Annual Financial Report

RNS Number : 0265C

Shires Smaller Companies PLC

28 February 2011

 



SHIRES SMALLER COMPANIES PLC

ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 DECEMBER 2010

1. CHAIRMAN'S STATEMENT

In my final full year as Chairman of Shires Smaller Companies it is satisfying to be able to report that 2010 has been another strong year of returns for the Company. The Board and the Manager have been very active over the last few years in repositioning the Company and as such it is very pleasing to see the evidence of our decisions coming to fruition. Protection of the dividend is foremost in the Board's mind and we understand the importance of this to our loyal shareholder base. Therefore, to be able to announce a fourth quarter dividend of 1.5p per share, for a covered full year dividend of 6p per share, in line with our expectations, underlines the resilience of the portfolio's dividend generation. At the current share price of £1.34 the Company yields 4.5% which remains attractive against the market yield of 2.9%.

Investment Returns

Shires Smaller Companies significantly outperformed the market with the NAV (total return) of 43.3%, and with the discount narrowing, the share price increased 50.3% on a total return basis for the year under review. With risk appetite returning, smaller companies continued their ascent and the FTSE Smaller Companies (ex Investment Companies) was up 16.9% on a total return basis for the year. Looking across the market cap spectrum, the standout performance for the year came from the FTSE Mid-250 which returned 27.4%, with the FTSE 100 up 12.6%. Performance was delivered across the bond, preference and equity portfolio with robust earnings being a significant contributor. 

Gearing

As announced with the half year results the work undertaken by the Board to replace the Zero Coupon financing was completed in July. In replacement the Board has secured a three year £10m revolving credit facility at an attractive rate of LIBOR + 200 basis points, providing a stable future platform for the Company. This will also provide a short to medium term benefit to the revenue account when you compare the current all-in rate of 2.625% against the 5.49% we paid previously. We will continue to keep this floating rate debt under review with the Manager as expectations for an interest rate hike are increasing. The Monetary Policy Committee tones have been more hawkish of late and with inflation running stubbornly above expectations the discussion has turned to when and not if rates will rise.

Structure, Earnings and Dividends

The portfolio structure has been simplified along with the gearing. The Manager felt it was prudent to diversify the exposure of the bond portfolio away from financial holdings, and introduced a number of utility and transportation companies. We have also reduced our exposure to the preference portfolio and with it, the importance of this to the revenue of the Company. These changes have improved the overall balance of revenue across sectors and holdings, with minimal impact to the earnings delivered and the resultant dividend.

On the above basis, and subject to any unforeseen circumstances, the Board anticipates that it should be possible to pay a maintained dividend of 6p per share for the year ending 31 December 2011.

Board

As I have indicated, this is my final statement to you as Chairman and Carolan Dobson will be appointed Chairman at the conclusion of the AGM. She along with your other Directors has led a search process and I am delighted to announce that Mr Barry Rose will join the Board with effect from 1 March 2011. It has been my pleasure to serve as Chairman since 2004 and as a Director for the last 15 years and I would like to thank our shareholders for their support over that period. We have emerged strongly from the financial turmoil of the last few years and I am delighted that the work undertaken by the Board and the Manager over that time sees the Company in a stable and healthy position, well placed for future growth.

Change of Name / Appointment of Broker

The Board have considered the name of the Company and it is our intention to change it to Aberdeen Smaller Companies High Income Trust PLC. This will be done by Directors' resolution, exercising the powers conferred under the new Articles adopted at last year's AGM and will take place at the conclusion of this year's AGM. We have also taken the decision to appoint Winterflood Securities as the Company's broker, with effect from today's date, to assist the Board and the Manager in promoting your Company.

Outlook

The Board believes that the Company's investment mandate remains relevant. Our strategy has delivered strong performance over the last two years and an attractive, stable and diversified yield for income conscious investors. We believe your Company remains well placed to continue to do so. 

H. S. Cathcart

Chairman

28 February 2011

2. MANAGER'S REVIEW

Background

The year end Manager's review provides an opportunity to reflect on the past year whilst also thinking about the challenges and opportunities for the year ahead. As Manager of the trust, looking at the returns in isolation is very comforting given the outperformance in what was another tumultuous year on a number of fronts. It is, however, also worth considering the outlook with sovereign debt concerns, commodity inflation and long awaited fiscal tightening weighing on the consumer. 

Performance

Shires Smaller Companies delivered an NAV total return of 43.3% over the year. 2010 was always going to be a sterner test of our stock picking abilities following the rally of the prior year. Whilst smaller company volatility remained high we saw a return to fundamentals with particular focus on strong franchises and especially on those with emerging market exposure. The work undertaken through 2010 in positioning the portfolio with a focus on high quality companies in niche areas with strong market positions came to the fore.     

Economic Backdrop

This year has seen the transition of the crisis from indebted financials to indebted governments. Bond yields and risk insurance (credit default swaps) have widened across a number of Eurozone regions. The most pronounced cases were Greece and Ireland where eventual bailout packages of €120bn and €85bn respectively were required. Contagion spread to other regions - although the quantum of the problem in Spain, the UK and Italy is arguably less severe. The debate has also become increasingly political with Brussels and key heads of state demanding rapid deficit reductions to align them with Eurozone targets. Whilst at times it can be confusing to piece together the different packages and bailout funds announced it is important to focus on the fact that action has been taken to stabilise the areas of most concern and make sure refinancing is available. Ultimately the trade off underlying all of the bailouts is that highly indebted governments will have access to funding in return for severe demands on deficit reductions.

The domestic UK economy has similar deficit problems. The data published in the HM Treasury spending review highlights very clearly the step change in 2008/09. To put this into perspective the coalition government has taken on Britain's largest budget deficit in peacetime history at 11% of GDP, with the state borrowing one pound in every four spent.

To close the gap, and keep debt repayments at an affordable level, public sector budgets are being cut across the board. These will be wide reaching and the knock on effects on unemployment and investor confidence have to be closely managed. How this feeds through to markets is still unknown and the recent Office for National Statistics (ONS) data on weakening Q4 GDP gives some cause for concern. Meanwhile, the Government is looking to stimulate private sector spending to offset these declines as one way of alleviating the pain but the message we are receiving from management teams remains cautious. There are pockets of optimism although it is worth noting that these have in general come from companies with emerging market exposure.

Equity Portfolio

Emerging market exposure was one of the big themes behind stockmarkets in general with smaller companies no exception. Whilst it is true that smaller company revenue is more domestically focused than that of their larger peers, 45% of the portfolio's revenue is derived from outside the UK. The Company has exposure to emerging markets through names like Aveva, Fenner, Oxford Instruments and Robert Walters. Whilst these have all been strong performers over the year valuations are reflective of the above trend growth they have delivered and are now looking more stretched. This is not only true of companies we own but also of those where we have conducted our due diligence, so whilst we continue to find attractive niche businesses, valuation is often the stumbling block.

Industrial engineering was one of the top performing sectors through 2010. The main contributors were Weir Group and Fenner both of which have exposure to the mining sector. Chinese demand has continued unabated and as service providers these companies have been beneficiaries of burgeoning capital investment. Both have strong aftermarket divisions that are accretive to margins and provide a balance to the original equipment sale. The Electrical and Electronics sector also had a good year. The sector held two of the top performing stocks in the portfolio - Oxford Instruments and XP Power which increased 252% and 146% respectively. The market has now caught up with these growth stories and with valuations looking stretched we have been recycling profits into other areas where we see more value.

We introduced several new names to the portfolio over the year. The first is Edinburgh based Forth Ports, the last UK listed port operator. The business owns a number of ports in Scotland including Grangemouth, Dundee, Leith and, south of the border, their Tilbury site on the River Thames. The structure of the contracts has provided downside protection in tougher times and, with trade flows increasing, they are well positioned to benefit. We also added Halfords, the speciality car maintenance, car enhancement and leisure products company. It provides an interesting example of a solely UK orientated retailer which can deliver attractive returns thanks to the strength of its competitive position, differentiated by its service offering, exposure to some structurally growing categories and the strength of its balance sheet which affords scope for acquisition opportunities, such as the recent Autocentres deal.

Merger and acquisition activity was also a key driver of performance. In terms of valuations these were not at the most demanding of multiples. While disappointing that we couldn't extract the full value for these businesses we did benefit from the short term crystallisation of value. Chloride was the exception due to a bidding war between Emerson Electric and ABB. The other acquisitions were BSS Group, Care UK, Rensburg Sheppards and lastly Brit Insurance. M&A activity is likely to remain high over the coming year as company balance sheets have been repaired. We have also seen the rebound and restocking effects come to an end and with companies up against tougher comparators, acquisitions will offer an additional growth driver.

Bond Portfolio

Interest rates remained at their all-time low of 0.5% throughout the year, while the Bank of England's asset purchase scheme was increased by £25bn to £200bn. There is still some debate in the UK over whether rates should be raised to curb inflation which remains stubbornly above the Monetary Policy Committee's target of 2%. UK Government bonds yields fell as they benefited from their perceived status as a 'safe haven'. Investors' increased appetite for risk assets has seen corporate bond spreads tighten throughout the year. Non financial bonds have almost tightened back to pre-crisis levels but financial spreads are still twice as high as those recorded in September 2007.

Company results have been positive with many beating analyst expectations and delivering good growth in profitability year on year, albeit from a low base. 

In the portfolio, we have locked in profits in subordinated financial bonds and switched out of lower yielding telecoms into higher yielding BBB rated utilities and transportation bonds.

European credit markets have started 2011 on a strong tone driven by positive economic data from the US. However, the issue of peripheral European government finances has not gone away and will likely come to a head in 2011. Refinancing requirements are high across Europe and the ability of both governments and banks to rollover debt during the year will be key to market direction.

Outlook

While the global economic recovery is expected to make further progress in 2011 there are also a number of headwinds and potentially destabilising factors. Commodity price inflation is likely to create a headache both for policymakers during a tentative period for economic growth and companies exposed to such commodities in their cost base. On balance it seems likely that interest rates will finally begin to rise towards the end of the year. Meanwhile fiscal austerity will have broader implications not least in the UK as governments address the longer term trajectory of the public finances. Related to this, it seems likely that concerns around the European periphery will resurface before year end.

Amidst these broader market risks it remains paramount, for us as investors implementing our bottom-up process, to focus on the outlook at the corporate level. Obvious concerns are public sector exposure and input cost inflation. The former has been in focus for some time; while the latter is a relatively new development for 2011. As such we are especially cognisant of companies' position in the supply chain and associated ability to pass input cost increases to their customers. More generally we have come through an extraordinary period of cost cutting reflected in a year in which earnings estimates were consistently beaten as operating leverage was underappreciated. Therefore companies will be facing new challenges from a position of strength; albeit strength which has often not been lost on the market. Topline growth will be increasingly important going forward now that the cost cutting phase has drawn to an end.

Although many companies have re-rated sharply, equity yields remain attractive against historic standards and on a relative basis versus bonds. As an example we took the opportunity to reduce the Northumbrian Water bond yielding 4% and buy higher yielding equity where we also see an attractive opportunity for capital growth. Prospects for dividend growth look good and it seems likely given strong corporate balance sheets, improved risk appetite and low levels of interest rates that M&A will see a continued surge during the year. All of this should help provide a broadly constructive environment for the portfolio.

Aberdeen Asset Managers Limited

28 February 2011

3. RESULTS & DIVIDENDS

Financial Highlights

	31 December 2010	31 December 2009	% change
Total investments	£42,814,000	£34,947,000	+22.5
Shareholders' funds	£34,545,000	£25,327,000	+36.4
Market capitalisation	£29,738,000	£21,004,000	+41.6
Net asset value per share	156.24p	114.55p	+36.4
Share price (mid market)	134.50p	95.00p	+41.6
Discount to adjusted NAV{A}	13.1%	15.8%
Gearing	23.9%	38.0%
Total expense ratio	1.8%	2.2%
Dividends and earnings
Revenue return per share{B}	6.04p	7.27p	-16.9
Dividends per share{C}	6.00p	7.00p	-14.3
Dividend cover	1.01	1.04
Revenue reserves{D}	£1,995,000	£2,041,000
{A}      Based on IFRS NAV above reduced by dividend adjustment of 1.50p (2009 - 1.75p).
{B}      Measures the revenue earnings for the year divided by the weighted average number of Ordinary shares in issue (see Statement of Comprehensive Income).
{C}      The figures for dividends per share reflect the years in which they were earned (see note 8).
{D}      The revenue reserve figure does not take account of the fourth interim dividend amounting to £332,000 (2009 - £387,000).

	1 year	3 year	5 year
	% return	% return	% return
Net asset value	+43.3	-12.0	-11.6
Share price (based on mid price)	+50.3	-0.7	-18.5
FTSE SmallCap Index (excluding Investment Companies)	+16.9	-4.7	-3.9
FTSE All-Share Index	+14.5	+4.4	+28.4
All figures are for total return and assume re-investment of net dividends excluding transaction costs.

Dividends

	Rate per share	xd date	Record date	Payment date
First interim dividend	1.50p	7 April 2010	9 April 2010	30 April 2010
Second interim dividend	1.50p	7 July 2010	9 July 2010	30 July 2010
Third interim dividend	1.50p	6 October 2010	8 October 2010	29 October 2010
Fourth interim dividend	1.50p	5 January 2011	7 January 2011	28 January 2011
2010	6.00p
First interim dividend	1.75p	15 April 2009	17 April 2009	30 April 2009
Second interim dividend	1.75p	8 July 2009	10 July 2009	31 July 2009
Third interim dividend	1.75p	7 October 2009	9 October 2009	30 October 2009
Fourth interim dividend	1.75p	6 January 2010	8 January 2010	29 January 2010
2009	7.00p

Distribution of Assets and Liabilities
	Valuation at		Movement during the year				Valuation at
	31 December					Gains/	31 December
	2009		Purchases	Sales	Other{A}	(losses)	2010
	£'000	%	£'000	£'000	£'000	£'000	£'000	%
Listed investments
Ordinary shares	23,084	91.1	9,731	(9,765)	-	9,850	32,900	95.2
Convertibles	1,206	4.8	-	-	-	(45)	1,161	3.4
Corporate bonds	6,499	25.7	1,670	(1,351)	(27)	(710)	6,081	17.6
Other fixed interest	4,158	16.4	-	(2,154)	-	668	2,672	7.7
	______	______	______	______	______	______	______
	34,947	138.0	11,401	(13,270)	(27)	9,763	42,814	123.9
Current assets	3,418	13.5					1,882	5.4
Current liabilities	(13,038)	(51.5)					(151)	(0.4)
Long-term loan	-	-					(10,000)	(28.9)
	______	______					______	______
Net assets	25,327	100.0					34,545	100.0
	______	______					______	______
Net asset value per Ordinary share	114.6p						156.2p
	______						______
{A} Amortisation adjustment of £27,000 (see note 2).

4. BUSINESS REVIEW

Activities

The Company is an investment trust. Its subsidiary undertaking, Shirescot Securities Limited, is an investment dealing company. There was no investment dealing activity in the year.

Results and Dividends

The financial statements are for the year ended 31 December 2010. Dividends declared for the year amounted to 6.00p per share (2009 - 7.00p).

A fourth interim dividend of 1.50p per share was announced by the Board on 15 December 2010 with an ExD date of 5 January 2011 and paid on 28 January 2011. Under International Financial Reporting Standards (IFRS) this dividend will be accounted for in the financial year ended 31 December 2011.

Current and Future Developments

A review of the business is given in the Chairman's Statement and the Investment Manager's Review.

SHIRES SMALLER COMPANIES PLC

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

		Year ended			Year ended
		31 December 2010			31 December 2009
		Revenue	Capital	Total	Revenue	Capital	Total
	Notes	£'000	£'000	£'000	£'000	£'000	£'000
Gains and losses on investments
Gains on investments at fair value	10	-	9,763	9,763	-	7,157	7,157
Fair value movement in zero coupon finance derivatives	13	-	(58)	(58)	-	(274)	(274)
Revenue	2
Dividend income		1,367	-	1,367	1,258	-	1,258
Interest income from investments		486	(27)	459	667	(33)	634
Deposit interest		19	-	19	23	-	23
Other income		1	-	1	134	-	134
		_______	_______	_______	_______	_______	_______
		1,873	9,678	11,551	2,082	6,850	8,932
Expenses		_______	_______	_______	_______	_______	_______
Investment management fee	3	(151)	(151)	(302)	(127)	(127)	(254)
VAT recovered on investment management fees	3	16	16	32	144	144	288
Other administrative expenses	4	(231)	-	(231)	(212)	-	(212)
Finance costs of borrowings	5	(171)	(279)	(450)	(279)	(279)	(558)
		_______	_______	_______	_______	_______	_______
Profit before tax		1,336	9,264	10,600	1,608	6,588	8,196
Tax expense	6	-	-	-	-	-	-
		_______	_______	_______	_______	_______	_______
Profit attributable to equity holders of the Group	7	1,336	9,264	10,600	1,608	6,588	8,196
		_______	_______	_______	_______	_______	_______
Earnings per Ordinary share (pence)	9	6.04	41.90	47.94	7.27	29.80	37.07
		_______	_______	_______	_______	_______	_______
The total column of this statement represents the Group's Statement of Comprehensive Income, prepared in accordance with IFRS. The supplementary revenue 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.
The Company does not have any income or expense that is not included in profit for the year, and therefore the "Profit attributable to equity holders of the Group" is also the "Total comprehensive income attributable to equity holders of the Group" as defined in IAS 1 (revised).
All of the profit and comprehensive income 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
		2010	2009	2010	2009
	Notes	£'000	£'000	£'000	£'000
Non-current assets
Ordinary shares		32,900	23,084	32,900	23,084
Convertibles		1,161	1,206	1,161	1,206
Corporate bonds		6,081	6,499	6,081	6,499
Other fixed interest		2,672	4,158	2,672	4,158
		________	________	________	________
Securities at fair value	10	42,814	34,947	42,814	34,947
Current assets
Cash and cash equivalents		1,552	2,381	1,552	2,381
Zero coupon finance derivatives at fair value	13	-	637	-	637
Investments in dealing subsidiary		-	-	-	-
Other receivables	12	330	400	472	542
		________	________	________	________
		1,882	3,418	2,024	3,560
		________	________	________	________
Current liabilities
Trade and other payables		(151)	(126)	(151)	(126)
Short-term loan	13	-	(7,000)	-	(7,000)
Zero coupon finance derivatives at fair value	13	-	(5,912)	-	(5,912)
		________	________	________	________
		(151)	(13,038)	(151)	(13,038)
		________	________	________	________
Net current assets/(liabilities)		1,731	(9,620)	1,873	(9,478)
		________	________	________	________
Total assets less current liabilities		44,545	25,327	44,687	25,469
		________	________	________	________
Non-current liabilities
Long-term loan	13	(10,000)	-	(10,000)	-
		________	________	________	________
Net assets		34,545	25,327	34,687	25,469
		________	________	________	________
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	7,571	(1,693)	7,571	(1,693)
Revenue reserve	15	1,995	2,041	2,137	2,183
		________	________	________	________
		34,545	25,327	34,687	25,469
		________	________	________	________
Net asset value per Ordinary share (pence)	9	156.24	114.55
		________	________	________	________

SHIRES SMALLER COMPANIES PLC

Consolidated Statement of Changes in Equity

Year ended 31 December 2010
			Share	Capital
		Share	premium	redemption	Capital	Revenue
		capital	account	reserve	reserve	reserve	Total
	Notes	£'000	£'000	£'000	£'000	£'000	£'000
As at 31 December 2009		11,055	11,892	2,032	(1,693)	2,041	25,327
Revenue profit for the year		-	-	-	-	1,336	1,336
Capital profits for the year		-	-	-	9,264	-	9,264
Equity dividends	8	-	-	-	-	(1,382)	(1,382)
		_______	_______	_______	_______	_______	_______
As at 31 December 2010		11,055	11,892	2,032	7,571	1,995	34,545
		_______	_______	_______	_______	_______	_______
Year ended 31 December 2009
			Share	Capital
		Share	premium	redemption	Capital	Revenue
		capital	account	reserve	reserve	reserve	Total
	Notes	£'000	£'000	£'000	£'000	£'000	£'000
As at 31 December 2008		11,055	11,892	2,032	(8,281)	2,677	19,375
Revenue profit for the year		-	-	-	-	1,608	1,608
Capital profits for the year		-	-	-	6,588	-	6,588
Equity dividends	8	-	-	-	-	(2,244)	(2,244)
		_______	_______	_______	_______	_______	_______
As at 31 December 2009		11,055	11,892	2,032	(1,693)	2,041	25,327
		_______	_______	_______	_______	_______	_______
Company Statement of Changes in Equity
Year ended 31 December 2010
			Share	Capital
		Share	premium	redemption	Capital	Revenue
		capital	account	reserve	reserve	reserve	Total
	Notes	£'000	£'000	£'000	£'000	£'000	£'000
As at 31 December 2009		11,055	11,892	2,032	(1,693)	2,183	25,469
Revenue profit for the year		-	-	-	-	1,336	1,336
Capital profits for the year		-	-	-	9,264	-	9,264
Equity dividends	8	-	-	-	-	(1,382)	(1,382)
		_______	_______	_______	_______	_______	_______
As at 31 December 2010		11,055	11,892	2,032	7,571	2,137	34,687
		_______	_______	_______	_______	_______	_______
Year ended 31 December 2009
			Share	Capital
		Share	premium	redemption	Capital	Revenue
		capital	account	reserve	reserve	Reserve	Total
	Notes	£'000	£'000	£'000	£'000	£'000	£'000
As at 31 December 2008		11,055	11,892	2,032	(8,281)	2,819	19,517
Revenue profit for the year		-	-	-	-	1,608	1,608
Capital profits for the year		-	-	-	6,588	-	6,588
Equity dividends	8	-	-	-	-	(2,244)	(2,244)
		_______	_______	_______	_______	_______	_______
As at 31 December 2009		11,055	11,892	2,032	(1,693)	2,183	25,469
		_______	_______	_______	_______	_______	_______
The revenue reserve represents the amount of the Company's reserves distributable by way of dividend.
The accompanying notes are an integral part of the financial statements.

SHIRES SMALLER COMPANIES PLC

Group and Company Cash Flow Statement

	Year ended		Year ended
	31 December 2010		31 December 2009
	£'000	£'000	£'000	£'000
Cash flows from operating activities
Investment income received		1,922		2,083
Deposit interest received		20		165
Investment management fee paid		(291)		(386)
VAT recovered		32		728
Other cash expenses		(240)		(255)
		________		________
Cash generated from operations		1,443		2,335
Interest paid		(428)		(560)
		________		________
Net cash inflows from operating activities		1,015		1,775
Cash flows from investing activities
Purchases of investments	(11,401)		(11,024)
Sales of investments	13,276		12,678
	________		________
Net cash inflow from investing activities		1,875		1,654
Cash flows from financing activities		________		________
Equity dividends paid	(1,382)		(2,244)
Repayment of July 2010 ZCF position	(5,337)		-
Repayment of September 2009 ZCF position	-		(5,377)
Loan repaid	(7,000)		(3,000)
Loan drawndown	10,000		-
	________		________
Net cash outflow from financing activities		(3,719)		(10,621)
		________		________
Net decrease in cash and cash equivalents		(829)		(7,192)
Cash and cash equivalents at start of year		2,381		9,573
		________		________
Cash and cash equivalents at end of year		1,552		2,381
		________		________

SHIRES SMALLER COMPANIES PLC

YEAR ENDED 31 DECEMBER 2010

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 International Financial Reporting 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.
		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 Statement of Comprehensive Income between items of a revenue and capital nature has been presented alongside the Statement of Comprehensive Income. In accordance with the Company's status as a UK investment company under Section 833 of the Companies Act 2006, 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 Sections 1158 - 1159 of the Corporation Tax Act 2010.
		At the date of authorisation of these financial statements, the following Standards and Interpretations were in issue but not yet effective:
		-	Amendments to IFRS 1 - First time adoption - Financial Instrument Disclosures (effective for annual periods beginning on or after 1 July 2010).
		-	Amendments to IFRS 7 - Financial Instruments: Disclosures on Derecognition 2011 (effective for annual periods beginning on or after 1 July 2011).
		-	IFRS 9 - Financial Instruments: Classification and Measurement (effective for annual periods beginning on or after 1 January 2013). This standard has not yet been adopted by the EU.
		-	Amendments to IAS 1 - First time adoption - narrow scope amendment (effective for annual periods beginning on or after 1 July 2011).
		-	Amendments to IAS 12 - Income taxes - deferred tax amendment (effective for annual periods beginning on or after 1 January 2012).
		-	Amendments to IAS 24 - Related Party Disclosures (effective for annual periods beginning on or after 1 January 2011).
		-	Amendments to IAS 32 - Classification of Rights Issues (effective for annual periods beginning on or after 1 February 2010).
		-	IFRIC 19 - Extinguishing Financial Liabilities with Equity Instruments (effective for annual periods beginning on or after 1 July 2010).
		-	Amendments to IFRIC 14 - Prepayments of a Minimum Funding Requirement (effective for annual periods beginning on or after 1 January 2011).
		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 a Statement of Comprehensive Income for the parent company, granted under Section 408 of the Companies Act 2006.
	(c)	Investments
		Investments have been designated upon initial recognition at fair value through profit or loss. Investments are recognised and de-recognised at trade date where a purchase or sale is under a contract whose terms require delivery within the time frame established by the market concerned, and are initially measured at fair value. Subsequent to initial recognition, investments are valued at fair value. For listed investments, this is deemed to be bid market prices or closing prices for SETS stocks sourced from The London Stock Exchange. SETS is the London Stock Exchange's electronic trading service for UK securities including all the FTSE All-Share Index constituents.
		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 Statement of Comprehensive Income.
	(e)	Zero coupon finance
		The Company had in place during the year medium-term funding in the form of zero coupon finance through a series of option transactions on the FTSE 100 Index. The final position was repaid in July 2010. 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 Consolidated Statement of Comprehensive Income.
	(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 Statement of Comprehensive Income, 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 Statement of Comprehensive Income 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.
		With the exception of loan redemption costs, which have been allocated 100% to capital, finance costs have been allocated 50% to revenue and 50% to capital in the Consolidated Statement of Comprehensive Income, 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 Consolidated Statement of Comprehensive Income 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 (see note 6 for a more detailed explanation). 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.

		2010	2009
2.	Income	£'000	£'000
	Income from investments
	Dividend income from UK equity securities	1,244	1,167
	Dividend income from overseas equity securities	123	91
	Interest income from investments	486	667
		_________	_________
		1,853	1,925
		_________	_________
		2010	2009
		£'000	£'000
	Other income
	Interest on VAT recoverable on investment management fees	1	132
	Deposit interest	19	23
	Underwriting commission	-	2
		_________	_________
		20	157
		_________	_________
	Total revenue income	1,873	2,082
		_________	_________
	As per note 1 (f), the Company amortises the premium or discount on acquisition on debt securities against unrealised capital reserve. For 2010 this represented £27,000 (2009 - £33,000) which has been reflected in the capital column of the Statement of Comprehensive Income.

		2010			2009
		Revenue	Capital	Total	Revenue	Capital	Total
3.	Investment management fees	£'000	£'000	£'000	£'000	£'000	£'000
	Investment management fee	151	151	302	127	127	254
		_____	_____	_____	_____	_____	_____
	For the year ended 31 December 2010 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.
	On 5 November 2007, the European Court of Justice ruled that management fees on investment trusts should be exempt from VAT. HMRC announced its intention not to appeal against this ruling to the UK VAT Tribunal and therefore protective claims were made in relation to the Company with HMRC. The Company has not been charged VAT on its investment management fees from 1 October 2007.
	The VAT charged on the investment management fees has been refunded in stages. The Manager has refunded £440,000 (excluding interest) for the period 1 January 2004 to 30 September 2007 and £288,000 (excluding interest) to the Company for VAT charged on investment management fees for the periods 28 August 1992 (commencement of trading) to 3 December 1996 and 1 January 2001 to 31 December 2003. The amounts received were included in the financial statements for the year ended 31 December 2008 and 31 December 2009 respectively. In addition, a further £32,000 (excluding interest) has been refunded by the Manager in the current year. The repayment relates to VAT charged on investment management fees for the quarter 1 July 2007 to 30 September 2007. 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.
	In addition, interest of £132,000 was received and included in the financial statements to 31 December 2009. A further £1,000 of interest has been included in the current year's financial statements in respect of the refund received in the current period.

		2010	2009
4.	Other administrative expenses	£'000	£'000
	Directors' remuneration - fees as Directors	77	71
	Fees payable to auditors and associates:
	- fees payable to the Company's auditors for the audit of the annual accounts	19	18
	Other management expenses	135	123
		_______	_______
		231	212
		_______	_______
	The Company had no employees during the year (2009 - nil). No pension contributions were paid for Directors (2009 - £nil).

		2010			2009
		Revenue	Capital	Total	Revenue	Capital	Total
5.	Finance costs and borrowings	£'000	£'000	£'000	£'000	£'000	£'000
	Bank loans	171	171	342	280	280	560
	Bank loan redemption costs	-	108	108	-	-	-
	Overdrafts	-	-	-	(1)	(1)	(2)
		_______	_______	_____	_______	_______	_____
		171	279	450	279	279	558
		_______	_______	_____	_______	_______	_____
	Bank loan redemption costs were incurred by the Company on repayment of the £7m loan facility with Royal Bank of Scotland. These costs have been charged to capital in accordance with the provisions of the SORP.

6.	Taxation
	Management expenses arising on revenue items this year were sufficient to offset against taxable revenue. Nil (2009 - £302,000) surplus management expenses arising on capital items were relieved against the remaining taxable revenue. In accordance with accounting policy 1(j) no amount (2009 - £nil) has been credited to capital and charged to revenue as a notional corporation tax item.
	At 31 December 2010, the Company had net surplus management expenses and loan relationship deficits of £8,274,000 (2009 - £7,851,000) 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 applicable at the year end was 28% (2009 - effective rate of 28%).
		2010			2009
		Revenue	Capital	Total	Revenue	Capital	Total
		£'000	£'000	£'000	£'000	£'000	£'000
	Profit before tax	1,336	9,264	10,600	1,608	6,588	8,196
	Taxation of return on ordinary activities at the standard rate of corporation tax	374	2,594	2,968	450	1,845	2,295
	Effects of:
	UK dividend income not liable to further tax	(373)	-	(373)	(353)	-	(353)
	Capital gains disallowed for the purposes of corporation tax	-	(2,726)	(2,726)	-	(1,995)	(1,995)
	Zero coupon finance costs not an allowable tax deduction	-	16	16	-	77	77
	Income not subject to tax	(34)	-	(34)	(12)	-	(12)
	Utilisation of surplus management expenses	-	-	-	(85)	-	(85)
	Excess management expenses not utilised	33	116	149	-	73	73
		_______	_______	_____	_______	_______	_____
	Taxation charge for the year	-	-	-	-	-	-
		_______	_______	_____	_______	_______	_____

7.	Revenue and capital profit attributable to equity holders of the Company
	The revenue and capital profits attributable to equity holders of the Group for the financial year includes £10,600,000 (2009 - profits of £8,196,000) which has been dealt with in the Company's financial statements.

		2010	2009
8.	Dividends	£'000	£'000
	Amounts recognised as distributions to equity holders in the period:
	Fourth interim dividend for the year ended 31 December 2009 of 1.75p (2008 - 4.90p) per share	387	1,083
	Three interim dividends for the year ended 31 December 2010 totalling 4.50p (2009 - 5.25p) per share	995	1,161
		_______	_______
		1,382	2,244
		_______	_______
	The fourth interim dividend of 1.50p per share, declared on 15 December 2010 and paid on 28 January 2011 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 Sections 1158-1159 of the Corporation Tax Act 2010 are considered:
		2010	2009
		£'000	£'000
	Three interim dividends for the year ended 31 December 2010 totalling 4.50p (2009 - 5.25p) per share	995	1,161
	Fourth interim dividend for the year ended 31 December 2010 of 1.50p (2009 - 1.75p) per share	332	387
		_______	_______
		1,327	1,548
		_______	_______

		2010	2009
9.	Return and net asset value per share	£'000	£'000
	The returns per share are based on the following figures:
	Revenue return	1,336	1,608
	Capital return	9,264	6,588
		_______	_______
	Net return	10,600	8,196
		_______	_______
	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 £34,545,000 (2009 - £25,327,000) and on the 22,109,765 (2009 - 22,109,765) shares in issue at 31 December 2010.

			Group & Company
			2010	2009
10.	Non current assets - securities at fair value		£'000	£'000
	Listed on recognised stock exchanges:
	United Kingdom		42,159	32,845
	Overseas		655	2,102
			_______	_______
			42,814	34,947
			_______	_______
			Group & Company
			2010	2009
			£'000	£'000
	Cost at 31 December 2009		38,355	45,244
	Investment holdings losses at 31 December 2009		(3,408)	(15,775)
			_______	_______
	Fair value at 31 December 2009		34,947	29,469
	Purchases		11,401	11,024
	Amortised cost adjustments to fixed interest securities		(27)	(33)
	Sales	- proceeds	(13,270)	(12,670)
		- net losses on sales	(256)	(5,210)
	Movement in investment holdings losses during the year		10,019	12,367
			_______	_______
	Valuation at 31 December 2010		42,814	34,947
			_______	_______
	Cost at 31 December 2010		36,203	38,355
	Investment holdings gains/(losses) at 31 December 2010		6,611	(3,408)
			_______	_______
	Fair value at 31 December 2010		42,814	34,947
			_______	_______
			Group & Company
			2010	2009
	Gains/(losses) on investments		£'000	£'000
	Net realised losses on sales		(256)	(5,210)
	Movement in fair value		10,019	12,367
			_______	_______
	Gains on investments		9,763	7,157
			_______	_______
	The total transaction costs on the purchases and sales in the year were £59,000 (2009 - £52,000) and £11,000 (2009 - £6,000) respectively.
	All investments are categorised as held at fair value through profit and loss.

		Company
		2010	2009
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 31 December 2010 Shirescot Securities Limited had net liabilities of £142,000 (2009 - net liabilities of £142,000). Shires Smaller Companies plc confirms that it will provide financial support for Shirescot Securities Limited to continue to trade.

		Group		Company
		2010	2009	2010	2009
12.	Other receivables	£'000	£'000	£'000	£'000
	Amounts due from brokers	-	6	-	6
	Accrued income & prepayments	287	391	287	391
	Due by subsidiary undertaking	-	-	142	142
	Other debtors	43	3	43	3
		_______	_______	_______	_______
		330	400	472	542
		_______	_______	_______	_______
	None of the above amounts are overdue.

		2010	2009
13.	Loans and zero coupon finance derivatives at fair value	£'000	£'000
	Bank loans included at amortised cost	10,000	7,000
	Zero coupon finance derivatives at fair value - current liabilities	-	5,912
		_______	_______
		10,000	12,912
		_______	_______
	Bank loans
	The bank loan of £7 million with Royal Bank of Scotland, due to be repaid on 23 December 2010, was repaid in full on 29 July 2010. The interest on this loan was fixed at 5.49% per annum on the principal amount. On 29 July 2010, a new three year facility of £10 million with National Australia Bank was drawn down in full. The loan was drawn down and rolled over monthly. On 30 November 2010 the loan was rolled over for 2 months at a rate of 2.63% per annum. The loan has subsequently been rolled over on 28 February 2011 for one month at a rate of 2.625%.
	The Directors are of the opinion that the fair value of the bank loan at 31 December 2010 is not materially different from the book value. At 31 December 2009 the fair value of the loan was determined to be £7,398,000 with reference to the interest profile of an equivalent gilt.
	Zero coupon finance
	The zero coupon finance arrangement comprised a set of separately traded financial instruments (FTSE 100 Index options) each with its own market value, which equated to their fair values. The options ran until July 2010 when the tranche taken out in July 2005, was repaid at a cost of £5.3 million. Set out below is an analysis of the different options split between put and call options and assets and liabilities as was disclosed in the Balance Sheet at 31 December 2009. 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 Statement of Comprehensive Income and where the position is closed out a realised loss is charged to the capital column of the Consolidated Statement of Comprehensive Income.
	The amount charged to capital fluctuates over accounting periods due to market volatility over the life of the options but was approximately 5.5% per annum for the options which expired in July 2010.
	On repayment of the July 2010 tranche the collateral previously pledged was no longer required. At 31 December 2009, the Company had pledged collateral equal to at least 160% of the market value of this finance in accordance with standard commercial practice. The actual carrying amount of financial assets pledged at 31 December 2009 equated to £8,463,000 in the form of securities.
		2010	2009
	Fair value at 31 December 2010	£'000	£'000
	Current assets
	Call option expiring on 29 July 2010	-	4
	Put option expiring on 29 July 2010	-	633
		_______	_______
		-	637
		_______	_______
		2010	2009
	Current liabilities	£'000	£'000
	Call option expiring on 29 July 2010	-	(1,414)
	Put option expiring on 29 July 2010	-	(4,498)
		_______	_______
		-	(5,912)
		_______	_______
	Net zero coupon finance liability - fair value	-	(5,275)
		_______	_______
	The movements in the fair value of this finance were as follows:
		Group and Company
		2010	2009
		£'000	£'000
	At 31 December 2009	5,275	10,384
	Cost of closure of existing zero coupon finance arrangement	(5,333)	(5,383)
		_______	_______
		(58)	5,001
	Finance costs charged to capital	58	274
		_______	_______
	At 31 December 2010	-	5,275
		_______	_______

		Ordinary shares
		of 50 pence each
14.	Called up share capital	Number	£'000
	Authorised
	At 31 December 2010 and 31 December 2009	35,000,000	17,500
		_________	_______
	Allotted, called up and fully paid
	At 31 December 2010 and 31 December 2009	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
						2010	2009
15.		Retained earnings				£'000	£'000
		Capital reserve
		At 31 December 2009				(1,693)	(8,281)
		Net losses on sales of investments during the year				(256)	(5,210)
		Movement in investment holdings gains during the year				10,019	12,367
		Amortised cost adjustment relating to capital				(27)	(33)
		Zero coupon finance costs (note 13)				(58)	(274)
		Finance costs of borrowings (note 5)				(279)	(279)
		Investment management fee				(151)	(127)
		VAT recovered on management fees				16	144
						_______	_______
		At 31 December 2010				7,571	(1,693)
						_______	_______
	The capital reserve includes investment holding gains amounting to £6,611,000 (2009 - losses of £3,408,000), as disclosed in note 10.
			Group	Company	Group		Company
			2010	2010	2009		2009
	Revenue reserve		£'000	£'000	£'000		£'000
	At 31 December 2009		2,041	2,183	2,677		2,819
	Revenue return		1,336	1,336	1,608		1,608
	Dividends paid		(1,382)	(1,382)	(2,244)		(2,244)
			_______	_______	_______		_______
	At 31 December 2010		1,995	2,137	2,041		2,183
			_______	_______	_______		_______

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 which ensures that the investment objective explained above 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 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 average	Weighted
				period for which	average interest	Fixed	Floating	Non interest
				rate is fixed	rate	rate	rate	bearing
		As at 31 December 2010		Years	%	£'000	£'000	£'000
		Assets
		UK corporate bonds		9.29	6.39	6,081	-	-
		UK preference shares		-	8.01	2,672	-	-
		Cash		-	-	-	1,552	-
				_______	_______	_______	_______	_______
		Total assets		-	-	8,753	1,552	-
				_______	_______	_______	_______	_______
				Weighted average	Weighted
				period for which	average interest	Fixed	Floating	Non interest
				rate is fixed	rate	rate	rate	bearing
				Years	%	£'000	£'000	£'000
		Liabilities
		Short-term bank loan		0.08	2.63	(10,000)	-	-
				_______	_______	_______	_______	_______
		Total liabilities		-	-	(10,000)	-	-
				_______	_______	_______	_______	_______
		Total		-	-	(1,247)	1,552	-
				_______	_______	_______	_______	_______
				Weighted average	Weighted
				period for which	average interest	Fixed	Floating	Non interest
				rate is fixed	rate	rate	rate	bearing
		As at 31 December 2009		Years	%	£'000	£'000	£'000
		Assets
		UK corporate bonds		8.30	7.19	6,499	-	-
		UK preference shares		-	7.47	4,158	-	-
		Zero coupon finance		-	-	-	-	637
		Cash		-	-	-	2,381	-
				_______	_______	_______	_______	_______
		Total assets		-	-	10,657	2,381	637
				_______	_______	_______	_______	_______
		Liabilities
		Short-term bank loan		0.98	5.49	(7,000)	-	-
		Zero coupon finance		-	-	-	-	(5,912)
				_______	_______	_______	_______	_______
		Total liabilities		-	-	(7,000)	-	(5,912)
				_______	_______	_______	_______	_______
		Total		-	-	3,657	2,381	(5,275)
				_______	_______	_______	_______	_______
		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 to the financial statements.
		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 2010		£'000	£'000		£'000		£'000	£'000	£'000
	Fixed rate
	UK corporate bonds		737	-		-		301	-	5,043
	Bank loan		-	-		(10,000)		-	-	-
			_______	_______		_______		_______	_______	_______
			737	-		(10,000)		301	-	5,043
			_______	_______		_______		_______	_______	_______
			Within	Within		Within		Within	Within	More than
			1 year	1-2 years		2-3 years		3-4 years	4-5 years	5 years
			£'000	£'000		£'000		£'000	£'000	£'000
	Floating rate
	Cash		1,552	-		-		-	-	-
			_______	_______		_______		_______	_______	_______
			1,552	-		-		-	-	-
			_______	_______		_______		_______	_______	_______
	Total		2,289	-		(10,000)		301	-	5,043
			_______	_______		_______		_______	_______	_______
			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 2009		£'000	£'000		£'000		£'000	£'000	£'000
	Fixed rate
	UK corporate bonds		672	-		771		507	306	4,243
	UK redeemable preference shares		221	-		-		-	-	-
	Bank loans		(7,000)	-		-		-	-	-
			_______	_______		_______		_______	_______	_______
			(6,107)	-		771		507	306	4,243
			_______	_______		_______		_______	_______	_______
	Floating rate
	Zero coupon finance		(5,275)	-		-		-	-	-
	Cash		2,381	-		-		-	-	-
			_______	_______		_______		_______	_______	_______
			(2,894)	-		-		-	-	-
			_______	_______		_______		_______	_______	_______
	Total		(9,001)	-		771		507	306	4,243
			_______	_______		_______		_______	_______	_______
	The maturity table above excludes the value of holdings in UK irredeemable preference shares held at the year end, which equated to £2,672,000 (2009 - £3,937,000).
	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 2010 would increase/decrease by £16,000 (2009 - £24,000). 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 2010 would increase/decrease by £237,000 (2009 - £458,000). 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 would not necessarily reflect 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 2010 would have increased/decreased by £3,406,000 (2009 - increase/decrease of £2,429,000). 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 (note 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;
	-	for part of the year a proportion of the Company's gearing related 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 tranche 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 managed 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:
					2010				2009
					Balance		Maximum		Balance	Maximum
					Sheet		exposure		Sheet	exposure
					£'000		£'000		£'000	£'000
	Non-current assets
	Securities at fair value through profit or loss				42,814		42,814		34,947	34,947
	Current assets
	Trade and other receivables				43		43		9	9
	Accrued income				287		287		391	391
	Cash and cash equivalents				1,552		1,552		2,381	2,381
	Zero coupon finance derivatives at fair value				-		-		637	637
					________		________		________	________
					44,696		44,696		38,365	38,365
					________		________		________	________
	None of the Company's financial assets is past due or impaired.
	Fair value of financial assets and liabilities
	The fair value of the short term loan is shown in Note 13. 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.
	For part of the year a further component of the Company's gearing related to the zero coupon finance raised in the derivatives market. The final liability of the zero coupon finance was pre-determined at the outset of each tranche of zero coupon finance. However the amount charged to capital fluctuated over accounting periods due to interest rate movements giving rise to interest rate risk. This was managed by investing the proceeds of the zero coupon finance in predominantly investment grade corporate bonds, the value of which were 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 contains a clause which stipulates that total borrowings cannot exceed 40% of adjusted assets. As at 31 December 2010 the reported ratio was 22.4%.
	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 2010 the net asset value stood at £34.5 million (2009 - £25.3 million).

17.	Income enhancement
	Zero coupon finance (note 13) raised in the derivatives market was invested in corporate fixed interest securities to augment the income available for distribution to shareholders. The cost of these funds was fixed when they were raised, and was 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.
		2010		2009
		Income	Capital	Income	Capital
		£'000	£'000	£'000	£'000
	Zero coupon finance:
	Finance costs charged to capital	-	(58)	-	(274)
	Return on corresponding investments	199	(355)	286	212
	Purchase of preference shares with discretionary dividends cum-dividend and sales ex-dividend	-	-	19	-
	Debt securities:
	Amortised cost adjustment charged to capital	27	(27)	33	(33)
	Tax value of loan relationship / management expenses arising in capital but utilised against income	-	-	85	(85)
		______	______	______	______
		226	(440)	423	(180)
		______	______	______	______

18.	Fair value hierarchy
	The Group adopted the amendments to IFRS 7 'Financial Instruments: Disclosures' effective from 1 January 2009. These amendments require an entity to classify fair value measurements using a fair value hierarchy that reflects the significance of the inputs used in making the measurements. The fair value hierarchy shall have the following levels:
	-  Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities;
	-  Level 2: inputs other than quoted prices included within Level 1 that are observable for the assets or liability, either directly (ie as prices) or indirectly (ie derived from prices); and
	-  Level 3: inputs for the asset or liability that are not based on observable market data (unobservable inputs).
	The financial assets and liabilities measured at fair value in the statement of financial position are grouped into the fair value hierarchy at 31 December 2010 as follows:
			Level 1	Level 2	Level 3	Total
		Note	£'000	£'000	£'000	£'000
	Financial assets at fair value through profit or loss
	Quoted equities	a)	35,572	-	-	35,572
	Quoted bonds	b)	7,242	-	-	7,242
	Derivatives	c)	-	-	-	-
			______	______	______	______
	Total		42,814	-	-	42,814
			______	______	______	______
	Financial liabilities at fair value through profit or loss
	Derivatives	c)	-	-	-	-
			______	______	______	______
	Net fair value		42,814	-	-	42,814
			______	______	______	______
	As at 31 December 2009
			Level 1	Level 2	Level 3	Total
		Note	£'000	£'000	£'000	£'000
	Financial assets at fair value through profit or loss
	Quoted equities	a)	27,242	-	-	27,242
	Quoted bonds	b)	7,705	-	-	7,705
	Derivatives	c)	-	637	-	637
			______	______	______	______
	Total		34,947	637	-	35,584
			______	______	______	______
	Financial liabilities at fair value through profit or loss
	Derivatives	c)	-	(5,912)	-	(5,912)
			______	______	______	______
	Net fair value		34,947	(5,275)	-	29,672
			______	______	______	______
	a) Quoted equities
	The fair value of the Group's investments in quoted equities have been determined by reference to their quoted bid prices at the reporting date. Quoted equities included in Fair Value Level 1 are actively traded on recognised stock exchanges.
	b) Quoted bonds
	The fair value of the Group's investments in Corporate quoted bonds has been determined by reference to their quoted bid prices at the reporting date.
	c) Derivatives
	The fair value of the Group's investments in Derivatives has been determined using observable market inputs other than quoted prices included within Level 1.

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 2010. The statutory accounts for the year ended 31 December 2010 received an audit report which was unqualified.

The statutory accounts for the financial year ended 31 December 2010 were approved by the Directors on 28 February 2011 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 13 April 2011 at Bow Bells House, One Bread Street, London EC4M 9HH.

The Annual Report will be posted to shareholders in March 2011 and additional copies will be available from the Manager (Investor Helpline - Tel. [phone]) 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

 

END

 

 

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