KIT.L Regulatory News (KIT)

Keystone Investment Trust Plc - Annual Financial Report

PR Newswire

London, November 24

KEYSTONE INVESTMENT TRUST PLC

ANNUAL FINANCIAL REPORT ANNOUNCEMENTFOR THE YEAR ENDED 30 SEPTEMBER 2017

FINANCIAL INFORMATION AND PERFORMANCE STATISTICS

Performance Statistics

† Defined in the Glossary of Terms on page 66.

(1) Source: Thomson Reuters Datastream.

CHAIRMAN’S STATEMENT

Performance

The total return to shareholders over the year to 30 September 2017 was 3.2%, based on the share price with dividends reinvested. While positive, this return is disappointing as it was some way behind our benchmark, the FTSE All-Share Index, which posted a total return of 11.9%. The total return on the underlying net asset value (NAV) per share was 7.8% with debt at market (fair) value, thus part of the share price underperformance came from the widening of the discount at which the shares traded relative to the NAV.

Both the three year share price and net asset value performance now lag our benchmark, with a NAV total return of 20.9% compared with 27.8% for the benchmark. Accordingly, no performance related fee is payable (2016: £65,000).

Longer term share price performance has also been affected by the variations in the discount. The Company’s five and ten year share price total returns were 55.7% and 114.7% respectively. The NAV per share total returns over the same periods were 78.6% and 120.4%, compared with total returns of 61.2% and 75.2% for the FTSE All-Share Index (source: Invesco, Thomson Reuters Datastream).

The Manager’s Report section of the Strategic Report provides background to the year’s investment performance and details some of the issues faced. A number of stock specific factors had a significant negative impact, such as Provident Financial, Acacia Mining and BT Group. In addition, not holding HSBC and being underweight in commodity stocks adversely affected the Company’s performance relative to the benchmark in the year under review.

The weighted average discount of the investment companies in the UK All Companies sector remained wide through the year and was 9.7% at 30 September 2017 compared with 9.2% at 30 September 2016 (source: JP Morgan Cazenove). The average discount at which the Company’s ordinary shares traded relative to their underlying NAV (with debt at fair value) over the past year widened to 10.6%, from 7.7% last year. At the year end the share price stood at a discount of 12.6% to the NAV (debt at fair value).

Revenue and Dividends

Income in the year, excluding special dividends, was £9,060,000 (2016: £9,062,000). The amount of special dividends received fell and consequently the total income for the year of £9,703,000 is marginally less than last year’s £9,783,000. The revenue return after tax fell correspondingly from 62p to 61.5p per ordinary share.

The Board has declared a second interim dividend, in lieu of a final, of 37p per share (2016: 35p), giving a total ordinary dividend for the year of 55p per share (2016: 53p). The dividend will be paid on 22 December 2017 to shareholders on the register on 1 December 2017.

The Company has continued to benefit from special dividends received from investee companies, albeit at a lower scale than last year. These dividends totalled £643,000, the equivalent of 4.76p this year (2016: £721,000; 5.33p) and the Board has decided again to pass the greater part of this on to shareholders as a special dividend of 4.7p (2016: 5.3p). The special dividend will be paid at the same time as the second interim dividend. As indicated in my statement last year, special dividends received are likely to continue to decline.

Management Arrangements – Portfolio Manager

As reported in the half-yearly report, James Goldstone took over from Mark Barnett as portfolio manager from 1 April 2017. The Board would like to thank Mark Barnett for his outstanding long term returns for shareholders over the past 14 years.

James has made significant changes to the portfolio, reflecting his views on the UK economic outlook amid wider political uncertainty. Encouragingly, the NAV total return of 3.6% achieved in the six months since he took control of the portfolio has matched the benchmark FTSE All-Share Index’s return of 3.6% over the same period, despite the setbacks outlined in his Manager’s Report.

Management Arrangements – Fees

During the year the Board agreed with the Manager a revised fee arrangement with an effective date of 1 April 2017. Under this new arrangement, the Manager is entitled to a reduced management fee of 0.45% per annum (previously 0.6%) of the Company’s market capitalisation. All other terms relating to fees remain unchanged from the existing management agreement.

The Board

The Directors recognise the importance of the AIC Code particularly in terms of evaluating the performance of the Board as a whole, the respective Committees of the Board and individual Directors. In May 2017, the Board engaged an independent consultancy firm, Nurole Limited, to undertake a review of the Board as then constituted. The review process is further detailed in the Directors’ Report on pages 52 and 53.

The Board announced on 22 August 2017 the appointment of two new non-executive Directors, Karen Brade and Katrina Hart, with effect from 18 January 2018. Both bring extensive experience of the equity markets to the Board, and therefore we recommend that shareholders support their election at the forthcoming AGM. Their profiles are set out on page 18. Peter Readman, who has served on the Board since 1993, will retire at the AGM and we extend our thanks for his long and dedicated service on behalf of shareholders.

Gearing

The Board takes responsibility for the Company’s gearing strategy and sets parameters within which the portfolio manager operates. The Company’s borrowings, in the form of long-term debentures, amount to £32 million. The net gearing of the Company is determined by the extent to which these borrowings are invested. The Board has remained fairly cautious throughout the past year, and the parameters limiting the Manager have not changed, being that no net purchases be made which would take equity exposure above 107.5% of net assets and that sales be made if, as a result of market movements, equity exposure goes higher than 115% of net assets. It is a decision of the portfolio manager where to set the portfolio’s exposure subject to these limits. When held, corporate bonds are not treated as equity exposure for the purposes of the gearing limits.

Outlook

Although the outlook for the UK remains uncertain, the Board is confident that James Goldstone has positioned the portfolio in opportunities that will, combined with his differentiated investment approach, generate worthwhile returns over time and enable the Company to fulfil its investment objective to provide shareholders with long-term growth of capital.

AGM

The Notice of the AGM of the Company is on pages 60 to 63 and a summary of the resolutions is set out in the Directors’ Report on pages 58 and 59. The AGM will be held on 18 January 2018 at 1st Floor, 43-45 Portman Square, London W1H 6LY at 11.00am and shareholders are cordially invited to attend.

This year, there is a new resolution in response to requests from voting agencies to have the opportunity to vote on the Company’s dividend payment policy, as detailed on page 8. This is an advisory resolution.

The Board has carefully considered all the resolutions proposed in the Notice and, in their opinion, consider them all to be in the interests of the shareholders as a whole. The Directors and the portfolio manager, James Goldstone, will be available at the meeting to answer shareholders’ questions.

Beatrice Hollond

Chairman

27 November 2017

STRATEGIC REPORTFOR THE YEAR ENDED 30 SEPTEMBER 2017

BUSINESS REVIEW

Keystone Investment Trust plc is an investment company holding investments with a market value in excess of £290 million and its investment objective is set out below. The strategy the Board follows to achieve that objective is to set investment policy and risk guidelines, together with investment limits, and to monitor how they are applied. These are also set out below.

The business model adopted by the Company to achieve its objective has been to contract the services of Invesco Fund Managers Limited (the ‘Manager’) to manage the portfolio in accordance with the Board’s strategy and under its oversight. The Manager also provides company secretarial, marketing and general administration services. The portfolio manager responsible for the day-to-day management of the portfolio was Mark Barnett to 31 March 2017 and, as explained in the Chairman’s Statement, James Goldstone took over as portfolio manager on 1 April 2017.

All administrative support is provided by third parties. In addition to the management and administrative functions of the Manager, the Company has contractual arrangements with Link Asset Services (formerly known as Capita Asset Services) as registrar and BNY Mellon Trust & Depositary (UK) Limited as the depositary. The depositary has delegated the safekeeping (custody) of the Company’s investments to The Bank of New York Mellon (London Branch). From 1 December 2017, the depositary and custodian will become The Bank of New York Mellon (International) Limited following novation of the depositary agreement. This transfer will have no substantive effect on the current services and arrangements.

Investment Objective and Policy

Investment Objective

The Company’s objective is to provide shareholders with long-term growth of capital, mainly from UK investments.

Investment Policy and Risk

The portfolio is invested by the Manager so as to maximise exposure to the most attractive sectors and stocks within the UK stock market and, within the limits set out below, internationally. The Manager does not set out to manage the risk characteristics of the portfolio relative to the benchmark index and the investment process will result in potentially very significant over or underweight positions in individual sectors versus the benchmark.

The Manager controls stock-specific and sector risk by ensuring that the portfolio is always appropriately diversified. In depth, continual analysis of the fundamentals of investee companies allows the portfolio manager to assess the financial risks associated with any particular stock. The portfolio is typically made up of 50 to 80 stocks. If a stock is not considered to be a good investment, then the Company will not own it, irrespective of its weight in the index.

Investment Limits

The Board has prescribed the following limits on the investment policy, all of which are at time of investment unless otherwise stated:

– no single equity investment in a UK listed company may exceed 12.5% of gross assets;

– the Company will not invest more than 15% of its assets in other listed investment companies;

– the Company will not invest more than £12 million in bonds, with a maximum of £1.5 million in any issue;

– the Company will normally not invest more than 5% of gross assets in unquoted investments;

– the Company will not normally invest more than 15% of its equity investments in companies that are not UK listed and incorporated; and

– borrowing may be used by the Company to create gearing within limits determined by the Board.

Gearing Policy

The Board carefully considers the Company’s policy in respect of the level of equity exposure. The Board takes responsibility for the Company’s gearing strategy and sets guidelines to control it, which it may change from time to time. These guidelines currently require that the Manager must make no net purchases if equity exposure is more than 107.5% of net assets, and must make sales if, as a result of market movements, equity exposure is to exceed 115% of net assets. When held, corporate bonds are not treated as equity exposure for the purposes of the gearing limits.

Foreign Exchange

The Company has some non-sterling denominated investments and is therefore subject to foreign exchange risk. The Board monitors foreign currency exposure and takes a view, from time to time, on whether foreign currency exposure should be hedged. For the present, the Board has prescribed that all currency exposure should be hedged other than US dollar and Swiss franc.

Performance

Delivery of shareholder value is achieved through outperformance of the relevant benchmark.

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

• net asset value (NAV) and share price total return compared with benchmark and peer group performance;

• share price premium/discount relative to the net asset value;

• dividends; and

• ongoing charges.

The Company’s NAV and share price total returns for the year to 30 September 2017 were 7.8% and 3.2% respectively, both of which were substantially less than the total return of the Company’s benchmark, the FTSE All-Share Index, of 11.9%. The Manager’s Report on pages 12 to 15 provides commentary on the reasons for the performance.

The combination of this year’s relative underperformance and that of last year has also affected longer term performance. Over three years, the Company’s NAV and share price returns were 20.9% and 12.2%, respectively, compared to the benchmark return of 27.8%. The Manager is entitled to a performance-related fee based on the last three years’ NAV performance, but this year no fee accrues.

A table of the returns for the last ten years, together with a graph, can be found on page 3.

Peer group performance is monitored by comparing the Company with the 13 investment companies making up the UK All Companies sector of the approximately 300 investment companies in the UK and a bespoke list of investment companies which the Board considers most closely resemble the Company. As at 30 September 2017, in NAV total return terms, the Company was ranked 11 in its sector over one year, 9 over three years and 7 over 5 years (source: JPMorgan Cazenove).

The Company’s shares traded at a discount relative to NAV (with debt at fair value) through the year, as shown in the following graph. The discount at the year end was 12.6%

There is no specific target discount. The Board asks shareholders to approve resolutions every year which allow for the repurchase of shares (for cancellation or to be held as treasury shares) and also their issuance. This may assist in the management of the discount. The Company has not issued any ordinary shares in the year and no shares were repurchased.

Dividends form a key component of the total return to shareholders. The income from the portfolio and potential level of dividend payable is reviewed at every board meeting. The Board’s Dividend Payment Policy is for the Directors to declare two dividends in respect of each accounting year, for payment in June and December. Additional special dividends may be declared, at the discretion of the Directors.

A first interim dividend of 18p (2016:18p) per share was paid on 23 June 2017 and a second interim dividend of 37p (2016: 35p) per share has been declared, which is payable on 22 December 2017 to shareholders on the register at 1 December 2017. These give a total ordinary dividend for the year of 55p compared with 53p for the previous year. The Board has also declared a special dividend of 4.7p (2016: 5.3p) to be paid at the same time as the second interim dividend. The dividend history of the Company over the last ten years is shown in the table on page 3.

The ongoing charge is the industry measure of the Company’s operating costs as a percentage of net asset value. The expenses of the Company are reviewed at every board meeting, with the aim of managing costs incurred and their impact on performance. The ongoing charges figure for the past year, which excludes any performance fee, was 0.61%, compared with 0.69% for the year to 30 September 2016. The ten year record of ongoing charges is shown on page 3.

Financial Position

At 30 September 2017, the Company’s net assets were valued at £275 million (2016: £265 million). These comprised a portfolio of mainly equity investments and net current assets.

At this and the previous year end, the Company’s ordinary shares were geared by borrowings in the form of two issues of long-term debentures, totalling £32 million nominal. Their weighted average interest rate was 6.77% for both years. The Company also had £0.25 million of 5% cumulative preference shares in issue.

The Company also has an uncommitted short-term overdraft facility, of up to 10% of net assets, with the custodian for settlement and liquidity purposes. This was undrawn at the year end.

Outlook and Future Trends

The main trends and factors likely to affect the future development, performance and position of the Company’s business can be found in the following Manager’s Report section of this Strategic Report. Further details as to the risks affecting the Company are set out below under ‘Principal Risks and Uncertainties’.

Principal Risks and Uncertainties

The audit committee regularly undertakes a robust assessment of the risks the Company faces, on behalf of the Board (see Audit Committee Report on pages 21 to 23).

The following are considered to be the most significant risks to the Company and to shareholders in relation to their investment in the Company. Further details of risks and risk management policies as they relate to the financial assets and liabilities of the Company are detailed in note 16 to the financial statements.

Investment Objective

There is no guarantee that the Company’s strategy and business model will be successful in achieving its investment objective.

The Board monitors the performance of the Company and has established guidelines to ensure that the investment policy that has been approved is pursued by the Manager.

Market Risk

The majority of the Company’s investments are traded on the London Stock Exchange. The principal risk for investors in the Company is of a significant fall in stock markets and/or a prolonged period of decline in the markets relative to other forms of investment. The value of investments held within the portfolio is influenced by many factors including the general health of the economy in the UK, interest rates, inflation, government policies, industry conditions, political events, tax laws, environmental laws and investor sentiment. The portfolio manager has summarised in the Manager’s Report section of this Strategic Report particular factors affecting the performance of markets in the year and his view of those most pertinent to the outlook for the portfolio. Such factors are out of the control of the Board and the Manager and may give rise to high levels of volatility in the prices of investments held by the Company, although the use or elimination of gearing may modify the impact on shareholder return.

Investment Risk

An inherent risk of investment is that the stocks selected for the portfolio do not perform well.

The investment process employed by the Manager combines top down assessment of economic and market conditions with stock selection. Fundamental analysis forms the basis of the Company’s stock selection process, with an emphasis on sound balance sheets, good cash flows, the ability to pay and sustain dividends, good asset bases and market conditions. The process is complemented by constant assessment of market valuations. It is important to have a sense of a company’s realistic valuation which, to some extent, will be independent of the price at which it trades in the market. Overall, the investment process is aiming to achieve absolute returns through a genuinely active fund management approach. This can therefore result in a portfolio which looks substantially different from the benchmark index.

Risk management is an integral part of the investment management process. The Manager effectively controls risk by ensuring that the Company’s portfolio is always appropriately diversified. Continual analysis of all holdings gives the Manager a full understanding of financial risks associated with them.

The portfolio of investments held at 30 September 2017 is set out on pages 16 and 17.

Past performance of the Company is not necessarily indicative of future performance.

Shares

Shareholders are exposed to certain risks in addition to risks applying to the Company itself.

The ordinary shares of the Company may trade at a premium or discount to its NAV. The Board monitors the price of the Company’s shares in relation to their NAV and the premium/discount at which they trade.

The value of an investment in the Company and the income derived from that investment may go down as well as up and an investor may not get back the amount invested.

While it is the intention of the Directors to pay dividends to ordinary shareholders twice a year, the ability to do so will depend upon the level of income received from securities and the timing of receipt of such income by the Company. Accordingly, the amount of the dividends paid to ordinary shareholders may fluctuate. Any change in the tax or accounting treatment of dividends or other investment income received by the Company may also affect the level of dividend paid.

The Directors seek powers to issue and buy back the Company’s shares each year, which can be used to help manage the level of discount. The Board also monitors the level of revenue available for distribution at each Board meeting.

Gearing

Gearing levels may change from time to time in accordance with the Manager’s and the Board’s assessment of risk and reward. Whilst the use of borrowings by the Company should enhance total return where the return on the Company’s underlying securities is rising and exceeds the cost of borrowing, it will have the opposite effect where the underlying return is falling. As at 30 September 2017, net gearing from borrowings stood at 6.6% (2016: 6.2%). The Board and the Manager regularly review gearing and will continue to monitor the level closely over the year ahead.

Reliance on the Manager and Other Service Providers

The Company has no employees and the Directors have all been appointed on a non-executive basis. The Company is reliant upon the performance of third party service providers for it to function. In particular, the Manager performs services that are integral to the operation of the Company. Failure by any service provider to carry out its obligations to the Company in accordance with the terms of its appointment or compromise of their systems could have a materially detrimental impact on the operation of the Company and could affect the ability of the Company to successfully pursue its investment policy.

The Company has limited direct exposure to cyber risk. However, the Company’s operations or reputation could be affected if any of its service providers suffered a major cyber security breach. The Board monitors the preparedness of its service providers in this regard and is satisfied that the risk is given due priority.

The Manager may be exposed to reputational risks. In particular, the Manager may be exposed to the risk that litigation, misconduct, operational failures, negative publicity and press speculation, whether or not it is valid, will harm its reputation. Any damage to the reputation of the Manager could result in potential counterparties and third parties being unwilling to deal with the Manager and by extension the Company. This could have an adverse impact on the ability of the Company to pursue its investment policy successfully. The Company’s main service providers are listed on page 65.

The Board monitors the services provided to the Company, informally at every Board meeting and formally at least annually.

Regulatory

The Company is subject to various laws and regulations by virtue of its status as a public limited company, as an investment trust and as an alternative investment fund. A loss of investment trust status could lead to the Company being subject to capital gains tax on the profits arising from the sale of its investments. A serious breach of other regulatory rules might lead to suspension from the Stock Exchange. Other control failures, either by the Manager or another of the Company’s service providers, might result in operational or reputational problems, erroneous disclosures or loss of assets through fraud, as well as breaches of regulations.

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

Viability Statement

The Company is 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 Company’s current position, the principal risks to which it is exposed and their potential impact on its future development and prospects. The most significant of these are shareholder dissatisfaction arising from failure to meet the Company’s investment objective, through poor investment performance or because the investment policy is no longer appropriate to the prevailing market conditions, and contributory market and investment risks. The Board also took into account the capabilities of the Manager and the varying market conditions experienced, which have effectively stress tested the Company over many years through different and difficult market cycles.

In terms of financial risks to viability, save for the limited value ascribed to unquoted investments, the Company’s portfolio is readily realisable and many times the value of its short term liabilities and annual operating costs. The Company also has long term debt obligations comprising two debentures. The smaller debenture, £7 million, falls due in 2020 and the larger, £25 million, in 2023. In aggregate this long term debt amounts to 10% of total assets less current liabilities, so the principal is more than nine times covered and the risk that interest obligations will not be met is negligible.

Based on the 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 Company’s policy on diversity is set out on page 52. The Nomination Committee considers diversity, including the balance of skills, knowledge, gender and experience, amongst other factors, when reviewing the composition of the Board and appointing new directors but does not consider it appropriate to establish targets or quotas in this regard. At the date of this report, the Board comprises five non-executive directors of whom one, the Chairman, is a woman thereby constituting 20% female representation. Two new female directors have been nominated for election at the forthcoming AGM, at which one of the male directors will retire, so this ratio will increase. Summary biographical details of the Directors are set out on page 18. The Company has no employees.

Social and Environmental Matters

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

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

Stewardship

The Board considers that the Company has a responsibility as a shareholder towards ensuring that high standards of corporate governance are maintained by the companies in which it invests. The Company’s stewardship functions have been delegated to the Manager, who exercises the Company’s voting rights and reports back to the Board. The Manager has adopted a clear and considered policy towards its responsibility as a shareholder on behalf of the Company. As part of this policy, the Manager takes steps to satisfy itself about the extent to which the companies in which it invests look after shareholders’ value and comply with local recommendations and practices, such as the UK Corporate Governance Code. A copy of the Manager’s Policy on Corporate Governance and Stewardship can be found at www.invescoperpetual.co.uk.

MANAGER’S REPORT

Market Review

As explained in the half year financial report, the UK equity market ended the 2016 calendar year on a strongly positive note as global equity markets and government bond yields rose in response to the surprise election of Donald Trump as US President and the resultant expectation of increased infrastructure spending, reduced regulation and lower taxes.

Through the remainder of the first half of the Company’s year the equity market continued to focus on foreign exchange and on the future direction of interest rates. The internationally weighted FTSE 100 index surged to a high in mid-March, coinciding with the high in US 10-year bond yields, as the market priced in stronger US and global growth and sterling remained weak against all major currencies.

As a result, sector performance rotated towards industries that would benefit from the rising yield curve, a pro-growth political backdrop and US dollar-denominated earnings, although this trend abated after dovish comments from the US Federal Reserve accompanied its March interest rate rise and as the Trump administration failed to progress healthcare reforms through Congress.

Equities continued their run into the second half of the Company’s financial year, buoyed by strengthening commodity prices and despite a recovery in sterling against the dollar. The FTSE 100 index reached a record high in early June, led by a rally in the oil and mining sectors and a temporary sell off in sterling in response to the surprise outcome of the UK general election.

Through the summer, however, growing tensions between the US and North Korea hit market sentiment globally and economic data provided mixed signals around UK economic growth; the Office of National Statistics revised down growth figures for the second quarter of 2017, the International Monetary Fund cut UK economic growth forecasts and there was some softening in construction activity and industrial production. Despite these issues, there was continued expansion in the service sector and some positive surprises in retail sales. In August the UK unemployment rate reached a 40-year low at 4.3%.

Renewed strength in sterling further dampened UK equity market performance in September after rhetoric from the Bank of England (BoE) suggested the BoE would “ease its foot off the accelerator” by raising interest rates at its November 2017 meeting.

While tangible progress in Brexit negotiations appears limited to date, Theresa May’s keynote speech in Florence in late September made clear that the UK government anticipates a two-year transitional period between leaving the EU in March 2019 and the start of any new trading relationship. An agreement along these lines would avoid the cliff-edge feared by the market and so the Prime Minister’s more co-operative tone was well received.

Change of Named Portfolio Manager and Portfolio Activity

I was appointed portfolio manager by the Board on 1 April 2017; portfolio activity from this date reflects the gradual transition to my preferred investment strategy.

By the Company’s year-end this process was largely completed, but given my focus on valuation to enhance return and mitigate risk, I have delayed adding or selling certain holdings in anticipation of a better opportunity to do so.

I have tilted the portfolio towards domestic cyclicals and financials by investing in businesses, often at depressed valuations, where I believe there is considerable potential upside to earnings.

New investments have been made in Acacia Mining, Ashtead, Balfour Beatty, Barclays, Cairn Homes, Coats, Cranswick, Gamma Communications, Hollywood Bowl, Howden Joinery, JD Sports, Just Eat, Lloyds Bank, McBride, Mears, Micro Focus International, PRS REIT, Randgold Resources, Royal Dutch Shell ‘B’, Safestyle, Saga, Shire, Sigma Technology, Standard Life and TP ICAP. Further details of my portfolio activity can be found in the Strategy and Outlook section.

The holdings in AstraZeneca, Beazley, Bunzl, Capita, Centrica, Compass, Doric Nimrod, G4S, KCOM, Lancashire, London Stock Exchange, NewRiver REIT, Novartis, Shaftesbury, SSE, TalkTalk, Thomas Cook and VPC Specialty Lending were sold. The holdings in Roche, BAE Systems and Imperial Brands were reduced.

Portfolio Performance Review

The Company’s net asset value, including reinvested dividends, rose by 7.8% during the year to 30 September 2017, compared with a rise of 11.9% by the FTSE All-Share index.

The portfolio delivered a positive return against a strong market backdrop, but failed to match the rise of the index.

Relative performance was negatively impacted by the portfolio’s underweight positioning in mining (which returned +32.7% over the year) and the oil and gas sectors which also performed strongly. Not holding HSBC (+35.2%) also detracted from relative performance.

The holdings in the tobacco sector were among the top contributors to performance, benefiting from the sector’s overseas earnings, but also from continued consolidation. British American Tobacco completed its merger with Reynolds American in July; the deal has created a combined entity which is well-positioned to exploit next generation products, particularly in the key US market. However, share prices were negatively affected across the sector in August as the stock market focused on plans announced by the US Food & Drug Administration to launch a consultation on lowering nicotine levels in cigarettes. We expect any new regulation emerging from the consultation will take significant time to come to fruition and the tobacco industry has grown well-accustomed to dealing with such headwinds. Elsewhere in the portfolio, the holding in BAE Systems (+24.9%) contributed positively to performance against a backdrop of rising geopolitical instability. The company, which derives a significant proportion of revenues overseas, benefited from sterling weakness and expectations of a sharp increase in defence spending following the US election. BAE confirmed a series of major contracts through the 12-month period, including a multi-billion pound deal for support work on new generation F-35 stealth fighters and a £3.7 billion contract with the Ministry of Defence to build a new fleet of warships.

Next (which rose 45% from its low point in July) contributed positively through what has been a fairly torrid year for UK retailers. After a tough Christmas trading period, the company’s recent interim results prompted a sharp rise in the shares as management modestly upgraded full-year sales and profit guidance on a “somewhat less challenging” outlook. This is a business with a track record of consistently delivering within the guidance range set at the start of each year and an exceptional understanding of shareholder value. Notwithstanding the ongoing structural challenges from online retail, Next’s online directory and logistics infrastructure equip the business to navigate the shift to online better than its competitors.

In the financial sector, Legal & General (L&G) (+25.0%) contributed positively. L&G continued to capitalise on opportunities in the bulk annuity market, where it has a global market-leading position.

Provident Financial (–71.4%) was the single largest driver of underperformance for the period. The sub-prime lender has delivered strong performance in the portfolio over many years, but the business was hit by major operational disruption in August following a strategic shift in its home credit operating model. The company issued a profit warning, downgrading Q3 earnings forecasts for its Consumer Credit Division and announcing that subsidiary Vanquis Bank is co-operating with an FCA investigation into its Repayment Option Plan ancillary product. The previously announced interim dividend was withdrawn and the CEO resigned. This prompted a 70% intra-day decline in the company’s share price. Subsequent to this initial decline, the share price showed some recovery, albeit from a low base, and I sold the holding.

Acacia Mining (which fell 56% over the second half of the year) also negatively impacted performance. The gold miner presented a compelling investment opportunity, offering free cash flow yield at the then prevailing gold price along with the downside protection of gold in an uncertain market environment. Acacia conducts the bulk of its exploration and extraction in Tanzania, which has traditionally been a business-friendly environment. Unfortunately, the company has found itself mired in a dispute with the Tanzanian government, who have alleged historic underdeclaration of exports and therefore tax payments and have, as a result, suspended Acacia’s concentrate exports.

BT Group (–23%) also detracted as the market continued to focus on ongoing developments around the legal separation of its Openreach high-speed broadband network. In January an update on accounting irregularities in the group’s Italian division prompted a sharp share price fall, which worsened after a profit warning from the company highlighted a more challenged outlook for domestic public services contracts. The valuation remains depressed, but the company is starting to see some improvement following its acquisition of EE.

Strategy and Outlook

Six months on from my first update to shareholders, the UK equity market continues to push higher. This is despite a growing list of things worth worrying about. In no particular order and to name but four: geopolitics (North Korea), domestic politics, monetary policy (global QE tapering/ reversal and rising base rate) and the uncertainties of Brexit. Whilst the headline valuation of the constituents of the FTSE All-Share Index looks reasonable at around 14 times 12-month forward earnings, that average conceals some stark valuation differences between stocks, sectors and “styles” that by historical standards look extreme and have thrown up some compelling opportunities. Accordingly, I have reshaped the portfolio over the past six months, with a slant towards selected domestic cyclicals and financials where the risk/reward looks most favourable.

Whilst my investment process revolves heavily around stock picking, I have made these changes to the portfolio in the context of a number of top down working assumptions about how the world will look over the next few years.

The most important of these is around inflation and the likely trajectory of interest rate policy. The sharp fall in sterling in the wake of the EU referendum flowed through quickly to the prices of food, energy and fuel and the tail-end of this move was still being felt in September with CPI at 3%. However, the recent recovery in sterling against the dollar (including on a trade-weighted basis) means CPI is likely to be at or close to peak for now and is a factor in the market’s view that interest rates will rise only very gradually. This potentially misses the significance of wage inflation. Private sector wage growth is already above 3% and the 1% cap on public sector pay has now been lifted. Wages at the bottom end of the pay scale will continue to accelerate thanks not just to the pre-determined increases in the national living wage, but also, according to anecdotal evidence from management teams we meet, to a very tight labour market. Since being given independence, the Bank of England has signalled consistently that inflation expectations, rather than current rates of inflation, drive interest rate policy and wage inflation is surely the biggest driver of those expectations.

This leads to several conclusions: firstly, that the risk to UK base rates and market rates of interest is clearly to the upside (against a similar backdrop globally); secondly, that in the near term, the recent decline in real disposable income is set to reverse and boost UK consumption and, in turn, the revenues and margins of companies exposed to the UK consumer; thirdly, that the pound, still well below purchasing power parity, could strengthen substantially and in the process dent the earnings of export-led and internationally based businesses, at the same time as expanding disposable incomes further.

The impact of all this could be very significant indeed, given the current valuation disparity between the potential winners and losers. The momentum that has characterised the last several years in the equity market has left the share prices of companies exhibiting “value” characteristics, relative to those exhibiting “growth” characteristics, at levels rarely seen in the last forty years; money has poured into so called “bond proxies” and into shares of companies perceived as capable of growing in a low growth environment. As an example, shares in UK Financials are still very close to their post referendum twenty year low relative to Consumer Staples. If the received wisdom that the low growth, low interest rate environment is permanent proves erroneous, sector rotation and the resultant correction in share prices could be dramatic.

Added to all this is the outcome of the Brexit negotiations and, in the shorter-term, the perception of the likely outcome. Whilst the process will inevitably continue to generate headlines about the two sides’ positions and the economic impact of a good deal or of no deal, I believe that in time an agreement will be reached that avoids unnecessary mutual pain. An intervening period of brinksmanship will of course bring volatility to the UK stock market but in time I expect this to be seen to have presented unusually attractive investment opportunities.

Another risk to domestic resurgence is the rise of the Labour party under Jeremy Corbyn, who has successfully identified a number of serious societal and generational issues and capitalised upon them in the face of a Tory party weakened and distracted by Brexit and the surprise general election result. Whilst a Labour majority in parliament could turn the valuation scenario discussed above on its head, it is difficult to envisage a set of conditions under which the Conservative party would precipitate another General Election over the next 24 months. I am therefore watching the domestic political situation extremely closely but don’t view the threat as imminent.

So with the risks either over-stated or sufficiently distant, I have favoured companies that offer undervalued exposure to a better domestic out-turn than is generally expected. This has resulted in significant holdings in domestically focused UK banks and life insurers, where the market has priced in such a negative view that valuations are very depressed. Barclays, Lloyds Bank, Legal & General and Aviva would all be beneficiaries of any increase in interest rates but crucially this is not currently priced into their consensus earnings forecast. In the case of Barclays and Lloyds Bank, they simply need to continue to deliver on cost reductions, whilst delivering only very modest volume growth and the current share prices will look unreasonably cheap; with any move in interest rates they will look even more so. Legal & General should continue to consolidate its position as a global leader in the bulk annuity market, while Aviva is starting to see better execution across its digital platforms driving cross-selling from life and pensions into general insurance products. Like with banks, if rates rise more quickly than the market is currently anticipating, earnings will surprise to the upside, but this is not required to justify my view that the shares are very undervalued.

Beyond Financials, I have invested in a number of UK companies which are exposed to UK consumption and stand to benefit if the consensus outlook for continued negative real wages and resultant weak demand fails to materialise.

Diversification of the portfolio of course remains key; while I have increased the portfolio’s domestic and financials exposure, I have retained – and in some areas increased – broad exposure to international earnings where valuations remain appealing. This has been the case with BP, which is now a top three position in the portfolio. Management have successfully adapted the business to the reality of a lower oil price, and are on the verge of covering an optically high but scrip-assisted historic dividend with free cash flow. BP have achieved cash flow breakeven at a $50 oil price and guided that they could achieve this at $35 in due course; management have also signalled plans not just to neutralise future scrip issuance but also to neutralise $5 billion of historic scrip through share buybacks. This would be a very significant event that would underline management’s commitment to shareholder value and to an appropriate capital allocation framework.

To conclude, the world feels an increasingly uncertain place but with the transition largely complete, I believe I have a portfolio of investments at attractive valuations which is both very well positioned to navigate what lies ahead and has the potential to deliver a compelling total return, comprising both income and capital growth.

James Goldstone, Portfolio Manager

The Strategic Report was approved by the Board of Directors on 27 November 2017.

Invesco Asset Management Limited

Company Secretary

STRATEGIC REPORT

INVESTMENTS IN ORDER OF VALUATIONAT 30 SEPTEMBER 2017

UK listed ordinary shares unless stated otherwise

NR is non-rated.

UQ is unquoted.

ADR is American Depositary Receipt.

STATEMENT OF DIRECTORS’ RESPONSIBILITIESIN RESPECT OF THE PREPARATION OF FINANCIAL STATEMENTS

The Directors are responsible for ensuring that the annual financial report is prepared in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have elected to prepare financial statements in accordance with UK Accounting Standards, including FRS 102 ‘The Financial Reporting Standard applicable in UK and Republic of Ireland’. Under company law, the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the net return of the Company for that period.

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

• select suitable accounting policies and then apply them consistently;

• make judgments and accounting estimates that are reasonable and prudent;

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

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

The Directors are responsible for keeping adequate accounting records which are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and which enable them to ensure that the financial statements comply with company law. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

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

The Directors of the Company, whose names are shown on page 18 of this Report, each confirm to the best of their knowledge that:

• the financial statements, which have been prepared in accordance with United Kingdom accounting standards on a going concern basis, give a true and fair view of the assets, liabilities, financial position and net return of the Company;

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

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

Beatrice Hollond

Chairman

Signed on behalf of the Board of Directors

27 November 2017

INCOME STATEMENT

FOR THE YEAR ENDED 30 SEPTEMBER

The total column of this statement represents the Company’s profit and loss account, prepared in accordance with UK Accounting Standards. The return after taxation is the total comprehensive income and therefore no 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 of the Company. No operations were acquired or discontinued in the year.

RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS

FOR THE YEAR ENDED 30 SEPTEMBER

The accompanying notes are an integral part of these statements.

BALANCE SHEET

The financial statements on pages 34 to 50 were approved and authorised for issue by the Board of Directors on 27 November 2017.

Signed on behalf of the Board of Directors

Beatrice Hollond

Chairman

The accompanying notes are an integral part of these statements.

CASH FLOW STATEMENT

FOR THE YEAR ENDED 30 SEPTEMBER

The accompanying notes are an integral part of these statements.

NOTES TO THE FINANCIAL STATEMENTS

1. Accounting Policies

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

A summary of the principal accounting policies adopted by the Company is set out below.

(a) Basis of Preparation

(i) Accounting Standards applied

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

(ii) Functional and presentation currency

The financial statements are presented in Sterling, which is the Company’s functional and presentation currency and the currency in which the Company’s share capital and expenses, as well as a majority of its assets and liabilities, are denominated.

(b) Financial Instruments

(i) Recognition of financial assets and financial liabilities

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

(ii) Derecognition of financial assets

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

(iii) Derecognition of financial liabilities

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

(iv) Trade date accounting

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

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

Financial assets

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

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

Fair value for investments that are actively traded in organised financial markets is determined by reference to stock exchange quoted bid prices at the balance sheet date. For investments that are not actively traded or where active stock exchange quoted bid prices are not available, fair value is determined by reference to a variety of valuation techniques including broker quotes and price modelling. Where there is no active market, unlisted/illiquid investments are valued by the Directors at fair value based on recommendations from Invesco’s Pricing Committee, which in turn is guided by the International Private Equity and Venture Capital Valuation Guidelines issued in 2015, using valuation techniques such as earnings multiples, recent arm’s length transactions and net assets.

Financial liabilities

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

(c) Accounting for Capital Reserves

Realised gains and losses on sales of investments (note 9(b)); realised gains or losses on forward currency contracts; realised gains and losses on foreign currency; management fees and finance costs allocated to capital; and any other capital charges, are included in the income statement and dealt with in the capital reserve. Unrealised increases and decreases in the valuation of investments at the year end (including the related foreign exchange gains and losses) are also included in the income statement and dealt with in the capital reserve.

(d) Cash and cash equivalents

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

(e) Income

Dividend income arises from equity investments held and is recognised on the date investments are marked ‘ex-dividend’. Where the Company elects to receive dividends in the form of additional shares rather than cash, the equivalent to the cash dividend is recognised as income in the revenue account and any excess in the value of the shares received over the amount of the cash dividend is recognised in capital reserve. Special dividends are taken to income unless they arise from a return of capital, when they are allocated to capital in the income statement. Interest income arising from fixed income securities and cash is recognised in the income statement using the effective interest method. Deposit interest and underwriting commission receivable are taken into account on an accruals basis.

(f) Management and Performance-related fees

Investment management fees are recognised on an accruals basis and are charged 75% to capital and 25% to revenue. This is in line with the Board’s expected long-term split of returns, in the form of capital gains and income respectively, from the investment portfolio of the Company.

Performance-related fees are calculated as detailed in the Directors’ Report and are charged wholly to capital as they arise mainly from capital returns on the investment portfolio.

(g) Expenses and Finance costs

Expenses are recognised on an accruals basis and finance costs are recognised using the effective interest method, with the debentures being held at amortised cost. The finance costs of debt are allocated 75% to capital and 25% to revenue for the reasons outlined in (f) above. The 5% cumulative preference shares are classified as a liability and therefore the dividends payable on these shares are classified as finance costs and charged to revenue in the income statement.

(h) Hedging

Forward currency contracts entered into for hedging purposes are valued at the appropriate forward exchange rate ruling at the balance sheet date. Profits or losses on the closure or revaluation of positions are included in capital.

(i) Foreign Currency Translation

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

(j) Taxation

Foreign dividends that suffer withholding tax at source are shown gross, with the corresponding tax charge in the income statement.

Deferred taxation is 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 has not been recognised in respect of surplus management expenses and losses on loan relationships, as the Company is unlikely to have sufficient future taxable revenue to offset against these.

(k) Dividends Payable

Dividends are not recognised in the financial statements unless there is an obligation to pay at the balance sheet date.

2. Income

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

Special dividends of £2,648,000 (2016: £88,000) have been recognised in capital.

3. Investment Management and Performance-related Fees

This note shows the fees paid to the Manager. These are made up of the management fee payable quarterly and a performance-related fee calculated annually. The latter is only payable when the portfolio outperforms the benchmark index plus its hurdle, which is +1.25% per annum.

Details of the management agreement are disclosed in the Directors’ Report.

The performance-related fee is due if the Company’s annualised total return over the previous three years is greater than the annualised return of the FTSE All-Share (Total Return) Index over the same period, plus the hurdle.

At 30 September 2017, an investment management fee of £261,000 (2016: £354,000) has been accrued in respect of the three months to 30 September 2017. No performance-related fee has been accrued for the year (2016: £65,000).

4. Other Expenses

The other expenses of the Company are presented below.

The Director's Remuneration Report provides further information on Directors' fees.

Fees payable to the Company’s auditor are shown excluding VAT which is included in other expenses.

Other expenses includes £6,000 (2016: £6,000) of employer’s National Insurance on Directors’ fees. As at 30 September 2017, the amount outstanding on Directors’ fees and employer’s National Insurance was £7,700 (2016: £6,900).

5. Finance Costs

Finance costs arise on any borrowing that the Company has, with the main borrowing being the £32 million of Debenture stocks (see note 12).

6. Tax on ordinary activities

As an investment trust, the Company pays no tax on capital gains and as the Company principally invests in UK assets, it has little overseas tax. This note shows details of the tax charge and why no deferred tax is required to provide for tax that is expected to arise in the future due to differences in accounting and tax bases.

(a) Current Tax Charge

(b) Reconciliation of Current Tax Charge

(c) Factors that may Affect Future Tax Changes

The Company has excess expenses of £71,913,000 (2016: £68,676,000) that are available to offset future taxable revenue. A deferred tax asset, of £12,225,000 measured at the standard corporation tax rate of 17% (2016: £11,675,000 at 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

Basic return per share is the amount of gain (or loss) generated for the financial year divided by the number of ordinary shares in issue. The calculation is based on the weighted average number of shares in issue during the year.

Basic revenue, capital and total return per ordinary share is based on each of the returns on ordinary activities after taxation and on 13,518,799 (2016: 13,518,799) shares being the number of ordinary shares in issue throughout the year.

8. Dividends

Dividends represent the return of income less expenses to shareholders. Dividends are paid as an amount per ordinary share held.

9. Investments

The portfolio is made up primarily of investments which are listed, i.e. traded on a recognised stock exchange, and some unlisted investments. Gains and losses are either:

– realised, usually arising when investments are sold; or

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

(a) Analysis of Investments by Listing Status

(b) Analysis of Investment Gains and Losses

(c) Transaction Costs

Transaction costs on purchases of £837,000 (2016: £171,000) and on sales of £194,000 (2016: £57,000) are included within gains and losses on investments in the income statement.

10. Debtors

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

11. Creditors: amounts falling due within one year

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

Details of the performance-related fee are given in note 3.

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

Long term creditors consist of £32 million of debentures and a small issue of preference shares. These form the principal borrowings of the Company and the fixed interest that the Company pays is reported under note 5 ‘Finance Costs’.

The debentures rank pari passu with each other, and ahead of shareholders, and are secured by floating charge over the assets of the Company.

The debenture stocks both pay interest twice a year; the 7.75% Debenture Stock 2020 for the six months ended 31 March and 30 September, and the 6.5% Debenture Stock 2023 for the six months to 27 April and 27 October. Both debenture stocks generally make the payments in April and October. The preference shares dividend is paid bi-annually in March and September.

13. Called up share capital

Ordinary share capital represents the total number of shares in issue, for which dividends accrue.

The ordinary shares are fully participating and on a poll carry one vote per £1 nominal held.

No shares were issued or bought back during the year (2016: nil).

14. Reserves

This note explains the different reserves that have arisen over the years. The aggregate of the reserves and share capital (see previous note) make up total shareholders’ funds.

The share premium comprises the net proceeds received by the Company following the issue of shares, after deduction of the nominal amount of 50 pence and any applicable issue costs. The capital redemption reserve maintains the equity share capital arising from the buy back and cancellation of shares; it, and the share premium, are non-distributable.

The capital reserve includes the investment holding gains/(losses), being the difference between cost and market value at the balance sheet date. 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. Share buy backs can be funded from the capital reserve. The revenue reserve shows the net revenue retained after payment of dividends. The revenue and capital reserves are distributable by way of dividend.

15. Net Asset Value

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

The following shows the shareholders' funds and net asset value (NAV) in pence per share, together with a reconciliation of NAV with debt at par to NAV with debt at market value. The difference in the NAVs arises from the valuation of the debenture stocks and preference shares. The number of shares in issue at the year end is shown in note 13.

Only the basic NAV is shown. There is no dilution in this or the previous year.

16. Financial Instruments

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

The Company’s financial instruments comprise its investment portfolio (as shown on pages 16 and 17), derivatives, cash, and any borrowings, debtors and creditors that arise directly from its operations such as sales and purchases awaiting settlement and accrued income. The accounting policies in note 1 include criteria for the recognition and the basis of measurement applied for financial instruments. Note 1 also includes the basis on which income and expenses arising from financial assets and liabilities are recognised and measured. The Company did not have any exposure to derivatives during the year (2016: none), apart from the use of forward currency contracts to hedge the Euro exposure.

The principal risks that an investment company faces in its portfolio management activities are set out below:

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

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

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

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

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

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

Risk Management Policies and Procedures

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

An investment company invests in equities and other investments for the long term so as to meet its investment objective and policies. In pursuing its investment objective, the Company is exposed to a variety of risks that could result in either a reduction in the Company’s net assets or a reduction of the profits available for distribution by way of dividends.

The risks applicable to the Company and the policies the Company used to manage these risks for the two years under review follow.

Market risk

The Company’s Manager assesses the Company's exposure when making each investment decision, and monitors the overall level of market risk on the whole of the investment portfolio on an ongoing basis. The Board meets at least quarterly to assess risk and review investment performance, as disclosed under Board Responsibilities on page 53. No derivatives or hedging instruments are utilised to manage market risk. Borrowings are used to enhance returns, however, this increases the Company's exposure to market risk and volatility.

Currency risk

The majority of the Company’s assets, liabilities and income are denominated in Sterling. There is some exposure to US dollars, Swiss francs and the Euro. The latter currency was hedged by the use of forward currency contracts.

Management of the currency risk

The Manager monitors the Company’s exposure to foreign currencies daily and reports to the Board on a regular basis.

Forward currency contracts can be used to limit the Company’s exposure to anticipated future changes in exchange rates which are also used to achieve the portfolio characteristics that assist the Company in meeting its investment objective and policies. All contracts are limited to currencies and amounts commensurate with asset exposure to those currencies.

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

Currency exposure

The fair values of the Company’s monetary items that had currency exposure at 30 September are shown below. Where the Company’s equity investments (which are not monetary items) are priced in a foreign currency, they have been included separately in the analysis so as to show the overall level of exposure.

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

Currency sensitivity

The table below illustrates the sensitivity of net assets and of net return after taxation for the year using the exchange rates shown below. It is based on the Company’s monetary foreign currency financial instruments held at each balance sheet date and takes account of forward foreign exchange contracts that offset the effects of changes in currency exchange rate.

The above percentages have been determined based on the market volatility in the year, using the standard deviation of Sterling’s daily fluctuation to the relevant foreign currencies against the mean during the year.

If Sterling were to weaken against the Euro, US dollar or Swiss franc to this extent, this would have the following effect:

If Sterling were to strengthen against the Euro, US dollar or Swiss franc to this extent, the effect would be the exact opposite.

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

Interest rate risk

Interest rate movements may affect the level of income receivable on cash deposits and the interest payable on the variable rate borrowings. When the Company has cash balances, they are held on variable rate bank accounts yielding rates of interest dependent on the base rate of the custodian. The Company has an uncommitted bank overdraft facility which it uses for settlement purposes, on which interest is payable at a variable rate. Use of this facility has been minimal over the two years being reported on. At the year end there was none drawn down (2016: nil).

At the balance sheet date the Company had structural debt comprising £32 million of debenture stocks and £250,000 of 5% cumulative preference shares. The interest rates on the debenture stocks and preference shares are fixed and details are shown in notes 5 and 12.

The Company’s portfolio is substantially invested in equities which are not directly exposed to interest rate risk.

Other price risk

Other price risk (i.e. changes in market prices other than those arising from interest rate risk or currency risk) may affect the value of the equity investments, and it is the business of the Manager to manage the portfolio to achieve the best returns.

Management of other price risk

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

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

Based on the equity portfolio value of £294,778,000 (2016: £281,835,000), if the value of the portfolio rose or fell by 1% at the balance sheet date, the net return after tax for the year and net assets would increase or decrease by £2.95 million (2016: £2.82 million) respectively; in calculating these amounts no adjustment has been made for other variables including management fees.

Liquidity risk

Liquidity risk is minimised as the majority of the Company’s investments are readily realisable securities which can be sold to meet funding commitments if necessary. In addition, the bank overdraft facility provides for additional funding flexibility. No special arrangements have been made in connection with the liquidity of any of the Company’s assets.

Liquidity risk exposure

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

The 5% cumulative preference shares do not have a fixed repayment date and are, as a result, not shown in the above table. Details are shown in note 12 of the financial statements.

Credit risk

Credit risk encompasses the failure by counterparties to deliver securities which the Company has paid for, or to pay for securities which the Company has delivered. This risk is mitigated by using only approved and appropriately regulated counterparties. Cash balances are limited to a maximum of either £10 or £15 million with any one deposit taker and 10% of gross assets for holdings in the Short-Term Investments Company (Global Series) plc, which invests in high quality sterling denominated money market investments such as commercial paper, certificates of deposit, time deposits and asset-backed commercial paper. Only deposit takers approved by the Board are used.

The portfolio may be adversely affected if the custodian of the Company’s assets suffers insolvency or other financial difficulties. The risk associated with failure of the custodian is mitigated by the appointment of a depositary. The depositary is ultimately responsible for safekeeping of the Company’s assets and is strictly liable for the recovery of financial instruments in the event of loss. As part of the Board’s risk management and control monitoring, the Board reviews the custodian’s annual control report and the Manager’s management of the relationship with the custodian.

17. Fair Value

The fair values of the financial assets and financial liabilities, other than debentures and preference shares, are either carried in the balance sheet at their fair value (investments), or the balance sheet amount is a reasonable approximation of fair value (due from brokers, dividends receivable, accrued income, due to brokers, accruals, cash at bank and overdraft).

Fair Value Hierarchy Disclosures

Nearly all of the Company’s portfolio of investments are in the Level 1 category as defined in FRS 102 as amended for fair value hierarchy disclosures (March 2016). The three levels set out in FRS102 follow:

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

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

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

Categorisation within the hierarchy is determined on the basis of the lowest level input that is significant to the fair value measurement of each relevant asset/liability. The valuation techniques used by the Company are explained in the accounting policies note.

A reconciliation of the fair value movements in Level 3 is set out below:

The book cost and market (fair) value of the debentures and the preference shares based on the offer value at the balance sheet date follow.

18. Capital Management

The Company’s capital, or equity, is represented by its net assets which are managed to achieve the Company’s investment objective set out on page 8.

The Company’s total capital employed at 30 September 2017 was £307,390,000 (2016: £296,919,000) comprising borrowings of £32,003,000 (2016: £31,972,000) and equity share capital and other reserves of £275,387,000 (2016: £264,947,000).

The Company’s total capital employed is managed to achieve the Company’s investment objective and policy as set out on page 6, including that borrowings may be used to raise equity exposure. At the balance sheet date, net gearing was 6.6% (2016: 6.2%). The Company’s policies and processes for managing capital are unchanged from the preceding year.

The main risks to the Company’s investments are shown in the Strategic Report under the ‘Principal Risks and Uncertainties’ section on pages 8 to 9. These also explain that the Company is able to gear and that gearing will amplify the effect on equity of changes in the value of the portfolio.

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

The Company is subject to externally imposed capital requirements with respect to the obligation and ability to pay dividends by section 1159 Corporation Tax Act 2010 and by the Companies Act 2006, respectively, and with respect to the availability of the overdraft facility, by the terms imposed by the custodian. The Board regularly monitors, and has complied with, the externally imposed capital requirements. This is unchanged from the prior year.

Borrowings comprise debenture stocks and preference shares, details of which are contained in note 12.

19. Contingencies, Guarantees and Financial Commitments

Contingencies or guarantees that the Company will or has given would be disclosed in this note if any existed. Likewise any commitments, being those amounts that the Company is contractually required to pay in the future as long as the other party meets their obligations.

There were no contingencies, guarantees or other financial commitments of the Company at the year end (2016: £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 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 on pages 25 to 26 with additional disclosure in note 4. No other related parties have been identified.

Details of the Manager’s services and fees are disclosed in the Directors’ Report on pages 55 and 56 and in note 3.

21. Post Balance Sheet Events

Any significant events that occurred after the Company’s financial year end but before the signing of the Balance Sheet will be shown here.

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

The financial information set out above does not constitute the Company’s statutory accounts for the year ended 30 September 2017. The financial information for the year ended 30 September 2016 is derived from the statutory accounts for 2016, which have been delivered to the Registrar of Companies. The 2016 accounts were audited and the audit report was unqualified, did not include a reference to any matters to which the auditor drew attention by way of emphasis without qualifying the report and did not contain a statement under section 498 of the Companies Act 2006. The statutory accounts for the year ended 30 September 2017 have been finalised and audited but have not yet been delivered to the Registrar of Companies. 

The audited annual financial report will be available to shareholders shortly. Copies may be obtained during normal business hours from the Company’s administration office, 6th Floor, 125 London Wall, London EC2Y 5AS and are available via the Company’s section of the Manager’s website at www.invescoperpetual.co.uk/keystone .

The Annual General Meeting will be held on 18 January 2018 at 11.00am at 43-45 Portman Square, London, W1H 6LY.

By order of the Board

Invesco Asset Management Limited

27 November 2017

Contact:

Shilla Pindoria 0203 753 1000