Final Results

MONTANARO UK SMALLER COMPANIES INVESTMENT TRUST PLC PRELIMINARY ANNOUNCEMENT OF AUDITED ANNUAL RESULTS The Directors announce the audited statement of results for the year ended 31 March 2003 as follows:- SUMMARISED STATEMENT OF TOTAL RETURN (incorporating the revenue account*) of the Company 1 April 2002 to 31 March 1 April 2001 to 31 March 2003 2002 Revenue Capital Total Revenue Capital Total £'000 £'000 £'000 £'000 £'000 £'000 Capital losses on investments - (29,413) (29,413) - (10,702) (10,702) Dividends and interest 2,179 - 2,179 2,256 - 2,256 receivable Other income - - - 13 - 13 Investment management (386) (387) (773) (510) (510) (1,020) fee Other expenses (238) - (238) (422) - (422) Net return before financing costs and taxation 1,555 (29,800) (28,245) 1,337 (11,212) (9,875) Interest payable and similar charges (299) (299) (598) (311) (311) (622) Return on ordinary activities before taxation 1,256 (30,099) (28,843) 1,026 (11,523) (10,497) Taxation on ordinary - - - - - - activities Return on ordinary 1,256 (30,099) (28,843) 1,026 (11,523) (10,497) activities after taxation Dividend proposed (928) - (928) (690) - (690) Transfer to/(from) reserves after dividends proposed 328 (30,099) (29,771) 336 (11,523) (11,187) Pence Pence Pence Pence Pence Pence Return per ordinary 3.37 (80.72p) (77.35p) 2.66 (29.84) (27.18) share * The revenue column of this statement is the revenue account of the Company. All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued in the year. SUMMARISED BALANCE SHEET As at As at 31 March 31 March 2003 2002 £'000 £'000 Investments 44,728 78,543 Net current assets/(liabilities) 9,270 (4,774) Total assets less current liabilities 53,998 73,769 Creditors - amounts falling due after more than one year (10,000) - Net assets 43,998 73,769 Net asset value per ordinary share 118.00p 197.84p STATEMENT OF CASHFLOWS Year to 31 Year to 31 March March 2003 2002 £'000 £'000 Operating activities - Investment income received 2,101 2,044 - Deposit interest received 155 262 - Underwriting commission received - 13 - Investment Management fee (681) (1,327) - Company Secretarial fees paid (51) (50) - Other cash expenses (345) (606) Net cash inflow from operating activities 1,179 336 Servicing of finance - Interest and similar charges paid (615) (614) Net cash outflow from servicing of finance (615) (614) Taxation - Taxation recovered 2 105 Net inflow from taxation 2 105 Capital expenditure and financial investment - Purchases of investments (16,560) (21,365) - Sales of investments 20,589 22,740 Net cash inflow from capital expenditure and financial investment 4,029 1,375 Equity dividends paid (690) (120) Financing - Proceeds of credit facility 2,500 - - Ordinary shares purchased for cancellation - (4,037) Net cash inflow/(outflow) from financing 2,500 (4,037) Increase/(decrease) in cash 6,405 (2,955) The financial information set out above does not constitute the Company's statutory accounts for the years ended 31 March 2002 or 2003. Statutory accounts for 2002 have been delivered to the Registrar of Companies, whereas those for 2003 will be delivered following the Company's Annual General Meeting. The auditors have reported on those accounts; their reports were unqualified and did not contain a statement under section 237 (2) or (3) of the Companies Act 1985. CHAIRMAN'S STATEMENT Background The Company was launched on 16 March 1995 as an asset allocation vehicle for institutional shareholders to invest in quoted UK 'smaller' companies. In 1996, the initial £25 million Company was increased in size through a £30 million 'C' share issue. Net assets now stand at £44 million. At the time of the launch, 'smaller' companies were defined as those with a market capitalisation of £100 million or less. Currently, the Company invests in companies falling within the smallest ten per cent of the UK stock market ('the HGSC'). The HGSC includes companies up to £600 million in size. The investment policy remains to research and invest in the 'smaller' end of the quoted UK small companies market. Performance In the year to 31 March 2003, the NAV of the Company declined by 40 % to 118.00p (2002: 197.84p) in comparison with a 35 % fall by the SmallCap. Since the launch of the Company , the NAV of the Company has increased by 20 %. T he SmallCap has fallen over this eight-year period by 3 %. Last year, the Company underperformed the SmallCap for the first time since launch, having outperformed for seven consecutive years. Dividend T he Company's primary focus is on capital appreciation rather than income. T he Board proposes a final dividend of 2.49p (2002: 1.85p) per ordinary share, which is the minimum payable. The final dividend will be payable on 31 July 2003 to shareholders on the register at the close of business on 6 June 2003. Discount The Company focuses on quoted UK 'smaller' companies, which are less widely researched. The illiquidity of the underlying investments tends to be reflected in the level of discount of the Company. The discount of the Company's share price to NAV on 31 March 2003 was 21%, in line with the sector average of 21% (Source: Thomson Financial). The discount of the Company over the past eight years has averaged 16% (Source: Bloomberg). Share Buy Backs The Board is responsible for the implementation of the share buy back programme, which is undertaken at arm's length from the Manager. The Board continues to consider share buy backs as and when appropriate. A resolution to renew this authority will be put to shareholders at the forthcoming Annual General Meeting. Gearing The Board reviews the level of gearing considered appropriate for the Company. One of the benefits of investment trusts is the ability to hold prudent levels of gearing, which can enhance investment returns. On 1 August 2002, the Company's £15 million gearing facility expired and was renewed. The new facility will mature on 1 August 2007 and has been reduced to £10.0 million at a fixed rate of 5.73%. The Board Peter Griffiths will be retiring from the Board on reaching his 70th birthday in September this year. I would like to record my thanks to him for his support and valuable contribution during his time as a Director of the Company. Both I, and my fellow Directors, wish him well for a long and happy retirement. I am pleased to welcome Laurie Petar to the Board. He has spent many years in the City specialising in investment trusts and has wide ranging expertise in the sector. I very much look forward to working with him. The Higgs Review A review of the role and effectiveness of non-executive directors by Derek Higgs was published in January 2003. It has created some controversy but, without endorsing all the detailed recommendations, any review that seeks to improve corporate governance must surely be welcomed. Much of the unease among investors in recent times and the associated weakness of stock markets has been caused by concerns over corporate conduct. High standards of corporate governance will protect and enhance shareholder interests, which should help to restore investor confidence. Higgs endorsed the central theme of Paul Myners' review in April 2001, which argued that institutional shareholders should be more actively involved with the companies in which they invest. He believes that 'institutional shareholders have a responsibility to make considered use of their votes. [They] should enter into a dialogue with companies based on the mutual understanding of objectives [and] when evaluating companies' governance arrangements, particularly those relating to board structure and composition, institutional investors should give due weight to all relevant factors drawn to their attention. [They] should, on request, make available to their clients information on the proportion of resolutions on which votes were cast [and] should take steps to ensure their voting intentions are being translated into practice [and] should be expected to attend AGMs where practicable'. While at first sight such suggestions are commendable, they will place a considerable burden on fund managers. They come at a time when many institutional investors in UK small companies have reduced internal resources to cut costs and are already stretched. This is less of a problem for specialists. The Manager already complies with many of the review's suggestions and considers good governance an essential part of the investment decision-making process. Corporate governance responsibilities are taken seriously by the Directors and Manager: shares are voted at AGMs as a matter of policy; an active dialogue with executive management is encouraged through one-on-one meetings; bonus schemes (including options) are openly debated with management; the splitting of the roles of Chairman and Chief Executive is encouraged; meetings with non-executive directors of investee companies (without executive directors present) are requested when necessary; candidates to become potential new directors are put forward (on request) for consideration by nominations committees. It will be interesting to see the final shape of the Higgs Review following a period of consultation. In the case of UK small listed companies, he has taken a pragmatic approach: 'The Review recognises that it may take more time for smaller listed companies to comply and that some of the Code's provisions may be less relevant or manageable for smaller companies (paragraph 16.8)'. Investing in Equities From its peak on 4 September 2000, the SmallCap has more than halved. Last year, the UK stock market saw the worst performance in both absolute and relative terms since 1974. For more than three years, investors have suffered one of the most extreme and longest Bear Markets in living memory. The most recent Barclays Equity-Gilt Study shows that equities gave investors real annual returns of just 3.9% over the past decade, less than half that of corporate bonds and only marginally better than cash at 3.4%. It is small wonder that investors are questioning whether the cult of the equity is finally over. Before throwing in the towel, equity investors can take some comfort from looking at the longer-term picture. This same study also highlights that £100 in 1899 would be worth £15,000 today if held in cash; £17,000 if invested in gilts; and £815,000 if invested in equities with dividends re-invested. The key to the higher returns lies in the importance of dividends, compounding over time, to overall investment returns. For the first time since 1957, the dividend yield on the UK stock market in 2003 has been greater than the yield on gilts. Clearly the income on gilts is fixed, whereas dividend income should grow over time in line with profits and the economy. As HSBC argue: 'We can see no justification for an asset offering a growing income stream [equities] to have the same upfront yield to one offering no growth ever [bonds], unless the income stream on equities is expected to actually fall. We have no such expectation for the UK and therefore see the dividend yield-bond yield parity as an absolute floor for the market'. As Alistair Ross Goobey states: 'Today, equities are better value against bonds than they have been for a generation' (Source: FTfm - 10 March 2003). The authors of the Barclays Equity-Gilt Study recommend that most investors should avoid bonds and overweight equities. For those investors swayed by such arguments and keen to gain diversified exposure to UK equities, there remains the choice of investing in large or small companies. One of the obvious benefits of investing in the FTSE-100 Index is liquidity, the ability to buy and sell shares at short notice. However, future returns are likely to be lower than in the heady days of the bull market in the 1980s and 1990s, commentators suggest possibly in the range of 7% - 8% per annum. In a low inflationary environment this still represents historically attractive real returns. On the other hand, UK small companies have outperformed large companies by more than 3% per annum since 1955 (Source: ABN Amro). They tend to underperform during periods of economic slowdown and uncertainty but outperform in times of recovery, benefiting from a strong domestic economy. Almost 1,300 companies fall within the HGSC, offering a wide choice of companies that are less well researched. At the end of March 2003, small companies were also almost 30% cheaper overall, based on price earnings ratio, than large companies (Source: ABN Amro). Fund Managers One of the features of the present bear market has been the impact on the fund management industry, which had come to expect the bull market since the early 1980s to continue forever. The excesses of what Warren Buffet terms the 'Great Bubble' led to overhead structures that could not support the dramatic subsequent fall in revenues. We are now witnessing long overdue cost cutting by many financial institutions. A number of brokers have withdrawn from the UK small companies market, leading to less research and reduced market-making capacity. Financial institutions facing the need to reduce costs have reduced internal resources devoted to small companies just at the time when support from brokers is diminishing and, if anything, more resource is needed. Many small company funds have fallen so much in value that they are no longer viable to fund managers. Fund Managers cannot simply abrogate their responsibility and leave portfolios inadequately managed. One possible solution would be for them to outsource UK small company mandates to specialist investors, as is commonly done in the case of private equity and property. This could reduce cost, allow internal resources to be deployed more efficiently elsewhere and bring the potential for higher returns. It would also enable institutional investors to meet the recommendations of the Higgs Review for more active management. SIR BRANDON GOUGH Chairman 23 May 2003

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