Aberforth Smaller Companies Trust Plc Regulatory News (ASL)

Aberforth Smaller Companies Trust Plc - Final Results

PR Newswire

London, January 28

Aberforth Smaller Companies Trust plcAudited Annual Results for the year to 31 December 2021

The following is an extract from the Company's Annual Report and Financial Statements for the year to 31 December 2021. The Annual Report is expected to be posted to shareholders by 7 February 2022. Members of the public may obtain copies from Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its website: www.aberforth.co.uk. A copy will also shortly be available for inspection at the National Storage Mechanism at: https://data.fca.org.uk/#/nsm/nationalstoragemechanism.

FINANCIAL HIGHLIGHTS

INVESTMENT OBJECTIVE

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

CHAIRMAN’S STATEMENT TO SHAREHOLDERS

Review of performance

It is pleasing to report on a good year for performance in 2021, one that contrasts sharply with the difficulties of 2020. ASCoT’s net asset value total return was 32.5%. The share price total return was lower at 20.3%, which reflects the widening of the discount from 3.4% to 12.6% over the course of 2021.

ASCoT’s net asset value performance compared well with that of the investment benchmark. The total return of the Numis Smaller Companies Index (excluding Investment Companies) (NSCI (XIC)) was 21.9%. The share prices of large companies also rose, though to a lesser extent with the FTSE All-Share up by 18.3% in total return terms.

The contrast between 2020 and 2021 was due among other things to the arrival of the vaccines, which gave confidence to markets that the pandemic could be controlled without reliance on lockdowns. The on-going uncertainties pertaining to the Omicron variant show that the effects of the coronavirus linger and it continues to extract a regrettable toll in terms of lives lost. However, from the investment perspective, it does feel that the issue at hand is the pace of recovery rather than recovery itself. In this context, it is encouraging that the resilience shown by ASCoT’s investee companies in 2020 allowed them to benefit from the first stages of economic recovery in 2021. In turn, as the Managers’ Report describes in detail, profits and dividends are rebounding well. The improvement in trading conditions is convincing, though it is necessary to recognise the challenges from inflation and supply chain problems that became increasingly evident through the latter part of the year.

Dividends

The recovery in the profits of small UK quoted companies is amply demonstrated by ASCoT’s Income Statement. A large increase in investment income through 2021 was always likely, given how far it had declined in 2020, which was the worst year for UK dividend income in the post war period. However, the degree of the pick-up has been greater than the Board had previously expected. Some of this is due to two special dividends received by the Company during the year, but the heavy lifting was done by numerous investee companies returning promptly to pay dividends having passed them amid 2020’s lockdown. This outcome is to the credit of the resilience and stewardship of the companies in which ASCoT invests.

The growth in investment income fed through to a 177% increase in the revenue return per Ordinary Share to 36.76p, which has allowed the Board the flexibility to propose a final dividend of 24.25p per Ordinary Share. This, together with the interim dividend of 10.95 pence, would give a total dividend of 35.20p per Ordinary Share in respect of the year to 31 December 2021. Growth of 5.7% is consistent with the Board’s aim to increase dividends in real terms. Notably, the 35.20p total dividend is funded entirely from the year’s revenue return – there has been no need to use revenue reserves, which is a better outcome than I had envisaged when I wrote my interim update.

Inflation running at its current elevated rate may prove a more demanding hurdle for the Board’s progressive dividend policy if the investee companies struggle in the near term to pass on higher costs. However, the Board takes encouragement from ASCoT’s revenue reserves, which were 59.0p per Ordinary Share at 31 December 2021 assuming approval of the final dividend. Additionally, the Managers’ dividend estimates for the portfolio plot a path for ASCoT’s investment income to exceed 2019’s pre-pandemic levels over the next couple of years.

Gearing

Throughout ASCoT’s life, it has been the Board’s policy to deploy gearing in a tactical fashion. Decisions to gear are motivated by periods of stress in equity markets. The pandemic and lockdown in 2020 produced such an episode, which allowed ASCoT to gear for the fourth time in its 31 year history. The £130m debt facility to enable this is provided by The Royal Bank of Scotland International. It has a term running to June 2023, which is designed to align with the three-yearly continuation vote cycle.

Gearing, which is the ratio of net debt to Shareholders’ Funds, was 5.6% at 31 December 2021, down slightly from 6.1% at the start of the year. This reduction in gearing reflects the increase in share prices and therefore in Shareholders’ Funds through the year. Despite this recovery, the Board and Managers consider that continued use of the debt facility is appropriate. As the Managers’ Report explains, the portfolio’s companies continue to make sound progress, while valuations remain attractive.

Share buy-back

The Company seeks authority to buy back up to 14.99% of its Ordinary Shares at the Annual General Meeting. The authority was renewed in March 2021. In the year to 31 December 2021, 874,800 shares were bought back and cancelled. The total value of these repurchases was £12.9m, on an average discount of 11.2%.

The Board continues to believe that, at the margin, buy-backs provide an increase in liquidity for those Shareholders wishing to crystallise their investment and, at the same time, deliver an economic uplift for those Shareholders wishing to remain invested in the Company. Accordingly, the Board will be seeking to renew the buy-back authority at the Annual General Meeting on 3 March 2022.

Stewardship

In November, COP26 reinforced the increasing importance of environmental, social and governance issues for economies and financial markets. As part of its stewardship responsibilities, the Board regularly reviews the Managers’ approach to these issues, which is described in additional detail elsewhere in this annual report. The Board endorses the Managers’ stewardship policy, which is set out in their submission as a signatory to the UK Stewardship Code 2020. This, together with examples relating to voting and engagement with investee companies, can be found in the literature library of the Managers’ recently refreshed and updated website at www.aberforth.co.uk.

Board changes

The Board regularly reviews its composition and structure in line with corporate governance requirements. As part of the Board’s succession planning, Paula Hay-Plumb, who has been a Director for eight years, will not stand for re-election at the forthcoming Annual General Meeting. Paula has made a valuable contribution to the Board’s deliberations and we wish her well for the future.

A recruitment process for a new Director, being run by the Board, is well advanced.

Annual General Meeting (“AGM”)

The AGM will be held at 14 Melville Street, Edinburgh EH3 7NS at 2.30 pm on 3 March 2022. Details of the resolutions to be considered by Shareholders are set out in the Notice of the Meeting on page 56. Shareholders are encouraged to submit their vote by proxy in advance of the meeting in case restrictions related to the Covid-19 pandemic apply and it is therefore not possible for shareholders to attend in person. The Company will issue a regulatory news announcement, which will also be posted on the website, if the only attendees permitted will be those required to allow the business of the meeting to be conducted. The Board welcomes questions from Shareholders and invites them to be submitted by email to enquiries@aberforth.co.uk before the meeting, in case attendance is not allowed. Questions will be considered by the Board and responses provided. In light of these circumstances a brief update on performance and the portfolio will be available on the Managers' website following the meeting. In accordance with normal practice, the results of the AGM will be issued in a regulatory news announcement and also posted on the website.

Conclusion

The enduring fascination of financial markets is that they never cease to surprise. Had I been told at the start of 2021 that ten year government bond yields would finish the year still below their pre-pandemic levels, I would have concluded that nascent inflationary pressures had given way to the disinflationary conditions with which we have become familiar since the global financial crisis. And yet the year ended with inflation running at its highest rates for decades. The Managers’ Report explores this conundrum in more detail, but, with the rhetoric from the central banks evolving, it does appear likely that the coming year will bring some form of resolution.

The nature of the resolution will have important implications for the direction of equities as a whole, for the Managers’ value investment style and for ASCoT’s returns. I would note that financial markets ended 2021 in a familiar manner – bond yields were low and growth stocks had resumed leadership within equity markets. At the risk of being confounded again, I would venture to suggest that the burden of proof does not sit with the value investor.

The second order effects of the pandemic, in the form of inflation and supply chain challenges, threaten to hamper the profit recovery in 2022, but a year of progress nevertheless seems likely. Political developments in many parts of the world remain unpredictable and affect equity valuations. At home, it is remarkable how rapidly political uncertainty has re-emerged after the decisive general election result at the end of 2019. This has no doubt contributed to the valuation of UK equities remaining below their global peers. It is notable, however, that these valuations are attracting the attention of other companies and private equity as M&A activity recovers to levels last seen before the EU referendum.

While politics and economics will be important influences on ASCoT’s near term returns, the more important contribution over time is the fortunes of the investee companies. I am struck by how well these businesses have fared through the great challenges of the past two years. Their resilience is brought out in the Managers’ Report through analyses of balance sheet strength, good returns on equity and growing dividends. Such characteristics may be considered to sit oddly with a portfolio managed under a value investment philosophy. My interpretation is that this is another instance of the financial markets’ ability to surprise and highlights the opportunity for ASCoT’s shareholders

Finally, my fellow Directors and I very much welcome the views of Shareholders and are available to talk to you directly.

My email address is noted below.

Richard Davidson

Chairman

28 January 2022

richard.davidson@aberforth.co.uk

MANAGERS’ REPORT

Introduction

Equity markets performed well in 2021. In the UK, the total return of large companies, represented by the FTSE All-Share, was 18.3%. This was surpassed by the 21.9% return of the NSCI (XIC), which defines ASCoT’s investment universe of small UK quoted companies. The net asset value total return of ASCoT itself was 32.5%, while the share price total return was 20.3%.

Following the negative returns of 2020, these numbers depict a welcome reversal of fortunes for UK equity markets. However, it would be remiss to pass over the contrast between this improvement and the development of the pandemic – the world is likely to have seen more deaths associated with the coronavirus in 2021 than in 2020. The disparity between investment returns is explained by the remarkably rapid development of the vaccines, which were announced towards the end of 2020. These spurred a powerful rally in share prices and allowed equity markets to fulfil their function by discounting a future in which the pandemic can be controlled and economic activity can normalise. In due course, the rollout of the vaccines allowed demand to begin its recovery, boosted by high household savings, loose monetary policy and fiscal support. Corporate profits followed, thus starting to justify the rebound in share prices.

The economic recovery progressed more or less as hoped through 2021. Support measures, such as the UK’s Job Retention Scheme, have been gradually phased out without, as yet, a significant impact on activity. However, it is notable that share prices struggled through the second half of the year. This reflects uncertainties that stem both from the continuing effects of the coronavirus itself and from the unintended consequences of the stimulus measures deployed in 2020 to mitigate the economic damage of the pandemic. Three particular issues stand out for their effects on equity valuations: variants of the virus, supply chain constraints and inflation.

• Despite the success of the vaccines, the prospect of further lockdowns has lingered owing to the emergence of new variants that might prove more infectious, virulent or resistant to the vaccines. Through 2021 the Delta and Omicron variants highlighted this risk and buffeted sentiment to companies that were benefiting from the return to normal economic activity. This is a factor that is likely to remain relevant until levels of immunity around the world are high enough to compromise the virus’s ability to evolve.

• Supply chains have been put under severe stress as demand has surged and as the impact of 2020’s lockdowns on industrial production and investment plays out. Employment has also been a challenge: with indications that elements of the labour force have been slow to re-engage after the lockdowns, wage growth is accelerating. In the UK, Brexit is an additional complication, though it is difficult to disentangle from the effects of the pandemic. These issues have combined with rising energy prices to exert pressure on households and on corporate profitability, which is being reflected in the trading updates of companies around the world, including several of the portfolio’s holdings. In 2021, this factor has tended merely to take the gloss off results that have been boosted by the demand recovery. However, the effect on profits in 2022 is likely to be greater.

• Supply chain constraints, rising wages and energy prices have combined to produce some of the highest rates of inflation in decades. In the UK, the CPI rose by 5.1% year-on-year in December 2021, while the rate in the US was 7.0%. As the effects of lockdown in 2020 washed through the data, it became clear that this rise in inflation is not as transitory as was widely expected at the start of the year. This is relevant to the performance of the portfolio since there is evidence that the value investment style, as followed by the Managers, fares relatively well when government bond yields rise, which they often do in response to higher inflation. However, in the latter part of 2021, there was little evidence of that relationship. It would seem that equity markets were focused on the possible responses from central banks, fearing that tighter monetary conditions might lower both inflation and real economic growth.

While the effect of these issues on ASCoT’s portfolio will become clearer through 2022, reassurance can be taken from the experience of the past two years. The sensitivity of the portfolio companies to economic conditions was clearly displayed both on the way down in 2020 and in the recovery phase in 2021. The resilience of ASCoT’s holdings comes with attractive valuations, despite the strong returns achieved in 2021.

Analysis of performance

To recap, ASCoT’s net asset value total return in 2021 was 32.5%, which exceeded the NSCI (XIC)’s return of 21.9%. The table below and following paragraphs explain this performance and provide additional detail about the portfolio.

Style

After the adverse experience of 2020, the value investment style in equity markets around the world benefited from the vaccine rally. This boosted ASCoT’s performance over 2021 as a whole, though its influence waned in the second half in response to the three challenges to equity valuations described above. According to the London Business School, which analyses style effects within the NSCI (XIC) using price to book ratios, value stocks out-performed growth stocks by just under 10% in 2021. This quantification of the style factor is a useful but imprecise gauge of the Managers’ approach to value investment. The Managers have always used a broader range of valuation metrics – notably EV/EBITA, the price earnings ratio, free cash flow yield and dividend yield – to determine the price targets for ASCoT’s holdings. Moreover, their investment cases are based on more than a statistically low valuation, additionally taking into account factors such as the development of profits, market position, pricing power and track record. Consideration is also given to risks and opportunities emerging from environmental, social and governance (ESG) issues.

Size

The following comments focus on the size effect within the NSCI (XIC), rather than on comparing the performances of large companies and small companies. The NSCI (XIC) is defined as the bottom ten percent by value of the total UK stockmarket. This means that the largest constituent’s market capitalisation is around £1.6bn and that roughly two thirds of the NSCI (XIC)’s value is represented by companies that are also members of the FTSE 250. For several years, the Managers have chosen to invest the portfolio in the index’s “smaller small” constituents, which can be thought of as non-FTSE 250 companies. The motivation for this was that the “smaller smalls” enjoyed much more attractive valuations, without having to compromise in terms of profit growth, returns on equity or leverage. For most of the period since the global financial crisis, this positioning was unhelpful to ASCoT’s returns as general concerns about liquidity overshadowed the opportunity. However, the advent of the vaccines appears to have been a catalyst for a re-evaluation of the “smaller smalls”. A gauge of this is the relative performance of the FTSE SmallCap, representative of “smaller smalls”, against the FTSE 250. After a strong end to 2020, the former went on to out-perform the latter by 13% in 2021, which is the best calendar year relative performance since 1999. Size was therefore beneficial to ASCoT’s performance in 2021.

Geography

The EU referendum in 2016 and the subsequent weakness in sterling led to a phase of share price under-performance by companies with greater exposure to the UK’s domestic economy. Just as greater political clarity seemed forthcoming at the end of 2019, domestically oriented businesses were put under renewed pressure by 2020’s lockdown, which was particularly troublesome for businesses in the retail, travel and leisure sectors. Moving into 2021, geographical exposure remained relevant, with the share prices of domestically oriented businesses rebounding more powerfully amid the vaccine rally, before giving up some of that out-performance through the middle of the year. Notably, the fourth quarter witnessed under-performance by the overseas oriented companies, which reflects their greater exposure, at least in the near term, to the supply chain issues described in the opening paragraphs. Over 2021 as a whole, the share prices of domestic businesses out-performed those of overseas businesses by 8%. This was helpful to ASCoT’s performance, since the portfolio has a weighting of 58% in the domestics, higher than the NSCI (XIC)’s 51%.

Dividends

The swings in the income experience of the portfolio and of small UK quoted companies in general have reflected their capital performance over the past two years. The London Business School calculated that NSCI (XIC) dividends fell by 52% in 2020, the worst outcome in the post war era. In 2021, dividends rebounded by 70%. ASCoT has benefited: the proposed total dividends in respect of 2021 are funded entirely by the year’s earnings. Even at the time of the interim results, the Managers had estimated that it would be necessary to draw on revenue reserves, albeit to a lesser extent than in 2020.

Behind this improvement was a better than expected underlying dividend experience, supplemented by two special dividends paid by investee companies to ASCoT. The dividend experience is portrayed in the following table, which categorises the portfolio’s 77 holdings at 31 December 2021 by their most recent dividend action.

The important categories are Returners and Nil Payers. The former captures those holdings that did not pay a dividend in 2020 but that have resumed distributions in 2021. There are more of these than the Managers had expected at the start of 2021, which is testament to the resilience and good stewardship of the investee companies in extremely challenging circumstances. These have provided a significant boost to ASCoT’s Income Statement. The Nil Payers category hints at the scope for further impetus. The Managers estimate that 14 of the Nil Payers will make dividend payments in the next two years. The other Nil Payers, which may be thought of as structural Nil Payers, are likely to take longer as their cash flows are prioritised for investment or debt repayment.

Balance sheets

The strong dividend performance described above is influenced by the resilience of balance sheets both within the portfolio and among small companies in general. The table below sets out the weight of the portfolio and the tracked universe in four leverage categories. Using the Managers’ estimates, it also shows those weights both at the end of 2021 and at the end of 2023. The tracked universe is those companies in the NSCI (XIC) that the Managers follow closely and represents 97% by value of the NSCI (XIC).

The resilience of small companies is evident from the table. Both the portfolio and the tracked universe are emerging from the pandemic with a skew to companies boasting strong balance sheets. Some of that resilience is due to equity issues in 2020, though these were fewer than the Managers had expected. The more important influences were the control of costs, recovering demand and a focus on free cash generation. It is also notable that, if anything, the portfolio’s companies look more conservatively financed than does the tracked universe. The latter has a higher exposure to more highly leveraged companies with net debt / EBITDA ratios above 2x.

The likely strengthening of balance sheets in the wake of the pandemic is consistent with the experience of the global financial crisis. Company boards are naturally slower to utilise their balance sheet strength in the aftermath of such events. Such caution is understandable, but it can be taken too far. A lack of investment is detrimental to the longer term prospects of individual companies and, by extension, to the economy as a whole. Furthermore, in the absence of attractive investment opportunities, excess cash can be returned to shareholders, as long as it does not jeopardise the underlying business’s viability.

Return on equity

There is a widespread view that companies in the value cohort of an index should generate much lower returns on equity (RoE) than do the growth cohort. This makes sense since, if the stockmarket is pricing efficiently, companies with high returns on equity should be on higher valuations, all else being equal. In turn, value investors would tend to find more opportunities among companies whose returns on equity and valuations are depressed by some issue but can revert to more normal levels once the issue is addressed.

The table shows the exposure of the portfolio and of the tracked universe to companies categorised by their RoE. The impact of 2020’s lockdown-induced recession is clear, with weightings in “loss makers” and “laggards” rising as profits declined. A more useful picture is painted by the data for relatively normal conditions of 2019. In that year, the portfolio’s exposures to the four categories compare well with those of the tracked universe. This contradicts the widespread view that value investors are condemned to owning less profitable companies. The explanation for this counterintuitive but encouraging finding lies in the portfolio’s relatively high exposure to the more attractively valued smaller small companies, which is addressed in more detail in the commentary on valuations below.

Corporate activity

The international appeal of UK assets diminished with 2016’s EU referendum. This was reflected in sterling weakness, in a widening of the valuation discount between UK and global equities and in a decline in takeover activity within the NSCI (XIC). However, the past year has seen some appetite return. UK equities have continued to under-perform their global peers, but sterling is above pre pandemic levels and ten percent above the nadir in the wake of the referendum. Of more direct relevance to the portfolio, the incidence of M&A within the NSCI (XIC) was at its highest level in 2021 since 2015. Private equity and other companies, both domestically based and overseas, have been keen to take advantage of the considerable value available within the UK equity market.

Nineteen constituents of the NSCI (XIC) were acquired last year, with offers for another six still outstanding at 31 December 2021. Of these 25 companies, the portfolio had holdings in six. In addition, there were public approaches for two holdings that were rejected by shareholders and other approaches that the Managers helped rebuff before disclosure was required. It remains the case that the stockmarket valuations for many investee companies are so low that the typical 20-30% premium for control does not get close enough to the Managers’ target prices.

ASCoT’s interim report described an upsurge in IPO activity in the first half of 2021, with most of the companies brought to the market on high valuations and with more appeal to the growth investor. There were few IPOs in the second half, but the year as a whole saw 23 companies float with current market capitalisations that brought them into the NSCI (XIC) on its 2022 rebalancing. The net effect of this rebalancing increased the number of constituents in the NSCI (XIC) from 334 at 1 January 2021 to 337 at 1 January 2022. The largest constituent in the 2022 vintage at 1 January 2022 had a market capitalisation of £1,645m.

Portfolio Turnover

Portfolio turnover is defined as the lower of purchases and sales divided by average portfolio value. Over the twelve months to 31 December 2021, the rate was 26%. This is in the middle of the range since the financial crisis, with turnover as low as the mid teens and as high as around 40%. There is often a relationship between ASCoT’s turnover and the relative performance of the portfolio. If the share prices of holdings rise close to the Managers’ targets, there is the opportunity to realise value and redeploy the proceeds in other companies with higher upsides. The Managers term this the “value roll”. On the other hand, weaker performance implies that the gaps between share prices and the Managers’ targets prices are widening and so, all else being equal, there is less incentive to change the portfolio.

Active share

Active share is a measure of how different a portfolio is from an index. It is calculated as half of the sum of the absolute differences between each stock’s weighting in an index and its weighting in the portfolio. The higher a portfolio’s active share, the higher its chance of either out or under-performing the index. At 31 December 2021, the portfolio’s active share was 76% relative to the NSCI (XIC), which was well above the Managers’ target ratio of at least 70%.

Valuations

Before examining the valuations of the portfolio, it is worth noting that UK equities remain lowly valued in the global context. Research by JP Morgan shows that UK equities have under-performed their US peers by 50% and their European peers by 25% since the EU referendum in 2016. This has left UK valuations relative to global equities over two standard deviations below their long term averages. A significant valuation discount persists even when valuations are adjusted for the UK stockmarket’s heavy exposure to the financials and commodities sectors. Though less exposed to these sectors, ASCoT’s investment universe and portfolio would appear to bear a UK discount.

The historical PE ratios of the portfolio and of the NSCI (XIC) rose through 2021. This was driven both by the recovery in share prices through the year and by companies reporting lower earnings in respect of the recession year of 2020. The long term average PE for the portfolio is 11.6x, while that of the NSCI (XIC) is 13.4x. At 31 December 2021, therefore, both the portfolio and index are more highly rated than usual. This reflects the fact that recovery in earnings has further to go – the Managers anticipate that pre-pandemic levels of profitability will be reached again in 2023. In relative terms, the portfolio PE is 20% lower than that of the NSCI (XIC) at 31 December 2021. This compares with an average discount over the long term of 13%.

Turning to dividend yields, the portfolio’s 1.9% is lower than the 3.2% long term average. While dividends recovered more quickly than expected through 2021, they remain below their pre-pandemic levels. Again, those levels are likely to be seen again in 2023. Consistent with this, the Managers’ estimates suggest a portfolio yield two years out of 3.1%. As dividends grow again, the presently high dividend cover of 4.0x should reduce closer to the long term average of 2.7x.

The table below sets out the forward valuations of the portfolio, the tracked universe and certain subdivisions of the tracked universe. The metric displayed is enterprise value to earnings before interest, tax and amortisation (EV/EBITA), which the Managers use most often in valuing companies. The estimates underlying the ratios are the Managers’. There follows a series of observations about the table.

• The decline in ASCoT’s EV/EBITA from 2020 to 2023 is driven by recovering profits and by a reduction in EV as free cash flow is generated to reduce debt. The 7.2x multiple in 2023 is based on profits that are expected to be back roughly to 2019 levels.

• Consistent with the Managers’ value investment philosophy, the portfolio is more attractively rated than the tracked universe, with a discount of 17% in 2020 expanding to 22% in 2023.

• The valuation stretch among small companies is shown in the EV/EBITA difference between the growth stocks and the rest of the tracked universe. It is in this latter cohort that the Managers focus their attention, though growth stocks do encounter trading issues and can offer opportunities as well.

• The bottom two rows demonstrate the present importance of size. Stocks with market capitalisations above £600m are an approximate match for those NSCI (XIC) constituents that are also members of the FTSE 250. Those with market capitalisations below £600m are the “smaller smalls”. Despite their better share price performance in 2021, these remain more attractively valued than their mid cap peers, but they are not inferior in terms of their growth potential, balance sheets and returns on equity. Since the global financial crisis, the stockmarket has penalised these companies for their small size and relative illiquidity. Through its diversified portfolio ASCoT has taken advantage of this and has a meaningfully higher exposure than does the index to the “smaller smalls”.

• Turning back to M&A within the NSCI (XIC), the average 2021 EV/EBITA multiple of the takeover targets (excluding property companies) was 17x. This is markedly higher than the 2021 valuation multiples of both the tracked universe and the portfolio, which illustrates the value available among small companies.

The EV/EBITA multiples usefully demonstrate the attractive valuations within the portfolio, but they are not the only element of the Managers’ investment cases. Each holding is ascribed a target price, which is usually based upon an estimate of normalised profits to which a multiple is applied. The emphasis of the investment process is assessment of the appropriate multiple, taking into account factors such as the company’s market position, its record, ESG risks and opportunities, management and longer term prospects. The ranking by upside to price targets allows the Managers to circulate capital from companies whose share prices are near their calculated values to those with a larger gap between the two. Over time this “value roll” can make a meaningful contribution to investment returns. It is the full investment cases of the holdings that is the main influence on the Managers’ consideration of ASCoT’s tactical gearing facility. Since attractive valuations continue to unpin significant estimated upside, it is appropriate that the portfolio remains geared.

Outlook and Conclusion

Equity returns are determined by the progress of corporate profits and the rating ascribed to those profits by investors. Inflation and monetary policy are important influences on the latter since they affect the discount rates used to value financial assets. One of the curiosities of 2021 is that the highest rates of inflation for decades have not had a greater impact on the pricing of financial assets. Government bond yields in both the UK and US are still below their pre-pandemic levels, while growth stocks returned to the fore after weaker relative performance amidst the vaccine rally. So far, therefore, the markets appear to be anticipating economic and financial conditions little changed from those that have pervaded since the global financial crisis: low real economic growth, low inflation, low interest rates and low bond yields.

It is not clear that today’s inflationary pressures will be short-lived and easily controlled. The supply chain problems will be sorted in time, but there may be more intractable influences. Under-investment in oil and gas development projects in recent years could keep energy prices high. Meanwhile, there is concern that the supply of labour has been affected by issues stemming from the pandemic and, in the UK at least, by Brexit. Macro-economic data and anecdotes from companies indicate that wages are accelerating.

Inflation raises the stakes. While its recent resurgence clearly does not prevent a return to the disinflationary conditions of the past dozen years, it is perplexing that the financial markets do not yet harbour more doubt. The chance that bond yields prove too low and that growth stocks are too highly valued is higher today than before the pandemic, but that is not reflected in current valuations. Were more doubt to creep into valuations, ASCoT’s value investment style should benefit in terms of relative performance. However, we should be careful what we wish for – equities struggle when monetary policy belatedly plays catch-up and relative gains might be achieved against the backdrop of lower share prices.

Turning back to corporate profits, the outlook is encouraging as economic activity normalises and demand continues its rebound from the 2020 recession. Such recovery remains a common theme from the Managers’ recent engagement with ASCoT’s investee companies. There are, though, risks. First, the pandemic is still with us and may elicit further measures by governments. However, the efficacy of the vaccines means that such measures should affect the pace of recovery rather than threaten the recovery itself. Second, there are the supply chain problems, which are another recurring feature of company trading updates and will take time to resolve. Indeed, energy and labour costs may put sustained pressure on corporate margins, with demand also threatened by the impact of energy costs on consumer spending. Third, there is the chance that central bankers tighten monetary policy to control inflation and thus bring about economic slowdown. At this stage, this risk is more speculative since monetary tightening, such as the Bank of England’s 0.15% increase in interest rates in December, has so far been modest – in most western economies interest rates remain deeply negative in real terms.

So, from the strategic perspective, 2022 feels like a pivotal year as the inflation debate comes to a head. Equity valuations will be affected, including those of small UK quoted companies. In such uncertain circumstances, the records of these companies offer reassurance. They have coped with the global financial crisis, the Eurozone crisis, Brexit and the pandemic. Despite their cyclicality they have displayed great resilience through each episode. ASCoT itself benefits from a diversified portfolio of companies, with wide ranging activities and geographical exposures. These companies boast strong balance sheets and generate returns on equity that point to profitable and growing underlying businesses. Remarkably, these characteristics are available to the Managers without having to compromise on the value investment philosophy.

Why should that be? Many aspects of ASCoT’s investment policy and strategy – investment in small UK quoted companies with a value philosophy – have been out of favour for several years.

• Since the financial crisis, smallness has come with concerns about low liquidity. These have trumped the longer term associations of smaller size with faster growth and higher total returns.

• Since the EU referendum, UK assets have been out of favour and remain lowly valued in the global context. This is despite the recent upsurge in M&A, which recognises the deep valuation discounts.

• Quoted companies are increasingly being seen as outmoded, with private equity meanwhile lauded for long termism and its ability to use more leverage. However, as mainstream funds increasingly look to take stakes in private businesses, it is notable that the private equity firms themselves are seeking stock exchange listings. Moreover, it is notable that illiquidity is not a concern when it comes to private equity.

• Finally, value investment has been challenged by the environment of low inflation and low interest rates since the global financial crisis. But a continuation of these conditions is not a given, especially in view of current inflationary pressures.

A reversal of one or more of these headwinds could supplement the progress of the underlying businesses in which the portfolio invests to boost returns for ASCoT’s shareholders. This optionality, in combination with the resilience of the investee companies, underlines the relevance of ASCoT’s investment proposition. These attributes and the upside they suggest are good reason for ASCoT to retain the tactical gearing of the portfolio, which has been in place since June 2020. They have also motivated the Managers to add further to their individual shareholdings in ASCoT.

Aberforth Partners

Managers

28 January 2022

DIRECTORS’ RESPONSIBILITY STATEMENT

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

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

(b) the Strategic Report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces; and

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

On behalf of the Board

Richard Davidson

Chairman

28 January 2022

PRINCIPAL RISKS

The Board carefully considers the risks faced by the Company and seeks to manage these risks through continual review, evaluation, mitigating controls and action as necessary. A risk matrix for the Company is maintained. It groups actual and emerging risks into the following categories: portfolio management; investor relations; regulatory and legal; and financial reporting. Further information regarding the Board’s governance oversight of risk, its review process and the context for risks such as conflicts of interest and ESG can be found in the Corporate Governance Report. The Audit Committee Report (pages 30 to 32 of the Annual Report) details matters considered and actions taken on internal controls and risks during the year. The Company outsources all the main operational activities to recognised, well-established firms and the Board receives internal control reports from these firms, where available, to review the effectiveness of their control frameworks. Since the Covid-19 pandemic, these firms have deployed alternative operational practices, including staff working remotely, to ensure continued business service.

Emerging risks are those that could have a future impact on the Company. The Board regularly reviews them and, during the year, it added to the risk matrix potential economic risks arising from inflation, reversal of quantitative easing and supply chain constraints. This risk was grouped under the principal risk category of market risk, as described below. The Board regularly monitors how the Managers integrate such risks into the investment decision making.

Principal risks are those risks derived from the matrix that have the highest risk ratings. They tend to be relatively consistent from year to year given the nature of the Company and its business. The principal risks faced by the Company, together with the approach taken by the Board towards them, are summarised below. To indicate the level of monitoring required during this year each principal risk has been categorised as either dynamic risk, requiring detailed monitoring as it can change regularly, or stable risk, requiring less monitoring.

(i) Investment policy/performance risk – The Company’s investment policy and strategy exposes the portfolio to share price movements. The performance of the investment portfolio typically differs from the performance of the benchmark and is influenced by stock selection, liquidity and market risk (see (ii) below and Note 19 to the financial statements for further details). Investment in small companies is generally perceived to carry more risk than investment in large companies. While this is reasonable when comparing individual companies, it is much less so when comparing the risks inherent in diversified portfolios of small and large companies. The Board monitors performance against the investment objective over the long term by ensuring the investment portfolio is managed appropriately, in accordance with the investment policy and strategy. The Board has outsourced portfolio management to experienced investment managers with a clearly defined investment philosophy and investment process. The Board receives regular and detailed reports on investment performance including detailed portfolio analysis, risk profile and attribution analysis. Senior representatives of Aberforth Partners attend each Board meeting. Peer group performance is also regularly monitored by the Board. This remains a dynamic risk, with detailed consideration during the year. The Managers’ Report contains information on portfolio investment performance and risk.

(ii) Market risk - Investment performance is affected by external market risk factors, including those creating uncertainty about future price movements of investments. The Board delegates consideration of market risk to the Managers to be carried out as part of the investment process. The Managers regularly assess the exposure to market risk when making investment decisions and the Board monitors the results via the Managers’ quarterly and other reporting. The Board and Managers closely monitor significant economic and political developments and, in particular, are mindful of the continued uncertainty following the departure of the UK from the EU, the impacts of the Covid-19 pandemic and government responses, and the potential effects of climate change. This remained a dynamic risk during the year, in which the Managers reported on market risks including inflation and supply-chain pressures and other geo-political issues as referred to in the Managers’ Report.

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

(iv) Gearing risk – In rising markets, gearing enhances returns, but in falling markets it reduces returns to Shareholders. The Board and the Managers have specifically considered the gearing strategy and associated risks during the year. At present this is a dynamic risk as the Company’s tactical gearing facility is partially deployed.

(v) Reputational risk – The reputation of the Company is important in maintaining the confidence of shareholders. The Board and the Managers monitor factors that may affect the reputation of the Company and/or of its main service providers and take action if appropriate. The Board reviews relevant internal control reporting for critical outsourced service providers. This has been monitored as a stable risk.

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

Going Concern

The Audit Committee has undertaken and documented an assessment of whether the Company is a going concern for the period of at least 12 months from the date of approval of the financial statements. This assessment included the impact on the Company of Covid-19. The Committee reported the results of its assessment to the Board.

The Company’s business activities, capital structure and borrowing facilities, together with the factors likely to affect its development and performance, are set out in the Strategic Report in the Annual Report. In addition, the Annual Report includes the Company’s objectives, policies and processes for managing its capital and financial risk, along with details of its financial instruments and its exposures to credit risk and liquidity risk. The Company’s assets comprise mainly readily realisable equity securities and funding flexibility can typically be achieved through the use of the borrowing facilities which are described in notes 12 and 13 to the financial statements. The Company has adequate financial resources to enable it to meet its day-to-day working capital requirements.

In summary and taking into consideration all available information, the Directors have concluded it is appropriate to continue to prepare the financial statements on a going concern basis.

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

INCOME STATEMENT

For the year ended 31 December 2021

(audited)

The Board declared on 28 January 2022 a final dividend of 24.25p per Ordinary Share. The Board declared on 27 July 2021 an interim dividend of 10.95p per Ordinary Share.

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

RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS

For the year ended 31 December 2021

(audited)

For the year ended 31 December 2020

(audited)

BALANCE SHEET

As at 31 December 2021

(audited)

CASH FLOW STATEMENT

For the year ended 31 December 2021

(audited)

SUMMARY NOTES TO THE FINANCIAL STATEMENTS

1. SIGNIFICANT ACCOUNTING POLICIES

The financial statements have been presented under Financial Reporting Standard 102 ("FRS 102") and under the AIC’s Statement of Recommended Practice “Financial Statements of Investment Trust Companies and Venture Capital Trusts” ("SORP") issued in 2021. The financial statements have been prepared on a going concern basis under the historical cost convention, modified to include the revaluation of the Company’s investments as described below. The Directors’ assessment of the basis of going concern is described above. The functional and presentation currency is pounds sterling, which is the currency of the environment in which the Company operates. The Board confirms that no critical accounting judgements or significant sources of estimation uncertainty have been applied to the financial statements and therefore there is not a significant risk of a material adjustment to the carrying amounts of assets and liabilities within the next financial year.

2. INVESTMENT MANAGEMENT FEE

The Managers, Aberforth Partners LLP, receive an annual management fee, payable quarterly in advance, equal to 0.75% of net assets up to £1 billion, and 0.65% thereafter. The investment management fee has been allocated 62.5% to capital reserve and 37.5% to revenue reserve, 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.

3. DIVIDENDS

The final dividend for the year ended 31 December 2021 of 24.25p (2020: 22.90p) will be paid, subject to shareholder approval, on 8 March 2022. These dividends for 2021 and 2020 have not been included as a liability in the financial statements.

4. RETURNS PER ORDINARY SHARE

There are no dilutive or potentially dilutive shares in issue.

5. INVESTMENTS AT FAIR VALUE

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

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

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

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

Investments held as fair value through profit or loss

During the year, an investment, Lookers, with a book cost of £16,538,000, was transferred back from Level 3 to Level 1 when its shares relisted on 29 January 2021.

6. NET ASSET VALUES

The Net Asset Value per share and the net assets attributable to the Ordinary Shares at the year end are calculated in accordance with their entitlements in the Articles of Association and were as follows.

7. SHARE CAPITAL

During the year, the Company bought back and cancelled 874,800 shares (2020: 710,000) at a total cost of £12,886,000 (2020: £6,090,000). During the period 1 January to 28 January 2022, 220,000 shares have been bought back for cancellation.

8. RELATED PARTY TRANSACTIONS

The Directors have been identified as related parties and their fees and shareholdings are detailed in the Directors’ Remuneration Report on pages 34 and 35 of the Annual Report. During the year no Director was interested in any contract or other matter requiring disclosure under section 412 of the Companies Act 2006.

9. INDEPENDENT AUDITOR

During the year an audit tender process was conducted by the Audit Committee and the Board has agreed to appoint Johnston Carmichael LLP as auditor for the financial year ending 31 December 2022. In view of its length of tenure to date, Deloitte LLP was not invited to tender. Deloitte LLP remains in office as auditor until the forthcoming Annual General Meeting at which a resolution for the appointment of Johnston Carmichael LLP will be proposed.

10. FURTHER INFORMATION

The foregoing do not constitute statutory accounts (as defined in section 434(3) of the Companies Act 2006) of the Company. The statutory accounts for the year ended 31 December 2020 which contained an unqualified Report of the Auditors, have been lodged with the Registrar of Companies and did not contain a statement required under section 498(2) or (3) of the Companies Act 2006.

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

The Annual Report is expected to be posted to shareholders by 7 February 2022. Members of the public may obtain copies from Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its website: www.aberforth.co.uk.

CONTACT: Euan Macdonald or Jeremy Hall, Aberforth Partners LLP, 0131 220 0733

Aberforth Partners LLP, Secretaries – 28 January 2022

ANNOUNCEMENT ENDS