Annual Financial Report

Montanaro UK Smaller Companies Investment Trust PLC ("MUSCIT") Annual Financial Report 2012 The full Annual Report and Accounts 2012 will be available on the Company's website www.montanarouksmaller.co.uk. Investment Objective MUSCIT's investment objective is capital appreciation through investing in small quoted companies listed on the London Stock Exchange or traded on the Alternative Investment Market ("AIM") and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding Investment Companies) Index ("SmallCap"). No unquoted investments are permitted. Highlights for the year ended 31 March 2012 Results NAV +4% Â£146m Gross assets +4% Â£163m Share price -2% Â£116m* FTSE SmallCap Index -3%** * Market capitalisation. ** Excluding Investment Companies. Year to Year to 31 March 31 March 2012 2011 Revenue return on ordinary 2,480 2,516 activities (Â£000) Movement in capital reserve (Â£ 4,778 38,413 000) Revenue return per Ordinary 7.41p 7.51p share Dividend per Ordinary share 6.76p 6.76p Total return per Ordinary 21.68p 122.26p share As at As at 31 March 31 March 2012 2011 Ordinary share price 348.00p 355.00p NAV per Ordinary share 436.57p 421.65p Chairman's Statement For over 20 years, Montanaro has delivered consistent outperformance across different market conditions. I believe that investors can look forward to the future of MUSCIT with confidence. Highlights 2012 - In the year to 31 March 2012, the NAV of MUSCIT increased by 4% to 436.57p in comparison with a 3% fall in the SmallCap. - Since launch, the NAV of MUSCIT has increased by 335% in comparison with a gain of 50% in SmallCap outperforming by 285%. Background I am pleased to present the 17th annual report of MUSCIT, which was launched in March 1995. In 1996, the initial investment of Â£25 million was increased in size through a Â£30 million "C" share issue. Net assets now stand at Â£146 million. An investment trust is an attractive vehicle for shareholders to invest in quoted UK "smaller" companies, which are less well researched and more illiquid than larger, blue chip companies. Performance The NAV of MUSCIT at 31 March 2012 increased in the year by 4% to 436.57p, by 118% over ten years and by 335% since launch. In comparison the SmallCap fell 3% in the year, moved by 0% over ten years and has gained 50% since launch. Since launch, the NAV of MUSCIT has outperformed the SmallCap by 285%. Discount The discount of MUSCIT's share price to NAV stood at 20.3% on 31 March 2012 in comparison with a weighted sector average of 16.2% (source: Close Wins Investment Trusts). Share Buy Backs The Board is responsible for share buy backs which are undertaken at arm's length from the Manager. No shares were bought back during the year. Holding Shares in Treasury Since December 2003, investment trusts have had the right to buy back shares and hold them in Treasury for re-issue at a later date. This has the benefit of improving liquidity as well as retaining the opportunity to enhance the NAV. The Board has actively and carefully considered the use of Treasury shares and had been among the industry's pioneers. Our policy is to ensure that shareholders receive a tangible benefit above and beyond an enhanced ability to manage the liquidity of the shares of MUSCIT. Shares held in Treasury will only be re-issued at a lower discount than when they were originally purchased and to produce a positive absolute return. As at 31 March 2012 no shares were held in Treasury. Gearing The Board reviews the level of gearing considered appropriate for the Company in discussion with the Manager. One of the benefits of investment trusts is the ability to hold prudent levels of gearing which can enhance investment returns. The Board has agreed to limit borrowings to 25% of shareholders' funds. On 19 December 2011 the Company entered into a new Â£15 million revolving credit facility with ING Bank. The facility is available for a term of five years until 19 December 2016. At the same time the Company entered into an interest rate swap effectively fixing the interest rate at 4.29% for the life of the facility. At 31 March 2012, Â£15 million was drawn down. During the year, Net Gearing ranged from 1.0% to 11.1%. At 31 March 2012, net gearing was 0.9% (debt as a % of gross assets) and 1.0% (debt as a % of net assets). Dividends MUSCIT's primary focus is on capital growth rather than income. The Board proposes a final dividend of 6.76p per Ordinary share payable on 10 August 2012 to shareholders on the register at the close of business on 29 June 2012. The Board has observed the changes to the taxation rules and the Companies Act that now permit the distribution of realised capital reserves as dividends. At this years' Annual General Meeting we are seeking Shareholder approval to amend the Company's Articles to reflect these changes. It is not the intention to change the Company's current dividend policy but could provide flexibility in the future. Directors In the year to 31 March 2012 there have been no changes to the structure of the Board. Corporate Governance The Directors have reviewed the recommendations of the AIC Code on Corporate Governance (the "AIC Code") and have implemented procedures where appropriate, such as an annual evaluation of the Board's performance. MUSCIT has complied with the AIC Code throughout the year except where compliance would be inappropriate given the size and nature of the Company. Full disclosure of MUSCIT's compliance with the AIC Code is included in the Directors' Report. The Manager has signed up to the Stewardship Code and has published its voting records on their website. The use of an internal audit function is not considered necessary given the inherent segregation of duties and internal controls. Chairman's Comment Institutional investors have spent much of the last decade remodelling their balance sheets to reduce risk. The average pension fund in the UK is approximately 47% invested in equities, down from around 70% a decade ago (source: Mercer), while the average insurer has cut its equity exposure to 34% from 46% (source: IMF). The same observation can be made for regulated financial institutions all across Europe where equities were swapped for the safety of bonds and credit. Pension scheme sponsors have tried to match their liabilities through LDI ("liability-driven investment") as defined benefit schemes have closed. Perhaps more importantly, sweeping regulatory changes (Basel III and Solvency II in particular) are being introduced at arguably the worst possible time. But in March 2012 the world watched with horror as Greece's default (euphemistically called "restructuring") - the first of a developed country since World War II - shattered the very notion that bonds are a "risk-free" asset class. Other countries may well follow suit and cost investors dear - Greece alone has wiped out over â‚¬100bn in creditors' wealth. It is a cruel irony of history that a number of sovereign bonds rated "A" or better may have morphed into ticking time-bombs. In the same vein, conventional wisdom has it that large companies are safer than small companies. Yet the list of casualties amongst larger companies since 2001 is long - think of Enron, WorldCom, Parmalat, General Motors, Lehman Brothers and RBS, to name a few. Investors lured to the safety of UK LargeCap have underperformed SmallCap by over 3% a year since 2000. Current events may lead investors to eventually reappraise the meaning of "equity risk". Equities are attractive on most valuation metrics - the last time the FTSE All-Share yielded close to 3% and more than the 10-year Gilt was at the depth of the crisis following the collapse of Lehman Brothers. Companies have rarely had so much cash at hand and are receiving further stimulus through a gradual reduction of the corporation tax rate. At the end of March, over 70% of companies in MUSCIT had a net cash position and a weighted net debt-to-equity ratio of under 10%. Most companies in the portfolio have lived through economic and financial turmoil before and many have a habit of emerging stronger from these trying periods. With a universe of over 2,000 quoted companies to choose from, experienced and well-resourced SmallCap managers such as Montanaro are able to construct portfolios of businesses with low fundamental risk characteristics. For over 20 years, Montanaro has delivered consistent outperformance across different market conditions. The iron rule of "quality first" underpinning the team's investment process should reassure investors in these uncertain times. I believe that investors can look forward to the future of MUSCIT with confidence. In future the Company's investments will be managed on a day-to-day basis by David Lindley supported by George Cooke. Charles Montanaro will continue to provide oversight and strategic guidance to the portfolio. Given the team approach of Montanaro Asset Management, it is not anticipated that there will be any change in the investment style and approach of the Manager. David Gamble Chairman 20 June 2012 Manager's Report Highlights 2012 The Company is well-positioned to benefit from an increased appetite for the highest quality "blue-chip" quoted small companies. We look forward to the coming year with cautious optimism after an encouraging start. Market Cap by Value of Holding Market Cap Percentage Â£50-Â£100m 2% Â£100-Â£200m 16% Â£200-Â£300m 17% Â£300-Â£600m 29% >Â£600m 36% Indexby Value of Holding Index Percentage Other UK equities 5% UK AIM 8% FTSE Fledgling 8% FTSE 250 35% FTSE SmallCap 44% Manager's Review After a strong performance in 2010, it was always going to be asking a lot for a repeat in 2011. As it happens, in a volatile year returns proved to be modest all round - the FTSE SmallCap (ex Investment Companies) index fell by 3%; the FTSE All-Share declined by 2%; whereas the Company's NAV showed a positive return, increasing by 4%. After the buoyant end to 2010, equities came under pressure early in the year due to several concerns, some quite unexpected. Political turmoil in North Africa and the Middle East led to increases in oil prices which, coupled with rising food prices, raised the spectre of rising inflation. A devastating 8.8 magnitude earthquake hit the North East of Japan causing a tsunami that resulted in a disruption of component supplies to the electronic and automotive industries. Equities declined significantly during the summer period as investors became worried about economic growth prospects in the United States and as the European debt crisis intensified. In August, there were signs of investor panic over the possibility of a default by Greece. After a difficult third quarter, the market rallied on hopes that the European Summit held in December had finally laid the foundations for a future fiscal union. Markets reasoned that, once Germany had imposed its fiscal rulebook to its single currency partners, moral hazard concerns would dissipate and justify a larger scale intervention by the ECB in bond markets. Meanwhile, signs that inflation was decelerating in Emerging Markets, and in China in particular, opened the door to monetary policy easing after nearly two years of tightening. China cut its required reserve ratio by 50bp in December 2011. As investors reduced "risk" by selling UK equities in the second half of 2011, in general portfolio managers at the start of 2012 were defensively positioned with higher than normal levels of cash. Many investors were both underweight in equities and UK SmallCap in particular. As a result, investors were wrong-footed by the strong January 2012 rally and scrambled to catch up, driving share prices ever higher. Many cyclical companies saw their shares return to 2011 highs. However, even after this recovery, UK SmallCap continues to trade on valuation multiples in line with historical averages. As the Company's Investment Manager, we are always looking ahead seeking to anticipate market sentiment and positioning the portfolio accordingly. The Board determines levels of gearing following recommendation from us. In 2011, we closed the calendar year with one of the highest levels of borrowing ever and were heavily overweight in cyclicals. This was a contrarian position and one that has been vindicated subsequently in 2012. The recent strong recovery in the UK stock market has allowed us to reduce borrowings considerably and to lock-in some profits. Outlook Companies around the world are sitting on large cash balances earning negative real returns. So we expect there to be increasing pressure to either invest or return some of this cash to investors. In addition, we see room for M&A activity to gather momentum as large firms seek external growth (acquisitions) to offset slowing earnings growth. Private equity transactions may also increase in the Small and MidCap sector. In the context of elevated macro-economic and political uncertainty surrounding the Euro, we expect further outperformance of "quality growth" i.e. well-managed companies offering secure earnings growth and good revenue visibility. However, with politicians in the driving seat everywhere and important elections this year, we would not be surprised to see stock market volatility return. Balance sheet strength remains crucial and needs to be watched. Banks will lend but, ironically, mainly to the strong companies which need financing the least. We will not compromise on quality in selecting investments within the portfolio. The Company is well-positioned to benefit from an increased appetite for the highest quality "blue-chip" quoted small companies. We look forward to the coming year with cautious optimism after an encouraging start. Montanaro Asset Management Limited 20 June 2012 Ten Largest Holdings as at 31 March 2012 VictrexPLC - Chemicals Manufacturer of high performance plastics. Â£5.40m 3.6% Â£1,139m Value Portfolio Market Cap Devro PLC - Food Producers Producers of manufactured casings for the food industry, supplying a wide range of products and technical support to manufacturers of sausages, salami, hams and other cooked meats. Â£5.12m 3.5% Â£506m Value Portfolio Market Cap Genus PLC -Pharmaceuticals and Biotechnology Genus is a world leader in applying science to animal breeding creating advances through biotechnology and selling added value products for livestock farming and food producers. Â£5.10m 3.4% Â£769m Value Portfolio Market Cap Dialight PLC -Electronic and Electrical Equipment Applied LED technology (energy saving, improved safety and easy disposal) for industrial and commercial uses including obstruction lighting, traffic and rail signalling. Â£5.06m 3.4% Â£293m Value Portfolio Market Cap Brammer PLC - Support Services A pan-European technical distributor of power transmission components. Â£4.96m 3.3% Â£398m Value Portfolio Market Cap NCC Group PLC - Software and Computer Services A provider of Escrow Solutions, Assurance Testing and Consultancy. Â£4.50m 3.0% Â£309m Value Portfolio Market Cap Domino Printing Sciences PLC - Electronic and Electrical Equipment An international group providing total coding and printing solutions to a wide portfolio of market sectors. Â£4.46m 3.0% Â£620m Value Portfolio Market Cap EnQuest PLC - Oil and Gas Producers EnQuest is an independent oil & gas development and production company with a geographic focus on the United Kingdom Continental Shelf. Â£4.41m 3.0% Â£1,012m Value Portfolio Market Cap Fenner PLC - Industrial Engineering A world leader in reinforced polymer technology. Â£4.34m 2.9% Â£838m Value Portfolio Market Cap SDL PLC - Software and Computer Services Provider of software and services for managing content and language translation. Â£4.26m 2.9% Â£588m Value Portfolio Market Cap Investment Portfolio as at 31 March 2012 Market Value % of Cap Holding Sector Â£000 portfolio Â£m Victrex Chemicals 5,400 3.6 1,139 Devro Food Producers 5,120 3.5 506 Genus Pharmaceuticals and 5,100 3.4 769 Biotechnology Dialight Electronic and Electrical 5,060 3.4 293 Equipment Brammer Support Services 4,964 3.3 398 NCC Group Software and Computer 4,500 3.0 309 Services Domino Printing Sciences Electronic and Electrical 4,464 3.0 620 Equipment EnQuest Oil and Gas Producers 4,413 3.0 1,012 Fenner Industrial Engineering 4,335 2.9 838 SDL Software and Computer 4,264 2.9 588 Services Oxford Instruments Electronic and Electrical 4,252 2.9 682 Equipment James Fisher Industrial Transportation 4,172 2.8 298 RPS Group Support Services 4,149 2.8 519 Fidessa Group Software and Computer 4,137 2.8 613 Services Dignity General Financials 4,060 2.7 445 AG Barr Beverages 3,992 2.7 460 Consort Medical Health Care Equipment and 3,825 2.6 182 Services Shaftesbury Real Estate/Real Estate 3,817 2.6 1,237 Investment Trusts Latchways Support Services 3,692 2.5 118 Croda International Chemicals 3,685 2.5 2,849 Twenty Largest Holdings 87,401 58.9 Domino's Pizza Travel and Leisure 3,669 2.5 701 Brewin Dolphin General Financials 3,540 2.4 438 Ocean Wilsons Holdings Industrial Transportation 3,525 2.4 415 Ricardo Support Services 3,368 2.3 186 Renishaw Electronic and Electrical 3,325 2.2 968 Equipment Dechra Pharmaceuticals Pharmaceuticals and 3,301 2.2 327 Biotechnology Mears Group Support Services 3,194 2.2 223 Aveva Group Software and Computer 2,983 2.0 1,127 Services Carclo Chemicals 2,869 1.9 229 M.P. Evans Group Food Producers 2,850 1.9 257 Premier Oil Oil and Gas Producers 2,746 1.9 2,075 Helical Bar Real Estate/Real Estate 2,369 1.6 224 Investment Trusts Clarkson Industrial Transportation 2,301 1.5 250 Brooks Macdonald Group General Financials 2,297 1.5 142 WSP Group Support Services 2,281 1.5 162 James Halstead Construction and Materials 2,273 1.5 521 Microgen Software and Computer 2,183 1.5 119 Services Primary Health Properties Real Estate/Real Estate 1,899 1.3 216 Investment Trusts Severfield-Rowen Industrial Engineering 1,815 1.2 161 Kewill Software and Computer 1,328 0.9 69 Services Albemarle & Bond Holdings General Financials 1,309 0.9 194 Marshalls Construction and Materials 1,281 0.9 194 Wilmington Group Media 1,208 0.8 81 Abcam Pharmaceuticals and 1,047 0.7 641 Biotechnology Andor Technology Electronic and Electrical 1,020 0.7 156 Equipment Immunodiagnostics Health Care Equipment and 991 0.7 87 Services Total Portfolio 148,373 100.0 Analysis of Investment Portfolio by Industrial or Commercial Sector as at 31 March 2012 Sector % of portfolio % of SmallCap Oil and Gas Producers 4.8 2.3 Oil and Gas 4.8 2.3 Chemicals 8.1 1.0 Industrial Metals - 0.3 Mining - 1.3 Basic Materials 8.1 2.6 Construction and Materials 2.4 4.9 Aerospace and Defence - 1.2 Electronic and Electrical Equipment 12.2 5.5 Industrial Engineering 4.1 3.6 Industrial Transportation 6.8 3.1 Support Services 14.6 15.1 Industrials 40.1 33.4 Automobiles and Parts - 0.3 Beverages 2.7 - Food Producers 5.4 5.0 Household Goods - 2.2 Leisure Goods - 0.7 Other - 0.6 Consumer Goods 8.1 8.8 Health Care Equipment and Services 3.2 1.3 Pharmaceuticals and Biotechnology 6.4 2.3 Health Care 9.6 3.6 General Retailers - 4.2 Media 0.8 5.4 Travel and Leisure 2.5 8.0 Consumer Services 3.3 17.6 Life and Non-life Insurance - 2.5 Real Estate 5.4 16.7 General Financials 7.5 3.4 Financials 12.9 22.6 Software and Computer Services 13.1 6.2 Technology Hardware and Equipment - 2.9 Technology 13.1 9.1 Total 100.0 100.0 The investment portfolio comprises 46 listed UK equity holdings including 7 holdings totalling Â£11,786,000 (representing 7.9% of the portfolio) traded on the Alternative Investment Market ("AIM"). Board of Directors David Gamble - Chairman Roger Cuming Kathryn Matthews Michael Moule Business Review The Business Review has been prepared in accordance with the Companies Act 2006 and should be read in conjunction with the Chairman's statement and the Manager's Report. Introduction The purpose of the Business Review is to provide an overview of the business of the Company by: â€¢ Analysing development and performance using appropriate key performance indicators ("KPIs"). â€¢ Outlining the principal risks and uncertainties affecting the Company. â€¢ Describing how the Company manages these risks. â€¢ Explaining the future business plans of the Company. â€¢ Setting out the Company's environmental, social and ethical policy. â€¢ Providing information about persons with whom the Company has contractual or other arrangements which are essential to the business of the Company. â€¢ Outlining the main trends and factors likely to affect the future development, performance and position of the Company's business. REVIEW OF THE DEVELOPMENT AND PERFORMANCE OF THE Business AND POSITION OF THE BUSINESS AND POSITION OF MUSCIT A description of MUSCIT's activities and a review of the development and performance of the business during the year is given in the Chairman's Statement and in the Manager's Report. MUSCIT is a closed-end investment trust listed on the London Stock Exchange with registration number 3004101. Its affairs are managed so that it receives approval from HM Revenue & Customs as an investment trust under s1158/1159 of the Corporation Tax Act 2010 ("s1158/1159") One of the criteria for compliance is that at least 85% of MUSCIT's eligible investment income arising in an accounting period is distributed to shareholders. The Board considers that MUSCIT will continue to qualify as an investment trust, which confers certain benefits such as exemption from the payment of capital gains taxes arising on the sale of investments. MUSCIT has most recently received approval under s1158 for the year ended 31 March 2011 and an application will be made to HM Revenue & Customs for MUSCIT's status as an investment trust in financial year 2011/12. Further details on the operation of investment trusts can be obtained from the Association of Investment Companies on their website at www.theaic.co.uk. New rules were introduced by HM Revenue and Customs for accounting periods beginning on or after 1 January 2012 and will therefore be applicable to the Company in its year commencing on 1 April 2012. The significant changes are to remove the maximum holding in any one investment of 15% and replace this with a risk diversification approach. The Board have considered this and agreed that the Company's Investment Policy offers suitable risk diversification. In addition in future the Company will be required to distribute a minimum of 85% of all its income as dividend payments compared to the current requirement of 85% of eligible investment income. MUSCIT is also an investment company as defined in Section 833 of the Companies Act 2006. The current portfolio of MUSCIT is such that its shares are eligible for inclusion in an ISA up to the maximum annual subscription limit and the Directors expect this eligibility to be maintained. MUSCIT's investment objective is capital appreciation (rather than income) achieved by investing in small quoted companies listed on the London Stock Exchange or traded on the Alternative Investment Market ("AIM") and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding Investment Companies) Index. No unquoted investments are permitted. The Company seeks to achieve its investment objective by investing in a portfolio of quoted UK small companies. At the time of initial investment, a potential investee company must be profitable and smaller than the largest constituent of the Numis Smaller Companies Index ("NSCI"), formerly RBS HGSC, which represents the smallest 10% of the UK Stock Market by value. At the start of January 2012, the largest company in the NSCI had a market capitalisation of over Â£1.3bn. The Manager focuses on the smaller end of this Index. The Manager will normally limit any one holding to a maximum of 4% of the Company's investments. The portfolio weighting of each investment is closely monitored to reflect the underlying liquidity of the particular company; smaller investments are made in less liquid companies. AIM exposure is also closely monitored by the Board and is limited to 30% of total investments, with Board approval required for exposure above 25%. At 31 March 2012 this was 7.9% (2011: 15.3%) The Manager is focused on identifying high quality niche companies operating in growth markets. This typically leads to investment in companies that enjoy high barriers to entry, pricing power, a sustainable competitive advantage and strong management teams. The portfolio is constructed on a "bottom up" basis and there are no sector constraints. The Board, in consultation with the Manager, is responsible for determining the gearing strategy for the Company. Gearing is used to enhance returns when the timing is considered appropriate. The Company currently has a credit facility of Â£15 million through ING Bank. The Board has agreed to limit borrowings to 25% of shareholders' funds. There are currently 33,475,958 Ordinary 10p shares in issue (2011: 33,475,958) none of which are held in Treasury (2011: nil). Holders of Ordinary shares have unrestricted voting rights of one vote per share at all general meetings of the Company. DESCRIPTION OF THE PRINCIPLE RISKS ASSOCIATED WITH MUSCIT The Board carefully considers the principal risks for MUSCIT and seeks to manage these risks through continual and regular review, policy setting, compliance with and enforcement of contractual obligations and active communication with the Manager, the Administrator and shareholders. The Board applies the principles detailed in the recommendations of the AIC Code as described in the Chairman's Statement. Details of MUSCIT's internal controls may be found in the Corporate Governance section in the full Annual Report and Accounts for the year ended 31 March 2012. Mitigation of the principal risks is sought and achieved in many ways as shown below: Investment Manager:Montanaro has been the Manager of MUSCIT since its launch in 1995. The success of MUSCIT and its strong performance is largely attributable to Montanaro. Should the current Manager not be in a position to continue its management of the Company, performance may be impacted. The Board meetings are attended by the Manager. Montanaro hasone of the largest specialist teams in the UK. Succession planning within Montanaro and recruitment of personnel are closely monitoredby the Board. Investment & Strategy: MUSCIT may underperform its benchmark as a result of poor stock selection, sector allocation or as a result of being geared in a falling market. The Manager meets regularly with the Board to discuss portfolio performance and strategy, and provides the Board and shareholders with monthly reports. The portfolio is well diversified thereby spreading investment risk and reducing stock specific risk. The Board receives and reviews monthly a report of all transactions and, through the forum of its Management Engagement Committee, formally reviews the performance of the Manager on an annual basis. Gearing: one of the benefits of closed-end investment trusts is the ability to use borrowings which can enhance returns in a rising stock market. However, gearing exacerbates movements in the net asset value both positively and negatively and will exaggerate declines in net asset value when prices of quoted UK small companies are falling. The Board monitors and discusses with the Manager the appropriate level of gearing of MUSCIT at each Board meeting. The Board agreed with the Manager to take out a five year borrowing commitment to December 2016. The Board monitors and discusses with the Manager the appropriate level of gearing for the portfolio and whether cash balances held are appropriate. Portfolio Liquidity: as with all small company investment trusts, there are times when the liquidity of the underlying portfolio is poor, such as when small companies are out of favour or during periods of adverse economic conditions. The Manager focuses on "smaller" companies where the opportunities may be more attractive but this can increase overall underlying illiquidity. This may result in the Manager being unable to buy or sell individual holdings within the portfolio. In addition, this may impact the discount of MUSCIT's share price to the net asset value of the portfolio. One of the benefits of investment trusts is that generally the Manager is not forced to buy or sell individual holdings at inopportune times. The Manager constantly reviews the underlying liquidity of the portfolio, which is well-diversified. Particular attention is paid to the AIM holdings, with the Manager providing the Board with liquidity reports at every meeting. Montanaro dealswith a wide range of brokers to enhance their ability to execute and minimise liquidity risk. Liquidity of MUSCIT Shares: as with many small company investment trusts, there are times when the liquidity of the shares of MUSCIT is low. In the case of MUSCIT, many of the shareholders are large financial institutions with a long-term investment horizon. Unlike other investment trusts where private individuals form a larger part of the share register, this may result in fewer shares being traded in MUSCIT on a daily basis and make it difficult at times for investors to buy or sell shares of MUSCIT. The Manager is encouraged by the Board to market the strong investment story of MUSCIT to private client wealth managers and other potential new investors. The goal is to widen the shareholder base to enhance liquidity. In addition, the ability to buy back shares to be held in Treasury for subsequent re-issue enhances the liquidity of MUSCIT shares. Discount Volatility: as with all small company investment trusts, the discount can fluctuate significantly both in absolute terms and relative to its peer group. The Board actively monitors and seeks to manage the discount of MUSCIT and is responsible for share buy backs or issuance from Treasury. Share buy backs may help to reduce the discount. During the year and up to the date of this report, MUSCIT has not used the authority granted at the Annual General Meeting held in 2011 to make market purchases of up to 5,018,046 Ordinary shares.No Ordinary shares are currently held in Treasury. The Board encourages the Manager to market MUSCIT to new investors to increase demand for its shares, which may help to increase liquidity and reduce the discount. Regulatory: a breach of s1158/1159 might lead to MUSCIT being subject to capital gains tax. A breach of rules of the London Stock Exchange might result in censure by the FSA and/or suspension of MUSCIT's listing on the London Stock Exchange. The Board has agreed a service level agreement with the Manager which includes active and regular review of compliance with s1158/1159 and compliance with the Company's published Investment Policy. During the year under review the Administrator reviewed compliance withFSA and London Stock Exchange Rules. This is reviewed at each Board meeting. Operational: if the Administrator's operational procedures proved deficient and its core accounting systems failed, accounting errors might occur resulting in inaccurate net asset valuations, performance data and possibly a qualified audit report and/or loss of s1158/1159 status. The Board monitors operational issues monthly and reviews them in detail at each Board meeting. Financial: inappropriate accounting policies or failure to comply with current or new Accounting Standards might lead to a breach of regulations and/or loss of s1158/1159 status. The Board monitors financial issues monthly and reviews them in detail at each Board meeting. Banking: a breach of MUSCIT's loan covenants might lead to funding being summarily withdrawn and investment holdings potentially being sold at a time of poor liquidity. The main financial covenants to which the Company is subject in respect of the ING Bank N.V. revolving credit facility require it to ensure that total borrowings will not exceed 30% of the adjusted Net Asset Value at any time and that the adjusted Net Asset Value does not fall below Â£39,000,000 at any time. The Board monitors compliance with banking covenants monthly and reviews them with the Administrator and Managerat each Board meeting. Reputational: inadequate or deficient controls of the Administrator or Manager or other third-party providers might result in breaches of regulations and damage the trust and confidence of shareholders in MUSCIT, leading to a widening of the discount. The Board continually monitors and reviews issues that may impact the standing of MUSCIT. Failure to keep current and potential investors informed of the Company's performance and development could result in fewer shares being traded in MUSCIT on a daily basis and also lower investor confidence. The Board and Manager maintain clear and frequent communication with shareholders and potential investorsandare both happy to meet with shareholders. Company Viability: through falling NAV, or a reduction in the size of the Company through purchases of its own shares, the size of the Company could make the continuing existence unviable in the opinion of investors. The Board actively monitors and seeks to manage the discount of MUSCIT and is responsible for share buy backs for cancellation or holding in Treasury. The resultant size of the Company is an important consideration of the decision to undertake buy backs. A description of MUSCIT's system for reviewing its risk-environment is set out above. Analysis of Performance Using Key Performance Indicators Results and Dividends: the results for the year are as set out in the Income Statement. The Directors recommend that a final dividend of 6.76p (2011: final 6.76p) per Ordinary share, amounting to Â£2,263,000 (2011: final Â£2,263,000) to be paid on 10 August 2012 to shareholders on the share register at the close of business on 29 June 2012. Net Asset Value: the NAV per Ordinary share, including revenue reserves, at 31 March 2012 was 436.57p (2011: 421.65p). The Board reviews performance by reference to a number of KPIs and considers that the most relevant KPIs are those that communicate the financial performance and strength of the Company as a whole. The Board and the Manager monitor the following KPIs: â€¢ the NAV over the previous ten years and since launch relative to the benchmark as disclosed in the Chairman's Statement; â€¢ the level of discount over the previous ten years as disclosed in the Chairman's Statement; and â€¢ the Ongoing Charges which were: 2012 2011 Ongoing Charges 1.3% 1.4% Performance fees 0.6% 0.6% Finance costs 0.2% 0.2% Total Ongoing Charges plus 2.1% 2.2% performance fees and finance costs Further KPIs are those which show the Company's position in relation to the investment trust tests which it is required to meet and maintain its investment trust status. SOCIALLY RESPONSIBLE INVESTMENT The Company has no employees and the Board is comprised entirely of non-executive directors. Day-to-day management of the Company's business is undertaken by Montanaro as the Investment Manager and the Company itself has no environmental, social or community policies. In carrying out business with its suppliers the Company aims to conduct itself responsibly, ethically and fairly. STEWARDSHIP CODE The Company has given discretionary voting powers to the Manager, Montanaro. AIC Code Principal 16 recommends that the Board should agree a policy regarding voting rights exercised by Montanaro. However, the Board has agreed that there is no need to set a written policy with Montanaro concerning key operational issues as the Board and Montanaro already have a clear understanding of their respective responsibilities. The Board encourages the Manager to give due consideration to environmental, social and governance matters whilst recognising the overall investment policy and objectives of the Company. Montanaro reports to the Board at every meeting and the Board reviews a full list of all votes cast on the Company's behalf. Montanaro votes against resolutions it considers may damage shareholders' rights or economic interests. Montanaro gives due weight to what it considers to be socially responsible investments, when making investment decisions, but its overriding objective is to produce good investment returns for shareholders. During the year the Manager on behalf of the Company exercised its voting authority as follows: Meetings Number of meetings voted at 49 Number of meetings voted against management or 17 abstained Resolutions Number of resolutions where voted with management 689 Number of resolutions where voted against management 27 or abstained The actual resolutions voted against 8 The full Annual Report and Accounts contain the following statements regarding responsibility for the financial statements. Statement of Directors' Responsibilities in Respect of the Annual Report and the Financial Statements The Directors are responsible for preparing the Annual Report and the financial statements in accordance with the applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial year. Under that law they have elected to prepare the financial statements in accordance with the UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, the Directors are required to; â— select suitable accounting policies and then apply them consistently; â— make judgements and estimates that are reasonable and prudent; â— state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and â—prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements comply with the Companies Act 2006. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and to prevent and detect fraud and other irregularities. Under applicable law and regulations, the Directors are also responsible for preparing a Directors' Report, Directors' Remuneration Report and Corporate Governance Statement that comply with that law and those regulations. The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company's website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. The Directors confirm to the best of their knowledge: â— the Financial Statements, prepared in accordance with UK Accounting Standards, give a true and fair view of the assets, liabilities, financial position and return of the Company; and â— the Chairman's Statement, Investment Manager's Report and Directors' Report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principle risks and uncertainties that it faces. On behalf of the Board DAVID GAMBLE Chairman 20 June 2012 Non-Statutory Accounts The financial information set out below does not constitute the Company's statutory accounts for the years ended 31 March 2012 or 31 March 2011 but is derived from those accounts. Statutory accounts for the year ended 31 March 2011 have been delivered to the Registrar of Companies and statutory accounts for the year ended 31 March 2012 will be delivered to the Registrar of Companies in due course. The Auditor has reported on those accounts; their reports were (i) unqualified, (ii) did not include a reference to any matters to which the Auditor drew attention by way of emphasis without qualifying their report and (ii) did not contain a statement under Section 498 (2) or (3) of the Companies Act 2006. The text of the Auditor's reports can be found in the Company's full Annual Report and Accounts at www.montanarouksmaller.co.uk. Income Statement for the year to 31 March 2012 Year to 31 March 2012 Year to 31 March 2011 Revenue Capital Total Revenue Capital Total Notes Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Gains on investments 10 - 6,607 6,607 - 40,006 40,006 designated as fair value through profit or loss Dividends and interest 2 3,667 - 3,667 3,639 - 3,639 Management fee 3 (781) (782) (1,563) (688) (688) (1,376) Management performance 3 - (812) (812) - (786) (786) fee Other expenses 4 (246) - (246) (316) - (316) Movement in fair value 15 - (75) (75) - - - of derivative financial instruments Net return before 2,640 4,938 7,578 2,635 38,532 41,167 finance costs and taxation Interest payable and 6 (160) (160) (320) (119) (119) (238) similar charges Net return before 2,480 4,778 7,258 2,516 38,413 40,929 taxation Taxation 7 - - - - - - Net return after 2,480 4,778 7,258 2,516 38,413 40,929 taxation Return per Ordinary 9 7.41p 14.27p 21.68p 7.51p 114.75p 122.26p share The total column of this statement is the profit and loss account of the Company. All revenue and capital items in the above statement derive from continuing operations. No Statement of Total Recognised Gains and Losses has been prepared as all such gains and losses are shown in the Income Statement. No operations were acquired or discontinued in the year. The notes below form part of these financial statements. Reconciliation of Movements in Shareholders' Funds for the year to 31 March 2012 Called-up Share Capital Distributable Total equity share premium redemption Special Capital revenue shareholders' capital account reserve reserve reserve reserve funds Year to 31 Notes Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 March 2012 As at 31 3,348 19,307 1,362 4,642 108,565 3,929 141,153 March 2011 Fair value 10 - - - - 6,607 - 6,607 movement of investments Costs - - - - (1,754) - (1,754) allocated to capital Dividends 8 - - - - - (2,263) (2,263) paid in the year Movement of 15 - - - - (75) - (75) fair value of derivative financial instruments Net revenue - - - - - 2,480 2,480 for the year As at 31 3,348 19,307 1,362 4,642 113,343 4,146 146,148 March 2012 Called-up Share Capital Distributable Total equity share premium redemption Special Capital revenue shareholders' capital account reserve reserve reserve reserve funds Year to 31 Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 March 2011 As at 31 3,348 19,307 1,362 4,642 70,152 2,484 101,295 March 2010 Fair value 10 - - - - 40,006 - 40,006 movement of investments Costs - - - - (1,593) - (1,593) allocated to capital Dividends 8 - - - - - (1,071) (1,071) paid in the year Net revenue - - - - - 2,516 2,516 for the year As at 31 3,348 19,307 1,362 4,642 108,565 3,929 141,153 March 2011 The notes below form part of these financial statements. Balance Sheet as at 31 March 2012 31 March 2012 31 March 2011 Notes Â£000 Â£000 Â£000 Â£000 Fixed assets Investments designated at fair 10 148,373 153,175 value through profit or loss Current assets Debtors 12 566 3,838 Cash at bank 21 13,966 406 14,532 4,244 Creditors: amounts falling due within one year Other creditors 13 (1,682) (1,266) Revolving credit facility 14 (15,000) (15,000) (16,682) (16,266) Net current liabilities (2,150) (12,022) Total assets less current 146,223 141,153 liabilities Creditors: amounts falling due 15 (75) - after more than one year Interest rate swap Net assets 146,148 141,153 Share capital and reserves Called-up share capital 16 3,348 3,348 Share premium account 19,307 19,307 Capital redemption reserve 1,362 1,362 Special reserve 4,642 4,642 Capital reserve 113,343 108,565 Distributable revenue reserve 4,146 3,929 Total equity shareholders' 146,148 141,153 funds Net asset value per Ordinary 19 436.57p 421.65p share These financial statements were approved by the Board of Directors on 20 June 2012. DAVID GAMBLE MICHAEL MOULE Company Registered Number: 3004101 The notes below form part of these financial statements. Statement of Cash Flows for the year to 31 March 2012 Year to Year to 31 March 2012 31 March 2011 Notes Â£000 Â£000 Â£000 Â£000 Operating activities Investment income received 3,600 3,548 Deposit interest received 1 1 Interest received on VAT 7 - reclaimed on administration and company secretarial fees Management fees paid (1,558) (1,339) Performance fees paid (786) - Company secretarial fees paid (86) (82) Other cash expenses (216) (233) Net cash inflow from 20 962 1,895 operating activities Servicing of finance Interest and similar charges (148) (286) paid Net cash outflow from (148) (286) servicing of finance Capital expenditure and financial investment Purchases of investments (26,508) (54,882) Sales of investments 41,517 47,554 Net cash inflow/(outflow)from 15,009 (7,328) investing activities Equity dividends paid (2,263) (1,071) Net cash inflow/(outflow) 13,560 (6,790) before financing Financing Proceeds of short-term credit - 5,000 facility Net cashinflowfrom financing - 5,000 Increase/(decrease)in cash 21 13,560 (1,790) The notes below form part of these financial statements. Notes to the Financial Statements at 31 March 2012 1 Accounting Policies Accounting Convention The financial statements are prepared on a going concern basis, under the historical cost convention as modified by the revaluation of fixed asset investments and in accordance with UK applicable accounting standards and the Statement of Recommended Practice regarding the Financial Statements of Investment Trust Companies and Venture Capital Trusts ("SORP") issued in January 2009. The principal accounting policies adopted in the preparation of these financial statements are set out below. These policies have been consistently applied throughout the year and the preceding year. Income Recognition Ddividend income is included in the financial statements when the investments concerned are quoted ex-dividend and shown net of any associated tax credit where applicable. Deposit interest and underwriting commissions receivable are included on an accruals basis. Management Expenses and Finance Costs All expenses are accounted for on an accruals basis. Management fees and finance costs are allocated 50% to the capital reserve and 50% to the revenue account. This is in line with the Board's expectations of long-term returns from the investment portfolio of the Company. Performance fees are charged 100% to capital. Costs arising on early settlement of debt are allocated 100% to capital, in accordance with the requirements of the SORP. All other expenses are allocated in full to the revenue account. Investments Investments are recognised and derecognised on the trade date where a purchase or sale is under a contract whose terms require delivery within the time frame established by the market concerned, and are initially measured at fair value. All investments held by the Company are classified as at "fair value through profit or loss". Investments are initially recognised at cost, being the fair value of the consideration given. After initial recognition investments are measured at fair value, with unrealised gains and losses on investments and impairment of investments recognised in the Income Statement and allocated to capital. For investments actively traded in organised financial markets, fair value is generally determined by reference to quoted market bid prices or closing prices for SETS (London Stock Exchange's electronic trading service) stocks sourced from the London Stock Exchange on the Balance Sheet date, without adjustment for transaction costs necessary to realise the asset. Treasury Shares The consideration paid for shares held in Treasury is presented as a deduction from equity shareholders' funds, in accordance with FRS 25: "Financial Instruments: Disclosure and Presentation". Any profit on the sale of shares out of Treasury is credited to the share premium account in full. Taxation The charge for taxation is based on the net revenue for the year. Deferred taxation is provided in accordance with FRS 19: "Deferred Taxation", on all timing differences that have originated but not reversed by the Balance Sheet date. Deferred taxation assets are only being recognised to the extent that they are regarded as recoverable. Dividends Payable to Shareholders In accordance with FRS 21: "Events after the Balance Sheet date", dividends to shareholders are recognised as a liability in the period in which they have been declared. Therefore, any interim dividends are not accounted for until paid, and final dividends are accounted for when approved by shareholders at an Annual General Meeting. Bank loans and borrowings All bank loans and borrowings are initially recognised at cost, being the fair value of the consideration received, less issue costs where applicable. After initial recognition, all interest bearing loans and borrowings are subsequently measured at amortised cost. Any differences between cost and redemption value is recognised in the Income Statement over the period of the borrowings on an effective interest basis. DERIVATIVE FINANCIAL INSTRUMENTS It is the Company's policy not to trade in derivative financial instruments. However, the Company has utilised an interest rate swap to mitigate its exposure to interest rate changes on its bank loan which is subject to a variable rate of interest. Details can be found in note 15. Derivatives are recognised at fair value. Movement in the fair value of the derivative is recognised in the Income Statement. RESERVES Capital reserve The following are accounted for in this reserve: â€¢ gains and losses on the realisation of investments; â€¢ net movement arising from changes in the fair value of investments that can be readily converted to cash without accepting adverse terms; â€¢ net movement from changes in the fair value of derivative financial instruments; and â€¢ expenses, together with related taxation effect, charged to this account in accordance with the above policies. Special reserve The special reserve was created by a reduction in the share premium account by order of the High Court in August 1998. It can be used for the repurchase of the Company's Ordinary shares. In accordance with the SORP, the consideration paid for shares bought into and held in Treasury is shown as a deduction from the special reserve. Capital redemption reserve The capital redemption reserve accounts for amounts by which the issued capital is diminished through the repurchase of the Company's own shares. 2 Income Year to Year to 31 March 2012 31 March 2011 Â£000 Â£000 Income from investments 3,659 3,638 UK dividend income 3,550 3,574 Overseas dividend income 109 64 Other income Bank interest 1 1 Interest received on VAT reclaimed on 7 - administration and company secretarial fees Total income 3,667 3,639 Total income comprises Dividends from financial assets designated at 3,659 3,638 fair value through profit or loss Interest from financial assets designated at 1 1 fair value through profit or loss Dividends and interest 3,660 3,639 Other income not from financial assets 7 - 3,667 3,639 All investment income has been obtained from investments listed in the UK. 3 Management Fee Year to 31 March 2012 Year to 31 March 2011 Revenue Capital Total Revenue Capital Total Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Management fee 781 782 1,563 688 688 1,376 Performance fee - 812 812 - 786 786 The Manager receives a monthly fee equivalent to 1/12 of 1.0% of the gross assets of the Company valued at the close of business on the last business day of each month and is entitled to a performance fee calculated as described in the Directors' Report in the full Annual Report and Accounts. At 31 March 2012, Â£947,000 (2011: Â£916,000) was due for payment to the Manager. 4 Other Expenses Year to Year to 31 March 2012 31 March 2011 Â£000 Â£000 Administration and company 86 82 secretarial fees VAT reclaimed on administration and (53) - company secretarial fees Auditor's remuneration (also see * below) for: - audit 20 18 Other expenses (including Directors' 193 216 remuneration and VAT) 246 316 * Total fees paid to the Auditor (excluding VAT) for the year, all of which were charged to revenue, comprised: Audit services - statutory audit 19 17 - expenses 1 1 20 18 5 Directors' Remuneration Year to Year to 31 March 2012 31 March 2011 Â£000 Â£000 Total fees 85 91 A breakdown of the Directors' remuneration is set out in the Directors' Remuneration Report in the full Annual Report and Accounts. The fees for the year ending 31 March 2011 include Â£10,000 paid to Directors who retired during the year ending 31 March 2011. The Company has no employees. 6 Interest Payable and Similar Charges Year to 31 March 2012 Year to 31 March 2011 Revenue Capital Total Revenue Capital Total Financial Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 liabilities not at fair value through profit or loss Interest payable on 160 160 320 119 119 238 loan 160 160 320 119 119 238 7 Taxation The current taxation for the year is lower than the standard rate of corporation tax in the UK of 26% (2011: 28%). A reconciliation is provided below: Year to 31 March 2012 Year to 31 March 2011 Revenue Capital Total Revenue Capital Total Â£000 Â£000 Â£000 Â£000 Â£000 Â£000 Return on ordinary 2,480 4,778 7,258 2,516 38,413 40,929 activities before taxation Theoretical 645 1,242 1,887 704 10,756 11,460 corporation tax at 26% (2011: 28%) Effects of: - capital gains - (1,698) (1,698) - (11,202) (11,202) that are not taxable - overseas (28) - (28) (18) - (18) dividend income not liable to corporation tax - UK dividend (901) - (901) (1,001) - (1,001) income not liable to corporation tax - expenses 1 - 1 1 - 1 disallowed for taxation purposes - excess 283 456 739 314 446 760 management expenses - - - - - - At 31 March 2012, the Company had surplus management expenses and non-trade losses of Â£27,605,536 (2011: Â£24,761,775), which have not been recognised as a deferred taxation asset. This is because the Company is not expected to generate taxable income in future periods in excess of the deductible expenses of those future periods and, accordingly, it is unlikely that the Company will be able to reduce future taxation through the use of existing surplus expenses. Due to the Company's status as an investment trust and the intention to continue meeting the conditions required to obtain approval in the foreseeable future, the Company has not provided deferred tax on any capital gains and losses arising on the revaluation or disposal of investments. 8 Dividends Year to Year to 31 March 31 March 2012 2011 Â£000 Â£000 Paid 2011 Final dividend of 6.76p (2011: 2,263 1,071 3.20p) per Ordinary share Proposed 2012 Final dividend of 6.76p (2011: 2,263 2,263 6.76p) per Ordinary share 9 Return per Ordinary Share Year to 31 March 2012 Year to 31 March 2011 Revenue Capital Total Revenue Capital Total Ordinary 7.41p 14.27p 21.68p 7.51p 114.75p 122.26p share Revenue return per Ordinary share is based on the net revenue after taxation of Â£2,480,000 (2011: Â£2,516,000) and 33,475,958 (2011: 33,475,958) Ordinary shares, being the weighted average number of Ordinary shares, excluding any shares held in Treasury. Capital return per Ordinary share is based on net capital gains for the year of Â£4,778,000 (2011: Â£38,413,000), and on 33,475,958 (2011: 33,475,958) Ordinary shares, being the weighted average number of Ordinary shares, excluding any shares held in Treasury. Normal and diluted return per share are the same as there are no dilutive elements on share capital. 10 Investments Year to Year to 31 March 31 March 2012 2011 Â£000 Â£000 Total investments at 148,373 153,175 fair value The investment portfolio comprises 46 listed UK equity holdings including 7 holdings totalling Â£11,786,000 (representing 7.9% of the portfolio) traded on the Alternative Investment Market ("AIM"). Yearto Year to 31 March 31 March 2012 2011 Â£000 Â£000 Opening book cost 105,747 94,272 Opening investment 47,428 15,888 holding gains Opening valuation 153,175 110,160 Movements in the year Purchases at cost 26,702 53,969 Sales - proceeds (38,111) (50,960) Sales - realised 9,606 8,466 gains on sales (Decrease)/ (2,999) 31,540 increase in investment holding gains Closing valuation 148,373 153,175 Closing book cost 103,944 105,747 Closing investment 44,429 47,428 holding gains 148,373 153,175 fair value hierarchy In accordance with FRS 29: "Financial Instruments: Disclosures", the Company must disclose the fair value hierarchy of financial instruments. The fair value hierarchy consists of the following three levels: â— level 1 - quoted prices (unadjusted) in active markets for identical assets or liabilities; â— level 2 - inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and â— level 3 - inputs for the asset or liability that are not based on observable market data (unobservable inputs). For financial instruments (within the scope of FRS 29), which are measured at fair value in the Balance Sheet an entity shall disclose the following for each class of financial instruments: â— the level in the fair value hierarchy into which the fair value measurements are categorised in their entirety; â— any significant transfers between level 1 and level 2 of the fair value hierarchy and the reasons for those transfers; â— for fair value measurements in level 3 of the hierarchy, a reconciliation from the beginning balances to the ending balances. As well as highlighting purchases, sales, and gains and losses, this reconciliation will identify transfers into or out of level 3 and the reasons for those transfers. The table below sets out fair value measurements of financial assets in accordance with FRS 29 fair value hierarchy system: 31 March 2012 31 March 2011 Level 1 Level 2 Total Level 1 Level 2 Total Â£'000 Â£'000 Â£'000 Â£'000 Â£'000 Â£'000 Equity investments 148,373 - 148,373 153,175 - 153,175 148,373 - 148,373 153,175 - 153,175 The table below sets out fair value measurements of financial liabilities in accordance with the FRS 29 fair value hierarchy system: 31 March 2012 31 March 2011 Level 1 Level 2 Total Level 1 Level 2 Total Â£'000 Â£'000 Â£'000 Â£'000 Â£'000 Â£'000 Derivative financial - 75 75 - - - instruments - 75 75 - - - TRANSACTION COSTS During the year, the Company incurred transaction costs of Â£177,000 (2011: Â£ 349,000) and Â£51,000 (2011: Â£90,000) on purchases and sales of investments, respectively. These amounts are deducted in determining gains on investments at fair value as disclosed in the Income Statement. 31 March 2012 31 March 2011 Â£000 Â£000 Net gains on investments at fair value though profit or loss Gains on sales 9,606 8,466 Changes in fair value (2,999) 31,540 6,607 40,006 A list of the investments by market value and an analysis of the investment portfolio by industrial or commercial sector are set out above. 11 Significant Holdings The Company has a holding of 3% or more of the voting rights attached to shares that is material in the context of the financial statements in the following investments: Security % of voting rights Latchways PLC 3.1 12 Debtors 31 March 2012 31 March 2011 Â£000 Â£000 Due from brokers - 3,406 Prepayments and accrued 84 9 income Dividends receivable 482 423 566 3,838 The carrying amount for prepayments, accrued income and dividends receivable disclosed above reasonably approximates to its fair value at the year end and is expected to be realised within a year from the Balance Sheet date. 13 Other Creditors 31 March 2012 31 March 2011 Â£000 Â£000 Due to brokers 471 277 Accruals and deferred 1,211 989 income 1,682 1,266 The carrying amount for accruals and deferred income disclosed above reasonably approximates to its fair value at the year end and is expected to be realised within a year from the Balance Sheet date. 14 Revolving Credit Facility 31 March 31 March 2012 2011 Â£000 Â£000 Falling due within one year 15,000 15,000 15,000 15,000 On December 19 2011 the Company agreed a new Â£15,000,000 Floating Rate Revolving Credit Loan Facility with ING Bank N.V. which replaced its existing Â£ 15,000,000 Revolving Credit Facility with ING bank N.V. At the same time the Company entered into a Â£15,000,000 Interest Rate Swap with ING Bank N.V. The new Floating Rate Revolving Credit Loan Facility is available for a five year term from 19 December 2011 to 19 December 2016. The loan was drawn down until 19 June 2012 and will be rolled over on a six monthly basis. Interest is payable at six month LIBOR plus a margin and MLA costs. The Interest Rate Swap is for five years and enables the Company to fix the effective interest rate of the Â£15,000,000 loan over its term at 4.2921%* per annum. * Including margin and mandatory costs. 15 Derivative Financial Instruments An interest rate swap is an agreement between two parties to exchange fixed and floating rate interest payments based upon interest rates defined in the contract without the exchange of the underlying principle amounts. The Company entered into an agreement on 19 December 2011 which swapped its obligation to pay variable rates of interest for a fixed rate of 4.2921% per annum, until 19 December 2016. The fair value of the derivative financial instrument is shown below: 31 March 2012 31 March 2011 Â£000 Â£000 Opening valuation - - Movement in fair value (75) - (75) - 16 Share Capital 31 March 2012 31 March 2011 Â£000 Â£000 Allotted, called-up and fully paid: 33,475,958 (2011: 33,475,958) Ordinary 3,348 3,348 shares of 10p each Voting rights Ordinary shareholders have unrestricted voting rights at all general meetings of the Company. At the Annual General Meeting on 29 July 2011 the Company was granted the authority to purchase 5,018,046 Ordinary shares. As at 31 March 2012 the Company had remaining authority to repurchase 5,018,046 Ordinary shares. This authority is due to expire at the conclusion of the next Annual General Meeting. During the year no shares were purchased for cancellation. The Company does not have any externally imposed capital requirements. The capital of the Company is managed in accordance with its investment policy in pursuit of its investment objective, both of which are detailed above. 17 Duration of the Company At the Company's AGM held on 31 July 2009 shareholders voted to remove the obligation under the Articles of Association to convene a General Meeting during 2010 for the purpose of voluntarily winding up the Company, as provided for in the Company's Articles of Association. The Company will be required to propose a resolution at a General Meeting every five years thereafter unless, at any AGM held within, and not more than, 18 months prior to the expiry of the relevant period of five years, an Ordinary resolution is passed releasing the Directors from the obligation to convene such a General Meeting. 18 Own Shares Held in Treasury The Company has taken advantage of the regulations which came into force on 1 December 2003 to allow companies, including investment trusts, to buy its own shares and hold them in Treasury for re-issue at a later date. There were no shares held in Treasury at any time during the year. 19 Net Asset Value per Ordinary Share Net asset value per Ordinary share is based on net assets of Â£146,148,000 (2011: Â£141,153,000) and on 33,475,958 (2011: 33,475,958 ) Ordinary shares, being the number of Ordinary shares in issue at the year end. 20 Reconciliation of Net Revenue Before Finance Costs and Taxation to Net Cash Inflow from Operating Activities Year to Year to 31 March 31 March 2012 2011 Â£000 Â£000 Net revenue before finance 2,640 2,635 costs and taxation Management fee (1,594) (1,474) charged to capital Increase in 49 825 creditors Increase in prepayments and (133) (91) accrued income Net cash inflow from operating 962 1,895 activities 21 Reconciliation of Net Cash Flows to Movements in Net Debt Year to Year to 31 March 2012 31 March 2011 Â£000 Â£000 Increase/(decrease) in 13,500 (1,790) cash in year Proceeds of credit - (5,000) facility Movement in net funds 13,560 (6,790) Net debt at beginning (14,594) (7,804) of year Net debt at end of year (1,034) (14,594) ANALYSIS OF NET DEBT 1 April Cash 31 March 2011 flows 2012 Â£000 Â£000 Â£000 Cash at bank 406 13,560 13,966 Debt due in less than (15,000) - (15,000) one year (14,594) 13,560 (1,034) 22 Analysis of Financial Assets and Liabilities As required by FRS 29: "Financial Instruments: Disclosures", an analysis of financial assets and liabilities, which identifies the risk to the Company of holding such items, is given below. BACKGROUND The Company's financial instruments comprise securities, cash balances and debtors and creditors that arise from its operations, for example, in respect of sales and purchases awaiting settlement and debtors for accrued income. The risk management policies and procedures outlined in this note have not changed substantially from the previous accounting period. The Company has little or no exposure to cash flow or foreign currency risk. The principal risks the Company faces in its portfolio management activities are: â— credit risk; â— market price risk, i.e. movements in the value of investment holdings caused by factors other than interest rate or currency movement; â— interest rate risk; â— liquidity risk i.e. the risk that the Company has difficulty in realising assets or otherwise raising funds to meet commitments associated with financial instruments; and â— gearing. The Manager monitors the financial risks affecting the Company on a daily basis. The Directors receive financial information on a monthly basis which is used to identify and monitor risk. (i)Credit Risk Credit risk is the risk of financial loss to the Company if the contractual party to a financial instrument fails to meet its contractual obligations. The carrying amounts of financial assets best represent the maximum credit risk exposure at the Balance Sheet date. The Company's listed investments are held on its behalf by HSBC acting as agent, the Company's custodian. Bankruptcy or insolvency of the custodian may cause the Company's rights with respect to securities held by the custodian to be delayed. The Board monitors the Company's risk by reviewing the custodian's internal controls reports. Investment transactions are carried out with a large number of brokers whose creditworthiness is reviewed by the Manager. Transactions are ordinarily undertaken on a delivery versus payment basis whereby the Company's custodian bank ensures that the counterparty to any transaction entered into by the Company has delivered in its obligations before any transfer of cash or securities away from the Company is completed. The banks at which cash is held are under constant review. The maximum exposure to credit risk at 31 March 2012 was: 31 March 2012 31 March 2011 Â£000 Â£000 Cash at bank 13,966 406 Debtors and 566 3,838 prepayments 14,532 4,244 None of the Company's assets are past due or impaired. (ii)Market Price Risk Market price risk arises mainly from uncertainty about future prices of financial instruments. The value of shares and the income from them may fall as well as rise and shareholders may not get back the full amount invested. The Manager continues to monitor the prices of financial instruments held by the Company on a real time basis. Adherence to the Company's investment objective mitigates the risk of excessive exposure to one issuer or sector. The Board manages the market price risks inherent in the investment portfolio by ensuring full and timely access to relevant information from the Investment Manager. The Board meets regularly and each meeting reviews the investment performance, the investment portfolio and the rationale for the current investment positioning to ensure consistency with the Company's objectives and investment policy. The portfolio does not seek to reproduce the index, investments are selected based upon the merit of individual companies and therefore the portfolio may well diverge from the short-term fluctuations of the benchmark. Fixed asset investments are valued at fair value as detailed in note 1. A list of the Company's equity investments is shown above. In addition, an analysis of the investment portfolio by broad industrial and commercial sector, an analysis of the portfolio by market capitalisation of holdings and a description of the 10 largest equity investments is set out above. The maximum exposure to market price risk is the fair value of investments of Â£148,373,000 (2011: Â£153,175,000). If the investment portfolio valuation fell by 1% from the amount detailed in the financial statements as at 31 March 2012 it would have the effect, with all other variables held constant, of reducing the net capital return before taxation by Â£1,484,000 (2011: Â£1,532,000). An increase of 1% in the investment portfolio valuation would have an equal and opposite effect on the net capital return before taxation. (iii)Interest Rate Risk Changes in interest rates may cause fluctuations in the income and expenses of the Company. The revolving credit facility with ING Bank N.V. is a floating rate facility (see note 14). The amount of such borrowings and the approved levels are monitored and reviewed regularly by the Board. The Company mitigates the risk by the use of an interest rate swap to fix the interest rates on borrowings. The Company received interest on cash deposits over Â£25,000 at a rate of 0.03%. The interest received in the year amounted to Â£1,000 (2011: Â£1,000). The interest risk profile of the Company is given below. If interest rates had reduced by 1% from those paid as at 31 March 2012 it would have the effect, with all other variables held constant, of increasing the net revenue return before taxation on an annualised basis by Â£150,000 (2011: Â£150,000). If there was an increase in interest rates of 1% the net revenue return before taxation on an annual basis would have decreased by Â£ 10,000 (2011: Â£ 150,000). The calculations are based on cash at bank, short-term deposits and the revolving credit facility as at 31 March 2012 and these may not be representative of the year as a whole. Due to the structure of the loan facility, changes in interest rates would not have an effect on the fair value of the loan. (iv)Liquidity Risk Liquidity risk is the risk that the Company will encounter difficulty in meeting obligations associated with financial liabilities. The Manager does not invest in unlisted securities on behalf of the Company. However, the investments held by the Company consist of UK quoted small companies which are inherently less liquid than quoted large companies. The Manager reviews the portfolio liquidity on a regular basis. Short-term flexibility is achieved through the use of bank borrowings. Liquidity risk is mitigated by the fact that the Company has Â£14.5 million cash at bank and short-term debtors which can satisfy its creditors and that as a closed end fund assets do not need to be liquidated to meet redemptions. (v)Gearing Gearing can have amplified effects on the net asset value of the Company. It can have a positive or negative effect depending on market conditions. It is the Company's policy to determine the adequate level of gearing appropriate to its own risk profile. (vi)Use of Derivatives It is the Company's policy not to trade in derivative financial instruments. However the Company has utilised an interest rate swap to mitigate its exposure to interest rate changes on its revolving credit facility. FINANCIAL ASSETS The Company's financial assets consist of listed equity shares, which neither pay interest nor have a maturity date, cash at bank and short-term debtors. No fixed interest assets were held at 31 March 2012 nor during the year. All financial assets are in sterling and disclosed at fair value through profit or loss. FINANCIAL LIABILITIES The Company finances its operations through equity, retained profits and bank borrowings (see note 14). The change in the fair value of financial liabilities during the year was not related to the credit risk profile. The interest rate risk profile of the financial liabilities of the Company as at 31 March 2012 is as follows: Weighted average Period interest until Total rate maturity Â£000 % Years Amounts drawn down under 15,000 3.96 0.22 revolving credit facility Derivative financial instruments 75 0.33 4.22 Financial liabilities upon which 1,682 - - no interest is paid The interest rate risk profile of the financial liabilities of the Company as at 31 March 2011 was as follows: Weighted average Period interest until Total rate maturity Â£000 % Years Amounts drawn down under fixed 15,000 1.61 0.13 revolving credit facility Financial liabilities upon which no interest 1,266 - - is paid The maturity profile of the Company's financial liabilities is as follows: As at As at 31 March 2012 31 March 2011 Â£000 Â£000 In one year or 16,682 16,266 less In more than one but not more than two years - - In more than two years but not more than 75 - five years 16,757 16,266 The Company had Â£nil undrawn under the fixed Revolving Credit Facility at 31 March 2012 (2011: Â£nil). The Company's revolving credit facility is measured at cost and denominated in sterling. All other financial liabilities are in sterling and disclosed at fair value. It is considered that, because of the short-term nature of the facility, cost approximates to fair value. 23 Capital Management Policies The objective of the Company is to achieve capital appreciation through investing in small quoted companies listed on the London Stock Exchange or traded on AIM and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding Investment Companies) Index. No unquoted investments are permitted. In pursuing this long-term objective, the Board has a responsibility for ensuring the Company's ability to continue as a going concern. It must therefore maintain an optimal capital structure through varying market conditions. This involves the ability to: issue and buyback share capital within limits set by the shareholders in general meeting; borrow monies in accordance with the Articles of Association and pay dividends to shareholders out of distributable revenue reserves. Changes to Ordinary share capital are set out in note 16. Dividend payments are set out in note 8. 31 March 2012 31 March 2011 Â£000 Â£000 Called-up share capital 3,348 3,348 Share premium account 19,307 19,307 Capital redemption reserve 1,362 1,362 Special reserve 4,642 4,642 Capital reserve 113,343 108,565 Distributable revenue reserve 4,146 3,929 Total equity shareholders' funds 146,148 141,153 The Company's objectives for managing capital are the same as the previous year and have been complied with throughout the year. 24 Previous Commitments and Contingent Liabilities At 31 March 2012, there were nil capital commitments (2011: nil). 25 Related Party Transactions Under the Listing Rules the Manager is regarded as a related party of the Company. The amounts paid to the Manager are disclosed in note 3. However, the existence of an independent Board of Directors demonstrates that the Company is free to pursue its own financial and operating policies, and therefore, in terms of FRS 8: "Related Party Transactions", the Manager is not considered a related party. The relationship between the Company, its Directors and the Manager is disclosed in the Directors' Report in the full Annual Report and Accounts. Company Summary Investment Objective MUSCIT's investment objective is capital appreciation through investing in small quoted companies listed on the London Stock Exchange or traded on the Alternative Investment Market ("AIM") and to achieve relative outperformance of its benchmark, the FTSE SmallCap (excluding Investment Companies) Index ("SmallCap"). No unquoted investments are permitted. Investment Policy The Company seeks to achieve its objective and to diversify risk by investing in a portfolio of quoted UK smaller companies. At the time of initial investment, a potential investee company must be profitable and smaller than the largest constituent of the NSCI, which represents the smallest 10% of the UK Stock Market by value. At the start of 2012, this was any company below Â£1.3 billion in size. The Manager focuses on the smaller end of this Index. In order to manage risk the Manager will normally limit any one holding to a maximum of 4% of the Company's investments. The portfolio weighting of each investment is closely monitored to reflect the underlying liquidity of the particular company. The Company's AIM exposure is also closely monitored by the Board and is limited to 30% of total investments with Board approval required for exposure to be above 25%. The Manager is focused on identifying high quality niche companies operating in growth markets. This typically leads the Manager to invest in companies that enjoy high barriers to entry, pricing power, a sustainable competitive advantage and strong management teams. The portfolio is therefore constructed on a "bottom up" basis and there are no sectoral constraints placed on the Manager. The Board, in consultation with the Manager, is responsible for determining the gearing strategy of the Company. Gearing is used to enhance returns when the timing is considered appropriate. The Company currently has a credit facility of Â£15 million through ING Bank of which Â£15 million was drawn as at 31 March 2012. The Board has agreed to limit borrowings to 25% of shareholders' funds. Benchmark FTSE SmallCap (excluding Investment Companies) Index ("SmallCap"). Gross Assets Â£162,905,000 as at 31 March 2012. Shareholders' Funds Â£146,148,000 as at 31 March 2012. Market Capitalisation Â£116,496,000 as at 31 March 2012. Capital Structure As at 31 March 2012 and at the date of this report, the Company had 33,475,958 Ordinary shares of 10p each in issue (of which none were held in Treasury). Wind up Date In accordance with the Articles of Association, an Ordinary resolution can be put to shareholders at an Annual General Meeting to be held after 30 November 2012 to release the Directors from the obligation to convene a General Meeting in 2014 for the purpose of winding up the Company. Management Fee The management fee comprises two components: a fixed fee of 1/12 of 1% of the gross assets of the Company, payable monthly in arrears, and a performance fee of 0.1% of the gross assets of the Company for each 1% outperformance (or part thereof) of the Company's NAV against the SmallCap over the financial year, subject to a maximum of 0.5% of the gross assets calculated at the end of the financial year. Administration and Company Secretarial Fees The Company Secretary receives an annual fee of Â£86,000, which is subject to an annual RPI uplift. The Company ceased to pay VAT on its administration and company secretarial fees in October 2008. Sources of Information All information contained within the Chairman's Statement and the Manager's Report has been provided by Montanaro Asset Management Limited unless otherwise noted. National Storage Mechanism A copy of the 2012 Annual Report and Accounts will be submitted shortly to the National Storage Mechanism ("NSM") and will be available for inspection at the NSM, which is situated at: www.hemscott.com/nsm.do. ENDS Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on this announcement (or any other website) is incorporated into, or forms part of, this announcement.

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