Annual Financial Report
ABERFORTH SMALLER COMPANIES TRUST plc
Audited Final Results for the year to 31 December 2010
The following is an extract from the Company's Annual Report and Accounts for
the year to 31 December 2010. The Annual Report is expected to be posted to
shareholders on 31 January 2011. Members of the public may obtain copies from
Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its
website at www.aberforth.co.uk. This will shortly be available for inspection
at the authority's document viewing facility at 25 The North Colonnade, Canary
Wharf, London, E14 5HS.
FEATURES
Net Asset Value Total Return +26.6%
Benchmark Index Total Return +28.5%
Ordinary Share Price Total Return +22.8%
Second Interim Dividend maintained at 13p per Share
The objective of Aberforth Smaller Companies Trust plc (ASCoT) is to achieve a
net asset value total return (with dividends reinvested) greater than on the
RBS Hoare Govett Smaller Companies Index (excluding Investment Companies) over
the long term. ASCoT is managed by Aberforth Partners LLP.
CHAIRMAN'S STATEMENT TO SHAREHOLDERS
Review of 2010 Performance
2010 has been another good year for UK equities. The FTSE 100 gave a total
return (including reinvested dividends) of 12.6%, while the FTSE All-Share
returned 14.5% and the FTSE Small Cap total return index (excluding investment
companies) rose 16.9%. The return on your Company's shares, with dividends
reinvested, was 22.8%, while your Company's net asset value total return was
26.6%. This was surpassed by the performance of your Company's investment
benchmark, the RBS Hoare Govett Smaller Companies Index (excluding investment
companies) (RBS HGSC (XIC)) which gave a return of 28.5%. The Managers' Report
below provides further information on the current year's performance, including
the reasons for the underperformance against benchmark. It also provides
Shareholders with greater insight into what has undoubtedly been an extremely
frustrating five year period for relative performance, particularly when set
against the longer term returns.
Continuation Vote
In viewing the table on page 18, your Board is acutely conscious of the
disappointing five year numbers sitting alongside the excellent long term
numbers. It is against this backdrop that your Board has carefully considered
its recommendation ahead of the three yearly continuation vote in March 2011.
In addition to the Shareholder meetings undertaken by the Managers, your Board
has sought, and received, feedback from Shareholders. As a Board, we strongly
believe that the Company's long term performance has benefited from the
management features offered by Aberforth Partners. Wholly owned by its
partners, Aberforth Partners continues to specialise solely in investment in
small UK quoted companies. The experienced investment personnel are also
significant investors in your Company and have delivered a level of continuity
few in the broader investment trust sector can rival. Aberforth Partners also
brings with it a consistent investment approach around the value investing
style.
These are truly torrid times for value investing. As the Managers' Report
demonstrates in greater detail, value investing within the UK, and especially
the UK smaller companies sector, has never been so out of favour over your
Company's history. Not only is the value style performing as poorly as it did
during the TMT millennium bubble, but it has done so for a longer period than
was the case back then. Investment styles wax and wane but there can be little
doubt that growth and (in most years) momentum have truly held the upper hand
over the past five years. Indeed, the experience in 2010 would suggest that
this trend is intensifying. However, as any stockmarket investor is acutely
aware, no investment style continues unchecked indefinitely. As value
investors, we believe that eventually, "true value will out". And certainly,
for patient investors, the smaller companies/value style segment has
outperformed all others over the longer run.
Your Board believes that investment style has been the overwhelming influence
behind your Company's under-performance against the benchmark. But, during such
a difficult period for value investing, it was almost inevitable that a
"perfect storm" might arrive. It did so in the shape of the exceptional
benchmark index rebalancing in 2009. Last year's Annual Report covered in
detail the impact of the 40 "Fallen Stars" that entered the RBS HGSC benchmark
at the start of 2009. These were once-large companies characterised by high
levels of debt and sizeable pension deficits. Had economic recovery been
delayed, many of them would likely not have survived. Nevertheless, when the
market recovered sharply in 2009, these high risk companies performed extremely
well, and the Company's exposure to them was limited. While this was
detrimental to relative capital performance, many of these companies went on to
make dividend cuts. Suffice it to say that the Company has a much rosier
outlook with regard to future growth in dividends to Shareholders.
Your Company's policy is to hold a continuation vote every three years. Since
the last vote three years ago, your Company's net asset value return has
underperformed its benchmark. However, on the brighter side, it is worth noting
that over this same period, the net asset value return has exceeded the total
return on the FTSE All Share index and has been appreciably larger than the
return on the FTSE Small Cap XIC index. Furthermore, the return to investors,
as measured by your Company's share price return, with dividends reinvested,
very nearly matched the return on the RBS HGSC index.
Under-performance is never an enjoyable experience but, in reviewing the past
three and five years, the Directors have carried out extensive analysis, and
have a comprehensive understanding of the factors behind the numbers. They have
spent much time reviewing the investment process with the Managers, and
continue to have full confidence in the professionalism of Aberforth Partners.
As the Managers' Report highlights, the portfolio is well populated with
soundly financed companies selling on attractive valuations. Your Company is a
large, liquid trust, following a consistent value style, with outstanding long
run performance. It occupies an important place in the market and in the
opportunity set available to investors. As a consequence, your Board
recommends that Shareholders vote in favour of your Company's continuation.
Your Directors intend to do so in respect of their aggregate beneficial
holdings of 135,425 Ordinary Shares.
Dividends
Alas, your Board is neither able, nor naïve enough, to attempt to call the
shift in investment styles, but perhaps the improvement we are seeing in
dividends from the companies in the portfolio offers some cause for optimism.
Your Board is pleased to declare a second interim dividend, in effect a final
dividend, of 13p per share. This results in total dividends for the year of
19p which is the same as last year.
In last year's Chairman's Statement, my predecessor cautiously forecast that
investment income from the portfolio might witness a "further modest decline"
during 2010. Encouragingly, investment income has surprised on the upside,
growing by a healthy 7.4%. Earnings per share for the year were 18.1p,
considerably higher than had been anticipated at the beginning of the year,
thereby resulting in a minimal 0.9p per share draw on revenue reserves to
maintain the current dividend. The Managers' Report provides Shareholders with
greater detail on what has been an excellent year for dividends.
Your Board has always emphasised the importance of the income element of the
total return from equities over the long term. Your Company's dividend per
share has increased on average by 8.2% p.a. and 7.9% p.a. over the past ten and
twenty years respectively, and has been a key component in delivering the long
term record. As we enter 2011, I am optimistic about your Board's ability to
resume this record of increasing the dividend paid to Shareholders.
Gearing
As you are aware, it has been your Company's policy to use gearing in a
tactical manner during its twenty year history. The current gearing was put in
place progressively from mid-2008 and has thus far been beneficial to
Shareholders. As at 31 December 2010, your Company was utilising £52 million of
the £75 million facility provided by The Royal Bank of Scotland plc. As the
Managers' Report covers in more detail, the current valuation levels are
supportive of the maintenance of a geared position. Your Board and Managers are
already in discussion regarding the replacement or rollover of the existing
facility in July 2011. I hope that the improvement we have seen in the
financial sector will be reflected in the terms of our new facility. We have
already seen some evidence of this through improved terms that the Managers
have agreed with the lender for the existing facility. This facility, which
represents 10.5% of Shareholders' funds, provides the Company with access to
liquidity for investment purposes and also to fund share buy-ins as and when
appropriate.
Share Buy-In Authority and Treasury Shares
At the Annual General Meeting in March 2010, the authority to buy-in up to
14.99% of your Company's Ordinary Shares was approved. During the year, 500,208
Ordinary Shares have been bought-in at a total cost of £2.746 million.
Consistent with your Board's stated policy, those Ordinary Shares have been
cancelled rather than held in treasury. Once again, your Board will be seeking
to renew the buy-in authority at the Annual General Meeting on 2 March 2011.
The Board keeps under constant review the circumstances under which the
authority is utilised in relation to the overall objective of seeking to
sustain a low discount.
Board Changes
Marco Chiappelli, who has been a Director for over nine years, will not be
standing for re-election at the forthcoming Annual General Meeting. We are
extremely grateful to Marco for his sound advice and wise counsel, and for his
outstanding contribution as Chairman of the Audit Committee for the last seven
years. David Jeffcoat succeeds Marco as Chairman of the Committee. We wish
Marco all the very best for the future.
Conclusion
2010 has seen a continuing recovery in the share prices of UK smaller companies
from the depths of the fourth quarter of 2008. While bad news over-populates
the nation's media, there is undoubtedly a good news story to be told about
corporates. UK equity investors are enjoying the fruits of that as the Managers
highlight in their report. Small UK quoted companies are very much part of that
story. A strong financial position, coupled with the diligent management of
costs during recent years, is allowing them to reward shareholders through
rising dividends as the business cycle slowly recovers from the global
financial crisis.
The prospects of rising dividends from investee companies - and hence for our
own Shareholders - will hopefully herald a return in the market to a focus on
value, which in turn will lead to an improvement in your Company's relative
performance. In this regard the outperformance versus the benchmark in the
second half of 2010 is an encouraging first step.
Your Board remains confident that the Managers' experience will continue to
benefit your Company over the long term.
Professor Paul Marsh
Chairman
26 January 2011
MANAGERS' REPORT
Introduction
Small UK quoted companies performed well in 2010, with the RBS Hoare Govett
Smaller Companies Index (excluding Investment Companies) (RBS HGSC (XIC) or the
benchmark) securing a total return of 28.5%. A good close to the year took the
benchmark above its previous peak in total return terms, which was set on 1
June 2007. Large companies, as measured by the FTSE All-Share, achieved a
14.5% total return. ASCoT's NAV total return was 26.6%, higher than that of
large companies but below that of the benchmark.
The strong gains enjoyed by equity markets over the past two years have been
driven by three factors.
Early 2009 witnessed a powerful "relief rally". The valuations of a
significant number of UK businesses reflected the risk of bankruptcy. However,
a series of rights issues served to recapitalise these companies and, by
extending the investment horizon, to breathe life into their valuations.
Despite this rally, corporate profits continued to decline through most of 2009
as revenues came under recessionary pressure. However, management teams
reacted promptly with deep restructuring programmes. Thus, when revenues
troughed late in 2009 and began to grow again in 2010, margins recovered
sharply, allowing a surprising number of businesses to exceed their previous
peak profit levels in 2010 - a remarkable feat when viewed in the context of
the global financial crisis.
Concurrently, monetary policy has remained extremely accommodative and indeed
has proceeded to embrace the unconventional measures termed as "quantitative
easing". As central banks have made direct purchases of government debt, bond
yields have moved downwards: in the UK, for example, ten year gilt yields
declined from 4.0% to 3.4% over the course of 2010. With government bond
yields forming the risk free basis of the discount rates used to value
equities, equity valuations may be considered to have benefited.
Investment Background
However, the year under review was punctuated by bouts of concern about the
sustainability of recovery, notably in May and June, when the RBS HGSC (XIC)
declined by 10%. Some of the challenges confronting equity markets are
described in the following paragraphs.
Western economies have depended on emerging markets in general and China in
particular as sources of demand growth through recession and the initial stages
of recovery. However, this reliance on economic imbalances can play both
ways. Inflationary pressures in the emerging world are manifest in renewed
commodity price rises. Of course, higher commodity prices apply too to Western
economies, which would also be affected should policymakers in the emerging
world move to quell the threat of inflation. Moving forward, China's
commitment to its mercantilist growth agenda will be pivotal.
In contrast to the inflationary issues in emerging markets, the focus in the
developed world has been on the robustness of recovery and the risk of the
notorious double-dip. In the US, the recovery has seen GDP return close to its
peak level at the end of 2007. Nevertheless, there is concern about pressures
on the US consumer sector, which has driven recoveries from earlier
recessions. News on housing and employment has been mixed and has generated
considerable short term stockmarket noise. However, the extension of the Bush
administration's tax cuts provides some relief and, cliché though it is,
writing off the US consumer is dangerous.
Europe has been the frequent focus of worries, with first Greece and then
Ireland raising questions about the viability of the single currency. The
markets were still digesting the implications of the Irish bail-out as the year
drew to a close, but it is difficult to believe that sovereign debt concerns in
the euro zone will be confined to 2010 or to Greece and Ireland. It is not all
bad news, however: the export led economies of Northern Europe - notably
Germany - are together much larger than the troubled "PIGS" and are benefiting
from the euro's 7% decline against the dollar in 2010.
In common with many Western economies, with the notable exception to date of
the US, the UK has embraced fiscal austerity. Indeed, the coalition
government's plans for public sector retrenchment are among the most drastic
yet announced. This has polarised opinion among economists, including members
of the Bank of England's Monetary Policy Committee, between those who see a
looming inflationary threat in persistently high CPI data and those who
identify lingering deflationary forces undermining the recovery. It is too
early to judge the merits of the coalition's experiment. However, the key to
its success lies in the ability of the corporate sector to take up the strain
as the public sector deficit narrows. In this, the consumer sector may be seen
as the wild card: its proclivity to save will be influenced by its perceptions
of the success of present economic policy.
Fortunately, the UK's corporate sector is in remarkably good shape, a
characteristic shared with other Western economies. British non-financial
companies have in aggregate generated cash, since the first quarter of 2002.
Thus, businesses on the whole were well prepared for the downturn. And balance
sheets have been further strengthened by cost cutting actions and the
subsequent pick-up in profitability. However, companies have not yet proved
willing to translate their financial wellbeing into the meaningful pick-up in
investment that will ease the economy's reliance on the public sector and
sustain overall economic growth. Private sector investment has recovered from
its recessionary nadir but remains well below its levels in the years leading
up to the credit crunch. So management teams now find themselves with an
intriguing question - what to do with their robust balance sheets. From the
point of view of an equity investor, this is not an unpleasant conundrum.
Investment Performance
ASCoT's 26.6% NAV total return in 2010 was below the 28.5% achieved by its
benchmark. This result continues a frustrating period of relative performance
that can be traced back to 2005. The following paragraphs provide some
explanation for 2010's performance and also draw out themes that help put the
longer term into context. The concluding section of the report, Investment
Outlook, then seeks to outline why your Managers believe that the portfolio is
well positioned to generate an improvement in relative performance over the
next five years.
Your Managers have consistently adhered to a value investment style over the
past 20 years. As a consequence, there have been periods, most notoriously
during the TMT boom at the turn of the century, in which relative performance
was poor, but overall this value philosophy has assisted ASCoT's returns. The
last five years, including 2010, have been extremely adverse for the value
style, favouring instead growth and momentum investors. This has been less
headline-grabbing than was the case during the TMT boom, but research conducted
by the London Business School suggests that the current bear market for value
stocks has been as deep and more prolonged. This research shows that value
stocks within the RBS HGSC (XIC) under-performed the benchmark as a whole by
10.8 percentage points in 2010 and by 34.0 percentage points over the last five
years. Though not insurmountable through good stock selection, this has
represented a major headwind to the value investor.
A related impact is that of size. It may seem strange for a small cap manager
to alight on this influence, but the RBS HGSC (XIC), which represents the
bottom 10% of the total market capitalisation of the UK stockmarket, now takes
in a significant portion of the FTSE 250 index. Indeed, with the largest
company in the benchmark boasting a market capitalisation of £1.3bn, mid cap
companies account for over 72% of the total value of the RBS HGSC (XIC). In
contrast, ASCoT's portfolio has moved steadily more under-weight the FTSE 250
component of the benchmark over the past five years to the extent that its
exposure stood at 44% at the end of 2010. This has proved ill-timed: the FTSE
250 has outstripped the FTSE SmallCap by 58% over the past five years,
including out-performance of 12% in 2010.
There are several factors that may have contributed to the substantially better
returns from the "larger small" companies. A precise quantification is
difficult but your Managers maintain that they have not had to compromise in
terms of fundamentals, such as growth and profitability, when investing in the
"smaller small" companies. The more significant influence has been on a
technical level. Mid caps have benefited from rising trading volumes and
stockmarket liquidity over the past decade, as hedge funds and long-only
managers sought to diversify risk within portfolios dominated by larger
companies. In this process, "smaller small" companies were left behind,
exaggerating the customary discount that reflects their lower liquidity. It is
this widening discount, which amounted to 20% on a forward PE basis at the end
of the year, that your Managers have been seeking to exploit in reallocating
capital from "larger small" companies to "smaller small" companies.
The following table is an attribution analysis, setting out the various
contributions to ASCoT's relative NAV performance through 2010.
For the twelve months ended 31 December 2010 Basis
points
Stock selection (255)
Sector selection (41)
----
Attributable to the portfolio of investments, based on mid prices (296)
(after transaction costs of 54 basis points)
Movement in mid to bid price spread 18
Cash/gearing 171
Purchase of ordinary shares 9
Management fee (82)
Other expenses (8)
----
Total attribution based on bid-prices (188)
----
Note: 100 basis points = 1%. Total Attribution is the difference between the
total return of the NAV and the Benchmark Index (i.e. NAV = 26.61%; Benchmark
Index = 28.49%; difference is -1.88% being -188 basis points).
Overall sector selection made a small negative contribution to relative
performance. One of the stockmarket's strongest themes over recent years, and
one that has intensified during the recovery phase, has been the
out-performance of businesses with high exposure to emerging markets, which
continued to grow while the developed markets languished. This trend has
benefited the commodity sectors and capital goods companies. The portfolio
was under-weight in commodity sectors: the companies available within the
benchmark often have valuations that are highly dependent on the resilience of
underlying commodity prices and, at an early stage of development, tend to
consume cash. Compensating for this positioning was the portfolio's large
over-weighting in capital goods, which benefit from similar demand drivers but
which also boast more attractive cash dynamics. However, the stockmarket's
fondness for this emerging markets trade opened up sizeable valuation
differentials with domestically oriented businesses. Consistent with their
value investment disciplines, your Managers therefore moved capital into
sectors such as Media and General Retailers through the year.
Stock selection made a negative contribution. This impact should be assessed
within the context of the comment on investment style made above. Within each
sector, your Managers' value investment philosophy tends to drive capital into
stocks sitting on lower valuations. This does not mean that the quality of the
underlying business or its growth prospects are ignored. It does mean that in
the trade-off of value and growth, your Managers will, as they always have,
emphasise the former. However, the stockmarket, as already described, has
preferred those businesses with higher growth profiles in the current
environment of economic uncertainty: i.e. genuine growth has attracted a
scarcity premium. This dynamic has exaggerated the "value stretch" within the
benchmark: the relatively narrow band of companies perceived to have reliable
growth prospects has seen its premium to the apparently dreary majority expand.
The strong absolute returns from ASCoT's portfolio meant that its gearing
enhanced NAV performance over 2010.
While many of the companies in which ASCoT invests might be described as out of
fashion for the present mood of the stockmarket, their underlying performance
has been robust, consistent with the benefits of economic recovery and rapid
cost cutting previously described. A demonstration of this fundamental
progress is the portfolio's dividend experience in 2010. The following table
classifies ASCoT's 88 investee companies at the year end by their most recent
dividend action:
Band Nil IPOs Down Flat +0-10% +10-20% + >20%
No. of holdings 15 3 3 23 16 11 17
The "Nil" category includes those companies that did not pay a dividend in
2010. Six of these can be termed structural nil payers, typically technology
businesses at a relatively early stage of development. The other nine may be
considered cyclical nil payers that will come back to the dividend register
once their profits recover. This latter phenomenon is relevant to the wider
small company universe and can have a meaningful effect on aggregate reported
dividend growth. Of the three holdings in the IPO category, two are expected
to go on to pay dividends. Three companies cut their dividends, which is not
an abnormal incidence even in steadier economic conditions. The positive
aspect of the analysis is the number of companies in the three right hand
columns: 44 companies chose to increase their dividends, some by a significant
amount.
Going into recession, your Managers emphasised the tactic of being "paid to
wait" for the eventual upturn: a sustainable dividend yield can provide some
compensation in periods of difficult trading. In the event, 2009 turned out to
be the worst for dividends in the RBS HGSC (XIC)'s history. ASCoT's portfolio
fared less badly, but there were nevertheless some disappointing dividend
decisions. The turnaround encapsulated in the preceding analysis is therefore
welcome and is indicative of the rapid cost reductions implemented by
management teams last year. The dividend recovery has come earlier than your
Managers had expected at the start of 2010 and is clearly supportive of ASCoT's
income account.
As described previously, the corporate sector in the UK is in a relatively
healthy position, with strong cash flows and balance sheets. These are
characteristics that are shared by the small company universe and by ASCoT's
portfolio, and that no doubt assisted company boards in deciding to increase
dividends. Entering 2011, almost 40% of the portfolio was invested in
companies with net cash on their balance sheets at the end of 2010. This
positioning hindered relative returns in 2009 as many highly geared businesses
enjoyed a powerful bounce in their share prices. However, in 2010 the impact
of balance sheet structure was less pronounced and, indeed, the share prices of
several of the indebted businesses that performed so strongly in 2009 slipped
back. Moving forward, your Managers are retaining the portfolio's bias to
strong balance sheets. This is less for defensive reasons and more as a result
of the stockmarket's current reluctance to look beyond the extremely low
returns from cash. Crucially, cash affords businesses a degree of competitive
advantage over rivals still focused on balance sheet repair and also gives
flexibility to make acquisitions or return capital to shareholders. It is not
your Managers' preference to see substantial balances of net cash reside on
balance sheets indefinitely: pressure will mount to deploy cash in a profitable
fashion for shareholders.
M&A activity within the RBS HGSC (XIC) in 2010 picked up from the depressed
levels of 2009, but, with 16 deals completed, was still some way short of the
50 per annum average over the preceding five years. However, the average deal
size rose markedly and, entering 2011, a number of deals were awaiting
completion. Echoing previous cycles, the predators have included large
American companies, which typically trade on higher valuations than their
smaller UK peers and, at the current time, benefit from the weakness of
sterling. The conditions for a further recovery in M&A and de-equitisation in
general are in place. As already noted, companies are under pressure to
utilise their strong balance sheets. Moreover, the gap between the cost of
debt and the cost of equity is wide: at the end of 2010, the BBB sterling 5-7
year corporate bond yield stood at 5%, whereas the portfolio's prospective
ratio of pre tax and interest profit to enterprise value was 13%. Valuations
within the small company universe are attractive, particularly down the scale
of market capitalisations. This has led to often exaggerated bid premiums to
prevailing stockmarket valuations but it has also invited some opportunistic
approaches. So, while the scope for more M&A ought to be of relative advantage
to ASCoT as it has been in the past, your Managers are mindful of balancing the
short term fillip from acquisitions to relative performance against the
intrinsic value of the underlying businesses.
Investment Outlook
From a top down perspective, it is not difficult to identify a series of
challenges to the current recovery in developed economies. The process of
deleveraging already underway is inherently deflationary. Policy makers thus
confront a tricky balancing act as demand from the public sector is reduced and
the willingness of the private sector to take up the slack is still unclear.
Complicating matters is the experiment with the unconventional tool of
quantitative easing, whose effectiveness is compromised by a transmission
mechanism, the banking system, whose focus remains on balance sheet repair.
Furthermore, unlike previous recoveries, there is the emerging markets
dimension: China in particular has played a crucial role in fostering recovery
to date and will remain a key influence on demand in Western economies.
Intriguingly, in the face of these challenges, 2010 drew to a close with a
series of more positive economic data releases in the US. These coincided with
renewed strength in industrial commodity prices and with a marked change in
sentiment within major government bond markets. For illustration, ten year
treasury yields in the US, which had declined steadily through most of the
year, rose from 2.4% to 3.3% through the fourth quarter. The majority of this
increase was driven by higher real yields, rather than by expectations of
increased inflation, which can be interpreted as an indication of stronger real
economic growth. While such a development perhaps says more about where bond
yields themselves had got to, the implications for equities are more positive:
the increase in the risk free rate is offset by the prospect of a more robust
outlook for growth.
However, it is helpful to bear in mind that ASCoT invests in businesses rather
than economies. The corporate sectors in many developed markets are in robust
health, both in absolute terms and relative to the other parts of the economy.
This is certainly the case in the UK and, most relevantly, in the small company
universe. The range of companies available to ASCoT during this upturn is very
different from those that populated the benchmark in the recovery from the
recession in the early 1990s. The intervening "hollowing-out" of UK industry
has left a collection of survivors with international-facing businesses:
roughly half of the revenues generated by portfolio companies in 2010 came from
outside the UK.
The corporate sector is in a fascinating position. In simple terms, it has two
choices. The first, no doubt favoured by policy makers, is to take the strain
from the public sector, using their balance sheets and cash flows to invest for
future growth. The second is to sit tight, enjoying the current period of
margin expansion, allowing balance sheets to strengthen further and
participating, one way or the other, in renewed de-equitisation. While the
merits of these can be debated, perhaps the most important point is that
companies do have a choice: either scenario could be supportive of good returns
for equity investors.
Of course, the probability of good returns is enhanced by attractive starting
valuations. ASCoT's portfolio would seem well positioned, as the table below
suggests.
31 December 2010 31 December 2009
Characteristics ASCoT Benchmark ASCoT Benchmark
Number of companies 88 430 87 448
Weighted average market capitalisation £424m £696m £368m £619m
Price earnings ratio (historic) 11.8x 13.7x 8.1x 11.2x
Dividend yield (historic) 2.5% 2.4% 3.2% 2.7%
Dividend cover (historic) 3.4x 3.0x 3.9x 3.3x
ASCoT's portfolio ended the year on a historic dividend yield of 2.5%. The
decline from last year's 3.2% was driven by a rise in the portfolio's value
over the twelve months and by trading activity. Working in the opposite
direction was the positive dividend experience described previously. The
outlook for continued growth in dividends is supported by the return of
cyclical nil payers to the dividend register and by the portfolio's dividend
cover of 3.4x, which is almost 40% above the average over ASCoT's 20 year life.
The historic PE ratio was 14% below that of the RBS HGSC (XIC) at the end of
the year. This compares with an average discount over ASCoT's history of 8%.
In absolute terms, ASCoT's PE of 11.8x compares with a 20 year average of 13.0x
and, given that profits are still recovering, might be considered low at this
stage of the cycle. However, with the presently low levels of return from
cash, PE ratios struggle to capture the crucial cash dynamic previously
described in this report. The EV/EBITA (i.e. enterprise value to profit before
interest, tax and amortisation), which is your Managers' key valuation metric
in the investment process, adds some colour.
Actual Forecast Forecast
EV/EBITA 2009 2010 2011
ASCoT 9.8x 9.2x 7.7x
The table above sets out the EV/EBITA progression for the year end portfolio.
There are two factors driving the decline in the ratio: first, profits are
expected to grow; and, second, the enterprise value is anticipated to decline
as retained cash flows reduce debt or increase cash. These low valuations,
underpinned as they are by strong cash generation at present levels of
profitability, might offer some downside protection in the event of a
deterioration in trading conditions, or if, indeed, growth forecasts simply
prove too ambitious.
However, low absolute and relative valuations have not necessarily served ASCoT
well over recent years. The key question is what can translate these
attractive valuations into improved relative investment performance going
forward. Though timing is near impossible to call, your Managers identify
three factors worthy of consideration.
As described in the Investment Performance section of this report, the
influences of style and size have acted as headwinds to ASCoT's relative
performance over the last five years. This is unusual in a longer term
context, as the following analysis, based on data from the London Business
School, demonstrates:
Total return pa 5 years 10 years 20 years Since 1955
RBS HGSC* +7.5% +7.8% +11.1% +15.5%
Value component +1.8% +11.1% +13.3% +19.4%
Small component +5.0% +8.6% +11.3% +17.4%
* Extended HGSC (XIC) from 1980 & HGSC for prior dates
In terms of both depth and duration, the present bear market for value
stocks and small stocks within the benchmark is without precedent over the last
55 years. Your Managers - biased as they are by their value investment
philosophy - contend that over the medium term the odds are that the present
style and size headwinds will swing to become tailwinds.
Through the recession, profits growth naturally became more difficult to find.
The valuations of companies capable of consistent growth therefore attained a
scarcity premium. This premium has been sustained through the early stages of
recovery as markets have continued to fret about the fragility of the upturn
and the threat of a double-dip. If, however, the recovery holds, the "need" to
pay up for growth might reasonably be considered to diminish. This might be
accompanied by a lengthening of the market's investment horizon, easing the
present extreme aversion to perceived illiquidity and focusing attention on
neglected "smaller small" companies. In these circumstances, cheaper and
smaller stocks might enjoy a re-rating.
Through the mid 1990s, the stockmarket's focus was on large companies that were
getting larger through mega mergers. Small companies as a consequence
languished. The trigger that set off a twelve year period of out-performance
by the RBS HGSC (XIC) was M&A: with stockmarket investors reluctant to venture
into the small company world, other corporates and private equity houses
stepped up to exploit the valuation opportunities. And, as noted previously,
the conditions for a renewed phase of M&A would appear to be in place.
Ultimately, the precise catalyst for a change in the stockmarket's appetites is
difficult to identify in advance. For your Managers, as value investors, the
key point is that the portfolio is demonstrably cheap in relation both to its
own history and to the benchmark. This value advantage has been achieved by
investing in a collection of sound and profitable businesses that have been
overlooked owing to their size or inability to generate serial upgrades to
their earnings estimates. Thus, in your Managers' judgement, there has been
little compromise in terms of the quality required in securing the portfolio's
valuation characteristics. The investment principles by which the portfolio
has been constructed are essentially the same as those that have driven ASCoT's
successful long term record. While relative performance more recently has been
disappointing, your Managers are confident that these principles are the basis
for an improvement in ASCoT's fortunes in coming years.
Aberforth Partners LLP
Managers
26 January 2011
DIRECTORS' RESPONSIBILITY STATEMENT
Each of the Directors confirm to the best of their knowledge that:
(a) the financial statements, which have been prepared in accordance with
applicable accounting standards, give a true and fair view of the assets,
liabilities, financial position and profit or loss of the Company; and
(b) the Annual Report includes a fair review of the development and performance
of the business and the position of the Company, together with a description of
the principal risks and uncertainties it faces. A summary of these can be found
below.
On behalf of the Board
Professor Paul Marsh
Chairman
26 January 2011
PRINCIPAL RISKS AND RISK MANAGEMENT
The Directors have established an ongoing process for identifying, evaluating
and managing the key risks faced by the Company. This process was in operation
during the year and continues in place up to the date of this report.
The Board believes that the Company has a relatively low risk profile in the
context of the investment trust industry. This belief arises from the fact that
the Company has a simple capital structure; invests only in small UK quoted
companies; has never been exposed to derivatives and does not presently intend
any such exposure; and outsources all the main operational activities to
recognised, well-established firms. Investment in small companies is generally
perceived to carry more risk than investment in large companies. While this is
reasonable when comparing individual companies, it is much less so when
comparing the volatility of returns from diversified portfolios of small and
large companies. The Board believes the Company's portfolio is diversified. In
addition, since returns from small and large companies are not perfectly
correlated, there is an opportunity for investors to reduce risk by holding
portfolios of both small and large companies together.
As the Company's investments consist of small UK quoted companies, the
principal risks facing the Company are market related and include interest
rate, liquidity, credit, and market price risk. An explanation of these risks
and how they are managed follows:
(i) Interest rate risk, being the risk that the interest receivable/payable and
the market value of investment holdings may fluctuate because of changes in
market interest rates.
When the Company decides to hold cash balances, all balances are held on
variable rate bank accounts yielding rates of interest linked to bank base rate
which at 31 December 2010 was 0.5% (2009: 0.5%). The Company's policy is to
hold cash in variable rate bank accounts and not usually to invest in fixed
rate securities. The Company's investment portfolio is not directly exposed to
interest rate risk.
The Company has a bank debt facility of £75,000,000 of which £51,750,000 was
drawn down as at 31 December 2010 (2009: debt facility of £75,000,000, of which
£48,250,000 was drawn down as at 31 December 2009).
(ii) Liquidity risk is the risk that the Company will encounter difficulty
raising funds to meet its cash commitments as they fall due. Liquidity risk may
result from either the inability to sell financial instruments quickly at their
fair values or from the inability to generate cash inflows as required.
The Company's assets comprise mainly readily realisable equity securities
which, if necessary, can be sold to meet any funding requirements though short
term funding flexibility can typically be achieved through the use of bank debt
facilities. The Company's current liabilities all have a remaining contractual
maturity of less than three months with the exception of the bank debt
facility.
(iii) Credit risk is the risk that a counterparty to a financial instrument
will fail to discharge an obligation or commitment that it has entered into
with the Company.
The Company invests in UK equities traded on the London Stock Exchange and
investment transactions are carried out with a large number of FSA regulated
brokers with trades typically undertaken on a delivery versus payment basis and
on a short settlement period.
Cash at bank is held with reputable banks with acceptable external credit
ratings.
The investment portfolio assets of the Company are held by The Northern Trust
Company, the Company's custodian, in a segregated account. In the event of the
bankruptcy or insolvency of Northern Trust the Company's rights with respect to
the securities held by the custodian may be delayed or limited. The Board
monitors the Company's risk by reviewing Northern Trust's internal control
report.
(iv) Market price risk, being the risk that the market value of investment
holdings will fluctuate as a result of changes in market prices caused by
factors other than interest rate or currency rate movement.
The Company's investment portfolio is exposed to market price fluctuations
which are monitored by the investment managers in pursuance of the investment
objective. No derivative or hedging instruments are currently utilised to
specifically manage market price risk. Further information on the investment
portfolio is set out in the Managers' Report. It is not the Managers' policy to
use derivatives to manage portfolio risk.
As at 31 December 2010, all of the Company's financial instruments were
included in the balance sheet at fair value. The fair value approximately
equates to the book value. The investment portfolio consisted of listed
investments valued at their bid price, which represents fair value. Any cash
balances, which are held in variable rate bank accounts, can be withdrawn on
demand with no penalty.
The Company's financial instruments are all denominated in sterling and
therefore the Company is not directly exposed to any significant currency risk.
However, it is recognised that most investee companies, whilst listed in the
UK, will be exposed to global economic conditions and currency fluctuations.
Additional risks faced by the Company, together with the approach taken by the
Board towards them, have been summarised as follows:
(i)Investment objective- is to achieve a net asset value total return (with
dividends reinvested) greater than on the RBS Hoare Govett Smaller Companies
Index (Excluding Investment Companies) over the long term. The performance of
the investment portfolio will often not match the performance of the benchmark.
However, the Board's aim is to achieve the investment objective over the long
term whilst managing risk by ensuring the investment portfolio is managed
appropriately.
(ii)Investment policy - a risk facing the Company is inappropriate sector and
stock selection leading to underperformance relative to the benchmark. The
Managers have a clearly defined investment philosophy and manage a diversified
portfolio. Furthermore, performance against the benchmark and the peer group is
regularly monitored by the Board. The Company may also be affected by events or
developments in the economic environment generally, for example inflation or
deflation, recession and movements in interest rates.
(iii)Share price discount - investment trust shares tend to trade at discounts to
their underlying net asset values. The Board and the Managers monitor the
discount on a daily basis.
(iv)Regulatory risk - failure to comply with applicable legal and regulatory
requirements could lead to suspension of the Company's share price listing,
financial penalties or a qualified audit report. Breach of Section 1158 of the
Corporation Tax Act 2010 could lead to the Company being subject to capital
gains tax. The Board receives quarterly compliance reports from the Secretaries
to monitor compliance with rules and regulations.
(V)Operational/Financial risk - failure of the Managers' accounting systems or
those of other third party service providers could lead to an inability to
provide accurate reporting and monitoring, or potentially lead to the
misappropriation of assets. The Board reviews regular reports on the internal
controls of the Managers and other key third party providers.
(vi) Gearing risk- in rising markets, the effect of borrowings would be
beneficial but in falling markets the gearing effect would adversely affect
returns to Shareholders.
PORTFOLIO INFORMATION
Valuation as at
31 December % of
2010 Total Net
No Company £'000 Assets Business Activity
1 JD Sports Fashion 25,208 3.5 Retailing - sports goods & clothing
2 RPS Group 19,053 2.7 Energy & environmental consulting
3 RPC Group 18,424 2.6 Plastic packaging
4 Anite 18,275 2.5 Software - telecoms & travel
5 e2v technologies 17,120 2.4 Electronic components & subsystems
6 Beazley 16,905 2.4 Lloyds insurer
7 JKX Oil & Gas 16,861 2.4 Oil & gas exploration & production
8 CSR 16,505 2.3 Location & connectivity chips for mobile devices
9 Punch Taverns 15,793 2.2 Leased & managed pub operator
10 Micro Focus International 15,784 2.2 Software - development & testing
Top Ten Investments 179,928 25.2
11 Huntsworth 15,728 2.2 Public relations
12 Bodycote 15,001 2.1 Engineering - heat treatment
13 Tullett Prebon 14,428 2.0 Inter dealer broker
14 ProStrakan Group 14,202 2.0 Speciality pharmaceutical business
15 National Express Group 12,918 1.8 Train, bus & coach operator
16 Millennium & Copthorne Hotels 12,900 1.8 Hotels
17 Collins Stewart 12,724 1.8 Stockbroker & private client fund manager
18 Phoenix IT Group 12,291 1.7 IT services & disaster recovery
19 Holidaybreak 12,044 1.7 Education & holiday services
20 Low & Bonar 11,825 1.6 Manufacture of industrial textiles
Top Twenty Investments 313,989 43.9
21 Mecom Group 11,643 1.6 European newspaper publisher
22 Regus 11,608 1.6 Serviced office accommodation
23 Galliford Try 11,268 1.6 Housebuilding & construction services
24 Future 11,203 1.6 Special interest consumer publisher
25 Lavendon Group 11,132 1.6 Hire of access equipment
26 Dunelm Group 11,049 1.5 Homewares retailer
27 Biocompatibles International 10,554 1.5 Drug-delivery technology
28 Domino Printing Sciences 10,548 1.5 Industrial printers & inks
29 Dialight 10,546 1.5 LED based lighting solutions
30 Keller Group 10,294 1.4 Ground engineering services
Top Thirty Investments 423,834 59.3
Other Investments 345,120 48.0
------- ----
Total Investments 768,954 107.3
Net Liabilities (52,165) (7.3)
------- ----
Total Net Assets 716,789 100.0
------- ----
The Income Statement, Balance Sheet, Reconciliation of Movements in
Shareholders' Funds and summary Cash Flow Statement are set out below:-
INCOME STATEMENT
For the year ended 31 December 2010
(audited)
For the year ended For the year ended
31 December 2010 31 December 2009
Revenue Capital Total Revenue Capital Total
£ 000 £ 000 £ 000 £ 000 £ 000 £ 000
Gains on investments - 140,996 140,996 - 169,395 169,395
Investment income 20,533 - 20,533 19,110 1,183 20,293
Other income 43 - 43 169 - 169
Investment management fee (1,803) (3,005) (4,808) (1,450) (2,417) (3,867)
Other expenses (455) (3,159) (3,614) (437) (2,624) (3,061)
-------- -------- -------- -------- -------- --------
Return on ordinary activities 18,318 134,832 153,150 17,392 165,537 182,929
before finance costs and tax
Finance costs (796) (1,327) (2,123) (579) (965) (1,544)
-------- -------- -------- -------- -------- --------
Return on ordinary activities 17,522 133,505 151,027 16,813 164,572 181,385
before tax
Tax on ordinary activities (10) - (10) - - -
-------- -------- -------- -------- -------- --------
Return attributable to
equity shareholders 17,512 133,505 151,017 16,813 164,572 181,385
====== ======= ======= ====== ======= =======
Returns per Ordinary Share 18.11p 138.08p 156.19p 17.35p 169.84p 187.19p
The Board declared on 26 January 2011 a second interim dividend of 13.0p per
Ordinary Share (2009 - 13.0p). The Board also declared on 4 March 2010 a first
interim dividend of 6.0p per Ordinary Share (2009 interim dividend of 6.0p).
The total column of this statement is the profit and loss account of the
Company. All revenue and capital items in the above statement derive from
continuing operations. No operations were acquired or discontinued in the
period. A Statement of Total Recognised Gains and Losses is not required as all
gains and losses of the Company have been reflected in the above statement.
SUMMARY RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' FUNDS
For the year ended 31 December 2010
(audited)
Capital
Share redemption Special Capital Revenue
Capital reserve reserve reserve reserve Total
£ 000 £ 000 £ 000 £ 000 £ 000 £ 000
Balance as at 31 December 2009 969 19 186,025 362,796 37,113 586,922
Return on ordinary activities after taxation - - - 133,505 17,512 151,017
Equity dividends paid - - - - (18,404) (18,404)
Purchase of Ordinary Shares (5) 5 (2,746) - - (2,746)
------- ------- ------- ------- ------- -------
Balance as at 31 December 2010 964 24 183,279 496,301 36,221 716,789
======= ======= ======= ======= ======= =======
For the year ended 31 December 2009
(audited)
Capital
Share redemption Special Capital Revenue
Capital reserve reserve reserve reserve Total
£ 000 £ 000 £ 000 £ 000 £ 000 £ 000
Balance as at 31 December 2008 969 19 186,192 198,224 38,711 424,115
Return on ordinary activities after taxation - - - 164,572 16,813 181,385
Equity dividends paid - - - - (18,411) (18,411)
Purchase of Ordinary Shares - - (167) - - (167)
-------- -------- -------- -------- -------- --------
Balance as at 31 December 2009 969 19 186,025 362,796 37,113 586,922
======= ======= ======= ======= ======= =======
BALANCE SHEET
As at 31 December 2010
(audited)
31 December 31 December
2010 2009
£ 000 £ 000
Fixed assets:
Investments at fair value through profit or loss 768,954 632,386
-------- --------
Current assets
Debtors 1,620 2,010
Cash at bank 68 362
-------- --------
1,688 2,372
Creditors (amounts falling due within one year) (53,853) (148)
-------- --------
Net current (liabilities)/assets (52,165) 2,224
-------- --------
Total Assets less Current Liabilities 716,789 634,610
Creditors (amounts falling due after more than one year) - (47,688)
-------- --------
Total Net Assets 716,789 586,922
======= =======
Capital and reserves: equity interests
Called up share capital (Ordinary Shares) 964 969
Reserves:
Capital redemption reserve 24 19
Special reserve 183,279 186,025
Capital reserve 496,301 362,796
Revenue reserve 36,221 37,113
-------- --------
Total Shareholders' Funds 716,789 586,922
======= =======
Net Asset Value per Ordinary Share 743.81p 605.90p
SUMMARY CASH FLOW STATEMENT
For the year ended 31 December 2010
(audited)
For the year ended For the year ended
31 December 2010 31 December 2009
£ 000 £ 000 £ 000 £ 000
Net cash inflow from operating activities 15,766 16,833
Taxation (35) -
Returns on investments and servicing of finance (1,739) (2,062)
Capital expenditure and financial investment
Payments to acquire investments (248,066) (238,152)
Receipts from sales of investments 251,430 235,245
-------- --------
Net cash inflow/(outflow) from capital
expenditure and financial investment 3,364 (2,907)
-------- --------
17,356 11,864
Equity dividends paid (18,404) (18,411)
-------- --------
(1,048) (6,547)
Financing
Purchase of Ordinary Shares (2,746) (167)
Net drawdown of bank debt facilities (before costs) 3,500 7,076
-------- --------
(Decrease)/increase in cash (294) 362
======= =======
Reconciliation of net cash flow to movement in net debt
(Decrease)/increase in cash in the year (294) 362
Net drawdown of bank debt facilities (3,500) (6,326)
Amortised costs in respect of the bank debt facility (423) (188)
-------- --------
Change in net debt (4,217) (6,152)
Opening net debt (47,326) (41,174)
-------- --------
Closing net debt (51,543) (47,326)
======= =======
NOTES TO THE FINANCIAL STATEMENTS
1. ACCOUNTING STANDARDS
The financial statements have been prepared under the historical cost
convention, as modified to include the revaluation of investments and in
accordance with applicable accounting standards and the AIC's Statement of
Recommended Practice "Financial Statements of Investment Trust Companies and
Venture Capital Trusts" issued in 2009. The total column of the Income
Statement is the profit and loss account of the Company. All revenue and
capital items in the Income Statement are derived from continuing operations.
No operations were acquired or discontinued in the
period.
The same accounting policies used for the year ended 31 December 2009 have been
applied.
2. INVESTMENT MANAGEMENT FEE
For the year to 31 December 2010
Revenue Capital Total
£ 000 £ 000 £ 000
Investment management fee 1,803 3,005 4,808
====== ====== ======
For the year to 31 December 2009
Revenue Capital Total
£ 000 £ 000 £ 000
Investment management fee 1,450 2,417 3,867
====== ====== ======
3.DIVIDENDS
Year to Year to
31 December 2010 31 December 2009
£000 £000
Amounts recognised as distributions to
equity holders in the period:
Second interim dividend of 13.0p 12,592 12,597
for the year ended 31 December 2009
(2008: 13.0p)
First interim dividend of 6.00p for the year 5,812 5,814
ended 31 December 2010 (2009: 6.0p)
------- ------
18,404 18,411
======= ======
The second interim dividend for the year ended 31 December 2010 of 13.0p will
be paid on 25 February 2011.
4. RETURN PER ORDINARY SHARE
The returns per Ordinary Share are based on:
Year to Year to
31 December 2010 31 December 2009
£000 £000
Returns attributable to Ordinary Shareholders 151,017 181,385
Weighted average number of shares in
issue during the period 96,685,671 96,897,197
5. NET ASET VALUE
The net assets and the net asset value per share attributable to the Ordinary
Shares at each period end are calculated in accordance with their entitlements
in the Articles of Association and were as follows:
31 December 31 December
2010 2009
£000 £000
Net assets attributable 716,789 586,922
Pence Pence
Net asset value attributable per Ordinary Share 743.81 605.90
As at 31 December 2010, the Company had 96,366,792 Ordinary Shares in issue (31
December 2009 - 96,867,000). During the year to 31 December 2010, the Company
bought in and cancelled 500,208 shares (2009 - 33,000 shares ) at a total cost
of £2,746,000 (2009 - £167,000).
6. FURTHER INFORMATION
The foregoing do not constitute statutory accounts (as defined in section 434
(3) of the Companies Act 2006) of the Company. The statutory accounts for the
year ended 31 December 2009, which contained an unqualified Report of the
Auditors, have been lodged with the Registrar of Companies and did not contain
a statement required under section 498(2) or (3) of the Companies Act 2006.
Certain statements in this announcement are forward looking statements. By
their nature, forward looking statements involve a number of risks,
uncertainties or assumptions that could cause actual results or events to
differ materially from those expressed or implied by those statements. Forward
looking statements regarding past trends or activities should not be taken as
representation that such trends or activities will continue in the future.
Accordingly, undue reliance should not be placed on forward looking statements.
The Annual Report is expected to be posted to shareholders on 31 January 2011.
Members of the public may obtain copies from Aberforth Partners LLP, 14
Melville Street, Edinburgh EH3 7NS or from its website at www.aberforth.co.uk.
CONTACT: David Ross/Alistair Whyte, Aberforth Partners LLP, 0131 220 0733
Aberforth Partners LLP, Secretaries - 26 January 2011
ANNOUNCEMENT ENDS
Monday, 20th May 2024
COMPANIES COVERED:
Latest directors dealings
- 15 minutes ago Standard Chartered
- 29 minutes ago Coca-Cola HBC AG (CDI)
- 43 minutes ago Airtel Africa
- 43 minutes ago Xaar
- 1 hour ago SpaceandPeople