Henderson Opportunity Trust Regulatory News (HOT)

HENDERSON INVESTMENT FUNDS LIMITED

HENDERSON OPPORTUNITIES TRUST PLC

LEGAL ENTITY INDENTIFIER (LEI): 2138005D884NPGHFQS77

7 February 2020

HENDERSON OPPORTUNITIES TRUST PLC

Annual Financial Report for the year ended 31 October 2019

This announcement contains regulated information

Investment Objective

The Company aims to achieve capital growth in excess of the FTSE All-Share Index from a portfolio of UK investments.

PERFORMANCE HIGHLIGHTS

Total Return Performance to 31 October 2019

1 Net Asset Value (NAV) per ordinary share total return with income reinvested

2 Share price total return using mid-market closing price with income reinvested

3 Average NAV of the AIC UK All Companies Sector with income reinvested

4 FTSE All-Share Index total return

5 Ongoing charge excludes performance fee. Ongoing charge including performance fee is 0.91% (2018: 0.84%) as no performance fee was paid during the year. The increase was largely attributable to increased marketing/shareholder engagement expenses

6 This represents an interim dividend of 7.0p and a proposed final dividend of 19.0p. See the Annual Report for more details

7 Based on the ordinary dividends paid and payable for the year and the mid-market closing price at the year end

A glossary of terms and Alternative Performance Measures can be found in the Annual Report

Sources: Morningstar for the AIC, Janus Henderson, Refinitiv Datastream

CHAIRMAN'S STATEMENT

Performance review

It was a difficult financial year for smaller companies and performance in absolute terms was disappointing relative to the benchmark. The Company's net asset value rose 0.2% on a total return basis while the FTSE All-Share Index rose 6.8%. However, the Company has outperformed the benchmark (on NAV total return) over three, five and ten years, as detailed in the table below:

Over the long term the best performers in the portfolio have tended to be small companies, with the largest successes being those that make the transition from small company up to the FTSE 100 (such as engineering software company Aveva which recently entered the FTSE 100). However, this financial year there was a significant dislocation between small company performance and the rest of the UK market - while the FTSE 100 rose 6.5% and the FTSE 250 rose 9.1%, the AIM All-Share Index fell 7.5% and the FTSE SmallCap Index finished approximately flat (-0.2%). This detracted from performance given the Company's substantial weighting in small and AIM quoted companies. This scale of divergence between small and medium sized company performance is unusual, and the Fund Managers go into the reasons for this in more detail in their report.

Another feature during the year was the widening in the discount level from 16.1% as at the previous year end to 19.8% at the end of this financial year. The Board recognises the primary route to discount reduction is strong performance. However, there are also other levers that fall within the Board's immediate control such as improved engagement with retail investors, using share buybacks selectively to enhance net asset value and increasing the attractiveness of the Company for income purposes. This year the dividend has been increased materially (by 24.0%) and next year we will move to a quarterly dividend payment structure, as described in more detail below. The dividend over the last 5 years has increased 15.8% compound annual growth rate per year.

Earnings and dividends

The revenue return was 29.9p compared to 20.2p last year. This notable increase was partly as a result of a high level of stock lending income, which totalled £373,000 during the financial year (2018: £49,000), contributing approximately 4.7p per share of income. Investment income also rose 21.0% year on year (including special dividends), helped by significant special dividends from holdings including IAG and RBS.

Despite the difficult year we are pleased to announce, subject to shareholder approval, a final dividend of 19.0p per share, resulting in a full year dividend of 26.0p, a 24.0% increase on the 21.0p paid last year. This has resulted in a further £312,000 being added to the revenue reserve, taking the total to £1.9m following payment of the final dividend.

The Board has decided, from the beginning of the 2020 financial year, to pay quarterly dividends to shareholders. We intend to make dividends as predictable for shareholders as possible and, in the absence of any adverse changes in conditions, expect to be able to declare quarterly dividends as follows:

Fees and expenses

The disappointing results this year mean there is no performance fee payable. The combined management and performance fees are capped at 1.5% of average net assets (calculated quarterly) during the year. This year the ongoing charge was 0.91% (2018: 0.84%), the increase was largely attributable to increased marketing/shareholder engagement expenses.

Continuation vote

Following a three year cycle, there will be a continuation vote at this year's AGM on 19 March 2020. The NAV total return for the last three financial years is up 22.6%, while the FTSE All-Share total return is up 20.6%. The dividends over the three years have increased 28.9%. The valuations of the stocks in the portfolio are undemanding and the earnings growth prospects are strong. The UK economy is coming through a period of change and a renewal of confidence could lead to robust economic growth. The Directors recommend a vote in favour of continuation. The Directors and the Fund Managers will be voting their shares accordingly. If shareholders vote in favour of continuation the next vote will be in March 2023.

Buybacks and share issuance

99,670 shares were bought back during the financial year. These were purchased at between a 14.6% and 17.7% discount to cum income NAV. A further 2,813 shares were bought following the financial year end at between an 18.3% and 18.6% discount to cum income NAV.

It is the view of the Board and the Fund Managers that share buybacks may be used when there is a combination of a high discount to net asset value and a clear valuation opportunity within the portfolio. Following weak periods for small company performance, as was the case in December 2018, January 2019 and November 2019, buybacks were carried out. The Board intends to continue to use buybacks opportunistically in this manner.

Gearing

Gearing at the end of the year was 12.7%, an increase on the previous year end of 6.7%. As the Fund Managers cover in more detail in the Fund Managers' report, gearing was increased in the fourth quarter of 2018 and early 2019 to take advantage of valuation opportunities in what was a very weak period for UK small company performance.

It is a distinct advantage to have the ability to use low cost gearing, and it will be deployed in most circumstances. The level of gearing will not depend on a top down view of where we are in the economic cycle but rather on valuation levels and the conviction of the Fund Managers in individual stocks. The current level of gearing reflects the Fund Managers' view that there is unrecognised value in the portfolio.

The Board

Max King, who has served on the Board for 14 years, will retire with effect from the conclusion of the AGM in March 2020. Max has contributed a wealth of investment experience and his input into the management of the Company on behalf of shareholders has been greatly appreciated.

We are very pleased to have appointed Davina Curling to the Board with effect from 1 November 2019. Davina has over 25 years of fund manager experience and is currently a director of Invesco Income Growth Trust plc and BlackRock Greater Europe Investment Trust plc. Davina will stand for appointment at the AGM in March 2020.

AGM

Our Annual General Meeting will be held at 2.30pm on 19 March 2020 at the registered office, 201 Bishopsgate, London EC2M 3AE. The Notice of Meeting accompanies the Annual Report. The Directors will vote their own shareholdings in favour of all the resolutions to be put to the AGM and the Directors recommend that the shareholders support all the resolutions.

In addition to the formal business of the meeting, the Fund Managers, James Henderson and Laura Foll, will give a presentation, following which tea will be served.

Outlook

The General Election in December brought greater clarity in regard to the domestic political outlook and this has been well received by investors with UK focused stocks being the main beneficiaries. The improved market context has been strongly reflected in the portfolio with the NAV (total return) rising by 9.3% in the current financial year to 31 December and the share price increasing by 19.1%, whilst our benchmark, the FTSE All-Share Index, rose by only 5.6% during these two months.

The Board and the Fund Managers anticipate that markets will always face headwinds of varying degrees and accordingly prefer to invest in management teams capable of growing their businesses by dealing with problems that emerge. In our view the portfolio companies offer products and services that should deliver growth, whilst in many cases valuations do not fully reflect their prospects. The start to the current financial year has been encouraging with SmallCap valuations showing improvement and, if this trend continues, your Company's portfolio should benefit significantly.

Peter Jones

Chairman

7 February 2020

FUND MANAGERS' REPORT

Investment backdrop

The UK economy has been growing at a very modest rate. Capital spending is running at low levels. This is not an easy background for investment. Sales growth and investment in new capital lies behind profit growth. Therefore there have been a larger than usual number of profit disappointments from UK smaller companies. The reaction these sometimes modest profit downgrades have met in share price terms has often been severe, with the share price falling a considerable amount. This is a result of general shareholder nervousness.

The companies that worried shareholders like to hold are predictable businesses with very solid profiles that they believe will have no operational problems. Companies that are thought to have these attributes have moved onto very high valuations while those that are thought to be in any way challenged have seen their valuations fall. The problem with this approach is that in a fast moving world the business model that works well today can easily be out of date in the near future. The life cycle of companies is getting shorter as early strong growth can give way to maturity and decline faster than in the past. The speed of information flow exposes companies to faster, often global, competition. Very few have 'a moat' round them and this is why there are inherent dangers in investing in high valuation companies. However, over the last year it has been the high valuation stocks that have performed the best. When economic growth picks up and some confidence returns, the valuation gap between highly rated shares and much cheaper shares may contract.

Portfolio review

The portfolio is divided into the seven classifications below. These classifications are not meant to be prescriptive (they are, to a degree, subjective). The aim is to ensure the portfolio remains diverse. Different classifications will perform well in different market environments.

This is the second year in which we have reported the portfolio in this manner to shareholders. The most notable changes since the breakdown of the portfolio last year are the increased weight in the recovery area (from 8% of the portfolio last year to 10% this year) and the lower weight in growth small cap (from 32% of the portfolio to 20%). The increase in recovery weighting is an active decision - new positions have been added including retail property company Hammerson and healthcare and industrial tape manufacturer Scapa. It is our view that some companies that are currently 'out of favour' are presenting compelling valuation opportunities, so there has been a deliberate modest increase in investment in that area. The decline in the 'growth small cap' weighting has come about for a mixture of active and passive reasons - there has been one material sale in the area (Keyword Studios, which has been exited) and there has also been a de-rating of one of the largest holdings, software company Blue Prism.

Source: Janus Henderson at 31 October 2019

Income

While the capital performance during the year was disappointing, the income received from the portfolio was encouraging, with investment income (including special dividends) rising 21.0%. In our view this demonstrates both the underlying value within the portfolio and also management confidence in the outlook for their businesses. In addition, stock-lending generated an exceptional £373,000, compared with just £49,000 last year.

Portfolio activity

We were active during the year, adding 19 new positions and selling out completely in 16. There was also one additional holding (M&G) inherited via a spin-out from the position in Prudential. This meant that as at 31 October 2019 there were 89 holdings in the portfolio (excluding those with nil value), compared to 85 at the previous year end.

The gearing level rose as purchases totalling £27.2m more than offset sales of £23.4m. This meant that gearing at year end was 12.7%, notably higher than 6.7% at the end of October 2018. This increase took place primarily in the fourth quarter of 2018 and at the beginning of 2019, as a 22% fall in the AIM Index resulted in a number of interesting valuation opportunities.

The gearing level within the portfolio is determined not by a view on macroeconomics but rather by a view on the valuation opportunities available. The low teens level of gearing at year end demonstrates that we think there is considerable value to be found currently in UK companies.

Purchases

The largest five purchases during the year were:

Sales

The largest five sales during the year were:

It is notable that of the five largest sales, three were as a result of a takeover approach. Dairy Crest was also sold during the year as a result of a takeover by a Canadian company. The scale of takeovers within the portfolio this year is, we think, a demonstration of the valuation opportunity currently available in UK smaller companies.

Attribution

As the Chairman describes in his statement it was a disappointing year for performance relative to the benchmark. The Company's NAV on a total return basis rose 0.2% relative to a 6.8% rise in the FTSE All-Share Index. There are two primary reasons for this - the portfolio's significant position in smaller companies relative to the index, and two sizeable stock specific detractors (LoopUp and Blue Prism), both of which we go into in more detail below.

At the end of the financial year, the portfolio had a weighting of 54.2% in AIM and 8.6% in the FTSE SmallCap Index. During the financial year, the FTSE 100 returned 6.5% while the AIM All-Share returned -7.5% and the FTSE SmallCap Index (excluding investment trusts) returned -0.2%. This weakness was limited to the smaller company area; over the same time period the FTSE 250 Index (of medium sized companies) returned 9.1%. This is a particularly unusual backdrop which requires explanation. There is an increasing desire for liquidity within open-ended funds to the detriment of smaller company positions. This means that some fund managers of open-ended vehicles are becoming forced sellers in the smaller company area, particularly of those with a market capitalisation below £250m. This pressure has been steadily increasing for some time but has become more pronounced this year. In the longer term, this provides a great opportunity for closed-end funds, such as your Company, to profit from materially undervalued growth companies. The other factor that is causing weakness in the area is the more domestic exposure of smaller companies at a time when there is still significant uncertainty regarding the future outlook for the UK.

This small company weakness has caused a material derating relative to the FTSE 250 Index.

(see chart in the Annual Report)

Source: Janus Henderson

The largest individual detractor during the year was conference call software provider LoopUp. This had been a good purchase since IPO, and we reduced the position modestly at a higher share price. However, this year the company has generated materially lower earnings than expected as the existing customer base has used the conference call facilities less. The customer base is approximately 50% UK and 50% US; the weakness in usage has been predominantly in the UK customer base, which is influenced by professional service firms. LoopUp is attributing the weakness to a difficult end market among their UK customer base. They can demonstrate that customers are not (on average) switching to competing software.

(see chart in the Annual Report)

The share price weakness has been a combination of substantially lower earnings in 2019 and a lower valuation on the shares. The current valuation is modest for a company that, despite its challenges, is forecast to grow sales and earnings substantially over the next few years. Any recovery will, however, take time as the management team needs to rebuild credibility.

The second largest detractor was Blue Prism, which provides robotic process automation software. This software allows the automation of relatively manual tasks, for example some customer service functions and payroll processing, with the idea of both reducing time and cost, and also improving accuracy. Similar to LoopUp, this position was purchased at IPO. It has been a very strong performer for the portfolio over the long term but this year has de-rated relative to its forecast sales (being loss making, a sales multiple is the best way to value it). There have not been any material disappointments that have caused the de-rating but rather there is a perception that Blue Prism is falling behind the curve relative to its two largest competitors. Both are American firms that have raised substantially more money than Blue Prism to invest in the area. This perception is, we think, largely correct but the rate of traction in the area means that sales can still continue to grow at a high rate. We have maintained the holding as the valuation is now modest relative to sales for this type of fast growing software company, and Blue Prism could be absorbed into one of the US competitors.

Source: Janus Henderson

For the second year in a row, the largest contributor to performance was Serica Energy, a North Sea oil and gas producer. Serica purchased assets from BP following the material fall in the price of oil during 2014 and 2015, at a time when BP were aiming to reduce leverage. These assets have proved to be a very good purchase, with both production rates and cash flow surprisingly positive. The position in Serica has been reduced in order to rotate elsewhere within the 'natural resources' allocation.

The second largest contributor to performance was RWS Holdings, which offers specialist translation services, for example within the pharmaceutical industry where patents have to be translated to a high degree of accuracy. RWS has a scale advantage in the area which allows them to hire their own teams of specialist translators rather than using freelancers, in turn allowing them to generate a higher margin than peers. This year the shares have benefitted from a combination of strong organic growth and margin improvement, leading to double digit earnings growth.

(see chart in the Annual Report)

Environmental, social and corporate governance (ESG)

Responsible Investment is the term used at Janus Henderson to cover our work on ESG issues in the Company's investee companies. It is very wide ranging and all investment decisions are made thinking about them in an ESG context. It is an integral part of the investment process. Further detail on Janus Henderson's commitment to Corporate Social Responsibility can be found in the Janus Henderson Impact Report, available on Janus Henderson's website (www.janushenderson.com).

In some areas, considerable progress can be seen. The governance of many businesses has improved. Board composition has become more diverse and gender equality is being tackled by the business community. Some governance issues are easily measurable and progress is being made. This includes some social issues. The attention being paid, for instance, to child labour has meant a closer scrutiny by large companies of their suppliers work practices has been beneficial. However, there are ESG issues that are subjective and as a result progress is difficult to monitor. The environmental area is particularly hard. The energy sector is the largest contributor to greenhouse gases and therefore global warming. Disinvestment is unlikely to help solve the problem, but being supportive of companies in their efforts to develop renewables might, provided that the returns on renewables appear sufficient. Decarbonisation might mean that the returns from the large energy companies are not sustainable but, at present, the speed of change is not rapid enough to disrupt the business model of large energy companies. We are still invested in traditional oil exploration companies, but in aggregate the portfolio companies have a lower carbon footprint than the index.

We prefer dialogue with, rather than the exclusion of, companies that score badly in environmental screens so as to try and understand the issues. One of the ways an awareness of these issues colours all investment decisions is in the search for companies that are positively helping provide the answers. For instance this year we participated in a capital raise for Ceres Power which is developing Fuel Cell technology. The company has recently made significant progress with its product being adopted by a major Chinese bus manufacturer.

ESG issues are both a challenge and an opportunity. For a company to have a long term sustainable business model it needs to be aware of the issues and act appropriately.

Outlook

Despite the disappointing performance in both absolute terms and relative to the FTSE All-Share index during the financial year, the portfolio ended the calendar year well-placed for the subsequent surge in the UK market. Our high exposure to smaller companies and in particular stocks quoted on AIM held us back during the year but benefited performance in the final two months of 2019 and will, we believe, continue to do so in 2020. The greatest opportunity lies in the smallest companies and AIM stocks, currently held back by liquidity concerns which have caused open-ended funds to consequently sell at low valuations but we expect a catch-up in performance in 2020. Closed end funds, such as yours, without the need to worry about liquidity, should be a beneficiary.

During the financial year, stock selection was a positive contributor in each size segment of the market; large caps, mid caps, small caps and AIM. Allocation between size segments, not stock selection within them, held back performance. In the current financial year, we expect the allocation effect to turn in our favour and believe that our stock selection will continue to be strong. The low turnover during the year reflected our confidence in the portfolio as did the increase in the gearing level to 12.7% (at the year end), in what others regarded as uncertain times. Investors who were patient with us last year should continue to be well rewarded this year.

James Henderson and Laura Foll

Fund Managers

7 February 2020

MANAGING OUR RISKS

The Board, with the assistance of the Manager, has carried out a robust assessment of the principal risks facing the Company, including those that would threaten its business model, future performance, solvency and liquidity. The principal risks and uncertainties facing the Company relate to investing in the shares of companies that are listed in the United Kingdom, including small companies. Although the Company invests almost entirely in securities that are listed on recognised markets, share prices may move rapidly, whether upwards or downwards, and it may not be possible to realise an investment at the Manager's assessment of its value. Falls in the value of the Company's investments can be caused by unexpected external events. The companies in which investments are made may operate unsuccessfully, or fail entirely, such that shareholder value is lost. The Company is also exposed to the operational risk that one or more of its contractors or subcontractors may not provide the required level of service.

The Board considers regularly the principal risks facing the Company in order to mitigate them as far as practicable. The Board monitors the Manager, its other service providers and the internal and external environments in whcht he Company operates to identify new and emerging risks. It is the Board's view that demographic change, technological change, environmental sustainability and political change are emerging risks.

The Board has drawn up a risk map which identifies the substantial risks to which the Company is exposed. The Board has also put in place a schedule of investment limits and restrictions, appropriate to the Company's investment objective and policy. These principal risks fall broadly under the following categories:

BORROWINGS

The Company has an unsecured loan facility in place which allows it to borrow as and when appropriate. £20m (2018: £20m) is available under the facility. Net gearing is limited by the Board to 25% of net assets. The maximum amount drawn down in the period under review was £14.6m (2018: £18.1m), with borrowing costs for the year totalling £177,000 (2018: £229,000). £12.6m (2018: £7.0m) of the facility was in use at the year end. Net gearing at 31 October 2019 was 12.7% (2018: 6.7%) of net asset value.

VIABILITY STATEMENT

The Company is normally a long term investor; the Board believes it is appropriate to assess the Company's viability over a five year period in recognition of our long term horizon and what the Board believes to be investors' horizons, taking account of the Company's current position and the potential impact of the principal risks and uncertainties as documented in the Strategic Report contained in the Annual Report.

The assessment has considered the impact of the likelihood of the principal risks and uncertainties facing the Company, in particular investment strategy and performance against benchmark, whether from asset allocation or the level of gearing, and market risk, materialising in severe but plausible scenarios, and the effectiveness of any mitigating controls in place.

The Directors took into account the liquidity of the portfolio and the borrowings in place when considering the viability of the Company over the next five years and its ability to meet liabilities as they fall due. This included consideration of the duration of the Company's borrowing facilities and how a breach of any covenants could impact on the Company's net asset value and share price.

The Directors do not expect there to be any significant change in the current principal risks and adequacy of the mitigating controls in place. Also the Directors do not envisage any change in strategy or objectives or any events that would prevent the Company from continuing to operate over that period as the Company's assets are liquid, its commitments are limited and the Company intends to continue to operate as an investment trust. Only a substantial financial crisis affecting the global economy could have an impact on this assessment. Whilst there is currently uncertainty in the markets due to the UK's negotiations having left the European Union, the Board does not believe that this will have a long term impact on the viability of the Company and its ability to continue in operation.

The Directors recognise that there is a continuation vote due to take place at the Annual General Meeting in March 2020. The Directors support the continuation of the Company and expect that the Company will continue to exist for the foreseeable future, at least for the period of the assessment.

Based on this assessment, the Board has a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the next five year period.

RELATED PARTY TRANSACTIONS

The Company's transactions with related parties in the year were with its Directors and the Manager. There have been no material transactions between the Company and its Directors during the year and the only amounts paid to them were in respect of expenses and remuneration for which there were no outstanding amounts payable at the year end. Directors' shareholdings are disclosed in the Annual Report.

In relation to the provision of services by the Manager, other than fees payable by the Company in the ordinary course of business and the facilitation of marketing activities with third parties, there have been no material transactions with the Manager affecting the financial position of the Company during the year under review. More details on transactions with the Manager, including amounts outstanding at the year end, are given in the Notes of the Annual Report.

STATEMENT OF DIRECTORS' RESPONSIBILITIES

In accordance with Disclosure Guidance and Transparency Rule 4.1.12, each of the Directors, who are listed in the Annual Report, confirms that, to the best of his or her knowledge:

·; the Company's Financial Statements, which have been prepared in accordance with UK Accounting Standards on a going concern basis, give a true and fair view of the assets, liabilities, financial position and profit of the Company; and

·; the Strategic Report and Financial Statements include 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.

For and on behalf of the Board

Peter Jones

Chairman

7 February 2020

Twenty Largest Holdings at 31 October 2019

The stocks in the portfolio are a diverse mix of businesses operating in a wide range of end markets.

At 31 October 2019 these investments totalled £47,560,000 or 45.9% of the portfolio.

* Not in the top 20 largest investments last year

1 Quoted on the Alternative Investment Market ('AIM')

Portfolio by Sector

As a percentage of the investment portfolio excluding cash

Portfolio by Index

As a percentage of the investment portfolio excluding cash

1 Other also includes AIM investments outside the FTSE AIM Index and shares listed on the main market which are not included in the FTSE All-Share Index

Market capitalisation of the portfolio at 31 October 2019

A glossary of terms and Alternative Performance Measures can be found in the Annual Report

Sources: Morningstar for the AIC, Janus Henderson, Refinitiv Datastream 

AUDITED INCOME STATEMENT

The total columns of this statement represent the Profit and Loss Account of the Company. The revenue return and capital return columns are supplementary to this and are prepared under guidance published by the Association of Investment Companies. All revenue and capital items in the above statement derive from continuing operations. The Company had no recognised gains or losses other than those disclosed in the Income Statement.

AUDITED STATEMENT OF CHANGES IN EQUITY

AUDITED STATEMENT OF FINANCIAL POSITION

AUDITED STATEMENT OF CASH FLOWS

NOTES TO THE FINANCIAL STATEMENTS

 1 Also includes special capital dividends of £92,000

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