KEYSTONE INVESTMENT TRUST PLC
ANNUAL FINANCIAL REPORT ANNOUNCEMENT
FOR THE YEAR ENDED 30 SEPTEMBER 2016
FINANCIAL INFORMATION AND PERFORMANCE STATISTICS
Performance Statistics
| 2016 | 2015 | ||||||
| % CHANGE | % CHANGE | ||||||
| Total Return Statistics(1) | |||||||
| (capital growth with income reinvested) | |||||||
| Net asset value (NAV) per share: | |||||||
| - debt at par | +5.6 | +6.7 | |||||
| - debt at fair value | +5.2 | +6.4 | |||||
| Share price | +1.3 | +7.3 | |||||
| FTSE All-Share Index | +16.8 | -2.3 | |||||
| AT | AT | ||||||
| 30 SEPTEMBER | 30 SEPTEMBER | % CHANGE | |||||
| 2016 | 2015 | ||||||
| Capital Statistics | |||||||
| Net assets (£'000) | 264,947 | 259,625 | +2.0 | ||||
| NAV per share: | |||||||
| - debt at par | 1959.8p | 1920.5p | +2.0 | ||||
| - debt at fair value | 1894.9p | 1867.1p | +1.5 | ||||
| Share price(1) | 1735.5p | 1776.0p | -2.3 | ||||
| FTSE All-Share Index(1) | 3755.3 | 3335.9 | +12.6 | ||||
| Discount" of share price to net asset value per share: | |||||||
| - debt at par | 11.4% | 7.5% | |||||
| - debt at fair value | 8.4% | 4.9% | |||||
| Gearing from borrowings" | -gross | 12.1% | 12.3% | ||||
| -net | 6.2% | 4.4% | |||||
| FOR THE YEAR TO 30 SEPTEMBER | |||||||
| 2016 | 2015 | ||||||
| Revenue Statistics | |||||||
| Net revenue available for ordinary shareholders (£'000) | 8,386 | 8,659 | |||||
| Revenue return per ordinary share | 62.0p | 64.1p | -3.3 | ||||
| Dividends per ordinary share - first interim | 18.0p | 18.0p | |||||
| - second interim | 35.0p | 33.0p | |||||
| 53.0p | 51.0p | +3.9 | |||||
| - special | 5.3p | 12.3p | |||||
| - total | 58.3p | 63.3p | |||||
| Ongoing charges": | |||||||
| Excluding performance fee | 0.69% | 0.71% | |||||
| Performance fee | 0.03% | 1.00% | |||||
" Defined in the Glossary of Terms on page 64.
(1) Source: Thomson Reuters Datastream.
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CHAIRMAN'S STATEMENT
Performance
The total return to shareholders over the year to 30 September 2016 was 1.3%, based on the share price with dividends reinvested. Whilst this was a marginally positive return it was some way behind our benchmark, the FTSE All-Share Index, which posted a total return of 16.8%. The total return on the underlying net asset value (NAV) per share was 5.6% with debt at par value and 5.2% with debt at market (fair) value, thus part of the share price underperformance coming from a widening of the discount at which the shares trade relative to the NAV.
The three year share price performance also now lags our benchmark. However, the three year net asset performance still exceeds it, with a NAV total return (debt at fair value) of 26.0% compared with 21.1% for the benchmark, so a performance related fee is again payable, although it is very much reduced from last year at £65,000 (2015: £2,544,000).
The Company's longer term performance continues to be strong with five and ten year share price total returns of 82.6% and 131.2% respectively, compared with total returns of 68.9% and 75.5% for the FTSE All-Share Index. The NAV per share (with debt at fair value) total returns over the same periods were 88.6% and 127.6% (all figures sourced from Thomson Reuters Datastream).
The Manager's Report section of the following Strategic Report provides background on the year's investment performance and a detailed explanation for this year's disappointing return. In summary, the continued lack of mining stocks in our portfolio, a strategy which had served the Company well for so many years, and low exposure to oil negatively impacted the period under review as share prices for such stocks rebounded sharply.
Discount widening was a sector wide phenomenon. The weighted average discount of the investment companies in the UK All Companies sector was 9.2% at 30 September 2016 compared with 4.9% at 30 September 2015 (source: J.P. Morgan Cazenove). The average discount at which the Company's ordinary shares traded relative to their underlying NAV (with debt at fair value) over the past year was 7.7%, compared with an average of 3.8% last year. The share price stood at a discount of 8.4% relative to the NAV (debt at fair value) at the year end.
Revenue and Dividends
Income in the year, excluding special dividends, increased by almost 8% to £9,062,000 from £8,400,000 last year. However the amount of special dividends fell and consequently the total income for the year of £9,783,000 was less than last year's £10,071,000. The revenue return after tax fell correspondingly to 62.0p per ordinary share, compared with 64.1p for the year to 30 September 2015.
The Board has declared a second interim dividend, in lieu of a final, of 35p per share (2015: 33p), giving a total ordinary dividend for the year of 53p per share (2015: 51p). The dividend will be paid on 23 December 2016 to shareholders on the register on 2 December 2016.
The Company has continued to benefit from special dividends received from investee companies, albeit at a lower scale than last year. These dividends totalled £721,000, the equivalent of 5.33p this year (2015: £1,671,000; 12.36p) and the Board has decided again to pass the greater part of this on to shareholders as a special dividend of 5.3p (2015: 12.3p). The special dividend will be paid at the same time as the second interim dividend. As indicated in my statement last year the reduction in special dividends received this year was not a surprise and we anticipate the level of special dividends is likely to continue to decline.
Gearing
The Board takes responsibility for the Company's gearing strategy and sets parameters within which the portfolio manager operates. The Company's borrowings, in the form of long-term debentures, amount to £32 million. The net gearing of the Company is determined by the extent to which these borrowings are invested. The Board has remained reasonably cautious through the past year, but relaxed the threshold in January 2016 after the market setback. Since then the parameters limiting the Manager have been that no net purchases be made which would take equity exposure above 107.5% of net assets (previously 105%), and that sales be made if, as a result of market movements, equity exposure goes higher than 115% of net assets. It is up to the portfolio manager to decide on exposure subject to these limits. When held, corporate bonds are not treated as equity exposure for the purposes of the gearing limits.
Foreign Exchange
The Company has some non-sterling denominated investments and is therefore subject to foreign exchange risk. The Board monitors foreign currency exposure and takes a view, from time to time, on whether foreign currency exposure should be hedged. For the present, the Board has prescribed that all currency exposure should be hedged other than US dollar and Swiss franc. At the year end 5.7% of the portfolio was exposed to US dollars and 5.1% to Swiss francs, neither of which were hedged.
Outlook
The UK stock market as a whole delivered impressive returns over the last year, notwithstanding the uncertainty and sterling weakness fostered by the referendum in June and its aftermath. These elements look likely to continue for some time and, combined with the other background concerns of downward pressure on corporate profitability and subdued global growth, will challenge the UK equity market's long term growth potential.
However, the Board remains confident that Mark Barnett and his team will continue to find opportunities for investment that will, combined with their proven long term investment approach, generate worthwhile returns over time and enable the Company to fulfil its investment objective to provide shareholders with long-term growth of capital.
Annual General Meeting
The Notice of the Annual General Meeting of the Company, which is to be held on 24 January 2017, is on pages 58 to 61 and a summary of the resolutions is set out in the Directors' Report on pages 56 and 57.
Beatrice Hollond
Chairman
29 November 2016
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STRATEGIC REPORT
FOR THE YEAR ENDED 30 SEPTEMBER 2016
BUSINESS REVIEW
Keystone Investment Trust plc is an investment company holding investments with a market value in excess of £280 million 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. These are also set out below.
The business model adopted by the Company to achieve its objective has been to contract the services of Invesco Fund Managers Limited (the 'Manager') to manage the portfolio in accordance with the Board's strategy and under its oversight. The Manager also provides company secretarial, marketing and general administration services. The portfolio manager responsible for the day-to-day management of the portfolio is Mark Barnett.
All administrative support is provided by third parties. In addition to the management and administrative functions of the Manager, the Company has contractual arrangements with Capita Asset Services as registrar and with BNY Mellon Trust & Depositary (UK) Limited as depositary. The depositary has delegated safekeeping of the Company's investments to The Bank of New York Mellon (London Branch) who acts as custodian under this authority.
Investment Objective and Policy
Investment Objective
The Company's objective is to provide shareholders with long-term growth of capital, mainly from UK investments.
Investment Policy and Risk
The portfolio is invested by the Manager so as to maximise exposure to the most attractive sectors and stocks within the UK stock market and, within the limits set out below, internationally. The Manager does not set out to manage the risk characteristics of the portfolio relative to the benchmark index and the investment process will result in potentially very significant over or underweight positions in individual sectors versus the benchmark.
The Manager controls stock-specific and sector risk by ensuring that the portfolio is always appropriately diversified. In depth, continual analysis of the fundamentals of investee companies allows the portfolio manager to assess the financial risks associated with any particular stock. The portfolio is typically made up of 50 to 80 stocks. If a stock is not considered to be a good investment, then the Company will not own it, irrespective of its weight in the index.
Investment limits
The Board has prescribed the following limits on the investment policy, all of which are at time of investment unless otherwise stated:
- no single equity investment in a UK listed company may exceed 12.5% of gross assets;
- the Company will not invest more than 15% of its assets in other listed investment companies;
- the Company will not invest more than £12 million in bonds, with a maximum of £1.5 million in any issue;
- the Company will normally not invest more than 5% of gross assets in unquoted investments;
-the Company will not normally invest more than 15% of its equity investments in companies that are not UK listed and incorporated; and
- borrowing may be used by the Company to create gearing within limits determined by the Board.
Gearing Policy
The Board carefully considers the Company's policy in respect of the level of equity exposure. The Board takes responsibility for the Company's gearing strategy and sets guidelines to control it, which it may change from time to time. Since January 2016 these guidelines have required that the Manager must make no net purchases if equity exposure was more than 107.5% of net assets (previously 105%), and must make sales if, as a result of market movements, equity exposure was to exceed 115% of net assets. When held, corporate bonds are not treated as equity exposure for the purposes of the gearing limits.
.
Performance
Delivery of shareholder value is achieved through outperformance of the relevant benchmark.
The Board reviews performance by reference to a number of Key Performance Indicators that include the following:
• net asset value (NAV) and share price total return compared with benchmark and peer group performance;
• share price premium/discount relative to the net asset value;
• dividends; and
• ongoing charges.
The Company's NAV (debt at fair value) and share price total returns for the year to 30 September 2016 were 5.2% and 1.3%, both of which were substantially less than the total return of the Company's benchmark, the FTSE All-Share Index, of 16.8%. The Manager's Report on pages 12 and 13 provides commentary on the reasons for the performance. The year's results do not reflect the longer term successful implementation of the business strategy by the Manager - over three years, the Company's NAV (debt at fair value) and share price returns were 26.0% and 16.7% respectively compared to the benchmark return of 21.1%. Over five years, the returns were 88.6% and 82.6% compared to the benchmark of 68.9%. The Manager is entitled to a performance-related fee based on the last three years' NAV performance and a fee of £65,000 consequently accrues. A table of the returns for the last ten years, together with a graph, can be found on page 3.
Peer group performance is monitored by comparing the Company with the 15 investment companies making up the UK All Companies sector of the approximately 300 investment companies in the UK. As at 30 September 2016, in NAV total return terms, the Company was ranked 8th in its sector over one year, 6th over three years and 7th over 5 years (source: JPMorgan Cazenove).
The Company's shares traded at a discount relative to NAV (with debt at fair value) through the year, as shown in the following graph. The discount at the year end was 8.4%.
Although there is no specific target discount range a small discount or a premium would imply that there was strong demand for the shares. In order to ensure that the demand for and supply of the Company's shares are roughly in balance, the Board asks shareholders to approve resolutions every year which allow for the repurchase of shares (for cancellation or to be held as treasury shares) and also their issuance. This may assist in the management of the discount. The Company has not issued any ordinary shares in the year and no shares were repurchased.
Dividends form a key component of the total return to shareholders. The income from the portfolio and potential level of dividend payable is reviewed at every board meeting. A first interim dividend of 18p (2015:18p) per share was paid on 10 June 2016 and a second interim dividend of 35p (2015: 33p) per share has been declared, which is payable on 23 December 2016 to shareholders on the register at 2 December 2016. These give a total ordinary dividend for the year of 53p compared with 51p for the previous year. The Board has also declared a special dividend of 5.3p (2015: 12.3p) to be paid at the same time as the second interim dividend. The dividend history of the Company over the last ten years is shown in the table on page 3.
Ongoing charges is the industry measure of costs as a percentage of net asset value. The expenses of the Company are reviewed at every board meeting, with the aim of managing costs incurred and their impact on performance. The ongoing charges figure for the past year, which excludes the performance fee, was 0.69%, compared with 0.71% for the year to 30 September 2015. The ten year record of ongoing charges is shown on page 3.
Financial Position
At 30 September 2016, the Company's net assets were valued at £265 million (2015: £260 million). These comprised a portfolio of mainly equity investments and net current assets. The Company has an uncommitted short-term overdraft facility with the custodian for settlement and liquidity purposes.
At 30 September 2015 and 30 September 2016, the Company's ordinary shares were geared by borrowings in the form of two issues of long-term debentures, totalling £32 million nominal. Their weighted average interest rate was 6.77% for both years. The Company also had £0.25 million of 5% cumulative preference shares in issue.
Outlook and Future Trends
The main trends and factors likely to affect the future development, performance and position of the Company's business can be found in the following Manager's Report section of this Strategic Report. Further details as to the risks affecting the Company are set out below under 'Principal Risks and Uncertainties'.
Principal Risks and Uncertainties
The audit committee regularly undertakes a robust assessment of the risks the Company faces, on behalf of the Board (see Audit Committee Report on pages 19 to 21).
The following are considered to be the most significant risks to the Company and to shareholders in relation to their investment in the Company. Further details of risks and risk management policies as they relate to the financial assets and liabilities of the Company are detailed in note 16 to the financial statements.
Investment Objective
There is no guarantee that the Company's strategy and business model will be successful in achieving its investment objective.
The Board monitors the performance of the Company and has established guidelines to ensure that the investment policy that has been approved is pursued by the Manager.
Market Risk
The majority of the Company's investments are traded on the London Stock Exchange. The principal risk for investors in the Company is of a significant fall in stock markets and/or a prolonged period of decline in the markets relative to other forms of investment. The value of investments held within the portfolio is influenced by many factors including the general health of the economy in the UK, interest rates, inflation, government policies, industry conditions, political events, tax laws, environmental laws and investor sentiment. The portfolio manager has summarised in the Manager's Report section of this Strategic Report particular factors affecting the performance of markets in the year and his view of those most pertinent to the outlook for the portfolio. Such factors are out of the control of the Board and the Manager and may give rise to high levels of volatility in the prices of investments held by the Company, although the use or elimination of gearing may modify the impact on shareholder return.
Investment Risk
An inherent risk of investment is that the stocks selected for the portfolio do not perform well.
The investment process employed by the Manager combines top down assessment of economic and market conditions with stock selection. Fundamental analysis forms the basis of the Company's stock selection process, with an emphasis on sound balance sheets, good cash flows, the ability to pay and sustain dividends, good asset bases and market conditions. The process is complemented by constant assessment of market valuations. It is important to have a sense of a company's realistic valuation which, to some extent, will be independent of the price at which it trades in the market. Overall, the investment process is aiming to achieve absolute returns through a genuinely active fund management approach. This can therefore result in a portfolio which looks substantially different from the benchmark index.
Risk management is an integral part of the investment management process. The Manager effectively controls risk by ensuring that the Company's portfolio is always appropriately diversified. Continual analysis of all holdings gives the Manager a full understanding of financial risks associated with them.
The portfolio of investments held at 30 September 2016 is set out on pages 14 and 15.
Past performance of the Company is not necessarily indicative of future performance.
Shares
Shareholders are exposed to certain risks in addition to risks applying to the Company itself.
The ordinary shares of the Company may trade at a premium or discount to its NAV. The Board monitors the price of the Company's shares in relation to their NAV and the premium/discount at which they trade.
The value of an investment in the Company and the income derived from that investment may go down as well as up and an investor may not get back the amount invested.
While it is the intention of the Directors to pay dividends to ordinary shareholders twice a year, the ability to do so will depend upon the level of income received from securities and the timing of receipt of such income by the Company. Accordingly, the amount of the dividends paid to ordinary shareholders may fluctuate. Any change in the tax or accounting treatment of dividends or other investment income received by the Company may also affect the level of dividend paid.
The Directors seek powers to issue and buy back the Company's shares each year, which can be used to help manage the level of discount. The Board also monitors the level of revenue available for distribution at each Board meeting.
Gearing
Gearing levels may change from time to time in accordance with the Manager's and the Board's assessment of risk and reward. Whilst the use of borrowings by the Company should enhance total return where the return on the Company's underlying securities is rising and exceeds the cost of borrowing, it will have the opposite effect where the underlying return is falling. As at 30 September 2016, net gearing from borrowings stood at 6.2%. The Board and the Manager regularly review gearing and will continue to monitor the level closely over the year ahead.
Reliance on the Manager and Other Service Providers
The Company has no employees and the Directors have all been appointed on a non-executive basis. The Company is reliant upon the performance of third party service providers for it to function. In particular, the Manager performs services that are integral to the operation of the Company. Failure by any service provider to carry out its obligations to the Company in accordance with the terms of its appointment or compromise of their systems could have a materially detrimental impact on the operation of the Company and could affect the ability of the Company to successfully pursue its investment policy.
The Company has limited direct exposure to cyber risk. However, the Company's operations or reputation could be affected if any of its service providers suffered a major cyber security breach. The Board monitors the preparedness of its service providers in this regard and is satisfied that the risk is given due priority.
The Manager may be exposed to reputational risks. In particular, the Manager may be exposed to the risk that litigation, misconduct, operational failures, negative publicity and press speculation, whether or not it is valid, will harm its reputation. 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. This could have an adverse impact on the ability of the Company to pursue its investment policy successfully. The Company's main service providers are listed on page 63.
The Board monitors the services provided to the Company, informally at every Board meeting and formally at least annually.
Regulatory
The Company is subject to various laws and regulations by virtue of its status as a public limited company, as an investment trust and as an alternative investment fund. A loss of investment trust status could lead to the Company being subject to capital gains tax on the profits arising from the sale of its investments. A serious breach of other regulatory rules might lead to suspension from the Stock Exchange. Other control failures, either by the Manager or another of the Company's service providers, might result in operational or reputational problems, erroneous disclosures or loss of assets through fraud, as well as breaches of regulations.
The Manager reviews the level of compliance with tax and other regulatory financial requirements on a daily basis. All transactions, income and expenditure are reported to the Board. The Board regularly considers all risks, the measures in place to control them and the possibility of any other risks that could arise. The Board ensures that satisfactory assurances are received from service providers. The Manager's Compliance Officer produces regular reports for review by the Company's Audit Committee.
Viability Statement
The Company is an investment company operating as an investment trust. As such, the Company is a collective investment vehicle rather than a commercial business venture and is designed and managed for long term investment. Long term for this purpose is considered to be at least five years and so 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.
In assessing the viability of the Company the Board considered the Company's current position, the principal risks to which it is exposed and their potential impact on its future development and prospects. The most significant of these are shareholder dissatisfaction arising from failure to meet the Company's investment objective, through poor investment performance or because the investment policy is no longer appropriate to the prevailing market conditions, and contributory market and investment risks. The Board also took into account the capabilities of the Manager and the varying market conditions experienced.
In terms of financial risks to viability, save for the limited value ascribed to unquoted investments, the Company's portfolio is readily realisable and many times the value of its short term liabilities and annual operating costs. The Company also has long term debt obligations comprising two debentures. The smaller debenture, £7 million, falls due in 2020 and the larger, £25 million, in 2023. In aggregate this long term debt amounts to 11% of total assets less current liabilities, so the principal is more than nine times covered and the risk that interest obligations will not be met is negligible.
Based on the foregoing analysis, the Directors 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.
Board Diversity
The Company's policy on diversity is set out on page 51. The Nomination Committee considers diversity, including the balance of skills, knowledge, gender and experience, amongst other factors, when reviewing the composition of the Board 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, the Chairman, is a woman thereby constituting 20% female representation. Summary biographical details of the Directors are set out on page 16. The Company has no employees.
Social and Environmental Matters
As an investment company operating as an investment trust, with no employees, 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, 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.
The Company is an investment vehicle and does not provide goods or services in the normal course of its business, or have customers. Accordingly, the Directors consider that the Company is not required to make any slavery or human trafficking statement under the Modern Slavery Act 2015.
Stewardship
The Board considers that the Company has a responsibility as a shareholder towards ensuring that high standards of corporate governance are maintained by the companies in which it invests. The Company's stewardship functions have been delegated to the Manager, who exercises the Company's voting rights and reports back to the Board. The Manager has adopted a clear and considered policy towards its responsibility as a shareholder on behalf of the Company. As part of this policy, the Manager takes steps to satisfy itself about the extent to which the companies in which it invests look after shareholders' value and comply with local recommendations and practices, such as the UK Corporate Governance Code. A copy of the Manager's Policy on Corporate Governance and Stewardship can be found at www.invescoperpetual.co.uk.
MANAGER'S REPORT
Market Review
The UK equity market was volatile during the first half of the Company's financial year with sentiment largely driven by the actions of central banks and by movements in commodity prices. After rallying strongly into the end of 2015, following the first increase in US interest rates for seven years, the FTSE All-Share index fell sharply to its lowest level since 2012 during the first quarter of 2016. Market moves were characterised by some particularly volatile, low volume trading days. Crude oil hit a ten-year low, fears grew over the risk of a global recession and oil and mining companies cut profit guidance and, in some cases, dividends.
The turbulence moderated through March as oil and mining prices showed some recovery, the ECB surprised financial markets by cutting interest rates in the Eurozone to zero and stepped up the pace of quantitative easing and Janet Yellen, Chair of the US Federal Reserve, provided a further boost to equities by stating that the US central bank should proceed cautiously with interest rate rises. The UK stock market rallied strongly and, after an initial sell-off, continued to do so after the EU referendum on 23 June as sterling's dramatic fall boosted international companies. There was significant divergence in sector performance, with share price falls after the referendum's Brexit result seen most acutely in certain domestically focused sectors, while the share prices of companies with US dollar denominated earnings rose strongly in anticipation of upgrades to forecast earnings. The resources sectors (oil and mining) performed notably well; crude oil continued to recover from its February price lows, particularly on news that OPEC members had proposed production cuts, while continued progress in commodity prices buoyed global mining companies.
The UK stock market's attention remained focused on the post-Brexit narrative as it unfolded and the timing of the next increase in US interest rates, which was generally perceived as being postponed by a dovish US Federal Reserve. Sector volatility moderated towards the end of the Company's financial year, with the share prices of domestically focused companies showing some recovery.
Portfolio Strategy and Review
The Company's net asset value (with debt at par value), including reinvested dividends, rose by 5.6% over the year ended 30 September 2016, compared with a rise of 16.8% by the FTSE All-Share index.
The portfolio delivered a positive return against a strong market backdrop, but failed to match the rise of the index. Relative performance was negatively impacted by the portfolio's zero weighting in mining companies and heavily underweight position in the oil sector - with share prices in the resources sectors rising strongly through the period. The continued zero weighting in the major UK domestic banks positively impacted performance, but the absence of a holding in HSBC proved a negative post the Brexit vote, as the company's international exposure saw its shares rise strongly. As in previous years, the portfolio held some direct investments in foreign listed companies (Reynolds American, Novartis, Roche) which enhanced performance as sterling fell.
The holdings in the tobacco sector were again amongst the top contributors to portfolio performance, benefiting from the sector's overseas earnings, but also from continued positive news flow. British American Tobacco is seeing the benefits of its focus on key brands - its Global Drive Brands posted a 10.5% volume increase in its second quarter earnings report. Imperial Brands and Reynolds American continue to see the benefits of last year's purchase by Reynolds of fellow US tobacco business Lorillard and by Imperial of certain Reynolds and Lorillard brands (including Winston) and of its manufacturing facilities. Both companies are posting double digit dividend increases on the back of strongly growing profits.
AstraZeneca, another US dollar beneficiary, issued plans to file its injectable asthma treatment drug with US and European regulators later this year, after favourable trial results. The failure of Bristol-Myers' lung cancer study was also seen as positive for AstraZeneca's combination therapy cancer drugs.
A significant positive contribution to portfolio performance came from the holding in Rentokil Initial. The pest control business reported strong overall performance and improved organic growth for the first half, supplemented by a plethora of merger and acquisition activity across the group's global operations. Other holdings to make notable positive contributions included BP, Bunzl, Compass, Homeserve, KCOM and RELX.
The portfolio's holdings in domestic sectors, notably those particularly exposed to the fall in sterling and those expected to be most impacted by any challenges to the UK economy, performed poorly in the aftermath of the Brexit vote. The stock market was also inclined to de-rate companies which warned of lower profits, compounding the impact on the share price.
Notable amongst these was the holding in Capita, which fell sharply in value as it downgraded full-year earnings forecasts, blaming a slow-down in specific trading businesses, one-off costs and problems with a major contract with Transport for London, along with delayed client decision-making since the EU referendum vote.
The holdings in the travel sector - easyJet and Thomas Cook - warned of the negative impact of weaker sterling and were additionally impacted during the period by concerns over terrorist activity and by air traffic control strikes. There was some respite for Thomas Cook shareholders towards period end as the company confirmed previous full year profit guidance. Strategic measures implemented by the company over the past two years have helped to offset the challenging trading environment.
Other domestically focused holdings to deliver negative share price performance included Derwent London, GAME Digital, Harworth Group, N Brown, P2P Global Investments and TalkTalk Telecom.
In terms of portfolio activity during the period, new investments were made in UK based specialist pharmaceutical company Diurnal, Hadrians Wall Secured Investments (a closed-end fund investing in UK small-to medium-sized enterprise (commercial loans), Marwyn Value Investors (a closed-end fund investing in European sectors impacted by structural and regulatory change), fashion retailer Next and challenger bank Secure Trust. The holdings in Amlin, Ladbrokes, Reckitt Benckiser, Rolls-Royce and Workspace were sold.
Outlook
It is likely that the near term outlook for the UK equity market will continue to be dictated by the movement of global bond prices and the sterling/US dollar exchange rate. These asset markets have exerted a major influence on UK equities over the course of 2016. The strong performance of the bond market, not always associated with a rising equity market, and the perceived benefit from the drop in sterling have been the driving forces behind the ongoing re-rating of UK equities to reach a current price to earnings valuation of 17.5 times forecast 2016 earnings per share. This valuation looks full, particularly relative to the disappointing overall level of underlying profit growth recorded this year (excluding the impact of sterling and the commodity bounce back). It is highly unlikely that the rerating of UK equities will continue unchecked against a backdrop of higher valuations and ongoing pressure on corporate profitability. It is noticeable how the rate of profit warnings across the market has increased in the past few weeks. In addition, the recent reversal of bond markets has put pressure on valuations in certain sectors.
There are several challenges which may force a reassessment of the current valuations that are being applied to the UK equity market. The first is the lack of overall profit growth, which, in the absence of the significant devaluation in sterling, would have seen another year of no growth in 2016. The underlying earnings outlook for next year looks similarly muted. Second, a more difficult near-term UK economic picture is likely to emerge. The reappearance of inflation - largely as a result of the movement in sterling - will pressurise consumer budgets and hinder overall levels of economic growth. This factor, coupled with the ongoing uncertainty over the political path to Brexit, may put a brake on UK employment levels and investment intentions, further moderating activity in the domestic economy. To some extent, this has been priced into equities, as the performance disparity between global and domestic companies since the referendum has been significant. Nevertheless, the backdrop to corporate profitability is unlikely to ease over the coming year as pricing power remains elusive.
The political backdrop has the potential to deliver more surprises over the coming year, a third factor likely to continue to exert major influence on both corporate behaviour and stock market performance. The election of Donald Trump as the next US president has already set off widespread expectations of fiscal reflation with knock-on effects in certain stock market sectors. The domestic political scene is currently overshadowed by the new government's evolving political agenda, while internationally, there are a series of important elections on the horizon; the potential for a sudden policy shift or unexpected election result is significant.
Finally, a shift in the value of global bonds also has the potential to de-stabilise the outlook for UK equities. This could emanate from US policy tightening or simply a realisation that the extreme low yields reached over the summer months across the world no longer represent a realistic view of the medium term outlook for inflation and interest rates. Indeed, at the time of writing, we are witnessing a meaningful shift upwards in 10 year bond yields globally.
Navigating any one of these obstacles, either individually or in combination, will continue to be challenging. The most important discipline is to remain vigilant about valuation. Notwithstanding the elevated level of stock market valuation, there are bottom-up opportunities for the long-term investor, which have started to emerge as a result of the substantial sector rotations that have occurred since the June Referendum. Where new opportunities arise, the emphasis will continue to be on companies that can demonstrate a sustainable top line growth and translate that into profit, free cash flow and dividends without excessive financial leverage.
Mark Barnett, Portfolio Manager
The Strategic Report was approved by the Board of Directors on 29 November 2016.
Invesco Asset Management Limited
Company Secretary
STRATEGIC REPORT
INVESTMENTS IN ORDER OF VALUATION
AT 30 SEPTEMBER 2016
UK listed ordinary shares unless stated otherwise
| Equity Investments | MARKET VALUE | % OF PORTFOLIO | |
| ISSUER | SECTOR | £'000 | |
| Reynolds American - US common stock | Tobacco | 14,786 | 5.2 |
| British American Tobacco | Tobacco | 13,775 | 4.9 |
| AstraZeneca | Pharmaceuticals & Biotechnology | 11,780 | 4.2 |
| Imperial Brands | Tobacco | 11,279 | 4.0 |
| BP | Oil & Gas Producers | 11,164 | 4.0 |
| Provident Financial | Financial Services | 9,390 | 3.3 |
| BT Group | Fixed Line Telecommunications | 9,188 | 3.3 |
| BAE Systems | Aerospace & Defence | 8,980 | 3.2 |
| Roche - Swiss common stock | Pharmaceuticals & Biotechnology | 8,795 | 3.1 |
| Legal & General | Life Insurance | 7,415 | 2.6 |
| Top Ten Investments | 106,552 | 37.8 | |
| RELX | Media | 6,679 | 2.4 |
| Rentokil Initial | Support Services | 6,368 | 2.3 |
| Babcock International | Support Services | 6,258 | 2.2 |
| Beazley | Non-life Insurance | 5,965 | 2.1 |
| London Stock Exchange | Financial Services | 5,962 | 2.1 |
| NewRiver REIT | Real Estate Investment Trusts | 5,677 | 2.0 |
| Compass | Travel & Leisure | 5,652 | 2.0 |
| Novartis - Swiss common stock | Pharmaceuticals & Biotechnology | 5,574 | 2.0 |
| Hiscox | Non-life Insurance | 5,499 | 1.9 |
| BTG | Pharmaceuticals & Biotechnology | 5,321 | 1.9 |
| Top Twenty Investments | 165,507 | 58.7 | |
| Shaftesbury | Real Estate Investment Trusts | 5,062 | 1.8 |
| Bunzl | Support Services | 5,009 | 1.8 |
| Centrica | Gas, Water & Multiutilities | 4,947 | 1.8 |
| SSE | Electricity | 4,767 | 1.7 |
| KCOM | Fixed Line Telecommunications | 4,254 | 1.5 |
| Capita | Support Services | 4,180 | 1.5 |
| HomeServe | Support Services | 4,060 | 1.4 |
| A J BellUQ | Financial Services | 4,032 | 1.4 |
| Derwent London | Real Estate Investment Trusts | 3,703 | 1.3 |
| Drax | Electricity | 3,702 | 1.3 |
| Top Thirty Investments | 209,223 | 74.2 | |
| BCA Marketplace | Financial Services | 3,697 | 1.3 |
| IP Group | Financial Services | 3,541 | 1.3 |
| Next | General Retailers | 3,397 | 1.2 |
| Imperial Innovations | Financial Services | 3,295 | 1.2 |
| G4S | Support Services | 3,223 | 1.2 |
| easyJet | Travel & Leisure | 3,176 | 1.1 |
| Lancashire | Non-life Insurance | 3,120 | 1.1 |
| P2P Global Investments | Equity Investment Instruments | 2,775 | 1.0 |
| Real Estate Investors | Real Estate Investment & Services | 2,724 | 1.0 |
| Oxford Sciences InnovationUQ | Financial Services | 2,677 | 0.9 |
| Top Forty Investments | 240,848 | 85.5 | |
| MARKET VALUE | % OF PORTFOLIO | |||||
| ISSUER | SECTOR | £'000 | ||||
| TalkTalk Telecom | Fixed Line Telecommunications | 2,517 | 0.9 | |||
| Smith & Nephew | Health Care Equipment & Services | 2,329 | 0.8 | |||
| PureTech Health | Health Care Equipment & Services | 2,237 | 0.8 | |||
| Motif Bio | Pharmaceuticals & Biotechnology | 2,142 | 0.8 | |||
| Harworth | Real Estate Investment & Services | 2,103 | 0.7 | |||
| Thomas Cook | Travel & Leisure | 2,089 | 0.7 | |||
| Diurnal | Pharmaceuticals & Biotechnology | 1,914 | 0.7 | |||
| Hadrians Wall Secured Investments | Equity Investment Instruments | 1,890 | 0.7 | |||
| Vectura | Pharmaceuticals & Biotechnology | 1,802 | 0.6 | |||
| Sherborne Investors Guernsey B - A shares | Financial Services | 1,722 | 0.6 | |||
| Top Fifty Investments | 261,593 | 92.8 | ||||
| Horizon Discovery | Pharmaceuticals & Biotechnology | 1,637 | 0.6 | |||
| Secure Trust Bank | Banks | 1,635 | 0.6 | |||
| CLS | Real Estate Investment & Services | 1,546 | 0.5 | |||
| Marwyn Value Investors | Equity Investment Instruments | 1,518 | 0.5 | |||
| Doric Nimrod Air Three - preference shares | Equity Investment Instruments | 1,414 | 0.5 | |||
| Doric Nimrod Air Two - preference shares | Equity Investment Instruments | 1,411 | 0.5 | |||
| N Brown | General Retailers | 1,355 | 0.5 | |||
| Macau Property Opportunities Fund | Real Estate Investment & Services | 1,324 | 0.5 | |||
| GAME Digital | General Retailers | 1,151 | 0.4 | |||
| VPC Speciality Lending Investments | Financial Services | 1,038 | 0.4 | |||
| Top Sixty Investments | 275,622 | 97.8 | ||||
| Silence Therapeutics | Pharmaceuticals & Biotechnology | 1,021 | 0.4 | |||
| NexeonUQ | Electronic & Electrical Equipment | 942 | 0.3 | |||
| MayAir | Industrial Engineering | 859 | 0.3 | |||
| PuriCore | Health Care Equipment & Services | 789 | 0.3 | |||
| Napo Pharmaceuticals - US common stockUQ | Pharmaceuticals & Biotechnology | 722 | 0.3 | |||
| Damille Investments II | Equity Investment Instruments | 692 | 0.3 | |||
| Funding Circle SME | Equity Investment Instruments | 569 | 0.2 | |||
| Lombard Medical - US common stock | Health Care Equipment & Services | 319 | 0.1 | |||
| Nimrod Sea Assets | Equity Investment Instruments | 135 | - | |||
| HaloSource | Chemicals | 97 | - | |||
| Top Seventy Investments | 281,767 | 100.0 | ||||
| Melrose Industries | Industrial Engineering | 44 | - | |||
| XTL Biopharmaceuticals - ADR | Pharmaceuticals & Biotechnology | 19 | - | |||
| Mirada | Media | 1 | - | |||
| Total Equity Investments (73) | 281,831 | 100.0 | ||||
| Other Investments | ||||||
| ISSUER AND ISSUE | SECTOR | MOODY/ S&P RATING | MARKET VALUE £'000 | % OF PORTFOLIO | ||
| Barclays Bank - Nuclear Power Notes 28 Feb 2019 | Non-Equity Investment Instruments | NR/NR | 4 | - | ||
| Total Investments (74) | 281,835 | 100.0 | ||||
| NR is non-rated. | ||||||
| UQ is unquoted. | ||||||
STATEMENT OF DIRECTORS' RESPONSIBILITIES
IN RESPECT OF THE PREPARATION OF FINANCIAL STATEMENTS
The Directors are responsible for ensuring that the annual financial report is prepared in accordance with applicable law and regulations.
Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have elected to prepare financial statements in accordance with UK Accounting Standards, including FRS 102 'The Financial Reporting Standard applicable in UK and Republic of Ireland'. Under company law, the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the net return of the Company for that period.
In preparing these financial statements, the Directors are required to:
• select suitable accounting policies and then apply them consistently;
• make judgments and accounting estimates that are reasonable and prudent;
• state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and
• prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business.
The Directors are responsible for keeping adequate accounting records which are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and which enable them to ensure that the financial statements comply with company law. 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 a Strategic Report, a Corporate Governance Statement, a Directors' Remuneration Report and a Directors' Report that comply with that law and those regulations.
The Directors of the Company, whose names are shown on page 16 of this Report, each confirm to the best of their knowledge that:
• the financial statements, which have been prepared in accordance with United Kingdom accounting standards on a going concern basis, give a true and fair view of the assets, liabilities, financial position and net return of the Company;
• the 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
• they consider that the 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.
Beatrice Hollond
Chairman
Signed on behalf of the Board of Directors
29 November 2016
INCOME STATEMENT
FOR THE YEAR ENDED 30 SEPTEMBER
| 2016 | 2015 | |||||||
NOTES | REVENUE £'000 | CAPITAL £'000 | TOTAL £'000 | REVENUE £'000 | CAPITAL £'000 | TOTAL £'000 | ||
| Gains on investments | 9 | - | 8,155 | 8,155 | - | 13,884 | 13,884 | |
| Foreign exchange losses | - | (11) | (11) | - | (10) | (10) | ||
| Income | 2 | 9,783 | 88 | 9,871 | 10,071 | - | 10,071 | |
| Investment management and performance-related fees | 3 | (343) | (1,092) | (1,435) | (365) | (3,637) | (4,002) | |
| Other expenses | 4 | (355) | - | (355) | (350) | - | (350) | |
| Net return before finance | ||||||||
| costs and taxation | 9,085 | 7,140 | 16,225 | 9,356 | 10,237 | 19,593 | ||
| Finance costs | 5 | (560) | (1,647) | (2,207) | (560) | (1,645) | (2,205) | |
| Return on ordinary activities | ||||||||
| before taxation | 8,525 | 5,493 | 14,018 | 8,796 | 8,592 | 17,388 | ||
| Tax on ordinary activities | 6 | (139) | - | (139) | (137) | - | (137) | |
| Net return on ordinary activities after taxation for the financial year | 8,386 | 5,493 | 13,879 | 8,659 | 8,592 | 17,251 | ||
| Return per ordinary share | ||||||||
| Basic | 8 | 62.0p | 40.7p | 102.7p | 64.1p | 63.5p | 127.6p | |
The total column of this statement represents the Company's profit and loss account, prepared in accordance with the accounting policies detailed in note 1 to the financial statements. The return on ordinary activities after taxation is the total comprehensive income and therefore no additional statement of comprehensive income is presented. The supplementary revenue and capital columns are presented for information purposes 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. No operations were acquired or discontinued in the year./p>
RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' FUNDS
FOR THE YEAR ENDED 30 SEPTEMBER
| CALLED UP SHARE CAPITAL £'000 | SHARE PREMIUM £'000 | CAPITAL REDEMPTION RESERVE £'000 | CAPITAL RESERVE £'000 | REVENUE RESERVE £'000 | TOTAL £'000 | |
| Balance at 30 September 2014 | 6,760 | 3,449 | 466 | 229,558 | 10,034 | 250,267 |
| Dividends paid - note 7 | - | - | - | - | (7,893) | (7,893) |
| Net return on ordinary activities | - | - | - | 8,592 | 8,659 | 17,251 |
| Balance at 30 September 2015 | 6,760 | 3,449 | 466 | 238,150 | 10,800 | 259,625 |
| Dividends paid - note 7 | - | - | - | - | (8,557) | (8,557) |
| Net return on ordinary activities | - | - | - | 5,493 | 8,386 | 13,879 |
| Balance at 30 September 2016 | 6,760 | 3,449 | 466 | 243,643 | 10,629 | 264,947 |
The accompanying notes are an integral part of these statements.
BALANCE SHEET
| AT 30 SEPTEMBER | |||
NOTES | 2016 £'000 | 2015 £'000 | |
| Fixed assets | |||
| Investments held at fair value through profit or loss | 9 | 281,835 | 275,790 |
| Current assets | |||
| Debtors | 10 | 724 | 642 |
| Cash and cash equivalents | 15,597 | 20,398 | |
| 16,321 | 21,040 | ||
| Creditors: amounts falling due within one year | 11 | (1,237) | (5,263) |
| Net current assets | 15,084 | 15,777 | |
| Total assets less current liabilities | 296,919 | 291,567 | |
| Creditors: amounts falling due after more than one year | 12 | (31,972) | (31,942) |
| Net assets | 264,947 | 259,625 | |
| Capital and reserves | |||
| Called up share capital | 13 | 6,760 | 6,760 |
| Share premium | 14 | 3,449 | 3,449 |
| Capital redemption reserve | 14 | 466 | 466 |
| Capital reserve | 14 | 243,643 | 238,150 |
| Revenue reserve | 14 | 10,629 | 10,800 |
| Shareholders' funds | 264,947 | 259,625 | |
| Net asset value per ordinary share | |||
| Basic | 15 | 1959.8p | 1920.5p |
The financial statements, on pages 32 to 49, were approved and authorised for issue by the Board of Directors on 29 November 2016.
Signed on behalf of the Board of Directors
Beatrice Hollond
Chairman
The accompanying notes are an integral part of this statement.
| CASH FLOW STATEMENT FOR THE YEAR ENDED 30 SEPTEMBER | |||
NOTES | 2016 £'000 | 2015 £'000 | |
| Cash flow from operating activities | |||
| Net return before finance costs and taxation | 16,225 | 19,593 | |
| Adjustments for: | |||
| Purchase of investments | (44,117) | (31,314) | |
| Sale of investments | 44,503 | 36,840 | |
| 386 | 5,526 | ||
| Scrip dividends | (39) | (237) | |
| Gains on investments | (8,155) | (13,884) | |
| Operating cash flows before movements in working capital | 8,417 | 10,998 | |
| Decrease in debtors | 133 | 456 | |
| (Decrease)/increase in creditors | (2,477) | 1,574 | |
| Tax on overseas income | 6 | (139) | (137) |
| Net cash inflow from operating activities | 5,934 | 12,891 | |
| Cash flow from financing activities | |||
| Interest paid on debenture stocks | (2,166) | (2,166) | |
| Preference dividends paid | (12) | (12) | |
| Net equity dividends paid | 7 | (8,557) | (7,893) |
| Net cash outflow from financing activities | (10,735) | (10,071) | |
| Net (decrease)/increase in cash and cash equivalents | (4,801) | 2,820 | |
| Cash and cash equivalents at the beginning of the year | 20,398 | 17,578 | |
| Cash and cash equivalents at the end of the year | 15,597 | 20,398 | |
| Reconciliation of cash and cash equivalents to the Balance Sheet is as follows: | |||
| Cash at custodian | 267 | 3,215 | |
| Short-Term Investment Company (Global Series) plc, money market fund | 15,330 | 17,183 | |
Cash and cash equivalents | 15,597 | 20,398 | |
| Cash flow from operating activities includes: | |||
| Interest received | 12 | 16 | |
| Dividends received | 9,479 | 9,871 |
NOTES TO THE FINANCIAL STATEMENTS
1. 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.
A summary of the principal accounting policies adopted by the Company is set out below.
(a) Basis of Preparation
(i) Accounting Standards applied
The financial statements have been prepared in accordance with applicable United Kingdom Accounting Standards and applicable law (UK Generally Accepted Accounting Practice (UK GAAP)) and with the Statement of Recommended Practice Financial Statements of Investment Trust Companies and Venture Capital Trusts, issued by the Association of Investment Companies in November 2014 (SORP). Accordingly, FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland applies to and has been applied for the first time. The financial statements are issued on a going concern basis.
As a result of the first time adoption of FRS 102 and the revised SORP, comparative figures and presentation have been revised where required. The net return attributable to ordinary shareholders and shareholders' funds remain unchanged. The accounting policies applied to these financial statements are consistent with those applied for the year ended 30 September 2015, apart from a revision to cash which is now defined as cash and cash equivalents. Note 1(d) sets out the accounting policy for cash and cash equivalents. No other accounting policies have changed as a result of the application of FRS 102, amendments to FRS 102 (see below) and the revised SORP.
Amendments to FRS 102 - Fair value hierarchy disclosures (March 2016) amends paragraphs 34.22 and 34.42 of FRS 102, revising the disclosure requirements for financial instruments held at fair value to align these with the disclosure requirements of EU-adopted IFRS. These amendments become effective for accounting periods beginning on or after 1 January 2017. The Company has chosen to early adopt these paragraphs. There are no accounting policy or disclosure changes as a result of this adoption.
(ii) 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 share capital and expenses, as well as a majority of its assets and liabilities, are denominated.
(b) 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 rights 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 and measurement 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 a documented investment strategy, and this is also the basis on which investment information 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 as part of gains and losses on investments in the income statement, and are subsequently valued at fair value.
Fair value for investments that are actively traded in organised financial markets 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. Where there is no active market, unlisted/illiquid investments are valued by the Directors at fair value based on recommendations from Invesco's Pricing Committee, which in turn is guided by the International Private Equity and Venture Capital Valuation Guidelines issued in 2012, using valuation techniques such as earnings multiples, recent arm's length transactions and net assets.
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.
(c) Accounting for Capital Reserves
Realised gains and losses on sales of investments (note 9(b)); realised gains or losses on forward currency contracts; realised gains and losses on foreign currency; management fees and finance costs allocated to capital; and any other capital charges, are included in the income statement and dealt with in the capital reserve. Unrealised increases and decreases in the valuation of investments at the year end (including the related foreign exchange gains and losses) are also included in the income statement and dealt with in the capital reserve.
(d) 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. Investments are regarded as cash equivalents if they meet all of the following criteria: highly liquid investments held in the Company's base currency that are readily convertible to a known amount of cash, are subject to an insignificant risk of change in value and provide a return no greater than the rate of a three-month high quality government bond.
(e) Income
Dividend income arises from equity investments held and is recognised on the date investments are marked 'ex-dividend'. Where the Company elects to receive dividends in the form of additional shares rather than cash, the equivalent to the cash dividend is recognised as income in the revenue account and any excess in the value of the shares received over the amount of the cash dividend is recognised in capital reserve. Special dividends are taken to income unless they arise from a return of capital, when they are allocated to capital in the income statement. Interest income arising from fixed income securities and cash is recognised in the income statement using the effective interest method. Deposit interest and underwriting commission receivable are taken into account on an accruals basis.
(f) Management and Performance-related fees
Investment management fees are recognised on an accruals basis and are charged 75% to capital and 25% to revenue. This is in line with the Board's expected long-term split of returns, in the form of capital gains and income respectively, from the investment portfolio of the Company.
Performance-related fees are calculated as detailed in the Directors' Report and are charged wholly to capital as they arise mainly from capital returns on the investment portfolio.
(g) Expenses and Finance costs
Expenses are recognised on an accruals basis and finance costs are recognised using the effective interest method, with the debentures being held at amortised cost. The finance costs of debt are allocated 75% to capital and 25% to revenue for the reasons outlined in (f) above. The 5% cumulative preference shares are classified as a liability and therefore the dividends payable on these shares are classified as finance costs and charged to revenue in the income statement.
(h) Hedging
Forward currency contracts entered into for hedging purposes are valued at the appropriate forward exchange rate ruling at the balance sheet date. Profits or losses on the closure or revaluation of positions are included in capital.
(i) Foreign Currency Translation
Transactions in foreign currency, whether of a revenue or capital nature, are translated to Sterling at the rates of exchange ruling on the dates of such transactions. Foreign currency assets and liabilities are translated to Sterling at the rates of exchange ruling at the balance sheet date. Any gains or losses, whether realised or unrealised, are taken to capital or to revenue, depending on whether the gain or loss is of a capital or revenue nature. All gains and losses are recognised in the income statement.
(j) Taxation
Foreign dividends that suffer withholding tax at source are shown gross, with the corresponding tax charge in the income statement.
Deferred taxation is provided using the liability method on all timing differences to the extent that they are expected to reverse in the future without being replaced, calculated at the rate at which it is anticipated the timing differences will reverse.
(k) Dividends Payable
Dividends are not recognised in the financial statements unless there is an obligation to pay at the balance sheet date.
2. Income
This note shows the income generated from the portfolio (investment assets) of the Company and income received from any other source.
| 2016 £'000 | 2015 £'000 | |
| Income from investments | ||
| UK dividends | ||
| -Ordinary dividends | 7,055 | 6,443 |
| -Special dividends | 305 | 1,124 |
| Overseas dividends | ||
| -Ordinary dividends | 1,725 | 1,609 |
| -Special dividends | 416 | 547 |
| Scrip dividends | 39 | 237 |
| Unfranked investment income | 207 | 95 |
| 9,747 | 10,055 | |
| Other income | ||
| Deposit interest | 12 | 16 |
| Other | 24 | - |
| 36 | 16 | |
| Total income | 9,783 | 10,071 |
Special dividends of £88,000 (2015: £nil) have been recognised in capital.
3. Investment Management and Performance-related Fees
This note shows the fees paid to the Manager. These are made up of the management fee payable quarterly and a performance-related fee calculated annually. The latter is only payable when the portfolio outperforms the benchmark index plus its hurdle, which is +1.25% per annum.
| 2016 | 2015 | ||||||
| Revenue £'000 | Capital £'000 | Total £'000 | Revenue £'000 | Capita £'000 | Total £'000 | ||
| Investment management fee | 343 | 1,027 | 1,370 | 365 | 1,093 | 1,458 | |
| Performance-related fee | - | 65 | 65 | - | 2,544 | 2,544 | |
| 343 | 1,092 | 1,435 | 365 | 3,637 | 4,002 | ||
Details of the management agreement are disclosed in the Directors' Report.
The performance-related fee is due if the Company's annualised total return over the previous three years is greater than the annualised return of the FTSE All-Share (Total Return) Index over the same period, plus the hurdle.
At 30 September 2016, an investment management fee of £354,000 (2015: £359,000) has been accrued in respect of the three months to 30 September 2016. In addition a performance-related fee of £65,000 (2015: £2,544,000) has been accrued for the year.
4. Other Expenses
The other expenses of the Company are presented below.
| 2016 £'000 | 2015 £'000 | |
| Directors' fees | 111 | 110 |
| Fees payable to the Company's auditor in relation to: | ||
| -the statutory audit of the financial statements | 26 | 25 |
| Other expenses | 218 | 215 |
| 355 | 350 |
The Directors' Remuneration Report provides further information on Directors' fees.
Fees payable to the Company's auditor are shown excluding VAT which is included in other expenses.
Other expenses includes £6,000 (2015: £6,000) of employer's National Insurance paid on Directors' fees. As at 30 September 2016, the amount outstanding on Directors' fees and employer's National Insurance was £6,900 (2015: £6,400).
5. Finance Costs
Finance costs arise on any borrowing that the Company has, with the main borrowing being the £32 million of Debenture stocks (see note 12).
| 2016 | 2015 | ||||||
| Revenue £'000 | Capital £'000 | Total £'000 | Revenue £'000 | Capital £'000 | Total £'000 | ||
| Interest payable on borrowings | |||||||
| repayable not by instalment: | |||||||
| Debenture stock repayable | |||||||
| after 5 years | 548 | 1,647 | 2,195 | 548 | 1,645 | 2,193 | |
| 548 | 1,647 | 2,195 | 548 | 1,645 | 2,193 | ||
| Dividends on 5% cumulative | |||||||
| preference shares | 12 | - | 12 | 12 | - | 12 | |
| 560 | 1,647 | 2,207 | 560 | 1,645 | 2,205 | ||
6. Tax on ordinary activities
As an investment trust, the Company pays no tax on capital gains and as the Company principally invests in UK assets, it has little overseas tax. This note shows details of the tax charge and why no deferred tax is required to provide for tax that is expected to arise in the future due to differences in accounting and tax bases.
(a) Current Tax Charge
| 2016 REVENUE £'000 | 2015 REVENUE £'000 | |
| Overseas tax | 139 | 137 |
(b) Reconciliation of Current Tax Charge
| 2016 £'000 | 2015 £'000 | |
| Total return on ordinary activities before taxation | 14,018 | 17,388 |
| UK Corporation Tax effective rate of 20% (2015: 20.50%) | 2,804 | 3,565 |
| Effect of: | ||
| -Gains on investments | (1,631) | (2,846) |
| -Loss on foreign exchange movements | 2 | 2 |
| -UK dividends which are not taxable | (1,415) | (1,494) |
| -Non-taxable overseas dividends | (415) | (430) |
| -Overseas tax | 139 | 137 |
| -Non-taxable scrip dividends | (8) | (49) |
| -Disallowed expenses | 3 | 4 |
| -Excess of management expenses over taxable income | 660 | 1,248 |
| Current tax charge for the year | 139 | 137 |
(c) Factors that may Affect Future Tax Changes
The Company has excess expenses of £68,676,000 (2015: £65,378,000) that are available to offset future taxable revenue. A deferred tax asset, of £11,675,000 measured at the standard corporation tax rate of 17% (2015: £13,076,000 at 20%), has not been recognised in respect of these expenses since the Directors believe that there will be no taxable profits in the future against which the deferred tax asset can be offset.
7. Dividends
Dividends represent the return of income less expenses to shareholders. Dividends are paid as an amount per ordinary share held.
| 2016 £'000 | 2015 £'000 | |
| Dividends on equity shares paid and recognised in the year: | ||
| Second interim dividend for 2015 of 33p (2014: 32.5p) | 4,461 | 4,394 |
| Special dividend for 2015 of 12.3p (2014: 8p) | 1,663 | 1,082 |
| First interim dividend for 2016 of 18p (2015: 18p) | 2,433 | 2,433 |
| 8,557 | 7,909 | |
| Return of unclaimed dividends from previous years | - | (16) |
| 8,557 | 7,893 | |
| 2016 | 2015 | |
| £'000 | £'000 | |
| Dividends on equity shares payable in respect of the year: | ||
| First interim paid 18p per ordinary share (2015: 18p) | 2,433 | 2,433 |
| Second interim dividend of 35p per ordinary share (2015: 33p) | 4,732 | 4,461 |
| 7,165 | 6,894 | |
| Special dividend of 5.3p per ordinary share (2015: 12.3p) | 716 | 1,663 |
| 7,881 | 8,557 |
Investment trusts must ensure that no more than 15% of total income is retained each year after providing for dividends payable.
8. Return per Ordinary Share
Basic return per share is the amount of gain (or loss) generated for the financial year divided by the number of ordinary shares in issue. The calculation is based on the weighted average number of shares in issue during the year.
Basic revenue, capital and total return per ordinary share is based on each of the returns on ordinary activities after taxation and on 13,518,799 (2015: 13,518,799) shares being the weighted average number of ordinary shares in issue throughout the year.
9. Investments
The portfolio is made up primarily of investments which are listed, i.e. traded on a regulated stock exchange, and some unlisted investments. Gains and losses are either:
- realised, usually arising when investments are sold; or
- unrealised, being the difference from cost on those investments still held at the year end.
(a) Analysis of Investments by Listing Status
| 2016 £'000 | 2015 £'000 | |
| Investments listed on a recognised stock exchange | 273,462 | 267,119 |
| Unlisted investments | 8,373 | 8,671 |
| 281,835 | 275,790 |
(b) Analysis of Investment Gains and Losses
| 2016 | 2015 | ||||
| Listed £'000 | Unlisted £'000 | Total £'000 | Total £'000 | ||
| Opening book cost | 192,245 | 8,573 | 200,818 | 193,801 | |
| Opening investment holding gains | 74,874 | 98 | 74,972 | 70,198 | |
| Opening valuation | 267,119 | 8,671 | 275,790 | 263,999 | |
| Movements in year: | |||||
| Purchases at cost | 42,608 | - | 42,608 | 33,118 | |
| Sales - proceeds | (44,718) | - | (44,718) | (35,211) | |
| Sales - net realised gains | 16,409 | - | 16,409 | 9,110 | |
| Bookcost written off | - | (1,523) | (1,523) | - | |
| Movement in investment holding gains | (7,956) | 1,225 | (6,731) | 4,774 | |
| Closing valuation | 273,462 | 8,373 | 281,835 | 275,790 | |
| Closing book cost | 206,544 | 7,050 | 213,594 | 200,818 | |
| Closing investment holding gains | 66,918 | 1,323 | 68,241 | 74,972 | |
| Closing valuation | 273,462 | 8,373 | 281,835 | 275,790 | |
| Net realised gains/(losses) based on historical cost | 16,409 | (1,523) | 14,886 | 9,110 | |
| Movement in investment holding gains in year | (7,956) | 1,225 | (6,731) | 4,774 | |
| Gains/(losses) on investments | 8,453 | (298) | 8,155 | 13,884 | |
(c) Transaction Costs
Transaction costs on purchases of £171,000 (2015: £129,000) and on sales of £57,000 (2015: £53,000) are included within gains and losses on investments in the income statement.
10. Debtors
Debtors are amounts which are due to the Company, such as income which has been earned (accrued) but not yet received and monies receivable from brokers for investments sold.
| 2016 £'000 | 2015 £'000 | |
| Amounts due from brokers | 215 | - |
| Prepayments and accrued income | 281 | 341 |
| Overseas withholding tax recoverable | 186 | 282 |
| Income tax recoverable | 42 | 19 |
| 724 | 642 |
11. Creditors: amounts falling due within one year
Creditors 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.
| 2016 £'000 | 2015 £'000 | |
| Amounts due to brokers | 19 | 1,567 |
| Accruals | 1,153 | 1,152 |
| Performance-related fee | 65 | 2,544 |
| 1,237 | 5,263 |
Details of the performance-related fee are given in note 3.
12. Creditors: amounts falling due after more than one year
Long term creditors consist of £32 million of debentures and a small issue of preference shares. These form the principal borrowings of the Company and the fixed interest that the Company pays is reported under note 5 'Finance Costs'.
| 2016 £'000 | 2015 £'000 | |
| Debenture Stock: | ||
| 7.75% redeemable 1 October 2020 | 7,000 | 7,000 |
| 6.5% redeemable 27 April 2023 | 24,968 | 24,968 |
| 31,968 | 31,968 | |
| Discount and issue expenses on debenture stock | (246) | (276) |
| 31,722 | 31,692 | |
| 5% cumulative preference shares of £1 each | 250 | 250 |
| 31,972 | 31,942 |
The debentures rank pari passu with each other, and ahead of shareholders, and are secured by floating charge over the assets of the Company.
The debenture stocks both pay interest twice a year; the 7.75% Debenture Stock 2020 for the six months ended 31 March and 30 September, and the 6.5% Debenture Stock 2023 for the six months to 27 April and 27 October. Both debenture stocks generally make the payments in April and October. The preference shares dividend is paid bi-annually in March and September.
13. Called up share capital
Ordinary share capital represents the total number of shares in issue, for which dividends accrue.
| 2016 | 2015 | |||
| NUMBER | £'000 | NUMBER | £'000 | |
| Allotted, called-up and fully paid: | ||||
| Ordinary shares of 50p each | 13,518,799 | 6,760 | 13,518,799 | 6,760 |
The ordinary shares are fully participating and on a poll carry one vote per £1 nominal held.
No shares were issued or bought back during the year (2015: nil).
14. Reserves
This note explains the different reserves that have arisen over the years. The aggregate of the reserves and share capital (see previous note) make up total shareholders' funds.
The share premium comprises the net proceeds received by the Company following the issue of shares, after deduction of the nominal amount of 50 pence and any applicable issue costs. The capital redemption reserve maintains the equity share capital arising from the buy back and cancellation of shares; it, and the share premium, are non-distributable.
The capital reserve includes the investment holding gains/(losses), being the difference between cost and market value at the balance sheet date, totalling a gain of £68,241,000 (2015: £74,972,000). It also includes cumulative realised gains/(losses).
Capital investment gains and losses are shown in note 9(b) and form part of the capital reserve. The revenue reserve shows the net revenue retained after payment of dividends. The revenue and capital reserves are distributable by way of dividend. Share buy backs can be funded from the capital reserve.
15. 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 share by dividing by the number of shares in issue.
The net asset value per ordinary share and the net assets attributable at the year end were as follows:
| NET ASSET VALUE PER SHARE | NET ASSETS ATTRIBUTABLE | |||
| 2016 | 2015 | 2016 | 2015 | |
| PENCE | PENCE | £'000 | £'000 | |
| Ordinary shares | ||||
| - Basic | 1959.8 | 1920.5 | 264,947 | 259,625 |
Net asset value per ordinary share is based on net assets at the year end and on 13,518,799 (2015: 13,518,799) ordinary shares, being the number of ordinary shares in issue at the year end.
16. Financial Instruments
Financial instruments comprise the Company's investment portfolio as well as its cash, borrowings, debtors and creditors. Derivative financial instruments are financial instruments that are used to manage the risk associated with fluctuations in the value of certain assets and liabilities. In accordance with Board approved policies, the Company can use derivatives to manage its exposure to fluctuations in foreign exchange rates.
The Company's financial instruments comprise its investment portfolio (as shown on pages 14 and 15), derivatives, cash, borrowings, debtors and creditors that arise directly from its operations such as sales and purchases awaiting settlement and accrued income. The accounting policies in note 1 include criteria for the recognition and the basis of measurement applied for financial instruments. Note 1 also includes the basis on which income and expenses arising from financial assets and liabilities are recognised and measured. The Company did not have any exposure to derivatives during the year (2015: none).
The principal risks that an investment company faces in its portfolio management activities are set out below:
Market risk - arising from fluctuations in the fair value or future cash flows of a financial instrument because of changes in market prices. Market risk comprises three types of risk: currency risk, interest rate risk and other price risk:
Currency risk - arising from fluctuations in the fair value or future cash flows of a financial instrument because of changes in foreign exchange rates;
Interest rate risk - arising from fluctuations in the fair value or future cash flows of a financial instrument because of changes in market interest rates; and
Other price risk - arising from fluctuations in the fair value or future cash flows of a financial instrument for reasons other than changes in foreign exchange rates or market interest rates.
Liquidity risk - arising from any difficulty in meeting obligations associated with financial liabilities.
Credit risk - arising from financial loss for a company where the other party to a financial instrument fails to discharge an obligation.
Risk Management Policies and Procedures
The Directors have delegated to the Manager the responsibility for the day-to-day investment activities of the Company as more fully described in the Directors' Report.
An investment company invests in equities and other investments for the long term so as to meet its investment objective and policies. In pursuing its investment objective, 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 of the profits available for distribution by way of dividends.
The risks applicable to the Company and the policies the Company used to manage these risks for the two years under review follow.
Market risk
The Company's Manager assesses the Company's exposure when making each investment decision, and monitors the overall level of market risk on the whole of the investment portfolio on an ongoing basis. The Board meets at least quarterly to assess risk and review investment performance, as disclosed on page 52. No derivatives or hedging instruments are utilised to manage market risk. Borrowings are used to enhance returns, however, this increases the Company's exposure to market risk and volatility.
Currency risk
The majority of the Company's assets, liabilities and income are denominated in Sterling. There is some exposure to US dollars and Swiss francs.
Management of the currency risk
The Manager monitors the Company's exposure to foreign currencies daily and reports to the Board on a regular basis.
Forward currency contracts can be used to limit the Company's exposure to anticipated future changes in exchange rates which are also used to achieve the portfolio characteristics that assist the Company in meeting its investment objective and policies. All 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 had currency exposure at 30 September are shown below. Where the Company's equity investments (which are not monetary items) are priced in a foreign currency, they have been included separately in the analysis so as to show the overall level of exposure.
| 30 SEPTEMBER 2016 | 30 SEPTEMBER 2015 | |||
| US DOLLAR | SWISS FRANC | US DOLLAR | SWISS FRANC | |
| £'000 | £'000 | £'000 | £'000 | |
| Debtors (due from brokers, dividends) | 125 | 186 | 107 | 84 |
| Foreign currency exposure on net monetary | ||||
| items | 125 | 186 | 107 | 84 |
| Investments at fair value through profit or loss | ||||
| that are equities | 15,981 | 14,369 | 19,255 | 12,301 |
| Total net foreign currency exposure | 16,106 | 14,555 | 19,362 | 12,385 |
The above amounts may not be representative of the exposure to risk during the year, because the levels of foreign currency exposure may change significantly throughout each year.
Currency sensitivity
The table below illustrates the sensitivity of net assets and of net return after taxation for the year using the exchange rates shown below. It is based on the Company's monetary foreign currency financial instruments held at each balance sheet date and takes account of forward foreign exchange contracts that offset the effects of changes in currency exchange rate.
| 2016 | 2015 | |
| £/US dollar | 5.4% | 2.2% |
| £/Swiss franc | 6.1% | 3.5% |
The above percentages have been determined based on the market volatility in the year, using the standard deviation of Sterling's daily fluctuation to the US dollar and Swiss franc against the mean during the year.
If Sterling were to weaken against the US dollar and Swiss franc to this extent, this would have the following effect:
| 30 September 2016 | 30 September 2015 | |||
| US DOLLAR £'000 | SWISS FRANC £'000 | US DOLLAR £'000 | SWISS FRANC £'000 | |
| Income statement - return after taxation | ||||
| Revenue return | 27 | 35 | 11 | 18 |
| Capital return | 863 | 877 | 424 | 431 |
| Total return after taxation for the year | 890 | 912 | 435 | 449 |
| Effect on net asset value | 0.3% | 0.3% | 0.2% | 0.2% |
If Sterling were to strengthen against the US dollar and Swiss franc to this extent, the effect would be the exact opposite.
In the opinion of the Directors, the above sensitivity analysis is not representative of the year as a whole, since the level of exposure may change frequently as part of the currency risk management process of the Company.
Interest rate risk
Interest rate movements may affect the level of income receivable on cash deposits and the interest payable on the variable rate borrowings. When the Company has cash balances, they are held on variable rate bank accounts yielding rates of interest dependent on the base rate of the custodian. The Company has an uncommitted bank overdraft facility which it uses for settlement purposes, on which interest is payable at a variable rate. Use of this facility has been minimal over the two years being reported on. At the year end there was none drawn down (2015: nil).
At the balance sheet date the Company had structural debt comprising £32 million of debenture stocks and £250,000 of 5% cumulative preference shares. The interest rates on the debenture stocks and preference shares are fixed and details are shown in notes 5 and 12.
The Company's portfolio is substantially invested in equities which are not directly exposed to interest rate risk.
Other price risk
Other price risk (i.e. changes in market prices other than those arising from interest rate risk or currency risk) may affect the value of the equity investments, and it is the business of the Manager to manage the portfolio to achieve the best returns.
Management of other price risk
The Directors manage the market price risks inherent in the investment portfolio by meeting regularly to monitor on a formal basis the Manager's compliance with the Company's stated objectives and policies and to review investment performance.
The Company's portfolio is the result of the Manager's investment process and as a result is not correlated with the Company's benchmark or the market in which the Company invests. The value of the portfolio will not move in line with the market but will move as a result of the performance of the company shares within the portfolio.
Based on the equity portfolio value of £281,835,000 (2015: £275,790,000), if the value of the portfolio rose or fell by 1% at the balance sheet date, the net return after tax for the year and net assets would increase or decrease by £2.82 million (2015: £2.76 million) respectively; in calculating these amounts no adjustment has been made for other variables including management fees.
Liquidity risk
Liquidity risk is minimised as the majority of the Company's investments are readily realisable securities which can be sold to meet funding commitments if necessary. In addition, the bank overdraft facility provides for additional funding flexibility. No special arrangements have been made in connection with the liquidity of any of the Company's assets.
Liquidity risk exposure
The contractual maturities of the financial liabilities at the year end, based on the earliest date on which payment can be required, are as follows:
| 2016 | 2015 | ||||||||
| LESS THAN THREE MONTHS £'000 | THREE TO TWELVE MONTHS £'000 | MORE THAN ONE YEAR £'000 | TOTAL £'000 | LESS THAN THREE MONTHS £'000 | THREE TO TWELVE MONTHS £'000 | MORE THAN ONE YEAR £'000 | TOTAL £'000 | ||
| Debenture stocks | - | - | 31,968 | 31,968 | - | - | 31,968 | 31,968 | |
| Interest on debenture | |||||||||
| stocks | 811 | 1,354 | 11,366 | 13,531 | 811 | 1,354 | 13,531 | 15,696 | |
| Amounts due to | |||||||||
| brokers | 19 | - | - | 19 | 1,567 | - | - | 1,567 | |
| Other creditors | |||||||||
| and accruals | 450 | - | - | 450 | 449 | - | - | 449 | |
| Performance fee | |||||||||
| accrued | 65 | - | - | 65 | 2,544 | - | - | 2,544 | |
| 1,345 | 1,354 | 43,334 | 46,033 | 5,371 | 1,354 | 45,499 | 52,224 | ||
The 5% cumulative preference shares do not have a fixed repayment date and are, as a result, not shown in the above table. Details are shown in note 12 of the financial statements.
Credit risk
Credit risk encompasses the failure by counterparties to deliver securities which the Company has paid for, or to pay for securities which the Company has delivered. This risk is mitigated by using only approved and appropriately regulated counterparties. Cash balances are limited to a maximum of either £10 or £15 million with any one deposit taker and 10% of gross assets for holdings in the Short-Term Investments Company (Global Series) plc, which invests in high quality sterling denominated money market investments such as commercial paper, certificates of deposit, time deposits and asset-backed commercial paper. Only deposit takers approved by the Board are used.
The portfolio may be adversely affected if the custodian of the Company's assets suffers insolvency or other financial difficulties. The risk associated with failure of the custodian is mitigated by the appointment in 2014 of a depositary. The depositary is ultimately responsible for safekeeping of the Company's assets and is strictly liable for the recovery of financial instruments in the event of loss. As part of the Board's risk management and control monitoring, the Board reviews the custodian's annual control report and the Manager's management of the relationship with the custodian.
Fair Values of Financial Assets and Financial Liabilities
The fair values of the financial assets and financial liabilities, other than debentures and preference shares, are either carried in the balance sheet at their fair value (investments), or the balance sheet amount is a reasonable approximation of fair value (due from brokers, dividends receivable, accrued income, due to brokers, accruals, cash at bank and overdraft). The book cost and fair value of the debentures and the preference shares based on the offer value at the balance sheet date follow.
| BOOK VALUE 2016 | FAIR VALUE 2016 | BOOK VALUE 2015 | FAIR VALUE 2015 | |
| £'000 | £'000 | £'000 | £'000 | |
| Debentures payable in less than 5 years: | ||||
| 7.75% Debenture Stock 2020 | 7,000 | 8,444 | 7,000 | 8,505 |
| Debentures repayable in more than 5 years: | ||||
| 6.5% Debenture Stock 2023 | 24,968 | 32,071 | 24,968 | 30,445 |
| Discount on issue of debentures | ( 246) | - | (276) | - |
| 31,722 | 40,515 | 31,692 | 38,950 | |
| 5% Cumulative preference shares of £1 each | 250 | 233 | 250 | 213 |
| 31,972 | 40,748 | 31,942 | 39,163 |
Fair Value Hierarchy Disclosures
Nearly all of the Company's portfolio of investments are in the Level 1 category as defined in FRS 102 as amended for fair value hierarchy disclosures (March 2016). The three levels set out in FRS102 follow:
Level 1-The unadjusted quoted price in an active market for identical assets or liabilities that the entity can access at the measurement date.
Level 2-Inputs other than quoted prices included within Level 1 that are observable (ie developed using market data) for the asset or liability, either directly or indirectly.
Level 3-Inputs are unobservable (ie for which market data is unavailable) for the asset or liability.
Categorisation within the hierarchy is determined on the basis of the lowest level input that is significant to the fair value measurement of each relevant asset/liability. The valuation techniques used by the Company are explained in the accounting policies note.
| 2016 | 2015 | ||||||||
| LEVEL 1 £'000 | LEVEL 2 £'000 | LEVEL 3 £'000 | TOTAL £'000 | LEVEL 1 £'000 | LEVEL 2 £'000 | LEVEL 3 £'000 | TOTAL £'000 | ||
| Financial assets | |||||||||
| designated at fair | |||||||||
| value through | |||||||||
| profit or loss: | |||||||||
| Quoted investments: | |||||||||
| Equities | 273,458 | - | - | 273,458 | 266,974 | - | - | 266,974 | |
| Other securities | - | 4 | - | 4 | - | 145 | - | 145 | |
| Unquoted investments: | |||||||||
| Equities | - | - | 8,373 | 8,373 | - | - | 8,671 | 8,671 | |
| Total for financial | |||||||||
| assets | 273,458 | 4 | 8,373 | 281,835 | 266,974 | 145 | 8,671 | 275,790 | |
A reconciliation of the fair value movements in Level 3 is set out below:
| 2016 £'000 | 2015 £'000 | |
| Opening fair value of Level 3 | 8,671 | 8,837 |
| Purchases at cost | - | 2,700 |
| Movement in holding gains on assets held at the year end | (298) | (2,866) |
| Closing fair value of Level 3 | 8,373 | 8,671 |
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 Company's total capital employed at 30 September 2016 was £296,919,000 (2015: £291,567,000) comprising borrowings of £31,972,000 (2015: £31,942,000) and equity share capital and other reserves of £264,947,000 (2015: £259,625,000).
The Company's total capital employed is managed to achieve the Company's investment objective and policy as set out on page 6, including that borrowings may be used to raise equity exposure. At the balance sheet date, net gearing was 6.2% (2015: 4.4%). The Company's policies and processes for managing capital are unchanged from the preceding year.
The main risks to the Company's investments are shown in the Strategic Report under the 'Principal Risks and Uncertainties' section on pages 8 to 10. These also explain that the Company is able to gear and that 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 obligation and ability to pay dividends by section 1159 Corporation Tax Act 2010 and by the Companies Act 2006, respectively, and with respect to the availability of the overdraft facility, by the terms imposed by the custodian. The Board regularly monitors, and has complied with, the externally imposed capital requirements. This is unchanged from the prior year.
Borrowings comprise debenture stocks and preference shares, details of which are contained in note 12.
17. Contingencies, Guarantees and Financial Commitments
Contingencies or guarantees that the Company will or has given would be disclosed in this note if any existed. Likewise any commitments, being those amounts that the Company is contractually required to pay in the future as long as the other party meets their obligations.
There were no contingencies, guarantees or other financial commitments of the Company at the year end (2015: £nil).
18. Related Party Transactions and Transactions with the Manager
A related party is a company or individual who has direct or indirect control or influence over the Company. Under accounting standards, the Manager is not a related party.
Under UK GAAP, the Company has identified the Directors as related parties. The Directors' emoluments and interests have been disclosed on pages 23 to 24 with additional disclosure in note 4. No other related parties have been identified.
Details of the Manager's services and fees are disclosed in the Directors' Report on page 53 and 54, and in note 3.
19. Post Balance Sheet Events
Any significant events that occurred after the Company's financial year end but before the signing of the Balance Sheet will be shown here.
There are no significant events after the end of the reporting period requiring disclosure.
.
The financial information set out above does not constitute the Company's statutory accounts for the year ended 30 September 2016. The financial information for the year ended 30 September 2015 is derived from the statutory accounts for 2015, which have been delivered to the Registrar of Companies. The 2015 accounts were audited and the audit report was unqualified, did not include a reference to any matters to which the auditor drew attention by way of emphasis without qualifying the report and did not contain a statement under section 498 of the Companies Act 2006. The statutory accounts for the year ended 30 September 2016 have been finalised and audited but have not yet been delivered to the Registrar of Companies.
The audited annual financial report will be available to shareholders shortly. Copies may be obtained during normal business hours from the Company's administration office, 6th Floor, 125 London Wall, London EC2Y 5AS and are available via the Company's section of the Manager's website at www.invescoperpetual.co.uk/keystone .
The Annual General Meeting will be held on 24 January 2017 at 11.00am at 43-45 Portman Square, London, W1H 6LY.
By order of the Board
Invesco Asset Management Limited
29 November 2016
Contact:
Paul Griggs 0203 753 1000
