Annual Financial Report

RNS Number : 1558O

Shires Smaller Companies PLC

03 March 2009

SHIRES SMALLER COMPANIES PLC

ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 DECEMBER 2008

1. CHAIRMAN'S STATEMENT

Financial Results

It is disappointing to report that 2008 was the most difficult period that your Company has endured in its 17 year history. UK equities produced their worst annual returns for more than 30 years as the global credit crisis accelerated and hit the real economy. For smaller company specialists it proved to be even more challenging. In the year to 31 December 2008, the FTSE Small Cap index (ex Investment Companies) which measures smaller company performance, declined by 48.3%. The Company's NAV per share fell to 87.6p at the period end. The results reflect the poor investment background which also affected our fixed income holdings. Despite weak capital performance, the Board was able to maintain dividend payments at a similar level to 2007 as the revenue account held up reasonably well.

Investment Returns

For the year to 31 December 2008, the total return on net assets was -58.1% compared to the benchmark return on the FTSE Small Cap index (ex IC) of -48.3%.The sharp fall in the Company's NAV was caused by:

- Shires Smaller Companies is a geared investment trust and historically the strategy has benefited performance and income generation. However, in falling markets, gearing has an adverse impact and compounds negative returns;

- The Company has used zero coupon finance (ZCF) as part of its gearing strategy for eight years. However, in September and October 2008, the clearer changed the collateral terms, conditions and costs at short notice citing exceptional market circumstances. The Company was able to meet these new conditions because it had been raising cash from early in the year but the efficiency of this type of financing has been seriously undermined;

- Gearing is employed to invest in UK corporate bonds to be held for yield and as collateral to back the ZCF arrangements. In 2008, turbulence in credit markets caused the corporate bond portfolio to fall in value contributing both to the overall underperformance and the requirement to lodge additional collateral, mainly cash. Preference shares also declined over the period.

The contributions to NAV total return were:

NAV Total Return -58.1%

FTSE Small Cap Index (ex IC) -48.3%

Contribution to NAV attributable to:

Equities -45.4%

Fixed Income -5.4%

Preference Shares -3.3%

Gearing -5.3%

Expenses (net of cash returns and VAT recoverable) 1.3%

Total -58.1%

On a share price basis, the total return to shareholders was -66.4% reflecting the movement in the discount from 17.6% to 32.3%. Discounts widened across the investment trust sector in 2008, particularly in the fourth quarter of the year. By end December 2008, the average investment trust discount was 22% but for some sectors such as smaller companies the discounts widened even further. Investment trusts with gearing such as Shires Smaller were de-rated more than ungeared vehicles. Since the year end, the Company's rating has improved and the discount has narrowed towards 13% on the current NAV of 70p.

Portfolio Profile and Gearing

The portfolio profile changed considerably over the year, as the Manager reacted very quickly to the changing market conditions and raised cash to control and reduce gearing and to provide a cash buffer against further stock market falls. Sales of equities (primarily smaller, less liquid AIM stocks) and bonds increased cash resources from £0.12m at the start of 2008 to around £16m by November 2008. Around £11m of cash was used to repay part of the zero coupon finance which matured in December 2008 and which the Board decided not to renew due to both cost and risk considerations. As a result of this strategy, even though the value of our assets became less as the markets fell sharply, the raising of cash and reduction in debt resulted in gearing declining over the year from 67.1% to 52.1%.

The Board has elected to repay early the September 2009 tranche of zero coupon finance and this was effected from existing cash resources for value 25 February 2009 at a cost of £5.36 million and will make a pre-payment of £3 million to the term loan, again from cash resources. The Board will continue to keep the structure of the Company's balance sheet under review in light of the overall investment objective.

Earnings and Dividends

For the year to 31 December 2008, the revenue return per share was 15.58p per share. The total dividend paid in the year covered by this Annual Report was 15.1p. This comprises the fourth interim dividend in 2007 of 4.9p together with the first three interim dividends paid in 2008 totalling 10.2p. As announced in December 2008, the fourth interim dividend for 2008 was maintained at 4.9p per share and paid to shareholders on 30 January 2009.

After careful consideration of the Company's projected income generation and the reduced gearing levels, the Board anticipates that it will pay a dividend of 7p per share for the year ending 31 December 2009, inclusive of the equivalent of 1p per share relating to the VAT rebate. A dividend of 7p is equivalent to a yield of 11.5% on the current share price of 61p.

The ability to maintain these quarterly dividends will depend on the level of dividends and income generated from the Company's assets and the future gearing and structure in place. Clearly these statements about future dividends are subject to market conditions and the absence of unforeseen conditions.

At this point in time, we expect the 2009 revenue account to face much greater pressure as companies consider cutting their dividends in the face of tough trading conditions and limited availability of credit.

VAT Case

As previously reported, The European Court of Justice ruled that management fees charged to UK investment trusts should be exempt from VAT. I am pleased to report that a rebate of £440,000 has been agreed with the Manager which reflects a full recovery of the VAT charged since 2004 to the date it was last levied and this has been recognised in the Company's accounts for the year under review.

Outlook

The UK economy is officially in recession along with other Western nations including the US and parts of Europe. The slow down is global but worse in those economies struggling with high consumer and corporate debt levels. Uncertainty remains over how effective government and central bank measures will be in preventing a deep and long lasting recession. In the short term, news flow is likely to remain negative and investors should be prepared for further volatility.

Equity markets have fallen significantly and are currently at levels that discount a significant setback in corporate profitability. This is particularly the case for smaller companies which are trading at historical lows compared to their larger peers. In a world of low interest rates, equities are attractive on yield grounds compared to UK gilts and cash. The case is even more compelling for smaller companies which, on average, yield more than the FTSE 100 index. We believe that corporate bonds and smaller companies will eventually recover and that current low valuations present an opportunity to invest selectively for the long term.

H. S. Cathcart

Chairman

2 March 2009

2. MANAGER'S REVIEW

Background

After five years of positive stock market returns, some correction in equities was to be expected. However, the scale, speed and causes of the past year's negative investment returns could not have been predicted. In the first part of 2008, the impact of the credit crisis began to spread outside the financial sectors to affect other areas of the economy such as house building, construction and retailing. At this stage, the economy was slowing down but was still in positive territory. The principal economic concern was the increase in inflation caused by high oil and commodity prices rather than the risk of recession.

Moving into the second half of the year, the financial crisis accelerated causing material damage to global confidence and economic growth. In September, the failure of Lehman Brothers caused carnage on Wall Street and beyond. The global banking system had to be bailed out to prevent systemic failure and major banks ended up part or wholly nationalised by their governments. By the end of 2008, the UK government owned Northern Rock and Bradford & Bingley, became the majority shareholder in Royal Bank of Scotland and encouraged the troubled mortgage provider, HBOS, to merge with Lloyds TSB.

As the year progressed, the credit crunch affected the broader economy causing job losses and eventually tipping the UK economy into recession. GDP contracted by 1.5% in the fourth quarter of 2008 with the slow down broadly based across manufacturing and services. The only good news was that inflation retreated from its highs as energy and commodity prices declined along with global growth prospects. The Bank of England held interest rates at 5% for five months to head off inflation but after the bank bail outs of the autumn, the MPC participated in a concerted effort by global central banks to reduce rates. After a 0.5% reduction in October to 4.5%, UK interest rates were cut every month to 2% by the end of the year. Concerns about inflation had been replaced by concerns over deflation and recession.

As the financial and economic outlook deteriorated, stock markets reported increasingly negative returns. In year under review, the FTSE All Share index declined by 29.9% in total return terms but the outcome was even worse for smaller companies. As investors became more risk averse, smaller companies suffered even more than larger ones. In the year to 31 December 2008, the FTSE Small Cap index (ex IC) decreased by 48.3% in total return terms. In the same period, Shires Smaller Companies made a total return on net assets of -58.1%. In such a difficult year only government bonds and cash made positive returns of 12.8% and 4.8% respectively.

Gearing

Although assets fell sharply in value during the period, the overall gearing ratio declined from 67.1% to 52.1%. The Manager raised cash throughout the year to offset the zero coupon finance and bank loan which together provided the Company's gearing. By November, the Company had cash resources of some £19m and used £11m of this to repay that part of the zero coupon finance which matured on 19 December 2008.

By the year end, the Company's gearing comprised £10m of fixed rate bank debt and £10.4m of zero coupon finance with maturities in September 2009 and January 2010. The Board has elected to repay early the September 2009 tranche of zero coupon finance and this was effected from existing cash resources for value 25 February 2009 at a cost of £5.36 million and will make a pre-payment of £3 milion to the term loan, again from cash resources. The Board will continue to keep the structure under review and to monitor pricing and liquidity in the zero coupon market.

Equity portfolio

The Hoare Govett Smaller Companies 2008 study was recently published and highlighted that this was the second worst year on record for smaller company returns since 1955. The research also demonstrated how much company size affected returns during the year. In 2008, the FTSE 100 declined by 28.3% but the FTSE Small Cap index declined by 48.3% and the AIM index fell by 61.8%, all in total return terms.

In the year to 31 December 2008, the total return on the Company's equity portfolio was -52.4%, 4.2% behind the benchmark index, principally due to stock specific events. During the year, Carter and Carter, a support services company, went into administration and Hat Pin, an AIM listed recruitment company was suspended and is likely to be liquidated. These problem companies offset the out performance from investments in Financials including Highway Insurance which was the subject of an agreed cash bid from Liverpool Victoria.

For much of the year, the investment strategy was focused on raising cash to reduce the Company's gearing. The Manager made a deliberate decision to generate the bulk of the sales from smaller, less liquid AIM holdings. At the start of 2008, the equity portfolio had over 30% of its assets invested in AIM shares. By the end of 2008, this was reduced to only 6 holdings or 7% of equities. The AIM holdings sold included oil and energy sensitive stocks such as Andes Energia, Baltic Oil Terminals, Nautilus Minerals and Circle Oil. Companies exposed to discretionary consumer spending such as Silverjet, Western & Oriental, United Carpets and Powerleague were also part of the disposal program. Given the under performance of AIM companies, the reduction proved to be timely.

At the same time, some re-balancing of sector exposures to diversify the portfolio resulted in lower weightings in Financials and higher weightings in Industrials, Basic Materials, Technology and Consumer Services. When opportunities allowed, new holdings were added but in larger, more liquid smaller companies. In total £8.6m was invested in equities over the period. Financial investments saw significant change starting in early 2008 with the disposal of London Scottish Bank the sub prime lender which announced higher than expected impairment charges and a capital shortfall. The Manager also sold a number of nil yielding stocks such as Origo Sino, an Indian investment bank and Impax Group, the environmental asset management company. Sales of investments in third party funds - Aberforth Geared Capital & Income, Geiger Counter and Midas Income & Growth further reduced the Financials exposure. The weighting in Insurance shares also decreased following the sales of Hardy Underwriting, Nationwide Accident Repair, St James Place and the takeover of Highway Insurance. Some of the disposal proceeds were invested to widen sector exposure. Healthcare was expanded with two new holdings, Care UK which specialises in care for the elderly and Dechra, a veterinary pharmaceutical manufacturer. In Consumer Services, a new holding was established in retailer Mothercare which is successfully expanding its franchise overseas and has a resilient UK business. Remaining with the consumer, a new investment was added in McBride, the own label personal & household products manufacturer. This company is benefiting from trading down by consumers and lower raw material costs as the oil price falls. In Oil & Gas, the AIM companies were sold and a new holding initiated in Venture Production. This company owns and acquires productive North Sea oil and gas assets and is able to fund its growth due to a well capitalised balance sheet and strong cash flow generation. Finally in Industrials, new holdings were added in Umeco, Oxford Instruments and Morgan Sindall. By the year end, the portfolio had achieved greater diversity and improved quality yet remained a focused portfolio of 43 holdings.

Fixed Income Securities

In 2008, non Government bonds performed poorly as spreads widened out to all time highs and liquidity became virtually non existent. In the twelve months to end December, the FTA Government All Stocks index made a total return of 12.8% in contrast to the iBoxx Sterling Non Gilts 1-15 years index, which measures corporate bond performance and declined by 3.6%. The Company's fixed income securities returned -13.4%. Concerns about corporate default rates, bank asset quality, subordinated debt calls and the macro environment were the principal reasons for the underperformance. Bonds issued by Insurance and Financial institutions came under the greatest pressure.

During the year a net £9.6m was raised from the fixed income assets to pay down gearing and provide a cash cushion against further market falls. Where possible the Manager also improved the quality of the portfolio by re-investing in higher quality and more defensive issues. Examples of such transactions included the switch of Compass Group 2012 into Deutsche Telekom 2012 bonds and disposing of Carnival 2012 bonds into the GE Capital UK 2013 issue.

Outlook

The economic news flow continues to deteriorate both in the UK and globally. Further downgrades to GDP forecasts and to corporate earnings are likely this year. Rights issues and dividend cuts are also set to increase as companies try to strengthen balance sheets and conserve cash. However, after last year's considerable setback, a lot of the bad news is discounted in share valuations, particularly at the smaller company end of the stock market. Having traded on a premium to large companies, smaller companies are back to discounts making them relatively attractive. Recovery may however, have to wait till there is clear evidence of improvement in banks and credit markets.

Aberdeen Asset Managers Limited

2 March 2009

3. RESULTS & DIVIDENDS

Financial Highlights

	2008	2007
Net asset value total return	-58.1%	-16.2%
Share price total return	-66.4%	-27.0%
Dividend per share	15.10p	14.95p

Performance (Total return)
	1 year	3 year	5 year
	% return	% return	% return
Net asset value	-58.1	-57.9	-32.0
Share price (based on mid price)	-66.4	-72.4	-56.8
FTSE SmallCap Index (excluding Investment Companies)	-48.3	-47.9	-29.9
FTSE All-Share Index	-29.9	-13.8	+18.6

All figures are for total return and assume re-investment of net dividends excluding transaction costs.

Cumulative Performance{A}

As at 31 December	1998	1999	2000	2001	2002	2003	2004	2005	2006	2007	2008
NAV - diluted	100.0	137.0	143.9	121.3	88.4	106.4	129.6	151.1	168.5	132.7	50.8
NAV total return{A}	100.0	141.6	153.2	136.0	106.9	140.1	182.9	226.3	271.3	227.2	95.2
Share price performance	100.0	129.7	156.3	153.5	109.0	143.8	176.2	197.3	209.6	144.9	43.8
Share price total return{A}	100.0	135.0	169.3	176.3	135.1	194.7	256.9	305.0	342.9	250.3	84.1
Benchmark performance	100.0	149.1	154.9	127.6	89.7	122.7	135.4	157.5	189.2	151.6	75.1
Benchmark total return{A}	100.0	153.5	164.1	138.7	100.2	141.1	159.6	189.8	233.2	191.4	98.9

{A} Total return figures are based on reinvestment of net income.
The figures for 2004 figures were restated following the introduction if International Reporting Standards ('IFRS'). Figures for 2003 and earlier have not been restated.

	Rate per share	xd date	Record date	Payment date
First interim dividend	3.40p	9 April 2008	11 April 2008	30 April 2008
Second interim dividend	3.40p	9 July 2008	11 July 2008	31 July 2008
Third interim dividend	3.40p	8 October 2008	10 October 2008	31 October 2008
Fourth interim dividend	4.90p	7 January 2009	9 January 2009	30 January 2009
2008	15.10p

First interim dividend	3.35p	11 April 2007	13 April 2007	30 April 2007
Second interim dividend	3.35p	11 July 2007	13 July 2007	31 July 2007
Third interim dividend	3.35p	10 October 2007	12 October 2007	31 October 2007
Fourth interim dividend	4.90p	9 January 2008	11 January 2008	31 January 2008
2007	14.95p

Distribution of Assets and Liabilities

	Valuation at		Movement during the year				Valuation at
	31 December					Gains/	31 December
	2007		Purchases	Sales	Other{A}	(losses)	2008
	£'000	%	£'000	£'000	£'000	£'000	£'000	%
Listed investments
Ordinary shares	54,792	107.8	8,581	(25,772)	-	(24,011)	13,590	70.1
Convertibles	1,410	2.8	-	-	-	(230)	1,180	6.1
Corporate bonds	20,636	40.6	3,082	(12,654)	(69)	(3,204)	7,791	40.2
Other fixed interest	8,097	15.9	1,353	(328)	-	(2,214)	6,908	35.7
	_______	_____	________	______	______	______	______	_____
	84,935	167.1	13,016	(38,754)	(69)	(29,659)	29,469	152.1
	_______	_____	________	______	______	______	______	_____

Other non current assets	2,765	5.4					3,048	15.7
Current assets	6,370	12.5					11,747	60.6
Current liabilities	(25,863)	(50.9)					(6,763)	(34.9)
Non current liabilities	(17,375)	(34.1)					(18,126)	(93.5)
	_______	_____	________	______	______	______	______	_____
Net assets	50,832	100.0					19,375	100.0
	_______	_____	________	______	______	______	______	_____
Net asset value per Ordinary share	229.9p						87.6p
	_______						______

{A} Amortisation costs of £69,000 (see note 2).

4. BUSINESS REVIEW

Status of the Company

The Company, which was incorporated in 1992, has received approval as an investment trust by the Inland Revenue for all accounting periods up to and including 31 December 2007 and has since continued to conduct its affairs so as to enable it to retain such approved status. This approval is subject to there being no subsequent enquiry under corporation tax self assessment. The Company is a member of the Association of Investment Companies. The Company is an investment company within the meaning of Section 833 of the Companies Act 2006. So far as the Directors are aware the close company provisions of the Income and Corporation Taxes Act 1988 do not apply to the Company.

Business Review

Activities

The Company is an investment trust. Its subsidiary undertaking, Shirescot Securities Limited, operates as an investment dealing company.

Results and Dividends

The financial statements for the year ended 31 December 2008 appear on pages 26 to 45. Dividends declared and paid in the year amounted to 15.10p per share (2007 - 14.95p).

A fourth interim dividend of 4.90p per share was announced by the Board on 22 December 2008 and paid on 30 January 2009. Under International Financial Reporting Standards (IFRS) this dividend will be accounted for in the financial year ended 31 December 2009.

Principal Risks and Uncertainties

The principal risks facing the Company relate to the Company's investment activities and include market risk, interest rate risk, credit risk and liquidity risk. An explanation of these risks and how they are managed is contained in note 16.

Investment Policy

The Company invests in equities, bonds and preference shares. Investment in corporate bonds and preference shares is primarily to enhance the income generation of the Company. The investment risk within the portfolio is managed by investing in different categories of investments and by the Manager adhering to various guidelines set by the Board. The Board regularly reviews the guidelines to ensure they remain appropriate and Board approval is required before any exceptions are permitted.

Gearing is used with the intention of enhancing long-term returns. The Company's gearing is in the form of bank borrowing and zero coupon finance.

The bank borrowing comprises a fixed rate unsecured loan of £10 million. The loan is due to be repaid in 2010. The interest rate on the loan is fixed at 5.49%.

The zero coupon finance comprises a set of put and call options on the FTSE 100 which generate a premium. The risk of the zero coupon finance is managed by the structure of the put and call options. The structure is such that the Company knows at the outset of the arrangement exactly how much it will require to repay when the options mature irrespective of the level of the FTSE 100.

The risk of the gearing is also managed by investing in corporate bonds, the vast majority of which are investment grade and preference shares of large financial institutions.

Investment Risk

The Directors are responsible for determining the investment policy and the investment objectives of the Company, while the day-to-day management of the Company's assets has been delegated to the Manager. The Manager invests in equities, bonds and preference shares, following their investment processes.

Equity Investment Process

The equity investment process is active and bottom-up, based on disciplined evaluation of companies through direct visits by fund managers. Stock selection is the major source of added value, concentrating on quality first, then value. Top-down investment factors are secondary in the equity portfolio construction, with diversification rather than formal controls guiding stock and sector weights. However, the exposure to equities is limited by investment guidelines drawn up by the Board in conjunction with the Manager. These include:

- Maximum equity gearing of 110% of Net Asset Value

- Maximum 5% of investee companies' ordinary shares

- Maximum 5% the Company's total assets invested in the securities of one company.

- No unquoted investments

Fixed Income Investment Process

The fixed income investment process is an active investment style which identifies value between individual securities. This is achieved by combining bottom-up security selection with a top-down investment approach. Investments in corporate bonds and preference shares are also managed by investment guidelines drawn up by the Board in conjunction with the Manager which include:

- Fixed Income Securities not to exceed 60% of shareholders funds

- No holding in a single fixed interest security to exceed 5% of the total bond issue of the investee company

- Maximum acquisition cost of an Investment Grade bond - £1 million

- Maximum acquisition cost of non-investment grade bond - £500,000

Manager and Company Secretary

Investment management services are provided to the Company by Aberdeen Asset Managers Limited. Company secretarial, accounting and administrative services are provided by Aberdeen Asset Management PLC. The fee is at a rate of 0.75% of shareholders funds plus short and medium-term funding. The contract may be terminated by either the Company or the Manager on the expiry of 12 months' written notice.

Investment Management Agreement

The key terms of the Investment Management Agreement including the calculation of the fee are set out in note 3. The Board believes the fee charged to be competitive with reference to other investment trusts with a similar mandate. The Board considers the continuing appointment of the Manager to be in the best interests of shareholders at this time.

Going Concern

The Board considers that the Group has adequate financial resources to continue in operational existence for the foreseeable future.

4. STATEMENT OF DIRECTORS' RESPONSIBILITIES

The Directors are responsible for preparing the Report & Accounts and the group and parent company financial statements (the 'financial statements'), in accordance with applicable law and regulations. Company law requires the Directors to prepare group and parent company financial statements for each financial year. Under the law they are required to prepare the group financial statements in accordance with IFRSs as adopted by the EU and have elected to prepare the parent company financial statements on the same basis.

The financial statements are required by law and IFRSs, as adopted by the EU, to present fairly the financial position of the group and the parent company and performance of the group; the Companies Act 1985 provides in relation to such financial statements that references in the relevant part of that Act to financial statements giving a true and fair view are references to their achieving a fair presentation.

In preparing each of the group and parent company financial statements, the Directors are required to:

- select suitable accounting policies and then apply them consistently;

- make judgements and estimates that are reasonable and prudent;

- state whether they have been prepared in accordance with IFRSs as adopted by the EU subject to any material departures disclosed and explained in the Notes to the Financial Statements; and

- prepare the financial statements on the going concern basis unless it is inappropriate to presume that the group and the parent company will continue in business.

The Directors confirm that the financial statements comply with these requirements.

The Directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the group and parent company and enable them to ensure that their financial statements comply with the Companies Act 1985. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the group 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.

We confirm to the best of our knowledge:

- the financial statements, prepared in accordance with the applicable accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company; and

- the Directors’ Report includes a fair review of the development and performance of the business and the position of the company, together with a description of the principal risks and uncertainties that the Company faces.

For and on behalf of Shires Smaller Companies plc

J. G. West

Chairman of the Audit Committee

2 March 2009

SHIRES SMALLER COMPANIES PLC

CONSOLIDATED INCOME STATEMENT

		Year ended			Year ended
		31 December 2008			31 December 2007
		Revenue	Capital	Total	Revenue	Capital	Total
	Notes	£'000	£'000	£'000	£'000	£'000	£'000
Gains and losses on investments
Losses on investments at fair value	10	-	(29,659)	(29,659)	-	(11,168)	(11,168)
Fair value movement in zero coupon finance derivatives	13	-	(1,504)	(1,504)	-	(1,119)	(1,119)

Revenue
Dividend income		2,704	-	2,704	3,278	-	3,278
Interest income from investments		1,247	(69)	1,178	1,536	(102)	1,434
Deposit interest		88	-	88	6	-	6
Other income		105	-	105	-	-	-
Net loss of dealing subsidiary		(109)	-	(109)	(162)	-	(162)
		_______	_______	_______	_______	_______	_______
	2	4,035	(31,232)	(27,197)	4,658	(12,389)	(7,731)
		_______	_______	_______	_______	_______	_______
Expenses
Investment management fee	3	(239)	(239)	(478)	(409)	(409)	(818)
VAT recoverable on investment management fees	18	220	220	440	-	-	-
Other administrative expenses	4	(260)	-	(260)	(281)	-	(281)
Finance costs of borrowings	5	(312)	(312)	(624)	(484)	(484)	(968)
		_______	_______	_______	_______	_______	_______
Profit/(loss) before tax		3,444	(31,563)	(28,119)	3,484	(13,282)	(9,798)
Tax expense	6	-	-	-	-	-	-
		_______	_______	_______	_______	_______	_______
Profit/(loss) attributable to equity holders of the Group	7	3,444	(31,563)	(28,119)	3,484	(13,282)	(9,798)
		_______	_______	_______	_______	_______	_______

Earnings/(loss) per Ordinary share (pence)	9	15.58	(142.76)	(127.18)	15.75	(60.07)	(44.32)
		_______	_______	_______	_______	_______	_______

The total column of this statement represents the Group's Income Statement, prepared in accordance with IFRS. The supplementary revenue return and capital columns are both prepared under guidance published by the Association of Investment Companies. All items in the above statement derive from continuing operations. All income and losses are attributable to the equity holders of the parent company. There are no minority interests. All items in the above statement derive from continuing operations. The accompanying notes are an integral part of these financial statements.

SHIRES SMALLER COMPANIES PLC

Balance Sheets

		Group		Company
		As at	As at	As at	As at
		31 December	31 December	31 December	31 December
		2008	2007	2008	2007
	Notes	£'000	£'000	£'000	£'000
Non-current assets
Ordinary shares		13,590	54,792	13,590	54,792
Convertibles		1,180	1,410	1,180	1,410
Corporate bonds		7,791	20,636	7,791	20,636
Other fixed interest		6,908	8,097	6,908	8,097
		_________	_________	_________	_________
Securities at fair value	10	29,469	84,935	29,469	84,935
Zero coupon finance derivatives at fair value	13	3,048	2,765	3,048	2,765
		_________	_________	_________	_________
		32,517	87,700	32,517	87,700
		_________	_________	_________	_________
Current assets
Cash and cash equivalents		9,573	115	9,573	115
Zero coupon finance derivatives at fair value	13	1,154	4,644	1,154	4,644
Investments in dealing subsidiary		-	455	-	-
Other receivables	12	1,020	1,156	1,162	1,647
		_________	_________	_________	_________
		11,747	6,370	11,889	6,406
		_________	_________	_________	_________
Total assets		44,264	94,070	44,406	94,106

Current liabilities
Trade and other payables		(303)	(281)	(303)	(281)
Short-term borrowings		-	(5,554)	-	(5,554)
Zero coupon finance derivatives at fair value	13	(6,460)	(20,028)	(6,460)	(20,028)
		_________	_________	_________	_________
		(6,763)	(25,863)	(6,763)	(25,863)
		_________	_________	_________	_________
Non-current liabilities
Long-term loan		(10,000)	(10,000)	(10,000)	(10,000)
Zero coupon finance derivatives at fair value		(8,126)	(7,375)	(8,126)	(7,375)
		_________	_________	_________	_________
	13	(18,126)	(17,375)	(18,126)	(17,375)
		_________	_________	_________	_________
Net assets		19,375	50,832	19,517	50,868
		_________	_________	_________	_________
Issued capital and reserves attributable to equity holders of the parent
Called up share capital	14	11,055	11,055	11,055	11,055
Share premium account		11,892	11,892	11,892	11,892
Capital redemption reserve		2,032	2,032	2,032	2,032
Retained earnings:
Capital reserve	15	(8,281)	23,282	(8,281)	23,282
Revenue reserve	15	2,677	2,571	2,819	2,607
		_________	_________	_________	_________
		19,375	50,832	19,517	50,868
		_________	_________	_________	_________

Net asset value per Ordinary share (pence):	9	87.63	229.91
		_________	_________	_________	_________

SHIRES SMALLER COMPANIES PLC

Consolidated Statement of Changes in Equity

Year ended 31 December 2008

					Share	Capital
			Share		Premium	Redemption	Capital	Revenue
			Capital		Account	Reserve	Reserve	Reserve	Total
	Notes		£'000		£'000	£'000	£'000	£'000	£'000
As at 31 December 2007			11,055		11,892	2,032	23,282	2,571	50,832
Revenue profit for the year			-		-	-	-	3,444	3,444
Capital losses for the year			-		-	-	(31,563)	-	(31,563)
Equity dividends	8		-		-	-	-	(3,338)	(3,338)
			______		_______	_________	________	_________	______
As at 31 December 2008			11,055		11,892	2,032	(8,281)	2,677	19,375
			______		_______	_________	________	_________	______

Year ended 31 December 2007
					Share	Capital
			Share		Premium	Redemption	Capital	Revenue
			Capital		Account	Reserve	Reserve	Reserve	Total
	Notes		£'000		£'000	£'000	£'000	£'000	£'000
As at 31 December 2006			11,055		11,892	2,032	36,564	2,361	63,904
Revenue profit for the year			-		-	-	-	3,484	3,484
Capital losses for the year			-		-	-	(13,282)	-	(13,282)
Equity dividends	8		-		-	-	-	(3,274)	(3,274)
			______		_______	_________	________	_________	______
As at 31 December 2007			11,055		11,892	2,032	23,282	2,571	50,832
			______		_______	_________	________	_________	______

Company Statement of Changes in Equity

Year ended 31 December 2008
				Share		Capital
		Share		Premium		Redemption	Capital	Revenue
		capital		Account		Reserve	Reserve	Reserve	Total
	Notes	£'000		£'000		£'000	£'000	£'000	£'000
As at 31 December 2007		11,055		11,892		2,032	23,282	2,607	50,868
Revenue profit for the year		-		-		-	-	3,550	3,550
Capital losses for the year		-		-		-	(31,563)	-	(31,563)
Equity dividends	8	-		-		-	-	(3,338)	(3,338)
		______		_______		_________	________	_________	______
As at 31 December 2008		11,055		11,892		2,032	(8,281)	2,819	19,517
		______		_______		_________	________	_________	______

Year ended 31 December 2007
				Share		Capital
		Share		Premium		Redemption	Capital	Revenue
		capital		Account		Reserve	Reserve	Reserve	Total
	Notes	£'000		£'000		£'000	£'000	£'000	£'000
As at 31 December 2006		11,055		11,892		2,032	36,564	2,251	63,794
Revenue profit for the year		-		-		-	-	3,630	3,630
Capital losses for the year		-		-		-	(13,282)	-	(13,282)
Equity dividends	8	-		-		-	-	(3,274)	(3,274)
		______		_______		_________	________	_________	______
As at 31 December 2007		11,055		11,892		2,032	23,282	2,607	50,868
		______		_______		_________	________	_________	______

SHIRES SMALLER COMPANIES PLC

Group and Company Cash Flow Statement

	Year ended		Year ended
	31 December 2008		31 December 2007
	£'000	£'000	£'000	£'000
Cash flows from operating activities
Investment income received		4,542		5,052
Deposit interest received		77		6
Money market interest received		105
Investment management fee paid		(442)		(864)
Net sales of dealing subsidiary		346		-
Other cash expenses		(264)		(299)
		_________		_________
Cash generated from operations		4,364		3,895
Interest paid		(624)		(966)
		_________		_________
Net cash inflows from operating activities		3,740		2,929
		_________		_________
Cash flows from investing activities
Purchases of investments	(13,016)		(32,004)
Sales of investments	38,740		33,740
Special dividends	-		90
	_________		_________
Net cash inflow from investing activities		25,724		1,826
		_________		_________
Cash flows from financing activities
Equity dividends paid	(3,338)		(3,272)
Repayment of December 2008 ZCF position	(16,098)		-
Proceeds from September 2009 ZCF tranche	4,984		-
	_________		_________
Net cash outflow from financing activities		(14,452)		(3,272)
		_________		_________
Net increase in cash and cash equivalents		15,012		1,483
Cash and cash equivalents at start of year		(5,439)		(6,922)
		_________		_________
Cash and cash equivalents at end of year		9,573		(5,439)
		_________		_________
Cash and cash equivalents comprise:
Cash and cash equivalents		9,573		115
Short-term borrowings		-		(5,554)
		_________		_________
		9,573		(5,439)
		_________		_________

SHIRES SMALLER COMPANIES PLC

YEAR ENDED 31 DECEMBER 2008

NOTES TO THE FINANCIAL STATEMENTS

1.	Accounting policies
	(a)	Basis of accounting
		The financial statements of the Group and Company have been prepared in accordance with International Financial Reporting Standards (IFRSs) which comprise standards and interpretations approved by the International Accounting Standards Board ('IASB'), and International Accounting Standards and Standing Interpretations Committee interpretations approved by the International Accounting Standards Committee ('IASC') that remain in effect, and to the extent that they have been adopted by the European Union.

		The financial statements have been prepared under the historical cost convention as modified to include the revaluation of securities held at fair value and on the assumption that approval as an investment trust will continue to be granted. The principal accounting policies adopted are set out below. These policies have been applied consistently throughout the year. Where presentational guidance set out in the Statement of Recommended Practice ('SORP') for investment trusts issued by the Association of Investment Companies in January 2009 is consistent with the requirements of IFRS, the Directors have sought to prepare the financial statements on a basis compliant with the recommendations of the SORP except as referred to in paragraph (f) and (j) below. The effects on capital and revenue of the items involving departures from the SORP are set out under risk management - Income Enhancement in note 17. The early adoption of the January 2009 SORP had no effect on the financial statements of the Company, other than the requirement to separately disclose capital reserves that relate to the revaluation of investments held at the reporting date. These are disclosed at note 10. This new requirement replaces the previous requirement to disclose the value of the capital reserve that was unrealised.

		In order to better reflect the activities of an investment trust company and in accordance with guidance issued by the AIC, supplementary information which analyses the Income Statement between items of a revenue and capital nature has been presented alongside the Income Statement. In accordance with the Company's status as a UK investment company under Section 266 of the Companies Act 1985, net capital returns may not be distributed by way of dividend. Additionally, the net revenue of the Company is the measure the Directors believe appropriate in assessing the Group's compliance with certain requirements set out in Section 842 of the Income and Corporation Taxes Act 1988.

		The Company did not adopt any new or amended IFRS and IFRIC interpretations during the year which had any effect on the financial statements of the Company, or require additional disclosures.

		At the date of authorisation of these financial statements, the following Standards and Interpretations were in issue but not yet effective:
		- Amendment to IAS 1 - Presentation of Financial Statements: A Revised Presentation (effective for annual periods beginning on or after 1 January 2009)
		- Amendments to IAS 23 - Borrowing Costs (effective for annual periods beginning on or after 1 January 2009)
		- Amendments to IAS 27 - Consolidated and Separate Financial Statements (effective for annual periods beginning on or after 1 January 2009)
		- Amendments to IAS 32 and IAS 1 - Puttable Financial Instruments and Obligations arising on Liquidation (effective for annual periods beginning on or after 1 January 2009)
		- Amendments to IAS 39 - Financial Instruments: Recognition and Measurement (effective for annual periods beginning on or after 1 January 2009)

		The Directors anticipate that the adoption of these Standards and Interpretations in future periods will have no material financial impact on the financial statements of the Group. The Group concludes however that certain additional disclosures may be necessary on their application.

	(b)	Consolidation
		The consolidated financial statements incorporate the financial statements of the Company and entity controlled by the Company (its subsidiary) made up to 31 December each year. Control is achieved where the Company has the power to govern the financial and operating policies of an investee entity so as to obtain benefits from its activities. All intra-group transactions, balances, income and expenses are eliminated on consolidation. The Company has availed itself of the relief from showing an Income Statement for the parent company, granted under Section 230 of the Companies Act 1985.

	(c)	Investments
		Investments are recognised or derecognised on the trade date where a purchase or sale is under a contract whose terms require delivery within the timeframe established by the market concerned, and are initially measured at fair value.

		All investments are designated upon initial recognition as held at fair value and are measured at subsequent reporting dates at their fair value, which is the bid price as at close of business on the Balance Sheet date.

		Gains and losses arising from the changes in fair value are included in net profit or loss for the period as a capital item. Transaction costs are treated as a capital cost.

	(d)	Investments in dealing subsidiary undertaking
		Investments held are shown as current assets at fair value. Gains and losses arising on these investments are dealt with in the revenue column of the Consolidated Income Statement.

	(e)	Zero Coupon Finance
		The Company has in place medium-term funding in the form of zero coupon finance through a series of option transactions on the FTSE 100 Index. The option contracts are accounted for as separate derivative contracts and therefore are shown on the Balance Sheet at their fair value i.e. market value adjusted for the amortisation of transaction expenses. Changes in the fair value of the option contracts are charged or credited to capital and presented as a capital item in the Income Statement.

	(f)	Income
		Dividend income from equity investments including preference shares which have a discretionary dividend is recognised when the shareholders' rights to receive payment have been established, normally the ex-dividend date.

		Interest from debt securities which include preference shares which do not have a discretionary dividend are accounted for on an effective yield basis. Any write off of the premium or discount on acquisition as a result of using this basis is allocated against capital reserve. The SORP recommends that such a write off should be allocated against revenue. The Directors believe this treatment is not appropriate for a high yielding investment trust which frequently trades in debt securities and believe any premium or discount paid for such an investment is a capital item.

		Interest receivable on AAA rated money market funds and short term deposits are accounted for on an accruals basis.

		Underwriting commission is taken to revenue, unless any shares underwritten are required to be taken up, in which case the proportionate commission received is deducted from the cost of the investment.

	(g)	Expenses
		All expenses are accounted for on an accruals basis. In respect of the analysis between revenue and capital items presented within the Income Statement, all expenses have been presented as revenue items except those where a connection with the maintenance or enhancement of the value of the investments held can be demonstrated. Accordingly the investment management fee and finance costs have been allocated 50% to revenue and 50% to capital, in order to reflect the Directors expected long-term view of the nature of the investment returns of the Company.

	(h)	Bank borrowings
		Interest-bearing bank loans and overdrafts are recorded at the proceeds received. Finance charges, including premiums payable on settlement or redemption and direct issue costs, are accounted for on an accruals basis in the Income Statement using the effective interest rate method.

	(i)	Finance costs and long-term borrowings
		Long-term borrowings are stated at the amount of the proceeds of issue net of expenses. The finance costs, being the difference between the net proceeds of borrowing and the total amount of payments that require to be made in respect of that borrowing, accrue evenly over the life of the borrowing and are allocated between capital and revenue.

		Finance costs have been allocated 50% to revenue and 50% to capital in the Income Statement, in order to reflect the Directors expected long-term view of the nature of the investment returns of the Company.

	(j)	Taxation
		The tax payable is based on the taxable profit for the year. Taxable profit differs from net profit as reported in the Income Statement because it excludes items of income or expenditure that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The Group has no liability for current tax.

		Deferred tax is provided in full on timing differences which result in an obligation at the Balance Sheet date to pay more tax, or a right to pay less tax, at a future date at rates expected to apply when they crystallise, based on current tax rates and law. Timing differences arise from the inclusion of items of income and expenditure in taxation computations in periods different from those in which they are included in financial statements. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that they will be recovered.

		The SORP requires that a transfer should be made from income to capital equivalent to the tax value of any management expenses that arise in capital but are utilised against revenue. The Directors consider that this requirement is not appropriate for an investment trust with an objective to provide a high and growing dividend that does not generate a corporation tax liability. Given there is only one class of shareholder and hence overall the net effect of such a transfer to the net asset value of the shares is nil no such transfer has been made.

	(k)	Foreign currencies
		Transactions involving foreign currencies are converted at the rate ruling at the time of the transaction. Assets and liabilities in foreign currencies are translated at the closing rates of exchange at the Balance Sheet date. Any gain or loss arising from a change in exchange rate subsequent to the date of the transaction is included as an exchange gain or loss in capital reserve or the revenue account as appropriate.

		2008	2007
2.	Income	£'000	£'000
	Income from investments
	Dividend income from equity securities	2,704	3,278
	Interest income from investments	993	933
	Overseas interest	254	603
		____________	____________
		3,951	4,814
		____________	____________
	Other income
	Deposit interest	88	6
	Interest from AAA rated money market funds	105	-
	Decrease in fair value of investments in subsidiary	(109)	(162)
		____________	____________
		84	(156)
		____________	____________
	Total revenue income	4,035	4,658
		____________	____________

	As per note 1 (f), the Company amortises the premium or discount on acquisition on debt securities against unrealised capital reserve. For 2008 this represented £69,000 (2007 - £102,000) which has been reflected in the capital column of the Income Statement.

		2008			2007
		Revenue	Capital	Total	Revenue	Capital	Total
3.	Investment Management fees	£'000	£'000	£'000	£'000	£'000	£'000
	Investment management fee	239	239	478	360	360	720
	VAT paid	-	-	-	49	49	98
		______	______	______	______	______	______
		239	239	478	409	409	818
		______	______	______	______	______	______

	For the year ended 31 December 2008 management and secretarial services were provided by Aberdeen Asset Managers Limited. The fee is at an annual rate of 0.75%, calculated monthly and paid quarterly. The fee is allocated 50% to capital and 50% to revenue.

	The fee for the year ended 31 December 2008 was exclusive of VAT whereas the fee for 2007 included VAT up to the quarter ended 30 September 2007. Note 18 provides further information on the status with regards to the recoverability of VAT previously charged on management fees and its implications for the Company.


4.	Other administrative expenses	£'000	£'000
	Directors' remuneration - fees as Directors	71	68
	Fees payable to auditors and associates:
	- fees payable to the Company's auditors for the audit of the annual accounts	18	16
	- fees payable to the Company's auditors and its associates for other services:
	- taxation services	-	7
	Other management expenses	171	190
		________	________
		260	281
		________	________
	The Company had no employees during the year (2007 - nil). No pension contributions were paid for Directors (2007 - £nil).

		2008			2007
		Revenue	Capital	Total	Revenue	Capital	Total
5.	Finance costs and borrowings	£'000	£'000	£'000	£'000	£'000	£'000
	Loan repayable in two to five years	276	276	552	276	276	552
	Bank loans and overdrafts	36	36	72	208	208	416
		______	______	______	______	______	______
		312	312	624	484	484	968
		______	______	______	______	______	______

6.	Taxation
	Management expenses arising on Revenue items this year were relieved against taxable revenue. By relieving £882,000 (2007 - £207,000) of surplus management expenses arising on Capital items against the remaining taxable revenue, the Company eliminated its corporation tax charge. In accordance with accounting policy 1(j) no amount (2007 - £nil) has been credited to Capital and charged to Revenue as a notional corporation tax item.

	At 31 December 2008, the Company had net surplus management expenses and loan relationship deficits of £7,890,000 (2007 - £8,441,000) in respect of which a deferred tax asset has not been recognised. This is because the Company is not expected to generate taxable income in a future period in excess of the deductible expenses and deficits of that future period and, accordingly, it is unlikely that the Company will be able to reduce future tax liabilities through the use of existing surplus expenses and loan relationship deficits.

	The UK Corporation tax rate was 30% until 31 March 2008 and 28% from 1 April 2008 giving an effective rate of 28.50% (2007 - 30%). The differences are explained below:

	2008			2007
	Revenue	Capital	Total	Revenue	Capital	Total
	£'000	£'000	£'000	£'000	£'000	£'000
Profit/(loss) before tax	3,444	(31,563)	(28,119)	3,484	(13,282)	(9,798)

Taxation of return on ordinary activities at the standard rate of corporation tax	982	(8,995)	(8,013)	1,045	(3,985)	(2,940)
Effects of:
UK dividend income not liable to further tax	(762)	-	(762)	(1,040)	-	(1,040)
Capital losses disallowed for the purposes of corporation tax	-	8,472	8,472	-	3,381	3,381
Zero coupon finance costs not an allowable tax deduction	-	429	429	-	336	336
Unrecognised deferred tax asset in respect of taxable loss	31	-	31	49	-	49
Utilisation of surplus management expenses	(251)	94	(157)	(54)	268	214
	______	______	______	______	______	______
Taxation charge for the year	-	-	-	-	-	-
	______	______	______	______	______	______

7.	Revenue and capital profit attributable to equity holders of the Company
	The revenue and capital losses attributable to equity holders of the Group for the financial year includes £28,013,000 (2007 - £9,636,000) which has been dealt with in the Company's financial statements.

		2008	2007
8.	Dividends	£'000	£'000
	Amounts recognised as distributions to equity holders in the period
	Fourth interim dividend for the year ended 31 December 2007 of 4.90p (2006 - 4.75p) per share	1,083	1,051
	Three interim dividends for the year ended 31 December 2008 totalling 10.20p (2007 - 10.05p) per share	2,255	2,223
		_________	_________
		3,338	3,274
		_________	_________
	The fourth interim dividend of 4.90p per share, declared on 22 December 2008 and paid on 30 January 2009 has not been included as a liability in these financial statements.

	We also set out below the total dividends payable in respect of the financial year, which is the basis on which the requirements of Section 842 of the Income and Corporation Taxes Act 1988 are considered:

	Three interim dividends for the year ended 31 December 2008 totalling 10.20p (2007 - 10.05p) per share	2,255	2,223
	Fourth interim dividend for the year ended 31 December 2008 of 4.90p (2007 - 4.90p) per share	1,083	1,083
		_________	_________
		3,338	3,306
		_________	_________

		2008	2007
9.	Return/(loss) and net asset value per share	£'000	£'000
	The returns/(losses) per share are based on the following figures:
	Revenue return	3,444	3,484
	Capital (loss)	(31,563)	(13,282)
		_________	_________
	Net return	(28,119)	(9,798)
		_________	_________
	Weighted average number of shares in issue	22,109,765	22,109,765
		_________	_________
	The net asset value per share is based on net assets attributable to shareholders of £19,375,000 (2007 - £50,832,000) and on the 22,109,765 (2007 - 22,109,765) shares in issue at 31 December 2008.

			Group & Company
			2008	2007
10.	Non current assets - Securities at fair value		£'000	£'000
	Listed on recognised stock exchanges:
	United Kingdom		25,954	77,813
	Overseas		3,515	7,122
			_________	_________
			29,469	84,935
			_________	_________

			Group & Company
			2008	2007
			£'000	£'000
	Cost at 31 December 2007		84,503	81,260
	Investment holdings gains at 31 December 2007		432	15,315
			_________	_________
	Fair value at 31 December 2007		84,935	96,575
	Purchases		13,016	32,004
	Amortised cost adjustments to fixed interest securities		(69)	(102)
	Sales	- proceeds	(38,754)	(32,284)
		- net realised (losses)/gains on sales	(13,452)	3,625
	Movement in investment holdings gains during the year		(16,207)	(14,883)
			_________	_________
	Valuation at 31 December 2008		29,469	84,935
			_________	_________

	Cost at 31 December 2008		45,244	84,503
	Investment holdings gains at 31 December 2008		(15,775)	432
			_________	_________
	Fair value at 31 December 2008		29,469	84,935
			_________	_________

			Group & Company
			2008	2007
	(Losses)/gains on investments		£'000	£'000
	Net realised (losses)/gains on sales		(13,452)	3,625
	Movement in fair value		(16,207)	(14,883)
	Special dividend allocated to capital		-	90
			_________	_________
	Losses on investments		(29,659)	(11,168)
			_________	_________

	The total transaction costs on the purchases and sales in the year were £76,000 (2007 - £58,000) and £57,000 (2007 - £73,000) respectively.

	All investments are categorised as held at fair value through profit and loss.

		Company
		2008	2007
11.	Subsidiary undertaking	£'000	£'000
	Shares at cost	-	-
		_________	_________
	The Company owns the whole of the issued ordinary share capital of its sole subsidiary undertaking, Shirescot Securities Limited, an investment dealing company registered in Scotland.

	As at the 31 December 2008 Shirescot Securities Limited had negative net assets of £142,000 (2007 - negative net assets of £36,000). Shires Smaller Companies plc confirms that it will provide financial support for Shirescot Securities Limited to continue to trade.

		Group		Company
		2008	2007	2008	2007
12.	Other receivables	£'000	£'000	£'000	£'000
	Amounts due from brokers	14	-	14	-
	Accrued income & prepayments	560	1,146	560	1,142
	Due by subsidiary undertaking	-	-	142	495
	VAT recoverable (see note 18)	440	-	440
	Other debtors	6	10	6	10
		_________	_________	_________	_________
		1,020	1,156	1,162	1,647
		_________	_________	_________	_________
	None of the above amounts are overdue.

		2008	2007
13.	Non-current liabilities	£'000	£'000
	Long-term loan included at amortised cost	10,000	10,000
	Zero coupon finance derivatives at fair value	8,126	7,375
		_________	_________
		18,126	17,375
		_________	_________
	Long-term loan
	The long-term loan of £10 million was taken out on 22 December 2005. The interest on this loan is fixed at 5.49% per annum on the principal amount and is payable quarterly in arrears. The loan is repayable at par on 23 December 2010 and is unsecured.

	The Directors' opinion of the fair value of the long-term loan at 31 December 2008, determined by discounting the future cash flows of the loan with reference to the current interest profile of an equivalent gilt, was £10,724,000 (2007 - £10,114,000).

	Zero coupon finance
	The zero coupon finance arrangement comprises a set of separately traded financial instruments (FTSE 100 Index options) each with its own market value, which equates to their fair values. The options run until 2009 and 2010. Set out below is a breakdown of the different options split between put and call options and assets and liabilities as disclosed in the Balance Sheet. The change in the net total market value of the options in each accounting period is treated as an unrealised loss and charged to the capital column of the Consolidated Income Statement.

	The December 2008 tranche of zero coupon finance was reduced by a partial repayment of £5 million in July 2008. The remaining balance of the December 2008 tranche was repaid at a cost of £11.1 million on maturity. A September 2009 tranche of zero coupon finance was taken out in July 2008 which generated premia of £4,986,000. The September 2009 tranche has a maturity value of £5.4 million. The July 2010 tranche has a maturity value of £5.3 million.

	The amount charged to capital will fluctuate over accounting periods due to market volatility over the life of the options but will range from 7.18% per annum for the options expiring in September 2009 to 5.5% per annum for the options which expire in July 2010.

	As at 31 December 2008, the Company had pledged collateral equal to at least 161% of the market value of this finance in accordance with standard commercial practice. The actual carrying amount of financial assets pledged equated to £16,747,000 (2007 - £28,453,000), in the form of £252,000 in cash and £16,495,000 in securities. The collateral position is monitored on a daily basis, which then determines if further assets are required to be pledged over and above those already pledged.

		2008	2007
	Fair value at 31 December 2008	£'000	£'000
	Current assets
	Call option expiring on 19 December 2008	-	4,625
	Put option expiring on 19 December 2008	-	19
	Call option expiring on 18 September 2009	112	-
	Put option expiring on 18 September 2009	1,042	-
		_________	_________
		1,154	4,644
		_________	_________
	Non-current assets
	Call option expiring on 29 July 2010	138	1,866
	Put option expiring on 29 July 2010	2,910	899
		_________	_________
		3,048	2,765
		_________	_________
	Current liabilities
	Call option expiring on 19 December 2008	-	(18,211)
	Put option expiring on 19 December 2008	-	(1,817)
	Call option expiring on 18 September 2009	(1,906)	-
	Put option expiring on 18 September 2009	(4,554)	-
		_________	_________
		(6,460)	(20,028)
		_________	_________
	Non-current liabilities
	Call option expiring on 29 July 2010	(1,052)	(4,783)
	Put option expiring on 29 July 2010	(7,074)	(2,592)
		_________	_________
		(8,126)	(7,375)
		_________	_________
	Net zero coupon finance liability - fair value	(10,384)	(19,994)
		_________	_________
	The movements in the fair value of this finance were as follows:
		Group and Company
		2008	2007
		£'000	£'000
	At 31 December 2007	19,994	18,875
	Proceeds from new zero coupon finance arrangement	4,984	-
		_________	_________
		24,978	18,875
	Cost of closure of existing zero coupon finance arrangement	(16,098)	-
		8,880	18,875
		_________	_________
	Finance costs charged to capital	1,504	1,119
		_________	_________
	At 31 December 2008	10,384	19,994
		_________	_________

		Ordinary shares
		of 50 pence each
14.	Called up share capital	Number	£'000
	Authorised
	At 31 December 2007 and 31 December 2008	35,000,000	17,500
		_________	_________

		Ordinary shares
		of 50 pence each
	Allotted, called up and fully paid	Number	£'000
	At 31 December 2007 and 31 December 2008	22,109,765	11,055
		_________	_________
	The objective of the Company is to provide a high and growing dividend and capital growth from a portfolio invested principally in the ordinary shares of smaller UK companies and UK fixed income securities.

	The Company manages its capital to ensure that it will be able to continue as a going concern while maximising the return to shareholders through the optimisation of the debt and equity balance.

	The Board monitors and reviews the broad structure of the Company's capital on an ongoing basis. This review includes:
	- the planned level of gearing, which takes account of the Investment Manager's views on the market;
	- the level of equity shares in issue; and
	- the extent to which revenue in excess of that which is required to be distributed should be retained.

	The Company's objectives, policies and processes for managing capital are unchanged from the preceding accounting period.

	The Company does not have any externally imposed capital requirements.

				Group & Company
				2008	2007
15.	Retained earnings			£'000	£'000
	Capital reserve
	At 31 December 2007			23,282	36,564
	Net (losses)/profits on sales of investments during the year			(13,452)	3,625
	Movement in investment holdings gains during the year			(16,207)	(14,883)
	Amortised cost adjustment relating to capital			(69)	(102)
	Zero coupon finance costs (note 14)			(1,504)	(1,119)
	Finance costs of borrowings (note 5)			(312)	(484)
	Special dividend allocated to capital			-	90
	Investment management fee			(239)	(409)
	VAT recoverable on management fees			220	-
				_________	_________
	At 31 December 2008			(8,281)	23,282
				_________	_________

		Group	Company	Group	Company
		2008	2008	2007	2007
	Revenue reserve	£'000	£'000	£'000	£'000
	At 31 December 2007	2,571	2,607	2,361	2,251
	Revenue return	3,444	3,550	3,484	3,630
	Dividends paid	(3,338)	(3,338)	(3,274)	(3,274)
		_________	_________	_________	_________
	At 31 December 2008	2,677	2,819	2,571	2,607
		_________	_________	_________	_________

16.	Risk management, financial assets and liabilities
	Risk management
	The Company's objective of providing a high and growing dividend with capital growth is addressed by investing in smaller UK market capitalisation equities to provide growth in capital and income and in fixed income securities to provide a high level of income.

	The impact of security price volatility is reduced by diversification. Diversification is by type of security - ordinary shares, preference shares, convertibles and corporate fixed interest - and by investment in the stocks and shares of companies in a range of industrial, commercial and financial sectors. The management of the portfolio is conducted according to investment guidelines, established by the Board after discussion with the Managers, which specify the limits within which the Manager is authorised to act.

	The Manager has a dedicated investment management process for managing equities and fixed income which ensures that the investment objective is achieved. Stock selection procedures are in place based on the active portfolio management and identification of stocks. The portfolio is reviewed on a periodic basis by a Senior Investment Manager and also by the Manager's Investment Committee.

	The Company's Manager has an independent Investment Risk department for reviewing the investment risk parameters of all core equity, balanced, fixed income and alternative asset classes on a regular basis. The department reports to the Manager's Performance Review Committee which is chaired by the Manager's Chief Investment Officer. The department's responsibility is to review and monitor ex-ante (predicted) portfolio risk and style characteristics using best practice, industry standard multi-factor models.

	Additionally, the Manager's Compliance department continually monitor the Company's investment and borrowing powers and report to the Manager's Risk Management Committee.

	The Manager has a business Risk department to consolidate risk management functions. The department is responsible for supporting management in the efficient identification of risk and resolution of control issues. The department incorporates Operational Risk, Breaches and Errors Risk Control Management, Counterparty Risk, and the Procedures and Business Control teams. The Head of Front Office risk reports directly to the Manager's Group Head of Risk.

	Financial assets and liabilities
	The Company's financial assets include investments, cash at bank and short-term debtors. Financial liabilities consist of bank loans and overdrafts, other short-term creditors and long-term creditors arising from option contracts and a fixed rate term loan.

	The main risks the Company faces from its financial instruments are (i) market risk (comprising interest rate risk, currency risk and other price risk), (ii) liquidity risk and (iii) credit risk. The Company has no exposure to foreign currency risk as it does not hold any foreign currency assets or have exposure to any foreign currency liabilities.

	The Company is subject to interest rate risk because bond yields are linked to underlying bank rates or equivalents, and its short-term borrowings and cash resources carry interest at floating rates. The interest rate profile is managed as part of the overall investment strategy of the Company.

	(i)	Market risk
		The fair value or future cash flows of a financial instrument held by the Company may fluctuate because of changes in market prices. This market risk comprises three elements - interest rate risk, currency risk and other price risk.

		Interest rate risk
		Interest rate movements may affect:
		-	the fair value of the investments in fixed interest rate securities;
		-	the level of income receivable on cash deposits;
		-	interest payable on the Company's variable rate borrowings.
		The possible effects on fair value and cash flows that could arise as a result of changes in interest rates are taken into account when making investment and borrowing decisions.

		The Board reviews on a regular basis the values of the fixed interest rate securities.

		Interest rate profile
		The interest rate risk profile of the portfolio of financial assets and liabilities (excluding Ordinary shares and Convertibles) at the Balance Sheet date was as follows:

		Weighted
	Weighted average	average			Non-
	period for which	interest	Fixed	Floating	interest
	rate is fixed	rate	rate	rate	bearing
As at 31 December 2008	Years	%	£'000	£'000	£'000
Assets
UK corporate bonds	8.89	6.94	7,791	-	-
UK preference shares	-	8.19	6,908	-	-
Zero coupon finance	-	-	-	-	4,202
Cash	-	-	-	9,573	-
	_________	_________	_______	_________	_______
Total assets	-	-	14,699	9,573	4,202
	_________	_________	_______	_________	_______
Liabilities
Long-term bank loan	1.98	5.49	(10,000)	-	-
Zero coupon finance	-	-	-	-	(14,586)
	_________	_________	_______	_________	_______
Total liabilities	-	-	(10,000)	-	(14,586)
	_________	_________	_______	_________	_______
Total	-	-	4,699	9,573	(10,384)
	_________	_________	_______	_________	_______

		Weighted
	Weighted average	average			Non-
	period for which	interest	Fixed	Floating	interest
	rate is fixed	rate	rate	rate	bearing
As at 31 December 2007	Years	%	£'000	£'000	£'000
Assets
UK corporate bonds	5.65	6.56	20,636	-	-
UK preference shares	-	8.78	8,097	-	-
Zero coupon finance	-	-	-	-	7,409
Cash	-	-	-	115	-
	_________	_________	_______	_________	_______
Total assets	-	-	28,733	115	7,409
	_________	_________	_______	_________	_______
Liabilities
Short-term bank loan	0.08	6.50	(5,554)	-	-
Long-term bank loan	2.98	5.49	(10,000)	-	-
Zero coupon finance	-	-	-	-	(27,403)
	_________	_________	_______	_________	_______
Total liabilities	-	-	(15,554)	-	(27,403)
	_________	_________	_______	_________	_______
Total	-	-	13,179	115	(19,994)
	_________	_________	_______	_________	_______

The weighted average interest rate is based on the current yield of each asset, weighted by its market value. The weighted average interest rate on bank loans is based on the interest rate payable, weighted by the total value of the loans. The maturity dates of the Company's loans are shown in note 13.

The cash assets consist of cash deposits on call earning interest at prevailing market rates.

Short-term debtors and creditors (with the exception of loans and zero coupon finance) have been excluded from the above tables.

All financial liabilities are measured at amortised cost.

	Maturity profile
	The maturity profile of the Company's financial assets and liabilities at the Balance Sheet date was as follows:

			Within	Within	Within	Within	Within	More than
			1 year	1-2 years	2-3 years	3-4 years	4-5 years	5 years
	At 31 December 2008		£'000	£'000	£'000	£'000	£'000	£'000
	Fixed rate
	UK corporate bonds		-	2,677	-	2,373	-	2,741
	UK redeemable preference shares		474	-	-	-	-	-
	Bank loan		-	(10,000)	-	-	-	-
			_______	_______	_______	_______	_______	_______
			474	(7,323)	-	2,373	-	2,741
			_______	_______	_______	_______	_______	_______
	Floating rate
	Zero coupon finance		(5,306)	(5,078)	-	-	-	-
	Cash		9,573	-	-	-	-	-
			_______	_______	_______	_______	_______	_______
			4,267	(5,078)	-	-	-	-
			_______	_______	_______	_______	_______	_______
	Total		4,741	(12,401)	-	2,373	-	2,741
			_______	_______	_______	_______	_______	_______

			Within	Within	Within	Within	Within	More than
			1 year	1-2 years	2-3 years	3-4 years	4-5 years	5 years
	At 31 December 2007		£'000	£'000	£'000	£'000	£'000	£'000
	Fixed rate
	UK corporate bonds		-	2,012	4,935	-	4,370	9,319
	Bank loans		(5,554)	-	(10,000)	-	-	-
			_______	_______	_______	_______	_______	_______
			(5,554)	2,012	(5,065)	-	4,370	9,319
			_______	_______	_______	_______	_______	_______
	Floating rate
	Zero coupon finance		(15,384)	-	(4,610)	-	-	-
	Cash		115	-	-	-	-	-
			_______	_______	_______	_______	_______	_______
			(15,269)	-	(4,610)	-	-	-
			_______	_______	_______	_______	_______	_______
	Total		(20,823)	2,012	(9,675)	-	4,370	9,319
			_______	_______	_______	_______	_______	_______

	The maturity table above excludes the value of holdings in UK irredeemable preference shares held at the year end, which equated to £6,434,000 (2007 - £8,097,000).

	Interest rate sensitivity
	The sensitivity analysis below have been determined based on the exposure to interest rates for both derivative and non-derivative instruments at the Balance Sheet date and the stipulated change taking place at the beginning of the financial year and held constant throughout the reporting period in the case of instruments that have floating rates.

	If interest rates had been 100 basis points higher or lower and all other variables were held constant, the Company's:
	-	profit before tax for the year ended 31 December 2008 would increase / decrease by £96,000 (2007 - £1,000). This is mainly attributable to the Company's exposure to interest rates on its floating rate cash balances. These figures have been calculated based on cash positions at each year end.
	-	profit before tax for the year ended 31 December 2008 would increase / decrease by £146,000 (2007 - £423,000). This is also mainly attributable to the Company's exposure to interest rates on its fixed interest securities. This is based on a Value at Risk ('VaR') calculated at a 99% confidence level.

	In the opinion of the Directors, the above sensitivity analyses are not representative of the year as a whole, since the level of exposure changes frequently as part of the interest rate risk management process used to meet the Company's objectives. The risk parameters used will also fluctuate depending on the current market perception.

	Other price risk
	Other price risks (ie changes in market prices other than those arising from interest rate or currency risk) may affect the value of the quoted investments.

	It is the Board's policy to hold an appropriate spread of investments in the portfolio in order to reduce the risk arising from factors specific to a particular sector. The allocation of assets to specific sectors and the stock selection process both act to reduce market risk. The Manager actively monitors market prices throughout the year and reports to the Board, which meets regularly in order to review investment strategy. The investments held by the Company are listed on the London Stock Exchange.

	Other price sensitivity
	If market prices at the Balance Sheet date had been 10% higher or lower while all other variables remained constant, the profit before tax attributable to ordinary shareholders for the year ended 31 December 2008 would have increased/decreased by £1,477,000 (2007 - increase/decrease of £5,620,000). This is based on the Company's equity portfolio and convertibles held at each year end.

(ii)	Liquidity risk
	This is the risk that the Company will encounter difficulty in meeting obligations associated with financial liabilities.

	Liquidity risk is not considered to be significant as the Company's assets comprise mainly readily realisable securities, which can be sold to meet funding commitments if necessary. Short-term flexibility is achieved through the use of loan and overdraft facilities (notes 12 and 13).
(iii)	Credit risk
	This is failure of the counter party to a transaction to discharge its obligations under that transaction that could result in the Company suffering a loss.

	The Company considers credit risk not to be significant as it is actively managed as follows:
	-	where the Manager makes an investment in a bond, corporate or otherwise, the credit rating of the issuer is taken into account so as to minimise the risk to the Company of default;
	-	investments in quoted bonds are made across a variety of industry sectors so as to avoid concentrations of credit risk;
	-	transactions involving derivatives are entered into only with investment banks, the credit rating of which is taken into account so as to minimise the risk to the Company of default;
	-	investment transactions are carried out with a large number of brokers, whose credit-standing is reviewed periodically by the Manager, and limits are set on the amount that may be due from any one broker;
	-	the risk of counterparty exposure due to failed trades causing a loss to the Company is mitigated by the review of failed trade reports on a monthly basis. In addition, the Custodian carries out a stock reconciliation to third party administrators' records on a monthly basis to ensure discrepancies are picked up on a timely basis. The Manager's Compliance department carries out periodic reviews of the Custodian's operations and reports its finding to the Manager's Risk Management Committee.
	-	transactions involving derivatives, structured notes and other arrangements wherein the creditworthiness of the entity acting as broker or counterparty to the transaction is likely to be of sustained interest are subject to rigorous assessment by the Manager of the credit worthiness of that counterparty. The Company's aggregate exposure to each such counterparty is monitored regularly by the Board;
	-	a proportion of the Company's gearing relates to the zero coupon finance raised in the derivatives market. The final liability of the zero coupon finance is pre-determined at the outset of each tranche of zero coupon finance. The zero coupon finance is subject to counterparty risk. The Company places trades through a broker and pledges collateral in support of the net market value of this finance in accordance with commercial practice. Collateral requirements can vary at the option of the broker and the broker's Euronext.LIFFE market clearer. The overall intended effect of the related put and call options which constitute each trance of zero coupon finance is dependent upon any liability of the Company under each constituent option contract being honoured. The option contracts are traded on Euronext.LIFFE. On-exchange trades go through LCH.Clearnet S.A. such that the Company is not exposed to the credit risk of the exchange member. The Company manages its collateral obligations on a daily basis; and
	-	cash is held only with reputable banks with high quality external credit enhancements.

	None of the Company's financial assets are secured by collateral or other credit enhancements.

	Credit risk exposure
	In summary, compared to the amounts in the Balance Sheet, the maximum exposure to credit risk at 31 December was as follows:

		2008		2007
		Balance	Maximum	Balance	Maximum
		Sheet	exposure	Sheet	exposure
		£'000	£'000	£'000	£'000
	Non-current assets
	Securities at fair value through profit or loss	29,469	29,469	84,935	84,935
	Zero coupon finance derivatives at fair value	3,048	3,048	2,765	2,765

	Current assets
	Trade and other receivables	460	460	-	-
	Accrued income	552	552	1,156	1,156
	Cash and cash equivalents	9,573	9,573	115	115
	Zero coupon finance derivatives at fair value	1,154	1,154	4,644	4,644
		_______	_______	_______	_______
		44,256	44,256	93,615	93,615
		_______	_______	_______	_______

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

Fair value of financial assets and liabilities
The fair values of the long term loan and zero coupon finance are shown on pages 36 to 38. Traded options contracts are valued at fair value which have been determined with reference to quoted market values of the contracts. The contracts are tradeable on a recognised exchange The book value of cash at bank and bank loans and overdrafts included in these financial statements approximate to fair value because of their short-term maturity. Investments held as dealing investments are valued at fair value. The carrying values of fixed asset investments are stated at their fair values, which have been determined with reference to quoted market prices. For all other short-term debtors and creditors, their book values approximate to fair values because of their short-term maturity.

Gearing
The Company has in place a £10 million unsecured loan. The Company augments this from time to time with short-term borrowings so that greater returns to shareholders may be generated from the capital stock thus enlarged. Although this gearing increases the opportunity for gain, it also increases the risk of loss in falling markets. The risk of increased gearing is managed by retaining the flexibility to reduce short term borrowings as appropriate.

A further component of the Company's gearing relates to the zero coupon finance raised in the derivatives market. The final liability of the zero coupon finance is pre-determined at the outset of each tranche of zero coupon finance. However the amount charged to capital will fluctuate over accounting periods due to interest rate movements giving rise to interest rate risk. This is managed by investing the proceeds of the zero coupon finance in predominantly investment grade corporate bonds, the value of which are also affected by interest rates but in an inverse manner to the zero coupon finance.

Gearing is also restricted by the various covenants applicable to the different borrowings. The unsecured loan and one of the short term borrowing facilities are with the same major bank. These loans contain a clause which stipulates that total borrowings cannot exceed 75% of adjusted total gross assets. As at 31 December 2008 the reported ratio was 51% (2007 - 41%). A second clause relates to the ratio of bank indebtedness to the value of the Company's investments. This ratio should not exceed 50%. As at 31 December 2008 the reported ratio was 43.7% (2007 - 26.9%).

There is a second short term borrowing facility with another major bank for £1 million. In respect of this lender, the Company's net asset value must not fall below £10 million. As at 31 December 2008 the net asset value stood at £19.4 million.

17.	Income enhancement
	Zero coupon finance (note 13) raised in the derivatives market is invested in corporate fixed interest securities to augment the income available for distribution to shareholders. The cost of these funds is fixed when they are raised, and is charged wholly to capital.

	In addition the SORP recommends that debt securities are accounted for on an effective yield basis with the associated adjustment being allocated to revenue. The Company has decided to allocate this adjustment to capital as explained in note 1(f). The effect of this treatment on revenue and capital is set out below.

	Finally, as explained in note 1(j) revenue utilises surplus management expenses that have arisen in capital but does not compensate capital as recommended by the SORP.

	The effect of these income enhancement strategies on capital and income is summarised in the table below. There is a risk with these strategies that capital will be eroded unless the charges to capital are covered by gains elsewhere in the portfolio, and this is managed by investing in a portfolio of shares which in the long run is expected to provide adequate capital growth to absorb both the zero coupon finance cost and the effective yield adjustment while paying growing dividends which contribute to the pursuit of the Company's objectives.

	In following this strategy, the Directors recognise that there is only one class of shareholder.

		2008		2007
		Income	Capital	Income	Capital
		£'000	£'000	£'000	£'000
	Zero coupon finance:
	Finance costs charged to capital	-	(1,504)	-	(1,119)
	Return on corresponding investments	577	(1,602)	673	(303)
	Purchase of preference shares with discretionary dividends cum-dividend and sales ex-dividend	-	-	-	-
	Debt securities:
	Amortised cost adjustment charged to capital	69	(69)	102	(102)
	Tax value of management expenses arising in capital but utilised against income	251	(251)	54	(54)
		_______	_______	_______	_______
		897	(3,426)	829	(1,578)
		_______	_______	_______	_______

18.	Commitments, contingencies and post Balance Sheet events
	On 5 November 2007, the European Court of Justice ruled that management fees on investment trusts should be exempt from VAT. HMRC has announced its intention not to appeal against this ruling to the UK VAT Tribunal and therefore protective claims which have been made in relation to the Company will be processed by HMRC in due course. The Company has not been charged VAT on its investment management fees from 1 October 2007.

	The Manager has agreed to refund £440,000 to the Company for VAT charged on investment management fees for the period 1 January 2004 to 30 September 2007 and this has been included in these financial statements. This repayment has been allocated to revenue and capital in line with the accounting policy of the Company for the periods in which the VAT was charged. The reclaim for previous periods, any interest due on recoverable amounts (including the period from 1 January 2004 to 30 September 2007) and the timescale for receipt are at present uncertain and the Company has taken no account in these financial statements of any such repayment.

19.	Subsequent events Since the year end, equity markets with the UK have continued to fall. The FTSE SmallCap Index (exIC) and the FTSE All-Share Index have fallen by 7.2% and 12.3% respectively. After adjusting for the payment of the fourth interim dividend of 4.9p per share the Company's NAV has fallen 15.7% in the period 31 December 2008 to 25 February 2009.

Additional Notes to the Annual Financial Report

This Annual Financial Report announcement is not the Company's statutory accounts for the year ended 31 December 2008. The statutory accounts for the year ended 31 December 2008 received an audit report which was unqualified but included a matter to which the auditors drew attention by way of emphasis without qualifying the report and did not include a statement under either section 237(2) or 237(3) of the Companies Act 1985.

The statutory accounts for the financial year ended 31 December 2008 were approved by the Directors on 2 March 2009 but will not be filed with the Registrar of Companies until after the company's Annual General Meeting which is to be held at 12 noon on Tuesday 7 April 2009 at One Bow Churchyard, London EC4M 9HH.

The Annual Report will be posted to shareholders in March 2009 and additional copies will be available from the Manager (Investor Helpline - Tel. 0845 60 24 247) or by download for the Company's webpage (www.shiressmallercompanies.co.uk)

Please note that past performance is not necessarily a guide to the future and that the value of investments and the income from them may fall as well as rise. Investors may not get back the amount they originally invested.

For Shires Smaller Companies plc

Aberdeen Asset Management PLC, Secretaries

This information is provided by RNS

The company news service from the London Stock Exchange

END

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