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Aberforth Smaller Co (ASL)

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Friday 25 January, 2019

Aberforth Smaller Co

Final Results

Aberforth Smaller Companies Trust plc
Audited Annual Results for the year to 31 December 2018

The following is an extract from the Company's Annual Report and Financial Statements for the year to 31 December 2018. The Annual Report is expected to be posted to shareholders by 31 January 2019.  Members of the public may obtain copies from Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its website: www.aberforth.co.uk. A copy will also shortly be available for inspection at the National Storage Mechanism at: www.morningstar.co.uk/uk/NSM.


FINANCIAL HIGHLIGHTS

Net Asset Value Total Return     -15.4%
Numis Smaller Companies Index (Excl. Investment Companies) Total Return     -15.3%
Ordinary Share Price Total Return       -11.8%
Total Dividends increased to 38.00p per Ordinary Share
(including a Special Dividend of 7.75p per Ordinary Share)

The investment objective of Aberforth Smaller Companies Trust plc (ASCoT) is to achieve a net asset value total return (with dividends reinvested) greater than that of the Numis Smaller Companies Index (excluding Investment Companies) (NSCI(XIC) or benchmark) over the long term. ASCoT is managed by Aberforth Partners LLP.

CHAIRMAN’S STATEMENT TO SHAREHOLDERS

Review of 2018 performance

Around the world, 2018 proved to be a year of negative returns for the vast majority of stockmarket indices.  As the year progressed, trade wars, politics and slowing economic activity all weighed heavily on markets. Perhaps unsurprisingly, with Brexit as its companion, small UK quoted companies did not escape.

The Numis Smaller Companies Index excluding Investment Companies (NSCI (XIC)), the Company’s benchmark, gave a total return of -15.3%.  The Company’s net asset value total return was -15.4%, which reflects the return attributable to equity Shareholders of -235.92p (2017: 279.32p), together with the effect of dividends received by them and re-invested. The share price generated a total return of -11.8%.

By comparison, the FTSE 100 Index’s total return was -8.7% and that of the FTSE All-Share Index, which is heavily weighted towards large companies, was -9.5%.

The Managers’ Report provides more detail on 2018’s performance.

Board changes

I have informed my colleagues of my decision not to stand for re-election at the forthcoming Annual General Meeting.  Initially appointed as a Director of the Company on 30 January 2013, and subsequently Chairman on 17 October 2014, it has been my privilege to serve the Shareholders of the Company.  My Board colleagues are a great team guiding the direction of the Company and I have enjoyed working with them throughout this time.  My replacement will further strengthen the Board.  I would like also to record my admiration for the partners and staff of Aberforth.  Their focus and depth of understanding is admirable in a world where so often asset gathering is prioritised over serving the needs of customers.  This is never an issue with Aberforth and I am confident this will remain the case.

We are delighted to appoint Richard Davidson as a Director with effect from 26 January 2019.  It is intended that he will become Chairman following the closure of the Annual General Meeting on 28 February 2019.  Richard brings a wealth of knowledge of the investment world and is looking forward to working with both his new Board colleagues and the Managers. An independent board of directors is undoubtedly one of the principal advantages and differentiators of investment trusts in the broader UK savings industry.

Dividends

The Board remains committed to a progressive dividend policy.  In this context, the Board is pleased to propose a final ordinary dividend of 20.75p.  Total ordinary dividends of 30.25p for 2018 represent a 5.0% increment when compared with 2017.

Since 2015, alongside the ordinary dividend declared, the Company has also paid a special dividend, thereby ensuring that the all-important minimum retention test imposed by HMRC is not breached.  The Board adopted such a strategy to avoid the pitfalls of allowing non-recurring revenue streams to become embedded into the progressive dividend policy, a particular risk given the greater prevalence of special dividends and non-recurring distributions since the financial crisis.

In 2018, the Company was once again a beneficiary of special dividends and the Board has declared a special dividend of 7.75p per share alongside the total ordinary dividend of 30.25p to ensure the retention test is met.

After adjusting for both the final ordinary and special dividends, the Company’s revenue reserves will be 68.8p per share, circa 2.3x the ordinary dividend.  Strengthened revenue reserves, and prudent management of the non-recurring revenue streams of recent years, leave the Board optimistic about the sustainability of the progressive dividend policy.  As highlighted in last year’s Chairman’s Statement, the ambition behind this strategy, and perhaps its acid test, will be for the Board to deliver dividend growth through the next downturn.  Dividend growth from small UK quoted companies has been exceptionally strong since the global financial crisis.  There was further progress in 2018, though the overall experience was more mixed than in previous years.

I would reiterate my comments from previous years that the base level for the Company’s progressive dividend policy is the ordinary dividend, i.e. 30.25p which excludes the special dividend.

Share buy-back

At the Annual General Meeting in March 2018, the authority to buy back up to 14.99% of the Company’s Ordinary Shares was approved.  During the year, 2,418,826 Ordinary Shares (2.6% of the issued share capital) were bought in at a total cost of £32.8m.  Consistent with the Board’s stated policy, those Ordinary Shares have been cancelled rather than held in Treasury.  Once again, the Board will be seeking to renew the buy-back authority at the Annual General Meeting on 28 February 2019.

Gearing

It has been the Company’s policy to use gearing in a tactical manner throughout its 28 year history.  The £125m facility with The Royal Bank of Scotland International has a term expiring in June 2020.  As has been the case in the past, the facility term dovetails with the three-yearly continuation vote cycle.  The facility continues to provide the Company with access to liquidity for investment purposes and to fund share buy-backs as and when appropriate.  In an illiquid, and at times volatile, asset class such as small UK quoted companies, having access to immediate funds through a credit facility provides the Managers with enhanced flexibility.  During the year, the level of gearing ranged from nil to 2.8%, with an average of 0.8%, and at the year end gearing stood at 1.3% of Total Shareholders’ Funds.

Outlook

Throughout my tenure as Chairman, politics has cast a somewhat dark shadow.  Two referendums, two general elections and the rise of populism globally have contributed to a challenging investment environment.  Brexit negotiations are currently centre stage.  The difficulties in reconciling a narrow referendum outcome, which would seem to be at odds with the majority in the Houses of Parliament, should not be underestimated, although it is perhaps the transition from quantitative easing to quantitative tightening that will have more lasting impact on the investment world.

Amidst all this uncertainty, the asset class is getting cheaper!  In October 2014, when I became Chairman, the NSCI (XIC) sold on a historic price/earnings multiple of 14.1x and yield of 2.5%.  As at 1 January 2019, it is selling on a 10.9x p/e multiple and yielding 3.6%.  As value investors, the Managers, unsurprisingly, oversee a portfolio that is selling at a lower p/e multiple of 9.6x and a yield of 3.7%.

The coming year will undoubtedly bring an array of surprises.  However, after a tough 2018, the Board looks forward with a degree of optimism, which is based upon the attractive valuations and the consistency of approach and professionalism of the Managers.

Finally, the Board very much welcomes the views of Shareholders and we are available to talk to you directly.  My email address is noted below.

Paul Trickett
Chairman
25 January 2019
[email protected]


MANAGERS’ REPORT

Introduction

In common with most other equity markets, UK stocks struggled in 2018.  The FTSE All-Share, which is dominated by large companies, produced a total return of -9.5%.  Small companies were weaker still, with a total return from the NSCI (XIC) of -15.3%.  Despite the good start to the year described in the interim report, ASCoT generated a net asset value total return of -15.4%.  The principal influences on this performance are described in the Investment performance section of this report.

These weak returns render 2018 the first bad year for UK equities since 2011.  Nevertheless, total returns from the NSCI (XIC) and the FTSE All-Share since 2011 have been 117% and 66% respectively.  After so strong a run, the chances of a setback inevitably climb, though probability offers little comfort when prices start to fall.  Back in 2011, the Eurozone crisis was in full swing.  Today, the obvious equivalent is the UK’s impending exit from the European Union.  Brexit has indeed affected the performance of small caps in general and the portfolio, but, as the year progressed, it became clear that the UK no longer has a monopoly on gloom. Macro-economic and populist challenges have arisen around the globe to undermine 2017’s synchronised global recovery and equity valuations.

Europe, whose growth surprised so positively in 2017, faltered in 2018.  The uncertainties of Brexit inevitably cast a shadow and the European Central Bank’s move to taper its quantitative easing programme adds further uncertainty.  Meanwhile, Italy’s populist government has challenged the European Commission with its controversial budget, a confrontation complicated by higher government spending in France as Emmanuel Macron backtracked on fuel duty increases.  Further afield, China has also seen a slowdown in its rate of growth, which at this stage seems as much a function of internal policy to address lending excesses as a result of trade wars with the US.

Donald Trump’s “America First” policies have helped to keep the US economy moving ahead at an enviable rate but have also represented a challenge to the era of globalisation, which has favoured capital over labour to the advantage of financial markets.  One manifestation has been the strong dollar, which is itself problematic for overseas businesses that have taken on dollar borrowings.  Another important influence on the dollar has been the tightening of monetary policy by the Federal Reserve.  Jay Powell, the recently appointed chairman, has thus far proved resolute in balancing the stimulus of the President’s inflationary fiscal policies with quantitative tightening and higher interest rates.  In response, US government bonds repriced, with the ten year yield rising from 2.4% at the start to the year through 3.2% in November.  However, financial markets grew increasingly alarmed about the pace of tightening and the ten year yield dropped back to 2.7% by the year end.  Through all this, the US yield curve – the difference between the yields of short and long dated bonds – flattened and has come close to inversion.  An inverted yield curve, where long dated yields are below short dated yields, has historically proved a good, though not flawless, indicator of recession.  Such concerns explain much of the weakness of global equity markets as 2018 came to an end – after a decade of very low interest rates and quantitative easing, normalisation of monetary policy in the world’s largest economy was never going to be straightforward.

While influenced by these global issues, the UK financial markets remain a case apart and, with Brexit unresolved, scepticism about the domestic economy abounds.  While catastrophe did not follow the referendum, it is clear that the leave vote has imposed an opportunity cost on the UK economy as it has dropped down the G7 growth rankings.  Sterling and asset valuations have taken the strain, but the risk of a hard Brexit and an economic downturn remains.  This risk disproportionately affects small UK quoted companies, which are more reliant on the domestic economy than their larger peers.  However, with valuations already depressed, the opposite also holds true: all else being equal, anything short of a departure without a deal should bode well for the asset class.

Brexit survey

To gain a different perspective on the ubiquitous Brexit debate, in September the Managers undertook a survey of the 93 companies held within Aberforth funds.  The questions focused on the companies’ reactions to the referendum and on potential future actions.  The response rate was 94%, which represents a useful cross-section of the small cap universe.

The overall impression was of frustration with the politics, the Brexit process and lingering uncertainty.  The lengthiest and most detailed responses tended to come from businesses oriented towards the domestic economy.  This is unsurprising, though to an extent reassuring, since it is these companies that have been most affected by the decision to leave the EU.  The survey identified three principal areas of concern.

  • Employment: executives are worried about the availability of relatively cheap and skilful labour from the EU against the background of the rising national living wage.
  • Sterling: there is an overwhelming assumption that sterling would weaken further in the event of a hard Brexit, which would be to the disadvantage of domestic businesses but to the benefit of overseas-oriented businesses.
  • Supply chain: there is concern that a deal-less Brexit would complicate the movement of goods into and out of the UK at least in the short term.  Contingency planning for several companies involves pre-emptive inventory building ahead of March.

The results of the survey need to be considered in the context of the continuing uncertainty about the Brexit process and outcome: company executives are having to operate with limited information and little guidance to date from government.  Nevertheless, the survey did suggest that the companies are not complacent: money and time are being spent on preparations.  This cannot, however, guarantee that the businesses will emerge unscathed, despite the commendable resilience displayed since the referendum in 2016. 

Investment performance

To recap, the NSCI (XIC)’s total return in 2018 was -15.3%, while ASCoT’s NAV total return was -15.4%.  Clearly, the most significant influence on ASCoT’s performance was the weak returns from equities in general.  Beginning with the table below, the following section analyses the other important influences in 2018. 

For the twelve months ended 31 December 2018 Basis points
 Stock selection -46
 Sector selection 89
----
Attributable to the portfolio of investments, based on mid prices
 (after transaction costs of 22 basis points)
43
  Movement in mid to bid price spread 2
  Cash/gearing -9
  Purchase of ordinary shares 30
  Management fee -70
  Other expenses -5
----
Total attribution based on bid prices -9
Note: 100 basis points = 1%.  Total Attribution is the difference between the total return of the NAV and the Benchmark Index (i.e. NAV = -15.44%; Benchmark Index = -15.35%; difference is -0.09% being -9 basis points).

Sectors

The overhang of Brexit means that sector exposure has been an unusually large influence on the performance of ASCoT and of small caps in general since the referendum.  The following comments on sectors are not made with reference to the NSCI (XIC)’s forty or so industrial classifications that determine the “Sector selection” data in the table above.  Rather, sector exposure here refers to two distinct groups of companies: those that derive a majority of their sales from the domestic economy and those more dependent on overseas markets.  The fortunes of these two groups have diverged substantially since the referendum, with the domestics under-performing the overseas earners by 24%.  This reflects different profit dynamics under the influence of sterling weakness.  The overseas companies have seen their sterling profits rise as income streams earned in euros or dollars have been translated into pounds.  In contrast, the domestics have had to deal with insipid consumer spending and a hit to gross margins as foreign currency input costs have risen in sterling terms.

The table below sets out the geographical exposures of the portfolio and of the benchmark.  These are calculated by reference to the sales of the underlying companies.  In comparison with the NSCI (XIC), ASCoT was well positioned for what followed the referendum and relative performance benefited accordingly.  However, the extent of the under-performance by the domestics is such that their valuations have become increasingly attractive.  Consistent with the Managers’ value investment discipline and as part of the usual bottom-up stock selection process, this resulted in capital within ASCoT’s portfolio gradually moving from overseas to domestic businesses.  It is worth noting, though, that the pervasive market weakness of the fourth quarter has levelled the playing field somewhat: there are opportunities in all parts of the stockmarket. 

ASCoT NSCI (XIC)
Overseas Domestic Overseas Domestic
End 2018 38% 62% 42% 58%
End 2016 47% 53% 41% 59%

Style & Size

Following a bad year for value investment in 2017 – the ninth worst since 1955 – the interim report noted the improved performance of the style through the second quarter and suggested that this might have been assisted by the sharp rise in US government bond yields.  The second half of the year saw the market question the lofty valuations of many of the US’s high growth internet businesses, but the relapse in bond yields into the end of the year undermined the rotation towards value.  In addition, style dynamics within the NSCI (XIC) were influenced by the specific issue of Brexit: today’s typical small cap value stock is sensitive to the economic cycle and so is likely to be particularly affected by the uncertain outlook.  Data from the London Business School suggest that, despite its strong start to the year, value modestly lagged growth over 2018 as a whole.    Given the Managers’ value investment philosophy, this represented a hindrance to ASCoT’s returns.

Turning to size, this was an important factor within the UK stockmarket.  Against the backdrop of heightened risk-aversion, particularly through the latter part of the year, small companies under-performed large in 2018, with a total return of -15.3% from the NSCI (XIC) and -9.5% from the FTSE All-Share.  However, within the NSCI (XIC) itself, size was not a significant influence on performance.  The NSCI (XIC) represents the bottom tenth of the total value of the UK stockmarket.  This means that its largest constituent has a market capitalisation of £1.3 billion and that 59% of its total value is made up of an overlap with the FTSE 250.  A useful gauge of size effects within the NSCI (XIC) is to compare the performances of the FTSE 250 and FTSE SmallCap.  In 2018, the latter fell by slightly less than the former.  Therefore, since ASCoT retains its bias towards the more attractively valued “smaller small” companies, the size factor would have been a modest boost to performance in 2018.

Balance sheets

To generalise, the boards of companies within the NSCI (XIC) reacted to the financial crisis by conserving cash to strengthen their balance sheets.  This was an understandable reaction to what they had endured in 2008 and 2009.  In more recent years, there have been signs of a return to more normal levels of confidence, with unusually strong balance sheets put to work in the form of greater investment, acquisitions or returns of cash to shareholders.  Assuming that investment propositions have been well judged, the Managers welcome this development, but there is the risk that balance sheets become over-stretched as happened in the years before the crisis.  This would not yet appear to be the case, as shown in the table below, which sets out the distribution of the portfolio and of the NSCI (XIC) by balance sheet strength of the underlying companies. 

Based on 2019 estimates Net cash Net debt/EBITDA < 2x Net debt/EBITDA > 2x Loss makers
ASCoT 21% 52% 27% 0%
NSCI (XIC) 27% 38% 28% 7%

As 2018 progressed, there were indications that banks have become choosier in their lending and that credit conditions are becoming less easy, with the retail and construction sectors appearing to be under particular pressure.  It is too early to determine whether this is simply a consequence of Carillion’s failure or if the lenders are girding themselves in the run-up to the departure from the EU.

Income

Dividend growth has been one of the most positive features of the small cap universe in recent years.  Between 2012 and 2017, annual growth from the NSCI (XIC) averaged 9%, adjusted for inflation, well above the 62 year average rate of 3%.  History dictates that a slowdown is inevitable and there are indications that it may have started in 2018.  It is tempting once again to identify Brexit concerns as an influence.  However, such a theme is not explicit in companies’ results statements and the deceleration would appear to be a function of one-off cuts and fewer special dividends.  Clearly, though, this might change in the event of a hard Brexit.

Turning to the portfolio’s dividend experience, the table below splits holdings into categories that are determined by each company’s most recent dividend announcement, excluding specials.  Notwithstanding the previous comments about small cap dividends in general, the message from the table is similar to that of recent years: a handful of dividend cutters, the persistence of several nil payers and a bias to companies that most recently increased their dividends.  As a reminder, the “Other” category includes companies that have returned to the dividend register or that have paid dividends for the first time and that therefore do not have a meaningful comparative payment in the previous year.  While the outlook for ASCoT’s dividends will be substantially influenced by the fortunes of smaller companies in general, the balance sheet picture described above and average portfolio dividend cover of 2.9x continue to offer support.

Down Nil payers No change Increase Other
7 18 24 28 4

Corporate activity

Against a backdrop of buoyant M&A activity around the world, Brexit concerns contributed to a quieter period for corporate activity within the NSCI (XIC).  Only 14 bids for NSCI (XIC) constituents were completed or were outstanding at the end of the year, down from 17 in 2017 and from 33 two years before that.  Of the 14, ASCoT held three, one of which was announced towards the end of 2017.  Overall, M&A dragged on ASCoT’s relative returns in 2018.

Despite some ambitious advisers and what is reputedly a full pipeline of potential deals, the frequency of IPOs also declined in 2018, with 13 completed against 21 the previous year.  ASCoT did not participate in any of the 13: in the opinion of the Managers, the valuations of the companies did not offer sufficient compensation for the information advantage enjoyed by the sellers.

Turnover

Portfolio turnover was 26% in 2018.  This compares with 22% in 2017 and with a long term average of 35%.  As usual, an element of the 26% was driven by situations in which ASCoT is effectively a forced seller, such as when a holding is taken over or is deemed too large to remain in the NSCI (XIC).  Excluding such situations, the underlying rate of turnover was low at 14% in 2018, which is below the long term average on this basis of 23%.  Underlying turnover tends to be influenced by investment performance: if the stockmarket chooses not to re-rate ASCoT’s holdings, there is not the scope to rotate capital into cheaper companies and so turnover is low.  Conversely, better relative performance tends to be associated with a pick-up in turnover.

Active share

Active share is a measure of how different a portfolio is from an index.  It is calculated as half of the sum of the absolute differences between each stock’s weighting in an index and its weighting in the portfolio.  A higher active share would indicate that a portfolio has a better chance of performing differently from the index, for better or worse.  The Managers target a ratio of at least 70% for ASCoT in relation to the NSCI (XIC) and at the start of January 2019 the ratio was 77%.  Active share can be flattered by holding companies that are not constituents of the comparable index.  The Managers believe that it is important for investors to know in what part of the stockmarket ASCoT is invested and accordingly there are limited circumstances in which the portfolio can hold companies that are not in the NSCI (XIC).  At the start of January 2019, all of the portfolio value was represented by constituents of the index.

Valuations

There is no shortage of data to suggest that sterling assets are particularly unloved at present.  Anxiety has intensified as Brexit enters, presumably, its final phase.  The bias of small companies to the domestic economy renders them particularly vulnerable to a badly handled departure.  As the table below shows, this has been reflected in a sharp de-rating of the asset class, with the historical PEs of both the NSCI (XIC) and the portfolio dropping sharply through 2018.  At 10.9x, the PE of the index is 19% below its average since 1990.  The only two occasions in which the multiple has been lower for a sustained period of time have coincided with recession, specifically in the early 1990s and during the financial crisis.

Portfolio characteristics 31 December 2018 31 December 2017
ASCoT NSCI (XIC) ASCoT NSCI (XIC)
Number of companies 81 359 86 350
Weighted average market capitalisation £524m £732m £712m £878m
Price earnings (PE) ratio (historic) 9.6x 10.9x 12.5x 14.3x
Dividend yield (historic) 3.7% 3.6% 2.9% 2.8%
Dividend cover 2.9x 2.6x 2.6x 2.5x

The table below provides forward-looking valuation data using the Managers’ favoured metric of enterprise value to earnings before interest, tax and amortisation (EV/EBITA).  Ratios are shown for the portfolio, the tracked universe and certain subdivisions of the tracked universe.  The tracked universe refers to the 284 companies that the Managers follow closely and that account for 97% by value of the entire NSCI (XIC).

EV/EBITA 2018 2019 2020
ASCoT 9.7x 8.3x 7.5x
Tracked universe (284 stocks) 10.5x 9.6x 8.5x
  -   49 growth stocks 16.5x 14.7x 13.2x
  -   235 other stocks 9.7x 8.8x 7.9x

The table demonstrates the valuation advantage enjoyed by the portfolio, which has been a constant feature of ASCoT’s portfolio over its 28 years and is a function of the Managers’ value investment philosophy.  Underlying that valuation advantage are three particular features of today’s universe of small UK quoted companies.

  • Despite pressure on the valuations of some of the world’s technology titans in recent months, the table shows that growth stocks remain significantly more expensive than value stocks.  In the UK context, that premium would be challenged by a period of more buoyant economic conditions and by progress towards a normalisation of monetary policy.
  • There remains a distinct premium for size and, by extension, liquidity.  The average 2019 EV/EBITA ratio of “larger small” companies (i.e. those with market capitalisations of at least £500m) is 27% higher than that of the “smaller smalls”, despite no obvious difference in the underlying business prospects for the two groups.
  • Using average 2019 EV/EBITA ratios, overseas facing companies enjoy a 12% premium to the domestics, which are perceived as potential Brexit victims.  The premium is not vast, but the profit dynamics of the two groups have diverged as sterling weakness has taken the profits of many overseas earners to all-time highs but has eroded margins of the domestic players.

Outlook & conclusion

The uncertainties surrounding the UK’s departure from the EU have clearly been a fundamental influence on the UK stockmarket over the past year and, with the matter yet to be resolved, it continues to affect the valuation opportunities described above.  It is tempting, as many have done, to portray investment in small UK quoted companies as binary at the current time.

  • In the event of a hard Brexit, the economy would be vulnerable to a further slowdown and, given presently low rates of growth, recession.  Renewed monetary stimulus would be likely.  It is possible that the risks of a downturn and further uncertainty would prove not to have been fully reflected in share prices and in sterling.  Weaker sterling would insulate the overseas earners, but businesses reliant on the domestic economy would come under renewed pressure.
  • A softer Brexit, along the lines of the prime minister’s withdrawal agreement, would avoid a near term downturn and, through the removal of uncertainty, might see an acceleration in the economy as businesses increase investment.  Sterling would plausibly recover at least some of its losses since the referendum and the outflow from UK assets would start to reverse.  Some of the current headwinds facing the profits of domestic businesses would presumably turn to tailwinds, with the opposite being the case for the overseas earners.

However, this stark portrayal of ASCoT’s investment proposition feels rather short term.  On the one side, it ignores the likelihood that political uncertainty will continue to beset the UK even if an immediate hard Brexit is avoided.  On the other, it implies something close to Doomsday for small companies, whereas the events of ten years ago in the financial crisis proved their resilience.  Good management and the support of the equity markets in the refinancing of 2009 allowed businesses to recover and grow.  From its previous peak in May 2007 to the end of 2018, the NSCI (XIC) doubled in total return terms.  The Managers therefore suspect that, after the inevitable short term adjustment to a hard Brexit, a degree of clarity would return to allow small companies to resume their well established habit of creating wealth for their shareholders.

The binary view also risks ignoring economic and financial developments in the rest of the world, which, as the events of the fourth quarter demonstrate, will affect perceptions of and future returns from UK equities.  Notably, there is potential for a normalisation of US monetary policy to upset the established investment strategies since the financial crisis.  This is not to argue that the valuations of growth stocks cannot move even higher or that the path to a normal cost of money will be short and without setbacks.  However, to judge by the portfolio profiles of investment and unit trusts investing in small UK quoted companies, the desire to own growth stocks is extreme, while value investing remains very much out of fashion.

Finally, the binary characterisation is essentially the consensus view.  This in itself does not mean that the view is wrong, but history suggests that a strong consensus can often lead to opportunities within financial markets, such as in 1981 when 364 economists penned a poorly timed letter criticising government policy.  The strength of the consensus against the majority of small UK quoted companies is evident in their unusually depressed valuations.  The Managers believe that the differentiation of ASCoT’s well diversified portfolio keeps it relevant and that, with sentiment towards UK equities, small companies and value investment so negative, it is well placed to generate good returns in the future.

Aberforth Partners LLP
Managers
25 January 2019

DIRECTORS’ RESPONSIBILITY STATEMENT

Each of the Directors confirms to the best of their knowledge that:

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

(b) the Strategic 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; and

(c) the Annual Report, taken as a whole, is fair, balanced and understandable and provides information necessary for Shareholders to assess the Company’s performance, business model and strategy.

On behalf of the Board

Paul Trickett
Chairman
25 January 2019

PRINCIPAL RISKS AND RISK MANAGEMENT

The Board carefully considers risks faced by the Company and seeks to manage these risks through continual review, evaluation, mitigating controls and taking action as necessary.

Investment in small companies is generally perceived to carry more risk than investment in large companies. While this is reasonable when comparing individual companies, it is much less so when comparing the risks inherent in diversified portfolios of small and large companies. In addition, the Company has a simple capital structure and outsources all the main operational activities to recognised, well-established firms.

The principal risks faced by the Company, together with the approach taken by the Board towards them, have been summarised below. Further information regarding the review process can be found in the Corporate Governance and Audit Committee Reports.

(i) Investment policy/performance risk – the Company’s portfolio is exposed to share price movements owing to the nature of its investment policy and strategy. The performance of the investment portfolio typically differs from the performance of the benchmark and is influenced by market related risks including market price and liquidity. The Board’s aim is to achieve the investment objective over the long term by ensuring the investment portfolio is managed appropriately. The Board has outsourced portfolio management to experienced managers with a clearly defined investment philosophy and investment process. The Board receives regular and detailed reports on investment performance including detailed portfolio analysis, risk profile and attribution analysis. Senior representatives of Aberforth Partners attend each Board meeting. Peer group performance is also regularly monitored by the Board. The Board and Managers closely monitor economic and political developments and, in particular, are mindful of the continuing uncertainty following the UK referendum result to leave the EU and other geopolitical issues referred to in the Managers’ Report.

(ii) Share price discount – investment trust shares tend to trade at discounts to their underlying net asset values but a significant share price discount, or related volatility, could reduce shareholder returns and confidence. The Board and the Managers monitor the discount on a daily basis both in absolute terms and relative to ASCoT’s peers. In this context, the Board intends to continue to use the buy-back authority as described in the Directors’ Report.

(iii) Gearing risk – in rising markets, gearing enhances returns; however, in falling markets the gearing effect adversely affects returns to Shareholders. The Board and the Managers consider the gearing strategy and associated risk on a regular basis.

(iv) Reputational risk – the Board and the Managers monitor external factors outwith the Company’s control affecting the reputation of the Company and/or the key service providers and take action if appropriate.

(v) Regulatory risk – failure to comply with applicable legal and regulatory requirements could lead to suspension of the Company’s share price listing, financial penalties or a qualified audit report. A breach of Section 1158 of the Corporation Tax Act 2010 could lead to the Company losing investment trust status and, as a consequence, any capital gains would then be subject to capital gains tax. The Board receives quarterly compliance reports from the Secretaries to evidence compliance with rules and regulations, together with information on future developments.  

INVESTMENT POLICY

The Investment Policy is set out in the Strategic Report. A non-material change has been made to the investment policy to conform with regulatory wording and market practice; the policy confirms that the Company will invest no more than 15% of total assets in other listed closed-ended investment funds.

The Income Statement, Balance Sheet, Reconciliation of Movements in Shareholders’ Funds and summary Cash Flow Statement are set out below:-


INCOME STATEMENT
For the year ended 31 December 2018
(audited)

For the year ended For the year ended
31 December 2018 31 December 2017
Revenue Capital Total Revenue Capital Total
£ 000 £ 000 £ 000 £ 000 £ 000 £ 000
Net (losses)/ gains on investments - (251,019) (251,019) - 232,376 232,376
Investment income 46,263 3,429 49,692 43,676 - 43,676
Other income 7 - 7 1 - 1
Investment management fee (3,777) (6,295) (10,072) (3,615) (6,026) (9,641)
Portfolio transaction costs - (2,935) (2,935) - (2,651) (2,651)
Other expenses (742) - (742) (750) - (750)
-------- -------- -------- -------- -------- --------
Net return before finance costs 41,751 (256,820) (215,069) 39,312 223,699 263,011
  and tax
Finance costs (301) (501) (802) (249) (415) (664)
-------- -------- -------- -------- -------- --------
Return on ordinary activities 41,450 (257,321) (215,871) 39,063 223,284 262,347
  before tax
Tax on ordinary activities - - - - - -
-------- -------- -------- -------- -------- --------
Return attributable to
  equity shareholders 41,450 (257,321) (215,871) 39,063 223,284 262,347
====== ======= ======= ====== ======= =======
Returns per Ordinary Share 45.30p (281.22p) (235.92p) 41.59p 237.73p 279.32p

The Board declared on 25 January 2019 a final dividend of 20.75p per Ordinary Share and a special dividend of 7.75p per Ordinary Share. The Board declared on 25 July 2018 an interim dividend of 9.50p per Ordinary Share.

The total column of this statement is the profit and loss account of the Company. All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued in the year. A Statement of Comprehensive Income is not required as all gains and losses of the Company have been reflected in the above statement.


RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS
For the year ended 31 December 2018
(audited)

Capital
Share redemption Special Capital Revenue
Capital reserve reserve reserve reserve Total
£ 000 £ 000 £ 000 £ 000 £ 000 £ 000
Balance as at 31 December 2017 930 58 148,201 1,206,534 79,919 1,435,642
Return on ordinary activities after taxation - - - (257,321) 41,450 (215,871)
Equity dividends paid - - - - (33,209) (33,209)
Purchase of Ordinary Shares (24) 24 (32,826) - - (32,826)
-------- -------- -------- -------- -------- --------
Balance as at 31 December 2018 906 82 115,375 949,213 88,160 1,153,736
====== ====== ====== ====== ====== ======

For the year ended 31 December 2017

(audited)

Capital
Share redemption Special Capital Revenue
Capital reserve reserve reserve reserve Total
£ 000 £ 000 £ 000 £ 000 £ 000 £ 000
Balance as at 31 December 2016 944 44 166,343 983,250 69,647 1,220,228
Return on ordinary activities after taxation - - - 223,284 39,063 262,347
Equity dividends paid - - - - (28,791) (28,791)
Purchase of Ordinary Shares (14) 14 (18,142) - - (18,142)
-------- -------- -------- -------- -------- --------
Balance as at 31 December 2017 930 58 148,201 1,206,534 79,919 1,435,642
====== ====== ====== ====== ====== ======


BALANCE SHEET
As at 31 December 2018
(audited)

31 December 31 December
2018 2017
£ 000 £ 000
Fixed assets
Investments at fair value through profit or loss 1,168,165 1,440,496
---------- ----------
Current assets
Debtors 3,230 3,649
Cash at bank 59 293
---------- ----------
3,289 3,942
Creditors (amounts falling due within one year) (309) (199)
---------- ----------
Net current assets 2,980 3,743
---------- ----------
Total Assets less Current Liabilities 1,171,145 1,444,239
Creditors (amounts falling due after more than one year) (17,409) (8,597)
---------- ----------
Total Net Assets 1,153,736 1,435,642
======= =======
Capital and reserves: equity interests
  Called up share capital 906 930
  Capital redemption reserve 82 58
  Special reserve 115,375 148,201
  Capital reserve 949,213 1,206,534
  Revenue reserve 88,160 79,919
---------- ----------
Total Shareholders’ Funds 1,153,736 1,435,642
======= =======
Net Asset Value per Ordinary Share 1,273.72p 1,543.72p


CASH FLOW STATEMENT
For the year ended 31 December 2018
(audited)

31 December 2018 31 December 2017
£’000 £’000
Operating activities
Net revenue before finance costs and tax 41,751 39,312
Scrip dividends received (319) -
Receipt of special dividends taken to capital 3,429 -
Investment management fee charged to capital (6,295) (6,026)
Decrease/(increase) in debtors 419 (768)
Decrease in other creditors (21) (17)
-------- --------
Net cash inflow from operating activities 38,964 32,501
===== =====
Investing activities
Purchases of investments (357,515) (301,163)
Sales of investments 376,211 343,405
-------- --------
Cash inflow from investment activities 18,696 42,242
===== =====
Financing activities
Purchases of Ordinary Shares (32,826) (18,142)
Equity dividends paid (33,209) (28,791)
Interest and fees paid (609) (758)
Net drawdown/(repayment) of bank debt facilities  
(before any costs)
8,750 (27,000)
-------- --------
Cash outflow from financing activities (57,894) (74,691)
===== =====
Change in cash during the period (234) 52
===== =====
Cash at the start of the period 293 241
Cash at the end of the period 59 293
====== ======


SUMMARY NOTES TO THE FINANCIAL STATEMENTS

1. SIGNIFICANT ACCOUNTING POLICIES                                                                                                                       

The Company has presented its financial statements under Financial Reporting Standard 102 (FRS 102) and under the AIC’s Statement of Recommended Practice “Financial Statements of Investment Trust Companies and Venture Capital Trusts (SORP) issued in 2014, updated in February 2018.  The principal accounting policies have been consistently applied throughout the year and the preceding year. The financial statements have been prepared on a going concern basis under the historical cost convention, modified to include the revaluation of the Company’s investments as permitted by FRS 102. The functional and presentation currency is pounds sterling, which is the currency of the environment in which the Company operates.

2. DIVIDENDS                                                                                                                                      

Year to 31 December 2018
£000
Year to 31 December 2017
£000
Amounts recognised as distributions to equity holders in the period:
Final dividend for the year ended 31 December 2017 of 19.75p (2016: 18.75p) paid on 6 March 2018 18,332 17,696
Special dividend for the year ended 31 December 2017 of 6.70p (2016: 2.75p) paid on 6 March 2018 6,219 2,595
Interim dividend for the year ended 31 December 2018 of 9.50p (2017: 9.05p) paid on 31 August 2018 8,658 8,500
------------ ------------
33,209 28,791
------------ ------------

The 6.70p special and 20.75p final dividend for the year ended 31 December 2018 will be paid, subject to shareholder approval, on 7 March 2019. These dividends have not been included as a liability in these financial statements.

3. RETURNS PER ORDINARY SHARE                                                                                                                                                                                                                       

The returns per Ordinary Share are based on:

Year to 31 December 2018 Year to 31 December 2017
Returns attributable to Ordinary Shareholders         (£ 215,871,000) £ 262,347,000 
Weighted average number of shares in issue
during the year
91,501,299  93,923,545 
Return per Ordinary Share                                               (235.92p)  279.32p 

There are no dilutive or potentially dilutive shares in issue.

4. INVESTMENTS AT FAIR VALUE

In accordance with FRS 102 fair value measurements have been classified using the fair value hierarchy:

Level 1 - using unadjusted quoted prices for identical instruments in an active market;

Level 2 - using inputs, other than quoted prices included within Level 1, that are directly or indirectly observable (based on market data); and

Level 3 - using inputs that are unobservable (for which market data is unavailable).

Investments held as fair value through profit or loss


As at 31 December 2018
Level 1
£’000
Level 2
£’000
Level 3
£’000
Total
£’000
Listed equities 1,168,165 - - 1,168,165
Unlisted equities - - - -
------------ ------------ ------------ ------------
Total financial asset investments 1,168,165 - - 1,168,165
------------ ------------ ------------ ------------

   

As at 31 December 2017 Level 1
£’000
Level 2
£’000
Level 3
£’000
Total
£’000
Listed equities 1,440,496 - - 1,440,496
Unlisted equities - - - -
------------ ------------ ------------ ------------
Total financial asset investments 1,440,496 - - 1,440,496
------------ ------------ ------------ ------------

5. NET ASSET VALUES                                                                                                                                        

The net asset value per share and the net assets attributable to the Ordinary Shares at the year end are calculated in accordance with their entitlements in the Articles of Association and were as follows:                                           

31 December 2018 31 December 2017
Net assets attributable £1,153,736,000 £1,435,642,000
Ordinary Shares in issue at the end of the year 90,580,311 92,999,137
Net asset value per Ordinary Share 1,273.72p 1,543.72p

6. SHARE CAPITAL

During the year, the Company bought back and cancelled 2,418,826 shares (2017: 1,404,155) at a total cost of £32,826,000 (2017: £18,142,000). During the period 1 January to 25 January 2019, no shares have been bought back.

7. RELATED PARTY TRANSACTIONS

Directors’ fees and their shareholdings are detailed in the Directors’ Remuneration Report contained in the Annual Report. There were no matters requiring disclosure under s412 of the Companies Act 2006.

8. FURTHER INFORMATION

The foregoing do not constitute statutory accounts (as defined in section 434(3) of the Companies Act 2006) of the Company. The statutory accounts for the year ended 31 December 2017, which contained an unqualified Report of the Auditors, have been lodged with the Registrar of Companies and did not contain a statement required under section 498(2) or (3) of the Companies Act 2006.

Certain statements in this announcement are forward looking statements.  By their nature, forward looking statements involve a number of risks, uncertainties or assumptions that could cause actual results or events to differ materially from those expressed or implied by those statements.  Forward looking statements regarding past trends or activities should not be taken as representation that such trends or activities will continue in the future.  Accordingly, undue reliance should not be placed on forward looking statements.

The Annual Report is expected to be posted to shareholders by 31 January 2019.  Members of the public may obtain copies from Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its website: www.aberforth.co.uk.

CONTACT:     Alistair Whyte/Euan Macdonald, Aberforth Partners LLP, 0131 220 0733

Aberforth Partners LLP, Secretaries – 25 January 2019

ANNOUNCEMENT ENDS


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