Final Results

Scottish Oriental Smlr Co Tst PLC
14 November 2024
 

THE SCOTTISH ORIENTAL SMALLER COMPANIES TRUST PLC

Annual Financial Report for the year ended 31 August 2024

·      During the year, the net asset value total return increased by 18.6 per cent, comparing favourably to the MSCI AC Asia ex Japan Small Cap Index return of 13.5 per cent and the MSCI AC Asia ex Japan Index return of 12.0 per cent.

·      The Board is proposing a final dividend of 14.0p per share (2023: 13.0p per share), a year-on-year increase of 7.7 per cent and an additional special dividend of 8.0p per share.

·      The Board is proposing a five for one share split to improve liquidity and marketability of the Company's shares.

Financial Highlights

Total Return Performance for the year ended 31 August 2024





Net Asset Value

18.6%

MSCI AC Asia ex Japan Small Cap Index (£)

13.5%





Share Price

16.5%

MSCI AC Asia ex Japan Index (£)

12.0%





Final dividend increased to 14p per share, with an additional special dividend of 8p per share

FTSE All-Share Index (£)

17.0%

 

 

Summary Data at 31 August 2024





Shares in issue

23,577,766

Shareholders' Funds

£403.1m





Net Asset Value per share

1,709.5p

Market Capitalisation

£346.6m





Share Price

1,470.0p

Share Price Discount to Net Asset Value

14.0%





Ongoing Charges Ratio*

0.98%

Active Share (MSCI AC Asia ex Japan Small Cap Index)

97.6%





Ongoing Charges Ratio (excluding performance fee)

0.95%







*A performance fee of £98,000 is payable relating to the year ending 31 August 2024 (2023: £2,247,000)

 

Chairman's Statement

 

I am pleased to present the Annual Report of the Company for the year ended 31 August 2024, my third as Chairman.

 

Investment Performance

During the period under review the Company's Net Asset Value ('NAV') Total Return increased by 18.6 per cent. This compared favourably against the MSCI AC Asia ex Japan Small Cap Index, the MSCI AC Asia ex Japan Index, and the FTSE All-Share Index which returned 13.5 per cent, 12.0 per cent and 17.0 per cent respectively during the same period. The NAV Total Return also outperformed the Company's peers in the Association of Investment Companies ('AIC') Asia Pacific Smaller Companies Sector peer group. The Company's share price increased by 15.3 per cent during the period under review, which, including the dividend, produced a Share Price Total Return of 16.5 per cent.

 

I would encourage shareholders to keep up to date on the performance of the portfolio through the Company's website at www.scottishoriental.com

 

In their report below, the Portfolio Managers provide a short handbook for the Scottish Oriental investor. Having invested across Asia for the past thirty years the Investment Manager is well versed in understanding the nature of Asian companies and the nuances of the Asian stock markets. The handbook highlights how the Portfolio Managers deploy your capital in companies with high quality management teams, sustainable earnings growth, using a long-term investment horizon with a focus on capital preservation. At the same time, the handbook describes the methods of avoiding some of the traps that lie in wait for the inexperienced investor. Amongst other traits, they are not prepared to invest in poor quality companies and managers; franchises with low returns on capital employed; value traps, box ticking ESG exercises or benchmark shadowing.

 

Many of you will have held your shares in Scottish Oriental over a number of years and will be familiar with this process. So it is pleasing to report that it has been successful. On a total return basis, over the last five years the Company's NAV has increased by 55.1 per cent and over the last ten years it has increased by 112.3 per cent.

 

Development of the Company

It is the Board's aim to broaden the shareholder base by increasing awareness of the Company, and to ensure a clear investment proposition is presented to the market. To achieve this we have planned the following actions:

 

Appointment of a Corporate Broker

Following a detailed review, the Board has appointed Investec Bank plc ('Investec') as the Company's Corporate Broker. Investec brings a wealth of experience in the investment trust sector and has strong relationships with retail shareholder platforms and wealth managers.

 

Marketing

We have developed a fresh marketing strategy with the Investment Manager. This involves an increased profile in leading financial publications and enhanced content on our website. The aim is to provide both current and prospective shareholders with a deeper understanding of the portfolio and the Investment Manager's process and enable them to learn more about the people behind the investment decisions.

 

Share Split

Due to the Company's strong investment returns over recent years, the existing ordinary shares of 25p have risen to 1,470.00p (at 31 August 2024). To assist monthly savers and those who reinvest their dividends or are looking to invest smaller amounts, at the Annual General Meeting, the Board is proposing that shareholders approve a five for one share split. This should improve the liquidity in and marketability of the Company's shares, which will benefit all shareholders.

 

Discount Management

Given the strong investment performance of the Company during the year, it is somewhat disappointing to report that the share price discount to NAV marginally increased to 14.0 per cent as at 31 August 2024 (31 August 2023: 12.4 per cent). Although of little comfort, there has been a general widening of discounts in the investment trust sector due to weak investor sentiment.

 

During the year, the Company bought back 782,085 ordinary shares (3.2 per cent of the shares in issue as at 31 August 2023). The Company's average discount during the period was 14.5 per cent (2023: 13.0 per cent). Whilst the Board continues to have no formal discount control mechanism in place, discretion will continue to be used to purchase shares in the market when deemed appropriate to do so.

 

Performance Fee

Following the change in performance fee comparator index, a new calculation methodology has been agreed. The key terms of the new methodology are;

·           The hurdle rate has been reduced from ten per cent to two per cent.

·           Periods of under-performance are now accumulated and applied against potential future performance fees.

·           A high watermark provision has been introduced, whereby a performance fee will only be paid when the Company's share price exceeds the level where a performance fee was previously paid.

·           If the total fee payable (base fee plus performance fee) in a year would be in excess of the cap of one and a half per cent of total assets, such excess will be carried forward and may be paid in future periods of positive performance where a performance fee is otherwise payable.

 

We believe that this new calculation methodology fairly remunerates the Investment Manager in periods of strong performance and offers some protection to shareholders in periods of weak performance. Please refer to pages 28 and 58 of the Annual Report for further details.

 

 

Revenue and Dividends

In last year's Annual Report, I reported a decrease in the Company's revenue earnings per share from 16.66p to 14.19p. As at 31 August 2024, revenue earnings per share have risen to 27.74p. This increase is primarily due to an increase in dividend receipts from the Company's underlying investment portfolio, enhanced by a number of special dividends.

 

The Board is proposing a final dividend of 14.0p per share (2023: 13.0p per share), a year-on-year increase of 7.7 per cent and an additional special dividend of 8.0p per share. The final and special dividends will be paid on 7 February 2025 to shareholders on the register as at 10 January 2025.

 

Board Composition

As previously detailed in my 2023 Chairman's Statement, Uma Bhugtiar was appointed as a non-executive Director of the Company on 19 October 2023. Karen Roydon was also appointed as a non-executive Director on 8 December 2023. Both Uma and Karen have already made significant contributions to the Board since their appointments. Uma and Karen's biographies can be found on page 23 of the Annual Report.

 

We continue to review Board composition and Directors' succession planning on a regular basis to ensure that we have a Board with a mix of tenures and one which provides diversity of perspective together with the range of appropriate skills and experience for your Company.

 

Annual General Meeting

The Annual General Meeting ('AGM') of the shareholders of the Company will be held on Wednesday, 29 January 2025 at the offices of First Sentier Investors, Finsbury Circus House, 15 Finsbury Circus, London. The Board looks forward to meeting with you in person.

 

As always, the Board welcomes communication from shareholders throughout the year, and I can be contacted directly through the Company Secretary at cosec@junipartners.com.

 

Jeremy Whitley

Chairman

13 November 2024

 

Portfolio Managers' Report

 

In this report, we address the following topics -

 

1.   Company Performance

2.   A Handbook for the Scottish Oriental Investor

3.   Recent Portfolio Activity

4.   Ten Largest Investments as at 31 August 2024

5.   Sector & Geographic Analysis

6.   Portfolio Positioning & Outlook

 

1.  Company Performance

 

Scottish Oriental's performance was strong over the last 12 months. Its net asset value rose by 18.6 per cent for the year ended 31 August 2024, compared to a gain of 13.5 per cent for the MSCI AC Asia ex Japan Small Cap Index and 12.0 per cent for the MSCI AC Asia ex Japan Index. The largest contributors to performance were the holdings in India and Philippines. The biggest detractors from performance were the holdings in Indonesia and Hong Kong.

 

Top Five Contributors

 

Company

Country

Sector

Absolute Return (Sterling) %

Contribution Performance %

Colgate Palmolive (India)

India

Consumer Staples

82.3

4.8

Blue Star

India

Industrials

125.4

3.9

Philippine Seven

Philippines

Consumer Staples

73.6

2.4

JNBY Design

China

Consumer Discretionary

81.8

2.4

Godrej Industries

India

Materials

78.9

2.2

 

Colgate Palmolive (India) reported strong sales and profit growth, as several of the initiatives introduced by its new Chief Executive Officer, Prabha Narasimhan, delivered results. The company has increased investments in brand-building, enhanced its focus on faster growing distribution channels and introduced new product variants across its portfolio. Colgate's strong pricing power has also helped the company improve its profitability levels.

 

Blue Star is a leading air-conditioner manufacturer in India, serving the consumer and projects segments. The company delivered strong growth in revenues and higher profitability levels during the year. The company benefited from rapid growth in demand for air-conditioners in India, while it continued to gain market share through optimising its product portfolio and expanding its distribution. Its projects business also benefited from strong demand in infrastructure development, in areas such as metro rail projects and data centres.

 

Philippine Seven is the exclusive franchise operator for 7-Eleven stores in the Philippines. It continued its recovery after the disruption caused by the pandemic. Footfalls rose across their store network, and the changes made to the store footprint, store assortment and increased digitisation during the pandemic led to strong same store sales growth for the company. These changes also led to a significant improvement in the company's profitability during the year, as it benefited from operating leverage.

 

JNBY Design is a leading designer apparel brand in China. The company reported strong growth in its revenues and profits, as it benefited from the removal of movement restrictions in China. In recent years, the company has refurbished its store network and strengthened its digital initiatives, focused on its membership program. These loyal members have driven strong growth for the brand, despite the relatively weak consumer environment in China.

 

Godrej Industries is a leading Indian conglomerate, which controls the group's key businesses in consumer products, real estate development, agriculture and financial services. Its consumer products, real estate and agriculture businesses reported strong performance during the year. The company has also been investing to scale-up its financial services operations, which are growing rapidly from its currently low base.

 

 

Top Five Detractors

 

 

Company

 

Country

 

Sector

Absolute Return (Sterling) %

Contribution Performance %

Hero Supermarket

Indonesia

Consumer Staples

(51.6)

(1.0)

Vitasoy International

Hong Kong

Consumer Staples

(47.7)

(0.9)

Mitra Adiperkasa

Indonesia

Consumer Discretionary

(26.1)

(0.8)

Sarimelati Kencana

Indonesia

Consumer Discretionary

(51.2)

(0.7)

Nissin Foods

Hong Kong

Consumer Staples

(30.3)

(0.7)

 

Hero Supermarket is a leading retailer in Indonesia, with operations across pharmacies, supermarkets and the franchise to operate IKEA stores in the country. During the year, the company reported a loss from operations due to weakening profitability at its IKEA stores and the intense competitive environment in the supermarket industry. The company expects the profitability of IKEA stores to improve as the brand's recognition develops further in Indonesia, while benefiting from the optimisation of its supermarket store network.

 

Vitasoy International is the market leader in soy-based beverages and lemon tea with operations in Hong Kong, China, as well as a number of other countries in Asia-Pacific. The company's operations in China have struggled since a political issue in Hong Kong led to a boycott of its products in China. It has also faced disruptions to its business in Australia, which led to a decline in its profitability.

 

Mitra Adiperkasa is the exclusive franchise operator for several leading global brands including Zara, Starbucks, Domino's and Sephora in Indonesia. The company's operations were affected by the negative consumer sentiment for some of its global brands, related to the conflict in the Middle East. The management has taken several steps to engage with various local stakeholders and increased brand building investments to mitigate this impact.

 

Sarimelati Kencana is the exclusive franchise operator for Pizza Hut in Indonesia. Its performance has been disappointing, with a net loss from operations recorded for 2023. The company expanded its store network substantially in previous years, with some of these stores performing below management's expectations. It was also negatively impacted by the consumer sentiment towards multinational brands during the year. The management is taking initiatives including rationalising its store footprint, introducing more innovative products in its menu and investing in brand-building to improve its operating performance.

 

Nissin Foods operates a leading instant noodle brand with operations mainly in Hong Kong and China. The company has suffered due to the poor consumer sentiment in both its key markets. Consumers have shifted towards lower priced products, which has affected Nissin due to its strong position in the premium segment. Migration of blue-collar workers from Southern China towards inland areas has also hurt its growth, as Nissin has a stronger presence in the Southern regions. Its management is launching more variants in the mid-priced segment and expanding its distribution presence to address these challenges.

 

 

2.  A Handbook for the Scottish Oriental Investor

 

Our investment approach is aimed at preserving capital and growing it sensibly. This approach has remained steadfast since the Company was established in 1995. In the fast-growing Asian region, there are several exciting stories or popular themes prevailing at any point of time, which promise attractive returns. These themes rarely stand the test of time - ranging from the mania for Telecom, Media and Technology (TMT) companies around the turn of the century, to real estate and infrastructure businesses before the global financial crisis, or "new-age" companies without clearly established business models in recent years. Investing behind such opportunities comes with the risk of permanent loss of capital. Therefore, our investment process starts by eliminating all those companies which we believe are not suited to meet our goal of capital preservation - simply put, we start by determining what we will not do. We do not believe that there is a price for every business - there are some companies in which we will not invest, irrespective of their growth opportunity or valuations. By eliminating such ideas, we can focus our research on a group of high-quality businesses which comprise our investable watchlist and the Company's portfolio.

 

Our investment process is predicated upon avoiding the following -

1. Investing in companies controlled by poor quality owners and managers.

2. Backing weak franchises with low returns on capital employed (ROCE).

3. Investing in businesses with poor growth prospects, available at "cheap" valuations.

4. Employing a box-ticking approach to environmental, social and governance (ESG) issues.

5. Trying to predict macro-economic variables and using those predictions to pick winners or losers.

6. Building a portfolio based on the composition of an index.

 

Investing in companies controlled by poor quality owners and managers

Our assessment of any business starts with the quality of its majority-owners and management team. We believe that those owners and managers which have a track record of treating other stakeholders poorly, ranging from their workers, suppliers or the communities in which they operate, will eventually compromise the interests of minority shareholders as well.

 

We prefer to invest behind family-owned companies, as families typically take a long-term view of building their businesses and are able to make counter-cyclical investments. In most cases, we don't find ourselves to be aligned with state-owned enterprises (SOEs) which typically need to shoulder national service obligations which may not be in the interests of minority shareholders. However, assessing which families are worth backing and which we should avoid is key. After three decades of investing in Asia, we have built strong networks across countries in the region which help us determine the local reputation of management teams. Our meetings with companies on the ground are supplemented by comprehensive checks with their suppliers, customers, distributors and competitors. In our experience, feedback from a supplier which indicates that a company habitually delays payments, or from a distributor that its management asks them to push sales aggressively just before the end of a quarter, tells us much more about the quality of a company's financials than spreadsheets. We pay close attention to changes in the ownership and management of companies, as those are often pivotal points of change in the direction of travel for the business.

 

One such example is United Breweries, the dominant beer company in India with 54 per cent market share in the industry, led by its Kingfisher brand. For several decades, the business was majority-owned by the Mallya family. While United Breweries had built a market leading position under their leadership, we had several concerns. The company's board was poor quality, with several of the chairman's friends and associates appointed as independent directors. This board permitted substantial related party transactions. We were also sceptical of our alignment with the promoter family, as the chairman had empire-building ambitions, having established a commercial airline, acquired a Formula-One franchise as well as a franchise in India's domestic cricket league (Indian Premier League). The listed company contributed to some of these endeavours, through its large brand-building budget. Due to these governance concerns, we were not invested in the business despite an appreciation for its strong franchise and growth potential. A gradual change in ownership was initiated because the promoter family had taken on high levels of personal debt to fund its ventures. They used the sale of their shareholding in the listed company to repay some of this debt, which led to Heineken building its stake in United Breweries starting in 2008. Our meetings with Heineken's representatives suggested that they were gradually appointing key management members to critical functions such as the chief financial officer, strengthening the quality of the board and terminating the related party transactions as they gained control. This improvement in the quality of ownership and management gave us conviction to establish a position in the company in 2014. Since then, the company has grown consistently while strengthening its dominant position in India's beer industry. We remain excited about its prospects.

 

Backing weak business franchises with low returns on capital employed (ROCE)

We avoid businesses which are price takers, have marginal positions in their category or are at the mercy of much larger customers or suppliers, with limited bargaining power. The low returns on capital such businesses earn forces them to rely on external funding sources to invest in future growth, leading to a leveraged balance sheet or dilution for shareholders. We like to own simple, predictable businesses which have market leading positions in under-penetrated categories. Our assessment is based on their ability to navigate changes in consumer preferences, competitive intensity and business cycles over their history. Their market leadership in their respective categories affords them strong bargaining power with their customers, suppliers and channel partners. This results in a sustainably high return on capital employed, which in our view is the best reflection of the quality of a business franchise.

 

Colgate Palmolive (India) has been present in India since 1937. A consistent focus on brand building, combined with a strong distribution advantage, has cemented its dominant position of more than 50 per cent market share - almost 3 times as much as its nearest competitor. This dominant market position allows it to command high levels of profitability, which it re-invests into continued brand building efforts. It has strong pricing power, which gives it the ability to pass on changes in raw material costs or currency fluctuations to its consumers without much impact on its market shares or profitability. The company's strong market position and strong brand also affords it attractive terms of trade with its distributors and advertising partners, resulting in a large working capital float which is used to fund its growth. These attributes have led to Colgate Palmolive (India) earning high ROCE, averaging more than 100 per cent in recent years. As its CEO, Prabha Narasimhan, has focused on increasing its investments in brand building and introducing several new products across its portfolio, its lead over its competitors is only likely to grow further in the coming periods, reinforcing this virtuous cycle.

 

Businesses with poor growth prospects available at "cheap" valuations

We often observe that as a business matures, its owners or management may lose their desire to continue driving growth. They are happy to collect their annual dividends, which can be invested in other ventures. The earnings growth as well as return on capital of these companies decline over time. We noticed such trends in several companies with operations in economies such as Singapore, Malaysia or Hong Kong a decade ago. These businesses had performed well in previous decades when the countries in which they operated were benefiting from strong growth. As their categories matured, their promoter families began to use the cash flows from dividends they received to fund other interests, with limited focus on the listed entity. Their earnings per share were declining and ROCE was deteriorating. These risks were justified by their "cheap" valuations, which were substantially lower than past levels. We avoid such value-traps. Businesses with declining earnings power only become more expensive over time. Comparisons to historical valuation levels hold little merit, given the lower ROCE and growth prospects. Management teams can also make poor capital allocation decisions such as expensive mergers and acquisitions during such periods, to mitigate this lack of growth.

 

Our focus is to own smaller companies which have the potential to emerge as much larger businesses in future. These operate in under-penetrated categories in large markets, which offer a long runway for growth. As these categories grow with steadily rising per-capita income levels, these businesses are likely to be the large businesses of the future. For example, Philippine Seven is the exclusive franchise operator for 7-Eleven stores in the Philippines. The company is majority owned by President Chain Stores, which has successfully built the 7-Eleven convenience format into a large retail network in Taiwan. Its management is led by Jose Victor Paterno, who comes from the founding family of the business in the Philippines. Under his leadership, Philippine Seven has built a dominant position in convenience stores, with over 4,000 stores across the country and 58 per cent market share, which is over twice as large as its nearest competitor. The management has also broadened its product offering to serve the evolving needs of consumers, such as fresh coffee and meal options as well as basic financial services. Despite the strong growth, convenience store penetration is still below 10 per cent of total modern retail sales in Philippines, compared to 30 per cent to 70 per cent in other regional markets such as Thailand, Taiwan and Indonesia. As per-capita incomes grow and customers prioritise convenience, this penetration of convenience stores is expected to rise consistently. With its clear market leadership which its management is strengthening further, Philippine Seven has the potential to emerge as a much larger business in the coming years.

 

Predicting macro-economic variables to identify potential winners and losers

Our investment process is bottom-up - instead of trying to predict the direction of interest rates or currencies, we try to find high quality businesses operated by competent management teams which have an established track record of performing well across these changes in the business environment. Asian countries have witnessed a range of disruptions since Scottish Oriental was established in 1995, ranging from the Asian Financial Crisis and the Global Financial Crisis to pandemics such as SARS and Covid-19. In our experience, well run businesses used each of these disruptions to emerge with a stronger market position in their respective categories. We assess the track records of companies to observe attributes such as their pricing power, market shares and returns on capital employed during difficult periods, to find resilient businesses which are likely to succeed over the long run.

 

Selamat Sempurna is the largest manufacturer of filters and radiators in Indonesia, predominantly used in the automotive and off-highway industries. Its leading market position and focus on the after-market segment rather than on selling to original equipment manufacturers (OEMs) who dictate pricing terms, has led to a consistent track record over decades. Since 1992, the company's sales have grown at 19 per cent and net profit has grown at 29 per cent annually. Despite facing several disruptions over this period, its net profit has declined in only 3 of the last 30 years. The filter and radiator industry is highly fragmented, dominated by small, informal players. Selamat Sempurna has used its net cash balance sheet to consolidate the industry by acquiring smaller competitors and in some cases, its channel partners to control its distribution more effectively. Its returns on capital employed has increased consistently, from 13 per cent to 18 per cent in the 1990s to 35 per cent currently, as it has improved its profitability through operating leverage from increased scale. Through its association with Donaldson Corporation of the United States of America, the company's management has also gained exposure to global best practices towards shareholder returns. Selamat Sempurna has grown its dividend per share in each of the last 19 years and was among the first companies in Indonesia to start paying quarterly dividends. Its conservative management team is focused on sustaining this track record in the coming periods as well.

 

A box-ticking approach towards environmental, social and governance issues

Our approach to assessing environmental, social and governance (ESG) issues is integrated into our analysis of businesses. In our view, if a business does not earn and sustain its social license to operate, derived from treating all stakeholders well, it will be reflected in lower growth and returns on capital over time. We don't pay heed to glossy ESG reports or rankings in sustainability indices, which we often find to have little correlation with the underlying sustainability practices of a business. An example of this are tobacco businesses, which produce ESG reports going into hundreds of pages and have consistently found a place in global sustainability indices. Instead, we consistently engage with the management teams of Scottish Oriental's holdings on a range of issues and actively vote on company resolutions. Through our engagement, we gain conviction in the quality of the management teams, view feedback from shareholders and other stakeholders constructively, are proactive about learning best practices and admit mistakes.

 

Many smaller companies may have the right intent towards ESG issues but lack the exposure to global best practices or sophisticated communication. Our approach starts by identifying those companies which employ strong governance standards. In our experience, the management teams which exhibit strong governance also learn and employ strong environmental and social practices over time. Century Pacific Food in the Philippines is one such company, which is a leading branded food manufacturer across categories such as tuna, meat, dairy and pet foods. We have admired the management's approach of leading their industry on a range of issues, such as being among the first consumer companies in the Philippines to adopt a formal sustainability strategy focused on "Protein, Planet and People." It launched new products such as milk products fortified with immunity boosters and plant-based meat alternatives following the adoption of this strategy. It was also among the first corporates in the country to achieve plastic neutrality. We have engaged with the company on issues ranging from the professionalisation of its management team to an acquisition of a business owned by its majority shareholder. Following our engagement, the management agreed to inject the business into the listed company at an attractive valuation of 1x Price / Book. In recent periods, we have increasingly engaged with the management on modern slavery risks in the fisheries industry, to which Century Pacific is exposed. The company has been receptive to our letters on this issue, and we have introduced the management to relevant domain experts. Since our first investment in 2017, we have observed that Century Pacific's management has upheld strong governance standards as well as making efforts to improve the company's environmental and social footprint. This has increased our conviction in the management's ability to address the challenges and opportunities the company will face over the long-term.

 

Building a portfolio based on the composition of an index

Our focus is on generating strong absolute returns and accordingly, we view risk as the permanent loss of capital, rather than underperforming a benchmark. Our country weightings bear no relationship to regional stock market indices. Regardless of index significance, we do not consider ourselves obliged to hold investments in any individual market.

 

We are often asked about our exposure to sectors such as information technology or to countries such as Taiwan and Korea, which comprise a large share of the benchmark. On a bottom-up basis, we have found few businesses in these markets which offer high standards of governance, a dominant business franchise and predictable growth. Several companies in the technology hardware supply chain in these countries operate as contract manufacturers for their customers. This gives them limited bargaining power, with their customers demanding annual reductions in their selling prices and long payment terms. This results in low returns on capital and these companies raise capital frequently, diluting shareholders. We are also cognisant of risks emanating from technology adoption cycles and disruptions, which makes their earnings unpredictable. An example is the recent excitement around artificial intelligence, which has led to a significant re-rating of the valuations of these companies. In our experience of previous such technology cycles, predicting the winners from the adoption of new technologies is difficult. Instead, we continue to find new investment opportunities in leading businesses operating in large addressable markets in India, China, Indonesia and Philippines. With growing per-capita incomes, the penetration levels of their categories is growing and these companies are acquiring a larger share of their respective profit pools. They comprise over 82 per cent of the Company's portfolio. The Company's sector and country allocations are entirely a residual of our bottom-up stock selection process, and we don't expect this allocation to necessarily bear any resemblance to our benchmark index.

 

Having detailed what we will not do, the investment approach and outcomes which Scottish Oriental's investors should expect are briefly described below.

 

1.   Investing in a portfolio of high-quality smaller companies. Scottish Oriental's portfolio comprises businesses which are simple and predictable, run by people who have a track record of treating all stakeholders fairly, with strong returns on capital and attractive growth prospects over the long term. Over time, the portfolio has been consolidated in favour of our highest conviction smaller companies. Since 2017, the share of the portfolio's top ten holdings has risen from 25 per cent to 42 per cent currently, and that of the top twenty holdings has risen from 44 per cent to 66 per cent of the portfolio over the same period. The quality of the portfolio is reflected in its high returns on equity, with the portfolio's median return on equity improving from 13.6 per cent to 19.0 per cent currently.

 

2.   A long-term investment horizon. Our investment horizon extends beyond five years, and many of Scottish Oriental's portfolio holdings have been held for over a decade. Seven of Scottish Oriental's ten largest holdings have been held in the Company's portfolio for over five years. This allows us to be viewed by the owners and management teams of these companies as a long-term stakeholder. Our engagement with them on issues ranging from the composition of their board of directors to their capital allocation strategy or environmental and social issues is viewed constructively and allows us to contribute to the development of the businesses in which we are invested.

 

3.   Companies which can grow their earnings sustainably. We are focused on owning smaller companies which have the potential to become significantly larger businesses in future. Their growth comes from rising penetration levels of the categories in which they operate, along with strengthening market positions. We expect that in periods of disruption, such as Covid-19, these companies gain market share from their smaller competitors and emerge with a larger share of their respective profit pools as the economy recovers. The portfolio's estimated earnings per share growth over two years has also risen from 14.2 per cent to 17.4 per cent, alongside the improvement in the portfolio's median return on equity (ROE).

 

4.   A focus on achieving strong absolute returns led by capital preservation. The chart on page 13 of the Annual Report reflects the performance of the portfolio against that of the comparator index since inception. In strong periods (months where the comparator index has risen), the Company's portfolio may not always keep pace with the market's returns. However, the Company has performed better than its comparator index in almost 80 per cent of weak periods (months where the comparator index has fallen). This ability to preserve capital during difficult times has driven Scottish Oriental's superior performance against the comparator index across the majority of market periods.

 

With an investment approach that is consistent since the inception of the Company, we expect these portfolio outcomes to sustain in the coming periods as well.

 

 

3.  Recent Portfolio Activity

 

New Holdings

The team has had an active programme of research visits to all Asian countries over the last year, leading to a number of attractive bottom-up opportunities emerging. These include new holdings in China, where some smaller companies have shown the ability to grow consistently despite the weak economic environment by gaining market share and are available at attractive valuations. The team continues to find several new investment opportunities in India. The first holding of the Company in New Zealand was also established during the period. We purchased six new holdings during the year.

 

DPC Dash is the exclusive franchise operator of Domino's Pizza in China. While Domino's has been present in China since 1997, a group of entrepreneurs led by the current chairman acquired the franchise in 2010 and began expanding the business. Its principal, Domino's Pizza, has also purchased a strategic stake in the company. The business has grown rapidly in recent years and now has over 1,000 stores in more than 30 cities. Domino's has built strong brand equity in China through its focus on the pizza category, menu innovations and strong delivery capabilities. Its expansion into smaller cities has received a strongly positive consumer response. With scale, operating leverage should drive a significant improvement in the company's profitability and returns on capital. The business has the potential to be dominant in the pizza category and eventually become several times its current size.

 

Cloud Music is the second largest online music platform in China with over 200 million active monthly users. It is majority-owned by Netease, with a distinct corporate culture. By contrast with many other Chinese internet businesses, the company's management takes a long term view and is willing to invest counter-cyclically. Instead of aggressive M&A, its focus is on organic growth and earning high returns on capital. The online music industry in China is an attractive duopoly along with Tencent Music, the market leader. The supply of content is fragmented in China. This provides the online music platforms with strong bargaining power. The company also has strong pricing power due to the duopoly industry structure and its loyal user base. In recent years, the company has focused on expanding the share of paying users. Cloud Music has the potential to grow steadily and earn substantially higher levels of profitability over time.

 

Mainfreight is a leading global logistics provider and freight forwarder, headquartered in New Zealand. The company was established by a family and is led by its long-standing, professional CEO. The leadership has inculcated a culture of decentralised management, which drives high levels of accountability for growth and profitability to the local operations. The profit-sharing schemes offered to employees also creates a strong sense of ownership. The global logistics and freight forwarding industry is highly fragmented. Mainfreight has a dominant position in the Australia and New Zealand markets. By deploying the steady cash flows from its presence here, it has gradually expanded internationally. The company has been gaining market share from new entrants who had emerged during the upcycle amidst the Covid-19 disruption but are currently sustaining losses. The company has the potential to grow consistently for several years, given the fragmented industry structure and its entry into the large US market.

 

Mahindra & Mahindra Financial Services ('MMFS') is a leading Indian non-bank finance company, majority-owned by the reputed Mahindra group. Given its position as one of the group's largest businesses, the parent company's management has increased its focus on strengthening MMFS' returns on equity and accelerating its growth. Under a new CEO, Raul Rebello, MMFS has strengthened its senior leadership team, made changes to its underwriting systems and processes, reduced exposure to riskier lending segments and is diversifying its loan book beyond its core automotive and tractor financing businesses. These changes should result in a substantial improvement in the company's returns on equity in the coming years and drive consistent growth.

 

RHI Magnesita India is the leading Indian refractory manufacturer, majority-owned by RHI Magnesita NV, the global market leader. The position of refractories as a critical but low-cost consumable in the steel manufacturing process gives RHI sticky customer relationships and pricing power. It has over 30 per cent market share in India, which is twice as large as its largest competitor. With significant capacity addition in the Indian steel industry over the next five years, there is potential for consistent volume growth. Following recent acquisitions, the company's margins declined due to lower utilisation rates at the acquired entities. The management is focused on ramping up these utilisation levels which should improve the company's profitability and returns on capital. It also provides the company an entry into adjacent segments such as cement and non-ferrous metals. These segments offer an attractive growth opportunity over the medium-term.

 

Honasa Consumer operates leading personal care brands in India, including MamaEarth, their flagship brand with a focus on safe and toxin-free products. The founders have built a high-quality board and hired several experienced senior management team members. Honasa initially built its brands as a direct-to-consumer online offering with an innovative positioning around toxin-free products which were not easily available in India. Subsequently, they have scaled MamaEarth by adding several SKUs, while also building other brands. The company successfully expanded into the large offline distribution network which has helped to scale up its operations substantially. There is a large growth opportunity offered by the severely under-penetrated personal care category in India. Honasa earns high gross margins. As its new brands also gain scale, the business' profitability is likely to be significantly higher as well.

 

Sales

We sold 13 holdings during the year. Several Indian holdings including Castrol India, Mahindra Lifespace, 360 One, Biocon, HeidelbergCement India and Delhivery were sold after their valuations became expensive following strong share price appreciation. We had purchased Tisco Financial in Thailand during the Covid-19 disruption, which had led to significant concerns about the credit losses in its vehicle finance portfolio. With the management's conservative approach towards its loan portfolio, Tisco benefited from a strong recovery and its valuations rose to more expensive levels. As its long-term growth opportunities are limited, we sold the holding. Indus Motor Company in Pakistan and Delta Brac in Bangladesh were also disposed of during the year. Both companies have suffered from the weak economic environment in their respective countries, as well as regulatory changes such as interest rate caps in Bangladesh which constrain their ability to maintain their high profitability levels. We also sold a few smaller holdings, including NHN KCP, Beijing Capital Airport, Vitasoy International and Luk Fook Holdings which faced difficult business outlooks, to consolidate the portfolio among higher conviction positions.

 

Bought and Subsequently sold

Haitian International is the global leader in the plastic injection moulding machine industry. It had suffered from the economic downturn in China, which led to attractive valuations. Its management was incubating new businesses in the export market, which offered steady growth potential. After our purchase, its strong performance led to a sharp increase in its valuations. We sold the holding as its valuations rose to more expensive levels. We had purchased small positions in LG Household & Healthcare (a Korean cosmetics company with significant operations in China) and Centre Testing (a leading testing service provider in China) as their valuations had declined to attractive levels due to the weak economic environment in their key operating markets. Both companies continued to suffer from intense competition while customer demand remained weak. We sold the small positions to consolidate the portfolio among higher conviction holdings.

 

4.  Ten Largest Investments as at 31 August 2024

 

Name of Holding

 

Sector

% of Shareholders' Funds

Colgate-Palmolive (India)

India

Consumer Staples

6.9

Colgate-Palmolive (India) is the market leader in the oral care segment in India, with about 50% market share in the toothpaste category. It also has potential to build a larger presence in segments such as personal care.

DPC Dash

China

Consumer Discretionary

5.1

DPC Dash is the exclusive franchise operator for Domino's Pizza stores in China. It is leading the development of the pizza category in China.

Uni-President China

China

Consumer Staples

5.1

The company operates leading instant noodle and beverage brands in China. Its management is focused on launching premium products which earn higher margins, while strengthening the company's distribution in emerging channels.

Philippine Seven

Philippines

Consumer Staples

5.0

It is the leading convenience store operator in the Philippines, with the exclusive right to use the 7-Eleven brand in the country. Philippine Seven is expected to lead the development of the convenience store industry in the country, as penetration is still at low levels.

JNBY Design

China

Consumer Discretionary

4.2

JNBY Design is a leading designer apparel brand in China. The company has built a strong network of loyal members which has driven its growth consistently.

Century Pacific Food

Philippines

Consumer Staples

4.1

Century Pacific Food is the largest canned food producer in the Philippines. The company is gaining traction in emerging categories such as milk and pet food products which should drive steady growth over the medium term.

Selamat Sempurna

Indonesia

Consumer Discretionary

3.5

Selamat Sempurna is the leading manufacturer of filters and radiators in Indonesia. Through its joint venture with Donaldson (based in the United States of America), it also exports products to global markets. Selamat has the potential to consolidate the fragmented domestic industry and enter new segments such as air and water filters, which have a large addressable market.

Blue Star

India

Materials

3.0

Blue Star operates one of the leading air-conditioner brands in India, which has been gaining market share consistently. The company executes engineering, procurement and construction (EPC) projects as well which are expected to grow with industrial and infrastructure development.

Kansai Nerolac Paints

India

Industrials

3.0

Kansai Nerolac Paints is a leading paint company with a dominant market share in automotive paints in India. Under a new CEO, the company has also taken several initiatives to improve its market position in decorative paints, by launching several new products, engaging with channel partners and expanding its distribution.

Metropolis Healthcare

India

Healthcare

2.9

Metropolis Healthcare is a leading diagnostics testing service provider in India. The company is leading the consolidation of the highly fragmented Indian diagnostics industry, as consumers shift towards accredited brands.

 

 

5.  Sector & Geographical Analysis

 

Sector Allocation at 31 August 2024

 

Sector

% Shareholder's Funds


2024

2023

Consumer Staples

29.3

29.5

Consumer Discretionary

23.6

22.2

Materials

11.3

16.4

Technology

10.0

5.1

Industrials

8.4

9.3

Healthcare

6.9

5.8

Financials

6.1

10.1

Utilities

2.9

2.2

Real Estate

1.7

4.2

Logistics

1.5

0.3

Net Current Assets

7.9

4.4

Non-Current Liabilities

(9.6)

(9.5)

 

Country Allocation at 31 August 2024 (based on geographical area of activity)

 

Country/Region

Scottish Oriental

2024

%

Scottish Oriental

2023

%

MSCI Small Cap¹

2024

%

MSCI²

2024

%

China

19.3

11.7

8.9

27.9

Hong Kong

2.0

5.1

3.4

4.6

Taiwan

9.1

4.8

25.2

21.5

Greater China

30.4

21.6

37.5

54.0

Indonesia

11.8

17.7

2.0

2.0

Malaysia

-

-

3.0

1.8

Philippines

10.4

9.6

0.9

0.7

Singapore

1.5

2.6

5.5

3.6

Thailand

-

1.6

3.4

1.7

Vietnam

2.3

1.8

-

-

South East Asia

26.0

33.3

14.8

9.8

Bangladesh

-

0.9

-

-

India

40.9

45.2

34.4

22.8

Pakistan

-

0.3

-

-

Indian Subcontinent

40.9

46.4

34.4

22.8

New Zealand

1.5

-

-

-

South Korea

2.9

3.8

13.3

13.4

Net Current Assets

7.9

4.4

-

-

Non-Current Liabilities

(9.6)

(9.5)

-

-

Net Assets

100.0

100.0

100.0

100.0

¹ Morgan Stanley Capital International AC Asia ex Japan Small Cap Index

² Morgan Stanley Capital International AC Asia ex Japan Index

 

6. Portfolio Positioning & Outlook

 

Our research efforts have been focused on visiting Scottish Oriental's portfolio holdings and our broader investable universe across Asian countries. These visits inform our outlook for the region and form the primary source of new idea generation. We have observed diverging trends across the various economies. India, Indonesia and Philippines have steadily recovered since the disruption of the pandemic. The business outlook here remains positive. In some instances, this is also reflected in the valuations of some companies in India being re-rated to expensive levels, which we have used to reduce our exposure. In China, companies have been weighed down by numerous challenges, including the impact of the pandemic on consumer sentiment, the decline in the large property sector, and regulatory interventions across industries ranging from e-commerce to healthcare. However, these challenges have also provided opportunities for well-run companies to gain market share. In the instances in which we find that valuations have declined to attractive levels, we have selectively used this to add to our holdings as well as initiate new positions. Taiwan and Korea have witnessed increased investor enthusiasm about the opportunity provided by artificial intelligence, reflected in the increase in valuations across several parts of the investment universe. These opportunities are yet to be seen in the performance of businesses. Our experience suggests that periods of technological disruption such as this usually come with low levels of predictability about the eventual winners. We typically avoid investing behind "themes", as detailed previously. These challenges have led to fewer investment opportunities for us on a bottom-up basis in Taiwan and Korea.

 

The outlook for Scottish Oriental's portfolio is exciting. The portfolio has been further consolidated among our highest conviction holdings, with the top 20 now comprising 65.7 per cent weight. The median return on equity remains high at 19 per cent and reflects the strong earnings quality of the holdings. At a median level, the portfolio's holdings maintain a net cash balance sheet, which makes them resilient. The portfolio's forecasted growth has moderated from the high base of recent years, which was due to the reopening of economies after the pandemic. On a normalised base, the portfolio's holdings continue to offer attractive growth in the years ahead. The valuations, in the context of the attractive growth potential and high returns on equity, are at reasonable levels.

 

 

As at 31 August

2017

2018

2019

2020

2021

2022

2023

2024

Weight of top 10 holdings %

25.1%

29.2%

29.6%

31.6%

31.8%

39.2%

38.2%

42.8%

Weight of top 20 holdings %

44.0%

50.8%

50.4%

52.4%

54.8%

63.1%

60.4%

65.7%

Median current year return on equity

13.6%

15.0%

16.3%

15.9%

15.3%

18.8%

19.2%

19.0%

Median 2-year forecast annualised earnings per share growth

14.2%

7.3%

1.5%

8.6%

34.1%

21.2%

17.6%

17.4%

Median forward price to earnings ratio

20.5x

26.8x

15.0x

24.9x

23.0x

17.4x

18.3x

18.9x

 

 

 

FSSA Investment Managers

13 November 2024

 

 

 

 

 

 

 

 

 

 

Income Statement for the year ended 31 August 2024                              

                                                                       

                                                                        2024                                                        2023

 

 

Revenue

£'000

Capital

£'000

Total*

£'000

Revenue

£'000

Capital

£'000

Total*

£'000








Gains on investments

-

67,406

67,406

-

22,540

22,540

Income from investments

12,382

-

12,382

8,411

-

8,411

Other income

80

-

80

42

-

42

Investment management fee

(2,802)

-

(2,802)

(2,549)

-

(2,549)

Performance fee

-

(98)

(98)

-

(2,247)

(2,247)

Currency losses

-

(357)

(357)

-

(713)

(713)

Other administrative expenses

(777)

-

(777)

(697)

-

(697)


 

 

 




Net return on ordinary activities before finance costs and taxation

8,883

66,951

75,834

 

5,207

19,580

24,787

Finance costs

  (835)

-

(835)

  (835)

-

(835)


 

 

 




Net return on ordinary activities before taxation

8,048

66,951

74,999

 

4,372

19,580

23,952

Tax on ordinary activities

(1,403)

(11,440)

(12,843)

(876)

(2,677)

(3,553)


 

 

 




Net return attributable to equity

shareholders

6,645

55,511

62,156

 

3,496

 

16,903

20,399

 

 

 

 




Net return per ordinary share

27.74p

231.73p

259.47p

14.19p

68.60p

82.79p

 

 

 

 




 

* The total column of this statement is the Profit & Loss Account of the Company. The revenue and capital columns are supplementary to this and are prepared under guidance published by the Association of Investment Companies.

 

There are no items of other comprehensive income, therefore this statement is the single statement of comprehensive income of the Company.

 

The Board is proposing a final dividend of 14.0p per share for the year ended 31 August 2024 (2023: 13.0p per share) and a special dividend of 8.0p per share (2023: nil) which if approved, will be payable on 7 February 2025 to shareholders recorded on the Company's shareholder register on 10 January 2025.

 

All revenue and capital items derive from continuing operations.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Summary Statement of Financial Position as at 31 August 2024

 


2024

2023

 

£'000

£'000

£'000

£'000






Investments held at fair value through profit or loss

 

409,758


372,660


 

 



Current Assets

 

 



    Debtors

2,834

 

1,052


    Cash and deposits

37,972

 

18,089



40,806

 

19,141


Current Liabilities

 

 



    Creditors

(8,948)

 

(3,572)



(8,948)

 

(3,572)


Net Current Assets

 

31,858


15,569

 

 

 



Non-Current Liabilities

 

 



Deferred tax liabilities on Indian capital gains

(8,706)


(3,820)


Loan notes

(29,842)


(29,832)


 

 

(38,548)


(33,652)

Total Assets less Liabilities

 

403,068


354,577

 

 

 



Capital and reserves

 

 



Ordinary share capital

 

7,853


7,853

Share premium account

 

34,259


34,259

Capital redemption reserve

 

58


58

Capital reserves

 

349,645


304,661

Revenue reserve

 

11,253


7,746

Total equity shareholders' Funds

 

403,068


354,577


 

 



Net asset value per share

 

1709.53p


1,455.58p

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash Flow Statement for the year ended 31 August 2024



2024


2023



£'000


£'000

 

Net cash outflow from operations before dividends, interest, purchases and sales of investments

(5,751)


(3,254)

Dividends received from investments

8,894


8,894

Interest received from deposits

80


42

Cash inflow from operations

6,884


5,682

Taxation

(1,396)


(971)

Net cash inflow from operating activities

5,468


4,711

 

 



Investing activities

 



Purchases of investments

(123,398)


(124,575)

Sales of investments

159,114


142,938

Capital gains tax paid on the sale of investments

(6,554)


(2,041)

Net cash inflow from investing activities

29,162


16,322

 

Financing activities

 



Interest paid

(825)


(825)

Equity dividend(s) paid

(3,138)


(3,457)

Buyback of ordinary shares

 

(10,427)


(5,439)

Net cash outflow from financing activities

(14,390)


(9,721)



 



Increase in cash and cash equivalents

20,240


11,312

Cash and cash equivalents at the start of the year

18,089


7,490

Effect of currency losses

(357)


(713)

Cash and cash equivalents at the end of the year*

37,972


18,089






*Cash and cash equivalents represents cash at bank.

 

 




Total tax paid for the year ended 31 August 2024 was £7,950,000 (2023: £3,011,000).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Statement of Changes in Equity

For the year ended 31 August 2024









Ordinary

share capital

Share premium account

Capital

redemption

reserve

 

Capital reserves

 

Revenue

reserve

 

 

Total


£'000

£'000

£'000

£'000

£'000

£'000

Balance at 31 August 2023

 

7,853

 

34,259

 

58

 

304,661

 

7,746

 

354,577

Total comprehensive income:

 

 

 






Return for the year

-

-

-

55,511

6,645

62,156

Transactions with owners recognised directly in equity:







Dividend paid in year

 

-

 

-

 

-

 

-

 

(3,138)

 

(3,138)

Buyback of Ordinary shares

 

-

 

-

 

-

 

(10,527)

 

-

 

(10,527)

Balance at 31 August 2024

 

7,853

 

34,259

 

58

 

349,645

 

11,253

 

403,068

 

 

 

 

Statement of Changes in Equity

For the year ended 31 August 2023









Ordinary

share capital

Share premium account

Capital

redemption

reserve

 

Capital reserves

 

Revenue

reserve

 

 

Total


£'000

£'000

£'000

£'000

£'000

£'000

Balance at 31 August 2022

 

7,853

 

34,259

 

58

 

293,325

 

7,707

 

343,202

Total comprehensive income:

 

 

 






Return for the year

-

-

-

16,903

3,496

20,399

Transactions with owners recognised directly in equity:







Dividends paid in year

 

-

 

-

 

-

 

-

 

(3,457)

 

(3,457)

Buyback of Ordinary shares

 

-

 

-

 

-

 

(5,567)

 

-

 

(5,567)

Balance at 31 August 2023

 

7,853

 

34,259

 

58

 

304,661

 

7,746

 

354,577

 

 

 

 

 

 

 

 

 

 

 

 

Principal Risks and Uncertainties

The Board has carried out a thorough assessment of risks faced by the Company. Below the Board has set out the principal and emerging risks identified from the consideration. The Company faces emerging risks from climate change and global political events. The impact of these on the principal risks is detailed below, together with a summary of the mitigating action taken to manage these risks.

 

Emerging Risks

Risk

Mitigation

Environmental, Social and Governance ("ESG")

There is increased awareness of the challenges posed by ESG and climate change. The increasing volume, short implementation deadlines and lack of commonality of new ESG regulations issued by multiple regulators, accompanied by increased regulatory focus and labeling and marketing of investment products as having ESG characteristics increase the perceived risk of greenwashing.

 

 

The investment process is focused on ESG issues and, as set out on page 21 of the Annual Report, puts a great deal of emphasis on good Governance. Overall the specific potential effects of climate change are difficult, if not impossible to predict. The Board and Investment Manager continue to monitor material physical and transition risks and opportunities as part of the investment process.

Social and political events

Economic and political events continue to impact global equity markets. Particularly relevant for the Company is the poor economic relationship between the United States and China. Investment flows have been significantly impacted; this has the potential to impact supply chains and may affect other countries in Asia.

 

 

Although not possible to predict the scale of unknown events, the Investment Manager invests in a portfolio of high quality companies which are resilient to market downturns.

 

The Board and the Investment Manager discuss the resiliency of the portfolio as part of regular meetings. Please refer to the Investment Managers' report above for further details

 

 

 

Principal Risks

Risk

Mitigation

Investment objective and strategy

An inappropriate or unattractive objective and strategy may have an adverse effect on Shareholder returns or cause a reduction in demand for the Company's shares, both of which could lead to a widening discount.

 

 

 

 

 

 

 

 

 

 

No change to this risk

 

The Company's investment objective and strategy is monitored by the Board to ensure it continues to remain appropriate.

 

The Board conducts annual strategy reviews and considers investment performance, shareholder views and developments in the marketplace as well as emerging risks which could impact the Company regularly throughout the year.

 

The Board reviews changes to the shareholder register at quarterly Board meetings and engages the Administrator to continually monitor the discount at which the Company's shares trade, reporting regularly to the Board and buying back shares when appropriate.

Investment performance

Poor investment performance may have an adverse effect on Shareholder returns.

 

In extreme circumstances, poor investment performance could lead to the Company breaching loan covenants.

 

 

 

 

No change to this risk

 

The Board reviews investment performance at each quarterly Board meeting. The Investment Manager reports on the Company's performance, transaction activity, individual holdings, portfolio characteristics and outlook.

 

The Investment Manager is formally appraised at least annually by the Management Engagement Committee.

 

The Board reviews compliance with the Company's loan covenants on a quarterly basis.

Financial and Economic

The Company's investments are impacted by financial and economic factors including market prices, interest rates, foreign exchange rates, liquidity and credit which could cause losses to the investment portfolio.

 

No change to this risk

 

The Board regularly reviews and agrees policies for managing market price risk, interest rate risk, foreign currency risk, liquidity risk and credit risk. These are explained in detail in note 16 to the financial statements on pages 64 to 68 of the Annual Report.

Share price discount/premium to net asset value

A significant share price discount or premium to the Company's net asset value per share, or related volatility, could lead to high levels of uncertainty or speculation and the potential to reduce investor confidence.

 

No change to this risk

 

 

The Board has established share issuance and share buyback processes to assist in the moderation of share price premium and discount to net asset value. Shareholders are kept informed of developments as far as practicable and are encouraged to attend briefings, such as the Company's Annual General Meeting, to understand the implementation of the investment policy to achieve the Company's objectives.

Operational

The Company is reliant on third party service providers including FSSA Investment Managers as Investment Manager, Juniper Partners as Company Secretary and Administrator, J P Morgan as Depositary and Custodian and Computershare as Registrar. Failure of the internal control systems of these third parties could result in inaccurate information being reported or risk to the Company's assets.

 

No change to this risk

 

The Audit Committee formally reviews each service provider at least annually, considering their reports on internal controls.

 

Further details of the Company's internal control and risk management system is provided on page 36 and 37 of the Annual Report.

Regulatory

The Company operates in a regulatory environment. Failure to comply with s1158 of the Corporation Tax Act 2010 could result in the Company losing investment trust status and being subject to tax on capital gains. Failure to comply with other regulations could result in financial penalties or the suspension of the Company's listing on the London Stock Exchange. 

 

No change to this risk

 

Compliance with relevant regulations is monitored on an ongoing basis by the Company Secretary and Investment Manager who report regularly to the Board.

 

The Board monitors changes in the regulatory environment and receives regulatory updates from the Company Secretary, Lawyers and Auditors as relevant.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Statement of Directors' Responsibilities in Respect of the Annual Financial Report

 

In accordance with the Disclosure Guidance and Transparency Rules, we confirm that to the best of our knowledge:

 

·              the Financial Statements, prepared in accordance with applicable United Kingdom accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company; and

 

·              the Strategic Report and the Directors' Report include a fair review of the development and performance of the business and the position of the Company, together with a description of the principal and emerging risks and uncertainties that the Company faces.

 

In addition, each of the Directors considers that the Annual Report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's performance, position, business model and strategy.

 

Going Concern

In assessing the Company's ability to continue as a going concern the Directors have considered the Company's investment objective detailed on page 24 of the Annual Report, risk management policies detailed above, the nature of its portfolio and expenditure projections and believe that the Company has adequate resources, an appropriate financial structure and suitable management arrangements in place to continue in operational existence for the foreseeable future and for at least 12 months from the date of the Annual Report. In addition, the Board has had regard to the Company's investment performance (see above), the price at which the Company's shares trade relative to their NAV (see above) and ongoing investor interest in the continuation of the Company (including feedback from meetings and conversations with Shareholders).

 

The Directors performed an assessment of the Company's ability to meet its liabilities as they fall due. In performing this assessment, the Directors took into consideration the following factors:

 

·      cash and cash equivalents balances and the portfolio of readily realisable securities which can be used to meet short-term funding commitments;

·      the ability of the Company to meet all of its liabilities and ongoing expenses from its assets;

·      revenue, operating and finance cost forecasts for the forthcoming year;

·      continued adherence to the loan covenants;

·      the ability of third-party service providers to continue to provide services; and

·      three potential downside scenarios including stress testing the Company's portfolio for a 30% fall in the value of the investment portfolio; a 50% fall in dividend income; and a similar level of share buybacks to the current year. The cumulative impact of these three downside scenarios would leave the Company with a positive net cash position.

 

Based on this assessment, the Directors are confident that the Company will have sufficient funds to continue to meet its liabilities as they fall due for at least 12 months from the date of approval of the financial statements, and therefore have prepared the financial statements on a going concern basis.

 

Related Party Transactions

The Directors' fees for the year are detailed in the Directors' Remuneration Report on pages 39 to 40 of the Annual Report. An amount of £28,500 was outstanding to the Directors at the year end (2023: £20,800). No Director has a contract of service with the Company. During the year no Director had any related party transactions requiring disclosure under section 412 of the Companies Act 2006.

 

The management and performance fees for the year are detailed in note 2 to the Financial Statements and amounts payable to the Investment Manager at year end are detailed in note 10 to the Financial Statements. The Investment Management team's individual shareholdings in the Company are set out on page 5 of the Annual Report.

 

Alternative Investment Fund Managers Directive (unaudited)

Under the Alternative Investment Fund Managers Directive the Company is required to publish maximum exposure levels for leverage on a 'Gross' and 'Commitment' basis. The process for calculating exposure under each method is largely the same, except that, where certain conditions are met, the Commitment method allows instruments to be netted off to reflect 'netting' or 'hedging' arrangements and the Company's leverage exposure would then be reduced. The AIFM set maximum leverage levels of 3.0 and 1.7 times the Company's net asset value under the 'Gross' and 'Commitment' methods respectively. At the Company's year end the levels were respectively 1.04 and 1.11 times the Company's net asset value.

 

The Alternative Investment Fund Managers Directive requires the AIFM to make available certain remuneration disclosures to investors. This information is available from the AIFM on request.

 

Notes:

 

1.   The Scottish Oriental Smaller Companies Trust plc is a public company limited by shares, incorporated and domiciled in Scotland, and carries on business as an investment trust.

 

These Financial Statements have been prepared under the historical cost convention (modified to include the revaluation of fixed asset investments which are recorded at fair value) and in accordance with the Companies Act 2006, UK Generally Accepted Accounting Practice ('UK GAAP'), including FRS 102, and the Statement of Recommended Practice "Financial Statements of Investment Trust Companies and Venture Capital Trusts" issued in July 2022 (the 'SORP'). These Financial Statements are prepared on a going concern basis.

 

All of the Company's operations are of a continuing nature.

 

 

Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

 

There are two areas of significant judgement -

 

·      The Directors use their judgement in selecting the appropriate rate of capital gains tax to apply to unrealised gains on Indian investments. The Directors have chosen to apply the long-term capital gains tax rate on unrealised gains on Indian investments. Please refer to note 5 (a) on page 59 of the Annual Report for further details.

·      The Directors use their judgement in recognising and classifying special dividends received as either revenue or capital in nature. All special dividends received in the year have been treated as revenue income.

 

The accounts have also been prepared on the assumption that approval as an investment trust will continue to be granted.

 

The functional and reporting currency of the Company is pounds sterling as this is the currency of the Company's share capital and the currency in which most of its shareholders operate.

 

2.   Fair Value Hierarchy

Investments in securities are financial assets designated at fair value through profit or loss on initial recognition. In accordance with FRS102, these investments are analysed using the fair value hierarchy described below. Short term balances are excluded as their carrying value at the reporting date approximates their fair value.

 

The levels are determined by the lowest level of input that is significant to the fair value measurement for the individual investment in its entirety as follows:

Level 1 - investments with prices quoted in an active market;

Level 2 - investments whose fair value is based directly on observable current market prices or is indirectly being derived from market prices; and

Level 3 - investments whose fair value is determined using a valuation technique based on assumptions that are not supported by observable current market data.

 

 

 

The Company held the following categories of financial instruments as at 31 August 2024:

 

 

Level 1

Level 2

Level 3

Total


£'000

£'000

£'000

£'000

Listed equities

385,316

24,442

-

409,758

Total

385,316

24,442

-

409,758

 

 

The Company held the following categories of financial instruments as at 31 August 2023:

 


Level 1

Level 2

Level 3

Total


£'000

£'000

£'000

£'000

Listed equities

313,937

58,723

-

372,660

Total

313,937

58,723

-

372,660

 

The above table provides an analysis of financial assets and financial liabilities based on the fair value hierarchy described below. Short term balances are excluded from the table as their carrying value at the reporting date approximates to their fair value.

 

 

3.   Cashflow reconciliation

 

Reconciliation of net return on ordinary activities before finance costs and taxation to net cash outflow from operations before dividends, interest, purchases and sales

2024

£'000

2023

£'000

Net return on activities before finance costs and taxation

75,834

24,787

Net gains on investments

(67,406)

(22,540)

Currency losses

357

713

Dividend income

(12,382)

(8,411)

Interest income

(80)

(42)

(Decrease)/increase in creditors

(2,070)

2,300

Increase in debtors

(4)

(61)

Net cash outflow from operations before dividends, interest, purchases and sales

(5,751)

(3,254)

 

 

4.  These are not statutory accounts in terms of Section 434 of the Companies Act 2006. Full audited accounts for the year to 31 August 2024 will be sent to shareholders in November 2024 and and copies will be available from the Company's website www.scottishoriental.com and the Company Secretary's office at 28 Walker Street, Edinburgh, EH3 7HR. The audited accounts for the year ended 31 August 2024 will be lodged with the Registrar of Companies.

 

 

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