Aberforth Smaller Companies Trust plc: Final Results

ABERFORTH SMALLER COMPANIES TRUST plc

Audited Final Results for the year to 31 December 2009

The following is an extract from the Company's Annual Report and Accounts for the year to 31 December 2009. The Annual Report is expected to be posted to shareholders on 30 January 2010. Members of the public may obtain copies from Aberforth Partners LLP, 14 Melville Street, Edinburgh EH3 7NS or from its website at www.aberforth.co.uk. This will shortly be available for inspection at the authority's document viewing facility at 25 The North Colonnade, Canary Wharf, London, E14 5HS.

FEATURES

Net Asset Value Total Return        +44.4% Benchmark Index Total Return        +60.7% Ordinary Share Price Total Return   +59.2% Dividend maintained at 13p per Share

The objective of Aberforth Smaller Companies Trust plc (ASCoT) is to achieve a net asset value total return (with dividends reinvested) greater than on the RBS Hoare Govett Smaller Companies Index (Excluding Investment Companies) over the long term. ASCoT is managed by Aberforth Partners LLP.

CHAIRMAN’S STATEMENT TO SHAREHOLDERS

Review of 2009 Performance

As noted in my Half Yearly Statement, the first three months of 2009 remained challenging for equity investors as the turmoil afflicting global economies towards the end of 2008 showed no signs of abating. However, stock markets then rallied strongly as economies stabilised in response to unprecedented monetary and fiscal stimulus, and as investors’ appetite for risk returned.

Against this background, ASCoT’s net asset value total return for the full year was 44.4%, the third best in its history. This was well ahead of the 30.1% total return of large companies, as represented by the FTSE All-Share Index, but was some way behind the 60.7% total return of the RBS Hoare Govett Smaller Companies Index (Excluding Investment Companies), ASCoT’s investment benchmark.

The Managers’ Report provides greater insight into ASCoT’s net asset value performance compared with the benchmark index. In particular, your Board understands the relatively cautious positioning of the portfolio coming into 2009. Many companies in the investment benchmark were confronted by a combination of profits reduced by recessionary conditions and highly geared balance sheets. Dividends suffered and the equity value of these companies was perilously close to being dictated by their lenders. Positioned to avoid these exposures, the portfolio was out of step with the stock market’s subsequent rally, which was helped by investors’ willingness to refinance indebted businesses through numerous rights issues.

Gearing

I commented last year that timing “the bottom” of the market with certainty was near impossible. Employing bank borrowing to gear the portfolio has, however, been helpful during 2009 as the market recovered.

As reported in my Half Yearly Statement, your Board negotiated terms in July 2009 on a new two year committed facility of £75 million, which replaced the previous arrangement.

At the year-end approximately £48 million of this facility was utilised. Your Board reviews the level of gearing regularly with the Managers and is comfortable that ASCoT has access to sufficient liquidity for both investment purposes and also to fund share buybacks as and when appropriate.

Share Buy Back Authority

At the Annual General Meeting in March 2009, the authority to buy-in up to 14.99% of ASCoT’s Ordinary Shares was renewed. Under that authority 33,000 shares have been bought in to the end of December at a total cost of £0.2 million. All shares bought in have been cancelled rather than held in treasury.

Your Board will be seeking a renewal of this authority at the Annual General Meeting to be held on 3 March 2010. The Board keeps under careful review the circumstances under which the buy-in authority is used in the context of its overall objective of seeking to sustain a low discount. It will remain the policy to cancel, rather than hold in treasury, any such shares.

Dividends

Your Board is pleased to declare a second interim dividend, in effect a final dividend, of 13 pence per share. This results in total dividends for the year of 19 pence per share, which is the same as the previous year, and delivers a yield of 3.6% on the year-end share price of 534 pence.

Reflecting the impact of the severe economic downturn and exacerbated by the credit crunch, portfolio dividend income for the year is approximately 20% lower than that recorded the previous year. As the Managers’ Report explains, this was nevertheless a considerably better outcome than that experienced by the benchmark. Whilst the worst is hopefully behind us, a further modest decline in dividend income in 2010 would not be a surprise.

In this context, your Board does have a degree of flexibility on dividends given the level of ASCoT’s revenue reserves which, after adjusting for payment of the second interim dividend, amount to 25.3 pence per share. Your Board is aware of the importance of the income component of the total return from equities over the long term.

The second interim dividend of 13.0 pence per share will be paid on 26 February 2010 to Shareholders on the register at the close of business on 5 February 2010. The last date for submission of Forms of Election for those Shareholders wishing to participate in ASCoT’s Dividend Reinvestment Plan (DRiP) is 5 February 2010. Details of the DRiP are available from Aberforth Partners LLP on request or on their website, www.aberforth.co.uk.

Alternative Investment Fund Managers Directive (AIFMD)

The AIFMD is draft legislation, currently being debated in Europe, which will regulate the managers of “alternative investment funds”. As currently drafted, UK investment trust companies fall within its scope. Certain of the draft proposals could have far reaching consequences for ASCoT and the whole of the investment trust industry in the UK. Your Board and Managers, as well as the Association of Investment Companies and others, have actively engaged in lobbying relevant parties to highlight the potential issues and seek changes to the draft. The outcome remains far from certain and it is unlikely that the Directive will be finalised before summer 2010.

Summary

Overall, 2009 has been a vintage year for the share prices of UK smaller companies. However, this performance has to be viewed in context of the steep declines suffered during the previous two years, with the benchmark index at the end of 2009 still some 21% below its peak reached in the second quarter of 2007. Accordingly, the Managers are of the view that UK small company equities remain attractive from a value perspective despite recent gains. As is their style, they have constructed the portfolio mindful of the short term risks of recovery, with stock selection based around sound fundamentals. Your Board remains confident that the Managers’ experience and this consistency of approach will benefit ASCoT over the long term.

Finally, and as announced in my Half Yearly Statement, I retire from the Board at the Annual General Meeting in March 2010, when Professor Paul Marsh will take over the role of Chairman. It has been my privilege to serve on the Board for fifteen years and to have held the Chair for five of these. As a shareholder, I will be following the fortunes of the Company closely in my retirement. In this regard, Paul and his colleagues on the Board have my full confidence and very best wishes.

David R Shaw Chairman 26 January 2010

MANAGERS’ REPORT

In ASCoT’s nineteen year history, 2009 ranks as both the best year of absolute performance from the HGSC (XIC) and the worst year of relative performance for ASCoT. Whereas the benchmark’s total return was 60.7%, ASCoT produced a return of 44.4%. This was nevertheless its third best ever annual return in absolute terms. Large companies meanwhile performed less well, though the 30.1% total return from the FTSE All-Share stands out in its own historical context.

The following paragraphs explain the strong performance of the benchmark in 2009 before moving on to address the relative returns from ASCoT.

Small companies

The HGSC (XIC)’s rise in 2009 has to be viewed against the background of the previous year’s substantial decline of 40.8%: over the two year period the total return from the benchmark has been -4.9%. Entering 2009, the market was confronted by a recession that was exacerbated by an unprecedented credit crunch – descent into depression was a widespread concern. Risk aversion, reflected in equity valuations and stretched credit market spreads, was at extreme levels in the wake of Lehman’s collapse. Governments and central banks were in the middle of unleashing substantial fiscal and monetary stimuli, which went on to enter the uncharted territory of quantitative easing. The climate of uncertainty persisted for much of the first quarter and was reflected in company results that were characterised by deep cost cutting and sharp reductions in dividends.

However, in mid March, small company share prices hit their lows for the year, from which they went on to bounce by 73%. This recovery has been based on improving fundamentals. The global economy has bottomed and subsequently started to pick up. A majority of major economies have now exited recession, with the UK, as yet, a notable exception. As the year progressed, businesses saw destocking come to an end and the start of tentative restocking in the latter part of the year. Sustainable demand levels remain unclear, but the combination of restocking and sharply reduced cost bases promises a period of good profits growth moving into 2010.

At the same time, the extreme risk aversion of 2008 has eased. Important in this regard have been the conventional and unconventional activities of central banks to influence the cost of borrowing. Notwithstanding the banks’ focus on repairing their own balance sheets, this has filtered through financial markets, bringing many spreads in the credit markets back to levels that prevailed before the failure of Lehman. Waning risk aversion has also been evident in equity markets, which have been led upwards by smaller companies and emerging markets, traditionally considered to be at the riskier end of equity investment. Though more powerful, the risk rally of 2009 is thus reminiscent of 2003, when the markets bounced strongly on recovery from the US’s mini-recession at the start of the decade.

A catalyst for this rediscovered appetite for risk was the preparedness of equity investors to finance the substantial volume of rights issues and placings from highly geared companies. Within the small company universe, this flood of re-equitisation started at the end of January, when valuations were at levels that suggested many UK businesses could go under. While the banks often retain rather too much influence, the removal of the risk of imminent failure added longevity to the equity of these geared companies and justified a re-rating from what were extremely low valuations of historical earnings.

Indeed, the historically low valuations that characterised the small cap universe are perhaps the most important way to understand the strong rally enjoyed by the benchmark.  The HGSC (XIC) came into 2009 valued on a historical PE of 6.4x and a yield of 5.9%, on both measures the cheapest over ASCoT’s history.  Clearly, a proportion of this apparent cheapness was justified by the sharp drops in earnings and dividends that companies went on to report as the year progressed: the lowest historical PEs were certainly to be found among those companies that were characterised by the unpleasant cocktail of falling profits, high debts and pension fund deficits.   However, with the benefit of hindsight, it is clear that these low valuations were overplaying the risk of descent into depression.  The subsequent stabilisation and even improvement in economic and credit conditions have therefore provided the basis of a powerful re-rating that took the historical PE up to 11.2x and the yield down to 2.7% by the end of the year.

ASCoT’s relative performance

An understanding of the mechanics of the benchmark, the HGSC (XIC), is a useful starting place for an explanation of ASCoT’s relative performance. The HGSC (XIC) comprises those companies that make up the bottom 10% of the market capitalisation of the total UK market, excluding AIM. At the end of 2009, this definition resulted in a ceiling of £1.188bn: in other words, any company with a market capitalisation of £1.188bn or less at 31 December 2009 is a member of the HGSC (XIC) in 2010. The benchmark is rebalanced just once a year, on 1 January. Ordinarily, this rebalancing exercise is rather low key, with turnover of perhaps half a dozen companies. In 2009 it was not ordinary: 40 companies were relegated to the rebalanced HGSC (XIC). As described in the interim report, these companies represented a quarter of the benchmark by value at the start of the year and together enjoyed a total return of 80% in 2009.

However, the typical ‘fallen star’ exemplified those characteristics that were shunned in 2008: high debts, falling profits, significant pension deficits and reduced dividends. So, in aggregate, the share prices of this group of 40 companies fell by two thirds in 2008, which was, of course, what cut them down to a size that meant inclusion in 2009’s benchmark. Your managers simulate a rebalanced HGSC (XIC) through the year, so it was not the case that they were suddenly overwhelmed on 1 January by the surprise inclusion of 40 new companies: the analytical work on these businesses was conducted through the second half of 2008.

Rather, the relevance of the ‘fallen stars’ to ASCoT’s relative performance is their typical characteristics previously described: with equity capital encumbered by substantial debts and pension deficits, this was a riskier than average group of companies. In contrast, the portfolio came into 2009 with a defensive orientation: the two strong themes detailed in last year’s annual report were those of robust balance sheets and ‘being paid to wait’ by a sustainable dividend yield through a downturn of uncertain duration. While each proved advantageous in 2008, neither helped in 2009: the more rewarding strategy would have been to pursue those companies that combined cut dividends and high levels of debt. Thus, your managers were too risk averse for the investment climate that developed through 2009.

The irony here is that your managers had been investing in anticipation of a recovery in share prices for some time. In the second half of 2008, the portfolio was cautiously reoriented towards domestic cyclical sectors and, in May 2008, ASCoT started to take on gearing for only the third time in its history. At that point, your managers judged that small company valuations were already at a level that discounted recession, but preferred to reflect this in gearing at the trust level across a well diversified portfolio of small companies, rather than exposing capital to individual highly geared businesses. That judgement was temporarily called into question by the collapse of Lehman and the consequent intensification of the credit crunch. However, given the rebound in share prices, the decision to gear has proved beneficial in 2009, as is demonstrated in the table below.

PERFORMANCE ATTRIBUTION ANALYSIS  For the year ended to 31 December 2009                 Basis                                                       Points  Stock Selection                                      (1,806) Sector Selection                                       (212)                                                      ------ Attributable  to  the  portfolio  of  investments    (2,018) (calculated on a mid-price basis) Impact of mid-price to bid-price                         82 Purchase of Ordinary Shares                               1 Cash/gearing                                            401 Management fee                                          (91) Other expenses                                          (10)                                                       ----- Total Attribution based on bid-prices                (1,635)  Note:  100  basis  points  =  1%.  Total  Attribution  is the difference between the total return of the net asset value and the  Benchmark Index (i.e. net asset value = +44.38%; Benchmark Index  =  +60.73%; difference is -16.35%  being -1,635 basis points).

But if it has not been the stabilisation and subsequent improvement in economic fundamentals, what has surprised your managers? The short duration of the downturn and the speed of return to the investment behaviours that prevailed before the credit crunch have been startling.

·  During the UK’s last recession, in the early 1990s, small company earnings      fell for three consecutive years.  In the present downturn, if analysts are      correct, the period of earnings contraction may be confined to just 18 months,      despite the accompanying credit crunch.  This itself would be a remarkable      outturn.  However, extrapolating from this, the equity valuations of a number of      cyclical businesses are already discounting a rapid return to previous peak      levels of profitability.  This seems improbable in view of the structural      challenges, principally significant levels of debt, faced by many economies.    ·  The equity issues that have resuscitated a number of distressed small      company equities, including a large portion of the ‘fallen stars’, have not      necessarily provided a long term cure.  The banks and pension fund trustees      frequently remain very influential, though this influence on the value due to      equity holders might not become manifest until the debt facility next comes up      for renewal, or until the outcome of the next triennial pension review is      revealed.    ·  The investment strategies that were popular up into the first half of 2008      but that suffered in the second half of that year have returned to favour more      quickly than expected.  In particular, commodities have enjoyed a strong      revival, as have businesses exposed to China’s secular growth story.  There is      evidence that these may be benefiting from a return of carry trade activity,      i.e. borrowing in currencies with low interest rates such as the dollar and      investing in riskier, higher-yielding assets.  This plays to concerns that an      element of the monetary authorities’ largesse is being diverted directly into      asset markets rather than being passed on through the banking system.

General caution about the speed, rather than the reality, of recovery is therefore an important factor in understanding ASCoT’s relative performance. This is reflected in the table above, which shows negative contributions from both stock and sector selection: your managers’ risk aversion limited the amount of capital exposed to those stocks, and indeed sectors, where highly geared balance sheets were a feature. Below this over-arching theme, there were other influences at work that provide more colour on the relative performance.

·  The portfolio contained many stocks that performed well in 2009.  At the      end of the year, there were 87 holdings but, over the course of the twelve      months, positions were taken in 118 companies.  Of those, 43 out-performed, out      of which 15 more than doubled.  However, of the doublers, none sat within the      top ten holdings at the start of the year.  This in part reflects the speed with      which the market’s mood changed in the first quarter in 2009.  But it is also      clear that relative performance could have been enhanced by better capital      allocation: attractively valued businesses were identified but could have been      pushed further up the portfolio.  On the other hand, any stock that suffered an      absolute fall in price had a significant impact on relative returns against a      benchmark that rose by 60.7%.  Four holdings combined sharp share price declines      with top ten positions within the portfolio at the start of the year.  These      four thus had a substantial impact on returns.  Two of them were constituents of      the Nonlife Insurance sector, which is addressed in the following paragraph.    ·  The negative impact from Sector Selection can be accounted for by Nonlife      Insurance, with the contributions from other sectors offsetting each other.  The      portfolio was over-weight in Nonlife Insurance, with three holdings at the start      of the year.  The sector had performed very well in 2008, actually managing to      rise by 15%.  However, what were considered positive attributes in 2008 – high      sustainable dividend yields, low price to book valuations and little exposure to      the general economic cycle – came to be perceived as handicaps in 2009 as the      market rediscovered its appetite for risk.  The sector therefore under-performed      by a wide margin in 2009, with a return of -7%.  This has left its constituents      offering some of the most attractive valuations within the HGSC (XIC), which      argues for maintaining a meaningful exposure to the sector in expectation of      another change in the stockmarket’s sentiment.

·  Before the onset of the credit crunch and recession, the UK stockmarket      benefited from the phenomenon of de-equitisation: the stock of quoted equity      capital shrank between 2003 and 2007 as new issuance was out-weighed by share      buybacks, dividends and takeover activity boosted by the highly leveraged      techniques of private equity.  This provided technical support to equity      valuations, particularly in the small company universe.  However, de-      equitisation went into reverse in 2008 as the banks started their rights issues.      This new trend of re-equitisation continued in 2009, with small companies      contributing to substantial equity issuance: almost a fifth of the HGSC (XIC)’s      constituents issued new equity that was equivalent to at least a tenth of their      outstanding equity capital at the start of the year.  As already described, the      willingness of shareholders to support these funding exercises made an important      contribution to the ensuing rally in share prices.  The discounts of the placing      price to the prevailing market were typically wide and, from the portfolio’s      point of view, could provide good opportunities to establish a holding, as long      as the new equity provided sufficient comfort against remaining debt covenants.      In all, the portfolio participated in 23 equity issues, using six of those as      the opportunity to acquire an initial position in the underlying business.

While equity issuance exploded, M&A activity dropped sharply, running at      around one third of its average over the past ten years.  This reflected      caution in the face of recession on the part of company boards and the      difficulty in securing debt funding as banks sought to repair their      balance sheets.  Reflecting your managers’ value investment philosophy,      the portfolio has historically benefited disproportionately from M&A and      indeed had holdings in three of the 14 companies in the HGSC (XIC) that      were acquired in 2009.  A return to normal levels of activity in 2010      would be beneficial.  There are numerous indications that this might be      the case, with corporate transactions already picking up in the US and      with UK assets, by virtue of lower valuations and the weakness of      sterling, looking vulnerable.

·  In terms of dividends, the portfolio out-performed the benchmark.  As noted      in the interim report, the current recession has been considerably worse for      dividends than was the previous downturn.  At work have been not only the      understandable pressures of recession and troubled lenders, but also the      frustrating influences of fashion and weak advice.  Large companies, whose      dividends in aggregate escaped unscathed from the recession of the early 1990s,      have seen a decline of roughly 20% in the present downturn, substantially      reflecting the problems of the banking sector.  The experience for small      companies is also worse than last time: the drop of 35-40% over the last 18      months compares with a fall of 20-25%, spread over a three year period, in the      early 1990s.       ASCoT found some protection in its focus on being ‘paid to wait’ for the      upturn.  It nevertheless experienced a decline in income of      approximately 20%.  With the benchmark’s dividends having fallen      further, the portfolio’s historical yield relative to that of the HGSC      (XIC) moved up steadily to end the year at a 20% premium.  This is close      to its highest level over ASCoT’s history.  Your managers believe that      over longer time periods, such a yield advantage will benefit the      portfolio’s absolute and relative returns.  Importantly, it has not been      secured by sacrificing quality.  Implied dividend cover rose sharply      through the second half to its highest ever level, ending the year at      3.9x.  This compares with a nineteen year average cover of 2.4x.  The      income profile is not dependent on very high yielding stocks whose      prospects of dividend growth might be considered to be limited, with 83%      of the portfolio invested in companies yielding less than 5%.       Indeed, 19% of the portfolio at the year end consisted of companies with      no yield, around half of which may be considered structural nil      yielders, i.e. companies whose business models do not support dividend      payments.  The other half can be classified as cyclical nil yielders,      i.e. businesses whose profits have suffered in recession and are      currently unable to pay.  Moving forward, an important dynamic will be      the return of these cyclical nil yielders to the dividend register as      recovery continues.  Other things being equal, this ought to provide a      boost to dividend growth across the portfolio, and indeed the small cap      market, in the medium term. However, whilst this is encouraging for the      medium term, it is not unlikely that a further modest decline in dividend      income in 2010 may occur.

Looking forward

From a macro economic perspective, it is difficult to muster a lot of optimism at the current time about the world’s developed economies. Policymakers have thus far done a good job in staving off the risk of the recession spiralling into depression. However, the measures required to achieve this have essentially been an exercise in moving lumps of debt from the private to the public sector. The burden of structurally high levels of debt therefore persists and this has to be worked down over time. It is reasonable to expect this to place a limit on economic growth over the medium term. This is particularly relevant to the UK, where the next government will have to embrace public spending cuts and where the savings rate among consumers is heading upwards.

With interest rates and government bond yields at their present low levels, financing high public borrowing is not too demanding. However, there are threats. Government bond yields have been held down for the time being by purchases by central banks and, as the year drew to a close, the gilt market weakened as fears built about the UK’s fiscal position. Moreover, scope for monetary policy error lingers. Thus far, rhetoric from the central banks is hinting at a bias to keeping rates ‘lower for longer’ in order to reduce the perceived risk of mistakes made in the 1930s depression. This, however, has reignited concerns about resurgent inflationary pressure and focused attention on exit strategies from the current phase of loose monetary policy. Peering into 2010, it is safe to state that the financial markets’ focus of concerns will continue to oscillate between inflation and deflation.

But there are offsetting factors, principally the increasing contribution to global economic growth of emerging markets and the relative health of the corporate sector. Recoveries from recession over the past couple of decades have typically been led by the US consumer, who has responded in Pavlovian fashion to interest rate reductions. However, with the US consumer at last in retrenchment mode and the current account deficit narrowing, the present recovery has been substantially powered by China and other emerging markets. And within China, the incremental growth has come not from the export sector, which is in any case highly dependent on the US consumer, but on internally generated demand. It would no doubt be better if this demand originated from the private sector rather than from the state, but the key issue is the fact of an alternative and autonomous source of growth that eases the process of adjustment within developed economies.

Meanwhile, in the wake of recession and credit crunch, the corporate sector in both the UK and US is in surprisingly good shape. Contributing to this have been the substantial equity issuance seen through 2009, reduced capital expenditure budgets, and the rapidity with which management teams reacted to the downturn with cost reductions. The strain has been taken by labour, with unemployment rates rising to multi year highs in several economies. While this dynamic curbs the enthusiasm of consumers to spend, it is consistent with a recovery that might be led initially by profits and then by capital expenditure. With ample spare capacity, such a scenario might also offer some comfort regarding inflation.

This relative strength of the corporate sector is evident in the substantial opportunity base that is the HGSC (XIC), where trading conditions for many businesses have stabilised and, boosted by tentative restocking, are starting to pick up. This improvement is reflected in the strong returns from small companies in 2009 and, as the table below demonstrates, has precipitated a substantial re-rating: historical PEs moved from 6.4x to 11.2x over the course of the year.

31 December 2009   31 December 2008 Characteristics              ASCoT   Benchmark ASCoT    Benchmark  Number of Companies          87      448       93            495 Weighted Average Market      £368m   £619m     £259m       £442m Capitalisation Price Earnings Ratio         8.1x    11.2x     6.0x         6.4x (Historic) Net Dividend Yield           3.2%    2.7%      5.3%         5.9% (Historic) Dividend Cover (Historic)    3.9x    3.3x      3.1x         2.6x

Despite this re-rating, small companies remain at the cheap end of their valuation range over ASCoT’s history. The average historical PE over the past 19 years has been 14x and, in the recovery phase of the recession in the early 1990s, it moved up to 18x. While the structural issues besetting the UK economy may prevent a return to this level of valuation, there would nevertheless appear to be plenty of scope for further re-rating on the assumption that the recovery is sustained.

Valuations within ASCoT’s portfolio are lower. The historical PE moved up through 2009, from 6.0x to 8.1x, but not as sharply as that of the benchmark, reflecting the lower return and also a more resilient earnings performance from the portfolio. On both an absolute and relative basis, the portfolio is offering what is approaching its best value over ASCoT’s history. Crucially, in your managers’ opinion, this has not been facilitated by a deterioration in quality. The portfolio retains its bias to companies with strong balance sheets, with just under a third invested in businesses with net cash. Such financial strength affords these companies flexibility to invest, which might reasonably prove a competitive advantage at a time when banks still appear reluctant to lend to indebted businesses. Another indication of quality might be the relative resilience of the portfolio’s income performance, which has helped its yield move from a 10% discount to that of the HGSC (XIC) at the start of the year to a 20% premium, while retaining a higher dividend cover.

While not being complacent about the challenges facing the domestic and global economies, the availability of well financed and attractively valued businesses, such as those that make up the portfolio, argues strongly for ASCoT to maintain its gearing. However, the gearing is employed on a tactical rather than structural basis and it will be withdrawn when absolute valuations within the portfolio move closer to more appropriate levels. The closure of these value gaps, enhanced by the gearing, should be the basis for an improvement in ASCoT’s relative performance. The precise timing is as difficult as ever to call, but some comfort may be drawn from ASCoT’s history: your managers’ value investment style has led to phases of weak relative returns in previous bull markets but returns have improved as the adjustment in risk appetites comes to an end.

Aberforth Partners LLP Managers 26 January 2010

DIRECTORS’ RESPONSIBILITY STATEMENT

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

(a) the financial statements, which have been prepared in accordance with applicable accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company; and (b) the Annual 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 it faces. A summary of these can be found below.

On behalf of the Board David R Shaw Chairman 26 January 2010

PRINCIPAL RISKS AND RISK MANAGEMENT

The Directors have established an ongoing process for identifying, evaluating and managing the key risks faced by the Company. This process was in operation during the year and continues in place up to the date of this report.

The Board believes that the Company has a relatively low risk profile in the context of the investment trust industry. This belief arises from the fact that the Company has a simple capital structure; invests only in small UK quoted companies; has never been exposed to derivatives and does not presently intend any such exposure; and outsources all the main operational activities to recognised, well-established firms. Investment in small companies is generally perceived to carry more risk than investment in large companies. While this is reasonable when comparing individual companies, it is much less so when comparing the volatility of returns from diversified portfolios of small and large companies. The Board believes the Company’s portfolio is diversified. In addition, since returns from small and large companies are not perfectly correlated, there is an opportunity for investors to reduce risk by holding portfolios of both small and large companies together.

As the Company’s investments consist of small UK quoted companies, the principal risks facing the Company are market related and include interest rate, liquidity, credit, and market price risk. An explanation of these risks and how they are managed are as follows:

(i) Interest rate risk, being the risk that the interest receivable/payable and the market value of investment holdings may fluctuate because of changes in market interest rates;

(ii) Liquidity risk is the risk that the Company will encounter difficulty raising funds to meet its cash commitments as they fall due. Liquidity risk may result from either the inability to sell financial instruments quickly at their fair values or from the inability to generate cash inflows as required;

(iii) Credit risk is the risk that a counterparty to a financial instrument will fail to discharge an obligation or commitment that it has entered into with the Company; and

(iv) Market price risk, being the risk that the market value of investment holdings will fluctuate as a result of changes in market prices caused by factors other than interest rate or currency rate movement.

The Company’s financial instruments are all denominated in sterling and therefore the Company is not directly exposed to any significant currency risk. However, it is recognised that most investee companies, whilst listed in the UK, will be exposed to global economic conditions and currency fluctuations.

(i) Interest rate risk When the Company decides to hold cash balances, all balances are held on variable rate bank accounts yielding rates of interest linked to bank base rate which at 31 December 2009 was 0.5% (2008: 2.0%). The Company’s policy is to hold cash in variable rate bank accounts and not usually to invest in fixed rate securities. The Company’s investment portfolio is not directly exposed to interest rate risk.

The Company has a bank debt facility of £75,000,000 of which £48,250,000 was drawn down as at 31 December 2009 (2008: debt facility of £80,000,000, of which £41,174,000 was drawn down as at 31 December 2008).

(ii) Liquidity risk The Company’s assets comprise mainly readily realisable equity securities which, if necessary, can be sold to meet any funding requirements though short term funding flexibility can typically be achieved through the use of bank debt facilities. The Company’s current liabilities all have a remaining contractual maturity of less than three months with the exception of the bank debt facility.

(iii) Credit risk The Company invests in UK equities traded on the London Stock Exchange and investment transactions are carried out with a large number of FSA regulated brokers with trades typically undertaken on a delivery versus payment basis and on a short settlement period.

Cash at bank is held with reputable banks with acceptable external credit ratings.

The investment portfolio assets of the Company are held by The Northern Trust Company, the Company’s custodian, in a segregated account. In the event of the bankruptcy or insolvency of Northern Trust the Company’s rights with respect to the securities held by the custodian may be delayed or limited. The Board monitors the Company’s risk by reviewing Northern Trust’s internal control report.

(iv) Market price risk The Company’s investment portfolio is exposed to market price fluctuations which are monitored by the investment managers in pursuance of the investment objective. No derivative or hedging instruments are currently utilised to specifically manage market price risk. Further information on the investment portfolio is set out in the Managers’ Report. It is not the Managers’ policy to use derivatives to manage portfolio risk.

As at 31 December 2009, all of the Company’s financial instruments were included in the balance sheet at fair value. The fair value approximately equates to the book value. The investment portfolio consisted of listed investments valued at their bid price, which represents fair value. Any cash balances, which are held in variable rate bank accounts, can be withdrawn on demand with no penalty.

Additional risks faced by the Company, together with the approach taken by the Board towards them, have been summarised as follows:

(i) Investment objective – is to achieve a net asset value total return (with dividends reinvested) greater than on the RBS Hoare Govett Smaller Companies Index (Excluding Investment Companies) over the long term. The performance of the investment portfolio will often not match the performance of the benchmark. However, the Board’s aim is to achieve the investment objective over the long term whilst managing risk by ensuring the investment portfolio is managed appropriately. The Corporate Governance Report provides additional information regarding the various areas considered by the Board.

(ii) Investment policy – a risk facing the Company is inappropriate sector and stock selection leading to underperformance relative to the benchmark. The Managers have a clearly defined investment philosophy and manage a diversified portfolio. Furthermore, performance against the benchmark and the peer group is regularly monitored by the Board. The Company may also be affected by events or developments in the economic environment generally, for example inflation or deflation, recession and movements in interest rates.

(iii) Share price discount – investment trust shares tend to trade at discounts to their underlying net asset values. The Board and the Managers monitor the discount on a daily basis.

(iv) Regulatory risk – failure to comply with applicable legal and regulatory requirements could lead to suspension of the Company’s share price listing, financial penalties or a qualified audit report. Breach of Section 842 could lead to the Company being subject to capital gains tax. The Board receives quarterly compliance reports from the Secretaries to monitor compliance with rules and regulations.

(v)   Operational/Financial risk – failure of the Managers’ accounting systems or those of other third party service providers could lead to an inability to provide accurate reporting and monitoring, or potentially lead to the misappropriation of assets. The Board reviews regular reports on the internal controls of the Managers and other key third party providers.

(vi) Gearing risk – in rising markets, the effect of borrowings would be beneficial but in falling markets the gearing effect would adversely affect returns to Shareholders.

PORTFOLIO INFORMATION Thirty Largest Investments                       Valuation                          as at    % of                    31 December   Total                           2009     Net No  Company              £'000  Assets Business Activity 1   Bellway             19,445     3.3 Housebuilder 2   Greggs              17,178     2.9 Retailer of sandwiches, savouries                                        and other bakery products 3   Domino Printing     15,930     2.7 Manufacture of industrial printing     Sciences                           equipment 4   Micro Focus         15,754     2.7 Software     International 5   Spectris            15,674     2.7 Manufacture of precision                                        instrumentation and controls 6   JD Sports           14,565     2.5 Retailer of sports and leisurewear     Fashion 7   Dunelm Group        14,505     2.5 Homewares retailer 8   Beazley             14,296     2.4 Lloyds insurer 9   RPC Group           13,686     2.3 Manufacture of rigid plastic                                        packaging 10  Robert Wiseman      13,524     2.3 Processing and distribution of milk     Dairies Top Ten Investments    154,557    26.3 11  Huntsworth          13,340     2.3 International public relations 12  Unite Group         12,791     2.2 Property 13  RPS Group           12,384     2.1 Consulting 14  Phoenix IT Group    12,372     2.1 IT services 15  KCOM Group          11,985     2.0 Telecommunications services 16  National            11,881     2.0 Bus and coach services     Express Group 17  Evolution Group     11,544     2.0 Stockbroker and private client fund                                        manager 18  Regus               11,040     1.9 Serviced offices 19  e2v                 10,974     1.9 Manufacture of electronic components     technologies                       and sub-systems 20  Bodycote             9,788     1.7 Industrial heat treatment Top Twenty Investments 272,656    46.5 21  Keller Group         9,590     1.6 Ground and foundation engineer 22  Vectura Group        9,322     1.6 Inhaled pharmaceuticals 23  Collins Stewart      9,300     1.6 Stockbroker and private client fund                                        manager 24  Brown (N.)           9,203     1.6 Home shopping catalogue retailer     Group 25  Pace                 9,036     1.5 Design and sourcing of set top boxes 26  Intec Telecom        8,552     1.5 Software and related services     Systems 27  Anite                8,530     1.5 Software 28  Wilmington           8,466     1.4 Information and training to the     Group                              professional business market 29  Hampson              8,414     1.4 Aerospace and automotive     Industries 30  Delta                8,378     1.4 Galvanising, manganese products and                                        industrial supplies Top Thirty Investments 361,447    61.6 Other Investments (57) 270,939    46.1 Total Investments      632,386   107.7 Net Liabilities        (45,464)   (7.7) Total Net Assets       586,922   100.0

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

INCOME STATEMENT  For the year ended  31 December 2009  (audited)                                For the year ended       For the year ended                                31 December 2009         31 December 2008                           Revenue   Capital    Total  Revenue  Capital    Total                             £ 000     £ 000    £ 000   £ 000     £ 000    £ 000   Realised losses on sales       -   (40,331) (40,331)      -    (9,027)  (9,027)  Increase/(decrease) in         -   209,726  209,726       -  (297,703)(297,703)  fair value                             ------  -------  -------  ------   -------  -------  Net gains/(losses) on          -   169,395  169,395       -  (306,730)(306,730)  investments  Dividend income           19,110     1,183   20,293  23,684     7,387   31,071  Interest income                1         -        1   1,152         -    1,152  Other income                 168         -      168      54         -       54  Investment management     (1,450)   (2,417)  (3,867) (1,636)   (2,727)  (4,363)  fee  Other expenses              (437)   (2,624)  (3,061)   (489)   (2,880)  (3,369)                            ------   -------  -------  ------   -------  -------  Return on ordinary        17,392   165,537  182,929  22,765  (304,950)(282,185)  activities    before finance costs  and tax  Finance costs               (579)     (965)  (1,544)   (526)     (877)  (1,403)                             ------  -------  -------  ------   -------  -------  Return on ordinary        16,813   164,572  181,385  22,239  (305,827)(283,588)  activities before tax  Tax on ordinary                -         -        -     (16)        -      (16)  activities                            ------   -------  -------  ------   -------  -------  Return attributable to    equity shareholders     16,813   164,572  181,385  22,223  (305,827)(283,604)                            ======   =======  =======  ======   =======  =======   Returns per Ordinary      17.35p   169.84p  187.19p  22.75p  (313.12p)(290.37p)  Share

The Board declared on 26 January 2010 a second interim dividend of 13.0p per Ordinary Share (2008 – 13.0p). The Board also declared on 22 July 2009 a first interim dividend of 6.0p per Ordinary Share (2008 interim dividend of 6.0p).

NOTES 1. The total column of this statement is the profit and loss account of the Company. All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued in the period. A Statement of Total Recognised Gains and Losses is not required as all gains and losses of the Company have been reflected in the above statement.

2. The calculations of revenue return per Ordinary Share are based on net revenue of £16,813,000 (2008 – £22,223,000) and on the weighted average Ordinary Shares of 96,897,197 (2008 – 97,670,037).

The calculations of capital return per Ordinary Share are based on net capital gains of £164,572,000 (2008 – net capital losses of £305,827,000) and on the weighted average Ordinary Shares of 96,897,197 (2008 – 97,670,037).

SUMMARY RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS For the year ended 31 December 2009 (Audited)

2009           2008                                                £ 000          £ 000   Opening shareholders’ funds                 424,115        735,021  Return on ordinary activities after         181,385       (283,604)  taxation  Equity dividends paid                       (18,411)       (16,189)  Purchase of Ordinary Shares                    (167)       (11,113)                                             --------       --------  Closing shareholders’ funds                 586,922        424,115                                              =======        =======

BALANCE SHEET  As at 31 December 2009  (Audited)                                           31 December   31 December                                                  2009          2008                                                 £ 000         £ 000  Fixed assets:  Investments at fair value through            632,386       464,427  profit or loss                                              --------      --------  Current assets  Debtors                                        2,010         2,278  Cash at bank                                     362             -                                              --------      --------                                                 2,372         2,278  Creditors (amounts falling due                  (148)      (42,590)  within one year)                                              --------      --------  Net current assets/(liabilities)               2,224       (40,312)                                              --------      --------  Total Assets less Current                    634,610       424,115  Liabilities  Creditors (amounts falling due after         (47,688)            -  more than one year)                                              --------      --------  Total Net Assets                             586,922       424,115                                               =======       =======   Capital and reserves: equity interests    Called up share capital (Ordinary Shares)      969           969  Reserves:    Capital redemption reserve                      19            19    Special reserve                            186,025       186,192    Capital reserve                            362,796       198,224    Revenue reserve                             37,113        38,711                                              --------      --------  Total Shareholders’ Funds                    586,922       424,115                                               =======       =======   Net Asset Value per Ordinary Share           605.90p       437.68p

SUMMARY CASH FLOW STATEMENT  For the year ended 31 December 2009  (Audited)                                     For the year ended  For the year ended                                       31 December 2009    31 December 2008                                        £ 000     £ 000      £ 000    £ 000   Net cash inflow from operating                 16,833              31,520  activities  Taxation                                            -                 (16)  Returns on investment and                      (2,062)             (1,381)  servicing of finance   Capital expenditure and  financial investment  Payments to acquire investments    (238,152)            (260,020)  Receipts from sales of              235,245              198,007  investments                                     --------              -------  Net cash outflow from capital    expenditure and financial                    (2,907)            (62,013)  investment                                               --------             -------                                                 11,864             (31,890)  Equity dividends paid                         (18,411)            (16,189)                                               --------             -------                                                 (6,547)            (48,079)  Financing  Purchase of Ordinary Shares                      (167)            (11,113)  Net drawdown of bank debt                       7,076              41,174  facilities (before costs)                                               --------             -------  Increase/(decrease) in cash                       362             (18,018)                                               ========             =======    Reconciliation of net cash flow to  movement in net debt   Increase/(decrease) in cash in the year           362             (18,018)  Net drawdown of bank debt facilities           (6,326)            (41,174)  Amortised costs in respect of                    (188)                  -  the bank debt facility                                               --------             -------  Change in net debt                             (6,152)            (59,192)  Opening net (debt)/funds                      (41,174)             18,018                                               --------             -------  Closing debt                                  (47,326)            (41,174)                                               ========             =======

NOTES TO THE FINANCIAL STATEMENTS

1. ACCOUNTING STANDARDS The financial statements have been prepared under the historical cost convention, as modified to include the revaluation of investments and in accordance with applicable accounting standards and the AIC's Statement of Recommended Practice "Financial Statements of Investment Trust Companies and Venture Capital Trusts" issued in January 2009. The total column of the Income Statement is the profit and loss account of the Company. All revenue and capital items in the Income Statement are derived from continuing operations. No operations were acquired or discontinued in the period.

The same accounting policies used for the year ended 31 December 2008 have been applied.

2. INVESTMENT MANAGEMENT FEE

For the year to 31 December 2009     Revenue    Capital    Total                                         £ 000      £ 000    £ 000  Investment management fee              1,450      2,417    3,867  VAT refund                                 -          -        -                                        ------     ------   ------  Total for the year to 31 December      1,450      2,417    3,867  2009                                        ======     ======   ======

For the year to 31 December 2008     Revenue    Capital    Total                                         £ 000      £ 000    £ 000  Investment management fee              1,901      3,170    5,071  VAT recovered                           (265)      (443)    (708)                                        ------     ------   ------  Total for the year to 31 December      1,636      2,727    4,363  2008                                        ======     ======   ======

The VAT recovered during the year to 31 December 2008 above represents the repayment of VAT incurred in respect of management fees paid between 1991 and 1996.

3.DIVIDENDS									                                               Year to             Year to                                      31 December 2009    31 December 2008 					         £000                £000 Amounts recognised as distributions to equity holders in the period: Second interim dividend of 13.0p for the year ended 31 December 2008 (2007: 10.5p)       12,597             10,375 First interim dividend of 6.00p for the year ended 31 December 2009 (2008: 6.0p)              5,814              5,814                                                 ------             ------                                                 18,411             16,189                                                 ======             ======

The second interim dividend for the year ended 31 December 2009 of 13.0p will be paid on 26 February 2010 to shareholders on the register on 5 February 2010.

4. RETURNS PER ORDINARY SHARE							  The returns per Ordinary Share are based on:                                                Year to            Year to                                       31 December 2009   31 December 2008 						  £000	             £000 Returns attributable to Ordinary Shareholders  181,385           (283,604)

Weighted average number of shares in issue during the period                     96,897,197         97,670,037

5. NET ASSET VALUES									 The net assets and the net asset value per share attributable to the Ordinary Shares at each period end are calculated in accordance with their entitlements in the Articles of Association and were as follows:			                                             31 December        31 December                                                   2009               2008 						  £000               £000 Net assets attributable			       586,922            424,115

Pence	            Pence Net asset value attributable per Ordinary Share	605.90	           437.68	 									 As at 31 December 2009, the Company had 96,867,000 Ordinary Shares in issue (31 December 2008 – 96,900,000). During the year to 31 December 2009, the Company bought in and cancelled 33,000 shares (2008 - 1,909,788 shares ) at a total cost of £ 167,000 (2008 - £11,113,000).

6. FURTHER INFORMATION The foregoing do not constitute statutory accounts (as defined in section 434(3) of the Companies Act 2006) of the Company. The statutory accounts for the year ended 31 December 2008, which contained an unqualified Report of the Auditors, have been lodged with the Registrar of Companies and did not contain a statement required under section 237(2) or (3) of the Companies Act 1985 (as amended).

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

CONTACT:  David Ross/Alistair Whyte, Aberforth Partners LLP, 0131 220 0733           Aberforth Partners LLP, Secretaries – 26 January 2010

ANNOUNCEMENT ENDS

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