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City Merchants High Yield Trust Ltd - Annual Financial Report

PR Newswire

London, March 30

City Merchants High Yield Trust Limited

Annual Financial Report Announcement

For the year ended 31 December 2020

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FINANCIAL INFORMATION AND PERFORMANCE STATISTICS

Year End Information

(1) Source: Refinitiv.

(2) Alternative Performance Measure (APM). See Glossary of Terms and Alternative Performance Measures on pages 68 to 71 of the financial report for details of the explanation and reconciliations of APMs.

(3) Reflects the proceeds of £3.27 million (2019: £5.62 million) from ordinary shares issued in the year.

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Chairman’s Statement

Performance

The Covid-19 pandemic dominated every aspect of life in 2020 and so it’s no surprise that the virus’s impact is easily discernible in the performance of the high yield market. Markets began 2020 in optimistic mood, buoyed by the prospect of a year of steady economic growth. However, optimism rapidly turned to panic as the full impact of the pandemic became clearer and in March the high yield market sold off to levels not seen since 2012. Governments responded to the pandemic by introducing restrictions on social movement, so-called ‘lockdowns’, and the resulting shock to activity saw the UK economy contract by 9.9% in 2020, the largest decline for at least 300 years and more than twice the fall caused by the Global Financial Crisis of 2007-08.

Given the pace and scale of Covid-19’s economic impact it may seem strange that the high yield market quickly rallied from its March lows and then over the remainder of the year returned to its immediate pre-Covid-19 level. The explanation for the rapid restoration of investor confidence lies with the scale of monetary and fiscal support provided by governments and central banks in their efforts to mitigate the pandemic’s economic impact. The huge scale of intervention put the UK on track for government debt to exceed the size of the economy for the first time in more than fifty years (more detail on the market environment and policy response can be found in the Portfolio Managers’ Report).

Despite this volatile and challenging market environment the Company’s net asset value (NAV) total return for the year was 6.9%, compared to a total return of 3.2% for the ICE Bank of America Merrill Lynch European High Yield Index (‘the Index’)(1) and an average return of 6.1% for funds in the Investment Association Sterling Strategic Bond Sector. A move from a premium to a small discount to NAV over the course of the year meant the share price return was more modest, at 1.8%.

The Board believes that investment performance is best assessed over a long-term horizon and hence we pay particular attention to returns over three and five years. For the three and five years to the end of 2020 the Company’s NAV total return was 16.9% and 42.6% respectively, compared to total returns of 13.4% and 34.5% for the Index. These strong performance numbers, achieved in challenging market conditions, are in the Board’s view, evidence of the Manager’s robust and rigorous investment process.

Income Account

Our investment policy is to provide a high level of dividend income relative to prevailing interest rates and despite the fact that interest rates available to savers declined in 2020 the Company maintained its dividend of 10 pence per share. We have now paid a dividend of 10 pence per share since 2011, a period in which the UK Base Rate has remained stubbornly below 1.0%, and far below its long-term average. The Board has stated its intention to continue to target a dividend of 10 pence in the current financial year although, subject to the merger with Invesco Enhanced Income Limited which is discussed in more detail below, the annual dividend target will increase to 11 pence per year over the next three years.

The dividend was paid in four equal instalments, with the fourth dividend payment paid on 25 February 2021 in the form of an interim dividend payment. Paying the final instalment in the form of an interim dividend means that it can be paid earlier than would be the case had we declared a final dividend, since this would require approval at the Annual General Meeting (‘AGM’). A dividend payment policy resolution is put to shareholders for approval at each AGM.

Costs

The Board is committed to ensuring that the Company is managed competitively and our key measure of the costs of running the Company is the ongoing charges ratio (OCR). The OCR is a widely used cost measure and expresses the expenses incurred in managing your Company as a percentage of its NAV. At the end of 2020 the OCR was 0.99% (compared to 1.02% at the end of 2019).

Discount/Premium and Issuance

The relationship between our share price and NAV experienced an unusually high degree of variability in 2020. We began the year with the share price at a premium to the NAV of 2.5% and closed the year at a small discount of 2.3%. The move from a premium to discount coincided with the emergence of the Covid-19 pandemic and resulting uncertainty surrounding economic prospects. Encouragingly, as growing evidence of vaccine efficacy emerged toward the end of the year, the discount narrowed.

We were able to continue to issue new shares to meet demand and in total issued a further 1,700,000 shares during the year. The average price of the shares issued in 2020 was 194.91p. Shares are always issued at a premium sufficient to ensure that existing shareholders do not suffer dilution of the net asset value. The benefits to shareholders of steady growth in the size of the Company include downward pressure on the OCR as costs are spread over a larger asset base.

Gearing

The Portfolio Manager, Rhys Davies, took advantage of market volatility in 2020 to gear the portfolio by means of repo financing, and as at 31 December 2020 the net gearing of the portfolio was 5.4%. The Company’s policy on borrowing remains unchanged and the maximum amount of borrowing is 30% of total assets.

Board Composition

2020 saw two Directors, John Boothman and Philip Austin, retire from the Board. John and Philip joined City Merchants High Yield Trust when it was incorporated in Jersey and during their nine years on the Board oversaw a successful period in the Company’s history. On behalf of the Board and shareholders I would like to thank them for their valuable contribution to the Company, and to wish them both well for the future.

I am delighted that two new Directors, Caroline Dutot and Tom Quigley, joined the Board in 2020. Caroline and Tom bring new skills and experience to the Board and I have no doubt that Caroline and Tom will have a substantial impact on the Board in 2021 and beyond.

Environmental, Social and Governance Matters (ESG)

The Board recognises and supports the growing regulatory and shareholder emphasis on ESG considerations and on page 18 we explain the Company’s approach. I have previously highlighted my belief that the Manager is well-placed to assess the risks and opportunities which will result from accelerating ESG-driven change. Specifically, the Manager is a Tier 1 signatory of the Financial Reporting Council’s Stewardship Code and is an active member of the UK Sustainable Investment and Finance Association. The Manager also achieved an A+ rating for its overall approach to responsible investment (Strategy and Governance) for the fourth consecutive year as well as achieving an A or A+ across all categories in the 2020 assessment period from the United Nations sponsored Principles of Responsible Investment (PRI) for Strategy and Governance. In addition, the Manager is a supporter of the Task Force for Climate Related Financial Disclosure (TCFD) since 2019 and has published its inaugural Climate Change report in line with the TCFD in July 2020.

I am pleased to report that the Manager continues to develop its ESG approach. Recent developments include the incorporation of ESG scoring into investment research, engagement with company management on ESG topics in instances where ESG risk is material for bondholders, and ESG-focussed portfolio reviews led by the Manager’s Global ESG team. The Manager has also voluntarily complied with a new piece of EU legislation, the Sustainable Finance Disclosure Regulation (SFDR) which came into effect within the European Union on 10 March 2021 and introduces a number of sustainability-related disclosure requirements for financial market participants.

Proposed Merger with Invesco Enhanced Income Limited

On 1 March 2021 we announced that the Company has agreed heads of terms in respect of a proposed merger with Invesco Enhanced Income Limited to be effected by way of a shareholder approved contractual scheme of reconstruction by Invesco Enhanced Income Limited and a transfer of the assets to the Company. It is proposed that the enlarged Company will be renamed as Invesco Bond Income Plus Limited (‘BIPS’).

The proposals, which are subject to shareholder, regulatory and tax approvals, would, in the opinion of the Board, provide a number of important benefits to shareholders. Shareholders will benefit from lower management fee arrangements and the prospect of a substantial reduction in the OCR, as well as increased scale and improved liquidity of its shares.

In recent years, the Company has paid an annual dividend of 10.0 pence per share by way of four quarterly payments of 2.5 pence per share. In connection with the proposals, it is proposed that BIPS adopt a dividend policy to target an annual dividend of 11.0 pence per share over a three year period following the implementation of the Scheme by way of four quarterly dividends of 2.75 pence per share. It is anticipated that dividends will be substantially covered by net income from the portfolio although BIPS will support the target dividend over this period through the use of revenue and capital reserves if necessary.

Thereafter, the board of BIPS shall give consideration to its ongoing dividend policy, taking into account the annualised net income from its portfolio and the market environment at that time.

The Board intends to recommend shareholders vote in favour of the proposed merger and are confident that if completed it will mark the start of a new, exciting chapter in the Company’s history.

AGM

The Company’s Annual General Meeting will be held on 22 June 2021 at 9.30am at the offices of JTC Fund Solutions (Jersey) Limited, 28 The Esplanade, St Helier, Jersey JE4 2QP. Details of the business of the meeting are set out in the Notice of AGM on pages 72 to 74.

The Board is mindful of the current travel and meeting restrictions in place in response to the Covid-19 pandemic and shareholders are therefore encouraged to submit their votes by proxy. Attendees will only be permitted to the meeting in line with current regulations at the date of the meeting. You are strongly encouraged to lodge your vote either electronically via the registrar’s online portal or using the Form(s) of Proxy to appoint the Chairman of the General Meeting as your proxy to vote on your behalf.

The Board is cognisant of the fact that many shareholders like this opportunity to hear from the Portfolio Managers and the Board and therefore invite you to attend a webinar with us on 16 June 2021 at 11 am. A presentation will be made by Rhys Davies followed by a question and answer session. Shareholders can submit questions during the webinar or in advance by writing to the Company Secretary at the address given on page 76. Details on how to register for the event are available via the Company’s website www.invesco.co.uk/citymerchants.

Outlook

The Covid-19 pandemic will, unfortunately, remain the dominant influence on the high yield market for the foreseeable future. As we have seen in recent months, predicting a precise path for the pandemic is impossible. However, there are reasons to hope that the roll out of vaccines will allow lockdown restrictions to be gradually eased, and hence for economic activity to recover.

In my opening remarks I noted that the dramatic fiscal and monetary response of governments to the crisis had proved decisive in helping to restore market confidence. At some stage policy will need to be re-established on a sustainable path. However, given the fragility of the economy and expectation that the threat from Covid-19 will linger, it seems likely that monetary policy will remain supportive in 2021, a prospect highlighted by recent comments from the Bank of England indicating that UK interest rates may yet turn negative before the path to sustainable recovery is fully established.

That said, ultimately the corporate sector will not be able to avoid the economic shock caused by Covid-19. We can expect to see a sharper contrast between those companies with sufficient resilience to continue and even flourish, and those which will face growing and possibly insurmountable financial strain. I have commented in previous reports on the importance of a rigorous approach to security selection and I have little doubt this central feature of the Manager’s investment process will continue to serve Shareholders well in the year ahead.

Tim Scholefield

Chairman

30 March 2021

(1) Index includes both sterling and euro denominated issuers.

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STRATEGIC Report

for the year ended 31 December 2020

PORTFOLIO MANAGERS’ REPORT

Market Background

2020 has been an extraordinary year for society and financial markets. Both have been dominated by Covid-19.

The effects of the virus began to be felt in financial markets in late February. As economies were shuttered the high yield market repriced aggressively with valuations reaching levels last seen in the euro sovereign debt crisis in 2012. However, from late March, markets have rebounded. The strongest returns were in Q2 with European high yield delivering a sterling hedged total return during this period of +11.35% – its best quarterly return since 2012. This followed the –14.63% return in Q1, the worst since Q4 2008.

The catalyst for the change in sentiment was the extraordinary monetary and fiscal policy response to the virus from central banks and governments. These measures included the US Federal Reserve directly purchasing corporate bonds. Unlike other central bank asset purchase schemes, the eligible securities for the US programme included bonds downgraded to high yield since the onset of the pandemic. The European Central Bank also extended its quantitative easing programme. In addition, for the first time, European governments agreed to a mutualisation of debt through a €750bn joint recovery fund. The fund includes €390bn of loans and €350bn of debt.

The rally continued until the end of August 2020. Then as autumn began, a resurgence of Covid-19 cases in Europe, as well as rising US political uncertainty, led to some consolidation in the high yield bond market. However, the rally resumed in the autumn as optimism over vaccines, a post Brexit trade deal between the UK and Europe and signs of a Democrat win in the US election outweighed concerns about a second wave of the virus in Europe and the US.

As markets have rallied, the demand for yield has remained very strong. In turn this has led to a surge in corporate bond issuance levels as issuers have sought to build up cash surpluses and repair their balance sheets.

To put the move in credit spreads this year into some context, European currency high yield credit spreads began 2020 at 324bps. By 23 March, at the height of concerns Covid-19, they had widened to 884bps. This was their widest level since the sovereign debt crisis in 2012. By the end of the year, spreads had fallen back to a level of 365bps. It was a similar story in the US high yield market. There, spreads widened from 360bps at the start of 2020 to 1,087bps in late March. They then fell back to 386bps by 31 December 2020.

Portfolio strategy

Over the 12-months to 31 December 2020 the NAV per share rose from 192.11p to 194.29p delivering a total return of 6.9%, which includes a total dividend of 10 pence paid for the year.

We used the significant repricing of markets during March as an opportunity to build exposure across all sectors. We were able to purchase bonds from good quality companies that had dramatically fallen in price, in some cases by over 20 or even 30 points. For example, the trust purchased bonds from Dutch cable operator, Ziggo Bond Finance, that had fallen 25 points below their February issue price. In the midst of the market sell-off we also utilised Credit Default Swaps as a means of protecting the portfolio.

As well as opportunities within the high yield market, we were also able to add some higher yielding investment grade names to the portfolio as issuance re-started in that market. An example was BMW US Capital, which came to the market in April with a 5-year bond offering a coupon of 3.9%. This was more than some high yield issuers were paying to raise capital at the start of the year.

Over the summer we started to take profits on some of the names added earlier in the year that had rallied strongly. However, we were still able to find opportunities. One notable example was Rolls Royce, which came to the market as a high yield issuer in October. Although the aerospace sector has been hard hit by the effects of the pandemic, we were encouraged by the company’s decision to raise £2bn of equity capital, which significantly strengthens its balance sheet. We added a 7-year bond paying a 5.75% coupon.

For the remainder of the year we continued to seek out opportunities. Many of these have been in higher quality companies such as Thames Water (Kemble) Finance and National Express as well as a single ‘A’ rated British Airways Bond that is secured against 14 of the company’s aircraft and pays a coupon of 4.25%.

After these adjustments the fund’s largest industry exposure remained financials (both subordinated bank and insurance bonds). Elsewhere the largest allocations are to telecoms, autos and food. The Company continues to exploit opportunities in both the European and US markets. Most of the currency exposure from these positions is hedged back to sterling.

As the Chairman stated, we also utilised a modest amount of gearing during the year by means of repo financing. The ability to gear the portfolio when markets offer an opportunity and protect the portfolio, either through Credit Default Swaps or duration (interest rate) hedges, are useful tools for bond funds.

There was a significant increase in defaults within the high yield market during the height of the market uncertainty. Moody’s reported that their twelve month European default rate increased from 1.7% at the end of 2019 to a high of 4.9% in November 2020, before starting to fall again. Nonetheless, not all of these saw investors suffer significant losses and many went on to successfully restructure. During the year a handful of positions in the portfolio witnessed credit events that resulted in debt restructurings. As at the end of the financial year one issuer, Petra Diamonds, remained in restructuring. The terms of an exchange into equity have been agreed by bondholders who will receive equity in exchange for their principal plus accrued interest.

Outlook

Markets have rallied significantly from the lows of March 2020. Whilst the volatility provided a fantastic opportunity to add future income to the portfolio, yields in the high yield market are once again heading lower, driven by the prospect of a prolonged period of low interest rates.

Although we will continue to seek out attractive income opportunities, such an environment does create challenges for future income. Furthermore, there are undoubtedly difficult times ahead for many high yield companies.

As we seek out appropriately priced income opportunities, we will continue to apply a thorough and comprehensive analysis of each issuer and we will maintain a diversified portfolio. We believe this approach has served shareholders well during 2020 and will continue to do so as we meet the challenges in the months ahead.

Rhys Davies Edward Craven

Portfolio Managers

30 March 2021

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STRATEGIC REPORT

Business Review

Purpose, Business Model and Strategy

City Merchants High Yield Trust Limited is a Jersey domiciled investment company which is listed on the London Stock Exchange and its investment objective is set out below.

The Company’s purpose is to generate sustainable returns for its shareholders by investing their pooled capital to achieve the Company’s investment objective through the application of its investment policy (set out below) and with the aim of spreading investment risk.

The strategy the Board follows to achieve the objective is to set investment policy and risk guidelines, together with investment limits, and to monitor how they are applied.

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

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

– JTC Fund Solutions (Jersey) Limited (the ‘Company Secretary’) to provide company secretarial and general administration service.

In addition to the management and administrative functions of the Manager and the Company Secretary, the Company has contractual arrangements with Link Market Services (Jersey) Limited to act as registrar and the Bank of New York Mellon (International) Limited (BNYMIL) as depository and custodian.

The Board has oversight of the Company’s service providers, and monitors them on a formal and regular basis. The Board has a collegiate culture and pursues its fiduciary responsibilities with independence, integrity and diligence, taking advice and outside views as appropriate and constructively challenging and interacting with service providers, including the Manager. The portfolio managers responsible for the day-to-day management of the portfolio are Rhys Davies, Portfolio Manager and Edward Craven, Deputy Portfolio Manager. Paul Read and Paul Causer, co-heads of the Invesco Henley Fixed Interest team, stepped back as co-fund managers of the Company on 22 July 2020. They continue to support the wider fixed interest team.

The Company is an alternative investment fund for the purposes of the Alternative Investment Fund Managers Directive.

Investment Objective and Policy

Investment Objective

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

Investment Policy

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

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

Investment Style

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

Investment Limits

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

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

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

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

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

Derivatives and Currency Hedging

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

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

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

Borrowings

The Company’s borrowing policy is determined by the Board, which has set a maximum of 30% of the Company’s total assets. This limit may be varied from time to time in the light of prevailing circumstances, but has not been changed since the Company’s incorporation in its current form. The Manager has discretion to borrow within the limit set by the Board. Any borrowings are covered by investments in matching currencies to manage exposure to exchange rate fluctuations.

The Board has reviewed the methods of financing available to the Company including repo financing whereby a company participates in sale and repurchase arrangements in connection with its portfolio. Under these arrangements, a company sells fixed interest securities and is contractually obliged to repurchase them at a fixed price on a fixed date, whilst retaining economic exposure to the securities sold. The difference between the (lower) sale price and the later purchase price is the cost (effectively interest) of the repo financing. Repo financing agreements are in place and may be used subject to the aggregate 30% ceiling. The Company started using repo financing during the year to 31 December 2020 and at year end the sum borrowed using this method was £13.5 million (2019: none). This represents gross gearing of 6.8% with cash of 1.4% giving net gearing of 5.4%.

Key Performance Indicators

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

• Performance

• Dividends

• Premium/Discount

• Ongoing Charges Ratio

Performance

As the Company’s objective is to seek to obtain capital growth and high income, the performance is best measured in terms of total return. There is no single index against which the Company’s performance may be meaningfully assessed. Therefore, the Board refers to a variety of relevant data and this is reflected in both the Chairman’s Statement and the Portfolio Managers’ Report on pages 3 to 7. The Manager has a long-term horizon and consequently the Board pays close attention to returns over three and five years in its assessment of investment performance. As explained in the Chairman’s Statement, the Board has noted the performance in the year and is satisfied with the longer term performance of the portfolio.

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

Dividends and Dividend Payment Policy

Dividends form a key component of the total return to shareholders and the Board currently targets dividends of 10p per year. This target has been met in the year under review. Dividends paid over the last ten years are shown in the table on page 2.

The Board’s Dividend Payment Policy is to pay dividends on a quarterly basis in May, August, November and February in respect of each accounting year. The timing of these regular three-monthly payments means that shareholders do not have an opportunity to vote on a final dividend. Recognising the importance of shareholder engagement, and although not required by any regulation, shareholders are given an opportunity to vote on this policy at the forthcoming AGM.

Premium/Discount

The Board monitors the price of the Company’s shares in relation to their net asset value and the premium/discount at which the shares trade. Powers are taken each year to issue and buy back shares, which can assist short term management, however the level of discount or premium is mostly a function of investor sentiment and demand for the shares, over which the Board may have limited influence. The ideal would be for the shares to trade close to their net asset value. The following graph shows the discount/premium through the year, ending with a discount of 2.3%. As explained in the Chairman’s Statement, demand for shares prior to the Covid-19 pandemic, during the year resulted in the issue of 1,700,000 shares at an average price of 194.91p.

Ongoing Charges Ratio

The expenses of managing the Company are carefully monitored by the Board. The standard measure of these is the ongoing charges ratio (OCR), which is calculated by dividing the sum of such expenses over the course of the year, including those charged to capital, by the average net asset value. This ongoing charges ratio provides a guide to the effect on performance of annual operating costs. The Company’s ongoing charges ratio for the current year was 0.99%, compared to 1.02% for the previous year.

Investment Process

At the core of the portfolio managers’ philosophy is a belief in active investment management. They seek to invest where they see the potential for attractive returns and to avoid risks that they do not think are well rewarded. Fundamental principles drive a genuinely unconstrained investment approach, with a strong emphasis on value.

The investment process comprises four key elements to deliver the information the portfolio managers use to make their decisions:

• top down, macroeconomic analysis – examining the factors that shape the economy;

• credit analysis using internal and external research with a view to maximising returns from acceptable and understood credit risk exposure;

• value assessment, considering the risk/return profile of any bond in relation to cash, core government bonds and the rest of the fixed interest universe; and

• risk considerations, analysing all holdings to allow for a comprehensive understanding of risks involved to ensure diversification of the portfolio.

The portfolio managers enter into the majority of positions with a view to holding them until their call or maturity date and their investment process is based on making investments where the yield to maturity or call appears to them to be at least an adequate reward for the risk. The nature of the high yield market and the Company’s mandate mean that there will be occasions when the value the portfolio managers assessed in an investment is fully realised by the market. On these occasions, they may exit the position before maturity.

The portfolio managers believe that it is good investment practice to try and keep the level of turnover low, whilst at the same time recognising that this should not at any time act as a deterrent to effective portfolio management. Turnover will generally be very low due to the long term nature of many of the holdings and given the closed end nature of the Company, the portfolio managers are not presented with regular daily inflows and outflows which require managing.

Internal Control and Risk Management

The Directors have overall responsibility for the Company’s system of internal controls and are responsible for reviewing the effectiveness of these controls. This includes safeguarding of the Company’s assets. The Directors have carried out a robust assessment of the principal and emerging risks facing the Company, including those that would threaten its business model, future performance, solvency or liquidity.

The Audit Committee (the ‘Committee’), on behalf of the Board, has established an ongoing process for identifying and assessing the risks to which the Company is exposed by reference to a risk control summary, which maps the risks, mitigating controls in place, and monitoring and reporting of relevant information to it. The review of the risk control summary also incorporated a robust assessment of new and emerging risks for monitoring purposes.

As part of the process, the Committee has identified four risk categories: strategic; investment management; third party service providers; and regulation and corporate governance. An explanation of these categories follows.

Strategic Risk

The Board sets the Company’s strategy, including setting its objective and how this should be achieved. The Board assesses the performance of the Company in the context of the market and macro conditions and gives direction to, and monitors, the Manager’s actions, and those of other third parties, on behalf of the Company.

Investment Management Risk

Investment management covers management of the portfolio together with cash management, gearing and hedging, all being areas the portfolio managers can control, and which generate the Company’s investment performance.

Third Party Service Providers Risk

The Company has no employees and its Directors are appointed on a non-executive basis. The Company is reliant on third party service providers (TPPs) for its executive functions. The Company’s most significant TPPs are the Manager, to which portfolio management is delegated, fund accounting and the Company Secretary. Other significant TPPs are the corporate broker, depositary, custodian, registrar and auditor.

Regulation and Corporate Governance Risk

The Company is required to comply with many regulations. For the year under review these included but were not limited to, the provisions of the Companies (Jersey) Law 1991, the UK Listing Rules, the Alternative Investment Fund Managers Directive, the Market Abuse Regulation, the FCA’s Disclosure Guidance and Transparency Rules, the UK Corporate Governance Code and International Financial Reporting Standards.

A matrix of the risks, set out according to their assessed risk levels after mitigation, enables the Directors to concentrate on those risks that are most significant, and also forms the basis of the list of principal risks and uncertainties on pages 13 to 15. The ratings take into account the Directors’ risk appetite and the ongoing monitoring by the Manager.

Oversight of the control environment is based on the Company’s relationship with its TPPs, all of which have clearly defined lines of responsibility, delegated authority, and control procedures and systems. The Company’s main TPPs, the Manager, fund accounting and the Company Secretary, all have, a ‘Three Lines of Defence Model’, which is embedded into their risk management systems.

The effectiveness of the Company’s internal control and risk management system is reviewed at least twice a year by the Committee. The Committee received and considered, together with representatives of the Manager, reports in relation to operations and systems of internal controls of the Manager, Company Secretary, accounting administrator, custodian and registrar. The Committee also receives regular reports from the Manager’s internal audit and compliance departments. The Committee also received a comprehensive and satisfactory report from the depositary at the year end Committee meeting. The Company’s risk management policies and procedures for financial instruments are set out in note 19 on pages 55 to 62.

Due diligence is undertaken before any contracts are entered into with any third party service provider. The Manager regularly reviews, against agreed service standards, the performance of TPPs through formal and informal meetings, and by reference to third party independently audited control reports. The results of the Manager’s reviews are reported to and reviewed by the Committee. These various reports and reviews did not identify any significant failings or weaknesses which were relevant to the Company during the year and up to the date of this annual financial report. If any had been identified, the required remedial action would have been taken.

Reporting to the Board at each board meeting comprises, but is not limited to: financial reports, including any hedging and gearing; performance against relevant indices and the Company’s peers; the portfolio managers’ review, including of the market, the portfolio, transactions and prospects; revenue forecasts; and investment monitoring against investment guidelines. The portfolio managers are permitted discretion within these investment guidelines, which are set by the Board. Compliance with the guidelines is monitored daily by the Manager. Any proposed variation to these guidelines is referred to the Board for consideration and approval.

The Board, through the Management Engagement Committee, formally reviews the performance of the Manager and the Company Secretary annually and informally at every board meeting. The Board has reviewed and accepted both the Manager’s and Company Secretary’s whistleblowing policy under which staff of both Invesco Fund Managers Limited and JTC Fund Solutions (Jersey) Limited can, in confidence, raise concerns about possible improprieties or irregularities in matters affecting the Company.

Principal Risks and Uncertainties

The Board has carried out a robust assessment of the risks facing the Company, including those that would threaten its business model, future performance, solvency and liquidity. As part of this process, new and emerging risks are considered. These are not necessarily principal risks for the Company, but may have the potential to be in the future. The principal risks that follow are those identified by the Board after consideration of mitigating factors. In carrying out this assessment, consideration was given to market uncertainty in relation to Brexit and the continuing impact of Covid-19.

Strategic Risks

Market Risk

The Risk: The Company invests primarily in fixed interest securities, the majority of which are traded on global security markets. The principal risk for investors in the Company is a significant fall and/or a prolonged period of decline in these markets. This could be triggered by unfavourable developments globally and/or in one or more regions, contemporary examples being the market uncertainty in relation to Brexit and the Covid-19 outbreak during 2020. The Board cannot control the effect of such external influences on the portfolio. Market risk also arises from movements in foreign currency exchange rates and interest rates.

Mitigating Procedures and Controls: An explanation of market risk and how this is addressed is given in note 19.1 to the financial statements. The Portfolio Managers’ report summarises particular macro economic factors affecting performance during the year and the portfolio managers' views on those most relevant to the outlook for the portfolio.

Investment Objectives

The Risk: The Company’s investment objective and strategy no longer meet investors’ demands.

Mitigating Procedures and Controls: The Board receives regular reports reviewing the Company’s investment performance against its stated objectives and peer groups, and reports from discussion with its broker and major shareholders. The Board also has a periodic strategy meeting.

Lack of Liquidity in the Company’s Shares

The Risk: Lack of liquidity and lack of marketability of the Company’s shares leading to stagnant share price and wide discount.

Mitigating Procedures and Controls: The Board receives regular reports from both the Manager and the Company’s broker on the Company’s share price performance and level of discount (or premium), together with regular reports on marketing and meetings with shareholders and prospective investors. The Board recognises the importance of the Company’s scale in terms of the aggregate value of its shares in the market (‘market cap’) in creating liquidity and the benefit of a wide shareholder base, and has the ability to both issue and buy back shares to assist with market volatility. The foundation to this lies in solid investment performance and a high level of dividend. Powers are also taken to issue and buy back shares.

Investment Management Risks

Performance

The Risk: The portfolio persistently underperforms relevant indices and/or peers because of the investments selected. Performance will also be affected by market risk, which was addressed above, and by credit risk. A significant portion of the Company’s portfolio consists of non-investment grade securities which by their nature have a higher risk of default as well as the likelihood of price volatility.

Mitigating Procedures and Controls: The Company does not have a formal benchmark, however, the ICE Bank of America Merrill Lynch European Currency High Yield Index (‘the Index’) is used in contribution analysis. This index tracks the performance of EUR and GBP denominated sub-investment grade corporate debt publicly issued in the eurobond, sterling domestic and euro domestic markets. The Board regularly compares the Company’s NAV performance over both the short and long term to that of the Index and relevant peers as well as reviewing analyses breaking out contributory elements of the portfolio’s performance compared with the Index. The Board also receives reports on and reviews: the constituents of the portfolio, transactions in the period and, if applicable, gearing and hedging. The investment process the portfolio managers employ to address risk versus return is explained on page 11, and an explanation of credit risk and how this is addressed is given in note 19.3 to the financial statements.

Borrowing Risk

The Risk: Borrowings for investment purposes will amplify the reduction in NAV in a falling market, which in turn is likely to adversely affect the Company’s share price. There is no guarantee that it will be possible to re-finance repo financing arrangements on their maturity either at all or on terms that are acceptable to the Company, in which case any amounts owing by the Company would need to be funded by the sale of investments and the Company may not be able to realise the expected value of those assets. Repo financing introduces an element of counterparty risk. Repo financing transactions require the counterparty to sell the relevant assets to the Company on the repurchase date at a fixed price but if a counterparty failed to do so, the Company would be left with a contractual claim against the defaulting counterparty and there is no guarantee the Company would be able to recover all of the value of the assets from that counterparty. In adverse market conditions, the risks of counterparty default may be greater than at other times.

Mitigating Procedures and Controls: All borrowings are actively managed by the Manager and monitored by the Board. The Company will only enter into repo arrangements with counterparties who are authorised or regulated by an appropriate regulator and whose credit rating is not less than the minimum investment grade credit ratings issued by internationally recognised agencies. There is a maximum limit allowed with any one counterparty, and transactions typically have a maturity tenor of three months or less.

Third Party Service Provider Risks

Unsatisfactory Performance of Third Party Service Providers (TPPs)

The Risk: Failure by any service provider to carry out its obligations to the Company in accordance with the terms of its appointment could have a materially detrimental impact on the operations of the Company and affect its ability to pursue successfully its investment policy and expose it to reputational risk. Disruption to the accounting, payment systems or custody records could prevent the accurate reporting and monitoring of the Company’s financial position.

Mitigating Procedures and Controls: Details of how the Board monitors the services provided by the Manager and the other TPPs, and the key elements designed to provide effective internal control, are included in the internal control and risk management section on pages 11 and 12.

Information Technology Resilience and Security

The Risk: The Company’s operational structure means that all cyber risk (information technology and physical security) arises at its TPPs. This cyber risk includes fraud, sabotage or crime perpetrated against the Company or any of its TPPs.

Mitigating Procedures and Controls: The Audit Committee on behalf of the Board regularly reviews TPPs’ service organisation control reports and meets with representatives of the Manager’s Investment Management, Compliance, Internal Audit and Investment Trust teams as well as the Company Secretary’s senior staff and Compliance team. The Board receives regular updates on the Manager’s and the Secretary’s information security arrangements. The Board monitors TPPs’ business continuity plans and testing – including their regular ‘live’ testing of workplace recovery arrangements.

Business Continuity Risk

The Risk: Impact of a major event, such as Covid-19, on the operations of the service providers, including any prolonged disruption.

Mitigating Procedure and Controls: The Manager’s business continuity plans are reviewed on an ongoing basis and the Directors are satisfied that the Manager has in place robust plans and infrastructure to minimise the impact on its operations so that the Company can continue to trade, meet regulatory obligations, report and meet shareholder requirements.

The Manager has mandated work from home arrangements and implemented split team working for those whose work is deemed necessary to be carried out on business premises. Any meetings are being held virtually or via conference calls.

Other similar working arrangements are in place for the Company’s third-party service providers. The Directors remain confident that with these measures in place, the Company is in a good position to continue operating as normal in these exceptional conditions. In addition, due to the nature of the Company being a closed end investment company, the portfolio managers are not presented with regular daily inflows and outflows that require managing.

Regulation and Corporate Governance Risk

Failure to Comply With or Adverse Changes to Law or Regulation

The Risk: A serious breach of law or regulation could lead to suspension from the Official List and from trading on the London Stock Exchange, a fine or a qualified audit report. Adverse changes to law or regulation could affect the ability of the Company to operate or the practicality of its domicile.

Mitigating Procedures and Controls: The Board, the Company Secretary and the Manager monitor compliance with and changes to government policy, legislation and other regulations relevant to the Company.

Viability Statement

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

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

The Company’s investment objective and policy are kept under review. In essence they are the same as they have been since the Company commenced trading in 2012, which in turn were unchanged from those of the Company’s UK based predecessor, City Merchants High Yield Trust plc. The continued relevance of the investment objective and policy are underlined by the Company’s annual continuation vote. Last year nearly 100% of the votes registered were in favour of continuation and the Board has no reason to believe that the continuation resolution will not be passed at the forthcoming and subsequent AGMs.

Performance derives from returns for risk taken. The Portfolio Managers’ Report on pages 6 and 7 sets out the current investment strategy of the portfolio managers. The portfolio contains a high level of relatively high-yielding non-investment grade bonds and these carry a higher risk of default than investment grade paper. This is discussed further in note 19 to the financial statements. The Board has adopted investment limits within which the portfolio managers operate. The Directors and the portfolio managers constantly monitor the portfolio, its ratings and default risk. A bond rating analysis of the portfolio at the year-end is shown on page 21. Exposure is weighted towards higher quality issuers where the risk of default is considered to be more remote.

The terms of the Company’s corporate transition in 2012 allow direct comparison of the Company’s financial information with its UK predecessor. Taking the two together, performance has been strong for many years through different, and difficult, market cycles – as shown by the ten year total return performance graph on page 10. The investment policy has effectively been stress tested by market events in 2007/8 and earlier cycles, and in recent times by both global and domestic events such as Covid-19. These events affected performance, but at no time did they threaten the viability of the Company. Whilst past performance may not be indicative of performance in the future, the investment policy has been consistent throughout those past periods.

Performance and demand for the Company’s shares are not things that can be forecast. Indeed the Covid-19 outbreak continues to have an impact on the economy and markets. The portfolio manager and other service providers have taken steps to mitigate and control the impact on their own businesses thereby ensuring that the Company can continue to trade, report and meet shareholder needs. There are no current indications that the Company is unable to weather the Covid-19 impact or that performance and demand for the Company’s shares may be permanently affected over the next five years so as to affect the Company’s viability.

As described in note 19.2 to the financial statements on pages 60 and 61 liquidity risk is not viewed by the Directors as a significant risk. The majority of the Company’s assets are readily realisable and amount to many times the value of its short term liabilities and annual operating costs. The Company is permitted to borrow up to a maximum of 30% of the Company’s total assets but currently has no long term debt obligations.

The Board announced on 1 March 2021 that it has signed Heads of Terms with the Board of Invesco Enhanced Income Limited (“IPE”) in respect of a proposed merger with IPE to be effected by way of a shareholder approved contractual scheme of reconstruction by IPE and a transfer of assets to the Company. Subject to shareholder approval, the Board believes that this will enable the Company's shareholders to benefit from the greater economies of scale that are expected to result from the enlarged asset base of the Company through lower management fee arrangements, lower ongoing charges, improved liquidity and the potential for strong share price rating.

Based on the above analysis, the Directors confirm that they have a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the five year period of their assessment. Despite the recent disruption from Covid-19 and the impact on global markets, the Directors consider that the Company's investment strategy will continue to serve shareholders well over the longer term.

Investment Management

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

The portfolio managers responsible for the day-to-day management of the portfolio are Rhys Davies Portfolio Manager and Edward Craven, Deputy Portfolio Manager.

The Manager’s Responsibilities

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

Assessment of the Manager

The performance of the Manager is reviewed continuously by the Board and the ongoing requirements of the Company and services received are assessed annually with reference to key performance indicators as set out on pages 9 to 11.

The Management Engagement Committee is responsible for reviewing the Manager. Based on its recent review of activities, the Board believes that the continuing appointment of Invesco Fund Managers Limited remains in the best interests of the Company and its shareholders.

Financial Position

The Company’s balance sheet on page 46 shows the assets and liabilities at the year end. A £20 million revolving credit facility was available until 4 May 2019 when this lapsed and was not renewed. The Company also has repo financing agreements in place, with an amount of £13.5 million borrowed at year end, representing gross gearing of 6.8% and net gearing of 5.4%, after taking cash and cash equivalents in account, as at 31 December 2020.

Performance and Future Development

The performance and future development of the Company depend on the success of the Company’s investment strategy. A review of the Company’s performance, market background, investment activity and strategy during the year, together with the investment outlook are provided in the Chairman’s Statement and Portfolio Managers’ Report on pages 3 to 7.

Annual Continuation Vote

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

Substantial Holdings in the Company

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

EO: Execution only.

Board’s Duty to Promote the Success of the Company

The Directors have a fiduciary duty to act, in good faith, for the benefit of shareholders taken as a whole. In the UK, section 172 of the Companies Act 2006 seeks to codify this duty and to widen the responsibility to incorporate the consideration of wider relationships that are necessary for the Company’s sustainability. As a UK listed Company it is necessary for the Company to report against this UK statutory duty, being that the Directors have a duty to promote the success of the Company, whilst also having regard to certain broader matters, including the need to engage with employees, suppliers, customers and others, and to have regard to their interests. This is reflected in the summary of the Board’s responsibilities on page 30.

In fulfilling these duties, and in accordance with the Company’s nature as an investment company with no employees and no customers in the traditional sense, the Board’s principal concern has been, and continues to be, the interests of the Company’s shareholders taken as a whole. Notwithstanding this, the Board has a responsible governance culture and also has due regard for broader matters so far as they apply. In particular, the Board engages with the Manager and Company Secretary at every Board meeting and the Management Engagement Committee also reviews the Company’s relationships with these and other service providers, such as the registrar, depositary and custodian, at least annually. The assessment of the Manager consequent to these reviews is set out on page 16.

The Company communicates with its shareholders at least three times a year providing information about shareholder meetings, dividend payments and half-yearly and annual financial results. In addition, the annual general meeting of the Company is under normal circumstances held in a central London location, providing shareholders with the opportunity to attend and meet with the Directors and the Manager. The Company’s AGM will be held on 22 June 2021 at 9.30am at the offices of JTC Fund Solutions (Jersey) Limited. The Board is mindful of the current travel and meeting restrictions in place in response to the Covid-19 pandemic and shareholders are therefore encouraged to submit their votes by proxy. Attendees will only be permitted to the meeting in line with current regulations at the date of the meeting.

The Board is cognisant of the fact that many shareholders like this opportunity to hear from the Portfolio Managers and the Board and therefore invite you to attend a webinar with us on l June 2021 at lam/pm. A presentation will be made by Rhys Davies followed by a question and answer session. Furthermore, the Manager provides a schedule of regional meetings with institutional investors and analysts to gather the views and thoughts of investors.

Board Diversity

The Company’s policy on diversity is set out on page 31. The Board considers diversity, including the balance of skills, knowledge, experience and gender amongst other factors when reviewing its composition and appointing new directors. The Board has considered the recommendations of the Davies and Hampton-Alexander review as well as the Parker review, but does not consider it appropriate to establish targets or quotas in this regard. During the year, the Board undertook a recruitment process to replace John Boothman and Philip Austin, who retired from the Board on 15 December 2020 having served for nine years. The recruitment process resulted in the appointment of Tom Quigley and Caroline Dutot. Further details of the recruitment process can be found on page 31. As a result, the Board currently comprises of five Directors, two of whom are female, thereby constituting 40% female representation. Summary biographical details of the Directors are set out on page 27. The Company has no employees.

Environment, Social and Governance (ESG) Matters

In relation to the portfolio, the Company has delegated the management of the Company’s investments to the current Manager, who has an ESG Guiding Framework which sets out a number of principles that are intended to be considered in the context of its responsibility to manage investments in the financial interests of shareholders. A greenhouse gas emissions statement is included in the Directors' Report on page 65.

The Manager is committed to being a responsible investor and applies, and is a signatory to, the United Nations Principles for Responsible Investment, which demonstrates its extensive efforts in terms of ESG integration, active ownership, investor collaboration and transparency. The Manager achieved an A+ rating for its overall approach to responsible investment (Strategy and Governance) for the fourth consecutive year since 2018 as well as achieving an A or A+ across all categories in the 2020 assessment period. In addition, the Manager is an active member of the UK Sustainable Investment and Finance Association as well as a supporter of the Task Force for Climate Related Financial Disclosure (TCFD) since 2019 and has published its inaugural Climate Change report in line with the TCFD in July 2020. Although TCFD does not apply directly to the Company at present, the Board confirms that it will comply with all reporting regulations as they are implemented.

The Manager has also voluntarily complied with the Sustainable Finance Disclosure Regulation (SFDR) which came into effect within the EU on 10 March 2021 and is disclosing in the AIFM document as well as the webpage how sustainability risks are integrated.

The Manager’s investment team incorporates ESG considerations in its investment process as part of the evaluation of new opportunities, with identified ESG concerns feeding into the final investment decision and assessment of relative value. The Portfolio Managers make their own conclusions about the ESG characteristics of each investment held and about the overall ESG characteristics of the portfolio, although third party ESG ratings may inform their view. Additionally, the Manager’s ESG team provides ESG monitoring.

Regarding stewardship, the Board considers that the Company has a responsibility as an investor towards ensuring that appropriate standards of corporate governance are maintained in the companies in which it invests. To achieve this, the Board does not seek to intervene in daily management decisions, but aims to support high standards of governance and, where necessary, will take the initiative to ensure those standards are met.

The Company’s stewardship functions have been delegated to the Manager. The current Manager has adopted a clear and considered policy towards its responsibility as an investor 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 current Invesco Stewardship Policy, which is updated annually, can be found at www.invesco.co.uk.

Modern Slavery Act 2015

The Company is an investment vehicle and does not provide goods or services in the normal course of 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.

This Strategic Report was approved by the Board of Directors on 30 March 2021.

JTC Fund Solutions (Jersey) Limited

Company Secretary

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INVESTMENTS IN ORDER OF VALUATION

AT 31 DECEMBER 2020

(1) Moody’s/Standard & Poor’s (S&P)/Equivalent average rating.

Abbreviations used in the above valuation:

Cnv: Convertible

FRN: Floating Rate Note

SNR: Senior

Var: Variable

SUB: Subordinated Note

STATEMENT OF DIRECTORS’ RESPONSIBILITIES

IN RESPECT OF THE PREPARATION OF FINANCIAL STATEMENTS

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

Company law requires the Directors to prepare financial statements for each financial period. Under that law the Directors have elected to prepare the financial statements in accordance with International Financial Reporting Standards as adopted by the European Union (IFRSs). The financial statements are required by law to give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period.

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

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

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

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

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

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

The financial statements have been prepared on a going concern basis. When considering this, the Directors took into account the annual shareholders’ continuation vote (as explained in detail on page 17) and the following: the Company’s investment objective and risk management policies, the nature of the portfolio and expenditure and cash flow projections. As a result, they determined that the Company has adequate resources, an appropriate financial structure, readily realisable fixed assets to repay current liabilities and suitable management arrangements in place to continue in operational existence for the foreseeable future.

The Directors are responsible for keeping proper accounting records that disclose with reasonable accuracy at any time the financial position of the Company and which enable them to ensure that the accounts comply with the Companies (Jersey) Law 1991. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

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

The Directors of the Company, who are listed on page 27, each confirm to the best of their knowledge that:

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

• this annual financial report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces; and

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

• so far as they are aware, there is no relevant audit information of which the Company’s auditor is unaware, and each Director has taken steps that they ought to have taken as a Director to make themselves aware of any relevant audit information and to establish that the Company’s auditor is aware of that information.

Signed on behalf of the Board of Directors

Heather MacCallum

Audit Committee Chair

30 March 2021

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STATEMENT OF COMPREHENSIVE INCOME

FOR THE YEAR ENDED 31 DECEMBER

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

STATEMENT OF CHANGES IN EQUITY

FOR THE YEAR ENDED 31 DECEMBER

The accompanying accounting policies and notes are an integral part of these financial statements.

BALANCE SHEET

AT 31 DECEMBER

The financial statements were approved and authorised for issue by the Board of Directors on 30 March 2021.

Heather MacCallum

Audit Committee Chair

Signed on behalf of the Board of Directors

STATEMENT OF CASH FLOWS

FOR THE YEAR ENDED 31 DECEMBER

NOTES TO THE FINANCIAL STATEMENTS

FOR THE YEAR ENDED 31 DECEMBER 2020

1. Principal Activity

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

2. Principal Accounting Policies

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

The principal accounting policies adopted in the preparation of these financial statements are set out below. These policies have been consistently applied during the current year and preceding year, unless otherwise stated. The financial statements have been prepared on a going concern basis as noted below.

(a) Basis of Preparation

(i) Accounting Standards Applied

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

Where presentational guidance set out in the Statement of Recommended Practice (SORP) ‘Financial Statements of Investment Trust Companies and Venture Capital Trusts’, updated by the Association of Investment Companies in October 2019, is consistent with the requirements of IFRS, the Directors have prepared the financial statements on a basis compliant with the recommendations of the SORP. The supplementary information which analyses the statement of comprehensive income between items of a revenue and a capital nature is presented in accordance with the SORP.

(ii) Going Concern

As explained on page 17, the Company has an Annual Continuation Vote and the Directors believe shareholders will vote for the Company to continue. Accordingly, the Directors have determined that the financial statements should and have been prepared on a going concern basis, which does not include any adjustments that might arise from cessation of the Company.

(iii) Adoption of New and Revised Standards

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

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

The following standards and amendments to existing standards became effective during the year:

• IAS 1 and IAS 8 Amendments (effective 1 January 2020) – definition of Material. The amendments to IAS 1, ’Presentation of Financial Statements’, and IAS 8, ’Accounting Policies, Changes in Accounting Estimates and Errors’, and consequential amendments to other IFRSs require companies to:

(i) use a consistent definition of materiality throughout IFRSs and the Conceptual Framework for Financial Reporting;

(ii) clarify the explanation of the definition of material; and

(iii) incorporate some of the guidance of IAS 1 about immaterial information.

• IFRS 3 Amendment (effective 1 January 2020) – definition of a Business. This amendment revises the definition of a business. To be considered a business, an acquisition would have to include an input and a substantive process that together significantly contribute to the ability to create outputs.

• IFRS 9 and IFRS 7 Amendments (effective 1 January 2020) – Interest Rate Benchmark Reform. These amendments provide certain reliefs in connection with the interest rate benchmark reform.

• IAS 1, 8, 34, 37, 38 and IFRS 2, 3, 6, 14, IFRIC 12, 19, 20, 22 and SIC 32 (effective 1 January 2020) – amendment to References to the Conceptual Framework.

The Directors do not expect the adoption of above standards and interpretations (or any other standards and interpretations which are in issue but not effective) will have a material impact on the financial statements of the Company in future periods and there was no material impact during the current year.

(iv) Critical Accounting Estimates and Judgements

The preparation of the financial statements may require the Directors to make estimations where uncertainty exists. It also requires the Directors to exercise judgement in the process of applying the accounting policies. There have been no significant judgements, estimates or assumptions for the current or preceding year, except for the allocation of management fee and finance costs (see note 2(h)).

(b) Foreign Currency

(i) Functional and Presentation Currency

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

(ii) Transactions and Balances

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

(c) Financial Instruments

(i) Recognition of Financial Assets and Financial Liabilities

Financial assets and financial liabilities are recognised when the Company becomes a party to the contractual provisions of the instrument. These are offset 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

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

(iii) Derecognition of Financial Liabilities

Financial liabilities are derecognised when the Company’s obligations are discharged, cancelled or expired.

(iv) Trade Date Accounting

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

(v) Classification of Financial Assets and Financial Liabilities

Financial Assets

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

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

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

Financial Liabilities

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

(d) Derivatives and Hedging

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

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

(e) Cash and Cash Equivalents

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

(f) Securities Sold Under Agreements to Repurchase (‘repo financing’)

The Company participates in repo financing arrangements in connection with its investment portfolio. Under these arrangements, the Company sells fixed interest securities but is contractually obliged to repurchase them at a fixed price on a fixed date. Securities which are the subject of repo financing arrangements are included in investments in the balance sheet at their fair value and the associated liability is recognised at amortised cost, being the capital amounts owing under the repo financing arrangements. The difference between sale and repurchase prices for such transactions is reflected in the statement of comprehensive income over the lives of the transactions, within finance costs which is allocated 35% to capital and 65% to revenue. This accounting has been adopted because the repurchase price results in a lender‘s return for the transferee as the Company has retained substantially all the risks and rewards of ownership of the asset.

(g) Income Recognition

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

Special dividends are considered individually to ascertain the reason behind the payment. This will determine whether they are treated as income or capital in the income statement.

(h) Expenses and Finance Costs

All expenses are accounted for on an accruals basis and are recognised in the statement of comprehensive income. Investment management fees and finance costs are allocated 35% to capital and 65% to revenue in accordance with the Board’s expected long-term split of returns, in the form of capital gains and income respectively, from the investment portfolio. Except for custodian dealing costs, all other expenses are charged through revenue. Since the year end and with effect from 1 January 2021, the investment management fees and finance costs will be allocated 50% to capital and 50% to revenue, based on the Board's expected long-term split of returns from the investment portfolio.

(i) Taxation

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

3. Segmental Reporting

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

4. Income

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

5. Investment Management Fee

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

Details of the investment management agreement are given on page 16 in the Strategic Report.

At 31 December 2020, £371,000 (2019: £360,000) was accrued in respect of the investment management fee.

6. Other Expenses

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

(i) The maximum Directors’ fees authorised by the Articles of Association are £150,000 per annum. The Report on Directors’ Remuneration and Interests on page 37, provides further information on Directors’ fees.

(ii) Auditor’s fees include out of pocket expenses.

(iii) Other expenses include:

• custodian transaction charges of £3,400 (2019: £3,000). These are charged to capital.

• amounts due to JTC Fund Solutions (Jersey) Limited (previously: R&H Fund Services (Jersey) Limited) who acted as Administrator and Company Secretary to the Company under an agreement starting from 10 December 2019. The fee is calculated at the rate of £70,000 per annum for company secretarial and administration services.

• an administration fee due to the Manager of £28,000 (2019: £27,000). It is based on an initial fee of £22,500 plus RPI increases in May of each year.

• £109,000 (2019: £nil) premium payable on Credit Default Swaps held during the year.

7. Finance Costs

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

The Company has repo financing arrangements in place which were used during the year in place of the revolving credit facility that lapsed in May 2019. For repos that are denominated in currencies where the interest rate is negative, the interest is receivable and has been netted against repo interest payable within finance costs, as they relate to borrowing costs.

Previously the Company had a 364 day committed £20 million multi-currency revolving credit facility with Bank of New York Mellon which lapsed on 4 May 2019 and was not renewed. No amounts had been drawn down under the facility during the previous year.

8. Taxation

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

The Company is subject to Jersey income tax at the rate of 0% (2019: 0%). The overseas tax charge consists of irrecoverable withholding tax suffered.

9. Return per Ordinary Share

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

The basic revenue, capital and total return per ordinary share is based on each of the returns on ordinary activities after taxation and on 101,553,976 (2019: 98,065,591) ordinary shares, being the weighted average number of ordinary shares in issue throughout the year.

10. Dividends on Ordinary Shares

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

Dividends paid in the year have been charged to revenue except for £50,000 (2019: £32,000) which was charged to stated capital. This amount is equivalent to the income accrued on the new shares issued in the year (see note 16).

Set out below are the dividends that have been declared in respect of the financial years ended 31 December:

The fourth interim dividend for 2020 was paid on 25 February 2021 to shareholders on the register on 22 January 2021.

11. Investments Held at Fair Value Through Profit and Loss

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

• realised, usually arising when investments are sold; or

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

(a) Analysis of investment profits in the year

The Company received £72,197,000 (2019: £57,191,000) from investments sold in the year. The book cost of these investments when they were purchased was £74,591,000 (2019: £53,324,000) realising a loss of £2,394,000 (2019: profit £3,867,000). These investments have been revalued over time and until they were sold any unrealised profits/losses were included in the fair value of the investments.

(b) Transaction costs

The transaction costs included in gains on investments amount to £nil (2019: £nil) on purchases and £nil (2019: £nil) for sales.

(c) Registration of investments

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

(d) Securities sold under agreements to repurchase

Included in the valuation above, are securities under agreements to repurchase which had a market value of £17,817,000 (2019: £nil).

12. Other Receivables

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

13. Derivative Financial Instruments

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

Derivative financial instruments comprise forward currency contracts.

14. Other Payables

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

15. Securities sold under agreements to repurchase

During the year, the Company entered into repo financing arrangements whereby securities are sold under agreements to repurchase. Further details are shown in note 2(f) and note 19.3.

16. Stated Capital

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

Details of the stated capital and rights attaching to the Company’s ordinary shares are shown in the Directors’ Report on page 65.

For the year to 31 December 2020 1,700,000 (2019: 2,950,000) new ordinary shares were issued to the Company’s corporate broker, Winterflood Securities Limited, for onward transmission to their clients. These shares were issued in tranches of various quantities throughout the year to satisfy secondary market demand. The gross issue proceeds were £3,313,000 (2019: £5,661,000), at an average price of 194.91p (2019: 191.90p), and the net proceeds after issue costs were £3,271,000 (2019: £5,617,000). The net proceeds included an aggregate amount of £50,000 (2019: £32,000) which arose from the income accrued component of the net asset value at the date of issue of the new shares.

Subsequent to the year end no ordinary shares were issued.

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

17. Reserves

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

The capital reserve includes unrealised investment holding profits and losses, being the difference between cost and market value at the balance sheet date, as well as realised profits and losses of disposals of investments. In addition, costs allocated to capital are recognised in the capital reserve. The revenue reserve shows the net revenue after payment of any dividend from the reserve. Both the capital and revenue reserves are distributable.

18. Net Asset Value per Ordinary Share

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

The net asset value per share and the net asset values attributable at the year end were as follows:

Net asset value per ordinary share is based on net assets at the year end and on 101,741,204 (2019: 100,041,204) ordinary shares, being the number of ordinary shares in issue (excluding treasury) at the year end.

19. Financial Instruments

Financial instruments comprise the Company’s investment portfolio and derivative financial instruments (for the latter see note 13) as well as any cash, borrowings (i.e. securities sold under agreements to repurchase otherwise known as ‘repo financing’), other receivables and other payables. The following note explains the risks that affect the Company’s financial instruments and looks at the Company’s exposure to these various risks.

Risk Management Policies and Procedures

The Strategic Report details the Company’s approach to investment management risks on pages 13 and 14 and the accounting policies in note 2 explain the Company’s valuation basis for investments and currency.

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

The Company’s principal financial instruments at risk comprise its investment portfolio. Other financial instruments at risk include cash and cash equivalents, borrowings (including repo financing), other receivables and other payables that arise directly from the Company’s operations.

The Company may enter into derivative transactions, including credit default swaps, for efficient portfolio management. Derivative instruments can be highly volatile and expose investors to a high risk of loss. Where used to hedge risk there is a risk that the return on a derivative does not exactly correlate to the returns on the underlying investment, obligation or market sector being hedged against. If there is an imperfect correlation, the Company may be exposed to greater loss than if the derivative had not been entered into. During the year the only derivatives entered into were forward currency contracts and credit default swaps. As at the year end, no credit default swaps were held.

These risks and the Directors’ approach to managing them are set out below, and have not changed from those applying in the comparative year.

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

High-yield fixed-interest securities are subject to a variety of risks, including credit risk (note 19.3).

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

19.1 Market Risk

Market risk arises from changes in the fair value or future cash flows of a financial instrument. Market risk comprises three types of risk: currency risk (note 19.1.1), interest rate risk (note 19.1.2) and other price risk (note 19.1.3).

19.1.1 Currency Risk

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

Management of the Currency Risk

The Board meets at least quarterly to assess risk and review investment performance. The portfolio managers monitor the Company’s exposure to foreign currencies on a daily basis and is reviewed by Directors at each Board meeting. The Company may use forward currency contracts to mitigate currency risk. Repo financing is matched to the currency of the underlying assets, which minimises currency risk on the movement of exchange rates affecting the underlying investments. Non-sterling investments that are not pledged under repo financing can be hedged using forward currency contracts. All borrowings and derivative contracts are limited to currencies and amounts commensurate with asset exposure to those currencies.

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

Currency Exposure

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

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

Currency Sensitivity

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

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

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

If sterling had weakened by the same amounts, the effect would have been the converse.

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

19.1.2 Interest Rate Risk

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

Management of Interest Rate Risk

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

When the Company has cash balances, they are held in variable rate bank accounts yielding rates of interest dependant on the base rate of the Custodian, the Bank of New York Mellon (International) Limited. Holdings in Invesco Liquidity Funds plc – Sterling are subject to interest rate changes.

The Company has available repo financing arrangements it can use to finance investment activity, details of which are shown in note 7. The Company uses these at levels approved and monitored by the Board.

Interest Rate Exposure

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

* Includes £1,620,000 (2019: £6,857,000) held in Invesco Liquidity Funds plc - Sterling (formerly Short-Term Investment Company (Global Series) plc).

The nominal interest rates on the investments at fair value through profit or loss are shown in the portfolio list on pages 22 to 26. The weighted average effective interest rate on these investments is 6.3% (2019: 6.5%). The weighted average effective interest rate on cash and cash equivalents is 0.22% (2019: 0.75%).

Interest Rate Sensitivity

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

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

The above exposure and sensitivity analysis are not representative of the year as a whole, since the level of exposure changes frequently as borrowings, which are predominantly from repo financing arrangements, can vary throughout the year.

19.1.3 Other Price Risk

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

Management of Other Price Risk

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

The Company’s exposure to other changes in market prices at 31 December on its investments is shown in the fair value hierarchy table on page 63.

Concentration of Exposure to Other Price Risks

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

Other Price Risk Sensitivity

Excluding fixed interest securities and convertibles, at the year end the Company held other investments of £4,378,000 (2019: £7,193,000). The effect of a 10% increase or decrease in the fair values of these investments (including any exposure through derivatives) on the profit after taxation for the year is £438,000 (2019: 30% increase or decrease: £2,158,000). This level of change is considered to be reasonably possible based on the observation of market conditions during the financial year, taking account of the subsequent recovery of markets in the aftermath of Covid-19, since March 2020. As for 2019, this sensitivity level was higher to reflect the extreme market volatility that was experienced subsequent to the year end in March 2020. The sensitivity analysis is based on the Company’s equities and equity exposure through derivatives at the balance sheet date with all other variables held constant.

19.2 Liquidity Risk

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

Management of Liquidity Risk

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

Liquidity Risk Exposure

The contractual maturities of the financial liabilities at 31 December, based on the earliest date on which payment can be required, was as follows:

19.3 Credit Risk

Credit risk is the risk that the failure of the counterparty to a transaction to discharge its obligation under that transaction could result in a loss to the Company. The Company’s principal credit risk is the risk of default on the non-investment grade debt. The Company’s other main credit risk arises from the repo financing arrangements whereby, if a counterparty failed to sell the required assets to the Company on the repurchase date, the Company would be left with the claim against the defaulting counterparty for the stock and, if applicable, any margin held by the counterparty and not returned.

At the year end 74.6% (2019: 74.8%) of the Company’s portfolio consisted of non-investment grade securities. To the extent that the Company invests in non-investment grade securities, the Company may realise a higher current yield than the yield offered by investment grade securities. On the other hand, investments in such securities involve a greater volatility of price and a greater risk of default by the issuers of such securities, with consequent loss of interest payments and principal. Non-investment grade securities are likely to be subject to greater uncertainties from exposure to adverse conditions and will be speculative with respect to an issuer’s capacity to meet interest payments and repay principal in accordance with its obligations.

Investment grade and non-investment grade securities totalled 93.4% (2019: 88.8%) of the portfolio at the year end. Adverse changes in the financial position of an issuer of such high-yield fixed-interest securities or in general economic conditions may impair the ability of the issuer to make payments of principal and/or interest or may cause the liquidation or insolvency of an issuer.

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

Management of and Exposure to Credit Risk

Almost all of the Company’s assets are subject to credit risk. Where the portfolio managers make an investment in a bond, corporate or otherwise, the credit rating of the issuer is also considered when assessing the risk of defaults. Investments in bonds are across a variety of industrial sectors and geographical markets to avoid concentration of credit risk. Counterparties for derivative transactions are also a source of credit risk. Transactions involving derivatives are entered into only with banks whose credit ratings are taken into account to minimise default risk. The credit ratings of the derivatives counterparties range from Aa3 through to Baa1. In addition, the Company may, and did to a minor extent, use credit default swaps (CDSs) to offset the credit risk of the portfolio (2019: none). At the year end, no credit default swaps were held by the Company.

Details of the Company’s investments, including their credit ratings, are shown on pages 22 to 26. Credit risk for transactions involving derivatives and equity investments is minimised as the Company only uses approved counterparties.

The Company manages the credit risk inherent in repo financing by only dealing with good quality counterparties whose credit-standing is reviewed periodically by the Manager. There is a maximum limit allowed with any one counterparty, and the repo entered into must have a maturity tenor of three months or less. The Company has exposure to credit risk on securities pledged under repo financing held, with three counterparties, as follows (2019: no exposure):

There were no amounts borrowed under Repo financing as at 31 December 2019.

Cash balances are held with approved deposit takers only and are limited to a maximum of 4% of the Company’s net asset value with any one deposit taker. Balances held with Invesco Liquidity Funds plc, a triple-A rated money market fund, are limited to a maximum of 10% of the Company’s net asset value. At the balance sheet date the Company had £1.32 million (2019: £1.46 million) held at the custodian and £1.62 million held in Invesco Liquidity Funds plc – Sterling (2019: £6.86 million held in Short-Term Investment Company (Global Series) plc).

There are no financial assets that are past due or impaired during the year (2019: none).

Fair Values of Financial Assets and Financial Liabilities

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

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

20. Classification Under Fair Value Hierarchy

The valuation techniques used by the Company are explained in the accounting policies note 2(c). The table that follows sets out the fair value of the financial instruments. The three levels set out in IFRS 7 hierarchy 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 (i.e. developed using market data) for the asset or liability, either directly or indirectly.

Level 3 – Inputs are unobservable (i.e. 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.

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

Normally investments would be valued using stock market active prices, with investments disclosed as Level 1 and this is the case for the quoted equity investments that the Company holds. However, the majority of the Company’s investments are non-equity investment. Evaluated prices from a third party pricing vendor are used to price these securities, together with a price comparison made to secondary and tertiary evaluated third party sources. Evaluated prices are in turn based on a variety of sources including broker quotes and benchmarks. As a result, the Company’s non-equity investments have been shown as Level 2 – recognising that the fair values of these investments are not as visible as quoted equity investments and their higher inherent pricing risk. However, this does not mean that the fair values shown in the portfolio valuation are not achievable at point of sale. No Level 3 investments were held during the year or the previous year.

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

21. 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 8.

The main risks to the Company’s investments are shown in the Strategic Report under the ‘Principal Risks and Uncertainties’ section on pages 13 to 15. These also explain that the Company is able to gear its portfolio by borrowing in the form of repo financing 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 Board regularly monitors the level of borrowing used by the Company and has imposed limits within which borrowings should be managed.

Total equity at the balance sheet date, the composition of which is shown on the balance sheet on page 46, was £197,675,000 (2019: £192,186,000).

22. Contingencies, Guarantees and Financial Commitments

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

There were no contingencies, guarantees or other financial commitments of the Company as at 31 December 2020 (2019: nil).

23. Related Party Transactions and Transactions with the Manager

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

Under International Financial Reporting Standards as adopted by the EU, the Company has identified the Directors as related parties and Directors fees paid have been disclosed in the Report on Directors’ Remuneration and Interests on pages 36 and 37 with additional disclosure in note 6. Full details of Directors’ interests are set out in the Report on Directors’ Remuneration and Interests on page 37. No other related parties have been identified.

Invesco Fund Managers Limited and Invesco Asset Management Limited, both of which are wholly owned subsidiaries of Invesco Limited, provided investment management and administration services to the Company. Details of the services and fees are disclosed in the Strategic Report and management fees payable are shown in note 5.

24. Post Balance Sheet Events

Any significant events that occurred after the end of the reporting period but before the signing of the balance sheet will be shown here.

The Board of the Company announced on 1 March 2021 that it has signed Heads of Terms with the Board of Invesco Enhanced Income Limited (“IPE”) in respect of a proposed merger with IPE to be effected by way of a shareholder approved contractual scheme of reconstruction by IPE and a transfer of assets to the Company. There are no other significant events after the end of the reporting period requiring disclosure.

This annual financial report announcement is not the Company’s statutory accounts. The statutory accounts for the period ended 31 December 2020 have been audited and approved but are not yet filed. They received an audit report which is unqualified and does not include a reference to any matters to which the auditors drew attention by way of emphasis without qualifying the report. 

The audited annual financial report will be posted to shareholders shortly. Copies may be obtained during normal business hours from the Company’s Registered Office, JTC Fund Solutions (Jersey) Limited, PO Box 1075, 28 Esplanade, St Helier, Jersey JE4 2QP or the Manager’s website via the directory found at the following link: www.invesco.co.uk/citymerchants. The Annual General Meeting of the Company will be held at 9.30am on 22 June 2021 at the offices of JTC Fund Solutions (Jersey) Limited, PO Box 1075, 28 Esplanade, St Helier, Jersey JE4 2QP

.

Hilary Jones

JTC Fund Solutions (Jersey) Limited

Telephone: 01534 700000

30 March 2021