Edinburgh Investment Trust PLC Regulatory News (EDIN)

Edinburgh Investment Trust Plc - Annual Financial Report

PR Newswire

London, May 31

 The Edinburgh Investment Trust plc

Annual Financial Report Announcement

For the Year Ended 31 March 2018

FINANCIAL INFORMATION AND PERFORMANCE STATISTICS

Notes:

(1) Defined in the Glossary of Terms in the annual financial report. NAV with debt at market value is widely used by the investment company sector for the reporting of performance or premium, discount, gearing and ongoing charges.

(2) Source: Thomson Reuters.

(3) Key Performance Indicator.

(4) Based on year end figures.

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Chairman’s Statement

Dear Shareholder

After almost twelve years on the Board and six of these as Chairman, Jim Pettigrew stood down in November 2017 and I was honoured to accept the Board’s invitation to become Chairman. Under Jim’s leadership the Company successfully emerged as a flagship holding in the sector, with a top class Manager, a strong Board and an attractive cost structure. I am sure you will wish to all join me in thanking Jim for his years of service. Following Jim’s departure the Company reviewed the composition of the Board and is currently in the process of recruiting a new director.

As you will read in the Performance section below, the Company had a disappointing year as profit warnings at a number of companies and a widening of the discount depressed the share price. Mark Barnett, the portfolio manager has reported on these in detail in his Portfolio Manager’s Report which follows, but I would like to make a few observations here.

As stated in the annual financial report, the Company has two objectives for the medium to long term: the first is to outperform the FTSE All-Share Index over the long term on a net asset value (NAV) basis and, second, to produce dividend growth in excess of UK inflation, by investing primarily in a portfolio of UK listed shares. The Board has delegated discretion to Mark to manage the portfolio (subject to certain prudential restrictions) and we meet regularly with him to discuss, challenge and oversee his actions. Over the past five years, both these objectives have been met: in that period, the Company’s NAV with debt at market value returned 25.8% cumulatively, whilst the Company’s benchmark over the same period returned 15.2%. In addition, annualised dividend growth of 3.1% over the past five years compares favourably with annualised inflation measured in term of the Retail Prices Index of 2.3%.

One of the attractions of Mark’s approach to investment, as Jim Pettigrew noted last year, is that it is based on fundamental research and Mark builds his portfolios using the convictions that result from his analysis. As a result, the portfolio tends to be concentrated in a number of holdings and sectors. This approach has the potential to deliver significant outperformance over the medium to long term but, inevitably, a concentrated portfolio of this kind may also result in periods of underperformance as has been the case in the past two years. The Board continues to believe that Mark’s approach, accompanied by appropriate Board support, oversight and challenge, is the right one.

Performance

For the year ended 31 March 2018, the Company’s net asset value total return was –5.9% with debt at market whilst the Company’s benchmark index returned +1.2%. The portfolio was adversely affected by profit warnings at Provident Financial, Capita and BT and by a sell-off in tobacco stocks. A more detailed explanation is set out in the Portfolio Manager’s Report.

The Company’s share price ended the year at 642p, a decline of 10% from the previous year’s closing price of 713.5p. This reflected the fall in NAV but was exacerbated by a modest widening of the discount: with debt at market the discount widened to 8.7% from 7.2% at the end of the previous year.

At 30 May 2018, the latest practical date before the signing of this report, the NAV and share price had risen and were respectively 758.45p and 686.00p and the resultant discount has narrowed to 9.6% with debt at market.

Dividend

In line with our policy of recent years to rebalance the interim and final dividend towards the interim dividend, in the year to 31 March 2018, the Board has declared three interim dividends of 5.8p (2017: 5.4p) and is proposing a final dividend of 9.2p (2017: 9.15p) per share. This would produce a total dividend of 26.60p for the year (2017: 25.35p), an increase of 1.25p. This would represent an increase of 4.9% in the total dividend over the previous year, which is in excess of the 3.3% annual increase in the Retail Prices Index and reflects the Board’s commitment to providing income growth which exceeds the rate of inflation. The final dividend, which is subject to approval by shareholders, will be paid on 24 July 2018 to shareholders on the register on 22 June 2018.

Borrowings and Gearing

The Company has in place a mixture of fixed and floating rate borrowings. These comprise the Company’s 7¾% 2022 debenture and a £150 million, 364 day revolving bank credit facility. By this means, Mark has the ability to vary the gearing level of the portfolio depending on his view of the market. Borrowings at the start of the year were £209.7 million (equivalent to gross gearing with debt at market value of 15.9%), aggregate borrowings during the year ranged between £122.3m and £231.8m and ended the year at £143.9m, equivalent to gross gearing with debt at market value of 12.1%, reflecting Mark’s more cautious outlook.

Costs

The on-going charges ratio fell from 0.60% to 0.57%. A significant proportion of these charges are paid to Invesco for a variety of services including portfolio management, administration, regulation and compliance, shareholder communication and support services and supervision of the arrangements with other key service providers.

Outlook

In the short term, stock market performance tends to be influenced by liquidity conditions but over the longer term, both liquidity conditions and stock markets are driven by market fundamentals. The UK markets, in particular, given the large number of global and emerging as well as domestic stocks listed here, are affected by a range of global and local fundamentals.

Today, these fundamentals are harder to assess than they have been for a long time. The UK faces considerable uncertainty relating to Brexit which is holding back domestic investment, and GDP growth has slowed: in the first quarter of 2018 GDP growth was just 0.1%, falling short of the estimate of 0.4% and implying that GDP growth may struggle to reach 1.5% for 2018. The Office for Budget Responsibility, which makes official forecasts for the Government, believes that annual UK GDP growth will remain under 2.0% in each of the next five years: if anything like this occurs, it will be the worst five-year period for UK GDP growth since 1875-1879. Even so the portfolio manager believes that there is considerable value in the UK as the market has oversold some good quality UK companies; you should note that the portfolio also contains significant positions that are geared to global growth. On the other hand, the market believes that the US is approaching full capacity – reported unemployment levels there have reached lows not previously seen since the 1970s – and is now expecting higher inflation and higher interest rates. The Federal Reserve expects US GDP growth to remain strong in 2018 and 2019 and the IMF expects global GDP growth to accelerate to 3.9% in 2018 and remain strong in 2019. These developments have led investors to switch funds from the UK to the international markets, substantially de-rating UK domestic companies.

Longer term, there are a number of important issues that may also affect growth and the performance of markets.

Over the past 30 years, three important developments have enabled the return on financial assets to be higher than GDP growth almost everywhere, despite the crises we have had to endure: first, the growth in the size of labour force in relation to population as the baby boomer generation entered the workforce. This has led to falling dependency ratios throughout the developed world and has allowed Governments to cut corporate taxes sharply and firms to reduce pension payments; second, integration of global markets, and of China in particular, has enabled global trade to grow faster than global GDP. This in turn has enabled more profitable reallocation of capital globally and higher returns to corporate investment, especially for those companies able to globalise their operations; and third, (and almost certainly related to the above two factors) a long term fall in inflation and interest rates has prompted a hunt for yield which made some kinds of financial assets very attractive to investors.

These trends are now abating: with a few exceptions, labour forces are expected to grow more slowly (or even decline) relative to the overall population, raising dependency costs and increasing pressure for higher taxes to pay for pensions, health and social care; global trade growth is under pressure as the US – the lynchpin of the global trading system – seeks to limit its trade deficits through tariffs, renegotiation of the North American Free Trade Agreement and a shift to operating through bilateral as opposed to multilateral institutions like the World Trade Organisation; and finally, markets have begun to price long term rises in interest rates, with the US 10 year Treasury bond now yielding almost 3%. It is of course possible that technology in the form of robots and artificial intelligence and new trading patterns will increase productivity, but these will come with social and political disruption.

The Board believes that this environment is best navigated through focused, fundamental research and careful stock picking and portfolio construction. This is the kind of approach that Mark has long adopted and, despite the disappointing performance of the last two years, it has produced good long-term results.

Glen Suarez

Chairman

31 May 2018

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Portfolio Manager’s Report

For the year ended 31 March 2018

Market Review

The UK stock market delivered flat performance over the 12 month period under review. This outcome masked some price volatility as the FTSE All-Share index reached an all-time high at the end of 2017. However this strength proved to be temporary as the market weakened in the early months of 2018. The period was dominated by the countervailing forces of better global economic growth, with associated increases in anticipated interest rates, and ongoing political concerns, especially domestically focused around the Brexit negotiations. The combination of these two opposing factors, alongside significant foreign exchange movements, led to increased polarisation of sector performance in the UK stock market.

The market’s rise of 2017 was led by a rally in the oil and mining sectors, on the back of an improving outlook for global growth, while sterling fell in response to the surprise outcome of the UK general election. However, in the final quarter of the period, rising geopolitical uncertainty, including the possible impact of trade wars, and strength in sterling on the back of better news on Brexit negotiations, resulted in a more difficult backdrop for the market. The most high profile underperformers were a range of global businesses, which saw double digit falls. The reality of rising interest rates and bond yields in the US, with the expectation of more to follow, also impacted the valuation of these companies which have a significant influence on the performance of the market.

The other dominant theme of the stock market throughout the past 12 months, which has gone largely unnoticed, has been the continued poor sentiment towards UK domestic sectors. This can be attributed to the combination of a pessimistic outlook towards the Brexit negotiations and the weak government elected last June alongside an improvement in the global backdrop. The result has been a collapse in valuations for domestically focused companies, leaving them at multi year lows.

Portfolio Strategy and Review

The Company’s net asset value, including reinvested dividends, returned –5.9% during the period under review, compared with a return of +1.2% (total return) by the FTSE All-Share Index.

The portfolio remains heavily weighted in the tobacco sector, with investments in Altria, British American Tobacco (BAT), Imperial Brands and Reynolds American (now merged with BAT). These companies have delivered exceptional returns for shareholders over the long term. However, over the past year the sector was impacted by headwinds which resulted in a negative performance. In 2017, the stock market focused on plans announced by the US Food and Drug Administration to launch a consultation on lowering nicotine levels in cigarettes (regulation which may be expected to take some time to come to fruition). Subsequent underperformance resulted from the weakness of the US dollar and the profit impact on translation into sterling, as well as the shift in market sentiment towards more economically sensitive sectors in a period of rising bond yields.

This negative performance came despite the successful completion last year by BAT of the acquisition of Reynolds American – creating an entity which is well positioned to exploit both traditional cigarettes and next generation products, particularly in the key US market. The headwinds described above overshadowed news of underlying growth across the business and a 15% increase in the dividend.

The holding in Provident Financial delivered negative returns over the period as a whole, despite rallying sharply in the final quarter. The company issued a profit warning last August, downgrading forecasts for its consumer credit division from a profit of £115m to a loss of between £80-120m for the year. Additionally, the business announced that its subsidiary Vanquis Bank was subject to, and co-operating with, a Financial Conduct Authority (‘FCA’) investigation into its repayment option plan ancillary product, along with the resignation of its chief executive and the cancellation of its dividend.

In February of this year, earlier than expected by the market, Provident Financial announced that it had reached resolution in respect of the FCA investigation and was raising a total of £300m to strengthen the balance sheet – maintaining its investment grade status – and that it will return to paying dividends this year before resuming a “progressive” dividend policy in 2019.

Capita also endured a challenging year. Following the news of the bankruptcy of fellow government outsourcer Carillion (which is not held in the portfolio), the company’s board revised its view of an appropriate balance sheet structure for the business. As a result, Capita announced the cancellation of its dividend and the outline of a fund raising, without the details – creating significant pressure on the shares. The company also announced a major re-structuring – which I believe will create a leaner, more focused, financially stronger and more efficient business. Subsequent to the period end, Capita announced a 3 for 2 rights issue raising £701 million which has been well received by the stock market.

The list of small but significant positions outlined above outweighed and overshadowed strong performances from elsewhere in the portfolio. Noteworthy amongst these again was Burford Capital – as the litigation financier confirmed that full year profits had more than doubled from the previous year and announced a 20% increase in its dividend. The outstanding success of this investment has affirmed my view of the value of non-correlated stocks within the portfolio, as I seek to find diversified sources of income growth. The positive contributions from non-life insurers Hiscox and Beazley were further confirmation of this strategy.

Some of the portfolio’s ‘Brexit hit’ stocks showed a significant turnaround in share price performance, with the holding in easyJet seeing its share price rise by over 50% over the period. The company maintained its impressive growth record, as it reported rising sales and revenues on the back of market share gains, with the bankruptcies of Monarch, Air Berlin and Alitalia providing opportunities for the company in a highly competitive market.

Sentiment towards the real estate sector – notably those exposed to the London office market – was also negatively impacted in the aftermath of the 2016 Referendum. Derwent London saw its share price recover some lost ground, as it confirmed strong growth in earnings on the back of a record lettings year. Tenant demand for Derwent’s differentiated buildings in near prime locations remains robust, with Brexit having ‘no impact so far’. Derwent further pleased investors with a special dividend of 75p a share.

The woes of the UK retail sector have been well publicised. However, Next confirmed that its multi channel offering allows it to see the growth of on-line shopping as an opportunity not a threat, while it can flex its leasehold property base to take best advantage of future trends in apparel retailing. Meanwhile, its focus on shareholder returns – through special dividends and further share buy backs – underpinned earnings growth despite a challenging retail back drop and increased investment in logistics to improve the efficiency of its on–line business.

In terms of portfolio activity during the period, new investments were made in real estate businesses Assura, British Land and Secure Income REIT, along with Eddie Stobart Logistics, Royal Dutch Shell ‘A’ and Tesco. As mentioned above, the holding in Reynolds American was taken over by BAT, with the portfolio receiving a mix of BAT shares and cash. The holdings in Centrica, Compass, Game Digital, London Stock Exchange, N Brown and SSE were sold.

Outlook

The performance of the UK stock market will remain heavily influenced in the near term by the combination of two key variables. The movements in sterling relative to the US dollar being a reflection of the Brexit negotiations in Brussels and the continued vacillations in sentiment to both the domestic economy and the fragile political scene.

The UK stock market is not expensively valued on an historical basis as demonstrated by a price earnings multiple of circa 14 times for the current year. This represents a significant discount to other major stock markets and is clearly indicative of the Brexit discount applied indiscriminately to UK quoted companies.

There is substantial opportunity in a number of high quality companies – global leaders in their field – which have been de-rated by the market as a mood of pessimism has overwhelmed the still-strong business fundamentals. As a prime example, the tobacco sector’s focus on pricing power, cash conversion and product innovation should continue to provide a reliable source of income, underpinning longer term returns to shareholders, while the next generation products have the potential to deliver a significant new revenue stream. Furthermore, the steep decline in the valuations given to this sector over recent months leaves the shares looking increasingly attractive long term investments.

However, perhaps the most significant area of opportunity – and the main focus of recent portfolio activity – is within the sectors that offer direct exposure to the UK economy, notably financials, consumer cyclicals and real estate. Whilst there has been plenty of negative commentary about the UK economy, in particular regarding the spike in headline inflation post the EU referendum and the impact on real wage growth, the underlying economic trends have started to reverse. Given the tightness in the labour market, there is likely to be an acceleration of real wages over the coming quarters, which in turn is likely to engender a greater sense of optimism than the consensus entrenched pessimism. Structural challenges and worrying newsflow will continue to affect those domestic legacy businesses that lack a sustainable competitive advantage, however there are now compelling opportunities for selective investment in a number of well managed domestically focused names, with substantial uncorrelated income and growth potential, that have been neglected by the market. It is noteworthy on that front that there has been a pick-up in corporate activity and takeover proposals to UK companies. For example, the widening discounts of the real estate sector have prompted approaches, including a recently unsuccessful bid proposal to Hammerson by French competitor Klepierre. Activist investors have taken advantage of depressed share prices to take stakes in large cap companies to encourage changes in corporate strategy.

Recent market swings have favoured momentum style investing, with an ever-increasing disparity between valuation and fundamentals becoming clear. It is frustrating that in periods of extreme momentum – as we have experienced over the past year – fund performance will predictably struggle to keep pace. The current environment is supporting premium valuations for growth or highly disruptive companies. 

My outlook and positioning has changed very little over the past few months. I am convinced that in a changing global environment the interests of investors are best served by employing a well-tested investment process, which is based on fundamental company analysis and a prudent approach to valuation. I continue to evaluate and to re-evaluate the holdings in the portfolio and to seek the best opportunities to create a sustainable flow of dividend income for investors. In times of extreme momentum and somewhat irrational market pricing it is vital that I remain rooted in the fundamental investment thesis which has served me well historically – and continues to do so.

Mark Barnett

Portfolio Manager

31 May 2018

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Business Review

Strategy and Business Model

The Edinburgh Investment Trust plc is an investment company and its investment objective is set out below. The strategy the Board follows to achieve that objective is to set investment policy and risk guidelines, together with investment limits, and to monitor how they are applied. These are also set out below and have been approved by shareholders.

The business model the Company has adopted to achieve its investment objective has been to contract the services of Invesco Fund Managers Limited (the ‘Manager’) to manage the portfolio in accordance with the Board’s strategy and under its oversight. The portfolio manager with individual responsibility for the day-to-day management of the portfolio is Mark Barnett and the deputy portfolio manager is James Goldstone.

In addition, the Company has contractual arrangements with Link Asset Services (formerly known as Capita Asset Services) to act as registrar and the Bank of New York Mellon (International) Limited (BNYMIL) as depositary and custodian. BNYMIL became the depositary following novation of the depositary agreement from BNY Mellon Trust & Depositary (UK) Limited, on 1 December 2017. This transfer has had no substantive effect on the services received by the Company.

Investment Objective and Policy

Investment Objective

The Company invests primarily in UK securities with the long term objective of achieving:

1. an increase of the Net Asset Value per share in excess of the growth in the FTSE All-Share Index; and

2. growth in dividends per share in excess of the rate of UK inflation.

Investment Policy

The Company will generally invest in companies quoted on a recognised stock exchange in the UK. The Company may also invest up to 20% of the market value of the Company’s investment portfolio, measured at the time of any acquisition, in securities listed on stock exchanges outside the UK. The portfolio is selected by the Manager on the basis of its assessment of the fundamental value available in individual securities. Whilst the Company’s overall exposure to individual securities is monitored carefully by the Board, the portfolio is not primarily structured on the basis of industry weightings. No acquisition may be made which would result in a holding being greater than 10% of the market value of the Company’s investment portfolio. Similarly, the Company may not hold more than 5% of the issued share capital (or voting shares) in any one company. Investment in convertibles is subject to normal security limits. Should these or any other limit be exceeded by subsequent market movement, each resulting position is specifically reviewed by the Board.

The Company may borrow money to provide gearing to the equity portfolio of up to 25% of net assets.

Use of derivative instruments is monitored carefully by the Board and permitted within the following constraints: the writing of covered calls against securities which in aggregate amount to no more than 10% of the value of the portfolio and the investment in FTSE 100 futures which when exercised would equate to no more than 15% of the value of the portfolio. Other derivative instruments may be employed, subject to prior Board approval, provided that the cost (and potential liability) of exercise of all outstanding derivative positions at any time should not exceed 25% of the value of the portfolio at that time. The Company may hedge exposure to changes in foreign currency rates in respect of its overseas investments.

Results and Dividends

At the year end the share price was 642.0p per ordinary share (2017: 713.5p). The net asset value (debt at market value) per ordinary share was 703.34p (2017: 768.81p).

Subject to approval at the AGM, the final proposed dividend for the year ended 31 March 2018 of 9.2p (2017: 9.15p) per ordinary share will be payable on 24 July 2018 to shareholders on the register on 22 June 2018. The shares will be quoted ex-dividend on 21 June 2018. This will give total dividends for the year of 26.6p per share, an increase of 4.9% on the previous year’s dividends of 25.35p. The revenue return per share for the year was 29.3p, a 5.0% increase on the 2017 return of 27.9p.

Performance

The Board reviews the Company’s performance by reference to a number of key performance indicators (KPIs) which are shown in the annual financial report. Notwithstanding that some KPIs are beyond its control, they are measures of the Company’s absolute and relative performance. The KPIs assist in managing performance and compliance and are reviewed by the Board at each meeting.

The Chairman’s Statement above gives a commentary on the performance of the Company during the year, the gearing and the dividend.

Expenses are reviewed at each Board meeting enabling the Board, amongst other things, to review costs and consider any expenditure outside that of its normal operations. For the year being reported, all KPIs are considered satisfactory.

The Board also regularly reviews the performance of the Company in relation to the 24 investment trusts in the UK Equity Income sector. As at 31 March 2018, the Company was ranked 23rd by NAV performance in this sector over one year and 20th over three and 8th over five years (source: JPMorgan Cazenove).

Analysis of Performance

Financial Position and Borrowings

The Company’s balance sheet below shows the assets and liabilities at the year end. Borrowings at the year end comprised the £100 million 73/4% debenture which matures in 2022 and £43.9 million (2017: £109.7 million) drawn down on the Company’s £150 million bank revolving credit facility. Details of this facility are contained in note 11.

The Company also has a bank overdraft facility of up to 10% of assets held by the custodian, which is available to facilitate settlement of short-term cash timing differences. As at 31 March 2018, this was not drawn down (2017: nil).

Outlook, including the Future of the Company

The main trends and factors likely to affect the future development, performance and position of the Company’s business can be found in the Portfolio Manager’s Report. Details of the principal risks affecting the Company follow.

Analysis of Performance – analyses the performance of the Company relative to its benchmark index.

Relative performance – represents the arithmetic difference between the NAV and the benchmark.

Net gearing effect – measures the impact of the debenture stock, bank loan and cash on the Company’s relative performance. This will be positive if the portfolio has positive performance.

Interest – arising from the debenture stock and bank loan interest paid has a negative impact on performance.

Management fee – the base fee reduces the Company’s net assets and decreases performance.

Other expenses and tax – reduce the level of assets and therefore result in a negative effect on relative performance.

Principal Risks and Uncertainties

The Company’s key long-term investment objectives are an increase in the net asset value per share in excess of the growth in the FTSE All-Share Index (the ‘benchmark’) and an increase in dividends in excess of the growth in RPI. The principal risks and uncertainties facing the Company are an integral consideration when assessing the operations in place to meet these objectives, including the performance of the portfolio, share price and dividends. The Board is ultimately responsible for the risk control systems but the day-to-day operation and monitoring is delegated to the Manager. The Board has carried out a robust assessment of the principal risks facing the Company, including those that would threaten its business model, future performance, solvency or liquidity and the following sets out a description of those risks and how they are being managed or mitigated.

Market Risk

A great majority of the Company’s investments are traded on recognised stock exchanges. The principal risk for investors in the Company is a significant fall, and/or a prolonged period of decline in those markets. The Company’s investments, and the income derived from them, are influenced by many factors such as general economic conditions, interest rates, inflation, political events, and government policies as well as by supply and demand reflecting investor sentiment. Such factors are outside the control of the Board and Manager and may give rise to high levels of volatility in the prices of investments held by the Company. The asset value and price of the Company’s shares and its earnings and dividends may consequently also experience volatility and may decline.

Investment Performance Risk

The Board sets performance objectives and delegates the investment management process to the Manager. The achievement of the Company’s performance objectives relative to the market requires active management of the portfolio of assets and securities. The Manager’s approach is to construct a portfolio which should benefit from expected future trends in the UK and global economies. The Manager is a long term investor, prepared to take substantial positions in securities and sectors which may well be out of fashion, but which the Manager believes will have potential for material increases in earnings and, in due course, dividends and share prices. Strategy, asset allocation and stock selection decisions by the Manager can lead to underperformance of the benchmark and/or income targets. The Manager’s style may result in a concentrated portfolio with significant overweight or underweight positions in individual stocks or sectors compared to the index and consequently the Company’s performance may deviate significantly, possibly for extended periods, from that of the benchmark. In a similar way, the Manager manages other portfolios holding many of the same stocks as the Company which reflects the Manager’s high conviction style of investment management. This could significantly increase the liquidity and price risk of certain stocks under certain scenarios and market conditions. However, the Board and Manager believe that the investment process and policy outlined above should, over the long term, meet the Company’s objectives of capital growth in excess of the benchmark and real dividend growth.

Investment selection is delegated to the Manager. The Board does not specify asset allocations. Information on the Company’s performance against the benchmark and peer group is provided to the Board at each Board meeting. The Board uses this to review the performance of the Company, taking into account how performance relates to the Company’s objectives. The Manager is responsible for monitoring the portfolio selected and seeks to ensure that individual stocks meet an acceptable risk-reward profile.

As shown in the investment policy, derivatives may be used provided that the market exposure arising is less than 25% of the value of the portfolio. During the year, no forward currency contracts or derivatives were used for hedging or market exposure respectively.

Gearing and Borrowing Risk

The Company may borrow to provide gearing to the equity portfolio of up to 25% of net assets. Borrowing is a mix of the Company’s £100 million debenture stock and the Company’s £150 million facility. Details of all borrowings are given in Notes 11 and 12. The principal gearing risk is that the level of gearing may have an adverse impact on performance. Secondary risks include whether the cost of borrowing is too high and whether the facility can be renewed on terms acceptable to the Company.

The Manager has full discretion over the amount of the borrowing it uses to gear its portfolio, whilst the issuance, repurchase, or restructuring of borrowing are for the Board to decide. Information related to borrowing and gearing is provided to the Directors as part of the Board papers. Additionally, the Board keeps under review the cost of buying back the debt.

Income/Dividend Risk

The Company is subject to the risk that income generation from its investments fails to reach the level of income required to meet its objectives.

The Board monitors this risk through the review of detailed income forecasts and comparison against budget. These are contained within the Board papers. The Board considers the level of income at each meeting.

Share Price Risk

There is a risk that the Company’s prospects and NAV may not be fully reflected in the share price from time-to-time.

The share price is monitored on a daily basis. The Board is empowered to repurchase shares within agreed parameters. The discount at which the shares trade to NAV can be influenced by share repurchases. The Company has not repurchased any shares in the year.

Control Systems Risk

The Board delegates a number of specific risk control activities to the Manager including:

- good practice industry standards in fund management operations;

- financial controls;

- meeting regulatory requirements;

- the management of the relationship with the depositary;

- via the depositary, the management of the custody and security of the Company’s assets; and

- the management of the relationship with the registrar.

Consequently in respect of these activities the Company is dependent on the Manager’s control systems and those of its depositary and registrar, both of which are monitored by the Manager in the context of safeguarding the Company’s assets and interests. There is a risk that the Manager fails to ensure that these controls are operated in a satisfactory manner. In addition, the Company relies on the soundness and efficiency of the custodian for good title and timeliness of receipt and delivery of securities.

A risk-based programme of internal audits is carried out by the Manager regularly to test the controls environment. An internal controls report providing an assessment of these risks and operation of the controls is prepared by the Manager and considered by the Audit Committee, and is formally reported to and considered by the Board.

Reliance on the Manager and other Third Party Providers

The Company has no employees and the Directors are all appointed on a non-executive basis. The Company is reliant upon the performance of third party providers for its executive function and other service provisions. The Company’s most significant contract is with the Manager, to whom responsibility both for the Company’s portfolio and for the provision of company secretarial and administrative services is delegated. The Company has other contractual arrangements with third parties to act as auditor, registrar, depositary and broker. 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 operation of the Company and could affect the ability of the Company to pursue successfully its investment policy and expose the Company to risk of loss or to reputational risk.

In particular, the Manager performs services which are integral to the operation of the Company. The Manager may be exposed to the risk that litigation, misconduct, operational failures, negative publicity and press speculation, whether or not it is valid, will harm its reputation. Any damage to the reputation of the Manager could result in counterparties and third parties being unwilling to deal with the Manager and by extension the Company. This could have an adverse impact on the ability of the Company to pursue its investment policy.

The Board seeks to manage these risks in a number of ways:

- The Manager monitors the performance of all third party providers in relation to agreed service standards on a regular basis, and any issues and concerns are dealt with promptly and reported to the Board. The Manager formally reviews the performance of all third party providers and reports to the Board on an annual basis.

- The Board reviews the performance of the Manager at every Board meeting and otherwise as appropriate. The Board has the power to replace the Manager and reviews the management contract formally once a year.

- The day-to-day management of the portfolio is the responsibility of the named portfolio manager, Mark Barnett, Head of UK Equities at Invesco. He has worked in equity markets since 1992 and has been part of the UK equities team at Invesco for over 20 years.

- The risk that the portfolio manager might be incapacitated or otherwise unavailable is mitigated by the fact that he works within, and is supported by, the wider Invesco UK Equity team. Moreover James Goldstone, as deputy portfolio manager, would be able to manage the portfolio if Mark Barnett was unable to for any reason.

- The Board has set guidelines within which the portfolio manager is permitted wide discretion. Any proposed variation outside these guidelines is referred to the Board and compliance with the guidelines and the guidelines themselves are reviewed at every Board meeting.

Other Risks

The Company may be exposed to other business, strategic and political risks in the future, as well as regulatory risks (such as an adverse change in the tax treatment of investment companies), and the perceived impact of the Manager ceasing to be involved with the Company.

The instruments in which the Company’s cash positions are invested are reviewed by the Board to ensure credit, liquidity and concentration risks are adequately managed. Where an Invesco Group vehicle is utilised, it is assessed for suitability against other similar investment options.

The Company is subject to laws and regulations by virtue of its status as an investment trust and is required to comply with certain regulatory requirements that are applicable to listed closed-ended investment companies. The Company is subject to the continuing obligations imposed by the UK Listing Authority on all companies whose shares are listed on the Official List. A breach of the conditions for approval as an investment trust could lead to the Company being subject to capital gains tax on the sale of the investments in the Company’s portfolio. A serious breach of other regulatory rules may lead to suspension from listing on the Stock Exchange.

The Manager is regulated by the Financial Conduct Authority and failure to comply with the relevant regulations could harm the Manager’s reputation with a potential detrimental effect on the Company.

The Manager reviews compliance with investment trust tax conditions and other financial and regulatory requirements on a daily basis. All transactions, income and expenditure are reported to the Board. The Board regularly considers all risks, the measures in place to control them and the possibility of any other risks that could arise. The Board ensures that satisfactory assurances are received from the service providers. The Manager’s compliance and internal audit officers produce regular reports for review by the Company’s Audit Committee.

Additionally, the depositary monitors stock, cash, borrowings and investment restrictions throughout the year. The depositary reports formally once a year and also has access to the Company Chairman and the Audit Committee Chairman if needed during the year.

There is an ongoing process for the Board to consider these other risks. In addition, the composition of the Board is regularly reviewed to ensure the membership offers sufficient knowledge and experience to assess, anticipate and mitigate these risks, as far as possible.

Viability Statement

The Company is a collective investment vehicle rather than a commercial business venture and is designed and managed for long term investment. The Company’s investment objective clearly sets this out. Long term for this purpose is considered by the Directors to be at least five years and accordingly they have assessed the Company’s viability over that period. However, the life of the Company is not intended to be limited to that or any other period.

In assessing the viability of the Company, the Directors considered the principal risks to which it is exposed, together with mitigating factors. The risks of failure to meet the Company’s investment objective, and contributory market and investment risks, were considered to be of particular importance. The Directors also took into account: the investment capabilities of the portfolio manager; the business model of the Company, which has effectively been stress tested for many years through different and difficult market cycles; the liquidity of the portfolio, with nearly all investments being listed and readily realisable; the Company’s borrowings – both long and short term – and the ability of the Company to meet its liabilities as they fall due; and the Company’s annual operating costs.

Based on the above, and assuming there is no significant adverse change to the regulatory environment and tax treatment of UK investment trusts, the Directors have a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the five year period of assessment.

Board Diversity

The Board considers diversity, including the balance of skills, knowledge, diversity (including gender) and experience, amongst other factors when reviewing its composition and appointing new directors, but does not consider it appropriate to establish targets or quotas in this regard. As a norm the Board comprises either five or six non-executive directors of which, at present, one is female. Summary biographical details of the Directors are set out in the annual financial report. The Company has no employees.

Social and Environmental Matters

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

The Company is an investment vehicle and does not provide goods or services in the normal course of its business, or have customers. Accordingly, the Directors consider that the Company is not required to make any slavery or human trafficking statement under the Modern Slavery Act 2015.

This Strategic Report was approved by the Board on 31 May 2018

Invesco Asset Management Limited

Company Secretary

.

Investments in Order of Valuation

At 31 March 2018

UK listed ordinary shares unless otherwise stated

AIM Investments quoted on AIM

.

Statement of Directors’ Responsibilities

in respect of the preparation of the Annual Financial Report

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

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have elected to prepare financial statements in accordance with UK Accounting Standards, including FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland.

Under company law, the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period.

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

– select suitable accounting policies and then apply them consistently;

– make judgements and estimates that are reasonable and prudent;

– state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and

– prepare the financial statements on the going concern basis unless it is inappropriate to presume that the company will continue in business.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and which enable them to ensure that the financial statements comply with the Companies Act 2006. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and to prevent and detect fraud and other irregularities.

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

The Directors of the Company each confirm to the best of their knowledge, that:

– the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit of the Company taken as a whole; and

– 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.

The Directors 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.

Signed on behalf of the Board of Directors

Glen Suarez

Chairman

31 May 2018

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For the year ended 31 March

Income Statement

The total column of this statement represents the Company’s profit and loss account, prepared in accordance with UK Accounting Standards. The return on ordinary activities after taxation is the total comprehensive income and therefore no additional statement of comprehensive income is presented. The supplementary revenue and capital columns are presented for information purposes in accordance with the Statement of Recommended Practice issued by the Association of Investment Companies. All items in the above statement derive from continuing operations. No operations were acquired or discontinued in the year.

Reconciliation of Movements in Shareholders’ Funds

.

As at 31 March

Balance Sheet

These financial statements were approved and authorised for issue by the Board of Directors on 31 May 2018.

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Notes to the Financial Statements

1. Principal Accounting Policies

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

The principal accounting policies adopted in the preparation of these financial statements are set out below. These policies have been consistently applied during the year and the preceding year.

A. Basis of Preparation

Accounting Standards Applied

The financial statements have been prepared in accordance with applicable United Kingdom Accounting Standards and applicable law (UK Generally Accepted Accounting Practice (UK GAAP)) and with the Statement of Recommended Practice Financial Statements of Investment Trust Companies and Venture Capital Trusts, issued by the Association of Investment Companies in November 2014 (SORP) and updated in January 2017. The financial statements are issued on a going concern basis.

As an investment fund the Company has the option, which it has taken, not to present a cash flow statement. A cash flow statement is not required when an investment fund meets all the following conditions: substantially all investments are highly liquid and are carried at market value, and where a statement of changes in equity (in these financial statements it is called the Reconciliation of Movements in Shareholders’ Funds) is provided.

B. Foreign Currency and Segmental Reporting

(i) Functional and presentational currency

The financial statements are presented in sterling, which is the Company’s functional and presentational currency and the currency in which the Company’s share capital and expenses, as well as its assets and liabilities, are denominated.

(ii) Transactions and balances

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

(iii) Segmental reporting

The Directors are of the opinion that the Company is engaged in a single segment of business of investing in equity and debt securities, issued by companies quoted mainly on the UK or other recognised stock exchanges.

C. Financial Instruments

The Company has chosen to apply Section 11 and 12 of FRS102 in full in respect of the financial instruments.

(i) Recognition of financial assets and financial liabilities

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

(ii) Derecognition of financial assets

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

(iii) Derecognition of financial liabilities

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

(iv) Trade date accounting

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

(v) Classification and measurement of financial assets and financial liabilities

– Financial assets

The Company’s investments are classified as held at fair value through profit or loss.

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 income statement, and are subsequently valued at fair value.

Fair value for investments that are actively traded in organised financial markets is determined by reference to stock exchange quoted bid prices at the balance sheet date. Fair value for investments that are actively traded but where active stock exchange quoted bid prices are not available is determined by reference to a variety of valuation techniques including broker quotes and price modelling. Unquoted, unlisted or illiquid investments are valued by the Directors at fair value using a variety of valuation techniques including earnings multiples, recent transactions and other market indicators, cash flows and net assets.

– Financial liabilities

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

D. Cash and Cash Equivalents

Cash and cash equivalents may comprise cash (including short term deposits which are readily convertible to a known amount of cash and are subject to an insignificant risk of change in value) as well as cash equivalents, including money market funds. Investments are regarded as cash equivalents if they meet all of the following criteria: highly liquid investments held in the Company’s base currency that are readily convertible to a known amount of cash, are subject to an insignificant risk of change in value and provide a return no greater than the rate of a three-month high quality government bond.

E. Hedging

Forward currency contracts entered into for hedging purposes are valued at the appropriate forward exchange rate ruling at the balance sheet date. Profits or losses on the closure or revaluation of positions are recognised in the income statement and taken to capital reserves.

F. Income

Interest income arising from fixed income securities and cash is recognised in the income statement using the effective interest method. Dividend income arises from equity investments held and is recognised on the date investments are marked ‘ex-dividend’.

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

Deposit interest and underwriting commission receivable are taken into account on an accruals basis.

G. Expenses and Finance Costs

Expenses are recognised on an accruals basis and finance costs are recognised using the effective interest method in the income statement.

The investment management fee and finance costs are allocated 70% to capital and 30% to revenue. This is in accordance with the Board’s expected long-term split of returns, in the form of capital gains and income respectively, from the portfolio.

Transaction costs are recognised as capital in the income statement. All other expenses are allocated to revenue in the income statement.

H. Taxation

The liability to corporation tax is based on net revenue for the year, excluding non-taxable dividends. The tax charge is allocated between the revenue and capital account on the marginal basis whereby revenue expenses are matched first against taxable income in the revenue account.

Deferred taxation is recognised in respect of all timing differences that have originated but not reversed at the balance sheet date where transactions or events that result in an obligation to pay more tax or a right to pay less tax in the future have occurred. Timing differences are differences between the Company’s taxable profits and its results as stated in the financial statements. Deferred taxation assets are recognised where, in the opinion of the directors, it is more likely than not that these amounts will be realised in future periods.

A deferred tax asset is only recognised in respect of surplus management expenses, losses on loan relationships and eligible unrelieved foreign tax to the extent that the Company is likely to have sufficient future taxable revenue to offset against these.

I. Dividends Payable

Dividends are not recognised in the accounts unless there is an obligation to pay at the balance sheet date. Proposed dividends are recognised in the year in which they are paid to shareholders.

2. Income

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

Special dividends of £492,000 were recognised in capital during the year (2017: £522,000).

3. Investment Management Fee

This note shows the fee due to the Manager. This is calculated and paid monthly.

Details of the investment management agreement are disclosed on page 35 in the annual financial report. At 31 March 2018 investment management fees of £576,000 (2017: £640,000) were accrued.

4. Other Expenses

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

Further information on Directors’ remuneration can be found in the Directors Remuneration Report. Included within other expenses is £16,000 (2017: £17,000) of employer’s National Insurance payable on Directors’ remuneration. As at 31 March 2018, the amount outstanding on Directors’ remuneration and employer’s National Insurance was £14,751 (2017: £17,620).

Fees payable to the Company’s auditor for audit related assurance services fees are for their review in connection with the half-yearly financial statements and the annual certificate to the trustee of the debenture stock, which are recognised in revenue. Fees payable to the Company’s auditor are shown excluding VAT, which is included in other expenses.

5. Finance costs

Finance costs arise on any borrowing facilities the Company has used. Borrowing facilities are the £100 million debenture stock and a £150 million bank revolving credit facility.

6. Tax on Ordinary Activities

As an investment trust the Company pays no tax on capital gains. As the Company invests principally in UK equities, it has little overseas tax and the overseas tax charge is the result of withholding tax deducted at source. This note also clarifies the basis for the Company having no deferred tax asset or liability.

(a) Tax charge

(b) Reconciliation of tax charge

(c) Deferred tax

Owing to the Company’s status as an investment company, and the Directors’ intention that it continues to meet the conditions required to maintain that approval in the foreseeable future, no deferred tax has been provided on any capital gains and losses arising on the revaluation or disposal of investments.

(d) Factors that may affect future tax changes

The Company has surplus management expenses and losses on loan relationships of £447,424,000 (2017: £436,223,000) that are available to offset future taxable revenue. A deferred tax asset of £76,062,000 (2017: £74,158,000), measured at the prospective rate of corporation tax of 17% (2017: 17%), has not been recognised in respect of these expenses since the Directors believe that there will be no taxable profits in the future against which the deferred tax assets can be offset.

7. Return per Ordinary Share

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

The basic, capital and total returns per ordinary share are based on each return on ordinary shares after tax and on 195,666,734 (2017: 195,666,734) ordinary shares, being the weighted average number of shares in issue during the year.

8. Dividends on Ordinary Shares

Dividends represent the distribution of income to shareholders. The Company pays four dividends a year – three interims and one final dividend.

The proposed final dividend is subject to approval by ordinary shareholders at the AGM.

9. Investments

The portfolio comprises investments which are principally listed on a regulated stock exchange or traded on AIM. A very small proportion of investments are valued by the Directors as they are unlisted or not regularly traded.

Gains or losses are either:

– realised, usually arising when investments are sold; or

– unrealised, being the difference from cost on those investments still held at the year end.

(a) Analysis of investments by listing status

(b) Analysis of investments gains

There were no purchases or sales of unlisted investments during the year (2017: £nil).

(c) (Losses)/gains on investments

(d) Transaction costs

Transaction costs on purchases of £1,157,000 (2017: £1,026,000) and on sales of £316,000 (2017: £314,000) are included within gains and losses on investments.

(e) Significant holdings

At 31 March 2018 the Company had holdings of 3% or more of the number in issue of the following investments:

10. Debtors

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

11. Creditors: amounts falling due within one year

Creditors are amounts which must be paid by the Company and are split between those payable within 12 months of the balance sheet date and those payable after that time. The main creditors are the debenture and bank borrowings. The other creditors include any amounts due to brokers for the purchase of investments or amounts owed to suppliers (accruals) such as the Manager and auditor.

The Company has a 364 day committed revolving credit facility (the ‘facility’) of £150 million (2017: £150 million) with the lender, The Bank of New York Mellon. The facility is due for renewal on 30 June 2018. Interest is payable at 0.70% over LIBOR with a commitment fee for undrawn amounts. Under the facility’s covenants, the Company’s total indebtedness must not exceed 25% of total assets and total assets must not be less than £700 million (2017: £700 million).

12. Creditors: amounts falling due after more than one year

These creditors are amounts that must be paid, as shown by note 11, but are due more than one year after the balance sheet date.

The debenture is secured by a floating charge on the Company, under which borrowing must not exceed a sum equal to the Adjusted Total of Capital and Reserves. The interest on the 7 3/4% debenture is payable in half-yearly instalments, in March and September, each year.

The effect on the net asset value of deducting the debenture stock at market value, rather than at par, is disclosed in note 15.

13. Share Capital

Share capital represents the total number of shares in issue.

Subsequent to the year end, and up to the date of this report, no shares were issued or bought back by the Company.

The Directors’ Report in the annual financial report sets out the Company’s share capital structure, restrictions and voting rights.

14. Reserves

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

The share premium comprises the net proceeds received by the Company following the issue of shares, after deduction of the nominal amount of 25 pence and any applicable issue costs. The capital redemption reserve maintains the equity share capital of the Company and arose from the nominal value of any shares bought back and cancelled; both are non-distributable.

The capital reserve includes the investment holding gains/(losses), being the difference between cost and market value at the balance sheet date. It also includes cumulative realised gains/(losses). Capital investment gains and losses are shown in note 9(b) and form part of the capital reserve.

The revenue reserve shows the net revenue retained after payment of any dividends. The capital and revenue reserves are distributable by way of dividend.

15. Net Asset Value per Ordinary Share

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

The NAV - debt at par is the NAV with the value of the £100 million debenture (the debt) at its nominal (equivalent to the par) value of £100 million. The NAV - debt at market value reflects the debenture stock at the value that a third party would be prepared to pay for the debt, and this amount fluctuates owing to various factors including changes in interest rates and the remaining life of the debt. The number of ordinary shares in issue at the year end was 195,666,734 (2017: 195,666,734).

(a) NAV – debt at par

The shareholders’ funds in the balance sheet are accounted for in accordance with accounting standards; however, this does not reflect the rights of shareholders on a return of assets under the Articles of Association. These rights are reflected in the net assets with debt at par and the corresponding NAV per share. A reconciliation between the two sets of figures follows:

(b) NAV – debt at market value

The market value of the debenture stock is determined by reference to the daily closing price, and is subject to review against various data providers to ensure consistency between data providers and against the reference gilt.

The net asset value per share adjusted to include the debenture stock at market value rather than at par is as follows:

16. Risk Management and Financial Instruments

Financial instruments comprise the Company’s investment portfolio, derivative instruments (if any) as well as cash, and any borrowings, debtors and creditors. This note sets out the Company’s financial instruments and the risks related to them.

Financial instruments

The Company’s financial instruments mainly comprise its investment portfolio (as shown on pages 18 and 19 in the annual financial report), a debenture, a bank loan as well as its cash, debtors and creditors that arise directly from its operations such as sales and purchases awaiting settlement and accrued income. For the purpose of this note ‘cash’ should be taken to comprise cash and cash equivalents as defined in note 1d. The accounting policies in note 1 include criteria for the recognition and the basis of measurement applied for financial instruments. Note 1 also includes the basis on which income and expenses arising from financial assets and liabilities are recognised and measured.

The main financial risks that the Company faces from its financial instruments are market risk, liquidity risk, and credit risk. These are set out below:

Market risk – arising from fluctuations in the fair value or future cash flows of a financial instrument because of changes in market prices. Market risk comprises three types of risk: currency risk, interest rate risk and other price risk:

– Currency risk – arising from fluctuations in the fair value or future cash flows of a financial instrument because of changes in foreign exchange rates;

– Interest rate risk – arising from fluctuations in the fair value or future cash flows of a financial instrument because of changes in market interest rates; and

– Other price risk – arising from fluctuations in the fair value or future cash flows of a financial instrument for reasons other than changes in foreign exchange rates or market interest rates.

Liquidity risk – arising from any difficulty in meeting obligations associated with financial liabilities.

Credit risk – arising from financial loss for a company where the other party to a financial instrument fails to discharge an obligation.

Risk Management Policies and Procedures

The Directors have delegated to the Manager the responsibility for the day-to-day investment activities and management of gearing of the Company as more fully described in the Directors’ Report.

As an investment trust the Company invests in equities and other investments for the long-term so as to fulfil its investment policy (incorporating the Company’s investment objective). In pursuing its investment objective, the Company is exposed to a variety of risks that could result in either a reduction in the Company’s net assets or a reduction of the profits available for dividends. These policies are summarised below and have remained substantially unchanged for the two years under review.

16.1 Market Risk

The Company’s Manager assesses the Company’s exposure when making each investment decision, and monitors the overall level of market risk for the whole of the investment portfolio on an ongoing basis. The Board has meetings in each calendar quarter to assess risk and review investment performance, as disclosed in the Board Responsibilities in the annual financial report. Any borrowing to gear the investment portfolio is used to enhance returns but also increases the Company’s exposure to market risk and volatility. The Company has the ability to gear by using its £100 million debenture stock 2022 and its bank facility of £150 million.

16.1.1 Currency risk

The majority of the Company’s assets and all of its liabilities are denominated in sterling. There is some exposure to US dollar, Swiss franc and the Euro.

Management of the currency risk

The Manager monitors the Company’s direct exposure to foreign currencies on a daily basis and reports to the board on a regular basis. Forward currency contracts can be used to reduce the Company’s exposure to foreign currencies arising naturally from the Manager’s choice of securities. All contracts are limited to currencies and amounts commensurate with the assets denominated in currencies. No forward currency contracts were used during the year (2017: none).

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.

The Company may invest up to 20% of the portfolio in securities listed on non-UK stock exchanges. At the year end holdings of non-UK securities total £122.4 million (2017: £270.2 million) representing 8.0% (2017: 15.6%) of the portfolio.

Currency exposure

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

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

Currency sensitivity

In respect of the Company’s direct foreign currency exposure to investments denominated in currencies, if sterling had weakened by 3.4% for the US dollar, 2.6% for the Swiss franc and 2.0% for the Euro during the year, the income statement capital return and net assets of the Company would have increased by £3.6 million (2017: £15.9 million). Conversely, if sterling had strengthened by the same percentage for the currencies mentioned above, the capital return and net assets of the Company would have decreased by the same amount. The exchange rate variances noted above have been based on the market volatility in the year, using the standard deviation of sterling’s fluctuation to the applicable currency. This sensitivity takes no account of any impact on the market values of the Company’s investments arising from the foreign currency mix of their respective revenues, expenses, assets and liabilities.±

16.1.2 Interest rate risk

Interest rate movements will affect the level of income receivable on cash deposits and money market funds, and the interest payable on variable rate borrowings. When the Company has cash balances, they are held on variable rate bank accounts yielding rates of interest dependent on the base rate determined by the custodian, The Bank of New York Mellon.

The Company has in place a revolving credit facility (the ‘facility’), details of which are shown in note 11. The Company uses the facility when required at levels monitored by the Board. At the maximum possible facility gearing of £150 million, the effect of a 1% increase/decrease in the interest rate would result in a decrease/increase to the Company’s income of £1,500,000 p.a..

The Company also has an uncommitted bank overdraft facility which it uses for settlement purposes and interest is dependent on the base rate determined by the custodian. At the year end, no amounts were overdrawn (2017: none).

The Company’s debt of £100 million (2017: £100 million) of debenture stock is fixed which exposes the Company to changes in market value in the event that the debt is repaid before maturity. Details of the debenture stock interest is shown in note 12, with details of its market value and the affect on net asset value in note 15(b).

The Company can invest in fixed income securities although at the year end none were held (2017: £nil).

Interest rate exposure

At 31 March the exposure of financial assets and financial liabilities to interest rate risk is shown by reference to:

– floating interest rates (giving cash flow interest rate risk) – when the interest rate is due to be re-set; and

– fixed interest rates (giving fair value interest rate risk) – when the financial instrument is due for repayment.

16.1.3 Other price risk

Other price risks (i.e. changes in market prices other than those arising from interest rate risk or currency risk) may affect the value of the equity investments, but it is the business of the portfolio manager to manage the portfolio to achieve the best return that he can.

Management of the other price risk

The Directors manage the market price risks inherent in the investment portfolio by meeting regularly to monitor on a formal basis the Manager’s compliance with the Company’s stated objectives and policies, and to review investment performance.

The Company’s portfolio is the result of the Manager’s investment process and need not be highly correlated with the Company’s benchmark or the market in which the Company invests. The value of the portfolio will not move in line with the market but will move as a result of the performance of the company shares within the portfolio.

If the value of the portfolio fell by 10% at the balance sheet date, the profit after tax for the year and the net assets of the Company would decrease by £154 million (2017: £173 million). Conversely, if the value of the portfolio rose by 10%, the profit after tax and the net assets of the Company would increase by the same amounts.

16.2 Liquidity risk

Liquidity risk is minimised as the majority of the Company’s investments constitute a diversified portfolio of readily realisable securities which can be sold to meet funding commitments as necessary. In addition, the Company has an overdraft facility which it can use to provide short-term funding flexibility.

Liquidity risk exposure

The contractual maturities of the financial liabilities at the year end, based on the earliest date on which payment can be required, are as follows:

16.3 Credit risk

Credit risk encompasses the failure by counterparties to deliver securities which the Company has paid for, or to pay for securities which the Company has delivered, and cash balances. Counterparty risk is minimised by using only approved counterparties. The Company’s ability to operate in the short-term may be adversely affected if the Company’s custodian suffers insolvency or other financial difficulties. However, with the support of the depositary’s restitution obligation the risk of outright credit loss on the investment portfolio is remote. The Board reviews the custodian’s annual controls report and the Manager’s management of the relationship with the custodian. Cash balances are limited to a maximum of 1% of net assets with any one deposit taker, with only approved deposit takers being used, and a maximum deposit of 5% of net assets with Short-Term Investments Company (Global Series) plc, a triple-A rated money market fund. These limits are at the discretion of the Board and are reviewed on a regular basis.

17. Fair Value

The values of the financial assets and financial liabilities are carried either at their fair value (investments), or at a reasonable approximation of fair value (amounts due from brokers, dividends receivable, accrued income, amounts due to brokers, accruals, cash and any drawings on the bank facility) or at amortised cost (debenture).

Fair Value Hierarchy Disclosures

All except two of the Company’s portfolio of investments are in the Level 1 category as defined in FRS 102 as amended for fair value hierarchy disclosures (March 16). The three levels set out in this follow.

Level 1 – the unadjusted quoted price in an active market for identical assets or liabilities that the entity can access at the measurement date.

Level 2 – Inputs other than quoted prices included within Level 1 that are observable (ie developed using market data) for the asset or liability, either directly or indirectly.

Level 3 – Inputs are unobservable (ie for which market data is unavailable) for the asset or liability.

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

The valuation techniques used by the Company are explained in the accounting policies note. One investment is shown in level 2 as a result of market inactivity: Barclays Bank – Nuclear Power Notes 28 February 2019. The investment in Level 3 is the result of a past corporate event on a listed security previously held; Eurovestech delisted from AIM. The holdings of Barclays Bank - Nuclear Power Notes 28 February 2019 and Eurovestech did not change during the year. The holding of Proximagen CVRs was written off in full because the rights expired on 31 August 2017 (2017: Level 3 and valued at £173,000).

The book cost and fair value of the debenture stock, based on the offer value at the balance sheet date, are as follows:

Incorporating the fair value of the debenture, results in the reduction of the net asset value per ordinary share to 703.34p (2017: 768.81p).

18. Capital Management

The Company's total capital employed at 31 March 2018 was £1,542,639,000 (2017: £1,743,501,000) comprising borrowings of £142,770,000 (2017: £208,319,000) and equity share capital and other reserves of £1,399,869,000 (2017: £1,535,181,000)

The Company’s total capital employed is managed to achieve the Company’s objective and investment policy as set out in the annual financial report, including that borrowings may be used to provide gearing of the equity portfolio up to the maximum authorised by shareholders, currently 25% of net assets. Net gearing was 11.8% (2017: 15.7%) at the balance sheet date. The Company’s policies and processes for managing capital were unchanged throughout the year and the preceding year.

The main risks to the Company’s investments are shown in the Strategic Report under the ‘Principal Risks and Uncertainties’ section in the annual financial report. These also explain that the Company is able to use borrowings to gear and that gearing will amplify the effect on equity of changes in the value of the portfolio.

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

The Company is subject to externally imposed capital requirements with respect to the obligation and ability to pay dividends by section 1159 Corporation Tax Act 2010 and by the Companies Act 2006, respectively, and with respect to the availability of the facility by the terms imposed by the lender. The Board regularly monitors, and has complied with, the externally imposed capital requirements. This is unchanged from the prior year. Borrowings comprise the debenture stock, details of which are contained in note 12, a bank facility and an overdraft facility which may be used for short-term funding requirements.

19. Contingencies, Guarantees and Financial Commitments

This note would show any liabilities the Company is committed to honour, and which are dependent on future circumstances or events occurring.

There are no contingencies, guarantees or financial commitments of the Company at the year end (2017: £nil).

20. 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 accounting standards, the Manager is not a related party.

Under UK GAAP, the Company has identified the Directors as related parties. The Directors’ remuneration and interests have been disclosed in the annual financial report with additional disclosure in note 4. No other related parties have been identified.

Details of the Manager’s services and fees are disclosed in the Directors’ Report in the annual financial report, and in note 3.

21. Post Balance Sheet Events

There are no significant events after the end of the reporting year requiring disclosure.

This Annual Financial Report announcement is not the Company’s statutory accounts. The statutory accounts for the year ended 31 March 2017 have been delivered to the Registrar of Companies. The statutory accounts for the year ended 31 March 2017 received an audit report which was unqualified, did not include a reference to any matters to which the auditor drew attention by way of emphasis without qualifying the report, and did not include a statement under either section 498(2) or 498(3) of the Companies Act 2006. The statutory accounts for the financial year ended 31 March 2018 have been approved and audited but have not yet been filed.

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, Quartermile One, 15 Lauriston Place, Edinburgh EH3 9EP. A copy of the Annual Financial Report will be available from Invesco Perpetual on the following website:

www.invescoperpetual.co.uk/edinburgh

The Annual General Meeting of the Company will be held at 11.00 am on 19 July 2018 at The Weston Link, National Galleries of Scotland, Princes Street, Edinburgh EH2 2EL.

By order of the Board

Invesco Asset Management Limited 

Company Secretary

31 May 2018