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City Merchants HYT (CMHY)

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Wednesday 30 March, 2016

City Merchants HYT

Annual Financial Report

City Merchants High Yield Trust Limited

Annual Financial Report Announcement

For the year ended 31 December 2015

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FINANCIAL INFORMATION AND PERFORMANCE STATISTICS

 AT
31 DECEMBER 2015
 AT
31 DECEMBER
2014
Total Return
Net Asset Value +2.7% +5.0%
Share price +0.7% +8.5%
Ongoing Charges 1.01% 1.02%
Dividend for the year 10p 10p

Year End Information

31 DECEMBER
2015
31 DECEMBER
2014
% CHANGE
Net asset value per share 178.34p 183.40p –2.8
Share price 180.75p 189.25p –4.5
Premium 1.4% 3.2%
Gearing
Gross gearing nil nil
Net cash 7.0% 6.5%

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CHAIRMAN’S STATEMENT

The Company performed satisfactorily in 2015 despite the continuing volatility in bond markets. For the year ended 31 December 2015, the total NAV return achieved was +2.7%, which compares favourably with –0.27% for the Investment Management Association Sterling Strategic Bond Sector.

The Manager’s Investment Report on the following pages summarises the market background and portfolio strategy for the year, including how the portfolio is positioned.

The Company continues to produce an attractive level of income for shareholders. We were again able to meet our dividend target of 10p in respect of the financial year, matching last year’s total, and we are targeting the same level for the coming year.

The Board believes the portfolio remains well positioned to continue to provide an attractive level of income for shareholders. There is potential for capital appreciation but also for some disappointment.

Demand for the Company’s shares continued to be strong and the shares traded at a small premium to NAV for most of the year. As a result, another 5,525,000 ordinary shares (approximately 6% of share capital) were issued in the year, with approximately £10 million of capital raised. The issues were priced at an average premium to NAV of 1.5% and the resultant enhancement to NAV was £60,000 after costs. A further 800,000 ordinary shares have been issued since the year end. The rate of issuance has been good but not as high as we had anticipated at this time last year. We are, therefore, asking shareholders to renew the authority to issue shares up to the usual limit of 10% of shares in issue at the forthcoming AGM, rather than the 20% limit we obtained last year.

Change of Auditor

Taking the Company and its UK incorporated predecessor together, this year’s audit was the tenth by Ernst & Young LLP. Consequently, although not required to, the Audit Committee put the 2016 audit of the Company out to competitive tender in the spirit of corporate governance best practice. The Board agreed with the Audit Committee’s recommendation and has invited PricewaterhouseCoopers to be the Company’s auditor. Accordingly, a resolution for shareholders to appoint PricewaterhouseCoopers as the Company’s auditor and for the Audit Committee to fix their remuneration will be proposed at the forthcoming Annual General Meeting.

Annual General Meeting (AGM)

The Company’s Articles of Association were amended at the last AGM removing the restriction on the location of the Company’s meetings. As a result the 2016 AGM will be held in London at The Oriental Club, Stratford House, Stratford Place, London W1C 1ES at 4.00pm on 14 June 2016. Shareholders attending will have an opportunity to pose questions on the annual financial report and hear from Rhys Davies, deputy portfolio manager.

The resolutions to be put to shareholders at the meeting are described in the Directors’ Report on pages 54 to 55. This year they include ordinary resolutions to re-elect all of the Directors, it being three years since they were last elected. There are also two new resolutions in response to requests from voting agencies to have the opportunity to vote on the Company’s dividend and on Directors’ remuneration. In addition, the usual ordinary resolution to receive this annual financial report will also be proposed, together with one for the appointment of the auditor as mentioned above.

Special business compromises four annual resolutions. Firstly an ordinary resolution on continuation of the Company and then three special resolutions: the authority to issue shares up to 10% of the existing share capital, also mentioned above, the renewal of the share buy-back authority and the authority to call general meetings (other than the AGM) on 14 days’ notice.

Clive Nicholson

Chairman

29 March 2016

STRATEGIC REPORT

FOR THE YEAR ENDED 31 DECEMBER 2015

MANAGER’S INVESTMENT REPORT

Market Background

Overall 2015 was a volatile year across financial markets, including the high yield bond sector. Data from Merrill Lynch show European currency (£ and €) high yield bond yields ranged between 4.4% and 6.1%.

The year began well for pan European high yield bonds, with the European Central Bank having taken up the liquidity baton after the US Federal Reserve ended its asset purchase programme. The Bank of America Merrill Lynch European Currency High Yield index returned 3.2% over the three months to the end of March. With demand for high yield bonds strong the primary market looked on course for another year of record issuance. Barclays estimate that, to 30 April, €52.8 billion was issued in Europe across all currencies, a 16% year-on-year increase.

This dynamic began to change in the spring. German government bond markets, where yields had reached extraordinarily low levels, led the sell-off initially. High yield bond markets with their high income cushion and lower sensitivity to interest rate risk held up reasonably well. However, this changed over the summer. Although it was widely known that China’s economic growth was slowing the decision by the Peoples Bank of China to devalue the Chinese yuan took financial markets by surprise. The ensuing collapse in Chinese equities and significant selling in commodity and emerging markets highlighted a general deterioration in risk appetite globally.

High yield companies with direct exposure to areas such as commodities or emerging markets saw their borrowing costs soar with energy companies particularly hard hit. It is worth noting that the energy sector is more of a concern for the US high yield bond market, which has a much higher number of such companies than the Eurozone or the UK. Companies that were not exposed to these troubled sectors experienced a less extreme rise in yields.

This period of volatility created some opportunities in the market with yields in aggregate rising to levels that we had not seen for a number of years. However, many of those opportunities disappeared quickly with high yield bond yields falling amidst the ongoing search for income. Further impetus was given to the rally by an expectation that the European Central Bank would significantly increase the amount of monetary stimulus it was providing the Eurozone economy. However, the announcement of only a limited stimulus package in early December disappointed the market causing high yield bond yields in both the Eurozone and UK to rise once again. In the UK as concerns about the global economy increased, and with inflation remaining at or very near zero, expectations about the timing of UK interest rate hikes were pushed out. This in turn benefitted the more interest rate sensitive parts of the sterling bond market such as high quality corporate bonds and Gilts.

Despite its promising start European high yield issuance was lower in 2015 than in 2014, with Barclays estimating €84.5 billion of European issuance across all currencies in 2015 compared to €92.2 billion during 2014.

According to data from Merrill Lynch, European currency high yield bonds had a total return for the year of 1.6% (the combination of a 5.4% income return and a –3.8% price return). Within this euro high yield returned 0.8% and sterling high yield, where prices were more stable, returned 5.4%. The aggregate yield for European currency high yield rose from 4.88% to 5.90%. This return compares to 0.5% for sterling investment grade bonds, 0.5% for UK Gilts and 0.3% for German Bunds.

Portfolio Strategy

Over the 12 months to 31 December 2015 the NAV total return for the ordinary shares of the Company was 2.7%. At the year end, the NAV had fallen by 2.8% to 178.34 pence. A total dividend of 10 pence has been paid for the year.

We maintained a defensive stance in the portfolio throughout the year. This defensive position helped to lessen the credit risk in the portfolio while also enabling us to quickly exploit investment opportunities that arose in periods of market stress. This was the case through the autumn where we selectively added some high yield exposure.

The portfolio holds a core of high yield corporate bonds, focused on seasoned issuers that we consider to be default-remote. In addition, we have significant exposure to areas of the market which we believe still offer relatively attractive yield. Approximately one quarter of the portfolio is invested in bank capital, predominantly in the subordinated debt of large European banks. Banks have made considerable progress since the financial crisis in repairing their balance sheets and we believe that these bonds provide a reasonable balance of risk and reward.

We also have holdings in corporate hybrid bonds. We believe the subordination risk of these more junior debt instruments is attractive in the context of the issuers’ relatively strong balance sheets. Many of the corporate hybrid bonds we hold are issued by investment grade companies.

We will continue to seek opportunities to add yield to the portfolio where we consider that the balance of reward to risk is attractive.

Outlook

Despite the volatility last year, the yield on higher quality high yield bonds ended 2015 at relatively low levels, offering only limited potential for further capital appreciation in 2016. This year, we think the market could face a number of potential headwinds including higher government bond yields, rising default rates, particularly in the US, and further financial market volatility. Indeed, we have already experienced significant volatility during the first quarter. This did give us the opportunity to buy some higher quality bonds at more attractive levels of yield. Periodic bouts of volatility in 2016 will, we expect, continue to provide selective opportunities. Given this uncertain backdrop we think it prudent to remain defensively positioned and maintain relatively high levels of liquidity.

Paul Read                   Paul Causer                Rhys Davies

Portfolio Managers                                              Deputy Portfolio Manager

29 March 2016

BUSINESS REVIEW

Strategy and Business Model

City Merchants High Yield Trust Limited is a Jersey domiciled investment company and its investment objective is set out below. The strategy the Board follows to achieve that objective is to set investment policy and risk guidelines, together with investment limits, and to monitor how they are applied.

The business model the Company has adopted to achieve its objective has been to contract investment management and administration to appropriate external service providers, who are subject to oversight by the Board. The principal service providers are:

–          Invesco Fund Managers Limited (the ‘Manager’) to manage the portfolio in accordance with the Board’s strategy; and

–          R&H Fund Services (Jersey) Limited to provide company secretarial and general administration services.

The Company also has contractual arrangements with third parties to act as registrar, corporate broker and depositary.

Investment Management

As noted above, the Manager provides investment management and certain administrative services to the Company. The agreement is terminable by either party giving no less than three months’ prior written notice and subject to earlier termination without compensation in the event of a material breach of the agreement or the insolvency of either party. The management fee is payable quarterly in arrear and is equal to 0.1875% of the value of the Company’s total assets under management less current liabilities at the end of the relevant quarter. In addition, the Manager is paid a fee of £22,500 plus RPI per annum for administrative services.

The portfolio managers responsible for the day-to-day management of the portfolio are Paul Read and Paul Causer, with Rhys Davies as deputy portfolio manager.

The Manager’s Responsibilities

The Directors have delegated to the Manager the responsibility for the investment management activities of the Company, for seeking and evaluating investment opportunities and for analysing the accounts of investee companies. The Manager has full discretion to manage the assets of the Company in accordance with the Company’s stated objectives and policies as determined from time to time by the Board and approved by shareholders. Within the guidelines specified by the Board, the Manager has discretion to make purchases and sales, make and withdraw cash deposits, enter into underwriting commitments and exercise all rights over the investment portfolio. The Manager also advises on currency exposures and borrowings.

Assessment of the Manager

The performance of the Manager is reviewed continuously by the Board and the ongoing requirements of the Company and services received are assessed annually with reference to key performance indicators as set out on page 7.

Based on its recent review of activities, the Board believes that the continuing appointment of Invesco Fund Managers Limited remains in the best interests of the Company and its shareholders.

Investment Objective and Policy

Investment Objective

The Company’s investment objective is to seek to obtain both high income and capital growth from investment, predominantly in high-yielding fixed-interest securities.

Investment Policy

The Company seeks to provide a high level of dividend income relative to prevailing interest rates mainly through investment in bonds and other fixed-interest securities. The Company also invests in equities and other equity-like instruments consistent with the overall objective.

This Investment Policy should be read in conjunction with the descriptions of Investment Style, Investment Limits, Derivatives and Currency Hedging, and Borrowings set out below.

Investment Style

The Company’s investment manager, Invesco Fund Managers Limited, seeks to ensure that the portfolio is diversified, having regard to the nature and type of securities (including duration, credit rating, performance and risk measures and liquidity) and the geographic and industry sector composition of the portfolio. The Company may hold both illiquid securities (for example, securities where trading volumes are relatively low and unlisted securities) and concentrated positions (for example, where a high proportion of the Company’s total assets is comprised of a relatively small number of investments).

Investment Limits

–   the Company may invest in fixed-interest securities, including but not restricted to preference shares, loan stocks (convertible and redeemable), corporate bonds and government stocks, up to 100% of total assets;

–   investments in equities may be made up to an aggregate limit of 20% of total assets;

–   the aggregate value of holdings of shares and securities in a single issuer or company, including a listed investment company or trust, will not exceed 15% of the value of the Company’s investments; and

–   investments in unlisted investments will not exceed 10% of the Company’s total assets for individual holdings and 25% in aggregate.

All the above limits are measured at the time a new investment is made.

Derivatives and Currency Hedging

The Company may enter into derivative transactions (including options, futures, contracts for difference, credit derivatives and interest rate swaps) for the purposes of efficient portfolio management. The Company will not enter into derivative transactions for speculative purposes.

Efficient portfolio management may include reduction of risk, reduction of cost and enhancement of capital or income through transactions designed to hedge all or part of the portfolio, to replicate or gain synthetic exposure to a particular investment position where this can be done more effectively or efficiently through the use of derivatives than through investment in physical securities or to transfer risk or obtain protection from a particular type of risk which might attach to portfolio investments.

The Company may hedge against exposure to changes in currency rates to the full extent of any such exposure.

Borrowings

The Company’s borrowing policy is determined by the Board. The level of borrowing may be varied from time to time in the light of prevailing circumstances subject to a maximum of 30% of the Company’s total assets at any time. Any borrowings are covered by investments in matching currencies to manage exposure to exchange rate fluctuations.

Key Performance Indicators

The Board reviews performance by reference to a number of Key Performance Indicators which include the following:

•          Performance

•          Dividends

•          Premium/Discount

•          Ongoing Charges

Performance

As the Company’s objective is to achieve both high income and capital growth, the performance is best measured in terms of total return. There is no stock market index against which the Company’s performance may be measured with any degree of relevance. Therefore, the Board refers to a variety of relevant data and this is reflected in both the Chairman’s Statement and the Manager’s Investment Report on pages 3 to 5. The Board is satisfied with the portfolio performance in the year.

When considering historical returns, the terms of the reconstruction in 2012 allow direct comparison of the Company’s financial information with that of its predecessor, City Merchants High Yield Trust plc. It is therefore appropriate to combine the information from both companies, and the graph that follows shows the performance of the share price and net asset value (both on a total return basis) for the last ten years.

Dividends and Dividend Payment Policy

Dividends form a key component of the total return to shareholders and the Board is currently targeting dividends of 10p per year. This target has been met in the year under review. It is the Board’s Dividend Payment Policy to pay dividends on a regular quarterly basis in May, August, November and February in respect of each accounting year. Shareholders are being given the opportunity to vote on this policy this year. Dividends paid over the last ten years are shown in the table on page 2.

Premium/Discount

The Board monitors the price of the Company’s shares in relation to their net asset value and the premium/discount at which the shares trade. The Board has limited influence on the price at which the Company’s shares trade, which is mostly a function of investor sentiment and demand for the shares. The ideal would be for the shares to trade close to their net asset value. The following graph shows the premium/discount through the year, ending with a premium of 1.4%. As explained in the Chairman’s Statement, demand for shares throughout the year resulted in the issue of 5,525,000 shares at an average price of 186.60p. Subsequent to the year end, a further 800,000 shares have been issued.

Ongoing Charges

The expenses of managing the Company are carefully monitored by the Board. The standard measure of these ongoing charges is calculated by dividing the sum of such expenses over the course of the year, including those charged to capital, by the average net asset value. This ongoing charges figure provides a guide to the effect on performance of annual operating costs. The Company’s ongoing charges figure for the current year was 1.01%, which compares with 1.02% for the previous year. The Board is satisfied with the level of ongoing charges.

Financial Position

The Company’s balance sheet on page 35 shows the assets and liabilities at the year end. A £20 million revolving credit facility is available, though it was not used during the year. Details of this facility, including applicable covenants, are shown in note 7 to the financial statements.

Performance and Future Development

The performance and future development of the Company depend on the success of the Company’s investment strategy. A review of the Company’s performance, market background, investment activity and strategy during the year, together with the investment outlook are provided in the Chairman’s Statement and Manager’s Investment Report on pages 3 to 5.

Annual Continuation Vote

The Articles of Association of the Company require that unless an ordinary resolution is passed at or before the Annual General Meeting (AGM) each year releasing the Directors from the obligation to do so, the Directors shall convene a general meeting within six months of the AGM at which a special resolution would be proposed to wind up the Company. Having made enquiries, the Directors have no reason to believe that the resolution to release them from that obligation, that is being put to shareholders at the forthcoming AGM, will not be passed.

Internal Control and Risk Management

The Directors acknowledge that they are responsible for ensuring that the Company maintains a system of internal financial and non-financial controls (internal controls) to safeguard shareholders’ investments and the Company’s assets.

The Directors have robustly assessed the risks to which the Company is exposed by reference to a risk control summary, which maps the risks, mitigating controls in place and relevant information reported to them. The resultant ratings of the mitigated risks, in the form of a risk heat map, allow the Directors to concentrate on those risks that are most significant and also forms the basis of the list of principal risks and uncertainties that follows this section. The ratings take into account the Directors’ risk appetite and the ongoing monitoring by the Manager.

The effectiveness of the Company’s internal control and risk management system is reviewed at least twice a year by the Audit Committee. The Audit Committee has received satisfactory reports on both the Manager’s and the custodian’s operations and systems of internal control from the Manager’s Compliance and Internal Audit Officers. The Committee also received a comprehensive, and satisfactory, report from the depositary at the year end Audit Committee meeting. The Manager regularly reviews, against agreed service standards, the performance of all third party providers through formal and informal meetings, and by reference to third party independently audited control reports. The results of the Manager’s reviews are reported to and reviewed by the Audit Committee. These various reports did not identify any significant failings or weaknesses during the year and up to the date of this annual financial report. If any had been identified, the required remedial action would have been taken.

Reporting to the Board at each board meeting comprises, but is not limited to: financial reports, including hedging and gearing; performance against stock market indices and the Company’s peer group; portfolio managers’ review, including of the market, the portfolio, transactions and prospects; revenue forecasts; and investment monitoring against guidelines. In particular the Board formally reviews the performance of the Manager annually and informally at every board meeting.

The Board has reviewed and accepted the Manager’s ‘Whistleblowing’ policy under which staff of Invesco Fund Managers Limited can, in confidence, raise concerns about possible improprieties or irregularities in matters affecting the Company.

Principal Risks and Uncertainties

The internal control and risk management system, identifies the key risks to the Company. These principal risks are considered to be:

Investment Objective

There can be no guarantee that the Company will meet its investment objective. The Board has established investment guidelines to ensure that investments are made in accordance with the investment policy.

Investment Risk

The Company invests primarily in fixed interest securities and equities, the majority of which are traded on the world’s major securities markets. A significant fall in the markets and/or a prolonged period of decline relative to other forms of investment pose a significant risk to investors. The Board cannot mitigate the effect of such external influences on the portfolio.

Other investment risks include market risk (currency, interest rate and other risk) and credit risk, including counterparty risk. A significant portion of the Company’s portfolio consists of non-investment grade securities which by their nature have a higher risk of default as well as the likelihood of price volatility. An explanation of market risk and how this is addressed is given in note 18 to the financial statements.

For a discussion of the economic and market conditions facing the Company and the current and future performance of the portfolio of the Company, see the Chairman’s Statement and the Manager’s Investment Report. The investment style employed by the Manager is set out under Investment Objective and Policy on pages 6 and 7.

Foreign Exchange Risk

The movement of exchange rates may have an unfavourable or favourable impact on returns as the majority of the assets are non-sterling denominated. This risk can be mitigated by the use of hedging and by the use of non-sterling denominated borrowing. The foreign currency exposure of the Company is monitored by the Manager on a daily basis and reviewed at Board meetings.

Derivatives

The Company may enter into derivative transactions for efficient portfolio management. Derivative instruments can be highly volatile and expose investors to a high risk of loss. Where used to hedge risk there is a risk that the return on a derivative does not exactly correlate to the returns on the underlying investment, obligation or market sector being hedged against. If there is an imperfect correlation, the Company may be exposed to greater loss than if the derivative had not been entered into. During the year the only derivatives entered into were forward currency contracts.

Dividends

The dividends declared by the Board are based on income generated from the portfolio and this is monitored regularly by the Board. There can be no guarantee that any dividend target set by the Board will be met.

Ordinary Shares and Discount

Past performance of the Company is not necessarily indicative of future performance. The Company’s share price may go down as well as up and investors may not get back the full value of their investment. The share price may not reflect the NAV per share and therefore trade at a discount. The Board, the Manager and the Company’s corporate broker maintain an active dialogue with the aim of ensuring that the market rating of the Company’s shares reflects the underlying NAV. Buy back and issuance facilities help the management of this process.

Although the shares trade on the London Stock Exchange, it is possible that there may be times when there is not a liquid market in the shares and shareholders may have difficulty selling them.

Gearing of Returns through Borrowings

Performance may be geared by means of the Company’s credit facility, which was available during the year, although not used.

There is no guarantee that this facility will be renewable at maturity on terms acceptable to the Company and any amounts owing by the Company would then need to be funded by the sale of investments. Both the Manager and Board monitor this position closely.

Gearing and borrowing levels are managed by the portfolio managers using their assessment of risk versus reward. Levels must be within the guidelines set strategically by the Board. Gearing for investment purposes will amplify the reduction in NAV in a falling market, which in turn is likely to adversely affect the Company’s share price.

Operational Risk, including Reliance on Third Party Providers

Disruption to, or failure of, any third party provider to carry out its obligations could have a materially detrimental impact on the effective operation of the Company, prevent accurate reporting and monitoring of the Company’s financial position or affect the ability of the Company to pursue its investment policy successfully. Such failure could also expose the Company to reputational risk. In addition, any damage to the reputation of the Manager could result in potential counterparties and third parties being unwilling to deal with the Manager and by extension the Company.

Details of how the Board monitors the services provided by the Manager and the other third party providers, and the key elements designed to provide effective internal control, are included in the internal control and risk management section on page 9, and in note 18 to the financial statements.

The risk that one of the portfolio managers might be incapacitated or otherwise unavailable is mitigated by the fact that they work within and are supported by the wider Invesco Fixed Interest team.

Regulatory and Tax Related

The Company is subject to various laws and regulations including from it being registered under the Companies (Jersey) Law 1991, its status as a collective investment fund registered under the Collective Investment Funds (Jersey) Law 1988, its listing on the Official List of the UK Listing Authority, its admission to trading on the London Stock Exchange and being an Alternative Investment Fund under the Alternative Investment Fund Managers Directive. A serious breach of regulatory rules may lead to suspension from the Official List and from trading on the London Stock Exchange, a fine or a qualified audit report.

Failure by the Company to maintain its non-UK tax resident status may subject the Company to additional taxes which may materially adversely affect the Company’s business and therefore its share value.

The Board relies on the ongoing monitoring of its company secretary, Manager and other professional advisers to ensure compliance and reviews their regular reports to the Board.

Viability Statement

This Company is an investment company whose business consists of investing the pooled funds of its shareholders to provide them with a high income and capital growth over the long term, predominantly from a portfolio of high yielding fixed income securities. Long term for this purpose is considered to be at least five years and the Directors have assessed the Company’s viability over that period. However, the life of the Company is not intended to be limited to that or any other period.

The main risk to the Company’s continuation is shareholder dissatisfaction through failure to meet the Company’s investment objective, through poor investment performance or the investment policy not being appropriate in prevailing market conditions, either of which could affect the demand for and liquidity of the Company’s shares. Accordingly, failure to meet the Company’s investment objective, and contributory market and investment risks, are deemed by the Board to be principal risks of the Company and are given particular consideration in the continuing assessment of its long term viability.

The wording of the Company’s investment objective and policy is kept under review and was changed slightly in the last annual financial report to clarify the delineation between the objective and the policy and to emphasise that the Company’s investments are mainly in fixed income securities. However, in essence they are the same as they have been since the Company commenced trading in 2012, which in turn were unchanged from those of the Company’s UK based predecessor, City Merchants High Yield Trust plc. The continued relevance of the investment objective and policy are underlined by the Company’s annual continuation vote. Only 0.02% of the votes registered last year did not support continuation and the Board has no reason to believe that the continuation resolution will not be passed at the forthcoming and subsequent AGMs, particularly in view of the premium rating of the shares throughout most of the year and the continued demand for new shares as described on page 8.

Performance derives from returns for risk taken. The Manager’s Investment Report on pages 4 and 5 sets out the current investment strategy of the portfolio managers. The portfolio contains a high level of relatively high–yielding non-investment grade bonds and these carry a higher risk of default than investment grade paper. This is discussed further in note 18 to the financial statements. The Board has adopted investment limits within which the investment managers operate. The Directors and the portfolio managers constantly monitor the portfolio, its ratings and default risk. A bond rating analysis of the portfolio at the year-end is shown on page 14. Exposure is weighted towards higher quality issuers where the risk of default is considered to be more remote.

The terms of the Company’s corporate transition in 2012 allow direct comparison of the Company’s financial information with its UK predecessor. Taking the two together, performance has been strong for many years through different, and difficult, market cycles – as shown by the ten year total return performance graph on page 8. The investment policy has effectively been stress tested by the market events in 2007/8 and earlier cycles, which affected performance but did not threaten the viability of the Company. Whilst past performance may not be indicative of performance in the future, the investment policy has been consistent and the Company’s portfolio managers, overseen by the Board, have been in place throughout those past periods.

Performance and demand for the Company’s shares are not things that can be forecast, but there are no current indications that either or both of these may falter materially over the next five years so as to affect the Company’s viability.

As described in note 18.2 to the financial statements liquidity risk is not viewed by the Directors as a significant risk. The majority of the Company’s assets are readily realisable and amount to many times the value of its short term liabilities and annual operating costs. The Company is permitted to borrow up to a maximum of 30% of the Company’s total assets but currently has no long term debt obligations.

Based on the above analysis, the Directors confirm that they have a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the five year period of their assessment.

Substantial Holdings in the Company

The Company has been notified of the following holdings of 3% and over of the Company’s ordinary share capital carrying unrestricted voting rights:

AT
29 FEBRUARY 2016
AT
31 DECEMBER 2015
AT
31 DECEMBER 2014
HOLDING % HOLDING % HOLDING %
Charles Stanley, stockbrokers 8,293,883 9.5 8,233,962 9.5 7,752,439 9.6
Invesco Perpetual 7,101,392 8.2 7,101,392 8.2 7,101,392 8.8
Hargreaves Lansdown, stockbrokers (EO) 5,256,193 6.1 5,066,796 5.8 3,949,936 4.9
Alliance Trust Savings 4,403,864 5.1 4,365,952 5.0 4,113,063 5.1
EFG Harris Allday, stockbrokers 4,250,132 4.9 4,140,553 4.8 2,042,284 2.5
Smith & Williamson 3,202,671 3.7 3,206,880 3.7 3,320,220 4.1
Redmayne Bentley, stockbrokers 3,131,026 3.6 3,158,295 3.7 2,471,506 3.1
Court Funds Office 2,938,744 3.4 3,068,352 3.6 3,819,686 4.7
Brewin Dolphin, stockbrokers 2,832,953 3.7 3,020,024 3.5 3,456,055 4.3
Rathbones 2,620,408 3.0 2,650,458 3.1 2,966,092 3.7

Board Diversity

The Company’s policy on diversity is set out on page 23. The Board considers diversity, including the balance of skills, knowledge, experience and gender amongst other factors when reviewing its composition and appointing new directors, but does not consider it appropriate to establish targets or quotas in this regard. The Board comprises five non-executive directors of whom one is a woman, thereby constituting 20% female representation. Summary biographical details of the Directors are set out on page 20. The Company has no employees.

Social and Environmental Matters

As an investment company with no property or activities outside investment, environmental policy has limited application. The Manager considers various factors when evaluating potential investments. While a company’s policy towards the environment and social responsibility, including with regard to human rights and the risk of involvement in human trafficking, is considered as part of the overall assessment of risk and suitability for the portfolio, the Manager does not necessarily decide to, or not to, make an investment on environmental and social grounds alone. The Manager applies the United Nations Principles for Responsible Investment.

This Strategic Report was approved by the Board of Directors on 29 March 2016.

R&H Fund Services (Jersey) Limited

Company Secretary

.

INVESTMENTS IN ORDER OF VALUATION

at 31 December 2015



ISSUER


ISSUE

MOODY/S&P RATING


INDUSTRY

COUNTRY OF INCORPORATION
MARKET
 VALUE
£’000

% OF PORTFOLIO
Lloyds Banking Group – Lloyds Bank & LBG Capital 7.875% Perpetual NR/BB– Financials UK 4,132 2.9
7% Var Perpetual NR/BB– 3,115 2.2
7,247 5.1
Aviva 6.125% Perpetual Baa1/BBB Financials UK 3,766 2.7
  General Accident 8.875% Preference NR/NR 1,610 1.1
5,376 3.8
Société Genérale 8.875% FRN Perpetual Ba2/BB+ Financials France 4,491 3.2
General Motors Wts 10 Jul 2019 Equity Consumer Goods USA 4,472 3.2
Premier Farnell 89.2p Convertible Preference NR/NR Industrials UK 4,155 2.9
Telefonica Europe 6.75% Perpetual Ba1/BB+ Telecommunications Netherlands 2,149 1.5
5.875% Perpetual Ba1/BB+ 1,032 0.7
4.9% Cnv 25 Sep 2017 NR/BB+ 692 0.5
3,873 2.7
Credit Agricole 7.589% FRN Perpetual Ba2/BB+ Financials France 2,331 1.6
7.5% Var Perpetual NR/NR 902 0.7
8.125% FRN Perpetual Ba2/BB+ 557 0.4
3,790 2.7
Twinkle Pizza 6.625% 01 Aug 2021 B2/B Consumer Services UK 1,943 1.3
8.625%  01 Aug 2022 Caa1/CCC+ 1,228 0.9
3,171 2.2
Standard Chartered 5.125% 06 Jun 2034 A2/BBB Financials UK 1,690 1.2
5.7% 26 Mar 2044 A2/BBB 1,328 0.9
3,018 2.1
Intesa Sanpaolo 8.375% FRN Perpetual Ba3/B+ Financials Italy 2,762 1.9
Balfour Beatty 10.75p Convertible Preference NR/NR Industrials UK 2,711 1.9
Enterprise Inns 6.5% 06 Dec 2018 (SNR) NR/BB– Consumer Services UK 2,659 1.9
Enel 7.75% 10 Sep 2075 Ba1/BB+ Utilities Italy 1,547 1.1
6.625% Var 15 Sep 2076 Ba1/BB+ 787 0.6
2,334 1.7
Barclays 9.25% Perpetual Ba1/BB+ Financials UK 1,191 0.8
7% Perpetual NR/B+ 980 0.7
2,171 1.5
Premier Foods Finance 6.5% 15 Mar 2021 (SNR) B2/B Consumer Goods UK 2,130 1.5
Citigroup Capital 6.829% FRN 28 Jun 2067 Ba1/BB+ Financials USA 2,120 1.5
Koninklijke KPN 6.875% FRN 14 Mar 2073 Ba2/BB Telecommunications Netherlands 2,059 1.5
REA Finance 8.75% 31 Aug 2020 NR/NR Consumer Goods Netherlands 2,030 1.4
Iron Mountain 6.125% 15 Sep 2022 Ba3/B+ Financials USA 2,002 1.4
Marfrig 8.375% 09 May 2018 B2/B+ Consumer Goods Netherlands 1,364 1.0
6.875% 24 June 2019 (SNR) B2/B+ 320 0.2
9.5% 04 May 2020 (SNR) B2/B+ 244 0.2
1,928 1.4
Chemours 6.625% 15 May 2023 (SNR) B1/BB– Basic Materials USA 1,339 0.9
6.125% 15 May 2023 B1/BB– 416 0.3
7% 15 May 2025 (SNR) B1/BB– 116 0.1
1,871 1.3
Electricite De France 6% Perpetual Baa1/BBB Utilities France 1,243 0.9
5.875% Perpetual Baa1/BBB 557 0.4
1,800 1.3
Constellium 7% 15 Jan 2023 (SNR) B3/B Basic Materials France 596 0.4
8% 15 Jan 2023 B3/B 547 0.4
4.625% 15 May 2021 B3/B 396 0.3
5.75% 15 May 2024 B3/B 231 0.2
1,770 1.3
Catlin Insurance 7.249% FRN Perpetual NR/BBB+ Financials USA 1,698 1.2
Obrascon Huarte Lain 5.5% 15 Mar 2023 (SNR) B1/NR Industrials Spain 1,686 1.2
Greenko 8% 01 Aug 2019 NR/B Utilities Netherlands 1,649 1.2
Thames Water 7.75% 01 Apr 2019 B1/NR Financials UK 1,115 0.8
5.875% 15 Jul 2022 (SNR) B1/NR 497 0.4
1,612 1.2
TMF 9.875% 01 Dec 2019 Caa1/CCC+ Financials Netherlands 1,580 1.1
VRX Escrow 4.5% 15 May 2023 (SNR) B1/B– Health Care Canada 877 0.6
5.375% 15 Mar 2020 B1/B– 427 0.3
6.125% 15 Apr 2025 B1/B– 250 0.2
1,554 1.1
Standard Life 6.75% Perpetual A3/A– Financials UK 1,114 0.8
5.5% 04 Dec 2042 Baa2/BBB 367 0.3
1,481 1.1
Santos Finance 8.25% FRN 22 Sep 2070 NR/BBB– Oil and Gas Australia 1,473 1.0
HSBC 4.25% 14 Mar 2024 A2/BBB+ Financials UK 435 0.3
5.25% 14 Mar 2044 A2/BBB+ 428 0.3
6.375% FRN Perpetual Baa3/NR 414 0.3
6.375% Cnv Perpetual Baa3/NR 174 0.1
1,451 1.0
Origin Energy 7.875% 16 Jun 2071 Ba2/BB Utilities Australia 1,421 1.0
UniCredit International Bank 8.5925% FRN Perpetual B1/B+ Financials Luxembourg 541 0.4
8.125% FRN Perpetual B1/B+ 831 0.6
1,372 1.0
Alcatel-Lucent 6.45% 15 Mar 2029 WR/B+ Technology USA 687 0.5
6.5% 15 Jan 2028 WR/B+ 681 0.5
1,368 1.0
Ecclesiastical Insurance Office 8.625% Preference NR/NR Financials UK 1,320 0.9
Galapagos 7% 15 Jun 2022 Caa1/CCC+ Industrials Luxembourg 1,294 0.9
BHP Billiton 6.5% Var 22 Oct 2077 A3/A– Basic Materials Australia 790 0.6
6.75% FRN 19 Oct 2075 A3/A– 465 0.3
1,255 0.9
Vougeot Bidco 7.875% 15 Jul 2020 B2/B Consumer Services UK 1,197 0.8
UBS 7% Perpetual NR/BB Financials Switzerland 611 0.4
6.875% Var Perpetual NR/BB 578 0.4
1,189 0.8
Southern Water (Greensands) 8.5% 15 Apr 2019 NR/BB– Utilities UK 1,128 0.8
Orange 5.875% Var Perpetual Baa3/BBB– Telecommunications France 1,107 0.8
Direct Line Insurance 9.25% FRN 27 Apr 2042 Baa1/BBB+ Financials UK 1,103 0.8
Deutsche Bank 7.125% Perpetual Ba3/BB– Financials Germany 1,092 0.8
Virgin Media Finance 6% 15 Apr 2021 Ba3/BB– Consumer Services UK 604 0.4
6.25% 28 Mar 2029 Ba3/BB– 482 0.3
1,086 0.7
ECO-BAT Finance 7.75% 15 Feb 2017 B3/CCC+ Industrials UK 1,074 0.8
AA Bond Co 5.5% Var 31 Jul 2043 (SNR) NR/BB– Industrials Jersey 1,043 0.7
Trinseo 6.75% 01 May 2022 (SNR) B3/B– Industrials Luxembourg 494 0.3
6.375% 01 May 2022 B3/NR 420 0.3
914 0.6
Stonegate Pub Company 5.75% 15 Apr 2019 B2/B Consumer Services UK 906 0.6
Bombardier 6% 15 Oct 2022 B2/B Industrials Canada 713 0.5
7.5% 15 Mar 2025 B2/B 190 0.1
903 0.6
Boparan Finance 5.5% 15 Jul 2021 B2/B+ Consumer Goods UK 885 0.6
Gala Electric Casinos 11.5% 01 Jun 2019 Caa1/CCC+ Industrials UK 877 0.6
Iceland Bondco 6.25% 15 Jul 2021 (SNR) B2/B+ Consumer Services UK 877 0.6
Time Warner Cable 5.25% 15 Jul 2042 Baa2/BBB Consumer Services USA 876 0.6
Algeco Scotsman Global Finance 9% 15 Oct 2018 B3/NR Consumer Services UK 873 0.6
BBVA 9% Perpetual NR/NR Financials Spain 871 0.6
Scottish Widows 5.5% 16 Jun 2023 Baa1/BBB+ Financials UK 833 0.6
Phoenix Life 7.25% Perpetual WR/NR Financials UK 823 0.6
BNP Paribas Fortis Cnv FRN Perpetual Ba3/BB+ Financials Belgium 821 0.6
Solvay Finance 5.869% Var Perpetual Ba1/BB Basic Materials France 454 0.3
5.425% Perpetual Ba1/BB 339 0.2
793 0.5
Bormioli Rocco 10% 01 Aug 2018 B3/B Consumer Goods Luxembourg 767 0.5
Paprec 7.375% 01 Apr 2023 B2/B– Consumer Services France 757 0.5
Zobele 7.875% 01 Feb 2018 B2/B+ Consumer Goods Italy 737 0.5
AXA 6.379% FRN Perpetual Baa1/BBB– Financials France 728 0.5
Rapid Holding 6.625% 15 Nov 2020 B2/B+ Utilities Germany 705 0.5
InterGen Services 7.5% 30 Jun 2021 B1/B+ Utilities Netherlands 701 0.5
Paternoster 8.5% 15 Feb 2023 (SNR) Caa1/CCC+ Industrials Germany 692 0.5
Peel Land & Property Investments 8.375% Var 30 Apr 2040 NR/BBB Financials UK 658 0.5
Owens - Brockway 5.875% 15 Aug 2023 B1/BB– Industrials USA 633 0.4
OHL Investments 4% Cnv 25 Apr 2018 NR/NR Industrials Luxembourg 625 0.4
Play Topco 7.75% 28 Feb 2020 Caa1/CCC+ Telecommunications Luxembourg 615 0.4
XPO Logistics 6.5% 15 Jun 2022 (SNR) B2/B– Industrials USA 615 0.4
Wagamama Finance 7.875% 01 Feb 2020 (SNR) B2/B– Consumer Services UK 592 0.4
Pendragon 6.875% 01 May 2020 Ba3/BB– Consumer Services UK 569 0.4
Mercury Bondco 8.25% 30 May 2021 (SNR ) B3/B Consumer Goods Jersey 550 0.4
CGG Veritas 6.5% 01 Jun 2021 (SNR) Caa1/CCC+ Oil and Gas France 389 0.3
6.875% 15 Jan 2022 Caa1/CCC+ 151 0.1
540 0.4
BNP Paribas 7.375% Var Perpetual Ba1/BBB– Financials France 536 0.4
Gala Finance 8.875% 01 Sep 2018 B1/B+ Industrials UK 525 0.4
Odeon & UCI Finco 9% 01 Aug 2018 B3/CCC+ Industrials UK 517 0.4
La Financiere Atalian 7.25% 15 Jan 2020 B2/B Industrials France 516 0.4
Legal & General 6.385% FRN Perpetual Baa2/BBB+ Financials UK 516 0.4
Principality Building Society 7% Perpetual Ba3/NR Financials UK 510 0.4
Darling Global Finance 4.75% 30 May 2022 (SNR) Ba3/BB+ Consumer Goods Netherlands 505 0.4
Anglo American Capital 3.25% 03 Mar 2023 (SNR) Baa3/BBB– Basic Materials UK 499 0.4
Unitymedia Hessen 5.625% 15 Apr 2023 Ba3/BB– Consumer Services Germany 498 0.4
Arqiva Broadcast Finance 9.5% 31 Mar 2020 B3/NR Telecommunications UK 496 0.3
Braas Monier Building FRN 15 Oct 2020 Ba3/BB– Industrials Luxembourg 489 0.3
ESAL 6.25% 05 Feb 2023 (SNR) NR/BB+ Consumer Goods Austria 472 0.3
Commerzbank 8.125% 19 Sep 2023 Ba2/BB+ Financials Germany 467 0.3
Altice 7.75% 15 May 2020 (SNR) B3/B Telecommunications Luxembourg 159 0.1
7.625% 15 Feb 2025 (SNR) B3/B 147 0.1
6.625% 15 Feb 2023 B1/BB– 134 0.1
440 0.3
M&G Finance 7.5% FRN Perpetual NR/NR Industrials Luxembourg 425 0.3
J Sainsbury 6.5% Var Perpetual NR/NR Consumer Services UK 412 0.3
SMCP 8.875% 15 Jun 2020 B3/B Consumer Services France 399 0.3
Vedanta Resources 8.25% 07 Jun 2021 B1/B+ Basic Materials UK 394 0.3
Eileme 2 11.75% 31 Jan 2020 B2/BB– Consumer Services Sweden 392 0.3
Tesco 5.2% 05 Mar 2057 Ba1/BB+ Consumer Services UK 387 0.3
Takko 9.875% 15 Apr 2019 Caa1/CCC+ Consumer Goods Luxembourg 387 0.3
Synlab Bondco 6.25% 01 Jul 2022 (SNR) B2/B+ Health Care UK 382 0.3
Ephios Holdco II 8.25% 01 Jul 2023 (SNR) Caa1/B– Health Care UK 372 0.3
Cognita Financing 7.75% 15 Aug 2021 (SNR) B2/B Consumer Services UK 371 0.3
Kerling 10.625% 01 Feb 2017 (SNR) Caa1/B– Basic Materials UK 369 0.3
Telenet Finance 6.75% 15 Aug 2024 B1/B+ Telecommunications Luxembourg 201 0.1
6.25% 15 Aug 2022 B1/B+ 158 0.1
359 0.2
Credit Suisse 6.25% Var Perpetual NR/BB Financials Switzerland 355 0.2
Gamenet 7.25% 01 Aug 2018 (SNR) B2/B Consumer Services Italy 344 0.2
KraussMaffei 8.75% 15 Dec 2020 B1/B Industrials Germany 341 0.2
Rothschilds Continuation Finance FRN Perpetual NR/NR Financials Netherlands 326 0.2
Nationale-Nederlanden 4.625% 08 Apr 2044 Baa3/BBB Financials Netherlands 321 0.2
Novae 6.5% 27 Apr 2017 Baa3/NR Financials UK 317 0.2
First Quantum Minerals 7.25% 15 May 2022 B3/B Basic Materials Canada 297 0.2
Entertainment One 6.875% 15 Dec 2022 (SNR) B1/NR Consumer Services Canada 289 0.2
Sisal 7.25% 30 Sep 2017 B1/B Consumer Services Italy 289 0.2
Eco Services Operations 8.5% 01 Nov 2022 (SNR) Caa1/CCC+ Basic Materials USA 288 0.2
Fiat Chrysler Automobiles 4.5% 15 Apr 2020 B2/BB– Consumer Goods Netherlands 273 0.2
CEMEX SAB 6.125% 05 May 2025 NR/B+ Industrials Mexico 267 0.2
Puma Energy 6.75% 01 Feb 2021 Ba3/NR Oil and Gas Luxembourg 258 0.2
Rothesay Life 8% 30 Oct 2025 NR/NR Financials UK 257 0.2
Whitbread 3.375% 16 Oct 2025 (SNR) NR/NR Consumer Services UK 246 0.2
Interroute FRN 15 Oct 2020 B1/B+ Telecommunications UK 240 0.2
Care UK Health and Social Care FRN 15 Jan 2020 Caa2/CCC Health Care UK 223 0.2
Royal Bank Of Scotland 8% Cnv FRN Perpetual NR/B Financials UK 208 0.1
Lecta 8.875% 15 May 2019 B2/B Basic Materials Luxembourg 193 0.1
Manutencoop Facility Management 8.5% 01 Aug 2020 B2/B Consumer Services Italy 169 0.1
Picard Bondco 7.75% 01 Feb 2020 B3/B– Consumer Goods UK 165 0.1
Abengoa 8.875% 05 Feb 2018 (SNR) Caa3/CCC– Oil and Gas Spain 113 0.1
7.75% 01 Feb 2020 (SNR) Caa3/CCC– 48
161 0.1
FAGE International 9.875% 01 Feb 2020 B3/B Consumer Goods Greece 123 0.1
CIS General Insurance 12% FRN 08 May 2025 NR/NR Financials UK 103 0.1
Charter Communications 6.484% 23 Oct 2045 Ba1/BBB– Telecommunications USA 85 0.1
Enquest 7% 15 Apr 2022 Caa2/B– Oil and Gas UK 83 0.1
Peabody Energy 4.75% Cnv 15 Dec 2066 C/CCC Basic Materials USA 68
141,833 100.0
Abbreviations used in the above valuation:
  Cnv: Convertible­
  FRN: Floating Rate Note
  SNR: Senior
  Var: Variable
  Wts: Warrants

.

STATEMENT OF DIRECTORS’ RESPONSIBILITIES

in respect of the preparation of financial statements

The Directors are responsible for preparing the annual financial report in accordance with applicable laws and regulations.

Company law requires the Directors to prepare financial statements for each financial period. Under that law the Directors have elected to prepare the financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. The financial statements are required by law to 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.

International Accounting Standard 1 requires that financial statements present fairly for each financial year the Company’s financial position, financial performance and cash flows. This requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the International Accounting Standards Board’s ‘Framework for the preparation and presentation of financial statements’. In virtually all circumstances, a fair presentation will be achieved by compliance with all applicable IFRSs.

In preparing these financial statements, the Directors are required to:

•   properly select and apply accounting policies and then apply them consistently;

•   present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information;

•   provide additional disclosures when compliance with specific requirements in IFRSs are insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance; and

•   make an assessment of the Company’s ability to continue as a going concern.

The financial statements have been prepared on a going concern basis. When considering this, the Directors took into account the annual shareholders’ continuation vote (as explained in detail on page 9) and the following: the Company’s investment objective and risk management policies, the nature of the portfolio and expenditure and cash flow projections. As a result, they determined that the Company has adequate resources, an appropriate financial structure and suitable management arrangements in place to continue in operational existence for the foreseeable future.

The Directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the Company and which enable them to ensure that the accounts comply with the Companies (Jersey) Law 1991. 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.

Under applicable law and regulations, the Directors are also responsible for preparing the Strategic Report, a Corporate Governance Statement and a Directors’ Report that comply with that law and those regulations.

The Directors of the Company, who are listed on page 20, each confirm to the best of their knowledge that:

•   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;

•   this annual financial 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

•   this annual financial report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s position and performance, business model and strategy.

Clive Nicholson

Chairman

Signed on behalf of the Board of Directors

29 March 2016


 

STATEMENT OF COMPREHENSIVE INCOME

For the year ended 31 December

2015 2014
REVENUE
£’000
CAPITAL
£’000
TOTAL
£’000
REVENUE
£’000
CAPITAL
£’000
TOTAL
£’000
NOTES
Loss on investments held at fair value 11 (5,662) (5,662) (2,674) (2,674)
Exchange differences (216) (216) (27) (27)
Profit on derivative instruments currency hedges 1,487 1,487 2,336 2,336
Income 4 10,009 10,009 8,922 8,922
Investment management fees 5 (745) (401) (1,146) (702) (378) (1,080)
Other expenses 6 (410) (1) (411) (383) (1) (384)
Profit/(loss) before finance costs and taxation 8,854 (4,793) 4,061 7,837 (744) 7,093
Finance costs 7 (28) (15) (43) (25) (14) (39)
Profit/(loss) before tax 8,826 (4,808) 4,018 7,812 (758) 7,054
Taxation 8 (127) (127) (119) (119)
Profit/(loss) after tax 8,699 (4,808) 3,891 7,693 (758) 6,935
Return per ordinary share 9 10.4p (5.8)p 4.6p 10.0p (1.0)p 9.0p

The total column of this statement represents the Company’s statement of comprehensive income, prepared in accordance with International Financial Reporting Standards. The profit after tax is the total comprehensive income. The supplementary revenue and capital columns are both prepared in accordance with the Statement of Recommended Practice issued by the Association of Investment Companies. All items in the above statement derive from continuing operations and the Company has no other profits or losses. No operations were acquired or discontinued in the year.

.

STATEMENT OF CHANGES IN EQUITY

FOR THE YEAR ENDED 31 DECEMBER

STATED CAPITAL
£’000
CAPITAL RESERVE
£’000
REVENUE RESERVE
£’000
TOTAL
£’000
NOTES
At 31 December 2013  113,410 18,368 2,239 134,017
Net proceeds from issue of new shares 14,939 14,939
Total comprehensive income for the year (758) 7,693 6,935
Dividends paid 10 (140) (7,540) (7,680)
At 31 December 2014 128,209 17,610 2,392 148,211
Net proceeds from issue of new shares 10,190 10,190
Total comprehensive income for the year (4,808) 8,699 3,891
Dividends paid 10 (76) (8,240) (8,316)
At 31 December 2015 138,323 12,802 2,851 153,976

.

BALANCE SHEET

At 31 December

NOTES 2015
£’000
2014
£’000
Non-current assets
  Investments held at fair value through profit or loss 11 141,833 135,749
Current assets
  Other receivables 12 2,936 2,833
  Derivative financial instruments – unrealised profit 13 466
  Cash and cash equivalents 10,730 9,577
13,666 12,876
Current liabilities
  Other payables 14 (432) (414)
  Derivative financial instruments – unrealised loss 13 (1,091)
(1,523) (414)
Net current assets 12,143 12,462
Net assets 153,976 148,211
Capital and reserves
  Stated capital 15 138,323 128,209
  Capital reserve 16 12,802 17,610
  Revenue reserve 16 2,851 2,392
Shareholders’ funds 153,976 148,211
Net asset value per ordinary share 17 178.34p 183.40p

These financial statements were approved and authorised for issue by the Board of Directors on 29 March 2016.

Signed on behalf of the Board of Directors

Clive Nicholson

Chairman

STATEMENT OF CASH FLOWS

FOR THE YEAR ENDED 31 DECEMBER

2015
£’000
2014
£’000
Cash flow from operating activities
Profit before tax 4,018 7,054
Taxation (127) (119)
Adjustment for:
  Purchases of investments (38,740) (63,066)
  Sales of investments 26,994 48,944
(11,746) (14,122)
  Loss on investments 5,662 2,674
  Exchange differences (71) 45
  Net decrease/(increase) in derivative instruments –
    currency hedges 1,557 (250)
  Finance costs 43 39
Operating cash flows before movements in working capital (664) (4,679)
Increase in receivables (103) (331)
Increase in payables 14 47
Net cash flows from operating activities (753) (4,963)
Cash flow from financing activities
Finance cost paid (43) (39)
Net proceeds from issue of shares 10,194 14,939
Equity dividends paid – note 10 (8,316) (7,680)
Net cash flows from financing activities 1,835 7,220
Net increase in cash and cash equivalents 1,082 2,257
Exchange differences 71 (45)
Movement in cash and cash equivalents 1,153 2,212
Cash and cash equivalents at beginning of year 9,577 7,365
Cash and cash equivalents at the end of the year 10,730 9,577
Cash flow from operating activities includes:
Interest received 9,153 7,850
Dividends received 684 620

NOTES TO THE FINANCIAL STATEMENTS

For the year ended 31 December 2015

1.         Principal Activity

The Company is a closed-end investment company incorporated in Jersey and operates under the Companies (Jersey) Law 1991. The principal activity of the Company is investment in a diversified portfolio of high-yielding fixed-interest securities as set out in the Company’s Investment Objective and Policy.

2.         Principal Accounting Policies

Accounting policies describe the Company’s approach to recognising and measuring transactions during the year and the position of the Company at the year end.

The principal accounting policies adopted in the preparation of these financial statements are set out below.

(a)        Basis of Preparation

(i)    Accounting Standards Applied

The financial statements have been prepared on an historical cost basis, except for the measurement at fair value of investments and derivatives, and in accordance with the applicable International Financial Reporting Standards (IFRS) and interpretations issued by the International Financial Reporting Interpretations Committee as adopted by the European Union. The standards are those endorsed by the European Union and effective at the date the financial statements were approved by the Board.

Where presentational guidance set out in the Statement of Recommended Practice (SORP) ‘Financial Statements of Investment Trust Companies and Venture Capital Trusts’, issued by the Association of Investment Companies in November 2014, is consistent with the requirements of IFRS, the Directors have sought to prepare the financial statements on a basis compliant with the recommendations of the SORP. The supplementary information which analyses the statement of comprehensive income between items of a revenue and a capital nature is presented in accordance with this.

(ii)   Going Concern

As explained under ‘Annual Continuation Vote’ on page 9, the Company has an annual continuation vote. However, as also explained in that note the Directors believe shareholders will vote for the Company to continue. Accordingly, the financial statements have been prepared on a going concern basis and the accounts do not include any adjustments which might arise from cessation of the Company.

(iii)   Adoption of New and Revised Standards

New and revised standards and interpretations that became effective during the year had no significant impact on the amounts reported in these financial statements but may impact accounting for future transactions and arrangements.

At the date of authorising these financial statements, the following standards and interpretations which have not been applied in these financial statements were in issue but not yet effective (and in some cases had not yet been adopted by the EU).

• IFRS 9: Financial Instruments (2014) (effective 1 January 2018).

• Amendment to IAS 1: Presentation of Financial Statements (effective 1 January 2016).

• Amendment to IAS 7: Disclosure initiative — Statement of Cashflows (effective 1 January 2017).

The Directors do not expect the adoption of the above standards and interpretations (or any other standards and interpretations which are in issue but not effective) will have a material impact on the financial statements of the Company in future periods.

(iv)  Critical Accounting Estimates and Judgements

The preparation of the financial statements requires the Company to make estimations where uncertainty exists. It also requires the Company to exercise judgement in the process of applying the accounting policies.

(b)        Foreign Currency

(i)    Functional and Presentation Currency

The financial statements are presented in sterling, which is the Company’s functional and presentation currency and the currency in which the Company’s stated capital and expenses are denominated, as well as certain of its income, assets and liabilities.

(ii)   Transactions and Balances

Transactions in foreign currency, whether of a revenue or capital nature, are translated to sterling at the rate of exchange ruling on the date of such transactions. Foreign currency assets and liabilities are translated to sterling at the rates of exchange ruling at the balance sheet date. All profits and losses, whether realised or unrealised, are recognised in the statement of comprehensive income and are taken to capital reserve or revenue reserve, depending on whether the gain or loss is capital or revenue in nature.

(c)        Financial Instruments

(i)    Recognition of Financial Assets and Financial Liabilities

The Company recognises financial assets and financial liabilities when the Company becomes a party to the contractual provisions of the instrument. The Company will offset financial assets and financial liabilities if the Company has a legally enforceable right to set off the recognised amounts and interests and intends to settle on a net basis.

(ii)   Derecognition of Financial Assets

The Company derecognises a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the right to receive the contractual cash flows on the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred. Any interest in the transferred financial asset that is created or retained by the Company is recognised as an asset.

(iii)   Derecognition of Financial Liabilities

The Company derecognises financial liabilities when its obligations are discharged, cancelled or expired.

(iv)  Trade Date Accounting

Purchases and sales of financial assets are recognised on trade date, being the date on which the Company commits to purchase or sell the assets.

(v)   Classification of Financial Assets and Financial Liabilities

Financial Assets

The Company’s investments are classified as held at fair value through profit or loss as the investments are managed and their performance evaluated on a fair value basis in accordance with the Company’s documented investment strategy and this is also the basis on which information about investments is provided internally to the Board.

Financial assets held at fair value through profit or loss are initially recognised at fair value, which is taken to be their cost, with transaction costs expensed in the statement of comprehensive income, and are subsequently valued at fair value.

For investments that are actively traded in organised financial markets, fair value is determined by reference to stock exchange quoted bid prices at the balance sheet date. For investments that are not actively traded or where active stock exchange quoted bid prices are not available, fair value is determined by reference to a variety of valuation techniques including broker quotes and price modelling.

Financial Liabilities

Financial liabilities, including borrowings, are initially measured at fair value, net of transaction costs and are subsequently measured at amortised cost using the effective interest method.

 (d)       Derivatives and Hedging

Derivative instruments are valued at fair value in the balance sheet. Hedge accounting has not been adopted.

Forward currency contracts entered into for hedging purposes are valued at the appropriate forward exchange rate ruling at the balance sheet date and any profits and losses are recognised in the statement of comprehensive income and taken to capital.

(e)        Cash and Cash Equivalents

Cash and cash equivalents may comprise cash (including short term deposits which are readily convertible to a known amount of cash and are subject to an insignificant risk of change in value) as well as cash equivalents, including money market funds.

(f)         Revenue Recognition

All income is recognised in the statement of comprehensive income. Interest income arising from fixed income securities is recognised using the effective interest method. Dividend income arises from equity investments held and is recognised on the date investments are marked ‘ex-dividend’. Deposit interest is taken into account on an accruals basis.

(g)        Expenses and Finance Costs

All expenses are accounted for on an accruals basis and are recognised in the statement of comprehensive income. Investment management fees and finance costs are allocated 35% to capital and 65% to revenue in accordance with the Board’s expected long-term split of returns, in the form of capital gains and income respectively, from the investment portfolio. Except for custodian dealing costs, all other expenses are charged through revenue. Expenses in relation to the set up of the Company are charged to stated capital.

(h)        Tax

Overseas interest and dividends are shown gross of withholding tax and the corresponding irrecoverable tax is shown as a charge in the statement of comprehensive income.

3.         Segmental Reporting

No segmental reporting is provided as the Directors are of the opinion that the Company is engaged in a single segment of business of investing in debt and, to a significantly lesser extent, equity securities.

4.         Income

This note shows the income generated from the portfolio (investment assets) of the Company and income received from any other source.

2015
£’000
2014
£’000
Income from investments
UK dividends 656 629
UK investment income – interest 3,526 3,032
Overseas investment income – interest 5,794 5,241
Overseas dividends 31 19
10,007 8,921
Other income
Deposit interest 2 1
Total income 10,009 8,922

5.         Investment Management Fee

This note shows the fees paid to the Manager, which are calculated quarterly on the basis of the value of the assets being managed.

2015 2014
REVENUE
£’000
CAPITAL
£’000
TOTAL
£’000
REVENUE
£’000
CAPITAL
£’000
TOTAL
£’000
Investment management fee 745 401 1,146 702 378 1,080

Details of the investment management agreement are disclosed on page 6. At the year end the management fee accrued was £289,000 (2014: £278,000).

6.         Other Expenses

The other expenses of the Company are presented below; those paid to the Directors and the auditor are separately identified.

2015 2014
REVENUE
£’000
CAPITAL
£’000
TOTAL
£’000
REVENUE
£’000
CAPITAL
£’000
TOTAL
£’000
General expenses (i) 265 1 266 240 1 241
Directors’ fees (ii) 114 114 114 114
Auditor’s remuneration:
  – for the audit of the financial statements 31 31 29 29
410 1 411 383 1 384

(i)  General expenses include £38,700 (2014: £38,200) due to R&H Fund Services (Jersey) who act as Administrator and Company Secretary to the Company under an Agreement dated 19 December 2011. This agreement is terminable at any time by either party giving no less than three months’ notice. The fee is payable quarterly in arrears based on the initial rate of £37,500 per annum. The fee is revised with effect from 1 January each year, by the application of a formula based on the Retail Price Index for the month of December of the previous year.

General expenses also include an administration fee due to Invesco Perpetual of £25,000 (2014: £24,000). It is based on an initial fee of £22,500 plus RPI increases in May.

Custodian dealing costs of £1,000 (2014: £1,000) are charged wholly to capital.

(ii) The maximum Directors’ fees authorised by the Articles of Association are £150,000 per annum.

7.         Finance Costs

Finance costs arise on any borrowing facilities the Company has and comprise commitment fees on any unused facility as well as interest when the facility is used.

2015 2014
REVENUE
£’000
CAPITAL
£’000
TOTAL
£’000
REVENUE
£’000
CAPITAL
£’000
TOTAL
£’000
Commitment fees due on loan facility 26 14 40 25 14 39
Bank charges 2 1 3
28 15 43 25 14 39

The Company has a 364 day committed £20 million multi-currency revolving credit facility with Bank of New York Mellon which is renewable on 6 May 2016. Available currencies are sterling, euros or US dollars. Drawings under this facility are subject to the restriction that the Company’s total financial indebtedness must not exceed 30% of total assets and that the assets must be in excess of £50 million. At the balance sheet date the Company had no drawdowns (2014: none).

Interest payable is based on the interbank offered rate for the currency drawn down. The commitment fee is based on 0.20% of the average undrawn amount each quarter.

8.         Taxation

As a Jersey investment company no tax is payable on capital gains and, as the Company principally invests in assets which do not suffer tax on income, the only overseas tax arises on the few assets domiciled in countries with which Jersey has no double-taxation treaty, e.g. Italy and Portugal.

2015
£’000
2014
£’000
Overseas taxation 127 119

The Company is subject to Jersey income tax at the rate of 0% (2014: 0%). The overseas tax charge consists of irrecoverable withholding tax.

9.         Return per Ordinary Share

Return per share is the amount of gain generated for the financial year divided by the weighted average number of ordinary shares in issue.

The basic revenue, capital and total return per ordinary share is based on each of the profit after tax and on 83,705,678 (2014: 77,275,510) ordinary shares, being the weighted average number of ordinary shares in issue throughout the year.

10.       Dividends on Ordinary Shares

Dividends are paid from the income less expenses. Dividends are paid as an amount per ordinary share held.

2015 2014
PENCE £’000 PENCE £’000
Dividends paid and recognised in the year:
Fourth interim 2.5 2,020 2.5 1,828
First interim 2.5 2,064 2.5 1,904
Second interim 2.5 2,102 2.5 1,962
Third interim 2.5 2,130 2.5 1,986
10.0 8,316 10.0 7,680

Dividends paid in the year have been charged to revenue reserve except for £76,000 (2014: £140,000) which was charged to stated capital. This amount is equivalent to the income accrued on the new shares issued in the year (see note 15).

Set out below are the dividends that have been declared in respect of the financial year:

2015 2014
PENCE £’000 PENCE £’000
Dividends in respect of the year:
First interim 2.5 2,064 2.5 1,904
Second interim 2.5 2,102 2.5 1,962
Third interim 2.5 2,130 2.5 1,986
Fourth interim 2.5 2,158 2.5 2,020
10.0 8,454 10.0 7,872

The fourth interim dividend for 2015 was paid on 26 February 2016 to shareholders on the register on 22 January 2016.

11.       Investments Held at Fair Value Through Profit or Loss

The portfolio is principally made up of investments which are listed and traded on a regulated stock exchange. Profits and losses are either:

•          realised, usually arising when investments are sold; or

•          unrealised, being the difference from cost of those investments still held at the year end.

(a)        Analysis of investment profits

2015
£’000
2014
£’000
Opening book cost 127,649 109,147
Opening investment holding profits 8,100 14,628
Opening valuation 135,749 123,775
Movements in the year:
  Purchases at cost 38,740 63,066
  Sales – proceeds (26,994) (48,418)
  Sales – net realised (loss)/profit (234) 3,854
Movement in investment holding profit (5,428) (6,528)
Closing valuation 141,833 135,749
Closing book cost 139,161 127,649
Closing investment holding profit 2,672 8,100
Closing valuation 141,833 135,749
Realised (loss)/profit in the year (234) 3,854
Movement in investment holding profit in the year (5,428) (6,528)
(5,662) (2,674)

(b)        Transaction costs

            The transaction costs on investments amount to £nil on sales and £nil on purchases (2014: £1,000 on sales and £3,000 on purchases).

(c)        Registration of investments

            The investments of the Company are registered in the name of the Company or in the name of nominees and held to the account of the Company.

12.       Other Receivables

Other receivables are amounts which are due to the Company, such as income which has been earned (accrued) but not yet received and monies due from brokers for investments sold.

2015
£’000
2014
£’000
Prepayments and accrued income 2,936 2,833
2,936 2,833

13.       Derivative Financial Instruments

Derivative financial instruments are financial instruments that derive their value from the performance of another item, such as an asset or exchange rates. They are used to manage the risk associated with fluctuations in the value of certain assets and liabilities. The Company can use derivatives to manage its exposure to fluctuations in foreign exchange rates.

2015
£’000
2014
£’000
Forward currency contracts – net unrealised (loss)/profit (1,091) 466
(1,091) 466

14.       Other Payables

Other payables are amounts which must be paid by the Company, and include any amounts due to brokers for the purchase of investments or amounts owed to suppliers, such as the Manager and auditor.

2015
£’000
2014
£’000
Accruals 432 414
432 414

15.       Stated Capital

The stated capital represents the total number of shares in issue, for which dividends accrue. Stated capital can be used for distributions under Jersey law.

2015 2014 2015 2014
Number Number £’000 £’000
Allotted ordinary shares of no par value
Brought forward 80,812,459 72,786,327 128,209 113,410
Net issue proceeds 5,525,000 8,026,132 10,190 14,939
Dividends paid from stated capital (76) (140)
Carried forward 86,337,459 80,812,459 138,323 128,209

Details of the stated capital and rights attaching to the Company’s ordinary shares are shown in the Director’s Report on page 53.

For the year to 31 December 2015, 5,525,000 (2014: 8,026,132) new ordinary shares were issued to the Company’s corporate broker, Winterflood Securities Limited, for onward transmission to their clients. These shares were issued in tranches of various quantities throughout the year to satisfy secondary market demand. The gross issue proceeds were £10,310,000 (2014: £15,048,000), at an average price of 186.60p (2014: 187.48p), and the net proceeds after issue costs were £10,190,000 (2014: £14,939,000). The net proceeds included an aggregate amount of £76,000 (2014: £140,000) which arose from the income accrued component of the net asset value at the date of issue of the new shares.

Subsequent to the year end 800,000 ordinary shares have been issued, at an average price of 172.96p.

Because the criteria in paragraphs 16C and 16D of IAS 32 Financial Instruments: Presentation, have been met, the stated capital of the Company is classified as equity even though there is a continuation vote.

16.       Reserves

This note explains the different reserves attributable to shareholders. The aggregate of the reserves and stated capital (see previous note) make up total shareholders’ funds.

The capital reserve includes investment holding profits and losses, being the difference between cost and market value at the balance sheet date, as well as realised profits and losses on disposals of investments. Both the capital and revenue reserves are distributable.

17.       Net Asset Value per Ordinary Share

The Company’s total net assets (total assets less total liabilities) are often termed shareholders’ funds and are converted into net asset value per ordinary share by dividing by the number of shares in issue.

The net asset value per ordinary share and the net assets attributable at the period end were as follows:

NET ASSET VALUE PER ORDINARY SHARE NET ASSETS ATTRIBUTABLE
2015 2014 2015 2014
Pence Pence £’000 £’000
Ordinary shares 178.34 183.40 153,976 148,211

The net asset value per ordinary share is based on 86,337,459 (2014: 80,812,459) ordinary shares, being the number of ordinary shares in issue at the year end.

18.       Financial Instruments

Financial instruments comprise the Company’s investment portfolio and derivative financial instruments (for the latter see note 13) as well as any cash, borrowings, other receivables and other payables. The following note explains the risks that affect the Company’s financial instruments and looks at the Company’s exposure to these various risks.

Risk Management Policies and Procedures

The Strategic Report details the Company’s approach to investment risk management on page 9 and the accounting policies in note 2 explain the Company’s valuation basis for investments and currency.

As an investment company, the Company invests in loan stocks, corporate bonds, government stocks, preference shares and equities which are held for the long-term in order to achieve the Company’s Investment Objective and Investment Policy. In pursuing these, the Company is exposed to a variety of risks that could result in either a reduction in the Company’s net assets or a reduction in the profits available for payment as dividends.

The Company’s principal financial instruments at risk comprise its investment portfolio. Other financial instruments at risk include cash, borrowings, other receivables and other payables that arise directly from the Company’s operations. These risks and the Directors’ approach to managing them are set out below, and have not changed from those applying in the comparative year.

Risk management is an integral part of the investment management process. The Manager controls risk by ensuring that the Company’s portfolio is appropriately diversified and the portfolio managers actively monitor both the ratings and liquidity of the fixed-interest securities taking into account the Company’s financing requirements. In-depth and continual analysis of market and stock fundamentals give the portfolio managers the best possible understanding of the risks associated with a particular stock. The portfolio managers assess the exposure to market risk when making each investment decision, and monitor the overall level of market risk on the whole of the portfolio on an ongoing basis.

High-yield fixed-interest securities are subject to a variety of risks, including credit risk (18.3). Gearing by using the Company’s credit facility increases the Company’s exposure to interest rate risk and this is explained under interest rate risk (18.1.2).

The day to day management of the investment activities, borrowings and hedging of the Company has been delegated to the Manager, and is the responsibility of the portfolio managers to whom the Board has given wide discretion to operate within set guidelines. Any proposed variation outside those guidelines is referred to the Board and the guidelines themselves are reviewed at every board meeting.

18.1     Market Risk

Market risk arises from changes in the fair value or future cash flows of a financial instrument because of movements in market prices. Market risk comprises three types of risk: currency risk (18.1.1), interest rate risk (18.1.2) and other price risk (18.1.3).

18.1.1         Currency Risk

The Company has assets, liabilities and income which are denominated in currencies other than sterling and movements in exchange rates will affect the sterling value of those items.

Management of the Currency Risk

The Board meets at least quarterly to assess risk and review investment performance. The portfolio managers monitor the Company’s exposure to foreign currencies on a daily basis and report to the Board. Drawings in foreign currencies on the borrowing facility can be used to limit the Company’s currency exposure and to achieve the portfolio characteristics that assist the Company in meeting its investment objective and policy. The Company may use forward currency contracts to mitigate currency risk. All facility drawings and derivative contracts are limited to currencies and amounts commensurate with asset exposure to those currencies.

Income denominated in foreign currencies is converted to sterling on receipt. The Company does not use financial instruments to mitigate the currency exposure in the period between the time that income is included in the financial statements and its receipt.

Currency Exposure

The fair values of the Company’s monetary items that have foreign currency exposure at 31 December follow. Where the Company’s investments (which are not monetary items) are priced in a foreign currency, they have been included separately in the analysis to show the overall level of exposure.   

EURO
£’000
US
DOLLAR
£’000
SWISS
FRANC
£’000
31 December 2015
Investments at fair value through profit or loss that are monetary items (fixed and floating interest) 32,254 23,755
Cash at bank 267 83 1
Other receivables (due from brokers and dividends) 602 506
Forward currency contracts (33,457) (13,225)
Foreign currency exposure on net monetary items (334) 11,119 1
Investments at fair value through profit or loss that are equities 4,472
Total net foreign currency exposure (334) 15,591 1
EURO
£’000
US
DOLLAR
£’000
SWISS
FRANC
£’000
31 December 2014
Investments at fair value through profit or loss that are monetary items (fixed and floating interest) 34,627 17,766
Cash at bank 2,994 983 1
Other receivables (due from brokers and dividends) 789 284
Forward currency contracts (35,752) (6,100)
Foreign currency exposure on net monetary items 2,658 12,933 1
Investments at fair value through profit or loss that are equities 4,971
Total net foreign currency exposure 2,658 17,904 1

The above may not be representative of the exposure to risk during the period reported because the levels of monetary foreign currency exposure may change significantly throughout the period.

Currency Sensitivity

The effect on the income statement and the net asset value that changes in exchange rates have on the Company’s financial assets and liabilities is based on the following exchange rates. These rates have been calculated by reference to the volatility of exchange rates during the period using the standard deviation of currency fluctuations against the mean.

2015 2014
£/Euro ±2.4% ±2.1%
£/US dollar ±1.8% ±2.7%

The following sensitivity analysis is based on the Company’s monetary foreign currency financial instruments held at the balance sheet date and takes account of any forward foreign exchange contracts that offset the effects of changes in currency exchange rates.

If sterling had strengthened by the changes in exchange rates shown above, this would have had the following effect:

EURO
£’000
US DOLLAR
£’000
2015
Effect on income statement
  Revenue loss (63) (30)
  Capital profit/(loss) 22 (272)
Effect on net asset value (41) (302)
Euro
£’000
US
Dollar
£’000
2014
Effect on income statement
  Revenue loss (58) (28)
  Capital loss (56) (483)
Effect on net asset value (114) (511)

If sterling had weakened by the changes in exchange rates shown above this would have an equal and opposite effect.

In the opinion of the Directors, the above sensitivity analysis is not representative of the period as a whole, since the level of exposure changes frequently as part of the currency risk management process of the Company.

18.1.2         Interest Rate Risk

The Company is exposed to interest rate risk in a number of ways. Movements in interest rates may affect the fair value of fixed-interest rate securities, income receivable on cash deposits and floating rate securities, and interest payable on variable rate borrowings. Interest rate risk is related above all to long-term financial instruments.

Management of Interest Rate Risk

The possible effects on fair value and cash flows that could arise as a result of changes in interest rates are taken into account as part of the portfolio management and borrowings processes of the Manager. The Board reviews on a regular basis the investment portfolio and borrowings. This encompasses the valuation of fixed-interest and floating rate securities.

When the Company has cash balances, they are held in variable rate bank accounts yielding rates of interest dependant on the base rate of the custodian.

The Company has a credit facility with which it can finance investment activity, details of which are shown in note 7. The Company uses the facility at levels approved and monitored by the Board.

Interest Rate Exposure

The following table shows the Company’s exposure to interest rate risk at the balance sheet date arising from its monetary financial assets and liabilities.


WITHIN
ONE
YEAR
£’000
MORE
THAN
ONE
YEAR
£’000



TOTAL
£’000
2015
Exposure to floating interest rates:
Investments at fair value through profit or loss 54,702 54,702
Cash and cash equivalents 10,730 10,730
10,730 54,702 65,432
Exposure to fixed-interest rates:
Investments at fair value through profit or loss 72,863 72,863
Net exposure to interest rates 10,730 127,565 138,295

   



WITHIN
ONE YEAR
£’000
MORE
THAN
ONE
YEAR
£’000



TOTAL
£’000
2014
Exposure to floating interest rates:
Investments at fair value through profit or loss 63,893 63,893
Cash and cash equivalents 9,577 9,577
9,577 63,893 73,470
Exposure to fixed-interest rates:
Investments at fair value through profit or loss 57,252 57,252
Net exposure to interest rates 9,577 121,145 130,722

The nominal interest rates on the investments at fair value through profit or loss are shown in the portfolio list on pages 16 to 19. The weighted average effective interest rate on these investments is 7.0% (2014: 6.7%). The weighted average effective interest rate on cash and cash equivalents is 0.33% (2014: 0.22%).

Interest Rate Sensitivity

The following table illustrates the sensitivity of the profit after taxation for the year to a 1% increase in interest rates in regard to the Company’s financial assets and financial liabilities. As future changes cannot be estimated with any degree of certainty, the sensitivity analysis is based on the Company’s financial instruments held at the balance sheet date, with all other variables held constant.

2015
£’000
2014
£’000
Effect on statement of comprehensive income
  Revenue profit 107 96
  Capital loss (5,421) (5,391)
Total loss after taxation for the year (5,314) (5,295)
Effect on NAV (6.2)p (6.6)p

If interest rates had decreased by 1%, this would have had an equal and opposite effect.

The above exposure and sensitivity analysis are not representative of the period as a whole, since the level of exposure changes frequently as borrowings are drawn down and repaid as required throughout the period. In particular, for the year under review there has been limited interest rate movements and as a consequence little change in interest rate sensitivity.

18.1.3            Other Price Risk

Other price risks includes changes in market prices, other than those arising from currency risk or interest rate risk, which may affect the value of the investment portfolio, whether by factors specific to an individual investment or its issuer, or by factors affecting the wider market.

Management of Other Price Risk

It is the portfolio managers’ responsibility to manage the portfolio and borrowings in accordance with the investment objective and policy, and in accordance with the investment policy guidelines set by the Board. The Board manages the market price risks inherent in the investment portfolio by meeting regularly to monitor on a formal basis compliance with these. The Board also reviews investment performance. Because the Company’s portfolio is the result of the portfolio managers’ investment process, performance may not correlate with the markets in which the Company invests.

The Company’s exposure to other changes in market prices at 31 December on its investments is shown in the fair value hierarchy table on page 50.

Concentration of Exposure to Other Price Risks

The Company’s investment portfolio is not concentrated in any single country of domicile, however, it is recognised that an investment’s country of domicile or listing does not necessarily equate to its exposure to the economic conditions in that country.

Other Price Risk Sensitivity

Excluding fixed interest securities and convertibles, at the year end the Company held other investments of £14,268,000 (2014: £14,604,000). The effect of a 10% increase or decrease in the fair values of these investments (including any exposure through derivatives) on the profit after taxation for the year is £1,427,000 (2014: £1,460,000). This level of change is considered to be reasonably possible based on the observation of current market conditions. The sensitivity analysis is based on the Company’s other investments (including equity exposure through derivatives) at the balance sheet date with all other variables held constant.

18.2     Liquidity Risk

This is the risk that the Company may encounter difficulty in meeting its obligations associated with financial liabilities i.e. when realising assets or raising finance to meet financial commitments. A lack of liquidity in the portfolio may make it difficult for the Company to realise assets at or near their purported value in the event of a forced sale.

Management of Liquidity Risk

Liquidity risk is not viewed by the Directors as a significant risk because a majority of the Company’s assets comprise readily realisable securities, although a lack of liquidity in non-investment grade securities may make it difficult to rebalance the Company’s investment portfolio as and when the portfolio managers believe it would be advantageous to do so. On a daily basis the portfolio managers ascertain the Company’s cash and borrowing requirements by reviewing future cash flows arising from purchases and sales of investments, interest and dividend receipts, expenses and dividend payments, and available financing.

Liquidity Risk Exposure

The contractual maturities of the financial liabilities at the balance sheet, based on the earliest date on which payment can be required follow:

2015
THREE MONTHS
OR LESS
£’000
2014
THREE MONTHS
OR LESS
£’000
Other payables 432 414
Unrealised loss on forward currency contracts 1,091
1,523 414

18.3     Credit Risk

Credit risk is the risk that the failure of the counterparty to a transaction to discharge its obligation under that transaction could result in a loss to the Company. This risk also includes transactions in derivatives.

At the year end 63.8% (2014: 62.8%) of the Company’s portfolio consisted of non-investment grade securities. To the extent that the Company invests in non-investment grade securities, the Company may realise a higher current yield than the yield offered by investment grade securities. On the other hand, investments in such securities involve a greater volatility of price and a greater risk of default by the issuers of such securities, with consequent loss of interest payments and principal. Non-investment grade securities are likely to have greater uncertainties of risk exposure to adverse conditions and will be speculative with respect to an issuer’s capacity to meet interest payments and repay principal in accordance with its obligations.

Investment grade and non-investment grade securities totalled 80% (2014: 79.8%) of the portfolio at the year end. Adverse changes in the financial position of an issuer of such high-yield fixed-interest securities or in general economic conditions may impair the ability of the issuer to make payments of principal and/or interest or may cause the liquidation or insolvency of an issuer.

The portfolio may be adversely affected if the Company’s custodian suffers insolvency or other financial difficulties. The appointment of a depositary has substantially lessened this risk. The Board reviews the custodian’s annual control report and the Manager’s management of the relationship with the custodian.

Management of and Exposure to Credit Risk

All of the Company’s assets are subject to credit risk. The Company’s principal credit risk is the risk of default of the non-investment grade debt. Where the portfolio managers make an investment in a bond, corporate or otherwise, the credit rating of the issuer is also considered when assessing the risk of defaults. Investments in bonds are across a variety of industrial sectors and geographical markets to avoid concentration of credit risk. Transactions involving derivatives are entered into only with banks whose credit rating are taken into account to minimise default risk.

Details of the Company’s investments, including their credit ratings, are shown on pages 16 to 19. Credit risk for transactions involving derivatives and equity investments is minimised as the Company only uses approved counterparties.

Cash balances are held with approved deposit takers only and are limited to a maximum of 4% of the Company’s net asset value with any one deposit taker. Balances held with Short-Term Investments Company (Global Series) plc, a triple-A rated money market fund (STIC), are limited to a maximum of 6% of the Company’s net asset value. At the balance sheet date the Company had £1.6 million (2014: £4.5 million) held at the custodian and £9.1 million (2014: £5.1 million) held in STIC.

Fair Values of Financial Assets and Financial Liabilities

Financial assets are either carried in the balance sheet at their fair value (investments and derivatives), or the balance sheet amount is a reasonable approximation of fair value (due from brokers, dividends receivable, accrued income, due to brokers, accruals and cash).

Financial liabilities are carried at amortised cost except for derivatives which as stated above, are carried at fair value.

19.       Classification Under Fair Value Hierarchy

The valuation techniques used by the Company are explained in the accounting policies note. The table that follows sets out the fair value of the financial instruments. The three levels set out in IFRS 13 hierarchy follow:

Level 1 – valued using quoted prices in active markets for identical assets.

Level 2 – valued by reference to valuation techniques using observable inputs other than quoted prices within Level 1.

Level 3 – valued by reference to valuation techniques using inputs that are not based on observable market data.

Categorisation within the hierarchy has been determined on the basis of the lowest level input that is significant to the fair value measurement of each relevant asset/liability.

There were no transfers in the period between any of the levels.

Level 1
£’000
Level 2
£’000
Level 3
£’000
Total
£’000
2015
Financial assets designated at fair value through profit or loss:
  Quoted securities:
  – Fixed interest securities(1) 124,977 124,977
  – Convertibles 2,588 2,588
  – Preference 2,930 2,930
  – Convertible preference 6,866 6,866
  – Warrants 4,472 4,472
14,268 127,565 141,833
Derivative financial instruments:
  Currency hedges
Total for financial assets 14,268 127,565 141,833
Financial liabilities designated at fair value through profit or loss:
Derivative financial instruments:
  Currency hedges 1,091 1,091
Total for financial liabilities 1,091 1,091

(1)Fixed interest securities include both fixed and floating rate securities.

Level 1
£’000
Level 2
£’000
Level 3
£’000
Total
£’000
2014
Financial assets designated at fair value through profit or loss:
  Quoted securities:
  – Fixed interest securities(1) 117,715 117,715
  – Convertibles 3,430 3,430
  – Preference 2,809 2,809
  – Convertible preference 6,824 6,824
  – Warrants 4,971 4,971
14,604 121,145 135,749
Derivative financial instruments:
  Currency hedges 466 466
Total for financial assets 14,604 121,611 136,215

(1)        Fixed interest securities include both fixed and floating rate securities.

Normally investment company investments would be valued using stock market active prices, with investments disclosed as Level 1 and this is the case for the quoted equity investments that the Company holds. However, the majority of the Company’s investments are non-equity investments. Evaluated prices from a third party pricing vendor are used to price these securities, together with a price comparison made to secondary and tertiary evaluated third party sources. Evaluated prices are in turn based on a variety of sources including broker quotes and benchmarks. As a result, the Company’s non-equity investments have been shown as Level 2 – recognising that the fair values of these investments are not as visible as quoted equity investments and their higher inherent pricing risk. However, this does not mean that the fair values shown in the portfolio valuation are not achievable at point of sale.

Level 3 investments comprise investments held at Directors’ valuation as disclosed in the accounting policies note. None were held at the end of the year and a reconciliation of movements in value for the two years is set out below.

2015
£’000
2014
£’000
Opening fair value 24
Investments redeemed, sold or written off (24)
Movement in holding losses in the year/period
Closing fair value of Level 3

20.       Capital Management

The Company’s capital, or equity, is represented by its net assets which are managed to achieve the Company’s investment objective set out on page 6.

The main risks to the Company’s investments are shown in the Strategic Report under the ‘Principle Risks and Uncertainties’ section on pages 10 and 11. These also explain that the Company is able to borrow and that any resultant gearing will amplify the effect on equity of changes in the value of the portfolio.

The Board can also manage the capital structure directly since it has taken the powers, which it is seeking to renew, to issue and buy-back shares and it also determines dividend payments.

The Company is subject to externally imposed capital requirements with respect to the availability of the borrowing facility, by the terms imposed by the lender. The Board regularly monitors, and has complied with, the externally imposed capital requirements throughout the period.

Total equity at the balance sheet date, the composition of which is shown on the balance sheet on page 35, was £153,976,000 (2014: £148,211,000).

21.       Contingencies, Guarantees and Financial Commitments

Liabilities the Company is committed to honour but which are dependent on a future circumstance or event occurring would be disclosed in this note if any existed.

There were no contingencies, guarantees or financial commitments outstanding at the balance sheet date.

22.       Related Party Transactions

A related party is a company or individual who has direct or indirect control or who has significant influence over the Company.

Under International Financial Reporting Standards, the Company has identified the Directors and the Manager as related parties. The Directors’ remuneration and interests have been disclosed on pages 27 and 28 with additional disclosure in note 6. No other related parties have been identified. Details of the Manager and the investment management agreement are disclosed in the Strategic Report on page 6 and management fees payable to the Manager are shown in note 5.

.

This annual financial report announcement is not the Company’s statutory accounts.  The statutory accounts for the period ended 31 December 2015 have been audited and approved but are not yet filed.  They received an audit report which is unqualified and does not include a reference to any matters to which the auditors drew attention by way of emphasis without qualifying the report.

The audited annual financial report will be posted to shareholders shortly.  Copies may be obtained during normal business hours from the Company’s Registered Office, Ordnance House, 31 Pier Road, St.Helier, Jersey, JE4 8PW or the Manager’s website via the directory found at the following link: www.invescoperpetual.co.uk/citymerchants.

The Annual General Meeting of the Company will be held at 4.00 pm on 14 June 2016 at The Oriental Club, Stratford House, Stratford Place, London W1C 1ES.

By order of the Board

R&H Fund Services (Jersey) Limited

Company Secretary

29 March 2016


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