Annual Financial Report

RNS Number : 0826V

Baillie Gifford Japan Trust PLC

27 October 2010

 



THE BAILLIE GIFFORD JAPAN TRUST PLC

ANNUAL FINANCIAL REPORT

A copy of the Annual Report and Financial Statements for the year ended 31 August 2010 of The Baillie Gifford Japan Trust PLC has been submitted electronically to the National Storage Mechanism (which replaced the UKLA's Document Viewing Facility on 1 September 2010) and will shortly be available for inspection at http://www.hemscott.com/nsm.do .

The Annual Report and Financial Statements for the year ended 31 August 2010 including the Notice of Annual General Meeting is also available on Baillie Gifford Japan's page of the Baillie Gifford website at:

www.japantrustplc.co.uk 

The unedited full text of those parts of the Annual Report and Financial Statements for the year ended 31 August 2010 which require to be published by DTR 4.1 is set out on the following pages.

Baillie Gifford & Co

Company Secretaries

27 October 2010

THE BAILLIE GIFFORD JAPAN TRUST PLC

Chairman's Statement

Japanese equities retreated in the second half of the year, after gains in the first. The fall was mitigated in sterling terms by the strength of the yen. Over the year your Company's net asset value (after deducting borrowings at fair value) rose by 0.8% compared with a fall of 0.7% in the benchmark TOPIX total return index (in sterling terms).

Stock selection over the year was good, but gains to performance were pared back because of the gearing. Further performance details can be found in the Manager's Report.

Investment income increased by 11% over the year reflecting higher dividends. Income was reduced by the sale of the bank bond which had a higher yield than equities. Expenses rose, mainly because of the effect of the increasing net assets on which the management fee is based. Overall revenue return per share was 0.72p. No dividend is payable as the revenue reserve remains in deficit.

Gearing

Net gearing amounted to 15% of net assets at the start of the year and ended the year at 18%. A tranche of the Company's loans was replaced during the year.  This was at a higher cost than the maturing loan, which is due to the higher margins being charged by banks but with the low cost of yen loans, we believe that borrowing to invest in Japanese equities is a sensible strategy.

Share Capital

The Company did not exercise its share buy back powers during the year.  Your Board believes however that it is important that the Company retains this power and is seeking to renew this facility at the Annual General Meeting. The Company is also seeking to renew the Directors' authority to issue new shares and to reissue any shares held in treasury up to 5% of the Company's issued share capital for cash on a non-pre-emptive basis.  Shares would only be issued/reissued at a premium to net asset value, thereby enhancing net asset value per share for existing shareholders.  The Directors will only seek to utilise this authority if they believe that it will be in the best interests of the Company to do so.

Continuance Vote and Investment Management Agreement

Our shareholders have the right to vote annually on whether the Company should continue in business, and will again have the opportunity to do so at the Annual General Meeting to be held on 30 November 2010.

Last year the Company received support for its continuance from 95.6% of those voting.  Your Directors are of the opinion that despite the continuing macro economic problems, there remains attractive opportunities in selected, well-run companies.

Given the favourable outlook, I and my fellow Directors intend where possible to vote our own shareholdings in favour of the resolution and hope that shareholders will feel disposed to do likewise.

Shareholders will note that in line with industry best practice, and at the suggestion of the Managers, the notice period for terminating the Management Agreement has been reduced from one year to six months with effect from 1 September 2010.

 

THE BAILLIE GIFFORD JAPAN TRUST PLC

Chairman's Statement (continued)

Outlook

The setback in the equity market in the second half of the year has left Japanese equities looking good value against other world equity markets. The political environment and the strength of the yen are discouraging some international investors from increasing their Japanese exposure.  There are however companies in Japan which have more shareholder friendly policies and which are likely to show good growth in earnings. The Board is confident that the Managers can continue to seek out such companies.

Richard A Barfield

8 October 2010

Past performance is not a guide to future performance.

THE BAILLIE GIFFORD JAPAN TRUST PLC

Managers' Report

Performance

During the year to 31 August 2010 the Japanese Stock Market was generally weak and the TOPIX ended at its lowest point.  In local currency terms the TOPIX total return index (including dividends) fell by 15.2%.  However the yen was strong, particularly against sterling, and consequently the currency adjusted benchmark declined by 0.7%.  In comparison, the Company's net asset value per share, after deducting borrowings at fair value, increased by 0.8%. 

The outperformance was due mainly to stock selection, with nearly all individual equity sectors showing positive returns relative to the market.  Major individual contributors were Sysmex (the haematology company), Itochu and Rakuten.  Given the falls in the level of the market the gearing had a negative effect.  Some of the holdings raised new equity finance, not always predictably, and those that did, such as Inpex and Tokyo Tatemono, hurt performance.  The table below shows the detail of the breakdowns between the sectors and between stock selection and gearing. 

Whilst the change in NAV over the year was small, there were sharp moves in Japanese markets during the year.  In autumn 2009 there was particular concern that Japan would undergo a 'double-dip' recession and this led to weakness in Japanese stocks.  But the continued recovery in the economy and a strong showing by corporate profits allowed a sharp recovery and the market reached its peak in April 24% above the year end level.  Then wider fears about economic prospects in Europe, the US and China concerned markets generally and coincided with yen strength, apparently as the yen was regarded as a less risky currency.    As a result the stock market fell sharply between April and the year end to levels comparable with those experienced in the financial crisis.

Portfolio

Turnover in the portfolio remained at low levels, reflecting our long term investment style, and fell to 16.7% during the year.  We have bought a total of seven new holdings and sold nine as well as the remaining holding in the bank bond, which had added marginally to performance.  The holdings sold were mainly those where we were less convinced about the longer term competitive advantage, particularly those in the financial sector, or where share prices rose to discount our positive view, such as Tokyo Electron.  We have also been concerned about share issuance by companies with weak balance sheets and sold Taiheiyo Cement and Juki as a result. 

The new holdings reflect various attractions.  Pigeon has a significant baby goods business in China, M3 offers drug companies an effective new sales channel which also appeals to doctors, Wacom has strong intellectual property in touch screens and Start Today is a leading on-line fashion retailer.  We also bought a holding in Mitsui, a large trading company with particular strengths in resources.  

Economy and Political Developments 

The Japanese economy has continued to recover after the global economic downturn and GDP growth for the current year is expected to be around +3.3%.  The rapid rebound seen in the second half of 2009 has moderated in the last quarter as conditions have normalised in some industrial sectors and some of the emergency stimulus measures made by various governments globally have finished.  Unemployment in Japan peaked in 2009 and has been relatively stable in 2010.  Deflation remains, exacerbated by the strength of the yen, although it has been acknowledged as a major issue by the government.  The Bank of Japan has not expanded its balance sheet as much as other major developed country banks and is under increasing pressure from a variety of politicians to do so.  There has recently been some intervention in the currency markets to weaken the yen, although the effects of this remain unclear. 

THE BAILLIE GIFFORD JAPAN TRUST PLC

Managers' Report (continued)

In the short term the fortunes of the economy will be tied to export markets.  Although there has been some recovery domestically it is not robust enough to withstand a significant deterioration in global trade.  However, Japan's largest export market is in Asia and growth is expected to continue there.  In the short term, diplomatic relations with China have been troubled after an incident near disputed territory, but this is unlikely seriously to impact the burgeoning economic links.  China has been a buyer of Japanese Government Bonds and there have been a number of small scale purchases of companies in Japan.  Longer term growth will be driven by the amount of policy change, either in monetary policy or deregulation. 

After the historic election victory in 2009, the Democratic Party of Japan has had a disappointing first year in government and Prime Minister Hashimoto resigned in June.  His successor Naoto Kan then had to fight an Upper House election in July and withstand a leadership challenge by the powerful Ichiro Ozawa, who is a former leader of the DPJ.  The government failed to secure a majority in the Upper House election, but Mr Kan was confirmed as Prime Minister and party leader.  This means that decision making in government is clearer but that controversial policy, such as the inevitable raising of the consumption tax, will have to win the agreement of opposition parties.  The preferences for change expressed by voters in several elections seem not yet fulfilled by the politicians.   Politics in Japan is in a long term transition from the one party dominance of the LDP to what may be a more responsive and democratic system, but the short term developments are unpredictable.  Mr Kan may yet be a strong and decisive Premier, introducing the ambitious policy agenda which the DPJ developed in opposition, but it will be a challenge. 

Japanese Corporate Developments

After the recession and rebound Japanese companies have managed to rebuild their profit margins, which in aggregate are now back to previous peaks.  This was due mainly to aggressive cut backs on investment and personnel.  The first quarter results for the current fiscal year were exceptionally strong, although momentum is expected to fade as the year progresses.  Current estimates are for profit growth of around 20% for the fiscal year as a whole; forecasts have been reduced by the strength of the yen. 

Significant efforts have been made by companies to internationalise their business and one source estimates that one third of the assets of Japanese companies are abroad and two thirds of large companies have subsidiaries in China.  Company balance sheets are strong with significant amounts of cash.  Some companies have been taking advantage of the strength of the yen to make overseas acquisitions, notably Rakuten which has bought companies in France and the US, and most are increasing their investment overseas faster than within Japan.  Forthcoming changes as Japan moves towards international accounting standards should make M&A more appealing in reporting results.

Dividends are now increasing again and are expected to rise 18% in the first half of the current fiscal year.  Equity yields remain above bond yields and the maturity of many domestic businesses mean that payout ratios should rise with dividends increasing faster than profits over the next few years. 

Outlook

Whilst the outlook for the Japanese economy is dull, particularly when compared to other nations in the region such as China, the potential for some Japanese companies to exploit particular niches is strong.  There is a feeling of pessimism about domestic developments, not helped by the poor showing of the new government, but differentiation should be made between economic performance and the outlook for individual investments.  The stock market is now cheaper than it has been since the early 1980s and sells on its stated book value.  Company managements are in general less complacent.  The rising competitive threat from Asia and the maturation of the domestic economy mean that even traditionally domestic companies are refocusing their efforts.  There is a growing list of exciting companies in the internet area, many manufacturing companies are supplying equipment and components elsewhere in Asia and retailers with strong business models continue to thrive.  We continue to find attractive investments and continue to own only those stocks which will benefit from their own efforts.

Portfolio Performance Attribution for the Year to 31 August 2010^†

Computed relative to the benchmark (TOPIX total return in sterling terms) with net income reinvested.

	Benchmark asset allocation		Baillie Gifford Japan asset allocation		Performance*                     TOPIX		Contribution to relative return	Contribution attributable to:
Portfolio breakdown	01.09.09	31.08.10	01.09.09	31.08.10	BG Japan	total return		Stock selection	Asset allocation	Gearing
	%	%	%	%	%	%	%	%	%	%
Financials	15.3	14.4	11.7	9.4	(9.9)	(18.5)	1.9	1.3	0.6	-
Commerce and Services	11.5	11.9	23.5	26.1	5.9	5.3	0.9	0.1	0.8	-
Electricals and electronics	13.7	14.3	16.4	16.0	8.4	3.6	0.9	0.7	0.2	-
Manufacturing and Machinery	19.3	19.2	15.2	14.9	6.7	(0.6)	1.1	1.1	-	-
Retail	3.6	3.6	8.4	10.2	5.5	2.9	0.4	0.2	0.2	-
Chemicals and other materials	13.7	13.0	8.4	8.0	(1.3)	(2.8)	0.2	0.1	0.1	-
Real estate and construction	4.6	4.2	2.3	3.4	(11.6)	(6.4)	0.1	-	0.1	-
Pharmaceuticals and food	7.4	7.8	6.3	5.7	10.8	7.2	0.1	0.2	(0.1)	-
Information, communication and utilities	10.9	11.6	5.3	6.3	10.2	12.9	(0.8)	(0.2)	(0.6)	-
Fixed Interest	-	-	2.5	-	-	-	0.1	-	0.1	-
Total (excluding gearing)	100.0	100.0	100.0	100.0	4.3	(0.7)	5.0	3.6	1.4	-
Impact of gearing					(2.5)	-	(2.5)	-	-	(2.5)
Total (including gearing)**					1.8	(0.7)	2.5	3.6	1.4	(2.5)

 

Past performance is not a guide to future performance.

Source: Statpro/Baillie Gifford & Co

Contributions cannot be added together, as they are geometric; for example, to calculate how a return of 4.3% against a benchmark return of (0.7%) translates into a relative return of 5.0%, divide the portfolio return of 104.3 by the benchmark return of 99.3 and subtract one.  In addition, the total contribution figures include a residual element that relates to changes in weightings mid-month, which cannot be attributed to individual sectors.  Consequently, the contributions for the individual sectors do not sum to the total contribution figures.

^†        The performance attribution table is based on total assets.

*    The returns are total returns (net income reinvested), calculated on a monthly linked method.

**  The total return performance of 1.8% excludes expenses and, therefore, differs from the NAV return

       (after deducting borrowings at fair value) of 0.8% as a result.

Investment Changes (£'000)

	Valuation at  31 August 2009	Net acquisitions/ (disposals)	Appreciation/ (depreciation)	Valuation at 31 August 2010
Equities:
Financials	15,700	(1,157)	(1,574)	12,969
Commerce and services	31,487	2,687	429	34,603
Electricals and electronics	21,888	(1,279)	1,442	22,051
Manufacturing and machinery	20,294	(2,487)	1,171	18,978
Retail	11,302	2,319	382	14,003
Chemicals and other materials	11,219	1,652	(306)	12,565
Real estate and construction	3,099	2,049	(512)	4,636
Pharmaceuticals and food	8,423	(1,228)	649	7,844
Information, communication and utilities	7,074	1,447	1,582	10,103
Total equity investments	130,486	4,003	3,263	137,752
Fixed interest	3,224	(3,601)	377	-
Total investments	133,710	402	3,640	137,752
Net liquid assets	5,065	44	780	5,889
Total assets	138,775	446	4,420	143,641
Bank loans	(23,481)	1	(4,028)	(27,508)
Shareholders' funds	115,294	447	392	116,133

TWENTY LARGEST EQUITY HOLDINGS at 31 August 2010
Name	Business	2010 Value £'000	2010 % of total assets	2009 Value £'000
Itochu	Trading conglomerate	5,167	3.6	3,370
Don Quijote	Discount store operator	3,905	2.7	3,624
Japan Tobacco	Tobacco manufacturer	3,762	2.6	2,808
Canon	Printers and copiers	3,540	2.5	3,150
Otsuka	IT hardware and software	3,441	2.4	2,409
Asahi Glass	TV, car and construction glass	3,323	2.3	2,802
Accordia Golf	Golf course owner and operator	3,276	2.3	4,116
Osaka Securities Exchange	Stock and futures exchange	3,244	2.3	2,884
Keihin	Honda related parts supplier	3,243	2.3	3,268
Rakuten	Internet retailer	3,198	2.2	2,413
Mitsubishi Electric	Industrial electric conglomerate	3,188	2.2	2,810
Yamada Denki	Major consumer electronics retailer	3,136	2.2	3,245
KDDI	Mobile telecommunications	3,125	2.2	3,485
Misumi Group	Precision machinery parts distributor	3,115	2.2	3,423
Sysmex	Medical equipment	2,913	2.0	2,807
Shimadzu	Analytical and measuring instrument company	2,910	2.0	2,947
Nintendo	Games consoles and software	2,899	2.0	1,964
East Japan Railway	Tokyo based railway	2,850	2.0	2,719
Ushio	Specialist lamps and digital cinema equipment	2,827	2.0	2,212
Mitsubishi UFJ Lease & Finance	Leasing company	2,783	1.9	2,347
		65,845	45.9	58,803

RELATED PARTY TRANSACTIONS

The Directors' fees for the year are detailed in the Directors' Remuneration Report. No Director has a contract of service with the Company. During the year no Director was interested in any contract or other matter requiring disclosure under section 412 of the Companies Act 2006. Baillie Gifford & Co are employed by the Company as Managers and Secretaries under a management agreement which is terminable on not less than 6 months notice, or on shorter notice in certain circumstances. The fee in respect of each quarter is 0.25% of the total net assets of the Company.   The details of the management fee are as follows:

	2010 £'000		2009 £'000
Investment management fee	1,188		987

PRINCIPAL RISKS AND UNCERTAINTIES

The Company invests in medium to smaller sized Japanese companies and makes other investments so as to achieve its investment objective of long term capital growth. The Company borrows money when the Board and Managers have sufficient conviction that the assets funded by borrowed monies will generate a return in excess of the cost of borrowing. In pursuing its investment objective, the Company is exposed to various types of risk that are associated with the financial instruments and markets in which it invests and could result in a reduction in the Company's net assets.

These risks are categorised here as market risk (comprising currency risk, interest rate risk and other price risk), liquidity risk and credit risk. The Board monitors closely the Company's exposures to these risks but does so in order to reduce the likelihood of a permanent loss of capital rather than to minimise the short term volatility.

The risk management policies and procedures outlined in this note have not changed substantially from the previous accounting period.

Market Risk

The fair value or future cash flows of a financial instrument or other investment held by the Company may fluctuate because of changes in market prices. This market risk comprises three elements - currency risk, interest rate risk and other price risk. The Board of Directors reviews and agrees policies for managing these risks and the Company's Investment Manager assesses the exposure to market risk when making individual investment decisions as well as monitoring the overall level of market risk across the investment portfolio on an ongoing basis.

(i) Currency Risk

The Company's assets, liabilities and income are principally denominated in yen. The Company's functional currency and that in which it reports its results is sterling. Consequently, movements in the yen/sterling exchange rate will affect the sterling value of those items.

The Investment Manager monitors the Company's yen exposure (and any other overseas currency exposure) and reports to the Board on a regular basis. The Investment Manager assesses the risk to the Company of the overseas currency exposure by considering the effect on the Company's net asset value and income of a movement in the rates of exchange to which the Company's assets, liabilities, income and expenses are exposed. However, the currency in which a company's share price is quoted is not necessarily the one in which it earns its profits. The movement in exchange rates on overseas earnings may have a more significant impact upon a company's valuation than a simple translation of the currency in which the share price of the company is quoted.

Yen borrowings are used periodically to limit the Company's exposure to anticipated future changes in the yen/sterling exchange rate which might otherwise adversely affect the value of the portfolio of investments. The Company may also use forward currency contracts to limit the Company's exposure to anticipated future changes in exchange rates so that the currency risks entailed in holding the assets are mainly eliminated.

Exposure to currency risk through asset allocation, which is calculated by reference to the currency in which the asset or liability is quoted, is shown below.

At 31 August 2010	Investments £'000		Cash and deposits £'000		Bank loans £'000		Other debtors and creditors* £'000		Net exposure £'000
Yen	137,752		6,032		(27,508)		95		116,371
Total exposure to currency risk	137,752		6,032		(27,508)		95		116,371
Sterling	-		61		-		(299)		(238)
	137,752		6,093		(27,508)		(204)		116,133

*    Includes net non-monetary assets of £22,000.

At 31 August 2009	Investments £'000		Cash and deposits £'000	Forward currency contracts £'000		Bank loans £'000		Other debtors and creditors* £'000		Net exposure £'000
Yen	130,486		5,696	3,308		(23,481)		(417)		115,592
Euro	3,224		-	(3,346)		-		21		(101)
Total exposure to currency risk	133,710		5,696	(38)		(23,481)		(396)		115,491
Sterling	-		87	26		-		(310)		(197)
	133,710		5,783	(12)		(23,481)		(706)		115,294

*      Includes net non-monetary assets of £7,000.

Currency Risk Sensitivity

At 31 August 2010, if sterling had strengthened by 10% against the yen, with all other variables held constant, total net assets and net return on ordinary activities after taxation would have decreased by £11,637,000 (2009 - £11,559,000). A 10% weakening of sterling against the yen, with all other variables held constant, would have had an equal but opposite effect on the financial statement amounts.

(ii) Interest Rate Risk

Interest rate movements may affect the level of income receivable on cash deposits and the fair value of the investment in fixed interest rate securities. They may also impact upon the market value of the Company's investments as the effect of interest rate movements upon the earnings of a company may have a significant impact upon the valuation of that company's equity.

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 decisions and when entering borrowing agreements.

The Board reviews on a regular basis the amount of investments in cash and the income receivable on cash deposits.

The Company finances part of its activities through borrowings at approved levels. The amount of such borrowings and the approved levels are monitored and reviewed regularly by the Board.

The interest rate risk profile of the Company's interest bearing financial assets and liabilities at 31 August 2010 is shown below. The main changes to the interest rate risk profile during the year were the sale of the Euro bond, the repayment of the ¥750 million outstanding on the ING ¥1 billion loan facility upon expiry and the draw down of The Royal Bank of Scotland ¥750 million loan.

Financial assets	2010			2009
	Fair value £'000	Weighted average interest rate	Weighted average period until maturity	Fair value £'000	Weighted average interest rate	Weighted average period until maturity
Fixed rate:
Euro bond	-	-	-	3,224	5.27%	39 years

The cash deposits generally comprise overnight call or short term money market deposits and earn interest at floating rates based on prevailing bank base rates.

Financial Liabilities

The interest rate risk profile of the Company's loans at 31 August was:

	2010			2009
	Book value £'000	Weighted average interest rate	Weighted average period until maturity	Book value £'000	Weighted average interest rate	Weighted average period until maturity
Bank Loans
Yen denominated - fixed rate	27,508	2.1%	25 months	23,481	1.9%	30 months

Interest Rate Risk Sensitivity

There were no bonds held at 31 August 2010.  An increase of 100 basis points in bond yields as at 31 August 2009 would have decreased total net assets and return on ordinary activities by £186,000. A decrease of 100 basis points would have had an equal but opposite effect.

(iii) Other Price Risk

Changes in market prices other than those arising from interest rate risk or currency risk may also affect the value of the Company's net assets. The Company's exposure to changes in market prices relates to the fixed asset investments as disclosed in note 8 of the Annual Report and Financial Statements.

The Board manages the market price risks inherent in the investment portfolio by ensuring full and timely access to relevant information from the Investment Manager. The Board meets regularly and at each meeting reviews investment performance, the investment portfolio and the rationale for the current investment positioning to ensure consistency with the Company's objectives and investment policies. The portfolio does not seek to reproduce the index, investments are selected based upon the merit of individual companies and therefore performance may well diverge from the comparative index.

Other Price Risk Sensitivity

A full list of the Company's investments is shown on pages 15 and 16 of the Annual Report and Financial Statements. In addition, a list of the 20 largest holdings together with various analyses of the portfolio by industrial sector and exchange listing are shown on pages 10 and 11 of the Annual Report and Financial Statements.

118.6% (2009 - 113.2%) of the Company's net assets are invested in Japanese quoted equities. A 10% increase in quoted equity valuations at 31 August 2010 would have increased total net assets and net return on ordinary activities after taxation by £13,775,000 (2009 - £13,049,000). A decrease of 10% would have had an equal but opposite effect.

Liquidity Risk

This is the risk that the Company will encounter difficulty in meeting obligations associated with financial liabilities. Liquidity risk is not significant as the majority of the Company's assets are in investments that are readily realisable.

The Board provides guidance to the Investment Managers as to the maximum exposure to any one holding (see Investment Policy on page 17 of the Annual Report and Financial Statements).

The Company has the power to take out borrowings, which give it access to additional funding when required. The Company's borrowing facilities are detailed in note 11 of the Annual Report and Financial Statements.

The maturity profile of the Company's financial liabilities at 31 August was:

Financial Liabilities	2010 £'000	2009 £'000
In less than one year In more than one year, but not more than two years In more than two years, but not more than five years	13,948 - 13,560	6,289 11,906 6,614
	27,508	24,809

Credit Risk

This is the risk that a failure of a counterparty to a transaction to discharge its obligations under that transaction could result in the Company suffering a loss. This risk is managed as follows:

·     where the Investment Manager makes an investment in a bond or other security with credit risk, that credit risk is assessed and then compared to the prospective investment return of the security in question;

·     the Company's listed investments are held on its behalf by Mizuho Corporate Bank, Ltd and the Bank of New York Mellon as the Company's custodians. Bankruptcy or insolvency of the custodians may cause the Company's rights with respect to securities held by the custodian to be delayed. The Investment Manager monitors the Company's risk by reviewing the custodians' internal control reports and reporting its findings to the Board;

·    investment transactions are carried out with a large number of brokers whose creditworthiness is reviewed by the Investment Manager. Transactions are ordinarily undertaken on a delivery versus payment basis whereby the Company's custodian bank ensures that the counterparty to any transaction entered into by the Company has delivered on its obligations before any transfer of cash or securities away from the Company is completed;

·    the creditworthiness of the counterparty to 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 Investment Manager; and

·    cash is only held at banks that are regularly reviewed by the Managers.

Credit Risk Exposure

The exposure to credit risk at 31 August was:

	2010 £'000	2009 £'000
Fixed interest investments	-	3,224
Cash and deposits	6,093	5,783
Debtors and prepayments	211	610
	6,304	9,617

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

Fair value of financial assets and financial liabilities

The Directors are of the opinion that the financial assets and liabilities of the Company are stated at fair value in the balance sheet with the exception of the long term borrowings which are included in the accounts in accordance with FRS 26. The fair value of borrowings is shown below.

	2010			2009
		Book Value £'000	Fair* Value £'000	Book Value £'000	Fair* Value £'000
Fixed rate yen bank loans		27,508	28,026	23,481	23,982

* The fair value of each bank loan is calculated with reference to a Japanese government bond

 of comparable yield and maturity.

Gains and losses on forward currency contracts

There were no forward currency contracts open at 31 August 2010.  At 31 August 2009 the following forward currency contracts, the purpose of which was to transfer the currency exposure of a euro denominated investment from euro to yen, were open:

At 31 August 2009
Currency sold	Currency amount sold	Currency bought	Currency amount bought	Settlement date	Fair Value £'000
Euro	(€3,800,000)	Sterling	£3,271,344	18/09/09	(75)
Sterling	(£3,244,752)	Yen	¥500,000,000	18/09/09	63
					(12)

Hedge accounting was not adopted for these derivatives.

Capital Management

The Company does not have any externally imposed capital requirements. The capital of the Company is the ordinary share capital as detailed in note 12 of the Annual Report and Financial Statements. It is managed in accordance with its investment policy in pursuit of its investment objective, both of which are detailed on page 17 of the Annual Report and Financial Statements, and shares may be repurchased or issued as explained on pages 22 and 23 of the Annual Report and Financial Statements.

Fair Value of Financial Instruments

Fair values are measured using the following fair value hierarchy:

Level 1:   reflects financial instruments quoted in an active market

Level 2:   reflects financial instruments whose fair value is evidenced by comparison with other observable current market transactions in the same instrument or based on a valuation technique whose variables includes only data from observable markets.

Level 3:   reflects financial instruments whose fair value is determined in whole or in part using a valuation technique based on assumptions that are not supported by prices from observable market transactions in the same instrument and not based on available observable market data.

The valuation techniques used by the Company are explained in the accounting policies on page 33 of the Annual Report and Financial Statements.

The financial assets designated as valued at fair value through profit or loss are all categorised as Level 1 in the above hierarchy.  None of the financial liabilities are designated at fair value through profit or loss in the financial statements.

Other Risks

Other risks faced by the Company include the following:

Regulatory Risk

Failure to comply with applicable legal and regulatory requirements could lead to suspension of the Company's Stock Exchange Listing, financial penalties or a qualified audit report. Breach of section 1158 of the Corporation Taxes Act 2010 (formerly section 842 ICTA 1988) could lead to the Company being subject to tax on capital gains.  The Managers monitor investment movements and the level of forecast income and expenditure to ensure the provisions of section 1158 are not breached. Baillie Gifford's Heads of Business Risk & Internal Audit and Regulatory Risk provide regular reports to the Audit Committee on Baillie Gifford's monitoring programmes.

Operational/Financial Risk 

Failure of the Managers' accounting systems or those of other third party service providers could lead to an inability to provide accurate reporting and monitoring or a misappropriation of assets. The Board reviews the Managers' Report on Internal Controls and the reports by other key third party providers are reviewed by the Manager on behalf of the Board.

Discount Volatility

The discount at which the Company's shares trade can widen. The Board monitors the level of discount and the Company has authority to buy back its own shares.

Gearing Risk

The Company may borrow money for investment purposes (sometimes known as 'gearing'). If the investments fall in value, any borrowings will magnify the extent of this loss. If borrowing facilities are not renewed, the Company may have to sell investments to repay borrowings.

All borrowings require the prior approval of the Board and gearing levels are discussed by the Board and Managers at every meeting. The majority of the Company's investments are in quoted securities that are readily realisable.

STATEMENT OF DIRECTORS' RESPONSIBILITIES IN RESPECT OF THE ANNUAL REPORT AND THE FINANCIAL STATEMENTS

The Directors are responsible for preparing the Annual Report, the Directors' Remuneration Report and the financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law they have elected to prepare the financial statements in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, the Directors are required to:

·    select suitable accounting policies and then apply them consistently;

·    make judgements and accounting estimates that are reasonable and prudent;

·    state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements respectively; and

·    prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements and the Directors' Remuneration Report comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Directors have delegated responsibility to the Managers for the maintenance and integrity of the Company's page of the Managers' website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

Each of the Directors, whose names and functions are listed within the Directors and Management section, confirm that, to the best of their knowledge:

·    the financial statements, which have been prepared in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law), give a true and fair view of the assets, liabilities, financial position and net return 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 it faces.

By order of the Board

Richard A Barfield

8 October 2010

INCOME STATEMENT

	For the year ended 31 August 2010				For the year ended 31 August 2009
	Revenue £'000	Capital £'000	Total £'000		Revenue £'000	Capital £'000	Total £'000
Gains on investments	-	3,640	3,640		-	7,476	7,476
Currency losses (note 2)	-	(3,248)	(3,248)		-	(4,110)	(4,110)
Income (note 3)	2,605	-	2,605		2,422	-	2,422
Investment management fee	(1,188)	-	(1,188)		(987)	-	(987)
Other administrative expenses	(267)	-	(267)		(247)	-	(247)
Net return before finance costs and taxation	1,150	392	1,542		1,188	3,366	4,554
Finance costs of borrowings	(530)	-	(530)		(503)	3	(500)
Net return on ordinary activities before taxation	620	392	1,012		685	3,369	4,054
Tax on ordinary activities	(173)	-	(173)		(153)	-	(153)
Net return on ordinary activities after taxation	447	392	839		532	3,369	3,901
Net return per ordinary share (note 5)	0.72p	0.63p	1.35p		0.86p	5.44p	6.30p

 All revenue and capital items in this statement derive from continuing operations. No operations were acquired or discontinued during the year.

A Statement of Total Recognised Gains and Losses is not required as all gains and losses of the Company have been reflected in the above statement.

BALANCE SHEET

at 31 August 2010

	At 31 August 2010		At 31 August 2009
	£'000	£'000	£'000	£'000
Fixed assets Investments		137,752		133,710
Current assets
Debtors	211		610
Cash and deposits	6,093		5,783
	6,304		6,393
Creditors: Amounts falling due within one year	(14,363)		(6,289)
Net current (liabilities)/assets		(8,059)		104
Total assets less current liabilities		129,693		133,814
Creditors: Amounts falling due after more than one year		(13,560)		(18,520)
Total net assets		116,133		115,294
Capital and reserves
Called-up share capital		3,097		3,097
Share premium		22,110		22,110
Capital redemption reserve		203		203
Capital reserve		98,217		97,825
Revenue reserve		(7,494)		(7,941)
Shareholders' funds		116,133		115,294

Net asset value per ordinary share	186.7p	185.3p
(after deducting borrowings at fair value)
Net asset value per ordinary share (after deducting borrowings at par value)	187.5p	186.2p
Ordinary shares in issue (note 8)	61,935,000	61,935,000

RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' FUNDS

For the year ended 31 August 2010

	Share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve* £'000	Revenue reserve £'000	Shareholders' funds £'000
Shareholders' funds at 1 September 2009	3,097	22,110	203	97,825	(7,941)	115,294
Net return on ordinary activities after taxation	-	-	-	392	447	839
Shareholders' funds at 31 August 2010	3,097	22,110	203	98,217	(7,494)	116,133

For the year ended 31 August 2009

	Share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve* £'000	Revenue reserve £'000	Shareholders' funds £'000
Shareholders' funds at 1 September 2008	3,097	22,110	203	94,456	(8,473)	111,393
Net return on ordinary activities after taxation	-	-	-	3,369	532	3,901
Shareholders' funds at 31 August 2009	3,097	22,110	203	97,825	(7,941)	115,294

* The capital reserve balance as at 31 August 2010 includes investment holding gains of £19,756,000 (2009 - gains of £16,952,000).

 

CASH FLOW STATEMENT
	For the year ended 31 August 2010						For the year ended 31 August 2009
	£'000		£'000				£'000			£'000
Net cash inflow from operating activities			1,095							1,069
Net cash outflow from servicing of finance			(511)							(522)
Financial investment
Acquisitions of investments	(24,026)						(29,563)
Disposals of investments	23,204						31,576
Realised profit on forward currency contract	-						471
Exchange differences on settlement of investment transactions	(87)						(289)
Net cash (outflow)/inflow from financial investment			(909)							2,195
Net cash (outflow)/inflow before financing			(325)							2,742
Financing
Bank loans drawn down	5,515						-
Bank loans repaid	(5,516)						(10,397)
Net cash outflow from financing			(1)							(10,397)
Decrease in cash			(326)							(7,655)
Reconciliation of net cash flow to movement in net debt
Decrease in cash in the year			(326)							(7,655)
Net cash flow from bank loans			1							10,397
Exchange differences on bank loans			(4,028)							(7,103)
Exchange differences on cash			636							2,927
Movement in net debt in the year			(3,717)							(1,434)
Net debt at 1 September			(17,698)							(16,264)
Net debt at 31 August			(21,415)							(17,698)
Reconciliation of net return before finance costs and taxation to net cash inflow from operating activities
Net return before finance costs and taxation			1,542							4,554
Gains on investments			(3,640)							(7,476)
Other exchange differences			(549)							(1,656)
Exchange differences on bank loans			4,028							5,650
Amortisation of fixed interest book cost			(2)							8
(Increase)/decrease in accrued income			(95)							34
(Increase)/decrease in other debtors			(7)							97
(Decrease)/increase in creditors			(17)							13
Overseas tax suffered			(165)							(155)
Net cash inflow from operating activities			1,095							1,069

NOTES

1.	The financial statements for the year to 31 August 2010 have been prepared on the basis of the same accounting policies set out in the Company's Annual Financial Statements at 31 August 2009. In accordance with The Financial Reporting Council's guidance on going concern and liquidity risk issued in 2009, the Directors have undertaken a rigorous review of the Company's ability to continue as a going concern. The Company's assets, the majority of which are investments in quoted securities which are readily realisable, exceed its liabilities significantly. All borrowings require the prior approval of the Board. Gearing levels and compliance with borrowing covenants are reviewed by the Board on a regular basis. In accordance with the Company's Articles of Association, shareholders have the right to vote annually at the Annual General Meeting on whether to continue the Company. The Directors have no reason to believe that the continuation resolution will not be passed at the Annual General Meeting. After making enquiries and notwithstanding the above, the financial statements have been prepared on the going concern basis as it is the Directors' opinion that the Company will continue in operational existence for the foreseeable future. If the continuation resolution is not passed, the Articles provide that the Directors shall convene a General Meeting within three months at which a special resolution will be proposed to wind up the Company voluntarily. If the Company is wound up, its investments may not be realised at their full market value. The Directors consider the Company's functional currency to be sterling as the Company's shareholders are predominantly based in the UK and the Company is subject to the UK's regulatory environment.
			31 August 2010 £'000	31 August 2009 £'000
2.	Currency Losses
	Exchange differences on bank loans		(4,028)	(7,103)
	Other exchange differences		780	2,993
			(3,248)	(4,110)
3.	Income
	Income from investments and interest receivable		2,605	2,351
	Other income		-	71
			2,605	2,422
4.	No final dividend will be declared.

5.	Net Return per Ordinary Share
		2010				2009
		Revenue	Capital	Total		Revenue	Capital	Total
	Net return on ordinary activities after taxation	0.72p	0.63p	1.35p		0.86p	5.44p	6.30p
	Revenue return per ordinary share is based on the net revenue return on ordinary activities after taxation of £447,000 (2009 - net revenue return of £532,000), and on 61,935,000 ordinary shares, being the number of ordinary shares in issue throughout each year.  Capital return per ordinary share is based on the net capital return for the financial year of £392,000 (2009 - net capital return of £3,369,000), and on 61,935,000 ordinary shares, being the number of ordinary shares in issue throughout each year. There are no dilutive or potentially dilutive shares in issue.
6.	Bank loans of £27.5 million (¥3.55 billion) have been drawn down under yen loan facilities which are repayable between May 2011 and August 2014 (31 August 2009 - £23.5 million (¥3.55 billion)).  During the year, the Company drew down ¥750 million under a new ¥750 million loan facility with The Royal Bank of Scotland plc, which expires on 6 August 2013.  The ¥1,000 million loan facility with ING expired on 9 August 2010 and the amount drawn down of ¥750 million was repaid.

7.	Transaction costs incurred on the purchase and sale of investments are added to the purchase costs or deducted from the sales proceeds, as appropriate.  During the year, transaction costs on purchases amounted to £18,000 (31 August 2009 - £27,000) and transaction costs on sales amounted to £17,000 (31 August 2009 - £27,000).
8.	At 31 August 2010 the Company had authority to buy back 9,284,056 shares. No shares were bought back during the year. Under the provisions of the Company's Articles of Association share buy backs are funded from the capital reserve.
9.	The financial information set out above does not constitute the Company's statutory accounts for the year ended 31 August 2010. The financial information for 2009 is derived from the statutory accounts for 2009, which have been delivered to the Registrar of Companies. The Auditors have reported on the 2009 and the 2010 accounts, their reports for both years were unqualified and did not contain a statement under sections 495 to 497 of the Companies Act 2006. The statutory accounts for 2010 will be delivered to the Registrar of Companies following the Company's Annual General Meeting which will be held at 12.30pm on Tuesday 30 November 2010.
	None of the views expressed in this document should be construed as advice to buy or sell a particular investment.

 

END

 

 

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