Annual Financial Report
25 March 2021
ANNUAL REPORT AND ACCOUNTS
Schroder Asian Total Return Investment Company plc (the "Company") hereby submits its Annual Report and Accounts for the year ended 31 December 2020, as required by the Financial Conduct Authority's Disclosure Guidance and Transparency Rule 4.1.
The Company's Annual Report and Accounts for the year ended 31 December 2020 are also being published in hard copy format and an electronic copy will shortly be available to download from the Company's website www.schroders.co.uk/satric . Please click on the following link to view the document:
http://www.rns-pdf.londonstockexchange.com/rns/4008T_1-2021-3-24.pdf
The Company has submitted its Annual Report and Accounts to the National Storage Mechanism and it will shortly be available for inspection at: https://data.fca.org.uk/#/nsm/nationalstoragemechanism .
Enquiries:
Benjamin Hanley
Schroder Investment Management Limited
Tel: 020 7658 3847
Chairman's Statement
I am delighted to report that despite an extremely challenging year for global stock markets in 2020 the Company has produced excellent performance. During the year ended 31 December 2020 the Company produced a net asset value ("NAV") total return of 33.7%, significantly outperforming the Reference Index which returned 18.7%. The Company once again outperformed the peer group, which produced an average total return of 30.9% for the year. Stock selection has proved key to the Company's strong performance. The Company was well positioned to benefit from the huge disparity in performance over the year between different sectors of the market. Companies such as technology and internet-related, whose businesses flourished under lockdown, lead the market rally as earnings were revised upwards and stocks were rerated. The more traditional value stocks, such as banks, utilities and airlines, suffered extremely difficult trading conditions and struggled to perform.
The share price also performed very well, producing a total return of 35.6% with the Company moving from a 0.7% premium to end the year on a 2.1% premium.
Since year end, and as at 22 March, the NAV per share has increased by 4.1% and the share price by 3.7%; the Reference Index increased by 3.1%.
Further comment on performance and investment policy may be found in the Portfolio Managers' review.
Earnings and dividends
The revenue return from the portfolio for the year increased to 8.46p per share from 8.10p per share in 2019. This increase in revenue was accounted for by the recovery of £1.3m from HMRC relating to a claim made by the Company for the repayment of corporation tax paid in 2007 and 2008 on overseas income. In addition the Company received special dividends of close to £1m which, after analysis of their source, have been accounted for as revenue. The Board has recommended a final dividend of 7.10p per share for the year ended 31 December 2020, an increase of 9.2% over the final dividend of 6.50p per share paid in respect of the previous financial year. £1.1m has been transferred to revenue reserves to take account of the exceptional tax credit received. Subject to approval at the AGM, the dividend will be paid on 14 May 2021 to shareholders on the register on 16 April 2021.
Promotion, discount control and share issuance
At the AGM on 19 May 2020, shareholders granted the Board authority to issue shares, including out of treasury. The Company's buyback authority was also renewed. Both authorities were used during the year. As outlined in more detail in the interim report, following a spike in the discount in March 2020 in the midst of market volatility caused by the pandemic, the Company utilised its share buyback authorities to purchase shares. A total of 180,508 shares were purchased and held in treasury. During the second half of the year, the share price returned to a premium, and the Company re-issued the shares being held in treasury, and a further 3,039,492 new shares. These were issued at an average premium to NAV of 1.3%. A resolution to renew the share issuance authorities will be proposed at the AGM, details of which can be found on page 74 of the 2020 Annual Report.
The Company will continue to implement both an issuance and a discount management policy. Shares will be issued at a moderate premium to net asset value and the discount policy will continue to target a discount to NAV of no more than 5% in normal market conditions. The Board believes that overall liquidity and, with respect to buybacks, the relative discount to the Company's peers has also to be considered in any decision to issue and to buy back shares. However, the Board continues to be of the view that good performance supported by good marketing is the best way to sustain a premium in the long term. The Board will be seeking approval from shareholders to renew the issuance and the buyback authorities at the AGM.
Gearing and the use of derivatives
Gearing was used effectively by the Portfolio Managers during the year. The Company may use gearing to enhance performance but net gearing will not exceed 30% of NAV. The Board has agreed a disciplined framework for using gearing to increase market exposure, based on a number of valuation indicators. Although the Company started the year with gearing of 2.2%, this was increased at close to the point that stock markets bottomed in late March, rising to a peak of around 12% in May. Having taken advantage of the very substantial rally in global markets during the second quarter of the year, the level of gearing was gradually reduced and stood at 5.7% at the end of the year. Shareholders should be aware that the use of borrowings must be seen in the context of the use of derivative hedging instruments to reduce the volatility of the portfolio.
Management fees
During the year, the Board reviewed the fees payable to the Manager. The Board concluded that the fee arrangements were broadly competitive and in line with the interests of shareholders. However, it has agreed with the Manager to make two amendments to the fee structure.
When calculating the performance fee, in addition to the existing performance fee requirements of the high water mark and the hurdle rate, an additional metric will need to be satisfied in order for the Manager to be paid a performance fee. For 2021 and future years, the Manager may only be paid a performance fee when the Company's NAV total return is equal or greater to the total return of the Reference Index.
Also effective from 1 January 2021, the overall cap on management fees (base fee and any performance fee) will be reduced from 1.5% to 1.25%. This reduces the potential total fee payable in any one year and, with the other change outlined above, the Board believes that fees are now set at an even more competitive level.
Further details are set out on page 38 of the 2020 Annual Report.
Annual General Meeting
The AGM will be held at 12.00 noon on Friday, 7 May 2021 at the Manager's offices at 1 London Wall Place, London EC2Y 5AU. I encourage all shareholders to sign up to the webinar by the Portfolio Managers. By using a webinar, I hope more shareholders, and interested parties, will be able to listen to, and ask questions of, the Portfolio Managers. Details on how to join are on the Company's webpage: www.schroders.co.uk/satric .
As it is likely that there will still be restrictions in place due to the pandemic, I encourage shareholders to follow Government directions and avoid attending the AGM in person. In addition to the webinar with the Portfolio Managers, I invite shareholders to contact me with questions. I, or the Board, will then answer in writing, by email or by phone. You can contact me through the Company Secretary using the details set out on page 37 of the 2020 Annual Report.
The formalities of the meeting, as required by the Companies Act 2006 and the Company's Articles of Association, will still take place.
All shareholders should vote by proxy. Proxy votes can be submitted electronically through the registrar's portal, and also by email. Details are included with the proxy forms and on the Company's webpages.
Outlook
The year ahead is unlikely to produce such strong returns from equity markets as those seen in 2020. Inflation concerns, debt levels and trade tensions have dampened the market euphoria that has been experienced by many sectors of the market. The rally in global stock markets has left valuations expensive or extended in some areas, with prices vulnerable to any earnings disappointments. Asian stock markets should prove more resilient, however, with higher earnings growth forecast for 2020 than other regions and forward price earnings ratios moderate on a relative basis. The Portfolio Managers' disciplined approach to investment has materially contributed to performance during the dramatic market sell off last spring. Good stock selection will remain crucial as economies experience structural shifts in the aftermath of the pandemic. We continue to expect our Portfolio Managers to find excellent opportunities for shareholders in this environment. We believe the investment trust structure offers potential to enhance returns to shareholders by allowing the Portfolio Managers to take a long term view and to utilise gearing when opportune. Similarly the tactical use of derivatives to mitigate against downside risk should be of benefit in difficult market conditions.
Sarah MacAulay
Chairman
24 March 2021
Portfolio Managers' Review
Our review for 2020 is quite long and split into two parts - a brief review of 2020 and then hopefully a more interesting investment outlook section which is a summary of our recently written Year of Ox report. What we do not intend to do in this report is wax lyrically on COVID and what it means for investment. We have done this many times in 2020 and for holders not heartily sick of the aforementioned five letter word there are plenty of articles available on Schroders' website.
A Brief Bullet Point Review of 2020
Performance and Attribution
• Over the year the Company enjoyed a much better performance both in absolute returns and relative to the Reference Index than we expected (in our year end 2019 reports we were forecasting returns of 10-15% for 2020). Over 2020 the Company's NAV rose 33.7% in total return terms, whilst the Reference Index rose 18.7% (Source: Morningstar/Schroders).
• The best performing markets in Asia over the year were Shenzhen, Korea and Taiwan all of which rose over 40% in US$ terms. All three indices have two things in common - firstly a high weighting in technology companies (the perceived COVID winners) and secondly from mid-2020 onwards a high and increasing level of retail investor participation in stock market activity. ASEAN indices lagged, posting negative returns for 2020, mostly due to their make up. All are heavily weighted in property, financials, retailers (perceived COVID losers) and have minimal internet and tech exposure. However, the fact the lower income Asian countries were hit harder by the COVID-19 crisis was also a factor. Australia, India and the main Hong Kong indices all posted moderate gains of 5-15%.
• Sector wise it was a hugely divergent year. Technology, internet, pharmaceutical, electric vehicle (EV) plays, and selected consumer names drove the vast bulk of market returns. Banks, property, energy, telecoms, insurance and utilities really struggled.
• Looking at the Company's attribution for the year - relative to the reference benchmark - the big contributors to performance can be broken down into four groups. These included our Taiwan technology stocks, Chinese stock selection in general (the positive of not owning banks, oil stocks, telecoms, state owned enterprises), and our Australia stocks. In the latter group we added to several oversold names at the peak of the crisis in March. The other big positive was our holding in ASEAN internet play Sea which more than quadrupled over the year. Despite gradually taking profits from mid-2020 (far too early!) this proved our most successful investment in 2020.
• In general it was a good year - however we should highlight to clients we missed many of the best performing parts of the market. We had little exposure to EV plays, which hopefully clients will be aware from past reports we think are a very clear bubble. We also had no exposure to the best performing Chinese emerging internet names like Meituan, JD and Pinduoduo. We think these are interesting, well run companies but we do not understand their valuations given the competition and regulatory risks they face. We also had little exposure to Chinese A shares where we just cannot get our head around most valuations, which in general make little sense in a broader Asian context. Fortunately we got the tech space broadly speaking correct (lots of TSMC, Samsung Electronics, Mediatek, Naver, Voltronics etc.).
• However, in truth the Company did well mostly because of what we did not own. We went into 2020 very cautious on banks due to fintech threats and disruption, and we have never really held much in the energy, utility, resources, cyclicals and in the telecoms space in Asia. Many of these companies are State-Owned Enterprises (SOEs) and/or have a fairly poor structural long-term outlook. All of these sectors performed poorly, as the impact of COVID and resulting changes in consumer behaviour accelerated many of the disruptive trends that we have discussed in previous reports.
Review of Quant Models and Stock Changes made in 2020
• We made no changes to the Company's investment process in 2020. After a difficult year in 2018 it was good to see both of the Company's models worked well in 2020 and materially contributed to performance. The short-term model started the year moderately cautious and we had some hedges in places during Q1, a strategy used to reduce the risk of adverse price movements, which added to performance during the market falls early in 2020. Both the short-term model and the long-term country forecasting models turned maximum bullish at the end of March so we closed all remaining hedges and used borrowing facilities, moving to a materially geared position (c.15% at the Company's highest level in Q2) (Source: HSBC).
• The models stayed positive until October so the Company fully benefited from the strong rebound in markets. At the end of the year the models gradually turned more cautious with the long-term country models in particular by December forecasting a relatively low probability of positive market returns in Asia on a one year view. In February 2021 the short-term models are neutral with all indicators positive except valuations - basically strong liquidity is balanced by high valuations. Given the increasing caution in the models we have gradually reduced gearing and started to build a position in puts (a put is an options contract that gives the owner the right, but not the obligation, to sell a certain amount of the underlying asset, at a set price within a specific time. The buyer of a put option believes that the underlying stock will drop below the exercise price before the expiration date) to hopefully provide an element of capital preservation if markets do pull back. The Company's stock level beta should also be falling as we take profits and rotate to laggard and perhaps more defensive stocks (Beta is a measure of volatility, or systemic risk, of a security or portfolio compared to the market as a whole).
• Stock turnover on the Company was just over 30% for the year. This is almost exactly in line with the seven year average. This rather surprised your Portfolio Managers who after a truly exhausting 2020 felt it must have been higher. However, looking at the numbers there were really two periods of intense activity (March/April and November/December) whilst for the rest of the year activity was more subdued.
• It will probably be no surprise that March/April was an active period for the Company. During this time many of our favoured long-term growth names, particularly in the technology sector, were sold down heavily. We took the opportunity to add, buying names like Mediatek, Naver, Aristocrat, Cochlear, Vanguard, SEEK, WuXi Biologics and Realtek. This proved to be well timed. To fund purchases, in addition to using gearing, we reduced our property and remaining financials exposure. This is because we took the view, in March as the crisis unfolded, that COVID-19 did appear likely to accelerate many of the disruptive themes we have discussed in past reports.
• In November and December with markets turning increasingly frothy (as a reference the Asian index at the time of writing in mid-February is now up 60% in GBP terms from March lows) we have been taking profits. This has led to a more active period for turnover on the Company. In November we trimmed almost half of our Alibaba position immediately after the Ant Group IPO (Initial Public Offering) was pulled as we felt this could herald increased regulatory scrutiny in the sector. We also trimmed some of our long-term winners like Techtronics, WuXi Biologics, ICTSI and Hong Kong Exchange which, whilst we like long term, have exceeded our fair values. Proceeds from sales have been reinvested into more domestically focused Australia stocks that have lagged and two financial names in Singapore where we think risks of disruption and government interference are relatively low.
Current Positioning
• The table on page 7 of the 2020 Annual Report is hopefully self-explanatory when it comes to the Company's positioning. The biggest individual exposure (and thus risk) is the technology exposure at over 30% of the Company's NAV. This is heavily weighted in Korea and Taiwan and mostly semiconductor related. Our semiconductor stocks have done well and are near or approaching our fair values. Secular trends around cloud, 5G, working from home, industrial automation - along with industry consolidation - are very supportive so, for the moment, we are sticking with our exposures. In our view these remain amongst the best companies listed in Asia.
• The Company's consumer services and consumer discretionary holdings are a mix of companies. Within this exposure there are branded Asian consumer businesses, Asian export companies with a US consumer focus along with our internet stocks like Alibaba, Tencent, Sea and Naver. Whilst we continue to like the business models of our internet holdings, worries over excessive expectations mean we have been trimming positions into strength. The other consumer names are often strong mid-cap names which we think have comparative advantages that mean they could take market share whether it be in Asia or globally.
• The country split is not something we tend to focus on. It is what a stock does that is important to us rather than where it is listed. Of note perhaps is the low weighting in ASEAN markets and India - both are areas we may look to add to over 2021 if we get good opportunities. We have a list of stocks we would like to own but at the moment most are above our fair values. As mentioned above, ASEAN performed poorly because the indices are heavily weighted in banks, telecoms and property. The more attractive stocks in ASEAN, like the consumer names, have actually performed well and trade on valuations we find harder to justify.
Investment Outlook
Summary
• Overall we think the next 12 months are likely to prove challenging for investors. High valuations, frothy expectations, clear bubbles in an increasingly large part of the market and rising and often irrational retail participation leave us cautious on the outlook for equity returns in Asia.
• We still hope the Company can make positive returns this year but we are now looking to position the Company more cautiously, taking profits on internet and technology stocks and if pricing is attractive adding to capital protection strategies via the purchase of puts.
• What does not change in our post-COVID world is the need for good long-term analysis. With the value of companies increasingly held in intangible assets this poses new challenges and requires a different approach. We need great analysts with the ability to think long-term and who do not get caught up in near term noise and momentum. On the other hand we also need analysts who are not so zealous on the use of traditional valuation metrics and modelling so as to think there is a magic "number" or fair value for a business. Long-term extrapolation ("what/if" and scenario analysis), deep industry knowledge, and out of the box thinking have become more important than ever as industry disruption accelerates. This is the key challenge for your Portfolio Managers, but also the most exciting one. It is what keeps us fully engaged despite the current frustrations of lockdowns and travel restrictions.
Topic 1 - Do we agree with Jeremy Grantham?
"The long, long bull market since 2009 has finally matured into a fully fledged epic bubble. Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterical investor behaviour, I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea Bubble, 1929, and 2000", Jeremy Grantham.1
1 Waiting for the Last Dance, GMO, January 2021.
Some strong words from Jeremy Grantham of GMO about the US stock market may be ringing in many investors' ears as we write in mid-February with stock markets climbing ever higher.
As Asian equity investors it is not our place to dwell on US stock markets. However, the more we look at valuations and current trading patterns there, the more we tend to agree with Mr Grantham's conclusions. With gains accelerating and the extremely high level of participation of retail investors, we do not view current US stock market conditions as healthy.
Are Asian equities in a bubble too?
In his report, Mr Grantham suggests that "value" stocks and emerging markets (of which Asian stock markets now account for 81%) are the safest places to be, relatively speaking (A value stock is a security trading at a lower price than what the company's performance may otherwise indicate).
However, we believe "frothy" (if not outright bubbly) conditions are now broadly prevalent across global stock markets. If the US stock market corrects, Asian markets will not be immune. Particularly given the very high correlations in short-term performance.
But how worried should investors in Asia be?
Let's start with the reassuring charts first. Chart 1 of the 2020 Annual Report shows a variety of valuation measures, on which Asia doesn't look crazily expensive, particularly on forecast 2021 price-to-earnings (P/E) ratios.
Meanwhile, most markets are offering dividend yields of between 2% and 4%, which perhaps are not to be sniffed at in a zero interest rate environment.
Also, as chart 2 of the 2020 Annual Report shows, although return on equity (RoE) has been under pressure, we should see a good cyclical improvement as the global economy normalises. This should support stock market performance.
These charts are pretty reassuring. However, other signs are more worrying and lead us to think that 2021 could be a challenging year for Asian investors to make significant absolute returns.
Chart 3 of the 2020 Annual Report, for example, shows that on current forecast price earnings multiples (P/E), Asian valuations are now as high as they have ever been in the recent past. This means we really need good earnings growth in 2021 to justify current share prices.
Can Asian profits meet such elevated expectations? Based on history, almost certainly not; brokers' forecasts nearly always disappoint. This is one of the main risks for 2021.
Chart 4 of the 2020 Annual Report has perhaps the more interesting sector breakdown. The black dots show the current forward P/E ratio (so assuming those nice earnings-per-share numbers come true) for all the key sectors in Asia. The bars have the historic range since 2004.
Of note is that nearly all sectors outside those facing significant, obvious and in some cases terminal, challenges (property, banks, insurance, utilities) are near or at the top of their historic ranges.
Valuations may not be crazy, but they are most definitely expensive versus history. And if earnings don't come through, we doubt markets in Asia will perform well in the near term.
More anecdotally, similar to in the US, we have seen a very large increase in retail investor participation in stock markets across Asia. Historically this has been a good indicator of market peaks.
What are these retail investors buying? It appears retail money is heavily flowing into thematic Exchange Traded Funds (ETFs) in the region, some of which have seen their assets grow exponentially.
The most popular themes are of course electric vehicles (EV - more on these later), the internet sector, technology, green energy, biotech and so on.
True to form, brokers are now feeding the bubble by coming up with ever more nonsensical price targets based on ever more nonsensical valuation methods to justify further moves in the hottest areas of the market.
This is summed up nicely in the great chart (chart 5 of the 2020 Annual Report) from David Scott of Chaam Advisors, which we think encapsulates the way the market often works for the "hot" sectors.
We are now indeed moving to the right hand side of the chart, with broker notes on EV stocks in particular now only talking about "potential customers", normally in 2030. Meanwhile, the one we love regarding the "neatness of business model" is that apparently EVs are really software platforms that provide mobility as a service.
Why the BEVI bubble is still a concern
As we've discussed regularly in recent months, the area that concerns us most regarding valuations is in the biotech, electric vehicle and internet (BEVI) sectors.
Our worries to date about the BEVI bubble ( https://www.schroders.com/en/uk/tp/markets2/markets/beware-the-bevi-bubble-in-asia/ ) have proved completely unfounded as most stocks have surged ever higher.
So have we got it wrong?
We think not. In fact, we would rate the current trading in the EV stocks in Asia as one of the clearest bubbles or manias we have seen in our 30-year investment careers.
Our problem with EVs is not that we do not believe they are better cars than traditional internal combustion engine ones (ICE). Nor do we doubt that we are on the cusp of an inexorable acceleration in EV car sales over the next five to ten years.
Our problem with EVs is that they are all technically very similar. An EV has a fraction of the number of moving parts that a traditional car has.
What does this mean? If an EV is mostly a battery, a motor, and a lot of electronics, then the barriers to entry are low as most of these can be bought off the shelf. An EV doesn't need hundreds of brilliant German engineers to optimise its ICE engine, so your entry barriers to making a good EV are lower.
With barriers to entry relatively low (vs a traditional ICE car), lots of hot money in the sector and a huge numbers of new start-ups, all the classic ingredients are in place for a major price war and shake out. This is very similar to what we have seen in the past in the smartphone and flat panel television market in Asia.
So what does all this mean for the automotive and related stocks in Asia? We think the EV stocks themselves are likely to disappoint and many are expected to fail as the industry will need to consolidate. Sales volumes should be strong as competition and rapid technology improvements lead to better, cheaper products. But the huge number of players making fairly generic products means profits are likely to be thin or non-existent.
Internet stocks are much more interesting and, in Asia's case, more important given they take up around 20% of the main Asian equity index, the MSCI AC Asia ex Japan.
These stocks are amongst the most innovative companies in Asia with genuinely disruptive business models that deliver new and better services to consumers, whether it is e-commerce, music and film streaming, social media, food delivery, ride hailing, travel aggregation and so on.
However, we are now increasingly worried that excessive euphoria is driving many stocks in the sector to bubble-like valuations which leave them vulnerable to very sharp falls if the now-lofty expectations for sales and profits fail to be met.
With brokers continually increasing their revenue and margin forecasts to justify share price moves (remember broker forecasts don't lead but follow share prices upward) we think the scope for disappointment within the sector is significant.
When we look at most internet-related sectors in China they seem to be getting more competitive, not less. Also, new formats like live streaming e-commerce look set to potentially disrupt more traditional e-commerce channels.
With rapid disruption, lots of competition, vast arrays of new disruptive services and a now relatively well penetrated e-commerce sector (latest consensus estimates are that e-commerce is now over 35% of total retail sales in China) we don't believe this is a case of everyone's a winner.
So going back to the first question: are Asian markets a bubble?
We would say in aggregate they are not - we can still find things we want to buy in some sectors, particularly in the semiconductor and tech hardware sectors.
But bubble-like conditions clearly are prevalent in a large and growing part of our Asian investment universe (and c.30% of Asian indices by market cap), so we need to tread carefully and be aware of the risks as we discuss in the next section.
Topic 2: The Return of Inflation (or not)
One of the most topical questions on investors' minds today is whether inflation is set to return after a three-decades-long absence. A judgement on this should be a key driver of investment strategies going forward. So where do your Portfolio Managers stand on this? The answer is likely to depend on the time horizon that one is looking at.
Certainly in the short-term, with the vaccine being increasingly rolled out globally, we think we are likely to see a temporary return of inflation. The anecdotal signs are already emerging: copper prices reaching eight-year highs, freight rates soaring worldwide, component shortages for IT hardware, global food prices surging to their highest level since 2015, and continually rising energy prices. These symptoms have, in our experience, always led to higher inflation, and there is no reason to believe that it will be different this time. In fact, an increase in inflation is almost necessary in order to balance the pent-up reopening demand with the disrupted supply chain.
Whether this short-term inflation persists into the long-term should however depend on a myriad of factors, in particular the reaction of policymakers.
Regular readers of our materials will be familiar with your Portfolio Managers' arguments for a deflationary world for a good part of the decade preceding this pandemic. Our reasons are surmised as the four Ds, namely demographics, disruption, disparity in income and deleveraging. Your Portfolio Managers are not going to torture readers with an umpteenth rendition of what the four Ds mean. However, it is worth noting that of the four forces, we have always viewed disruption and deleveraging as the two most powerful factors driving deflation - and neither of these has gone away.
However new long-term factors could now change our structurally deflationary thesis. Rising trade tensions generally but particularly between China and the USA are likely to lead to a de-globalisation of supply chains. This started during Donald Trump's term in the White House and looks set to continue and possibly accelerate post the pandemic. The Chinese are unlikely to allow themselves to be subjected to the whims of the US government for their semiconductor supplies over the long-term, just as most countries are unlikely to expose themselves to the supply instability of key medical items such as respirators and PPE again. The localisation of production of those goods considered by politicians to be "essential" will necessarily be inflationary for at least those goods concerned and are expected to add to the overall price pressures.
Meanwhile, the pandemic has also provided policymakers an opportunity to repair a key mechanism that had prevented the massive central bank balance sheet expansions over the last decade from being transmitted to the real economy. That mechanism is the broken credit multiplier that had resulted because commercial banks were reluctant to expand bank credit amid an environment of rising indebtedness. With governments now taking over the reins of money creation and offering credit guarantees to commercial banks, the new "fountain pen" money is already finding its way into not just base money growth but broad money supply increases as well. If "inflation is (truly) always and everywhere a monetary phenomenon" as posited by Milton Friedman, then higher prices are set to follow.
Whether these inflationary pressures from de-globalisation and fountain pen money are sufficient to offset the disinflationary effects of disruption and deleveraging will hinge critically on the responses of central bankers and policymakers.
For governments and policymakers, the return of inflation will be a test of their political resolve in keeping to fiscal and budgetary responsibilities. This however requires them to unwind their stimulus efforts at the same time as economic recovery takes hold, which will likely prove unpalatable to the general public. Saddled with a mountain of public debt, governments might instead prefer to see a return of inflation in order to shrink the real value of their debt and ease budget strain.
The long-term evolution of inflation will hinge critically on how these two policy reactions interact.
For now, we view inflation as a significant near-term downside risk to stock market returns this year. Taper tantrums appear increasingly likely as the world normalises and potential pent-up demand, particularly for services, feeds through. Early indications of shortages and logistical challenges in the semiconductor and goods sector do suggest that pressures are mounting. For those "growth" themed stocks that have skyrocketed on the back of central bank largesse and retail fervour, the risk of rising inflation and interest rate worries leaves this part of the market particularly vulnerable. This also means that those "value" stocks that have mostly lagged the market over the last few years should continue to see spurts of outperformance.
Longer-term, whether inflation becomes more permanent will depend on whether monetary and fiscal policies confluence into a Modern Monetary Theory (MMT)-type union which, when combined with an end of globalisation, may well overwhelm the deflationary forces (4 Ds) that have been so prevalent since the Global Financial Crisis.
Topic 3: The rise of intangibles
Over the last decade, a structural trend has been playing out which your Portfolio Managers believe should massively transform the way business models operate, and significantly alter the way investors should analyse and invest in companies. That trend is the Rise of Intangibles.
Intangible assets are essentially "identifiable, non-monetary assets without physical substance." Examples of these include things like brands, patents, copyrights, and innovative products. Intangible assets, like tangible assets, generate future economic benefits for businesses. However, they possess very different economic characteristics which means that businesses with mostly intangible assets often behave very differently from the ones with lots of tangible assets. Economists Jonathan Haskel and Stian Westlake coined the term the "four Ss" to describe these distinctive characteristics of intangibles.
The 4 Ss of Intangibles
The first S stands for scalability. Unlike tangible assets which can only be used by one person at any time, intangible assets are highly scalable as they can be used repeatedly and simultaneously without constraint or decay. This is perhaps one of the most important features of intangibles because powerful network effects fuel scalability. The more people who use a company's services, the more useful these services then are to other users. This increasing returns to scale also means that the bigger they get, the cheaper it becomes to serve another customer. This scalability of knowledge has been vital to the success of companies like Google, Alibaba, and Facebook, and helps create barriers to potential competition. The result is therefore a winner-takes-all landscape in which the dominant player is miles ahead of the second-best firm. An eventual winner-takes-all outcome explains why a number of these intangible-heavy companies could stay loss-making for years as they continually plow their cash flow into ever more intangibles creation in a bid to be the last man standing. The scalability of intangibles also means that mean reversion, a key tenet to value investing , may have become much less likely. After all, the economic reasoning behind mean reversion is the belief that supernormal profits attract new entrants who then compete those profits away, while subnormal profits see competition exiting the market and hence restoring normal profits. While this is true when businesses are mostly driven by tangible assets, it is unlikely to be so when intangibles are increasingly the name of the game.
The second S stands for sunkenness. Sunkenness refers to the fact that the expenses incurred in creating an intangible asset is often sunk and irrecoverable. Unlike physical assets which usually have some second-hand value, intangible assets, unless they are brands or patents, are typically not easily transferred and are difficult to liquidate. After all, how does one sell one's corporate culture, or a set of relationships with customers and suppliers? This creates a problem for companies looking to debt-finance investments in intangible assets, as banks are more likely to balk at the lack of collateral available for lender liquidation. Without sufficient internally generated cash, this leaves equity issuance as their only major financing channel.
The third S refers to spillovers. These effects are generated by intangible investments because, unless protected by patents and copyrights, business and product ideas are often relatively easy to copy. This means that companies may be unwilling to invest in intangibles if they are unsure that they will retain the benefits of their investments. This however creates a problem for "Value" stocks who are facing declining profitability from disruption and new competition. Their reluctance to invest in R&D, marketing etc actually ends up keeping them mired in that low-value bracket, rendering them as value traps.
The last S refers to synergies which are important because ideas and their counterparts often work well together, and multiply in value when combined. Intangible assets therefore generate more synergies than their tangible cousins, with much of that intangible synergy being driven by open innovation.
The confluence of the four Ss ultimately means that there is greater uncertainty in the value of intangible investments. This also means that strong qualitative judgement becomes key in identifying the winners and losers.
Perhaps the best illustration of the importance of intangibles can be found in Techtronics and Stanley Black & Decker. Power tool manufacturer Techtronics has been one of the investment trust's best performing long-term holdings. At first glance, the lack of operating leverage in the company is intriguing. While revenues of the company have been growing rapidly over the last few years, its R&D and SG&A expenses (as a proportion of sales) have expanded as well. Meanwhile its competitor Stanley Black & Decker has seen its proportion of R&D spend decline as sales grew, a feature that investors accustomed to analyzing companies with lots of tangible assets have come to expect. In reality, what Techtronics has been doing is to relentlessly invest in intangibles. This has allowed the company to continually roll out ever more powerful tools that can take full advantage of the massive improvements in batteries, motors and integration software. The result is significant market share gains for Techtronics versus Stanley Black & Decker, and superb share price outperformance to boot.
Implications for equity investors
So what does this all mean for us as equity investors?
1. Scrutinise how companies are investing, especially in intangibles. Are they sacrificing long-term profits for short-term returns by under-investing in intangibles?
2. Where companies are investing heavily in intangibles, we should accept that uncertainty is part of the game. Instead of pursuing quick investment paybacks (or pushing for loss-making companies to quickly get into the black), we should instead be asking ourselves whether we believe in what they are doing. If so, our price targets should reflect that potential long-term value creation rather than the short-term profitability.
3. Greater uncertainty in the value of intangible investments also means that it is important to spend as much time exploring the range of fair value outcomes as it is in figuring out the fair value of a stock under a base-case scenario.
4. Be mindful that for some "value" companies, the pace of mean reversion may have significantly slowed down, if not halted. For certain "value" sectors such as traditional retailers who are challenged by e-commerce, large fossil fuel companies who are facing headwinds from renewable energy and shale technology, or legacy financials who are threatened by customer-friendly fintech startups boasting slick mobile interfaces and innate online instincts, it means that they may remain trapped as value for years to come.
5. The lack of mean reversion and the scalability of intangibles, when turbo-charged by synergies, also means that companies who are currently growing rapidly may not see a fade in their growth rates until much later.
6. The winner-takes-all nature of intangibles-driven industries should see the lion share of the benefits accrue to the dominant player. It can be argued that in some sectors today, we are already seeing every player being valued as that dominant player. One will prove to be true, which leaves shareholders in the rest at risk of ending with little or nothing. Superior qualitative judgement will be key in identifying that one eventual winner.
7. Not all intangibles are equal, and not all of them will reside in the internet, e-commerce and biotechnology industries. Even in old-economy sectors, there can be intangible-rich companies such as Techtronics in power tools.
Topic 4 - So how is the Company Positioned?
A brief summary of the current country and sector positioning of the Company was outlined in Part 1 of this report. In Chart 12 of the 2020 Annual Report we highlight some of the key secular trends we have exposure to via the companies the Company is invested in.
Going back to Table 1 of the 2020 Annual Report at the very beginning of the report we have circled in red a few of the areas which we think are of most interest to clients. Sector-wise the Company is significantly invested in consumer areas (but not staples), and is also heavily weighted in the information technology sector (in particular semiconductors in Taiwan and Korea). Lastly we thought it worth noting the combined HK/China country weighting within the Company is almost 40%. This weighting is actually down from a peak of over 50% early in 2020, so perhaps it is worth discussing how we see the current balance of risks in China versus the long-term investment opportunities.
As we discussed previously the fall in the Company's weighting in Chinese stocks is principally due to a reduction in our exposure to Chinese internet names. However we are also concerned that the market is choosing to gloss over some of the macro risks in China. Firstly as we have highlighted in past reports, Chinese debt levels are high in absolute terms and relative to comparable countries at similar stage of economic development. As Chart 13 of the 2020 Annual Report shows, having stabilised from 2017-2019 after a very sharp rise in indebtedness post the Global Financial Crisis (GFC) in 2008, debt levels jumped again in 2020 on the back of COVID stimulus measures.
The rapid increase in Chinese debt levels post the Global Financial Crisis was primarily to fund state driven infrastructure and property projects, often with questionable return profiles. We therefore continue to suspect there are significant unrealised bad debts in the banking system and that a substantial level of ever greening of loans is taking place. This is why the Chinese banks remain an unattractive investment proposition (even before we start talking about disruption from internet banks). It is also why the state owned sector generally continues to make very poor returns as investment decisions are not based on commercial considerations but the greater good or perhaps in China's case the "greater glory". We expect China's economic growth rate to slow from here as investment rates fall if, on the other hand, debt driven investment continues the risk of more serious financial problems in the future will rise.
The second key risk we see in China is a continuing deterioration in US-China relations and an escalation of commercial tensions. We worry that a combination of China's increasingly assertive stance in its relations with many Western countries will enable a more "diplomatic" Biden-led administration to build a cohesive coalition and coherent set of policies when dealing with China. For liberal, outward looking investors like your Portfolio Managers we find this both sad and concerning.
What could this mean in practice for investors? We expect broad and increasing restrictions on Chinese access to US/Western technology, and of course much less academic sharing of materials and overseas study. Increasingly in many technology areas there is likely to be a China bloc and a Western block and neither will want to be reliant on the other for critical supply of technology and materials (whether that is intellectual property or physical goods). This does have implications for investment and we are cautious on Chinese companies, particularly technology ones, where the investment case is based on a significant growth in sales to Western markets.
So what do we hold in China and why does the Company have around 40% of its assets directly or indirectly (via Hong Kong) invested there? Despite the risks, private sector Chinese stocks are the most dynamic and interesting part of the Asian investment universe. Urban China is the fastest changing society we visit (or sadly as stands today, used to visit!) - both physically in terms of infrastructure, buildings etc. but more importantly socially with a relatively young, dynamic and increasingly well educated population who embrace new technology at an often frightening pace. Despite some Western perceptions of China as an oppressive, highly controlled state, any visitor will instead notice how vibrant, dynamic and rapidly moving society there is - this makes it fascinating for the investor.
As Chart 12 of the 2020 Annual Report at the beginning of this section highlights one of the key areas of focus for the Company is the upgrading of Chinese consumption and services. We remain focused on this as we see investment in China moving increasingly to services and intangible areas and away from capital goods. China is a global research and development powerhouse (Chart 14 of the 2020 Annual Report), and as investment in this and intangibles grows we continue to see the best Chinese companies rapidly improving product quality and levels of innovation.
Going back to Chart 12 of the 2020 Annual Report it is perhaps worth noting the Company has relatively little exposure to ASEAN stock markets and rising middle class/consumption plays in Asia outside of China. Why is this given for many this is the prime reason to invest in the region?
Chart 15 of the 2020 Annual Report is a chart we often use to debunk some of the myths of investing in Asia and Emerging Markets. There is no historic correlation between per capita growth rates and starting income levels. And low/middle income countries "catching up" with rich countries is not the norm - in 2018 more countries were falling behind the US (in terms of GDP per capita) than catching up. Given this there is no reason to believe it is inevitable most emerging market countries are suddenly going to have a rapidly rising middle class.
Instead to get a rising middle class and consumption upgrading you need productivity growth. This requires at least some of the following: improving education levels, infrastructure, legal frameworks, ease of doing business, property rights, stable tax system, etc. etc. When we look at progress in many of these areas we see the emerging ASEAN countries struggling (Charts 16 and 17 of the 2020 Annual Report), which is why we think places like Thailand and Malaysia risk falling into middle income traps, whilst Philippines and Indonesia face major challenges if they want growth to accelerate from current levels.
What about India - surely we are more upbeat here? We are indeed at a macro level more positive on India relative to ASEAN. For all the questionable aspects of Mr Modi's policies (it is very much two step forwards, one step backwards - on a good day) there does appear to be progress on the infrastructure side and legal frameworks (bankruptcy codes etc). As Chart 18 of the 2020 Annual Report from Macquarie shows from a low base we are at least moving in the right direction.
The improved policy framework, combined perhaps with a desire from exporters to diversify manufacturing bases, has seen foreign direct investment (FDI) into India finally pick up (Chart 19 of the 2020 Annual Report). What is also quite interesting is that much of the pick up in FDI is going into digital areas. With a young population, now thanks to Reliance/Jio connected to the internet, the scope for India to grow by adopting new technology and taking out wasteful middlemen is huge given the low starting base.
This is all good news, but there are headwinds. The state bank sector remains saddled with bad debts, and it is still unclear how much of the restructured assets will relapse. As can be seen from Chart 20 of the 2020 Annual Report the post COVID credit hangover looks significant and could hold back investment and growth in India near term.
So putting this all together - we are more upbeat on India than many other stock markets in Asia. There are some excellent companies bottom up in India and policy is hopefully gradually moving in the right direction. We have added slightly to weightings in India over the last 12 months - principally to Indian IT software plays like Infosys and TCS and also to private sector banks (which in this instance we view as the disruptors in the sector). We also have a small exposure to internet play Infoedge. We are likely to use any stock market dips to add to India but are happy to do so cautiously - valuations are high and the consumer stocks in particular we think may disappoint as rising input costs are expected to be a headwind for margins.
The other large area of exposure within the Company and one we have significantly raised over the course of the last 12 months is our information technology exposure. Clients should note in this instance we are principally referring to semiconductor stocks. These stocks, along with our internet names, were by far the biggest contributors to the absolute performance of the Company in 2020. Unlike internet names we have not taken profits on our semiconductor stocks but instead have decided to maintain and in some cases add to exposures.
Why do we remain positive? This comes down to two factors. Firstly valuations for Asian semiconductor stocks remain relatively "sensible" especially when compared with US peers and secondly we believe the actual outlook for our companies has structurally improved in our new post COVID world. The upgrading of technology has been accelerated by COVID and the rapid changes and disruption we already expected should now be larger. In a nutshell, versus 12 months ago we think the investment thesis has changed and improved for many of these stocks and thus our fair values have materially moved up.
Congratulations to anyone who has managed to read the whole report - it ended up much longer and more verbose than your Portfolio Managers expected. Perhaps given the incredible events over the last 12 months this is not altogether surprising!
Robin Parbrook/Lee King Fuei
24 March 2021
Strategic Report
Principal risks and uncertainties
The Board is responsible for the Company's system of risk management and internal control and for reviewing its effectiveness. The Board has adopted a detailed matrix of principal risks affecting the Company's business as an investment trust and has established associated policies and processes designed to manage and, where possible, mitigate those risks, which are monitored by the audit and risk committee on an ongoing basis. This system assists the Board in determining the nature and extent of the risks it is willing to take in achieving the Company's strategic objectives. Both the principal risks and the monitoring system are also subject to regular, robust review. The last review took place in March 2021.
Although the Board believes that it has a robust framework of internal controls in place this can provide only reasonable, and not absolute, assurance against material financial misstatement or loss and is designed to manage, not eliminate, risk.
Actions taken by the Board and, where appropriate, its committees, to manage and mitigate the Company's principal risks and uncertainties are set out in the table below.
Emerging risks and uncertainties
During the year, the Board also discussed and monitored a number of risks that could potentially impact the Company's ability to meet its strategic objectives. These were political risk, climate change risk and COVID-19-related risks. The Board has determined they are not currently material for the Company. The Board receives updates from the Manager, Company Secretary and other service providers on potential other risks that could affect the Company.
Political risk includes regional tensions, trade wars, sanctions and Brexit. The Board believes that the Company's portfolio of equities in the Asia Pacific region shields the Company from Brexit-related risks. However, currency rates and borrowings drawn down by the Company may be affected by geopolitical developments. The Board is also mindful that changes to public policy in the US, UK, or in the Asia Pacific region, could impact the Company in the future.
Climate change risk includes how climate change could affect the Company's investments, and potentially shareholder returns. The Board notes the Manager has integrated ESG considerations, including climate change, into the investment process. The Board will continue to monitor this.
COVID-19 risk includes the impact on investment management and service providers, due to the uncertainty caused by the pandemic affecting the value of the Company's investments due to the disruption of supply chains and demand for products and services, increased costs and cash flow problems, and changed legal and regulatory requirements for companies. The Board notes the Manager's investment process is unaffected by the pandemic and it continues to focus on long-term company fundamentals and detailed analysis of current and future investments. COVID-19 also affected the Company's service providers, who implemented business continuity plans in line with government guidelines. All service providers continue to operate on a business as usual basis, despite the need to comply with government restrictions such as working from home.
|
Risk |
Mitigation and management |
|
|
|
|
Strategic
The Company's investment objectives may become out of line with the requirements of investors, resulting in a wide discount of the share price to underlying NAV per share. |
The appropriateness of the Company's investment remit is periodically reviewed and the success of the Company in meeting its stated objectives is monitored.
The share price relative to NAV per share is monitored and the use of buy back authorities is considered on a regular basis.
The marketing and distribution activity is actively reviewed.
Proactive engagement with shareholders.
|
|
The Company's cost base could become uncompetitive, particularly in light of open ended alternatives. |
The ongoing competitiveness of all service provider fees is subject to periodic benchmarking against their competitors.
Annual consideration of management fee levels.
|
|
Investment management
The Manager's investment strategy, if inappropriate, may result in the Company underperforming the market and/or peer group companies, leading to the Company and its objectives becoming unattractive to investors. |
Review of: the Manager's compliance with its agreed investment restrictions, investment performance and risk against investment objectives and strategy; relative performance; the portfolio's risk profile; and whether appropriate strategies are employed to mitigate any negative impact of substantial changes in markets.
Annual review of the ongoing suitability of the Manager is undertaken.
|
|
Financial and currency
The Company is exposed to the effect of market and currency fluctuations due to the nature of its business. A significant fall in regional equity markets or substantial currency fluctuation could have an adverse impact on the market value of the Company's underlying investments. |
The risk profile of the portfolio and appropriate strategies to mitigate any negative impact of substantial changes in markets are discussed with the Manager.
The derivative strategy employed by the Manager is subject to review by the Board.
The Board considers the overall hedging policy on a regular basis.
|
|
Custody
Safe custody of the Company's assets may be compromised through control failures by the depositary. |
The depositary reports on safe custody of the Company's assets, including cash, and portfolio holdings are independently reconciled with the Manager's records.
Review of audited internal controls reports covering custodial arrangements.
An annual report from the depositary on its activities, including matters arising from custody operations is received.
|
|
Gearing and leverage
The Company utilises credit facilities. These arrangements increase the funds available for investment through borrowing. While this has the potential to enhance investment returns in rising markets, in falling markets the impact could be detrimental to performance.
|
Gearing is monitored and strict restrictions on borrowings imposed: gearing continues to operate within pre-agreed limits so as not to exceed 30% of net asset value.
The Board oversees the Manager's use of derivatives.
|
|
Accounting, legal and regulatory
In order to continue to qualify as an investment trust, the Company must comply with the requirements of Section 1158 of the Corporation Tax Act 2010.
Breaches of the UK Listing Rules, the Companies Act or other regulations with which the Company is required to comply, could lead to a number of detrimental outcomes.
|
Service providers give regular confirmation of compliance with relevant laws and regulations.
Shareholder documents and announcements, including the Company's published annual report, are subject to stringent review processes.
Procedures established to safeguard against disclosure of inside information.
|
|
Service provider
The Company has no employees and has delegated certain functions to a number of service providers, principally the Manager, depositary and registrar. Failure of controls, and poor performance of any service provider, could lead to disruption, reputational damage or loss. |
Service providers are appointed subject to due diligence processes and with clearly documented contractual arrangements detailing service expectations.
Regular reports are provided by key service providers and the quality of their services is monitored. The Directors also receive presentations from the Manager, depositary and custodian, and the registrar on an annual basis. This included reporting on the arrangements for working during the COVID-19 pandemic lockdowns.
Review of annual audited internal controls reports from key service providers, including confirmation of business continuity arrangements and IT controls, and follow up of remedial actions as required.
|
|
Cyber
The Company's service providers are all exposed to the risk of cyber attacks. Cyber attacks could lead to loss of personal or confidential information or disrupt operations. |
Service providers report on cyber risk mitigation and management at least annually, which includes confirmation of business continuity capability in the event of a cyber attack.
In addition, the Board received presentations from the Manager, depositary and custodian, and the registrar on cyber risk, and the additional steps those companies were taking during the COVID-19 pandemic and the need for employees to work from home.
|
Risk assessment and internal controls review by the Board
Risk assessment includes consideration of the scope and quality of the systems of internal control operating within key service providers, and ensures regular communication of the results of monitoring by such providers to the audit and risk committee, including the incidence of significant control failings or weaknesses that have been identified at any time and the extent to which they have resulted in unforeseen outcomes or contingencies that may have a material impact on the Company's performance or condition.
No significant control failings or weaknesses were identified from the audit and risk committee's ongoing risk assessment which has been in place throughout the financial year and up to the date of this report. The Board is satisfied that it has undertaken a detailed review of the risks facing the Company.
A full analysis of the financial risks facing the Company is set out in note 21 to the accounts on pages 68 to 73 of the 2020 Annual Report.
Viability statement
The Directors have assessed the viability of the Company over a five year period, taking into account the Company's position at 31 December 2020 and the potential impact of the principal risks and uncertainties it faces for the review period. They have also reviewed the impact of the COVID-19 pandemic on the Company as further detailed in the Chairman's Statement, Portfolio Managers' Review and Emerging Risks sections of this report. The Directors have assessed the Company's operational resilience and they are satisfied that the Company's outsourced service providers will continue to operate effectively, following the implementation of their business continuity plans as required by COVID-19.
The Board believes that a period of five years reflects a suitable time horizon for strategic planning, taking into account the investment policy, liquidity of investments, potential impact of economic cycles, nature of operating costs, dividends and availability of funding. In its assessment of the viability of the Company, the Directors have considered each of the Company's principal risks and uncertainties detailed on pages 31 and 33 of the 2020 Annual Report and in particular the impact of a significant fall in regional equity markets on the value of the Company's investment portfolio.
The Directors have also considered the Company's income and expenditure projections and the fact that the Company's investments comprise readily realisable securities which can be sold to meet funding requirements if necessary. Based on the Company's processes for monitoring operating costs, the Board's view that the Manager has the appropriate depth and quality of resource to achieve superior returns in the longer term, the portfolio risk profile, limits imposed on gearing, counterparty exposure, liquidity risk and financial controls, the Directors have concluded that there is a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the five year period of their assessment.
Going concern
The Directors have assessed the principal risks, the impact of the emerging risks and uncertainties and the matters referred to in the viability statement. Based on the work the Directors have performed, they have not identified any material uncertainties relating to events or conditions that, individually or collectively, may cast significant doubt on the Company's ability to continue as a going concern for the period assessed by the Directors, being the period to 31 March 2022 which is at least 12 months from the date the financial statements were authorised for issue.
Statement of Directors' Responsibilities
The Directors are responsible for preparing the annual report, and the financial statements in accordance with applicable law and regulations.
Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the financial statements in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards, comprising Financial Reporting Standard (FRS) 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland" and applicable law). 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 return 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;
- state whether applicable UK Accounting Standards, comprising FRS 102, have been followed, subject to any material departures disclosed and explained in the financial statements;
- notify the Company's shareholders in writing about the use of disclosure exemptions in FRS 102, used in the preparation of the financial statements; and
- prepare the financial statements on a going concern basis unless it is inappropriate to presume that the Company will continue in business.
The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements 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 Manager is responsible for the maintenance and integrity of the webpage dedicated to the Company. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
Each of the Directors, whose names and functions are listed on pages 34 and 35 of the 2020 Annual Report, confirm that to the best of their knowledge:
- the financial statements, which have been prepared in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law), give a true and fair view of the assets, liabilities, financial position and net return of the Company;
- the Strategic Report contained in the report and accounts includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces; and
- the annual report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's position and performance, business model and strategy.
Income Statement
for the year ended 31 December 2020
|
|
Revenue |
2020 |
Total |
Revenue |
2019 |
Total |
|
|
£'000 |
£'000 |
£'000 |
£'000 |
£'000 |
£'000 |
|
Gains on investments held at fair value through profit or loss |
- |
111,853 |
111,853 |
- |
47,073 |
47,073 |
|
Net gains/(losses) on derivative contracts |
- |
1,555 |
1,555 |
- |
(4,390) |
(4,390) |
|
Net foreign currency gains |
- |
1,168 |
1,168 |
- |
319 |
319 |
|
Income from investments |
9,211 |
1,979 |
11,190 |
9,417 |
666 |
10,083 |
|
Other interest receivable and similar income |
7 |
- |
7 |
32 |
- |
32 |
|
Gross return |
9,218 |
116,555 |
125,773 |
9,449 |
43,668 |
53,117 |
|
Investment management fee |
(675) |
(2,026) |
(2,701) |
(559) |
(1,677) |
(2,236) |
|
Performance fee |
- |
(4,552) |
(4,552) |
- |
(2,838) |
(2,838) |
|
Administrative expenses |
(689) |
- |
(689) |
(646) |
- |
(646) |
|
Net return before finance costs and taxation |
7,854 |
109,977 |
117,831 |
8,244 |
39,153 |
47,397 |
|
Finance costs |
(113) |
(338) |
(451) |
(113) |
(339) |
(452) |
|
Net return before taxation |
7,741 |
109,639 |
117,380 |
8,131 |
38,814 |
46,945 |
|
Taxation |
567 |
- |
567 |
(478) |
- |
(478) |
|
Net return after taxation |
8,308 |
109,639 |
117,947 |
7,653 |
38,814 |
46,467 |
|
Return per share |
8.46p |
111.59p |
120.05p |
8.10p |
41.10p |
49.20p |
The "Total" column of this statement is the profit and loss account of the Company. The "Revenue" and "Capital" columns represent supplementary information prepared under guidance issued by The Association of Investment Companies. The Company has no other items of other comprehensive income, and therefore the net return after taxation is also the total comprehensive income for the year.
All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued in the year.
Statement of Changes in Equity
for the year ended 31 December 2020
|
|
Called-up share capital |
Share premium |
Capital redemption reserve |
Special reserve |
Capital |
Revenue reserve |
Total |
|
|
£'000 |
£'000 |
£'000 |
£'000 |
£'000 |
£'000 |
£'000 |
|
At 31 December 2018 |
4,570 |
37,081 |
11,646 |
29,182 |
196,014 |
15,290 |
293,783 |
|
Issue of shares |
325 |
23,054 |
- |
- |
- |
- |
23,379 |
|
Net return after taxation |
- |
- |
- |
- |
38,814 |
7,653 |
46,467 |
|
Dividend paid in the year |
- |
- |
- |
- |
- |
(5,758) |
(5,758) |
|
At 31 December 2019 |
4,895 |
60,135 |
11,646 |
29,182 |
234,828 |
17,185 |
357,871 |
|
Repurchase of the Company's own shares into treasury |
- |
- |
- |
- |
(648) |
- |
(648) |
|
Reissue of shares out of treasury |
- |
156 |
- |
- |
648 |
- |
804 |
|
Issue of shares |
152 |
13,784 |
- |
- |
- |
- |
13,936 |
|
Net return after taxation |
- |
- |
- |
- |
109,639 |
8,308 |
117,947 |
|
Dividend paid in the year |
- |
- |
- |
- |
- |
(6,362) |
(6,362) |
|
At 31 December 2020 |
5,047 |
74,075 |
11,646 |
29,182 |
344,467 |
19,131 |
483,548 |
Statement of Financial Position
at 31 December 2020
|
|
2020 |
2019 |
|
|
£'000 |
£'000 |
|
Fixed assets |
|
|
|
Investments held at fair value through profit or loss |
513,671 |
368,537 |
|
Current assets |
|
|
|
Debtors |
2,411 |
454 |
|
Cash at bank and in hand |
2,010 |
4,202 |
|
Derivative financial instruments held at fair value through profit or loss |
947 |
477 |
|
|
5,368 |
5,133 |
|
Current liabilities |
|
|
|
Creditors: amounts falling due within one year |
(28,276) |
(15,799) |
|
Bank overdraft |
(7,215) |
- |
|
|
(35,491) |
(15,799) |
|
Net current liabilities |
(30,123) |
(10,666) |
|
Total assets less current liabilities |
483,548 |
357,871 |
|
Net assets |
483,548 |
357,871 |
|
Capital and reserves |
|
|
|
Called-up share capital |
5,047 |
4,895 |
|
Share premium |
74,075 |
60,135 |
|
Capital redemption reserve |
11,646 |
11,646 |
|
Special reserve |
29,182 |
29,182 |
|
Capital reserves |
344,467 |
234,828 |
|
Revenue reserve |
19,131 |
17,185 |
|
Total equity shareholders' funds |
483,548 |
357,871 |
|
Net asset value per share |
479.07p |
365.57p |
Cash Flow Statement
for the year ended 31 December 2020
|
|
2020 |
2019 |
|
|
£'000 |
£'000 |
|
Net cash inflow from operating activities |
3,841 |
6,697 |
|
Investing activities |
|
|
|
Purchases of investments |
(169,974) |
(127,719) |
|
Sales of investments |
136,762 |
97,782 |
|
Net cash flows on derivative instruments |
1,085 |
(4,886) |
|
Net cash outflow from investing activities |
(32,127) |
(34,823) |
|
Net cash outflow before financing |
(28,286) |
(28,126) |
|
Financing activities |
|
|
|
Dividends paid |
(6,362) |
(5,758) |
|
Interest paid |
(438) |
(461) |
|
Net bank loans drawn down |
11,979 |
695 |
|
Repurchase of the Company's own shares into treasury |
(648) |
- |
|
Reissue of shares out of treasury |
804 |
- |
|
Issue of new shares |
13,936 |
23,379 |
|
Net cash inflow from financing activities |
19,271 |
17,855 |
|
Net cash outflow in the year |
(9,015) |
(10,271) |
|
Cash at bank and in hand at the beginning of the year |
4,202 |
14,709 |
|
Net cash outflow in the year |
(9,015) |
(10,271) |
|
Exchange movements |
(392) |
(236) |
|
Cash at bank and in hand at the end of the year |
(5,205) |
4,202 |
Dividends received during the year amounted to £10,171,000 (2019: £9,913,000) and deposit interest receipts amounted to £8,000 (2019: £30,000).
Notes to the Accounts
1. Accounting Policies
The accounts are prepared in accordance with the Companies Act 2006, United Kingdom Generally Accepted Accounting Practice ("UK GAAP"), in particular in accordance with Financial Reporting Standard (FRS) 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland", and with the Statement of Recommended Practice "Financial Statements of Investment Trust Companies and Venture Capital Trusts" (the "SORP") issued by the Association of Investment Companies in October 2019. All of the Company's operations are of a continuing nature.
The accounts have been prepared on a going concern basis under the historical cost convention, as modified by the revaluation of investments and derivative financial instruments held at fair value through profit or loss. The Directors believe that the Company has adequate resources to continue as a going concern for the period assessed by the Directors, being the period to 31 March 2022 which is at least 12 months from the date the financial statements were authorised for issue. In forming this opinion, the Directors have taken into consideration: the controls and monitoring processes in place; the Company's low level of debt and other payables; the low level of operating expenses, comprising largely variable costs which would reduce pro rata in the event of a market downturn; that the Company's assets comprise cash and readily realisable securities quoted in active markets; and potential adverse consequences of COVID-19.
The accounts are presented in sterling and amounts have been rounded to the nearest thousand.
The accounting policies applied to these accounts are consistent with those applied in the accounts for the year ended 31 December 2019.
No significant judgements, estimates or assumptions have been required in the preparation of the accounts for the current or preceding financial year.
2. Income
|
|
2020 |
2019 |
|
|
£'000 |
£'000 |
|
Income from investments: |
|
|
|
Overseas dividends |
8,184 |
9,292 |
|
Overseas special dividends |
975 |
122 |
|
Stock dividend |
52 |
3 |
|
|
9,211 |
9,417 |
|
Other interest receivable and similar income |
|
|
|
Deposit interest |
7 |
32 |
|
|
9,218 |
9,449 |
|
Capital: |
|
|
|
Overseas special dividends allocated to capital |
1,979 |
666 |
3. Investment management fee and performance fee
|
|
|
2020 |
|
|
2019 |
|
|
|
Revenue |
Capital |
Total |
Revenue |
Capital |
Total |
|
|
£'000 |
£'000 |
£'000 |
£'000 |
£'000 |
£'000 |
|
Investment management fee |
675 |
2,026 |
2,701 |
559 |
1,677 |
2,236 |
|
Performance fee |
- |
4,552 |
4,552 |
- |
2,838 |
2,838 |
|
|
675 |
6,578 |
7,253 |
559 |
4,515 |
5,074 |
The bases for calculating the investment management and performance fees are set out in the Directors' Report on page 37 of the 2020 Annual Report and details of all amounts payable to the Manager are given in note 18 on page 67 of the 2020 Annual Report.
4. Dividends
Dividends paid and declared
|
|
2020 |
2019 |
|
|
£'000 |
£'000 |
|
2019 final dividend of 6.5p (2018: 6.2p), paid out of revenue profits1 |
6,362 |
5,758 |
|
|
|
|
|
|
2020 |
2019 |
|
|
£'000 |
£'000 |
|
2020 final dividend proposed of 7.1p (2019: 6.5p), to be paid out of revenue profits2 |
7,166 |
6,363 |
1 The 2019 final dividend amount to £6,363,000. However the amount actually paid was £6,362,000 as shares were repurchased into treasury, after the accounting date but prior to the dividend Record Date.
2 The proposed final dividend amounting to £7,166,000 (2019: £6,363,000) is the amount used for the basis of determining whether the Company has satisfied the distribution requirements of Section 1158 of the Corporation Tax Act 2010. The revenue available for distribution by way of dividend for the year is £8,308,000 (2019: £7,653,000).
5. Return per share
|
|
2020 |
2019 |
|
|
£'000 |
£'000 |
|
Revenue return |
8,308 |
7,653 |
|
Capital return |
109,639 |
38,814 |
|
Total return |
117,947 |
46,467 |
|
Weighted average number of shares in issue during the year |
98,248,381 |
94,433,447 |
|
Revenue return per share |
8.46p |
8.10p |
|
Capital return per share |
111.59p |
41.10p |
|
Total return per share |
120.05p |
49.20p |
6. Called-up share capital
|
|
2020 |
2019 |
|
|
£'000 |
£'000 |
|
Allotted, called-up and fully paid: |
|
|
|
Ordinary shares of 5p each: |
|
|
|
Opening balance of 97,895,159 (2019: 91,400,159) shares |
4,895 |
4,570 |
|
Repurchase of 180,508 (2019: nil) shares into treasury |
(9) |
- |
|
Reissue of 180,508 (2019: nil) shares out of treasury |
9 |
- |
|
Issue of 3,039,492 (2019: 6,495,000) new shares |
152 |
325 |
|
Total of 100,934,651 (2019: 97,895,159) shares |
5,047 |
4,895 |
During the year, the Company repurchased a total of 180,508 of its own shares, nominal value £9,025, for a total consideration of £648,000 to hold in treasury, representing 0.2% of the shares outstanding at the beginning of the year. The reason for these share purchases was to seek to manage the volatility of the share price discount to net asset value per share. The entire 180,508 of these shares held in treasury were later reissued to the market to satisfy demand, at an average price of 445.4p, for a total consideration of £804,000.
During the year, 3,039,492 new shares, nominal value £151,975, were issued to the market at a premium to NAV per share to satisfy demand. These shares were issued at an average price of 458,5p per share for a total consideration of £13,936,000.
7. Net asset value per share
|
|
2020 |
2019 |
|
Total equity shareholders' funds (£'000) |
483,548 |
357,871 |
|
Shares in issue at the year end |
100,934,651 |
97,895,159 |
|
Net asset value per share |
479.07p |
365.57p |
8. Transactions with the Manager
Under the terms of the Alternative Investment Fund Manager Agreement, the Manager is entitled to receive management, secretarial and performance fees. Details of the basis of these calculations are given in the Directors' Report on page 37 of the 2020 Annual Report. If the Company invests in funds managed or advised by the Manager, any fees earned by the Manager are rebated to the Company. The management fee payable in respect of the year ended 31 December 2020 amounted to £2,701,000 (2019: £2,236,000) of which £825,000 (2019: £586,000) was outstanding at the year end.
A performance fee amounting to £4,552,000 (2019: £2,838,000) is payable in respect of the year, and the whole of this amount (2019: same) was outstanding at the year end.
The secretarial fee payable for the year amounted to £75,000 (2019: £76,000) of which £19,000 (2019: £19,000) was outstanding at the year end.
No Director of the Company served as a Director of any company within the Schroder Group at any time during the year.
9. Related party transactions
Details of the remuneration payable to Directors are given in the Directors' Remuneration Report on page 46 of the 2020 Annual Report and details of Directors' shareholdings are given in the Directors' Remuneration Report on page 47 of the 2020 Annual Report. Details of transactions with the Manager are given in note 18 of the 2020 Annual Report. There have been no other transactions with related parties during the year (2019: nil).
10. Status of announcement
2019 Financial Information
The figures and financial information for 2019 are extracted from the published Annual Report and Accounts for the year ended 31 December 2019 and do not constitute the statutory accounts for that year. The 2019 Annual Report and Accounts have been delivered to the Registrar of Companies and included the Report of the Independent Auditors which was unqualified and did not contain a statement under either section 498(2) or section 498(3) of the Companies Act 2006.
2020 Financial Information
The figures and financial information for 2020 are extracted from the Annual Report and Accounts for the year ended 31 December 2020 and do not constitute the statutory accounts for the year. The 2020 Annual Report and Accounts include the Report of the Independent Auditors which is unqualified and does not contain a statement under either section 498(2) or section 498(3) of the Companies Act 2006. The 2020 Annual Report and Accounts will be delivered to the Registrar of Companies in due course.
Neither the contents of the Company's webpages nor the contents of any website accessible from hyperlinks on the Company's webpages (or any other website) is incorporated into, or forms part of, this announcement.
RNS may use your IP address to confirm compliance with the terms and conditions, to analyse how you engage with the information contained in this communication, and to share such analysis on an anonymised basis with others as part of our commercial services. For further information about how RNS and the London Stock Exchange use the personal data you provide us, please see our Privacy Policy.
COMPANIES COVERED:
Latest directors dealings
- 19 hours ago Cerillion
- 20 hours ago Associated British Foods
- 20 hours ago B&M European Value Retail S.A. (DI)
- 21 hours ago B&M European Value Retail S.A. (DI)
- 21 hours ago Haleon