELOPMENT AND PERFORMANCE OF THE Business AND POSITION of MUSCIT A description of MUSCIT's activities and a review of the development and performance of the business during the year is given in the Chairman's Statement and in the Manager's Report. MUSCIT is a closed-end investment trust listed on the London Stock Exchange with registration number 3004101. Its affairs are managed so that it receives approval from HM Revenue & Customs as an investment trust under s1158 of the Corporation Tax Act 2010. One of the criteria for compliance is that at least 85% of MUSCIT's eligible investment income arising in an accounting period is distributed to shareholders. The Board considers that MUSCIT will continue to qualify as an investment trust, which confers certain benefits such as exemption from the payment of capital gains taxes arising on the sale of investments. MUSCIT has most recently received approval under s1158 for the year ended 31 March 2010 and an application will be made to HM Revenue & Customs for MUSCIT's status as an investment trust in financial year 2010/11. Further details on the operation of investment trusts can be obtained from the Association of Investment Companies on their website at www.theaic.co.uk. MUSCIT is also an investment company as defined in Section 833 of the Companies Act 2006. The current portfolio of MUSCIT is such that its shares are eligible for inclusion in an ISA and PEPs up to the maximum annual subscription limit and the Directors expect this eligibility to be maintained. MUSCIT's investment objective is capital appreciation (rather than income) achieved by investing in small quoted companies listed on the London Stock Exchange or traded on the Alternative Investment Market ("AIM") and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding Investment Companies) Index ("SmallCap"). No unquoted investments are permitted. The Company seeks to achieve its investment objective by investing in a portfolio of quoted UK small companies. At the time of initial investment, a potential investee company must be profitable and smaller than the largest constituent of the RBS HGSC Index, which represents the smallest 10% of the UK Stock Market by value. At the start of January 2011, the largest company in the RBS HGSC had a market capitalisation of over £1.4bn. The Manager focuses on the smaller end of this Index. The Manager will normally limit any one holding to a maximum of 4% of the Company's investments. The portfolio weighting of each investment is closely monitored to reflect the underlying liquidity of the particular company; smaller investments are made in less liquid companies. AIM exposure is also closely monitored by the Board and is limited to 30% of total investments, with Board approval required for exposure above 25%. The Manager is focused on identifying high quality niche companies operating in growth markets. This typically leads to investment in companies that enjoy high barriers to entry, pricing power, a sustainable competitive advantage and strong management teams. The portfolio is constructed on a "bottom up" basis and there are no sector constraints. The Board, in consultation with the Manager, is responsible for determining the gearing strategy for the Company. Gearing is used to enhance returns when the timing is considered appropriate. The Company currently has a credit facility of £15 million through ING Bank. The Board has agreed to limit borrowings to 25% of shareholders' funds. There are currently 33,475,958 Ordinary 10p shares in issue (2010: 33,475,958) none of which are held in Treasury (2010: nil). Holders of Ordinary shares have unrestricted voting rights of one vote per share at all general meetings of the Company. Description of Principal Risks Associated with MUSCIT The Board carefully considers the principal risks for MUSCIT and seeks to manage these risks through continual and regular review, policy setting, compliance with and enforcement of contractual obligations and active communication with the Manager, the Administrator and shareholders. The Board applies the principles detailed in the recommendations of the AIC Code as described in the Chairman's Statement. Details of MUSCIT's internal controls may be found in the Corporate Governance section in the full Annual Report and Accounts for the year ended 31 March 2011. Mitigation of the principal risks is sought and achieved in many ways as shown below: Investment Manager: Montanaro has been the Manager of MUSCIT since its launch in 1995. The success of MUSCIT and its strong performance is largely attributable to Montanaro. Should the current Manager not be in a position to continue its management of the Company, performance may be impacted. The Board meetings are attended by the Manager. Montanaro hasone of the largest specialist teams in the UK. Succession planning within Montanaro and recruitment of personnel are closely monitoredby the Board. Investment & Strategy: MUSCIT may underperform its benchmark as a result of poor stock selection, sector allocation or as a result of being geared in a falling market. The Manager meets regularly with the Board to discuss portfolio performance and strategy, and provides the Board and shareholders with monthly reports. The portfolio is well diversified thereby spreading investment risk and reducing stock specific risk. The Board receives and reviews monthly a report of all transactions and, through the forum of its Management Engagement Committee, formally reviews the performance of the Manager on an annual basis. Gearing: one of the benefits of closed-end investment trusts is the ability to use borrowings which can enhance returns in a rising stock market. However, gearing exacerbates movements in the net asset value both positively and negatively and will exaggerate declines in net asset value when prices of quoted UK small companies are falling. The Board monitors and discusses with the Manager the appropriate level of gearing of MUSCIT at each Board meeting. Portfolio Liquidity: as with all small company investment trusts, there are times when the liquidity of the underlying portfolio is poor, such as when small companies are out of favour or during periods of adverse economic conditions. The Manager focuses on "smaller" companies where the opportunities may be more attractive but this can increase overall underlying illiquidity. This may result in the Manager being unable to buy or sell individual holdings within the portfolio. In addition, this may impact the discount of MUSCIT's share price to the net asset value of the portfolio. One of the benefits of investment trusts is that generally the Manager is not forced to buy or sell individual holdings at inopportune times. The Manager constantly reviews the underlying liquidity of the portfolio, which is well-diversified. Particular attention is paid to the AIM holdings, with the Manager providing the Board with liquidity reports at every meeting. Montanaro dealswith a wide range of brokers to enhance their ability to execute and minimise liquidity risk. Liquidity of MUSCIT Shares: as with many small company investment trusts, there are times when the liquidity of the shares of MUSCIT is low. In the case of MUSCIT, many of the shareholders are large financial institutions with a long-term investment horizon. Unlike other trusts where private individuals form a larger part of the share register, this may result in fewer shares being traded in MUSCIT on a daily basis and make it difficult at times for investors to buy or sell shares of MUSCIT. The Manager is encouraged by the Board to market the strong investment story of MUSCIT to private client wealth managers and other potential new investors. The goal is to widen the shareholder base to enhance liquidity. In addition, the ability to buy back shares to be held in Treasury for subsequent re-issue enhances the liquidity of MUSCIT shares. Discount Volatility: as with all small company investment trusts, the discount can fluctuate significantly both in absolute terms and relative to its peer group. The Board actively monitors and seeks to manage the discount of MUSCIT and is responsible for share buy backs or issuance from Treasury. Share buy backs may help to reduce the discount. During the year and up to the date of this report, MUSCIT has notusedthe authoritygranted at the Annual General Meeting held in 2010to make market purchases of up to 5,018,046 Ordinary shares and as at the date of this report has the authority to purchase 5,018,046 Ordinary shares. No Ordinary shares are currently held in Treasury. No shares were purchased during the year. The Board encourages the Manager to market MUSCIT to new investors to increase demand for shares of MUSCIT, which may help to increase liquidity and reduce the discount. Regulatory: a breach of s1158 might lead to MUSCIT being subject to capital gains tax. A breach of rules of the London Stock Exchange might result in censure by the FSA and/or suspension of MUSCIT's listing on the London Stock Exchange. The Board has agreed a service level agreement with the Managerwhich includes active and regular review of compliance with s1158, and FSA and London Stock Exchange Rules. This is reviewed at each Board meeting. Operational: if the Administrator's operational procedures proved deficient and its core accounting systems failed, accounting errors might occur resulting in inaccurate net asset valuations, performance data and possibly a qualified audit report and/or loss of s1158 status. The Board monitors operational issues monthly and reviews them in detail at each Board meeting. Financial: inappropriate accounting policies or failure to comply with current or new Accounting Standards might lead to a breach of regulations and/or loss of s1158 status. The Board monitors financial issues monthly and reviews them in detail at each Board meeting. Banking: a breach of MUSCIT's loan covenants might lead to funding being summarily withdrawn and investment holdings potentially being sold at a time of poor liquidity. The main financial covenants to which the Company is subject in respect of the ING Bank N.V. revolving credit facility require it to ensure that total borrowings will not exceed 30% of the adjusted Net Asset Value at any time and that the adjusted Net Asset Value does not fall below £39,000,000 at any time. The Board monitors compliance with banking covenants monthly and reviews them with the Administrator and Manager. Reputational: inadequate or deficient controls of the Administrator or Manager or other third-party providers might result in breaches of regulations and damage the trust and confidence of shareholders in MUSCIT, leading to a widening of the discount. The Board continually monitors and reviews issues that may impact the standing of MUSCIT. Reputational: failure to keep current and potential investors informed of the Company's performance and development could result in fewer shares being traded in MUSCIT on a daily basis and also lower investor confidence. The Board and Manager maintain clear and frequent communication with shareholders and potential investorsandare both happy to meet with shareholders. Company Viability: through falling NAV, or a reduction in the size of the Company through purchases of its own shares, the size of the Company could make the continuing existence of the Company unviable in the opinion of investors. The Board actively monitors and seeks to manage the discount of MUSCIT and is responsible for share buy backs for cancellation or holding in Treasury. The resultant size of the Company is an important consideration of the decision to undertake buy backs. A description of MUSCIT's system for reviewing its risk-environment is set out above. Analysis of Performance Using Key Performance Indicators Results and Dividends: the results for the year are as set out in the Income Statement. The Directors recommend that a final dividend of 6.76p (2010: final 3.20p, interim 3.0p) per Ordinary share, amounting to £2,263,000 (2010: final £ 1,071,000, interim £1,004,000) to be paid on 12 August 2011 to shareholders on the share register at the close of business on 1 July 2011. Net Asset Value: the NAV per Ordinary share, including revenue reserves, at 31 March 2011 was 421.65p (2010: 302.59p). The Board reviews performance by reference to a number of KPIs and considers that the most relevant KPIs are those that communicate the financial performance and strength of the Company as a whole. The Board and the Manager monitor the following KPIs: • the NAV over one, three and five years and since launch relative to the benchmark and peer group; • the high, low and closing level of discount; and • the Total Expense Ratio which was 1.4% in the year to 31 March 2011. Further KPIs are those which show the Company's position in relation to the investment trust tests which it is required to meet and maintain its investment trust status. Voting Policy and Socially Responsible Investment The Company has no employees and the Board is comprised entirely of non-executive Directors. Day-to-day management of the Company's business is undertaken by Montanaro as the Investment Manager and the Company itself has no environmental, social or community policies. In carrying out business with its suppliers the Company aims to conduct itself responsibly, ethically and fairly. The Company has given discretionary voting powers to the Manager, Montanaro. AIC Code Principal 16 recommends that the Board should agree a policy regarding voting rights exercised by Montanaro. However, the Board has agreed that there is no need to set a written policy with Montanaro concerning key operational issues as the Board and Montanaro already have a clear understanding of their respective responsibilities. The Board encourages the Manager to give due consideration to environmental, social and governance matters whilst recognising the overall investment policy and objectives of the Company. Montanaro reports to the Board at every meeting on how the Company's voting powers have been exercised. Montanaro votes against resolutions it considers may damage shareholders' rights or economic interests. Montanaro gives due weight to what it considers to be socially responsible investments, when making investment decisions, but its overriding objective is to produce good investment returns for shareholders. During the year the Manager on behalf of the Company exercised its voting authority as follows: Meetings Number of meetings voted at 63 Number of meetings voted against management or 1 abstained Resolutions Number of resolutions where voted with management 710 Number of resolutions where voted against management 1 or abstained The actual resolutions voted against - The full Annual Report and Accounts contain the following statements regarding responsibility for the financial statements. Statement of Directors' Responsibilities in Respect of the Annual Report and the Financial Statements The Directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial year. Under that law they have elected to prepare the financial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice). 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 assets, liabilities and financial position of the Company, and of the profit or loss 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 judgements and 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 that 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 enable them to ensure that the financial statements comply with the Companies Act 2006. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and to prevent and detect fraud and other irregularities. Under applicable law and regulations, the Directors are also responsible for preparing a Directors' Report, Directors' Remuneration Report and Corporate Governance Statement that comply with that law and those regulations. The Directors, to the best of their knowledge, state that: ● the financial statements, prepared in accordance with UK Accounting Standards, give a true and fair view of the assets, liabilities, financial position and return of the Company; and ● this Annual Report includes a fair review of the development and performance of the business and the position of the Company together with a description of the principal risks and uncertainties that it faces. The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company's website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. On behalf of the Board DAVID GAMBLE Chairman 17 June 2011 Non-Statutory Accounts The financial information set out below does not constitute the Company's statutory accounts for the year ended 31 March 2011 but is derived from those accounts. Statutory accounts for 2011 will be delivered to the Registrar of Companies in due course. The Auditor has reported on those accounts; their report was (i) unqualified, (ii) did not include a reference to any matters to which the Auditor drew attention by way of emphasis without qualifying their report and (ii) did not contain a statement under Section 498 (2) or (3) of the Companies Act 2006. The text of the Auditor's report can be found in the Company's full Annual Report and Accounts at www.montanarouksmaller.co.uk. Income Statement for the year to 31 March 2011 Year to 31 March 2011 Year to 31 March 2010 Revenue Capital Total Revenue Capital Total Notes £000 £000 £000 £000 £000 £000 Gains on investments 10 - 40,006 40,006 - 37,277 37,277 designated as fair value through profit or loss Dividends and interest 2 3,639 - 3,639 3,206 - 3,206 Management fee 3 (688) (688) (1,376) (486) (487) (973) Management performance 3 - (786) (786) - - - fee Other income 2 - - - 3 - 3 Other expenses 4 (316) - (316) (341) - (341) Net return before 2,635 38,532 41,167 2,382 36,790 39,172 finance costs and taxation Interest payable and 6 (119) (119) (238) (86) (86) (172) similar charges Net return before 2,516 38,413 40,929 2,296 36,704 39,000 taxation Taxation 7 - - - - - - Net return after 2,516 38,413 40,929 2,296 36,704 39,000 taxation Return per Ordinary 9 7.51p 114.75p 122.26p 6.86p 109.64p 116.50p share The total column of this statement is the profit and loss account of the Company. All revenue and capital items in the above statement derive from continuing operations. No Statement of Total Recognised Gains and Losses has been prepared as all such gains and losses are shown in the Income Statement. No operations were acquired or discontinued in the year. The notes below form part of these financial statements. Reconciliation of Movements in Shareholders' Funds for the year to 31 March 2011 Called-up Share Capital Distributable Total equity share premium redemption Special Capital revenue shareholders' capital account reserve reserve reserve reserve funds Year to 31 Notes £000 £000 £000 £000 £000 £000 £000 March 2011 As at 31 3,348 19,307 1,362 4,642 70,152 2,484 101,295 March 2010 Fair value 10 - - - - 40,006 - 40,006 movement of investments Costs - - - - (1,593) - (1,593) allocated to capital Dividends 8 - - - - - (1,071) (1,071) paid in the year Net revenue - - - - - 2,516 2,516 for the year As at 31 3,348 19,307 1,362 4,642 108,565 3,929 141,153 March 2011 Called-up Share Capital Distributable Total equity share premium redemption Special Capital revenue shareholders' capital account reserve reserve reserve reserve funds Year to 31 £000 £000 £000 £000 £000 £000 £000 March 2010 As at 31 3,348 19,307 1,362 4,642 33,448 3,485 65,592 March 2009 Fair value 10 - - - - 37,277 - 37,277 movement of investments Costs - - - - (573) - (573) allocated to capital Dividends 8 - - - - - (3,297) (3,297) paid in the year Net revenue - - - - - 2,296 2,296 for the year As at 31 3,348 19,307 1,362 4,642 70,152 2,484 101,295 March 2010 The notes below form part of these financial statements. Balance Sheet as at 31 March 2011 31 March 2011 31 March 2010 Notes £000 £000 £000 £000 Fixed assets Investments designated at 10 153,175 110,160 fair value through profit or loss Current assets Debtors 12 3,838 341 Cash at bank 20 406 2,196 4,244 2,537 Creditors: amounts falling due within one year Other creditors 13 (1,266) (1,402) Revolving credit facility 14 (15,000) (10,000) (16,266) (11,402) Net current liabilities (12,022) (8,865) Total assets less current 141,153 101,295 liabilities Net assets 141,153 101,295 Share capital and reserves Called-up share capital 15 3,348 3,348 Share premium account 19,307 19,307 Capital redemption reserve 1,362 1,362 Special reserve 4,642 4,642 Capital reserve 108,565 70,152 Distributable revenue 3,929 2,484 reserve Total equity shareholders' 141,153 101,295 funds Net asset value per Ordinary 18 421.65p 302.59p share These financial statements were approved by the Board of Directors on 17 June 2011. DAVID GAMBLE MICHAEL MOULE Company Registered Number: 3004101 The notes below form part of these financial statements. Statement of Cash Flows for the year to 31 March 2011 Year to Year to 31 March 2011 31 March 2010 Notes £000 £000 £000 £000 Operating activities Investment income received 3,548 3,136 Deposit interest received 1 7 Management fees paid (1,339) (939) Company secretarial fees paid (82) (80) Other cash expenses (233) (213) Net cash inflow from 19 1,895 1,911 operating activities Servicing of finance Interest and similar charges (286) (125) paid Net cash outflow from (286) (125) servicing of finance Capital expenditure and financial investment Purchases of investments (54,882) (47,066) Sales of investments 47,554 39,606 Net cash outflow from (7,328) (7,460) investing activities Equity dividends paid (1,071) (3,297) Net cash outflowbefore (6,790) (8,971) financing Financing Proceeds of short-term credit 5,000 5,000 facility Net cash inflow from financing 5,000 5,000 Decrease in cash 20 (1,790) (3,971) The notes below form part of these financial statements. Notes to the Financial Statements at 31 March 2011 1 Accounting Policies Accounting Convention The financial statements are prepared on a going concern basis, under the historical cost convention as modified by the revaluation of fixed asset investments and in accordance with UK applicable accounting standards and the Statement of Recommended Practice regarding the Financial Statements of Investment Trust Companies and Venture Capital Trusts ("SORP") issued in January 2009. The principal accounting policies adopted in the preparation of these financial statements are set out below. These policies have been consistently applied throughout the year and the preceding year. Income Recognition UK dividend income is included in the financial statements when the investments concerned are quoted ex-dividend and shown net of any associated tax credit. Deposit interest and underwriting commissions receivable are included on an accruals basis. Management Expenses and Finance Costs All expenses are accounted for on an accruals basis. Management fees and finance costs are allocated 50% to the capital reserve and 50% to the revenue account. This is in line with the Board's expectations of long-term returns from the investment portfolio of the Company. Performance fees are charged 100% to capital. Costs arising on early settlement of debt are allocated 100% to capital, in accordance with the requirements of the SORP. All other expenses are allocated in full to the revenue account. Investments Investments are recognised and derecognised on the trade date where a purchase or sale is under a contract whose terms require delivery within the time frame established by the market concerned, and are initially measured at fair value. All investments held by the Company are classified as at "fair value through profit or loss". Investments are initially recognised at cost, being the fair value of the consideration given. After initial recognition investments are measured at fair value, with unrealised gains and losses on investments and impairment of investments recognised in the Income Statement and allocated to capital. For investments actively traded in organised financial markets, fair value is generally determined by reference to quoted market bid prices or closing prices for SETS (London Stock Exchange's electronic trading service) stocks sourced from the London Stock Exchange on the Balance Sheet date, without adjustment for transaction costs necessary to realise the asset. Treasury Shares The consideration paid for shares held in Treasury is presented as a deduction from equity shareholders' funds, in accordance with FRS 25: "Financial Instruments: Disclosure and Presentation". Any profit on the sale of shares out of Treasury is credited to the share premium account in full. Taxation The charge for taxation is based on the net revenue for the year. Deferred taxation is provided in accordance with FRS 19: "Deferred Taxation", on all timing differences that have originated but not reversed by the Balance Sheet date. Deferred taxation assets are only being recognised to the extent that they are regarded as recoverable. Dividends Payable to Shareholders In accordance with FRS 21: "Events after the Balance Sheet date", dividends to shareholders are recognised as a liability in the period in which they have been declared. Therefore, any interim dividends are not accounted for until paid, and final dividends are accounted for when approved by shareholders at an Annual General Meeting. Bank loans and borrowings All bank loans and borrowings are initially recognised at cost, being the fair value of the consideration received, less issue costs where applicable. After initial recognition, all interest bearing loans and borrowings are subsequently measured at amortised cost. Any differences between cost and redemption value is recognised in the Income Statement over the period of the borrowings on an effective interest basis. Reserves Capital reserve The following are accounted for in this reserve: • gains and losses on the realisation of investments; • net movement arising from changes in the fair value of investments that can be readily converted to cash without accepting adverse terms; and • expenses, together with related taxation effect, charged to this account in accordance with the above policies. Special reserve The special reserve was created by a reduction in the share premium account by order of the High Court in August 1998. It can be used for the repurchase of the Company's Ordinary shares. In accordance with the SORP, the consideration paid for shares bought into and held in Treasury is shown as a deduction from the special reserve. Capital redemption reserve The capital redemption reserve accounts for amounts by which the issued capital is diminished through the repurchase of the Company's own shares. 2 Income Year to Year to 31 March 31 March 2011 2010 £000 £000 Income from investments 3,638 3,205 UK dividend income 3,574 3,167 Overseas dividend income 64 38 Other income Bank interest 1 1 Underwriting commission - 3 Total income 3,639 3,209 Total income comprises Dividends from financial assets designated at 3,638 3,205 fair value through profit or loss Interest from financial assets designated at 1 1 fair value through profit or loss Dividends and interest 3,639 3,206 Other income not from financial assets - 3 Other income - 3 3,639 3,209 All investment income has been obtained from investments listed in the UK. 3 Management Fee Year to 31 March 2011 Year to 31 March 2010 Revenue Capital Total Revenue Capital Total £000 £000 £000 £000 £000 £000 Management fee 688 688 1,376 486 487 973 Performance fee - 786 786 - - - The Manager receives a monthly fee equivalent to 1/12 of 1.0% of the gross assets of the Company valued at the close of business on the last business day of each month and is entitled to a performance fee calculated as described in the Directors' Report in the full Annual Report and Accounts. At 31 March 2011, £916,000 (2010: £93,000) was due for payment to the Manager. 4 Other Expenses Year to Year to 31 March 31 March 2011 2010 £000 £000 Administration and company 82 80 secretarial fees Auditor's remuneration (also see * below) for: - audit 18 24 - other services to the Company - 5 Other expenses (including Directors' 216 232 remuneration and VAT) 316 341 * Total fees paid to the Auditor for the year, all of which were charged to revenue, comprised: Audit services - statutory audit 18 24 Tax services - compliance services - 5 18 29 The Directors do not consider that the provision of non-audit work to the Company affects the independence of the Auditor. 5 Directors' Remuneration Year to Year to 31 March 2011 31 March 2010 £000 £000 Total fees 91 87 A breakdown of the Directors' remuneration is set out in the Directors' Remuneration Report in the full Annual Report and Accounts. The Company has no employees. 6 Interest Payable and Similar Charges Year to 31 March 2011 Year to 31 March 2010 Revenue Capital Total Revenue Capital Total Financial £000 £000 £000 £000 £000 £000 liabilities not at fair value through profit or loss Interest payable on 119 119 238 86 86 172 loan 119 119 238 86 86 172 7 Taxation The current taxation for the year is lower than the standard rate of corporation tax in the UK of 28% (2010: 28%). A reconciliation is provided below: Year to 31 March 2011 Year to 31 March 2010 Revenue Capital Total Revenue Capital Total £000 £000 £000 £000 £000 £000 Return on 2,516 38,413 40,929 2,296 36,704 39,000 ordinary activities before taxation Theoretical 704 10,756 11,460 643 10,277 10,920 corporation tax at 28% (2010:28%) Effects of: - capital gains - (11,202) (11,202) - (10,438) (10,438) that are not taxable - overseas (18) - (18) (11) - (11) dividend income not liable to corporation tax - UK dividend (1,001) - (1,001) (887) - (887) income not liable to corporation tax - expenses 1 - 1 8 - 8 disallowed for taxation purposes - excess 314 446 760 247 161 408 management expenses - - - - - - At 31 March 2011, the Company had surplus management expenses and non-trade losses of £24,761,775 (2010: £22,025,508), which have not been recognised as a deferred taxation asset. This is because the Company is not expected to generate taxable income in future periods in excess of the deductible expenses of those future periods and, accordingly, it is unlikely that the Company will be able to reduce future taxation through the use of existing surplus expenses. Due to the Company's status as an Investment Trust and the intention to continue meeting the conditions required to obtain approval in the foreseeable future, the Company has not provided deferred tax on any capital gains and losses arising on the revaluation or disposal of investments. 8 Dividends Year to Year to 31 March 31 March 2011 2010 £000 £000 Paid 2010 Final dividend of 3.20p (2009: 1,071 2,293 6.85p*) per Ordinary share Interim dividend paid of nil p per - 1,004 Ordinary share (2010: 3.00p) Proposed 2011 Final dividend of 6.76p (2010: 2,263 1,071 3.20p) per Ordinary share * Including a non-recurring element of 1.99p. 9 Return per Ordinary Share Year to 31 March 2011 Year to 31 March 2010 Revenue Capital Total Revenue Capital Total Ordinary 7.51p 114.75p 122.26p 6.86p 109.64p 116.50p share Revenue return per Ordinary share is based on the net revenue after taxation of £2,516,000 (2010: £2,296,000) and 33,475,958 (2010: 33,475,958) Ordinary shares, being the weighted average number of Ordinary shares, excluding any shares held in Treasury. Capital return per Ordinary share is based on net capital gains for the year of £38,413,000 (2010: £36,704,000), and on 33,475,958 (2010: 33,475,958) Ordinary shares, being the weighted average number of Ordinary shares, excluding any shares held in Treasury. Normal and diluted return per share are the same as there are no dilutive elements on share capital. 10 Investments Year to Year to 31 March 31 March 2011 2010 £000 £000 Total investments at 153,175 110,160 fair value The investment portfolio comprises 52 listed UK equity holdings including 10 holdings totalling £23,438,000 (representing 15% of the portfolio) traded on the Alternative Investment Market ("AIM"). Yearto Year to 31 March 31 March 2011 2010 £000 £000 Opening book cost 94,272 80,990 Opening investment 15,888 (16,783) holding gains/(losses) Opening valuation 110,160 64,207 Movements in the year Purchases at cost 53,969 41,644 Sales - proceeds (50,960) (32,968) Sales - realised 8,466 4,606 gains on sales Increase in 31,540 32,671 investment holding gains Closing valuation 153,175 110,160 Closing book cost 105,747 94,272 Closing investment 47,428 15,888 holding gains 153,175 110,160 Fair value hierarcHy In accordance with FRS 29: "Financial Instruments: Disclosures", the Company must disclose the fair value hierarchy of financial instruments. The fair value hierarchy consists of the following three levels: ● level 1 - quoted prices (unadjusted) in active markets for identical assets or liabilities; ● level 2 - inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and ● level 3 - inputs for the asset or liability that are not based on observable market data (unobservable inputs). For financial instruments (within the scope of FRS 29), which are measured at fair value in the Balance Sheet an entity shall disclose the following for each class of financial instruments: ● the level in the fair value hierarchy into which the fair value measurements are categorised in their entirety; ● any significant transfers between level 1 and level 2 of the fair value hierarchy and the reasons for those transfers; ● for fair value measurements in level 3 of the hierarchy, a reconciliation from the beginning balances to the ending balances. As well as highlighting purchases, sales, and gains and losses, this reconciliation will identify transfers into or out of level 3 and the reasons for those transfers. All of the Company's financial instruments measured at fair value through profit and loss fall into level 1, being valued at quoted prices in active markets. Transaction Costs During the year, the Company incurred transaction costs of £349,000 (2010: £ 246,000) and £90,000 (2010: £62,000) on purchases and sales of investments, respectively. These amounts are deducted in determining gains on investments at fair value as disclosed in the Income Statement. 31 March 31 March 2011 2010 £000 £000 Net gains on investments at fair value though profit or loss Gains on sales 8,466 4,606 Changes in fair value 31,540 32,671 40,006 37,277 A list of the investments by market value and an analysis of the investment portfolio by industrial or commercial sector are set out above. 11 Significant Holdings The Company has a holding of 3% or more of the voting rights attached to shares that is material in the context of the financial statements in the following investments: Security % of voting rights Brooks Macdonald Group plc 3.5 Latchways PLC 3.2 12 Debtors 31 March 31 March 2011 2010 £000 £000 Due from brokers 3,406 - Prepayments and accrued 9 8 income Dividends receivable 423 333 3,838 341 The carrying amount for prepayments, accrued income and dividends receivable disclosed above reasonably approximates to its fair value at the year end and is expected to be realised within a year from the Balance Sheet date. 13 Other Creditors 31 March 31 March 2011 2010 £000 £000 Due to brokers 277 1,190 Accruals and deferred 989 212 income 1,266 1,402 The carrying amount for accruals and deferred income disclosed above reasonably approximates to its fair value at the year end and is expected to be realised within a year from the Balance Sheet date. 14 Revolving Credit Facility 31 March 31 March 2011 2010 £000 £000 Falling due within one year 15,000 10,000 Falling due after more than - - one year 15,000 10,000 The Company has a £15,000,000 Revolving Credit Facility with ING Bank N.V. As at 31 March 2011, £15,000,000 was drawn down (31 March 2010: £10,000,000), all of which has a fixed interest rate of 1.29%* until 16 May 2011. On 16 May 2011 the £15,000,000 loan was rolled over until 16 June 2011 at a fixed interest rate of 1.23228%*. On 16 June 2011 the £15,000,000 loan was rolled over until 16 August 2011 at a fixed interest rate of 1.30935%*. It is the Board's intention to continue to roll over the loan on a short-term basis until the facility expiration date of 24 November 2011. * Including margin and mandatory costs. 15 Share Capital 31 March 31 March 2011 2010 £000 £000 Allotted, called-up and fully paid: 33,475,958 (2010: 33,475,958) Ordinary 3,348 3,348 shares of 10p each Voting rights Ordinary shareholders have unrestricted voting rights at all general meetings of the Company. At the Annual General Meeting on 30 July 2010 the Company was granted the authority to purchase 5,018,046 Ordinary shares. As at 31 March 2011 the Company had remaining authority to repurchase 5,018,046 Ordinary shares. This authority is due to expire at the conclusion of the next Annual General Meeting. During the year no shares were purchased for cancellation. The Company does not have any externally imposed capital requirements. The capital of the Company is managed in accordance with its investment policy in pursuit of its investment objective, both of which are detailed above. 16 Duration of the Company At the Company's AGM held on 31 July 2009 shareholders voted to remove the obligation under the Articles of Association to convene a General Meeting during 2010 for the purpose of voluntarily winding up the Company, as provided for in the Company's Articles of Association. The Company will be required to propose a resolution at a General Meeting every five years thereafter unless, at any AGM held within, and not more than, 18 months prior to the expiry of the relevant period of five years, an Ordinary resolution is passed releasing the Directors from the obligation to convene such a General Meeting. 17 Own Shares Held in Treasury The Company has taken advantage of the regulations which came into force on 1 December 2003 to allow companies, including investment trusts, to buy its own shares and hold them in Treasury for re-issue at a later date. There were no shares held in Treasury at any time during the year. 18 Net Asset Value per Ordinary Share Net asset value per Ordinary share is based on net assets of £141,153,000 (2010: £101,295,000) and on 33,475,958 (2010: 33,475,958) Ordinary shares, being the number of Ordinary shares in issue at the year end. 19 Reconciliation of Net Revenue Before Finance Costs and Taxation to Net Cash Inflow from Operating Activities Year to Year to 31 March 31 March 2011 2010 £000 £000 Net revenue before finance 2,635 2,382 costs and taxation Management fee (1,474) (487) charged to capital Increase in 825 40 creditors Increase in prepayments and (91) (24) accrued income Net cash inflow from operating 1,895 1,911 activities 20 Reconciliation of Net Cash Flows to Movements in Net Debt Year to Year to 31 March 2011 31 March 2010 £000 £000 Decrease in cash in (1,790) (3,971) year Proceeds of credit (5,000) (5,000) facility Movement in net funds (6,790) (8,971) Net (debt)/cash at (7,804) 1,167 beginning of year Net debt at end of year (14,594) (7,804) Analysis of Net Debt 1 April Cash 31 March 2010 flows 2011 £000 £000 £000 Cash at bank 2,196 (1,790) 406 Debt due in less than (10,000) (5,000) (15,000) one year (7,804) (6,790) (14,594) 21 Analysis of Financial Assets and Liabilities As required by FRS 29: "Financial Instruments: Disclosures", an analysis of financial assets and liabilities, which identifies the risk to the Company of holding such items, is given below. Background The Company's financial instruments comprise securities, cash balances and debtors and creditors that arise from its operations, for example, in respect of sales and purchases awaiting settlement and debtors for accrued income. The risk management policies and procedures outlined in this note have not changed substantially from the previous accounting period. The Company has little or no exposure to cash flow or foreign currency risk. The principal risks the Company faces in its portfolio management activities are: ● credit risk; ● market price risk, i.e. movements in the value of investment holdings caused by factors other than interest rate or currency movement; ● interest rate risk; ● liquidity risk i.e. the risk that the Company has difficulty in realising assets or otherwise raising funds to meet commitments associated with financial instruments; and ● gearing. The Manager monitors the financial risks affecting the Company on a daily basis. The Directors receive financial information on a monthly basis which is used to identify and monitor risk. (i)Credit Risk Credit risk is the risk of financial loss to the Company if the contractual party to a financial instrument fails to meet its contractual obligations. The carrying amounts of financial assets best represent the maximum credit risk exposure at the Balance Sheet date. The Company's listed investments are held on its behalf by HSBC acting as agent, the Company's custodian. Bankruptcy or insolvency of the custodian may cause the Company's rights with respect to securities held by the custodian to be delayed. The Board monitors the Company's risk by reviewing the custodian's internal controls reports. Investment transactions are carried out with a large number of brokers whose creditworthiness is reviewed by the Manager. Transactions are ordinarily undertaken on a delivery versus payment basis whereby the Company's custodian bank ensures that the counterparty to any transaction entered into by the Company has delivered in its obligations before any transfer of cash or securities away from the Company is completed. The banks at which cash is held are under constant review. The maximum exposure to credit risk at 31 March 2011 was: 31 March 2011 31 March 2010 £000 £000 Cash at bank 406 2,196 Debtors and 3,838 341 prepayments 4,244 2,537 None of the Company's assets are past due or impaired. (ii)Market Price Risk Market price risk arises mainly from uncertainty about future prices of financial instruments. The value of shares and the income from them may fall as well as rise and shareholders may not get back the full amount invested. The Manager continues to monitor the prices of financial instruments held by the Company on a real time basis. Adherence to the Company's investment objective mitigates the risk of excessive exposure to one issuer or sector. The Board manages the market price risks inherent in the investment portfolio by ensuring full and timely access to relevant information from the Investment Manager. The Board meets regularly and each meeting reviews the investment performance, the investment portfolio and the rationale for the current investment positioning to ensure consistency with the Company's objectives and investment policy. The portfolio does not seek to reproduce the index, investments are selected based upon the merit of individual companies and therefore the portfolio may well diverge from the short-term fluctuations of the benchmark. Fixed asset investments are valued at fair value as detailed in note 1. A list of the Company's equity investments is shown above. In addition, an analysis of the investment portfolio by broad industrial and commercial sector, an analysis of the portfolio by market capitalisation of holdings and a description of the 10 largest equity investments is set out above. The maximum exposure to market price risk is the fair value of investments of £ 153,175,000 (2010: £110,160,000). If the investment portfolio valuation fell by 1% from the amount detailed in the financial statements as at 31 March 2011 it would have the effect, with all other variables held constant, of reducing the net capital return before taxation by £1,532,000 (2010: £1,102,000). An increase of 1% in the investment portfolio valuation would have an equal and opposite effect on the net capital return before taxation. (iii)Interest Rate Risk Changes in interest rates may cause fluctuations in the income and expenses of the Company. The revolving credit facility with ING Bank N.V. is a fixed rate facility (see note 14). The amount of such borrowings and the approved levels are monitored and reviewed regularly by the Board. The Company mitigates the risk by fixing the interest rates. The Company received interest on cash deposits over £25,000 at a rate of 0.03%. The interest received in the year amounted to £1,000 (2010: £1,000). The interest risk profile of the Company is given below. If interest rates had reduced by 1% from those paid as at 31 March 2011 it would have the effect, with all other variables held constant, of increasing the net revenue return before taxation on an annualised basis by £150,000 (2010: £100,000). If there was an increase in interest rates of 1% there would have been an equal and opposite effect in the net revenue return before taxation. The calculations are based on cash at bank, short-term deposits and the revolving credit facility as at 31 March 2011 and these may not be representative of the year as a whole. Due to the short-term nature of the loan facility, changes in interest rates would not have an effect on the fair value of the loan. (iv)Liquidity Risk Liquidity is the risk that the Company will encounter difficulty in meeting obligations associated with financial liabilities. The Manager does not invest in unlisted securities on behalf of the Company. However, the investments held by the Company consist of UK quoted small companies which are inherently less liquid than quoted large companies. Short-term flexibility is achieved through the use of bank borrowings. Liquidity risk is mitigated by the fact that the Company has £4.2 million cash at bank and short-term debtors which can satisfy its creditors and that as a closed end fund assets do not need to be liquidated to meet redemptions. (v)Gearing Gearing can have amplified effects on the net asset value of the Company. It can have a positive or negative effect depending on market conditions. It is the Company's policy to determine the adequate level of gearing appropriate to its own risk profile. (vi)Use of Derivatives It is not the Company's policy to enter into derivative contracts. Financial Assets The Company's financial assets consist of listed equity shares, which neither pay interest nor have a maturity date, cash at bank and short-term debtors. No fixed interest assets were held at 31 March 2011 nor during the year. All financial assets are in sterling and disclosed at fair value through profit or loss. Financial Liabilities The Company finances its operations through equity, retained profits and bank borrowings (see note 14). The change in the fair value of financial liabilities during the year was not related to the credit risk profile. The interest rate risk profile of the financial liabilities of the Company as at 31 March 2011 is as follows: Total Weighted Period average until interest maturity rate £000 % Years Amounts drawn down under fixed 15,000 1.6052 0.13 revolving credit facility Financial liabilities upon which 1,266 - - no interest is paid The interest rate risk profile of the financial liabilities of the Company as at 31 March 2010 was as follows: Total Weighted Period average until interest maturity rate £000 % Years Amounts drawn down under fixed 10,000 2.0381 0.70 revolving credit facility Financial liabilities upon which no interest 1,402 - - is paid The maturity profile of the Company's financial liabilities is as follows: As at As at 31 March 31 March 2011 2010 £000 £000 In one year or less 16,266 11,402 In more than one but not more than two years - - In more than two years but not more than - - five years 16,266 11,402 The Company had £nil undrawn under the fixed Revolving Credit Facility at 31 March 2011 (2010: £5,000,000). The Company's fixed revolving credit facility is measured at cost and denominated in sterling. All other financial liabilities are in sterling and disclosed at fair value. It is considered that, because of the short-term nature of the facility, cost approximates to fair value. 22 Capital Management Policies The objective of the Company is to achieve capital appreciation through investing in small quoted companies listed on the London Stock Exchange or traded on AIM and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding Investment Companies) Index. No unquoted investments are permitted. In pursuing this long-term objective, the Board has a responsibility for ensuring the Company's ability to continue as a going concern. It must therefore maintain an optimal capital structure through varying market conditions. This involves the ability to: issue and buyback share capital within limits set by the shareholders in general meeting; borrow monies in accordance with the Articles of Association and pay dividends to shareholders out of distributable revenue reserves. Changes to Ordinary share capital are set out in note 15. Dividend payments are set out in note 8. 31 March 2011 31 March 2010 £000 £000 Called-up share capital 3,348 3,348 Share premium account 19,307 19,307 Capital redemption reserve 1,362 1,362 Special reserve 4,642 4,642 Capital reserve 108,565 70,152 Distributable revenue reserve 3,929 2,484 Total equity shareholders' funds 141,153 101,295 The Company's objectives for managing capital are the same as the previous year and have been complied with throughout the year. 23 Previous Commitments and Contingent Liabilities At 31 March 2011, there were no capital commitments (2010: nil). 24 Related Party Transactions Under the Listing Rules the Manager is regarded as a related party of the Company. The amounts paid to the Manager are disclosed in note 3. However, the existence of an independent Board of Directors demonstrates that the Company is free to pursue its own financial and operating policies, and therefore, in terms of FRS 8: "Related Party Transactions", the Manager is not considered a related party. The relationship between the Company, its Directors and the Manager is disclosed in the Directors' Report in the full Annual Report and Accounts. Company Summary Investment Objective MUSCIT's investment objective is capital appreciation through investing in small quoted companies listed on the London Stock Exchange or traded on the Alternative Investment Market ("AIM") and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding Investment Companies) Index ("SmallCap"). No unquoted investments are permitted. Investment Policy The Company seeks to achieve its objective and to diversify risk by investing in a portfolio of quoted UK smaller companies. At the time of initial investment, a potential investee company must be profitable and smaller than the largest constituent of the RBS HGSC Index, which represents the smallest 10% of the UK Stock Market by value. At the start of 2011, this was any company below £1.4 billion in size. The Manager focuses to on the smaller end of this Index. In order to manage risk the Manager will normally limit any one holding to a maximum of 4% of the Company's investments. The portfolio weighting of each investment is closely monitored to reflect the underlying liquidity of the particular company. The Company's AIM exposure is also closely monitored by the Board and is limited to 30% of total investments with Board approval required for exposure to be above 25%. The Manager is focused on identifying high quality niche companies operating in growth markets. This typically leads the Manager to invest in companies that enjoy high barriers to entry, pricing power, a sustainable competitive advantage and strong management teams. The portfolio is therefore constructed on a "bottom up" basis and there are no sectoral constraints placed on the Manager. The Board, in consultation with the Manager, is responsible for determining the gearing strategy of the Company. Gearing is used to enhance returns when the timing is considered appropriate. The Company currently has a credit facility of £15 million through ING Bank of which £15 million was drawn as at 31 March 2011. The Board has agreed to limit borrowings to 25% of shareholders' funds. Benchmark FTSE SmallCap (excluding Investment Companies) Index ("SmallCap"). Gross Assets £157,419,000 as at 31 March 2011. Shareholders' Funds £141,153,000 as at 31 March 2011. Market Capitalisation £118,840,000 as at 31 March 2011. Capital Structure As at 31 March 2011 and at the date of this report, the Company had 33,475,958 Ordinary shares of 10p each in issue (of which none were held in Treasury). Wind up Date In accordance with the Articles of Association, an Ordinary resolution can be put to shareholders at the Annual General Meeting to be held after 30 November 2012 to release the Directors from the obligation to convene a General Meeting in 2014 for the purpose of winding up the Company. Management Fee The management fee comprises two components: a fixed fee of 1/12 of 1% of the gross assets of the Company, payable monthly in arrears, and a performance fee of 0.1% of the gross assets of the Company for each 1% outperformance (or part thereof) of the Company's NAV against the SmallCap over the financial year, subject to a maximum of 0.5% of the gross assets calculated at the end of the financial year. Administration and Company Secretarial Fees The Company Secretary receives an annual fee of £82,000, which is subject to an annual RPI uplift. The Company ceased to pay VAT on its administration and company secretarial fees in October 2008. Sources of Information All information contained within the Chairman's Statement and the Manager's Report has been provided by Montanaro Asset Management Limited unless otherwise noted. National Storage Mechanism A copy of the Annual Report and Accounts 2011 will be submitted shortly to the National Storage Mechanism ("NSM") and will be available for inspection at the NSM, which is situated at: www.hemscott.com/nsm.do. ENDS Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on this announcement (or any other website) is incorporated into, or forms part of, this announcement.

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