Annual Financial Report

RNS Number : 9985Z

Herald Investment Trust PLC

14 March 2013

 

Regulatory Announcement

 

HERALD INVESTMENT TRUST plc

 

ANNUAL REPORT AND FINANCIAL STATEMENTS

A copy of the Annual Report and Financial Statements for the year ended 31 December 2012 of Herald Investment Trust plc has been submitted electronically to the National Storage Mechanism and will shortly be available for inspection at http://www.hemscott.com/nsm.do.

The Annual Report and Financial Statements for the year ended 31 December 2012 including the Notice of Annual General Meeting is also available on Herald Investment Management Limited's website at:

www.heralduk.com 

At the Annual General Meeting to be held on 23 April 2013, it is proposed that new Articles of Association are adopted. Details of the changes to be made can be found in the Directors' Report within the Annual Report and Financial Statements for the year to 31 December 2012. Copies of the new Articles of Association are available for inspection at 10-11 Charterhouse Square, London, EC1M 6EE and 20 Cursitor Steet, London, EC1A 1LT.

The unedited full text of those parts of the Annual Report and Financial Statements for the year ended 31 December 2012 which require to be published by DTR 4.1 is set out on the following pages.

Neither the contents of the Managers' website nor the contents of any website accessible from hyperlinks on the Managers' website (or any other website) is incorporated into, or forms part of this announcement.

Baillie Gifford & Co

Company Secretaries

14 March 2013

CHAIRMAN'S STATEMENT

In 2012 the NAV returned 12.3%. This is satisfactory in the context of returns made from the wider indices, and in particular the decision to remain heavily weighted in the UK, where smaller companies proved one of the strongest asset classes, was vindicated again. The UK portfolio delivered a total return of 18.0%, but the Numis Smaller Companies Index returned 22.5%. In contrast the US portfolio returned only 1.4% (in £) compared with the Russell 2000 Technology Index rising 4.5%. In consequence the UK portfolio has now risen to the highest proportion of the equity portfolio this century at 70.9%, while the US portfolio has fallen to 20.9%. The European portfolio recovered by 17.5% (in £), but remains a modest weighting, while the Far East delivered a total return of 10.3%, including the Taiwan portfolio which returned 19.3% (in £) and the strongest component.

The goal of the Company is to achieve real long term capital appreciation. It is worth observing that over the longer term the total returns are as follows:

Total return	1 year	3 years	5 years	10 years	Inception (February 1994)
Herald Investment Trust (including dividends distributed)	12.3%	50.8%	61.8%	210.6%	557.6%
Numis Smaller Companies Index plus AIM (total return ex. investment companies)	22.5%	40.0%	18.3%	193.5%	261.2%
Russell 2000 (small cap) Technology Index (in sterling terms)	4.5%	35.3%	53.0%	133.4%	-

The TMT sector (technology, media and telecoms) has continued to be exposed to an abnormally high degree of corporate activity, but supply and demand do appear to be more balanced. The IPO market remains virtually closed. Fourteen stocks in the portfolio were taken over with a total consideration of £26.8m, and four takeovers pending account for a further £9m. This takes the cumulative value of takeover bids to £218m over the last six years. In context that exceeds the net assets of the fund at the end of 2008. In fact this year there were some significant takeovers in the larger capitalisation TMT stocks in the UK in which had grown out of the smaller market capitalisation remit of Herald Investment Trust (HIT) i.e Logica, Misys,Cable & Wireless Worldwide and Aegis. The equity market continues the long term trend of net equity withdrawal in the UK with takeovers exceeding IPOs by number and value. In 2012 the number of fully listed companies fell 6.3% to 929, and the number of AIM listed companies fell by 4.1% to 1,096 in 2012. The shortage of capital for equity investment continues to be particularly evident in the UK than anywhere else. The sharp decline of pension funds and insurance companies as owners of UK equities has unquestionably had a profoundly damaging effect on the UK technology sector. Above all the technology sector requires equity and not bank debt. The United States has over the last thirty years been the most professional and prolific market in providing equity both at the early venture stage, and through IPOs. That is why the US technology sector is so large and successful. In respect of the UK, and indeed Europe as a whole, this is a failing of the regulatory environment, actuaries, accounting rules and the wider UK investment industry, which from the Herald perspective is damaging to both the sector and the economy. In particular the drive to minimise volatility and match assets and liabilities has driven asset allocation away from equities. However, at this time HIT continues to enjoy having some equity capital in a capital constrained environment, and it may well be that the sector has performed well in the UK as takeover proceeds have been recycled into other stocks in the sector. It may also be that the bulk of the asset reallocation is now behind us, and that the market will stop shrinking.

HIT has continued to support companies by participation in primary placings. Since inception it has raised £95m from shareholders (£65m in 1994 and £30m in 1996), and has subsequently bought back £31m so net outside capital has been £64m. In contrast it has participated in UK issues to £233m including £20m in 2012. The power of compounding is helpful in terms of scale, and it is fulfilling to see the Company's investment enabling job creation and positive tax payments, as well as delivering profits to HIT's shareholders.

A number of holdings delivered a return in excess of 100% in 2012 including Bango, Wandisco, Pace, IDOX, Mellanox and BSE. Takeovers in which the Company was not invested aside, the area of relative underperformance came from certain large holdings which have contributed strongly to outperformance in previous periods. In particular Imagination and SDL in the UK, and Ceva and Silicon Motion in the US fall into this camp.

The consumerisation of technology continues apace. Developed markets are moving to 4G (fourth generation mobile phone), and less developed markets are buying smarter phones with internet access. The internet continues to be both disruptive and creative. Corporate IT departments are struggling to deliver to the performance of consumer devices, and security issues become ever more frightening. Data is being generated at an unprecedented rate, and there are ever more creative applications for applying this data. Although the sector is more appealing than the wider economy, there will continue to be both winners and losers, but overall interesting opportunities continue to emerge.

2012 has been another solid year in terms of corporate profitability albeit the growth rate has slowed to high single digits on average. At this stage a similar growth rate is anticipated in aggregate market forecasts for 2013. With fiscal tightening the fashion for Governments around the world the outlook for profits growth seems challenging, but the sector has resilient attractions, and continues to be creative and disruptive which may more than offset the economic challenges in share price terms.

There is a small income surplus as in previous years after expensing all costs. This enables the Board to recommend a 1.00p dividend (2011 - 1.00p).

The Board has been considering how to address the Alternative Investment Fund Managers Directive. This requires the appointment of an Alternative Investment Fund Manager with separate functions for internal audit, risk management and compliance and certain other parameters. It also requires the appointment of a separate depositary. The Board currently appoints Herald Investment Management Ltd as fund manager. The fund administration, including fund accounting and secretarial, is undertaken independently by Baillie Gifford & Co with daily reconciliations between the manager and the administrator, and the administrator and independent custodian, providing a high level of investor protection and oversight. Furthermore, the Board is responsible for overseeing the Trust's risks.

The Board will endeavour to accommodate the Directive, while incurring the minimum additional cost, and without incurring too much additional risk associated with the likely complexity inherent in the AIFMD regime, and without too much distraction for the manager from the investment process. However, it will not be possible to avoid the costs of the independent depositary which are expected to be material in relation to the Company's revenue account.  The Board does not consider that the Directive is in the interests of shareholders and does not believe that it will provide any perceptible benefit to them.  Investment trusts, which already comply with company law and the listing rules of the Stock Exchange, were not the original target of this proposed European Union law, but have regrettably been caught within its scope.  The impact is particularly burdensome in the case of a successful specialist company such as Herald, which plays a valuable part in supplying scarce equity capital to young British technology companies.

The Company's Articles of Association first gave shareholders the right to vote at the Annual General Meeting (AGM) on 14 April 2004 (and at AGMs to be held in every third year thereafter) as to whether the Company should continue to operate as an investment trust. Accordingly, an ordinary resolution, Resolution 10 in the Notice of Annual General Meeting, is being proposed at the AGM of the Company to be held on 23 April 2013 to the effect that the Company should continue as an investment trust.  Herald Investment Trust is one of the largest investment trusts specialising in technology, communications and multi-media and is one of the best performing investment trusts since its launch in February 1994. Furthermore it is the only specialist technology orientated investment trust with a material exposure to the United Kingdom. The Herald Board believes that the focus of the Trust on smaller capitalisation companies provides exposure to some of the most rapidly growing companies within the Trust's target sectors and should continue to provide attractive long term investment opportunities. The Directors believe that the prospects for investment in the technology and media sectors remain positive and the Company is managed by one of the most experienced and successful managers in the sector. Your Board strongly recommends that shareholders vote in favour of the resolution. The Directors intend to vote their own shareholdings in favour of the resolution for the Company to continue as an investment trust.

Julian Cazalet

Chairman

27 February 2013

INVESTMENT MANAGER'S REPORT

2012 has been a more challenging year for the global TMT sector. One of the cornerstone markets, the PC, has seen steady downward revisions, as the tablet and the economy has eroded demand for notebooks. According to IDC, volumes declined 3.2% to c350m in 2012. There are some high profile large companies that have been challenged such as Nokia and RIM which fell with the rise of the iPhone, and look-a-likes from Samsung in 2011. 2012 was the year when the iPad and its clones rocked the PC market. HP and Dell are high profile casualties, but the less visible supply chain in Asia has also had a tough time. Meanwhile a sluggish economy has reduced demand for office fit outs, and corporate IT budgets have been constrained. Against this background the UK sector has done remarkably well, and European companies have bounced after a poor year in 2011. In part this reflects the fact that Europe no longer has a manufacturing sector, and this price sensitive/volume sensitive market is now in Asia. The UK sector has been more service led and IP or design oriented. Meanwhile the smartphone market is still showing good volume growth, and internet usage growth continues unabated. Additional competition in the tablet market followed the launch of new Kindle devices from Amazon, a new Nexus product from Google, and the Surface from Microsoft. Different regions have different characteristics.

UK

The UK portfolio remains the most important within the Company, and now accounts for over 70% of the equity portfolio. The total return for Herald's UK portfolio was 18% versus the Numis Smaller Companies Index extended to include AIM returning 22.5%. Although over the long term Herald Investment Trust has dramatically outperformed the Numis Index there have been years when the UK return has lagged. This is the first year when it has lagged when the relevant sectors have outperformed the Index. The reasons for the underperformance are as follows:

1.  Poor share price performance of the two largest investments Imagination and SDL. In declining 25% and 23.5% respectively these effectively accounted for half the underperformance. Material profits have already been realised on these investments, which have been outstanding over the last decade. At the start of 2012 the Imagination holding had been reduced from over 15m shares to less than 5m, and SDL reduced somewhat less. In spite of the poor performance in 2012 these companies had a realised and unrealised profit of £62m on a maximum invested value of £8.2m.

2.  Certain large stocks that performed particularly well which were not owned by HIT and peripheral to the defined remit. Firstly Renishaw (+111%), which is a company that I knew well pre Herald as analyst at its corporate advisor. I have great respect for the way they have built the business, but have not perceived it to be in the TMT defined remit in which we invest. Secondly TalkTalk (+81%) which was previously in the retail sector.

3.  Certain stocks which we ought to have owned - Oxford Instruments and Dialight and possibly Perform. Other stocks such as Johnston Press, Trinity Mirror, Pace, CSR and Wolfson have bounced strongly. We have benefited from being underweight or not owning them in the past, but in consequence have had modest positions for the rally.

4.  The weighted return of AIM stocks in the target sector is far lower, and the portfolio is skewed to these smaller companies.

Over the long term the UK has performed well, and compounded in capital terms since 1994 at c14%. We do not have a formal benchmark, and in any one accounting period divergences are inevitable.

US

The US market performed much less well than the UK. In sterling, the Russell 2000 Technology Index rose 4.5%, and the large cap Russell 1000 index returned 7.4%.

The star performer was Mellanox, which appreciated 116% ($10.4m rise). They are market leader in Infiniband which has been adopted more widely since Intel launched the Romley server processors for high speed datacentre connections. The share price peaked at $120 in September. Abovenet, Standard Microsystems, Retalix and MIPS have all performed on takeover offers, albeit Retalix and MIPS have yet to complete.

Offsetting this Ceva and Silicon Motion have been particularly poor performers declining 48% and 28% respectively (in $), both of which had been star performers in previous years. In 2011 Silicon Motion had risen 341% (in $). In addition there were lacklustre performances from holdings such as Advent Software, Websense and Pegasystems.

The US portfolio has been derated this year, and stands at a modest 10% premium to the UK portfolio in p/e terms on 2013 numbers, which is the smallest premium in HIT's history. The US sector is strong, and the economy will benefit from cheap domestically produced energy.

Eurpoe

The European portfolio is small, but rallied 20% in local currency or 17.5% in £.

Far East

The Far East portfolio has delivered a £ return of 10.3%. Taiwan returned 19.3%, and Korea returned 8.2%. Companies domiciled in these two countries account for the majority of the Far East portfolio. The Far East is now significant in terms of number of companies, but we have struggled to find companies with pricing power, and a structure which will respect outside shareholders. We have watched the feeding frenzy of mindless money invest as they did in TMT in the UK and US in 1999-2000, and to a lesser extent in the AIM market in 2005-2006. It seems probable that there will be some worthwhile investments as we have found post bubble in the UK. Regrettably the legal environment is much less developed than in the UK or the US. We have purposefully targeted resource in this area, which has thus far been productively deployed to keep us out of trouble.

The Addressable Market

Ultimately we invest in companies, not a concept. We have expressed our concern for a number of years about the proliferation of takeovers in the UK in particular. The numbers are stark, and it is now inevitable that the UK will fall as a percentage of the portfolio, but we have enjoyed the harvest. A screen of stocks in the technology and media sectors as defined by Bloomberg is summarised in the table below.

Number of quoted companies with market capitalisation <£1bn >£30m

Sector	UK	W Europe	N America	Asia Dev	Asia Emerging	World
Technology	64	183	353	667	283	1,635
Media	30	64	76	131	75	421
Electronic & Electrical Equipment	18	78	90	441	278	943
Total	112	325	519	1,239	636	2,999

Source:Bloomberg 31/12/2012

Prior to the financial crisis there were as many companies in the UK as the rest of Europe put together. That reflected a bigger investment sector, and heavy investing by pension funds and insurance companies in smaller early stage companies as well as entrepreneurialism and creativity. We have migrated to the European model of no new equity, or worse equity withdrawal, but remained with the Anglo-Saxon openness with regard to take-overs hence the dramatic contraction. The list is not the entire investable orbit for two reasons. Firstly we do invest in companies with a market capitalisation below £30m, and eliminating the £30m market capitalisation floor changes the numbers as shown in the table below. Secondly a number of companies classified within support services, electrical and electronic equipment and industrials are also in the remit, but for illustrative purposes this table highlights how small the UK quoted sector has become in a global context.

Number of quoted companies with market capitalisation <£1bn

Sector	UK	W Europe	N America	Asia Dev	Asia Emerging	World
Technology	140	521	1,075	1,369	666	4,174
Media	80	195	354	228	185	1,222
Electronic & Electrical Equipment	46	162	342	863	448	2,082
Total	266	878	1,771	2,460	1,299	7,478

Number of quoted companies with market capitalisation >£1bn

Sector	UK	W Europe	N America	Asia Dev	Asia Emerging	World
Technology	7	18	137	64	23	258
Media	11	24	38	14	13	112
Electronic & Electrical Equipment	3	6	29	34	14	88
Total	21	48	204	112	50	458

Source:Bloomberg 31/12/2012

The TMT sector targeted remains dynamic, and we shall continue to be vigilant in targeting value in any geographic market. However, the UK and US remain preferred locations for the reliable auditing and minority protections. The US is the best environment for companies to scale to address the largest markets, but has inefficiencies in the smaller companies market, and is rather too efficient in larger companies' valuations. Unlike the UK there is no system of house brokers to promote companies. The micro-cap market in the US and UK seems to be where value lies, and to find the same value in Asia and Europe requires greater selectivity. I draw attention to the fact that there are only 25 companies in Europe including the UK in the Bloomberg defined technology sector with a market value exceeding £1bn. This list includes a number of depressingly challenged companies such as Nokia, Alcatel Lucent, STMicro and Infineon. The UK boasts companies with momentum such as Arm, Imagination and Aveva, Germany has SAP and the Netherlands ASML and ASM. In contrast the US has companies with an order of magnitude greater in scale such as Apple, Google, Qualcomm, Intel, Microsoft and IBM. While we continue to find value in smaller UK and European companies, Europe really is marginal in terms of larger capitalisation technology companies, because at the year end there were 137 US technology companies with a market value exceeding £1bn. The Japanese technology sector is in poor shape. We have elected not to invest in Japan because there do not appear to be sufficient opportunities to justify the required resource. There is a paucity of entrepreneurialism, and the big companies are challenged. Elpida, Sharp, Panasonic and Sony have had particularly challenging years. The TV market has moved to Korea, and the computer games consoles have had a terrible Christmas as smart phones take the spending $. Korea has an extraordinarily strong company in Samsung and LG is not far behind. Taiwan has TSMC, and a number of challenged companies in the PC supply chain. China has many jobs, but few with pricing power. Furthermore, China is ceasing to be a low cost manufacturer. With increased automation and component integration the labour cost is low versus import tariffs into the US and Europe. It seems probable that there will be selective repatriation of manufacturing to the US. They own the companies with brands, innovation and low energy costs. Apple have already announced a modest initiative to build Macs in the US.

In a global economy beset by Government deficits the spotlight is on companies with subnormal tax charges. The technology sector in particular has the ability to move IP and manufacturing around the world with its global supply chain. Many of the large companies have significant offshore earnings with low tax charges, but are not repatriating profits to the US because they face 35% Federal tax charges, and state taxes on top. It has to be a major consideration on Capitol Hill to adjust these taxes. It is anomalous that the tax system is incentivising Apple to fund the capital investment of its supply chain in the Far East rather than repatriating profits to invest at home. The US Government may consider charging companies a reduced tax of say 10% on foreign earnings, but then permit repatriation. This tax anomaly has been an additional reason why so many UK companies have been acquired by US companies who have cash offshore not worth face value.

The Company continues to have a £50m loan facility and an associated interest swap, which continues to trade at a similar loss as a year ago. Whilst we value the flexibility, and have benefited from the use of the capital that the facility affords clearly the timing of the swap was ill-judged. After consideration it seems appropriate to continue the position.

Summary

2012 has been adequate, but could have been better. The five year performance is good. The outlook for 2013 remains uncertain, but from the perspective of the sectors targeted by Herald the US seems to be better placed to address its economic issues than elsewhere. There remains more value in microcaps, but the ability for companies to grow profits appears to be more challenging than it has been. The UK portfolio seems likely to decline as a percentage of the whole. While a degree of caution seems rational it remains a mandate that seems to have attractions relative to most other asset classes. We continue with enthusiasm.

Performance Attribution (in sterling terms)

	Comparative index allocation		Herald asset allocation		Performance*			Contribution attributable to:
							Contribution to relative return
Equity Markets	01.01.12	31.12.12	01.01.12	31.12.12	Herald	Comparative index		Stock selection	Asset allocation†
	%	%	%	%	%	%	%	%	%
UK	66.7	66.7	68.6	72.2	18.0	22.4	(2.4)	(2.5)	0.1
Europe ex. UK	-	-	2.1	2.5	17.5	-	-	-	-
USA	33.3	33.3	25.0	21.3	1.4	4.5	0.5	(0.5)	1.0
Asia Pacific ex. Japan	-	-	6.9	5.6	10.3	-	(0.3)	-	(0.3)
Emerging Markets	-	-	0.4	0.4	13.4	-	-	-	-
Bonds	-	-	5.8	6.4	5.0	-	(0.6)	-	(0.6)
Cash	-	-	6.8	5.6	0.3	-	(1.1)	-	(1.1)
Swap	-	-	(4.5)	(4.0)	n/a	-	0.3	-	0.3
Loans	-	-	(11.1)	(10.0)	2.1	-	1.4	-	1.4
Total	100.0	100.0	100.0	100.0	13.5	16.3	(2.4)	(3.1)	0.7

Past performance is not a guide to future performance.

Source: HSBC

*  The above returns are calculated on a total return basis with net income reinvested.  Dividends and interest are reinvested on a cash basis, unlike the NAV calculation where income is recognised on an accruals basis.  Relative performance may differ as a result.

Contributions cannot be added together, as they are geometric; for example, to calculate how a return of 13.5% against a comparative index return of 16.3% translates into a relative return of (2.4%), divide the portfolio return of  113.5 by the comparative index return of 116.3 and subtract one.

†   Asset allocation includes the contribution attributable to currency movements.

Katie Potts

27 February 2013

DISTRIBUTION OF ASSETS

 

			At 31 December 2012 %		At 31 December 2011 %
Equities:	United Kingdom		63.2		59.2
	Continental Europe		2.2		1.8
	USA		18.6		21.6
	Asia Pacific		4.9		6.0
	Emerging Markets		0.4		0.4
Total equities			89.3		89.0
Sterling denominated bonds			3.1		3.1
Euro denominated bonds			2.5		1.9
Net current assets			5.1		6.0
Total assets (before deduction of bank loans and derivative financial instruments)			100.0		100.0

TOP TWENTY HOLDINGS at 31 December 2012

 

A brief description of the twenty largest equity holdings in companies is as follows:

Imagination Technologies
Imagination Technologies is an international leader in the creation and licensing of semiconductor System-on-Chip Intellectual Property (SoC IP). Imagination creates market-leading embedded graphics, video and display acceleration, multi-threaded processing and multi-standard receiver technologies and licenses this IP Intellectual Property) to global semiconductor and system companies. These Technologies are used for systems-on-chip (SoC) in the following markets: digital radio and audio, mobile phone, handheld multimedia, personal media player, car navigation and driver information, personal navigation, mobile computing, digital TV and set-top box and mobile TV. Imagination has been particularly successful in selling graphics technology to the mobile phone and LCD TV sectors and is a pioneer in developing Digital Audio Broadcasting Technology (DAB). Imagination Technology incorporates this technology in its "Pure Digital" radio brand, which is the number one supplier of radios in the UK. The adoption of digital radio in other countries, France and Germany in particular, is opening up a bigger international market and they have launched an internet radio range for the US market. The group has a highly skilled workforce of around 1,200 people, of which over 80% are R&D engineers. Apple and Intel are both investors in Imagination Technologies.	Country                  United Kingdom % of total assets                            3.4                            31/12/12      31/12/11 Valuation (£m)       19.55            27.73 Shares (m)             4.96                5.05
Telecom Plus
Telecom Plus, which owns and operates the Utility Warehouse brand, is the UK's only fully integrated provider of a wide range of competitively priced utility services, spanning both the communications and energy markets. Telecom Plus supplies fixed wire and mobile telecommunications services, gas and electricity to over 405,000 residential and small business customers in the United Kingdom with a unified bill and good value utilities. Telecom Plus was incorporated in 1996 and began operations in 1997 providing a unique range of low-cost telephony services to the residential and SOHO markets. They use the collective buying power of individual users to negotiate bulk buying deals with major suppliers, passing the benefit back to their customers. Telecom Plus does not advertise and has no shops. Instead, they rely on word of mouth recommendations from satisfied customers and from a network of Independent Distributors.	Country                  United Kingdom % of total assets                            2.7                            31/12/12      31/12/11 Valuation (£m)       15.19            14.52 Shares (m)             1.65             1.89

IDOX
IDOX plc is a supplier of software solutions and services to the UK public sector and increasingly to highly regulated asset intensive industries around the world in the wider corporate sector. The Public Sector Software Division is a major supplier of software solutions and managed services to the public sector and is the leading applications provider to local government for core functions relating to land, people and property. Over 90% of UK local authorities are customers for document and case management solutions, workflow systems, content and related Web-based portals. The IDOX Engineering Information Management Division is a leading supplier of engineering document management and control solutions to asset intensive industry sectors. Operating under the McLaren Software brand the division supplies solutions to leading international oil & gas, energy & utilities, manufacturing, life sciences, transportation and natural resources companies.	Country                  United Kingdom % of total assets                            2.6 % of issued share capital held     8.1                            31/12/12      31/12/11 Valuation (£m)       15.01              7.28 Shares (m)             28.32            30.32
SDL
SDL is the leader in Global Information Management (GIM) solutions that help organisations to accelerate the delivery of high-quality multilingual content to global markets alongside their products and services. SDL's best-of-breed Web Content Management, eCommerce, Structured Content and Language Technologies, combined with its Language Services drive down the cost of content creation, management, translation and publishing. SDL solutions increase conversion ratios and customer satisfaction through targeted information across all customer touch points. SDL has over 1,500 enterprise customers, has deployed over 185,000 software licenses and has a global infrastructure of more than 70 offices in 38 countries. SDL is in Gartner's leader quadrant for web content management.	Country                  United Kingdom % of total assets                            2.6 % of issued share capital held    3.7                            31/12/12      31/12/11 Valuation (£m)       14.89            19.70 Shares (m)               2.95              2.98
Diploma
Diploma is a group of specialised distribution businesses serving industries with long term growth potential and with the opportunity for sustainable superior margins through the quality of customer service, depth of technical support and value-adding activities. The three sectors the company focuses on are life sciences, seals and controls.	Country                  United Kingdom % of total assets                            2.2                            31/12/12      31/12/11 Valuation (£m)       12.80              8.00 Shares (m)               2.35              2.35
Phoenix IT Group
Phoenix IT was established in 1980, the Group provides a growing range of complementary IT infrastructure support services including systems management, communications, remote telephone support, high-touch field services, project and consultancy services as well as business continuity and disaster recovery services. Often these services are sold and delivered as a managed service where Phoenix manages complex IT infrastructures to agreed levels of service under long term contracts. In May 2007 Phoenix acquired ICM for £130m in cash and shares, ICM had been a portfolio holding since 2002.	Country                  United Kingdom % of total assets                            2.2 % of issued share capital held    9.2                            31/12/12      31/12/11 Valuation (£m)       12.42              8.80 Shares (m)              6.93               5.58
OpSec Security
OpSec provides solutions to combat counterfeiting and the related problems of diversion, grey marketing, online brand abuse and fraud. It provides anti-counterfeiting technologies, services and software to over 300 global brands across industry sectors and over 50 governments worldwide. The Group operates manufacturing facilities and laboratories in the USA and the UK, and has sales operations in the Americas, Europe and Asia. OpSec supplies technologies and solutions into three core markets: Banknote and High Security Documents; Brand Protection; and ID Solutions.	Country                  United Kingdom % of total assets                            1.7 % of issued share capital held   23.6                            31/12/12      31/12/11 Valuation (£m)         9.93              9.71 Shares (m)               23.65          18.68

Bango
Founded in 1999 to capitalise on the growth in the number of mobile phones and the arrival of the internet on these devices. Bango powers payment and analytics on the mobile web, providing users with a smooth payment experience. Bango powers mobile payments for leading app stores, brands, publishers and developers across all devices, networks and connections worldwide. Bango powers mobile analytics for leading content publishers and mobile marketers providing the most accurate measurement of mobile visitors and marketing campaigns. Bango's pervasive presence across the web creates a platform effect for partners, identifying hundreds of millions of users and maximizing the number of one-click payments. Customers include Facebook, BlackBerry App World, Windows Phone Store, Amazon and major mobile brands including CNN, Cartoon Network and EA Mobile.	Country                  United Kingdom % of total assets                            1.7 % of issued share capital held   12.4                            31/12/12      31/12/11 Valuation (£m)         9.61              3.18 Shares (m)               5.16              4.82
Wilmington Group
Wilmington's businesses enable professionals and their organisations to perform better by providing quality, relevant and reliable information, education and knowledge to professional markets. Activities are segmented into six business divisions: Legal, Banking & Compliance, Pensions & Insurance, Healthcare, Business Intelligence and Accountancy.	Country                  United Kingdom % of total assets                            1.6 % of issued share capital held     7.3                            31/12/12      31/12/11 Valuation (£m)         9.40              4.21 Shares (m)               6.22             5.13
M&C Saatchi
M&C Saatchi is a global marketing services business working for clients across a wide variety of industry sectors. The Company was founded in 1995. Starting with a strong base in the UK and Australia, M&C Saatchi have added new agencies and disciplines in Asia, USA and Europe. M&C Saatchi currently has 26 offices in 18 countries.	Country                  United Kingdom % of total assets                            1.6 % of issued share capital held     8.1                            31/12/12      31/12/11 Valuation (£m)         9.06              5.92 Shares (m)               5.15              5.15
Euromoney Institutional Investor
The group publishes more than 70 titles in both print and online format, including Euromoney Institutional Investor and Metal Bulletin, and is a leading provider of electronic research and data under the BCA Research, Ned Davis Research and ISI Emerging Markets brands. It also runs an extensive portfolio of conferences, seminars and training courses for financial markets. The group's main offices are in London, New York, Montreal and Hong Kong and more than a third of its revenues are derived from emerging markets.	Country                  United Kingdom % of total assets                            1.5                            31/12/12      31/12/11 Valuation (£m)         8.64              6.56 Shares (m)             1.00                1.05
ATMI
ATMI Inc. is a supplier of materials, materials packaging and materials delivery systems used globally in the manufacture of microelectronics devices. The company's products consist of front-end semiconductor performance materials, sub-atmospheric pressure gas delivery systems for safe handling and delivery of toxic and hazardous gases and materials packaging and dispensing systems. ATMI serves and provides applications and analytical support services to three markets: semiconductors, flat-panel displays and life sciences. ATMI is devoted to constantly improving microelectronic and life science manufacturing technologies, helping them drive these industries forward.	Country                                       USA % of total assets                            1.3                            31/12/12      31/12/11 Valuation (£m)         7.70              7.73 Shares (m)               0.60              0.60
IQE
IQE is one of the leading suppliers of semiconductor wafer products for wireless and optoelectronic components, photovoltaics and silicon based epitaxy. Customers are supplied with process optimized, cost effective, world-class wafers from any one of IQE's worldwide manufacturing sites. Contract wafer manufacturing is a fundamental business strategy for an ever-increasing number of compound semiconductor device manufacturers. The epitaxy process is one of the most critical and expensive parts of the manufacturing chain. IQE possesses the largest independent manufacturing capacity worldwide, IQE are able to achieve enhanced economies of scale that no other merchant epiwafer manufacturer can realise and few in-house capabilities can match.	Country                  United Kingdom % of total assets                            1.3 % of share capital held                4.3                            31/12/12      31/12/11 Valuation (£m)         7.59              3.77 Shares (m)             25.08            20.64

NCC Group
As a trusted adviser, NCC Group provides business critical IT assurance and protection to over 15,000 organisations worldwide, including 94 out of the FTSE 100. The Group operates two main complementary divisions, Escrow and Assurance: Escrow, includes ensuring source code, data or other business critical material is protected and accessible should anything happen to a key supplier. Furthermore NCC confirm the material held is properly protected by verifying that it can be rebuilt from its source code components. Assurance, incorporates expert led security testing, covering forensics, vulnerability research and the development of expert software to aid organisations in their on-going battle with information security breaches.	Country                  United Kingdom % of total assets                            1.3                            31/12/12      31/12/11 Valuation (£m)         7.30            10.05 Shares (m)               4.80              1.21
StatPro Group
StatPro has been in the business of portfolio analytics since 1994, has over 300 clients across 25 countries and around 250 staff globally. StatPro provides detailed portfolio analytics products for the front and middle offices of portfolio managers, enabling portfolio risk measurement, attribution and reporting. StatPro has comprehensive data coverage of over 500,000 assets including an ever increasing number of securities, covering global markets including evaluated bond prices. StatPro has developed a cloud computing version of it software - StatPro Revolution.	Country                  United Kingdom % of total assets                            1.3 % of issued share capital held   11.2                            31/12/12      31/12/11 Valuation (£m)         7.18              5.92 Shares (m)               7.56              6.88
GB Group
GB Group, the UK's leading identity management business, helps organisations realise the full value of their customer base by recognising and verifying all elements of a consumer's identity at every interaction. Through the application of technology, GB Group protects, predicts and provides information that is used to maximise customer value for some of the largest companies in the UK. The company provides an integrated and comprehensive range of data services to clients allowing them to interact effectively with their customers, improve long term profitability and reduce fraud. GB Group has four complementary identity management offerings: ID Verification, ID Customer Registration, ID Engagement and ID Tracing Services.	Country                  United Kingdom % of total assets                            1.2 % of issued share capital held    6.9                            31/12/12      31/12/11 Valuation (£m)         6.77              3.72 Shares (m)               7.52              7.92
Allocate Software
Allocate Software plc is a global workforce and corporate governance software solutions provider for organisations with large, multi-skilled workforces. With a blue chip client base spanning the public and private sector, its key vertical markets include healthcare, defence and maritime offshore oil and gas. At the core of the business is Allocate's workforce optimisation software, which streamlines the whole workforce management of multi disciplinary groups, across diverse locations. Headquartered in London, it employs around 300 people providing services and support to its increasing international customer base through regional offices in the UK, Australia, Malaysia, Sweden and the USA.	Country                  United Kingdom % of total assets                            1.2 % of issued share capital held   13.4                        31/12/12      31/12/11 Valuation (£m)         6.67              6.58 Shares (m)                8.55              8.55
Mellanox Technologies
Mellanox is a leading supplier of end-to-end InfiniBand and Ethernet interconnect solutions and services for servers and storage. Mellanox interconnect solutions increase data center efficiency by providing the highest throughput and lowest latency, delivering data faster to applications and unlocking system performance capability. Mellanox offers a choice of fast interconnect products: adapters, switches, software and silicon that accelerate application runtime and maximize business results for a wide range of markets including high performance computing, enterprise data centers, Web 2.0, cloud, storage and financial services. Founded in 1999, Mellanox Technologies is headquartered in Sunnyvale, California and Yokneam, Israel.	Country                                       USA % of total assets                            1.1                        31/12/12     31/12/11 Valuation (£m)         6.52              5.77 Shares (m)               0.18              0.28

Advent Software
Advent supplies investment management companies with integrated software products and services in portfolio administration, including workflows within the managers and external portfolio reporting. Each solution focuses on specific mission-critical functions of the front, middle and back offices and is designed to meet the needs of the particular client, as determined by size, assets under management and complexity of the investment environment. With more than 4,500 client firms in 60 countries, Advent has established itself as a leading provider of mission-critical applications to meet the demands of investment management operations around the world. It has adopted a rental model.	Country                                       USA % of total assets                            1.1                         31/12/12        31/12/11 Valuation (£m)         6.31              7.52 Shares (m)                0.48              0.48
Silicon Motion Technology
Established in 1995, Silicon Motion Technology designs, is a fabless semiconductor company which develops and markets high performance, low-power semiconductor solutions for multimedia consumer electronics applications, such as smartphones, digital cameras, notebook and tablet PCs and personal navigation devices. It has three product lines: mobile storage, multimedia systems-on-a-chip (SoC) for embedded graphics applications and mobile communications. Silicon Motion Technology is often at the forefront of microcontroller and NAND flash storage devices, with their products being used in many of the leading smartphone and mobile devices. The Company's mobile communications product line consists of mobile television integrated circuit solutions and handset transceiver circuits. Its embedded graphics processors are generally used to render text, or two-dimensional graphics and user interfaces.	Country                                       USA % of total assets                            1.1                        31/12/12          31/12/11 Valuation (£m)         6.12              9.86 Shares (m)                0.70              0.75

Note: A figure is presented for % issued share capital held only if greater than 3%.

 

RELATED PARTY TRANSACTIONS

The Directors' fees for the year are detailed in the Directors' Remuneration Report contained within the Annual Report. No Director has a contract of service with the Company. During the year no Director was interested in any contract or other matter requiring disclosure under the Companies Act 2006.

Herald Investment Management Limited is appointed as investment manager under a management agreement which is terminable on twelve months' notice. Their fee is calculated on a monthly rate of 0.08333% of the Company's net asset value based on middle market prices. The management fee is levied on all assets except the holding in Herald Ventures II Limited Partnership managed by Herald Investment Management Limited.

The details of the management fee are as follows:

	2012 £'000		2011 £'000
Investment management fee	4,950		4.752

 

PRINCIPAL RISKS AND UNCERTAINTIES

In accordance with the corporate objective of maximising capital appreciation, the Company invests in securities on a worldwide basis. The Company makes use of gearing to achieve improved performance in rising markets and has an interest rate swap, the purpose of which is to hedge the variability in cash flows arising from interest rate fluctuations on bank loans. The Company's other financial instruments consist of cash, short term debtors and creditors.

The main risks arising from the Company's financial instruments are:

A.   Market Risk

(i)    Other price risk, being the risk that the value of investment holdings will fluctuate as a result of changes in market prices caused by factors other than interest rate or currency rate movement.

(ii)   Interest rate risk, being the risk that the future cash flows of a financial instrument will fluctuate because of changes in market interest rates; and

(iii)   Foreign currency risk, being the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates.

B.   Credit Risk, being the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.

C.   Liquidity Risk, being the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities.

These risks and the policy for managing them have been applied throughout the year and are summarised below.

A.  Market Risk

(i)    Other Price Risk

The Company's investment portfolio is exposed to market price fluctuations which are monitored by the Manager in pursuance of the corporate objective. Securities held by the Company are valued at bid prices, whereas material unlisted investments are valued by the Directors on the basis of the latest information in line with the relevant principles of the International Private Equity and Venture Capital Valuation Guidelines. These valuations also represent the fair value of the investments.

An analysis of the investment portfolio by broad industrial or commercial sector and a review of the 20 largest equity investments by their aggregate market value, are shown above.

Other Price Risk Sensitivity

29.9% of the Company's equity investments at 31 December 2012 (2011 - 33.6%) were listed on the main list of the London Stock Exchange and a further 38.0% (2011 - 31.6%) on AIM. The NASDAQ Stock Exchange accounts for 20.9% (2011 - 24.2%) and other stock exchanges 8.3% (2011 - 9.2%). A 10% increase in stock prices at 31 December 2012 would have increased total net assets and net return on ordinary activities after taxation by £51,100,000 (2011 - £46,200,000). A decrease of 10% would have had an equal but opposite effect. The portfolio does not target any exchange as a comparative index, and the performance of the portfolio has a low correlation to generally used indices.

The shares of Herald Investment Trust plc have an underlying NAV per share. The NAV per share of Herald Investment Trust plc fluctuates on a daily basis. In addition, there is volatility in the discount/premium the share price has to NAV.

(ii)   Interest Rate Risk

The majority of the Company's assets are equity shares and other investments which neither pay interest nor have a maturity date. However, the Company does hold Convertible Bonds and Government Securities, the interest rate and maturity dates of which are detailed below. Interest is accrued on sterling cash balances at a rate linked to the UK base rate.

The Company has borrowings. The aim of the use of gearing is to enhance long term returns to shareholders by investing borrowed funds in equities and other assets. Gearing is actively managed. How and where borrowings are invested is reviewed by the Board in consultation with the Manager at every Board meeting. In light of the decisions made, appropriate adjustments to the gearing position are then made by the Manager.

At the year end the Company had borrowings of £50 million (2011 - £50 million). Under the terms of an interest rate swap, the interest payable on the bank loans has been fixed.

The interest rate risk profile of the financial assets and financial liabilities at 31 December was:

Financial Assets

		2012			2011
	Fair value £'000	Weighted average interest rate/interest rate	Weighted average period until maturity/ maturity date	Fair value £'000	Weighted average interest rate/interest rate	Weighted average period until maturity/ maturity date
Fixed rate:
UK bonds	17,816	4.7%	4 years	16.445	4.9%	5 years
EUR bonds	14,015	5.0%	4 years	9,791	4.4%	6 years
UK convertible bonds	729	7.5%	2 years	1,162	7.5%	3 years
Cash:
Other overseas currencies	6,341			1,762
Sterling	22,609	0.7%		28,259	0.3%
	28,950			30,021

The cash deposits generally comprise call or short term money market deposits with original maturities of less than 3 months which are repayable on demand. The benchmark rate which determines the interest payments received on cash balances is the bank base rate.

Financial Liabilities

		2012			2011
	£'000	Net Interest rate paid	Loan Facility expired/expires	£'000	Net Interest rate paid	Loan Facility expired/expires
Bank loan	25,000	1.7%	May 2013	25,000	1.3%	May 2011
	25,000	2.4%	May 2013	25,000	1.6%	May 2013
				25,000	2.4%	May 2013
		2.1%			1.9%
Swap	50,000	4.0%		50,000	4.1%
		6.1%			6.0%

The effective fixed rate of interest on the loans of 6.1% (2011 - 6.0%) reflects a weighted average variable interest rate paid of 2.1% (2011 - 1.9%), with a further weighted average of 4.0% paid on the swap (2011 - 4.1%). The Company's facilities are rolling on a quarterly basis with the facilities expiring in May 2013. While the 30 year swap remains in place, the net interest payable will effectively be fixed for the duration of the term of the loan facilities.

	2012				2011
	Notional contract amount £'000	Fair value assets £'000	Fair value liabilities £'000	Fair value balance £'000	Notional contract amount £'000	Fair value assets £'000	Fair value liabilities £'000	Fair value balance £'000
Total derivative assets/(liabilities)	50,000	27,569	(47,866)	(20,297)	50,000	27,551	(47,908)	(20,357)

Interest rate risk sensitivity

(a) Cash

An increase of 100 basis points in interest rates as at 31 December 2012 would have a direct effect on net assets. Based on the position at 31 December 2012, over a full year, an increase of 100 basis points would have increased the net return on ordinary activities after taxation by £290,000 (2011 - £300,000) and would have increased the net asset value per share by 0.36p (2010 - 0.38p). The calculations are based on the cash balances as at the respective balance sheet dates and are not representative of the year as a whole.

(b) Fixed rate bonds

An increase of 100 basis points in bond yields as at 31 December 2012 would have decreased total net assets and total return on ordinary activities by £980,000 (2011 - £817,000) and would have decreased the net asset value per share by 1.24p (2011 - 1.02p). A decrease in bond yields would have had an equal and opposite effect. The Convertible loan stocks having an element of equity are not included in this analysis as given the nature of the businesses and the risk profile of the balance sheets they are considered to have more equity like characteristics.

(c) Bank loans

The effect of an increase or decrease of 100 basis points in 3 month LIBOR interest rates as at 31 December 2012 on the interest cost of the bank loans and the net income return has been eliminated through a 30 year floating interest rate to fixed interest rate swap. The swap generates payments or charges that offset changes in the 3 month LIBOR interest rate, so that the interest payable on the bank loans is effectively converted to a fixed rate loan at 4.8975% (2011 - 4.8975%) plus margin cost. The initial term of the swap on commencement at 30 years did not match the term of the loans, therefore, hedge accounting is not used and changes in the fair value of the swap are captured in the net return on ordinary activities as set out in (d) below.

(d) Floating interest rate to fixed interest rate swap

A decrease of 100 basis points on 30 year interest rates as at 31 December 2012 would have a direct effect on the fair value of the swap and net assets. Based on the position as at 31 December 2012, over a full year, a decrease of 100 basis points would have decreased the gains on investments and net return on ordinary activities after taxation by £11,941,000 (2011 - £12,020,000) and would have decreased the net asset value per share by 15.05p (2011 - 15.08p). An increase of 100 basis points would have had an equal but opposite effect.

(iii)  Foreign Currency Risk

The Company's reporting currency is sterling, but investments are made in overseas markets as well as the United Kingdom and the asset value can be affected by movements in foreign currency exchange rates.

Furthermore many companies trade internationally both through foreign subsidiaries, and through exports. The greatest foreign currency risk occurs when companies have a divergence in currencies for costs and revenues. A much less risky exposure to currency is straight translation of sales and profits. The List of Investments on pages 16 to 20 of the Annual Report breaks down the portfolio by geographic listing. However the location of the stock market quote only has a limited correlation to the costs, revenues and even activities of those companies, and so this note should not be regarded as a reliable guide to the sensitivity of the portfolio to currency movements. For example, the holdings in the portfolio that have suffered most from US$ weakness are UK companies with dollar revenues and sterling costs.

The Company does not hedge the sterling value of investments that are priced in other currencies. Overseas income is subject to currency fluctuations. The Company does not hedge these currency fluctuations because it is impossible to quantify the effect for the reasons stated above. However, from time to time the Manager takes a view by holding financial assets or liabilities in overseas currencies.

Exposure to currency risk through asset allocation by currency of listing is indicated below:

At 31 December 2012

	Investments £'000	Cash and deposits  £'000	Loans £'000	Other  debtors and creditors* £'000	Net exposure £'000
US dollar	107,482	146	-	(68)	107,560
Norwegian krone	17,326	-	-	-	17,326
Korean won	14,609	-	-	26	14,635
Taiwan dollar	7,706	6,195	-	-	13,901
Euro	9,296	-	-	403	9,699
Other overseas currencies	6,974	-	-	-	6,974
Exposure to currency risk on translation of valuations of securities listed in overseas currencies	163,393	6,341	-	361	170,095
Sterling	379,749	22,609	(50,000)	(20,507)	331,851
	543,142	28,950	(50,000)	(20,146)	501,946

*Includes net non-monetary assets of £38,000.

At 31 December 2011

	Investments £'000	Cash and deposits  £'000	Loans £'000	Other  debtors and creditors* £'000	Net exposure £'000
US dollar	113,211	1	-	3	113,215
Korean won	15,351	-	-	5	15,356
Norwegian krone	11,046	-	-	232	11,278
Taiwan dollar	10,343	1,761	-	-	12,104
Euro	8,051	-	-	(19)	8,032
Other overseas currencies	6,397	-	-	-	6,397
Exposure to currency risk on translation of valuations of securities listed in overseas currencies	164,399	1,762	-	221	166,382
Sterling	324,290	28,259	(50,000)	(19,632)	282,917
	488,689	30,021	(50,000)	(19,411)	449,299

*Includes net non-monetary assets of £32,000.

Foreign currency risk sensitivity

At 31 December 2012, had sterling strengthened by 10% (2011 - 10%) in relation to all currencies, with all other variables held constant, total net assets and net return on ordinary activities after taxation would have decreased by the amounts shown below based solely on translation of securities quoted in currencies overseas. A 10% (2011 - 10%) weakening of sterling against all currencies, with all other variables held constant, would have had an equal but opposite effect on the financial statement amounts. However, companies whose cost base diverges in currency terms from its sales will in the longer term have a significantly greater effect on valuation than simple translation. In the short term investee companies generally cover their currency exposure to varying degrees. There is insufficient publicly disclosed information to quantify this, but in the long term this effect is expected to dwarf simple translation of foreign listings in terms of both risk and reward, because many investee companies trade globally. Furthermore, the country of listing is not necessarily an indication of the geography of some or even any operational activities for investee companies. The Manager does not use financial instruments to protect against currency movements. From time to time financial leverage has been made using debt in overseas currencies.

	2012	2011
	£'000	£'000
US dollar	10,756	11,321
Norwegian krone	1,733	1,128
Korean won	1,463	1,536
Taiwan dollar	1,390	1,210
Euro	970	803
Other overseas currencies	697	640
	17,009	16,638

B.  Credit Risk

Credit risk is the risk that a counterparty to a financial instrument will fail to discharge an obligation or commitment which it has entered into with the Company. The Manager monitors counterparty risk on an ongoing basis.

The Company has investments in convertible loan stocks that have an element of equity. These securities are viewed as having a risk profile similar to the equity holdings. This is because the convertibles held are in nascent technology companies that may be loss making and may have weak balance sheets. For this reason these stocks are categorised as equity holdings.

The fixed interest securities held are UK and Norwegian Government securities and UK corporate bonds.

Credit Risk Exposure

The exposure to credit risk at 31 December was:

	2012	2011
	£'000	£'000
Fixed interest investments	31,831	26,236
Cash and short term deposits	28,950	30,021
Debtors and prepayments	1,985	1,947
	62,766	58,204

The maximum exposure in fixed interest investments was £33,170,000 (2011 - £30,587,000) and the minimum £26,228,000 (2011 - £20,059,000). The maximum exposure in cash was £36,288,000 (2011 - £42,208,000) and the minimum £17,863,000 (2011 - £12,009,000).

None of the Company's financial assets are past due or impaired.

C. Liquidity Risk

The Company's policy with regard to liquidity is to provide a degree of flexibility so that the portfolio can be repositioned when appropriate and that most of the assets can be realised without an excessive discount to the market price.

(a)   Equity Securities

The Company's unlisted investments are not readily realisable, but these only amount to 2.1% of the Company's total assets at 31 December 2012 (201 - 1.8%).

In practice, liquidity in investee companies is imperfect, particularly those with a market value of less than £100 million. To reduce this liquidity risk it is the policy to diversify the holdings and generally to restrict the holding in any one company to less than 10% of the share capital of that company. Furthermore the guideline is for no single investment to account for more than 5% of the assets of the Company.

The market valuation of each underlying security gives an indication of value, but the price at which an investment can be made or realised can diverge materially from the bid or offer price depending on market conditions generally and particularly to each investment. 34% (£182 million) (2011 - 34% (£168 million)) of the portfolio is invested in listed stocks with a market capitalisation below £100 million, where liquidity is expected to be more limited. If these stocks had on average a realisable value 20% below the bid price the value of the total fund would be adversely affected by 6.7% (2011 - 6.9%).

(b)   Floating interest rate to fixed interest rate swap

The fair value of the swap is estimated by RBS the provider of the swap and is compared to an external model and external prices. We believe the RBS valuation to be reasonable.  The RBS valuation methodology and assumptions may change at any time.

The swap valuation gives an indication of fair value, but the price at which the swap can be unwound or realised may diverge materially from this valuation depending on market conditions and liquidity.

Liquidity Risk Exposure

Contractual maturities of the financial liabilities at the year end, based on the earliest date on which payment can be required are as follows:

	2012 One year or less	2011 One year or less
	£'000	£'000
Bank loans	50,492	51,727
Derivative financial instruments	24,136	25,725
Other creditors	470	444
	75,098	77,896

Fair Value of Financial Instruments

Fair values are measured using the following fair value hierarchy:

Level  1: reflects financial instruments quoted in an active market.

Level 2: reflects financial instruments whose fair value is evidenced by comparison with other observable current market transactions in the same instrument or based on a valuation technique whose variables includes only data from observable markets.

Level 3: reflects financial instruments whose fair value is determined in whole or in part using a valuation technique based on assumptions that are not supported by prices from observable market transactions in the same instrument and not based on available observable market data.

The valuation techniques used by the Company are explained in the accounting policies on pages 40 and 41 of the Annual Report and Financial Statements.

The tables below set out the fair value measurements using the fair value hierarchy.

At 31 December 2012

	Level 1  £'000	Level 2 £'000	Level 3 £'000	Total £'000
Financial assets
Equity investments	502,141	-	9,170	511,311
Government debt securities	23,020	-	-	23,020
Other debt securities	5,754	-	3,057	8,811
Current assets	30,935	-	-	30,935
Total assets	561,850	-	12,227	574,077
Financial liabilities
Bank loans	50,000	-	-	50,000
Derivatives	-	20,297	-	20,297
Current liabilities (excluding bank loans)	1,834	-	-	1,834
Total liabilities	51,834	20,297	-	72,131
Total net assets	510,016	(20,297)	12,227	501,946

A reconciliation of fair value measurements in Level 3 is set out below:

At 31 December 2012

	Equity Investments £'000
Opening balance at 1 January 2012	9,556
Purchases	2,089
Sales	(944)
Total gains or (losses):
-               on assets sold during the year	(1,694)
-               on assets held at 31 December 2012	3,220
Closing balance at 31 December 2012	12,227

At 31 December 2011

	Level 1  £'000	Level 2 £'000	Level 3 £'000	Total £'000
Financial assets
Equity investments	454,597	-	7,856	462,453
Government debt securities	18,934	-	-	18,934
Other debt securities	5,602	-	1,700	7,302
Current assets	31,968	-	-	31,968
Total assets	511,101	-	9,556	520,657
Financial liabilities
Bank loans	50,000	-	-	50,000
Derivatives	-	20,357	-	20,357
Current liabilities (excluding bank loans)	1,001	-	-	1,001
Total liabilities	51,001	20,357	-	71,358
Total net assets	460,100	(20,357)	9,556	449,299

A reconciliation of fair value measurements in Level 3 is set out below:

At 31 December 2011

	Equity Investments £'000
Opening balance at 1 January 2011	3,900
Purchases	3,558
Sales	(703)
Transfers into Level 3	2,469
Total gains or losses:
-               on assets sold during the year	(1,088)
-               on assets held at 31 December 2011	1,420
Closing balance at 31 December 2011	9,556

Transfers into Level 3 relate to investments for which listing has been suspended during the year.

Other Risks

Other risks faced by the Company include the following:

Regulatory Risk - failure to comply with applicable legal and regulatory requirements could lead to suspension of the Company's Stock Exchange Listing, financial penalties or a qualified audit report. Breach of Sections 1158 and 1159 of the Corporation Tax Act 2010 could lead to the Company being subject to tax on capital gains. The Manager's Compliance Officer and Baillie Gifford's Heads of Business Risk & Internal Audit and Regulatory Risk provide regular reports to the Audit Committee on their monitoring programmes. The Manager monitors investment positions and the Secretary monitors the level of forecast income and expenditure to ensure the provisions of Sections 1158 and 1159 are not breached.

Major regulatory change could impose disproportionate compliance burdens on the Company.  In such circumstances representation is made to ensure that special circumstances of investments trusts are recognised.

Operational/Financial Risk - failure of the Secretary's accounting systems or those of other third party

service providers could lead to an inability to provide accurate reporting and monitoring or a misappropriation of assets. The Secretary has a comprehensive business continuity plan which facilitates continued operation of the business in the event of a service disruption or major disruption. The Audit Committee reviews the Secretary's Report on Internal Controls and the reports by other key third party providers are reviewed by the Secretary on behalf of the Audit Committee.

Discount Volatility - the discount at which the Company's shares trade can widen. The Board monitors the level of discount and the Company has authority to buy back its own shares.

Gearing Risk - the Company may borrow money for investment purposes. If the investments fall in value, any borrowings will magnify the extent of this loss. If borrowing facilities are not renewed, the Company may have to sell investments to repay borrowings.

All borrowings require the prior approval of the Board and gearing levels are discussed by the Board and Managers at every meeting. The majority of the Company's investments are in quoted securities.

 

STATEMENT OF DIRECTORS' RESPONSIBILITIES

The Directors are responsible for preparing the Annual Report, the Directors' Remuneration 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 the Directors have elected to prepare the financial statements in accordance with applicable law and United Kingdom Accounting Standards (United Kingdom 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 state of affairs 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 accounting estimates that are reasonable and prudent; and

·          state whether applicable UK Accounting Standards have been followed, subject to any material  departures disclosed and explained in the financial statements.

The Directors are responsible for the keeping of 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 and the Directors' Remuneration Report comply with the Companies Act 2006. 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.

The Directors have delegated responsibility to the Manager for the maintenance and integrity of the Company's page of the Manager's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

The work carried out by the Auditor does not involved any consideration of these matters and, accordingly, the Auditor accepts no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the website.

Each of the Directors, whose names and functions are listed within the Directors, Manager and Advisers

section of the Annual Report and Financial Statements confirm that, to the best of their knowledge:

·          the financial statements, which have been prepared in accordance with applicable law and  United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice), give a true and fair view of the assets, liabilities, financial position and net return of the Company; and

·          the Directors' 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.

By order of the Board

Julian Cazalet

27 February 2013

INCOME STATEMENT

	For the year ended 31 December 2012				For the year ended 31 December 2011
	Revenue £'000	Capital £'000	Total £'000		Revenue £'000	Capital £'000	Total £'000
Gains/(losses) on investments	-	54,673	54,673		-	(25,012)	(25,012)
Currency losses	-	(39)	(39)		-	(66)	(66)
Income (note 2)	9,164	-	9,164		9,171	-	9,171
Investment management fee	(4,950)	-	(4,950)		(4,752)	-	(4,752)
Other administrative expenses	(329)	-	(329)		(350)	-	(350)
Net return before finance costs and taxation	3,885	54,634	58,519		4,069	(25,078)	(21,009)
Finance costs of borrowings	(2,998)	-	(2,998)		(2,978)	-	(2,978)
Net return on ordinary activities before taxation	887	54,634	55,521		1,091	(25,078)	(23,987)
Tax on ordinary activities	(137)	-	(137)		(144)	-	(144)
Net return on ordinary activities after taxation	750	54,634	55,384		947	(25,078)	(24,131)
Net return per Ordinary share (note 3)	0.94p	68.78p	69.72p		1.19p	(31.43p)	(30.24p)
Dividend per Ordinary share (note 4)	1.00p				1.00p

   The total column of this statement is the profit and loss account of the Company.

All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued during the year.

A Statement of Total Recognised Gains and Losses is not required as all gains and losses of the Company have been reflected in the above statement.

BALANCE SHEET

		At 31 December 2012		At 31 December 2011
		£'000		£'000
FIXED ASSETS Investments held at fair value through profit or loss		543,142		488,689
CURRENT ASSETS
Debtors		1,985		1,947
Cash and short term deposits		28,950		30,021
		30,935		31,968
CREDITORS: Amounts falling due within one year (note 5)		(51,834)		(51,001)
Derivative financial instruments (note 5)		(20,297)		(20,357)
		(72,131)		(71,358)
Net current liabilities		(41,196)		(39,390)
TOTAL NET ASSETS		501,946		449,299
CAPITAL AND RESERVES
Called up share capital		19,830		19,924
Share premium		73,738		73,738
Capital redemption reserve		2,122		2,028
Capital reserve		403,415		350,721
Revenue reserve		2,841		2,888
SHAREHOLDERS' FUNDS		501,946		449,299
Net asset value per Ordinary share (including current year income)		632.78p		563.75p
Net asset value per Ordinary share (excluding current year income)		631.84p		562.56p
Ordinary shares in issue (note 6)		79,323,283		79,698,283

RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' FUNDS

For the year ended 31 December 2012

	Called up share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve*    £'000	Revenue reserve £'000	Shareholders' funds £'000
Shareholders' funds at 1 January 2012	19,924	73,738	2,028	350,721	2,888	449,299
Net return on ordinary activities after taxation	-	-	-	54,634	750	55,384
Shares bought back	(94)	-	94	(1,940)	-	(1,940)
Dividends paid during the year	-	-	-	-	(797)	(797)
Shareholders' funds at 31 December 2012	19,830	73,738	2,122	403,415	2,841	501,946

*Capital reserve as at 31 December 2012 included investment holding gains of £115,847,000.

For the year ended 31 December 2011

	Called up share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve*      £'000	Revenue reserve £'000	Shareholders' funds £'000
Shareholders' funds at 1 January 2011	19,978	73,738	1,974	376,931	1,941	474,562
Net return on ordinary activities after taxation	-	-	-	(25,078)	947	(24,131)
Shares bought back	(54)	-	54	(1,132)	-	(1,132)
Shareholders' funds at 31 December 2011	19,924	73,738	2,028	350,721	2,888	449,299

* Capital reserve as at 31 December 2011 included investment holding gains of £72,225,000.

 

SUMMARISED CASH FLOW STATEMENT
	For the year ended 31 December 2012			For the year ended 31 December 2011
	£'000	£'000			£'000	£'000
NET CASH INFLOW FROM OPERATING ACTIVITIES		3,526				3,547
NET CASH OUTFLOW FROM SERVICING OF FINANCE		(2,998)				(2,935)
FINANCIAL INVESTMENT
Purchase of investments	(63,903)				(89,449)
Sale of investments	65,041				80,493
NET CASH INFLOW/(OUTFLOW) INVESTMENT		1,138				(8,956)
EQUITY DIVIDEND PAID		(797)				-
NET CASH INFLOW/(OUTFLOW) BEFORE FINANCING		869				(8,344)
FINANCING
Bank loans drawn down	-				25,000
Bank loans repaid	-				(25,000)
Shares repurchased	(1,940)				(1,132)
NET CASH OUTFLOW FROM FINANCING		(1,940)				(1,132)
DECREASE IN CASH		(1,071)				(9,476)
RECONCILIATION OF NET CASH FLOW TO MOVEMENT IN NET DEBT
Decrease in cash for period		(1,071)				(9,476)
MOVEMENT IN NET DEBT IN PERIOD		(1,071)				(9,476)
NET DEBT AT 1 JANUARY		(19,979)				(10,503)
NET DEBT AT 31 DECEMBER		(21,050)				(19,979)
RECONCILIATION OF NET RETURN BEFORE FINANCE COSTS AND TAXATION TO NET CASH INFLOW FROM OPERATING ACTIVITIES
Net return on ordinary activities before finance costs and taxation		58,519				(21,009)
(Gains)/losses on investments		(54,673)				25,012
Currency losses		39				66
Amortisation of fixed income book cost		112				(25)
Changes in debtors and creditors		(292)				(291)
Income tax (suffered)/ repaid		(3)				4
Overseas tax suffered		(137)				(144)
Realised currency loss		(39)				(66)
NET CASH INFLOW FROM OPERATING ACTIVITIES		3,526				3,547

 

NOTES

1.		The financial statements for the year to 31 December 2012 have been prepared on the basis of accounting policies which are consistent with those set out in the Company's Annual Report and Financial Statements at 31 December 2011. The Directors consider the Company's functional currency to be sterling as the Company's shareholders are predominantly based in the UK and the Company is subject to the UK's regulatory environment.
				31 December 2012 £'000								31 December 2011 £'000
2.	Income
	Income from investments and interest receivable			9,164								9,171
				9,164								9,171
				31 December 2012 £'000							31 December 2011 £'000
3.	Net return per ordinary share
	Revenue return			750							947
	Capital return			54,634							(25,078)
	Total return			55,384							(24,131)
	Net return per Ordinary share is based on the above totals of revenue and capital and on 79,437,013 Ordinary shares (2011 - 79,799,598) being the weighted average number of Ordinary shares in issue during the year. There are no dilutive or potentially dilutive shares in issue.
				31 December								31 December
				2012			2011					2012 £'000			2011 £'000
4.	Ordinary Dividends
	Amounts recognised as distributions in the period:
	Previous year's final			1.00p			-					797			-
	Set out below are the total dividends payable in respect of the financial year, which is the basis on which the requirements of Section 1158 of the Corporation Tax Act 2010 are considered.  The revenue available for distribution by way of dividend for the year ended 31 December 2012 is £750,000 (2011 - £947,000).
	Amounts paid and proposed in respect of the period:
	Proposed final dividend per Ordinary share		1.00p			1.00p					793			797
	The current year's proposed dividend will be paid on 3 May 2013 to all shareholders on the register at the close of business on 12 April 2013.  The ex-dividend date is 10 April 2013.

5.	The Company has a £50 million multi-currency variable rate loan facility with The Royal Bank of Scotland plc, which comprises two £25 million tranches expiring in May 2013.  This was replaced on 6 February 2013 with a £50 million multi-currency variable rate loan facility maturing 31 December 2014. At 31 December 2012, there were outstanding drawings of £50 million (2011 - £50 million). Interest on the loans is payable in quarterly instalments in January, April, July and October. The estimated repayment value of the loan at 31 December 2012 was £50 million. The indicative costs of repaying the loan as at 31 December 2012 were not material in the context of the above figures. The interest on £50 million of this facility has been fixed for the long term through a 30 year interest rate swap but may vary on periodic renewals of the debt facility to the extent that the mark up over LIBOR charged by a lending bank varies. The fair value of the interest rate swap contract at 31 December 2012 was an estimated liability of £20.3 million (2011 - £20.4 million) which was based on the swap provider's valuation. The loan has been disclosed as due within one year as the Company has an unconditional and irrevocable right to prepay the advance under the terms and conditions of the loan agreement.  The duration of the advance is 1, 3 or 6 months and the decision to rollover the loan is made at quarterly board meetings based on circumstances prevailing at the time.  The decision to continue with the swap arrangement is reviewed at the same time as the loan agreement.
6.	At the Annual General Meeting in April 2012, Shareholders granted the Company authority to purchase shares in the market up to 11,946,772 Ordinary shares (equivalent to 14.99% of its issued share capital at that date). In the year to 31 December 2012, a total of 375,000 (2011 - 215,000) Ordinary shares with a nominal value of £93,750 (2011 - £53,750) were bought back at a total cost of £1,940,000 (2011 - £1,132,000). At 31 December 2012 the Company had authority to buy back a further 11,571,772 Ordinary shares. Under the provisions of the Company's Articles share buy-backs are funded from the capital reserve.
7.	During the period transaction costs on purchases amounted to £310,000 (2011 - £424,000) and transaction costs on sales amounted to £218,000 (2011 - £198,000).
8.	The financial information set out above does not constitute the Company's statutory accounts for the year ended 31 December 2012.  The financial information for 2011 is derived from the statutory accounts for 2011 which have been delivered to the Registrar of Companies.  The Auditors have reported on the 2011 and 2012 accounts; their reports for both years were unqualified and did not contain a statement under sections 495 to 497 of the Companies Act 2006.  The statutory accounts for 2012 will be delivered to the Registrar of Companies following the Company's Annual General Meeting.
	None of the views expressed in this document should be construed as advice to buy or sell a particular investment.

Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on the Company's website (or any other website) is incorporated into, or forms part of, this announcement.

- ends -

 

END

 

 

ACSSFASULFDSESD