The Merchants Trust Plc
Annual Report 2010

Plain-text annual report

128644 Merchants Report Cover 7/4/10 5:17 pm Page BC1 The Merchants Trust PLC Annual Financial Report for the year ended 31 January 2010 RCM UK Limited, 155 Bishopsgate, London EC2M 3AD T: +44 (0)20 7859 9000 F: +44 (0)20 7859 3507 www.rcm.com RCM UK Limited is a company of Allianz Global Investors www.merchantstrust.co.uk 128644 Merchants Report Cover 7/4/10 5:17 pm Page IFC1 Printed on FSC-certified paper from well-managed forests and recycled wood or fibre, using vegetable based inks. The Merchants Trust PLC Contents Investment Policy.............................................................................................................................................................................................................. Financial Summary .......................................................................................................................................................................................................... Chairman’s Statement...................................................................................................................................................................................................... Historical Record .............................................................................................................................................................................................................. Performance Attribution Analysis .................................................................................................................................................................................. Investment Manager’s Review ........................................................................................................................................................................................ 2 2 3 5 5 6 Listed Holdings.................................................................................................................................................................................................................. 11 Distribution of Total Assets.............................................................................................................................................................................................. 13 Performance Graphs ........................................................................................................................................................................................................ 15 Directors, Manager and Advisers .................................................................................................................................................................................. 16 Directors’ Report .............................................................................................................................................................................................................. 17 Corporate Governance Statement .......................................................................................................................................................................... 21 Statement of Directors’ Responsibilities........................................................................................................................................................................ 28 Directors’ Remuneration Report .................................................................................................................................................................................... 29 Independent Auditors’ Report ........................................................................................................................................................................................ 31 Income Statement ............................................................................................................................................................................................................ 32 Reconciliation of Movements in Shareholders’ Funds................................................................................................................................................ 33 Balance Sheet .................................................................................................................................................................................................................... 34 Cash Flow Statement........................................................................................................................................................................................................ 35 Statement of Accounting Policies .................................................................................................................................................................................. 36 Notes to the Financial Statements.................................................................................................................................................................................. 38 Investor Information & Contact Details ........................................................................................................................................................................ 51 Notice of Meeting ............................................................................................................................................................................................................ 54 The Merchants Trust The Merchants Trust was incorporated on 16 February 1889. It was launched by Robert Benson & Co., predecessors of the current Manager, RCM (UK) Ltd, and originally invested mainly in American railroads. The initial capital was £2 million, of which half was subscribed. 1 The Merchants Trust PLC Investment Policy Investment Objective To provide an above average level of income and income growth together with long term growth of capital through a policy of investing mainly in higher yielding UK FTSE 100 companies. Benchmark The Company’s investment performance is assessed by comparison with other investment trusts within the UK Growth and Income sector. In addition, it is benchmarked against the FTSE 100 Index, reflecting the emphasis within the portfolio, as well as the FTSE 350 Higher Yield Index, reflecting the Company’s higher yield objective. Gearing The Company’s policy is to remain substantially fully invested. The Company has the facility to gear – borrow money – with the objective of enhancing future returns. Historically, gearing has been in the form of long-term, fixed-rate debentures. The Board monitors the level of gearing and makes decisions on appropriate action based on the advice of the Manager and the future prospects of the Company’s portfolio. The Company’s authorised borrowing powers set out in the Articles of Association state that the Company’s borrowings may not exceed its called up share capital and reserves. In normal market conditions, it is unlikely that gearing (borrowings as a percentage of net assets) will exceed 35%. Risk Diversification The Company will aim to achieve a spread of investments, with no single investment representing more than 15% of assets. The Company will seek to diversify its portfolio into at least five industrial sectors, with no one sector comprising more than 35% of the portfolio. Financial Summary Revenue Net return attributable to Ordinary Shareholders† Net return attributable to Ordinary Shareholders# Earnings per Ordinary Share Ordinary dividends per Ordinary Share Special dividend per Ordinary Share Assets Total Assets* Net Assets Net Asset Value per Ordinary Share Ordinary Share Price Discount of Ordinary Share Price to Net Asset Value Discount (Premium) (Debt at market value) FTSE 100 Index (Capital Return) FTSE 350 Higher Yield Index (Capital Return) For the year ended 31 January 2010 For the year ended 31 January 2009 £23,686,655 £19,498,068 £19,022,109 18.91p 22.50p – 2010 £498,205,486 £384,747,214 372.8p 329.1p 11.7% 7.7% 5,188.5 2,879.1 £31,729,754 £28,017,898 £26,211,995 27.25p 22.30p 0.5p 2009 £428,277,126 £314,804,036 306.2p 282.0p 7.9% (1.3%) 4,149.6 2,434.0 % change -25.3 -30.4 -27.4 -30.6 +0.9 n/a % change +16.3 +22.2 +21.8 +16.7 n/a n/a +25.0 +18.3 Including a refund of VAT paid on management fees and associated interest income of £475,959 (2009 – £1,805,903). Excluding refund of VAT paid on management fees and associated interest income. Net of current liabilities. Notes † # * 2 The Merchants Trust PLC Chairman’s Statement Market and Portfolio Background Last year saw a welcome recovery in share prices, but at the same time an almost unprecedented fall in the level of dividends declared by UK companies, particularly in the financial sector, as a result of the crisis which began in the Summer of 2007 and which is still not played out. Results The net asset value per share increased by 21.8% to 372.8p and the total return per share, including dividends paid, was 29.2%. This compares with the total returns of 30.4% and 24.7% recorded by the FTSE 100 Index and the FTSE 350 Higher Yield Index, respectively. The full performance breakdown is shown on page 5. Over the year, the Trust’s share price rose by 16.7% from 282.0p to 329.1p, having hit a low of 222.0p last March. At 6 April 2010, the Trust’s ordinary shares yielded 6.1% compared with the yield on the FTSE 100 Index of 3.2%. Earnings per share Earnings per share fell by 30.6% to 18.91p, principally because of the dividend cuts to which I have already referred. This year’s earnings include a VAT refund amounting to £476,000 (including interest) (2009 – £1,806,000). Excluding the two VAT refunds, the net return attributable to Ordinary Shareholders fell by 27.4%. Dividends The Board is recommending a final ordinary dividend of 5.7p per share, payable on 14 May 2010 to Shareholders on the register on 16 April 2010. This payment would give a total of 22.5p for the year, an increase of 0.9% over the total for the previous year. In order to meet the payment it has been necessary to transfer £3,724,961 (3.6p per share) from our reserves. As at 31 January 2010 and after providing for this transfer, the Trust’s reserves amounted to £14,408,093 (14.0p per share). Gearing and Balance Sheet The Trust has remained fully invested throughout the market’s downturn and its subsequent recovery. The investment objective of the Trust is clearly stated on the opposite page; it follows that in the Board’s view the allocation of assets by shareholders as between equities and other forms of investment should be a matter for them and not for the Trust. Moreover, the principal long term aim of the Trust is to generate growth in dividends and a sale of part of the equity portfolio would compromise this objective, given the low levels of return currently available on cash deposits or UK government securities. As a consequence of the Trust remaining fully invested, the book value of our long term debt as a percentage of our net assets rose to a peak of 46% in March of last year before falling back to just below 30% at the year end. In the light of this, and as anticipated in my last Chairman’s Statement, the Board directed the fund managers to make use of exchange-traded options, on a relatively modest scale, with the object of protecting the portfolio in the event of a substantial fall in the market. This was achieved through the sale of call options on a small part of our portfolio, the proceeds of which were used to purchase FTSE 100 put options at considerably lower than the then prevailing market levels. This strategy would have provided a measure of protection had the market fallen to below 2600 on the FTSE 100, so that even at this level the managers would have been able to invest the portfolio primarily with a view to maximising investment returns rather than maintaining the necessary asset covers for our debentures. Towards the end of the year, the Board concluded that the short-term threat to the financial system had reduced and that the purchase of the ‘deep out of the money’ put options should be suspended. The proceeds from the sale of any call options now taken out will be applied as an addition to the Trust’s income. VAT As mentioned above, we have received a refund of VAT in respect of the period 2000 to 2007 which, including interest, totals £1,249,000. This figure has been incorporated in our results for the financial period under review. Issue and Repurchase of Shares During the financial year we were able to issue 400,000 new shares at a premium to the net asset value. No shares were bought back for cancellation. However, as in previous years, the Board is proposing to renew the authority to repurchase shares at the forthcoming Annual General Meeting. 3 The Merchants Trust PLC Chairman’s Statement The Board Since the last Annual General Meeting, Simon Fraser has joined the Board. I am delighted that he has done so. He has had an exceptionally successful career in the fund management industry; he is Chairman-elect of Foreign & Colonial Investment Trust and since last year a non- executive director of Barclays. This is my tenth annual statement to shareholders and it will be my last. I believe that now is the right time for me to step down and I will be retiring from the Board at the conclusion of the forthcoming Annual General Meeting. It is intended that Sir James Sassoon, currently Senior Independent Director and the Chairman of the Audit Committee, will succeed me as Chairman of the Trust. Annual General Meeting The Annual General Meeting of the Company will be held on Tuesday 11 May 2010 at 12.00 noon and we look forward to seeing as many shareholders then as are able to attend. The ten years of my Chairmanship have not been all plain sailing. During the period we have experienced two vicious bear markets. Nevertheless, as indicated by the performance graph on page 15, over the decade the Merchants net asset value total return has been 4.67% per annum, compared with a total return from the FTSE 100 of 1.45% per annum. (We have not quite matched the return on our other benchmark, the FTSE 350 Higher Yield Index, but this index has an extremely high degree of inherent risk – three companies alone account for nearly half the index.) Moreover we have been able to increase our dividend in every year and the Merchants dividend has grown in real, as well as nominal, terms. I am very grateful to all those who have contributed to this record and who have supported the Trust in other ways during my Chairmanship and I wish them well. Hugh Stevenson Chairman 7 April 2010 4 The Merchants Trust PLC Historical Record Revenue and Capital for years ended 31 January Revenue (£’000s) Earnings per Ordinary Share Dividends per Share 2001 21,546 16.35p 16.40p Ordinary Dividend per Share 16.40p – Special Dividend per Share 1.82p 18.22p Tax Credit per Share Gross Dividend per Share Total Net Assets attributable 2002 21,596 16.70p 16.80p 16.80p – 1.87p 18.67p 2003 22,101 17.26p 17.20p 17.20p – 1.91p 19.11p 2004 22,247 17.34p 17.60p 17.60p – 1.96p 19.56p 2005 22,675 17.58p 18.00p 18.00p – 2.00p 20.00p 2006 24,714 19.44p 18.90p 18.90p – 2.10p 21.00p 2007 27,750 22.17p 20.00p 20.00p – 2.22p 22.22p 2008 28,495 22.86p 21.60p 21.60p – 2.40p 24.00p 2009 31,730 27.25p 22.80p 22.30p 0.50p 2.53p 25.33p 2010 23,687 18.91p 22.50p 22.50p – 2.50p 25.00p to Ordinary Capital (£’000s) 473,729 420,983 273,407 357,442 424,511▲ 514,713 588,835 506,187 314,804 384,747 Net Asset Value per Ordinary Share NAV Total Return (%)* Retail Price Index Increases (%)** Notes 463.5p +25.8 412.3p -7.4 267.8p -30.9 350.1p +37.3 415.8p▲ +20.8▲ 504.1p +25.6 567.5p +16.4 492.3p -9.6 306.2p -33.4 372.8p +29.2 +1.8 +2.6 +2.7 +2.4 +2.1 +2.3 +4.2 +4.1 +0.1 +4.6 * NAV total return reflects both the change in net asset value per ordinary share and the net ordinary dividends paid. ** RPIX – excludes the effect of mortgage rates. ▲ Restated in accordance with Financial Reporting Standards 25 ‘Financial Instruments: Disclosure and Presentation’ and 26 ‘Financial Instruments: Recognition and Measurement’. Years prior to 2005 have not been restated. Performance Attribution Analysis for the year ended 31 January 2010 Capital return of index Relative return from portfolio Capital return of portfolio Impact of gearing on portfolio Revenue deficit* Expenses charged to capital Management fee VAT refund Issue of Ordinary Shares Other Change in Net Asset Value per Ordinary Share FTSE 100 Index % 25.0 (6.5) 18.5 8.1 (1.3) (2.3) 0.2 0.1 (1.5) 21.8 FTSE 350 Higher Yield Index % 18.3 0.2 18.5 8.1 (1.3) (2.3) 0.2 0.1 (1.5) 21.8 * Dividends paid on Ordinary Shares amounted to £23,589,084 (refer to Note 6). This exceeds the revenue return for the period by £4,091,016. 5 The Merchants Trust PLC Investment Manager’s Review Economic Background The year under review witnessed a major recession in most of the developed world as the full effects of the financial crisis were felt. Reduced availability of finance and lower confidence led consumers and businesses to cut spending, particularly on big ticket items and services. In response to lower demand, companies aggressively cut costs by reducing production, inventory levels and employment. The severity of the recession was mitigated by an unprecedented level of government stimulus around the world. Interest rates were cut to near zero levels in the USA, UK, Eurozone and Japan. Liquidity was boosted by governments providing bank loan guarantees and via central bank purchases of assets through the “Quantitative Easing” process. Enormous government spending packages were introduced to support industries including banking and finance, automobiles and infrastructure investment. Unemployment rose but not by as much as would normally be expected as many companies reduced working hours and froze wages. Inflation was generally subdued in a weak demand environment. As the year progressed the major economies gradually emerged from recession with the UK posting modest growth in the fourth quarter of 2009. However confidence remained fragile and significant areas of activity remained depressed, such as the important US housing market which saw 550,000 new housing starts compared to a fifty year average of 1.5 million and previous low of 1 million. Several emerging markets managed to avoid recession, with China in particular delivering rapid growth on the back of a huge infrastructure investment programme and rapid credit expansion. Arguably the biggest feature of the year was the government support of the global financial system which had been severely strained. However the costs of the rescue packages and measures to mitigate the recession were massive increases in the developed world’s budget deficits and the ballooning of government debt levels. Market Trends Financial markets began the year in a state of turmoil and the stockmarket fell heavily in February amid continued concerns about the banking system and the health of the major economies. However in March the stockmarket began a sharp recovery with the approval of US stimulus packages pointing to a more credible government response to the economic crisis. Stockmarket recoveries often start at a point of great pessimism and market levels were depressed with many shares looking extremely cheap. After a slight pause in June and July the market rally continued until the beginning of January 2010 before a minor sell-off in the last few weeks of the financial year. Overall the FTSE 100 Index delivered a total return of 30% for the year but there were significant differences at the stock and sector level. In general the more cyclical and higher risk parts of the stockmarket, which had suffered the most in the downturn, saw the sharpest recoveries. The mining sector more than doubled as commodity prices rebounded in response to a step up in Chinese infrastructure investment. Bank shares and general retailers rallied hard, rising by over 50% in the first half of the year before consolidating. There was also a marked outperformance by smaller companies, which tend to be more economically sensitive, with the FTSE 250 Mid Cap Index rising by over 50%. On the other hand many of the larger, more defensive shares lagged the market rally. The utilities and pharmaceutical sectors delivered total returns of 6% with virtually no capital gain and tobacco posted a 14% return. This made it a difficult year for income investors with the FTSE 350 Higher Yield Index returning “only” 25% as the market focused on recovery rather than dividend yield. At the individual stock level the polarisation was even more extreme. Of the 100 constituents of the FTSE 100 Index at the start of the period, 5 produced negative returns and 30 were up less than 15%, whilst the top 30 performers were each up over 70% including 8 stocks that more than doubled. Within the market there were a large number of dividend cuts and rights issues as companies focused on reducing debt levels as the credit crunch restricted the availability and raised the cost of bank finance. 6 The Merchants Trust PLC Investment Manager’s Review FTSE 100 Price Index from 31 January 2005 to 31 January 2010 7000 6500 6000 5500 5000 4500 4000 3500 3000 31 Jan 2005 31 Jan 2006 31 Jan 2007 31 Jan 2008 31 Jan 2009 31 Jan 2010 Souce: RCM/Datastream Investment Performance The Merchants Trust portfolio delivered a strong absolute performance in a rising market. As the Trust has a policy of investing in high yielding shares which generally lagged the market, performance was behind the total return of the FTSE 100 Index although it was in line with the FTSE 350 Higher Yield Index. Looking at the individual stock contributions there was a standout performance from many of the more cyclical medium sized companies in the Trust. Even though the portfolio is predominantly invested in large companies, nine of the top ten positive stock contributions came from outside of the FTSE 100 Index with three of these more than doubling and another three returning over 90%. Performance further benefited from the decision to increase the Trust’s holdings in many mid-caps at depressed levels during the market downturn. Certain of these stocks passed their dividends during the credit crunch but we decided to retain the holdings due to their compelling valuations. The only top ten contributor from within the FTSE 100 was Imperial Tobacco where the portfolio “benefited” from not owning the company as its shares lagged the market considerably. Contribution to Investment Performance relative to FTSE 100 Index Positive Contributions Inchcape Melrose Britvic International Personal Finance Meggitt Dairy Crest GKN IG Group Imperial Tobacco Pendragon % Negative Contributions Rio Tinto 1.1 BAE Systems 0.8 Xstrata 0.6 Anglo American 0.6 0.6 GlaxoSmithKline Reed Elsevier 0.5 Scottish & Southern Energy 0.5 Standard Chartered 0.4 HSBC 0.4 Vodafone 0.3 % -2.0 -1.5 -1.2 -1.2 -1.1 -0.8 -0.8 -0.7 -0.6 -0.6 In terms of negative contributions, two themes dominate. Three of the four top negative stocks were mining companies. We had limited exposure to the sector during the year due to the low or zero dividend yields and our concerns about the industry outlook and valuation. Performance suffered from not owning these companies as the sector surged in the market rally. The second clear theme was the muted performance of several large, defensive companies like BAE Systems, GlaxoSmithKline, Reed Elsevier and Scottish & Southern Energy. Big positions in these high 7 The Merchants Trust PLC Investment Manager’s Review yielding and lowly valued businesses held back the overall portfolio return. Two banks also featured in the top 10 negatives. The portfolio did not own Standard Chartered and had an underweight position in HSBC. As in the mining sector, these low yielding banks were re-rated on hopes for economic recovery, especially in the key Asian region. Portfolio Changes Extreme moves within the stockmarket can present both challenges and opportunities for investors. Activity within the portfolio was quite high, driven primarily by individual stock issues rather than broader industry considerations. However there were some changes at the sector level as we reduced the portfolio’s exposure to commodities (oil and mining) and telecommunications whilst increasing exposure to financial services (including real estate) and support services. We added ten new companies to the portfolio and completely sold seven investments. As described in the interim report, several major market features influenced activity, namely, high volatility, extreme polarisation, dividend cuts and rights issues. Volatility often presents opportunities to make investments or sales at particularly attractive levels but it can also reflect real risks. We devoted considerable resource during the economic downturn to stress test the business models of investee companies and to understand how macroeconomic developments might impact them. Our analysis prompted us to maintain certain positions or even increase them, whilst reducing or exiting others. Regarding new additions, having not owned any real estate companies for about 12 months, we took advantage of the sector’s weakness to buy Hammerson in February when they announced a rights issue to strengthen their balance sheet. We also bought British Land later in the period. With property yields well above gilt and cash yields and signs that the property sector was turning, these high yielding companies looked attractive. Volatility also enabled us to buy the media conglomerate WPP and electricity generator International Power at particularly attractive valuations as described in the interim report. Another new investment was Premier Farnell, a high service distributor of electronic components. The shares were depressed after severe industry destocking and the valuation did not reflect either the potential for cyclical recovery or the fundamental restructuring being undertaken to cut costs and target three areas of potentially higher returns; sales over the internet, sales to research and design engineers and sales within emerging markets. The extreme polarisation of market returns created opportunities. As investors focused on cyclical businesses, many defensive or higher growth businesses lagged behind the market rally and traded at compelling valuations. As well as Bunzl and Catlin which were purchased in the first half, we bought Reckitt Benckiser, a leading consumer products and healthcare business with brands such as Finish dishwasher tablets, Cillit Bang, Nurofen and Strepsils. Reckitts has an excellent record of growth and cash generation and has raised its dividend materially in recent years. The remaining two new investments were in the financial services arena. We purchased Ashmore, an emerging market fixed income fund manager which is well placed to exploit the structural trend of greater investment allocations to emerging markets among bond investors. With a high net cash position on its balance sheet it is financially secure and offers an attractive dividend yield. Finally we purchased Friends Provident during its takeover by Resolution Plc as the latter is embarking on a strategy of consolidating and restructuring parts of the financial services industry. There were many additions to existing positions reflecting the opportunities in the volatile and polarised market. Notable trades included adding to IG Group and International Personal Finance after material weakness with both shares subsequently more than doubling by year end. We significantly increased the holdings in Unilever, AstraZeneca and BAE Systems all of which are relatively well protected from a tough economic environment and, in our view, represented good value. We also added to a number of positions via right issues, such as HSBC, Inchcape and GKN. Dividend cuts were a notable feature of the market, especially in the first half, and drove some of the sell decisions in the year. Although the Trust has a clear high income objective, we do not automatically sell shares when they cut or pass dividends. We review each situation on its own merits from a total return perspective, but we also need to consider the impact on the total portfolio yield. We retained positions in, among others, Barclays and Inchcape and we decided to sell Lloyds Banking Group and Anglo American with considerable uncertainty about the prospects for both businesses. We switched part of the Anglo holding into BHP Billiton our favoured mining company. Later in the period we bought back into a modest position in Lloyds Banking Group ahead of their rights issue aimed at avoiding the government’s Asset Protection Scheme. Whilst Lloyds is not paying a dividend we believed the risk profile was significantly reduced by the share issue and it could offer substantial upside in the medium term. 8 The Merchants Trust PLC Investment Manager’s Review During the year we reduced the portfolio’s relatively high level of concentration. The biggest net sale was a reduction of the large BP position in several trades as the shares recovered and the dividend yield looked less enticing compared to other opportunities. We also reduced Royal Dutch Shell on similar considerations. With smaller reductions to the GlaxoSmithKline and Vodafone positions, the largest four investments accounted for under 31% of the portfolio at the year end, down from almost 39% a year earlier. This move reflects a wider range of available high yielding investment opportunities in a more stable economic and financial environment. Other sales reflected the themes discussed earlier. The strong recovery of small and mid cap shares provided the opportunity to reduce and ultimately sell out of GKN (post rights issue), Dairy Crest and Marshalls at relatively full valuations. Amongst the more economically defensive stocks, Diageo and Sage had performed well and, with fairly muted short term prospects, they looked expensive compared to many better opportunities elsewhere. The final complete sale was water company Severn Trent. A draft determination from the regulator OFWAT looked set to put pressure on the industry’s future dividends so we switched the investment into additional shares in utilities National Grid and Scottish & Southern Energy. Elsewhere, having added to BT at depressed levels in February, we reduced the holding later in the year after the shares had been significantly re- rated and more fully reflected the restructuring opportunities in the business. We also started to sell down the Inchcape position into strength. After supporting the rights issue at 6p per share, we sold shares as they approached fair value at various levels from 19p up to 35p. Outside of the top 10 net sales, we reduced positions in a wide range of companies as they rallied and offered less value. These included mid caps; Britvic, Halfords, Melrose, IG Group and Meggitt, as well as FTSE 100 companies; Home Retail Group, Man Group and Legal & General. Largest Net Purchases Unilever British Land AstraZeneca Premier Farnell Reckitt Benckiser Bunzl International Power HSBC BAE Systems Catlin Group Largest Net Sales £m BP 6.4 BT 5.5 Anglo American 5.2 Sage 5.0 4.6 GKN 4.5 Diageo 4.4 Dairy Crest 4.3 3.6 3.3 Royal Dutch Shell “B” BHP Billiton Inchcape £m 7.8 6.5 5.4 5.2 4.9 4.8 4.5 4.4 4.0 3.8 Derivatives Strategy As explained in the Chairman’s Statement, we initiated a strategy of writing (selling) covered call options on a limited number of stocks within the equity portfolio and using the proceeds to buy out-of-the-money put options on the FTSE 100 Index. The call option purchaser can buy stock from the Trust at a pre-agreed price for a limited period. The put options are essentially an “insurance policy” to provide some downside protection if the market were to fall very significantly. In January 2010 the directors decided to suspend further purchases of put options. The fund managers will continue writing call options selectively in order to generate additional income for the Trust, rather than for the purpose of capital protection. Call options are only written on stocks owned within the portfolio and with a maximum exposure of 20% of gross assets at the time of writing. Future Policy A year ago the economy was in the deepest recession for a generation and the credit crunch had called into question the viability of many businesses and even the financial system. Compared with that desperate situation, the outlook today is much clearer with the developed world out of recession and corporate balance sheets and profits recovering. However compared to more normal times, the economic challenges and risks today remain immense. Governments and central banks are walking along a delicate tightrope. On the one hand they need a loose monetary and fiscal policy to stimulate growth and turn a fragile recovery into a more sustainable upturn. On the other hand they need to reduce spending and raise taxes to bring budget deficits under control. Failure to sustain growth could lead to a double dip recession and even larger debt problems, whilst failure to cut deficits can lead to a loss of market confidence, rising bond yields, austerity packages, devaluations and in extremis government debt defaults. These pressures are evident even within the EU, with the Irish economy in a deep recession caused by austerity measures whilst Greece has 9 The Merchants Trust PLC Investment Manager’s Review suffered a loss of confidence in its debt market with implications for the Euro. The UK is in a worse funding position than much of Europe, but a floating currency and independent interest rates allow greater flexibility of policy response. Despite the risks, our central view is that the developed world will continue to see an economic recovery due to the economic stimuli and inflation will not be a major short term concern. However we expect growth to remain below the longer term trend for a considerable period as both consumers and governments struggle to reduce excessive debt levels. Several of the key emerging markets are performing better than the developed world, delivering higher growth with stronger financial balances. China in particular has benefitted from a huge infrastructure and investment boom. The challenge for China is to rebalance the economy from investment towards consumer spending without serious dislocation. The equity market is not as cheap as it was a year ago but corporate balance sheets and cashflows have improved materially and aggregate valuations are still reasonable. There are many anomalies within the market as might be expected after a period of economic volatility and we have positioned the portfolio to take advantage of these. After two years where macro-economic themes and sector rotation have dominated market moves, a period of lower volatility could lead to a greater focus on company fundamentals. We think valuations, including dividend yields, are likely to be more important differentiators of stock performance. Sustainable profits growth may well be more highly rated in a muted economic environment and companies with strong, defendable market positions and pricing power are also likely to be more highly valued. We continue to have a large exposure to big, multinational, well financed businesses that are not particularly cyclical and generally trade on low valuations with attractive dividend yields. Examples would include GlaxoSmithKline, Vodafone, BAE Systems, Royal Dutch Shell and National Grid. We have also built up exposure to higher growth businesses where these were available at attractive valuations and offered a reasonable dividend yield. Higher growth stocks in general look cheaper than they have been for many years and we have invested in Reckitt Benckiser, IG Group, Bunzl and Ashmore amongst others. Other themes we are exploiting include seeking companies with exposure to emerging market consumers, such as British American Tobacco, WPP, IPF and Unilever. Also we favour those companies that benefit from recovering asset values in real estate or credit markets, such as Hammerson, British Land and Aviva. We are generally cautious about big ticket corporate spending in what is likely to be a relatively muted economic recovery so we have limited exposure to cyclical industrial companies, although we are becoming more positive on day to day spending in areas like advertising. We have a very low exposure to the mining industry, partly due to unattractive valuations and dividends, but also due to the risk to commodity prices as China slows down its investment spending. Amongst financials the portfolio has a modest exposure to banks, mainly via HSBC, but we see many opportunities in the broader financial sector. Banks are extremely difficult to value given the uncertain profile of any cyclical recovery and significant structural challenges including increased regulation, tighter capital restrictions and higher taxation. Dividends The Merchants Trust has a twenty eight year record of consistently raising its dividend and the portfolio is managed with a view to maintaining a high level of income. The revenue reserves have allowed the directors to maintain this track record at a time when there have been material dividend cuts across the wider market. The worst of the dividend cuts seem to be behind us with underlying market dividend growth now positive again. A year ago we mentioned four significant risks to income generation, namely; the depth and duration of the recession, financial asset values, the level of sterling, particularly against the dollar, and commodity prices, especially oil. Three of these factors have improved markedly. Only the US dollar moved against the Trust although even that has moderated recently. The value of the dollar affects the large amount of dividends paid in dollars when translated back into sterling. Simon Gergel 7 April 2010 10 Listed Holdings at 31 January 2010 Name Royal Dutch Shell ‘B’ Shares GlaxoSmithKline Vodafone BP HSBC AstraZeneca BAE Systems Scottish & Southern Energy British American Tobacco Unilever BHP Billiton Centrica National Grid Reed Elsevier Aviva BT Group Compass Group Britvic International Personal Finance Barclays Hammerson International Power Premier Farnell Reckitt Benckiser Bunzl Meggitt IG Group British Land British Insurance Balfour Beatty Legal & General Man Group WPP Rexam Inchcape Lloyds Banking Group Arriva Halfords Catlin Melrose Home Retail Interserve Informa Resolution Ashmore Pendragon Total Equities Value (£) 40,876,409 38,185,935 37,449,638 33,726,136 29,338,374 20,859,554 20,538,561 19,914,400 19,655,050 18,612,750 16,607,400 13,878,142 13,608,000 11,990,881 11,888,100 10,016,875 6,958,250 6,933,833 6,050,000 6,006,210 5,666,050 5,622,750 5,540,370 5,362,500 5,339,475 5,299,760 5,278,882 5,168,400 4,944,501 4,811,719 4,733,040 4,732,922 4,389,342 3,784,024 3,646,636 3,594,240 3,537,946 3,511,104 3,329,060 3,263,940 3,135,098 2,742,810 2,263,800 2,157,300 1,852,585 1,484,339 488,287,091 The Merchants Trust PLC Principal Activities Oil & Gas Producers Pharmaceuticals & Biotechnology Mobile Telecommunications Oil & Gas Producers Banks Pharmaceuticals & Biotechnology Aerospace & Defence Electricity Tobacco Food Producers Mining Gas, Water & Multiutilities Gas, Water & Multiutilities Media Life Insurance Fixed Line Telecommunications Travel & Leisure Beverages General Financial Banks Real Estate Investment Trust Electricity Support Services Household Goods & Home Construction Support Services Aerospace & Defence General Financial Real Estate Investment Trust Non-life Insurance Construction & Materials Life Insurance General Financial Media General Industrials General Retailers Banks Travel & Leisure General Retailers Non-life Insurance Industrial Engineering General Retailers Support Services Media Life Insurance General Financial General Retailers 11 Value (£) 49,875 33,250 – 83,125 (750) (1,000) (1,750) (1,900) (3,750) (4,250) (4,500) (6,375) (11,250) (12,200) (13,125) (20,000) (21,000) (101,850) (18,725) 488,268,366 The Merchants Trust PLC Listed Holdings at 31 January 2010 Listed Derivatives Name FTSE 100 Jun 2010 2600 FTSE 100 Sept 2010 2600 FTSE 100 Mar 2010 2600 Purchased Put Options Royal Dutch Shell Feb 2010 2000 GlaxoSmithKline Feb 2010 1400 BHP Billiton Mar 2010 2400 National Grid Mar 2010 720 BHP Billiton Feb 2010 2200 BP Feb 2010 640 Vodafone Feb 2010 150 BP April 2010 680 Centrica Mar 2010 300 Reckitt Mar 2010 3400 BT Group Mar 2010 160 Reed Elsevier Mar 2010 540 BAE Systems Mar 2010 380 Written Call Options Total Derivative Financial Instruments Total Listed Investments 12 Distribution of Total Assets Total Assets (less creditors due within one year) £498,205,486 (2009 – £428,277,126). Oil & Gas Oil & Gas Producers Basic Materials Mining Industrials Aerospace & Defence Construction & Materials General Industrials Industrial Engineering Support Services Consumer Goods Automobiles & Parts Beverages Food Producers Household Goods & Home Construction Tobacco Healthcare Pharmaceuticals & Biotechnology Consumer Services General Retailers Media Travel & Leisure Telecommunications Fixed Line Telecommunications Mobile Telecommunications Utilities Electricity Gas, Water & Multiutilities Financials Banks General Financial Life Insurance Non-Life Insurance Real Estate The Merchants Trust PLC Percentage of total assets at 31 January 2010 Percentage of total assets at 31 January 2009 15.0 15.0 3.3 3.3 5.2 1.0 0.8 0.7 2.7 10.4 – 1.4 3.7 1.1 3.9 10.1 11.8 11.8 2.4 3.7 2.1 8.2 2.0 7.5 9.5 5.1 5.5 10.6 7.8 3.6 3.8 1.7 2.2 19.1 18.8 18.8 4.7 4.7 5.2 0.7 0.9 0.6 0.5 7.9 0.5 2.5 2.6 – 3.5 9.1 12.6 12.6 2.2 3.2 1.9 7.3 2.9 9.0 11.9 4.0 6.3 10.3 5.3 2.2 3.6 1.3 – 12.4 13 The Merchants Trust PLC Distribution of Total Assets Information Technology Software & Computer Services Total Investments Net Current Assets Total Assets Percentage of total assets at 31 January 2010 Percentage of total assets at 31 January 2009 – – 98.0 2.0 100.0 1.2 1.2 96.2 3.8 100.0 14 The Merchants Trust PLC Performance Graphs 10 year record as at 31 January The Merchants Trust 10 Year Cumulative Return compared to key UK equity indices 280 260 240 220 200 180 160 140 120 100 80 60 50 2000 The Merchants Trust share price total return The Merchants Trust NAV total return FTSE 100 total return FTSE 350 Higher Yield total return 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Mellon (Re-based to 100) The Merchants Trust Net Dividend Growth compared to inflation Net Dividend UK Retail Price Index 170 160 150 140 130 120 110 100 2000 2001 Source: RCM Datastream (Re-based to 100) 2002 2003 2004 2005 2006 2007 2008 2009 2010 The Merchants Trust Discount to Net Asset Value % 0 -2 -4 -6 -8 -10 -12 -14 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: RCM Datastream 15 The Merchants Trust PLC Directors The current Directors’ details are set out below. All Directors are non-executive and independent of the Manager. Mr H. A. Stevenson (Chairman) (Born September 1942) joined the Board in September 1999. Formerly Chairman of Mercury Asset Management Group plc and Equitas Limited, he is Deputy Chairman of the Financial Services Authority. Mr R. A. Barfield (Born April 1947) joined the Board in May 1999. Formerly Chief Investment Manager of Standard Life Assurance Company, he is a Chairman of The Baillie Gifford Japan Trust PLC and a Director of JPMorgan Fleming Overseas Investment Trust PLC, The Edinburgh Investment Trust PLC and Standard Life Investments Property Income Trust Limited. He is a member of The Professional Oversight Board, a Non-Executive member of the Pension Protection Fund Board and advises a number of pension funds. Mr S. J. Fraser (Born May 1959) joined the Board in August 2009. He is a non-executive director of and Chairman-elect of Foreign & Colonial Investment Trust PLC and a non-executive director of Barclays PLC, Barclays Bank PLC, Fidelity European Values PLC and Fidelity Japanese Values PLC. He spent his career at Fidelity International Limited, where he held a number of positions, including Chief Investment Officer from 1999-2005, President of Fidelity International’s European and UK Institutional business and latterly President of the Investment Solutions Group. He stepped down from executive responsibilities at the end of 2008. Mr M. J. E. McKeon (Born October 1956) joined the Board in May 2008. He is Group Finance Director of Severn Trent plc and prior to that, from 2000 until 2005, he was Group Finance Director of Novar plc. He held various senior roles at Rolls-Royce plc from 1997 to 2000. He has extensive experience in a number of overseas positions, having worked at CarnaudMetalbox, Elf Atochem and PricewaterhouseCoopers. He is a Chartered Accountant. Sir James Sassoon (Chairman of the Audit Committee) (Born September 1955) joined the Board in July 2006. He is a Director of Nuclear Liabilities Fund Limited, a member of the Economic Recovery Committee of the Shadow Cabinet and a Trustee of the British Museum. He was formerly President of the Financial Action Task Force, Managing Director, Finance and Industry at HM Treasury and Vice Chairman, Investment Banking, at UBS Warburg. He is a Chartered Accountant. Mr H. E. Staunton (Born May 1948) joined the Board in May 2008. He is a non-executive director of Ladbrokes plc, Legal & General plc and Standard Bank Plc. He was previously Finance Director at ITV plc and Granada Group plc. He was also a non-executive director of Emap plc, BSkyB, Independent Television News Limited, Vector Hospitality plc and Ashtead Group plc, of which he was also Chairman between 2001 and 2004. He is a Chartered Accountant. Manager and Advisers Fund Manager RCM (UK) Limited, Represented by Simon Gergel, Portfolio Manager, and Simon White, Head of Investment Trusts Secretary and Registered Office Kirsten Salt BA (Hons) ACIS, 155 Bishopsgate, London EC2M 3AD. Telephone: 020 7065 1513, Email: kirsten.salt@uk.rcm.com Independent Auditors PricewaterhouseCoopers LLP, Hay’s Galleria, 1 Hay’s Lane, London SE1 2RD Bankers HSBC Bank, Barclays Bank Stockbroker JPMorgan Cazenove Legal Advisers Herbert Smith LLP 16 The Merchants Trust PLC Directors’ Report The Directors present the annual financial report of the Company and give their report for the year ended 31 January 2010. Business Review Business and Status of the Company The Company is an investment company as defined in Section 833 of the Companies Act 2006. The Company carries on business as an investment trust and was approved by HM Revenue & Customs as an investment trust in accordance with Section 842 of the Income and Corporation Taxes Act 1988 for the year ended 31 January 2009. In the opinion of the Directors, the Company has subsequently conducted its affairs so that it should continue to qualify. The Company will continue to seek approval under Section 842 of the Income and Corporation Taxes Act 1988 each year. The Company is not a close company for taxation purposes. Regulatory Environment The Company is listed on the London Stock Exchange and is subject to UK company law, financial reporting standards, listing rules, tax law and its own Articles of Association. In addition to annual and half yearly financial reports published under these rules, the Company announces net asset values per share on a daily basis for the information of investors. It provides more detailed information on a monthly basis to the Association of Investment Companies, of which the Company is a member, in order for brokers and investors to compare its performance with its peer group. The Board of Directors is charged with ensuring that the Company complies with its own objectives as well as these rules. The Board has appointed RCM (UK) Limited to carry out investment management, accounting, secretarial and administration services on behalf of the Company. The Company has no employees or premises of its own. Investment Objective and Policies The Company’s objective is to provide an above average level of income and income growth together with long term growth of capital through a policy of investing mainly in higher yielding UK FTSE 100 companies. The Company’s investment performance is assessed by comparison with other investment trusts within the UK Growth and Income sector. In addition, it is benchmarked against the FTSE 100 Index, reflecting the emphasis within the portfolio, as well as the FTSE 350 Higher Yield Index, reflecting the Company’s higher yield objective. The Company pays quarterly dividends and the Board has a policy of making these progressive from year to year, in keeping with the Company’s stated objective to provide an above average level of income and income growth. The dividend has increased every year for the past twenty seven years and details of historic dividend payments are set out on page 5. Performance In the year to 31 January 2010 the NAV per Share rose by 21.8%. This compares with the capital return on the Company’s benchmark indices of 25.0% (FTSE 100) and 18.3% (FTSE 350 Higher Yield). At 31 January 2010 the value of the Company’s investment portfolio was £488.3m. The Investment Manager’s review on pages 6 to 10 includes a review of developments during the year as well as information on investment activity within the Company’s portfolio. Key Performance Indicators (“KPIs”) The Board uses certain financial KPIs to monitor and assess the performance of the Company. The principal KPIs are: • • • Performance against the benchmark indices The Company’s performance is benchmarked against the FTSE 100 Index and the FTSE 350 Higher Yield Index. These are the most important KPIs by which performance is judged. Performance against the Company’s peers The Board also monitors the Company’s performance with reference to its investment trust peer group. Performance Attribution The performance attribution is considered at each Board Meeting and enables the Directors to judge how the Company achieved its performance relative to the benchmark index and to see the impact on the Company’s relative performance of factors including stock and sector allocation. A Performance Attribution Analysis for the year ended 31 January 2010 is given on page 5. 17 The Merchants Trust PLC Directors’ Report • Discount to net asset value (“NAV”) The Board has a share buy back programme which has a role to play in enhancing the NAV for existing shareholders, as shares are bought back at a discount, and in minimising the volatility of movements in the discount. In the year to 31 January 2010 the shares traded between a discount of -9.9% and a premium of +20.7% with debt at fair value. • Total expense ratio (“TER”) The most significant expense for the Company is the cost of the management fee and the costs of interest on the Company’s borrowings. Other expenses include the costs of investment transactions, directors’ fees and insurance, professional advice and regulatory fees and the costs of production of the reports to shareholders. The TER is calculated by dividing operating expenses, that is, the Company’s management fee and all other operating expenses (including tax relief where allowable, but excluding interest payments and investment management fee VAT refund) as a percentage of total assets less current liabilities at the year end. The TER for the year ended 31 January 2010 was 0.45% (2009 – 0.58%). Revenue The return attributable to Ordinary Shareholders for the year amounted to £19,498,068 (2009 – £28,017,898). Earnings per ordinary dividend amounted to 18.91p. The first and second interim dividends of 5.6p and 5.6p respectively have been paid during the year. Since the year end the third interim dividend of 5.6p has been paid. The final proposed dividend of 5.7p is payable on 14 May 2010. In accordance with FRS 21 ‘Events after the Balance Sheet Date’, the third dividend and final dividend are not recognised as liabilities within the financial statements on the basis that they have not been paid and approved, respectively, by the shareholders. Historical Record The distribution of total assets is shown on pages 13 and 14, and the historical record of the Company’s revenue, capital and invested funds over the past ten years is shown on page 5. Graphs appear on page 15 showing the performance on a total return basis over the past ten years of the Net Asset Value of the Company’s Ordinary Shares against the Company’s benchmark indices, the growth in net ordinary distributions made by the Company against the Retail Price Index, and the Company’s discount to Net Asset Value over the same period. Invested Funds Sales of investments during the year resulted in net losses based on historical costs of £54,388,557 (2009 – £38,449,932). Provisions contained in the Finance Act 1980 exempt approved Investment Trusts from corporation tax on their chargeable gains. Invested funds at 31 January 2010 had a value of £488,295,791 (2009 – £411,795,591) before deducting net liabilities of £103,548,577 (2009 – £96,991,555). Principal Risks and Uncertainties With the assistance of the Manager the Board has drawn up a risk matrix which identifies the key risks to the Company. These key risks fall broadly under the following categories: Investment Activity and Strategy: An inappropriate investment strategy, e.g., asset allocation or the level of gearing, may lead to under- performance against the Company’s benchmark index and peer group companies, and also in the Company’s shares trading on a wider discount. The Board manages these risks by diversification of investments through its investment restrictions and guidelines which are monitored and on which the Board receives reports. RCM (UK) Limited (“RCM”) provides the Directors with management information including performance data and reports and shareholder analyses. The Board monitors the implementation and results of the investment process with the investment manager, who attends all board meetings, and reviews data which show risk factors and how they affect the portfolio. The Board reviews investment strategy at each board meeting. Accounting, Legal and Regulatory: In order to qualify as an investment trust the Company must comply with Section 842 of the Income and Corporation Taxes Act 1988 (“Section 842”), and details are given above under the heading ‘Business of the Company’. A breach of Section 842 could result in the Company losing investment trust status and, as a consequence, gains in the Company’s portfolio would be subject to Corporation Tax. The Section 842 criteria are monitored by RCM and results are reported to the Board at each Board Meeting. The Company must comply with the provisions of the Companies Act 2006 (“Companies Act”), and, as the Company’s shares are listed on the London Stock Exchange, the Company must comply with the UK Listing Authority’s Listing Rules and Disclosure and Transparency Rules (“UKLA Rules”). A breach of the Companies Act could result in the Company and/or the Directors being fined or becoming the subject of criminal proceedings. Breach of the UKLA Rules could result in the suspension of the Company’s shares which would in turn lead to a • • 18 The Merchants Trust PLC Directors’ Report breach of Section 842. The Board relies on its company secretary and seeks advice from professional advisers to ensure compliance with the Companies Act and UKLA Rules. Corporate Governance and Shareholder Relations: Details of the Company’s compliance with Corporate Governance best practice, including information on relations with shareholders, are set out in the Corporate Governance Statement on pages 21 to 25. Operational: Disruption to, or failure of, RCM’s accounting, dealing or payment systems or the custodian’s records may prevent accurate reporting and monitoring of the Company’s financial position. RCM has contracted operational functions, principally relating to trade processing and investment administration, to The Bank of New York Mellon – London Branch. Details of how the Board monitors the services provided by RCM and other suppliers and the key elements designed to provide effective internal control are included within the Internal Control section of the Corporate Governance Statement on page 24. Financial: The financial risks associated with the Company include market risk (price and yield), interest rate risk, liquidity risk and credit risk. Further analysis of these risks can be found in Note 18 on pages 46 to 50. • • • Future Development The future development of the Company is dependent on the success of the Company’s investment strategy against the economic environment and market developments. The investment manager discusses his view of the outlook for the Company’s portfolio in his report beginning on page 6. Going Concern The Directors have considered the Company’s investment objective and capital structure and, having noted that the portfolio consists mainly of securities which are readily realisable, have concluded that the Company has adequate resources to continue in operational existence for the foreseeable future. For this reason the Directors continue to adopt the going concern basis in preparing the financial statements. Net Asset Value The Net Asset Value of the Ordinary Shares of 25p at the year end was 372.8p as compared with a value of 306.2p at 31 January 2009. Share Capital Details of the Company’s share capital are set out in Note 11 on page 44. Payment Policy It is the Company’s payment policy for the forthcoming financial year to obtain the best terms for all business and therefore there is no consistent policy as to the terms used. In general, the Company agrees with its suppliers the terms on which business will take place and it is our policy to abide by these terms. The Company had no trade creditors at the year end (2009 – £nil). Donations and Subscriptions There were no charitable donations and subscriptions in respect of the year (2009 – £nil). No political donations were made during the year. Final Dividend Subject to the final dividend being approved by shareholders at the Annual General Meeting, payment will be made on 14 May 2010 to shareholders on the Register of Members at the close of business on 16 April 2010 at the rate of 5.7p per Ordinary Share. Further details are provided in Note 6 on page 40. Capital Structure The Company’s capital structure is summarised on page 44. 19 The Merchants Trust PLC Directors’ Report Voting Rights in the Company’s Shares The voting rights at 31 March 2010 were: Share class Ordinary shares of 25p 3.65% Cumulative Preference shares of £1 Total Number of shares issued 103,213,464 1,178,000 104,391,464 Voting rights per share 1 1 Total Voting Rights 103,213,464 1,178,000 104,391,464 These figures remained unchanged at the date of this report. Interests in the Company’s Share Capital As at 6 April 2010 the following had declared a notifiable interest in the Company’s issued share capital: Ordinary Shares: Name Rensburg Sheppards Investment Management Group Limited AXA S.A. Legal & General Group PLC Lloyds Banking Group PLC 3.65% Cumulative Preference Stock: Name P. S. & J. M. Allen Prudential plc Ecclesiastical Insurance Office plc F&C Asset Management plc D. J. Edwards J. Y. Miller Number of Shares 4,017,845 4,125,070 4,099,823 4,086,614 Percentage of Voting Rights 3.9% 4.0% 4.0% 4.0% Number of Shares Percentage of Voting Rights 185,582 176,000 134,690 60,000 50,000 36,000 15.8% 14.9% 11.4% 5.1% 4.2% 3.0% The rules concerning the appointment and replacement of directors, amendment of the Articles of Association and powers to issue or buy back the Company’s shares are contained in the Articles of Association of the Company and the Companies Act 2006. There are no restrictions concerning the transfer of securities in the Company; no special rights with regard to control attached to securities; no agreements between holders of securities regarding their transfer known to the Company; no agreements which the Company is party to that might affect its control following a takeover bid; and no agreements between the Company and its directors concerning compensation for loss of office. Directors and Management All Directors listed on the next page served throughout the financial year under review. The Directors retiring by rotation at the Annual General Meeting (‘AGM’) are Hugh Stevenson, Dick Barfield and Sir James Sassoon. Sir James Sassoon and Mr Barfield each offers himself for re-election and both have the full support of the Board in doing so. In addition, Simon Fraser, having been appointed since the last AGM, is standing for election at this year’s AGM. The Board used an external recruitment consultant in the appointment of Simon Fraser. Hugh Stevenson is retiring from the Board and so does not offer himself for re-election. The Board confirms that, since the year end, the performances of all of the Directors have been subject to a formal evaluation and that each continues to be effective and committed to his role. The Board considers Mr Barfield to be independent, notwithstanding his length of service, and continues to be of the view that his extensive experience and active knowledge of industry and financial services are of great benefit to the Board. Biographical details of the current Directors are on page 16. 20 The Merchants Trust PLC Directors’ Report The current Directors and their beneficial interests in the share capital of the Company as at 31 January 2010 and 31 January 2009 are listed below: H. A. Stevenson R. A. Barfield S. J. Fraser* Sir James Sassoon M. J. E. McKeon H. E. Staunton *Joined the Board on 1 August 2009. Ordinary Shares of 25p 2010 25,000 2,440 20,000 40,145 450 10,000 2009 25,000 2,440 – 35,600 450 10,000 No contracts of significance in which Directors are deemed to have been interested have subsisted during the year under review. Contracts of service are not entered into with the Directors, who hold office in accordance with the Articles of Association. Management Contract and Management Fee The management contract with RCM (UK) Limited (‘RCM’) provides for a fee of 0.35% per annum (2009 – 0.35%) of the value of the assets, calculated quarterly, after deduction of current liabilities, short term loans under one year and any funds within the portfolio managed by RCM. The management contract is terminable at one year’s notice (2009 – one year). The Manager’s performance under the contract and the contract terms are reviewed at least annually by the Management Engagement Committee. This committee consists of the Directors not employed by the management company in the past five years and therefore includes the entire Board. During the year, the committee met the Manager to review the current investment framework, including the Trust’s performance, marketing activity and total expense ratio. The committee also reviewed the terms of the management contract and considered the level of the management fee. The committee was satisfied with its review and believes that the continuing appointment of the Manager is in the best interests of shareholders as a whole. Related Party Transactions During the financial year no transactions with related parties have taken place which would materially affect the financial position or the performance of the Company. Individual Savings Accounts The affairs of the Company are conducted in such a way as to meet the requirements for an Individual Savings Account and it is the intention to continue to do so. Corporate Governance Statement The Board has considered the principles and recommendations of the Association of Investment Companies Code of Corporate Governance (“AIC Code”) by reference to the AIC Corporate Governance Guide for Investment Companies (“AIC Guide”). The AIC Code, as explained by the AIC Guide, addresses all the principles set out in Section 1 of the Combined Code which was issued by the Financial Reporting Council in June 2008, as well as setting out additional principles and recommendations on issues that are of specific relevance to the Company. The Board considers that reporting against the principles and recommendations of the AIC Code, and by reference to the AIC Guide, will provide better information to shareholders. The Company has complied with the recommendations of the AIC Code and the relevant provisions of Section 1 of the Combined Code, except in relation to the Combined Code provisions relating to: the role of the chief executive, executive directors’ remuneration and the need for an internal audit function. For the reasons set out in the AIC Guide, and in the preamble to the Combined Code, the Board considers these provisions are not relevant to the Company as it is an externally managed investment company. The Company has therefore not reported further in respect of these provisions. 21 The Merchants Trust PLC Directors’ Report The Board The Board currently consists of six Directors, all of whom are non-executive and independent of the Company’s investment manager. The Directors’ biographies, on page 16, demonstrate a breadth of investment, industrial, commercial and professional experience. The Chairman of the Company is a non-executive Director. Sir James Sassoon is the Senior Independent Director. The Board follows the AIC Code and considers Dick Barfield to be independent, notwithstanding that he has served on the Board for more than nine years. The Board does not consider that length of service has diminished his independence and continues to be of the view that his extensive experience and active knowledge of the industry is of great benefit to the Board. The composition of the Board is reviewed regularly. The Board’s tenure policy is that new Directors stand for election at the first Annual General Meeting following their appointment and then at least one third of Directors retire by rotation at each Annual General Meeting. Every Director is required to seek re-election at least every three years and annually after nine years’ service. The names of the Directors retiring by rotation and those other Directors retiring in accordance with the Articles of Association at this year’s Annual General Meeting are given on page 20. The Board meets at least six times a year and convenes other meetings as and when required. Between meetings, regular contact with the investment manager is maintained. The Board has a schedule of matters reserved for its approval to ensure it has full and effective control over appropriate issues. These issues include approval of the Company’s investment policy, capital structure, share price and discount, committee membership and terms of reference, financial reporting, risk management, board appointments and removals, corporate governance, internal controls and contracts. A procedure has been adopted for Directors, in the furtherance of their duties, to take independent professional advice at the expense of the Company. The Directors have access to the advice and services of the Company Secretary, who is responsible to the Board for ensuring that Board procedures are followed and that the Company complies with applicable rules and regulations. When a new Director is appointed there is an induction process carried out by the investment manager. Directors are provided, on a regular basis, with key information on the Company’s regulatory and statutory requirements and internal financial controls. Changes affecting Directors’ responsibilities are advised to the Board as they arise. During the year, the effectiveness of the Board and the performance of individual Directors was assessed through interviews conducted by the Chairman with each Director. The Chairman’s own performance was evaluated by the other Directors in discussions with Sir James Sassoon as Senior Independent Director. The results of the effectiveness assessment and performance evaluation have been presented to the Nomination Committee. The effectiveness assessment determined that with the planned recruitment of new Directors the balance of the Board was satisfactory. The Board has contractually delegated to the investment manager the management of the investment portfolio, and the day to day accounting and company secretarial requirements. This contract was entered into after full and proper consideration by the Board of the quality and cost of services offered, including the financial control systems in operation, in so far as they relate to the affairs of the Company. The Board receives and considers reports regularly from the investment manager and ad hoc reports and information are supplied to the Board as required. The Board’s statement on its review of the management contract appears on page 21. Attendance by Directors at formal Board and committee meetings during the year was as follows: Director No. of meetings H. A. Stevenson R. A. Barfield S. J. Fraser~ Sir James Sassoon M. J. E. McKeon P. J. Scott Plummer# H. E. Staunton Board 6 6 6 2 6 6 2 6 Audit Committee 2 2* 2 – 2 2 – 2 Nomination Committee 1 1 1 – 1 1 – 1 Management Engagement Committee 1 1 1 – 1 1 – 1 * Invited to attend meetings, although not a committee member. ~ Appointed to the Board in August 2009. # Retired from the Board in May 2009. 22 The Merchants Trust PLC Directors’ Report Conflicts of Interest The Companies Act 2006 sets out directors’ general duties with some changes from the previously existing law. A director must avoid a situation where he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the Company’s interests. Since 1 October 2008, directors are able to authorise these conflicts and potential conflicts. The Board reports annually on the Company’s procedures for ensuring that its powers of authorisation of conflicts are operated effectively and that the procedures have been followed. Each of the Directors has provided a statement of all conflicts of interest and potential conflicts of interest relating to the Company. These statements have been considered and approved by the Board. The Directors have undertaken to notify the Chairman and Company Secretary of any proposed new appointments and new conflicts or potential conflicts for consideration, if necessary, by the Board. The Board has agreed that only Directors who have no interest in the matter being considered will be able to take the relevant decision and that in taking the decision the Directors will act in a way they consider, in good faith, will be most likely to promote the Company’s success. The Board is able to impose limits or conditions when giving authorisation if it thinks this is appropriate. The Board confirms that its powers of authorisation are operating effectively and that the agreed procedures have been followed. Board Committees Audit Committee The Audit Committee consists of all of the independent non-executive Directors, with the exception of the Chairman, and has defined terms of reference and duties. The role of the Audit Committee is to assist the Board in relation to the reporting of financial information. The Audit Committee is chaired by Sir James Sassoon. The committee considers that, collectively, its members have sufficient recent and relevant financial experience to discharge their responsibilities fully. The committee meets at least twice each year and reviews the annual and half yearly financial statements and considers the Auditors’ report on the annual accounts, the planning and the process of the audit and the Auditors’ independence and objectivity. It has also considered the non-audit services provided by the Auditors and determined that they have had no impact on the Auditors’ independence and objectivity. The Audit Committee reviews the Company’s accounting policies and considers their appropriateness. The Committee also reviews the terms of appointment of the Auditors together with their remuneration. It meets representatives of the Manager twice-yearly and receives reports on the internal controls maintained on behalf of the Company and reviews the effectiveness of these controls. The Audit Committee continues to believe that the Company does not require an internal audit function of its own as it delegates its day to day operations to third parties from whom it receives internal controls reports. As the Company has no employees it does not have a formal policy concerning the raising, in confidence, of any concerns about improprieties, whether in matters of financial reporting or otherwise, for appropriate independent investigation. The Audit Committee has, however, received and noted the Manager’s policy on this matter. Nomination Committee The Nomination Committee meets at least once each year and makes recommendations on the appointment of new Directors and the re-election of existing Directors by shareholders. The committee also determines the process for the annual evaluation of the Board. The Committee is chaired by Hugh Stevenson, the Chairman of the Board. All Directors serve on the committee and consider nominations made in accordance with an agreed procedure. Management Engagement Committee The Management Engagement Committee meets at least once each year to review the Management Agreement and the Manager’s performance. It has defined terms of reference and consists of the non-executive Directors and excludes any Directors previously employed by the Manager. It is chaired by Hugh Stevenson, the Chairman of the Board. The Board has not constituted a Remuneration Committee; all Directors are non-executive and remuneration matters are dealt with by the whole Board. Terms of Reference The Terms of Reference for each of the committees may be viewed by shareholders on request and are published on the website www.merchantstrust.co.uk. Financial Reporting The Statement of Directors’ Responsibilities in respect of the financial statements is on page 28. The Independent Auditors’ Report can be found on page 31. 23 The Merchants Trust PLC Directors’ Report Auditors’ Information Each of the persons who is a Director at the date of approval of this report confirms that: (a) (b) in so far as the Director is aware, there is no relevant audit information of which the Company’s auditors are unaware; and the Director has taken all the steps he ought to have taken as a Director in order to make himself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of Section 418(2) of the Companies Act 2006. Internal Control The Directors have overall responsibility for the Company’s system of internal control. Whilst acknowledging their responsibility for the system of internal control, the Directors are aware that such a system is designed to manage rather than eliminate the risk of a failure to achieve business objectives and can provide only reasonable but not absolute assurance against material misstatement or loss. The Board has established an ongoing process for identifying, evaluating and managing the significant risks faced by the Company. This process is subject to review by the Board and accords with the Internal Control Guidance for Directors in the Combined Code published in September 1999 and revised by the Financial Reporting Council in October 2005 (“the Turnbull guidance”). The process has been fully in place throughout the year under review and up to the date of signing of this Annual Financial Report. The key elements of the procedures that the Directors have established and which are designed to provide effective internal control are as follows: • • • • • The Board, assisted by the Manager, undertook a full review of the Company’s business risks and these are analysed and recorded in a risk matrix. Every six months the Board receives from the Manager a formal report which details any known internal controls failures, including those that are not directly the responsibility of the Manager. The Board continues to check that good systems of internal control and risk management are embedded in the operations and culture of the Company and its key suppliers. The appointment of RCM (UK) Limited (‘RCM’) as the Manager provides investment management, accounting and company secretarial services to the Company. The Manager therefore maintains the internal controls associated with the day to day operation of the Company. These responsibilities are included in the Management Agreement between the Company and the Manager. The Manager’s system of internal control includes organisation arrangements with clearly defined lines of responsibility and delegated authority as well as control procedures and systems which are regularly evaluated by management and monitored by its internal audit department. RCM is regulated by the Financial Services Authority (‘FSA’) and its compliance department regularly monitors compliance with FSA rules. The Company receives reports at least annually from the manager on its internal controls. The Company, in common with other investment trusts, has no internal audit department, but the effectiveness of the Manager’s internal controls is monitored by Allianz Global Investors’ internal audit function. There is a regular review by the Board of asset allocation and any risk implications. There is also regular and comprehensive review by the Board of management accounting information including revenue and expenditure projections, actual revenue against projections and performance comparisons. Authorisation and exposure limits are set and maintained by the Board. The Audit Committee assesses the Manager’s and Custodian’s systems of controls by reviewing Internal Control reports provided by the Managers and third party service providers, including those of the Company’s Registrars, Capita Registrars, and Custodian, HSBC Bank plc. The Directors confirm that the Audit Committee has reviewed the effectiveness of the system of internal control. During the course of its review of the system of internal control, the Board has not identified nor been advised of any failings or weaknesses which it has determined to be significant. Relations with Shareholders The Board strongly believes that the annual general meeting should be an event which private shareholders are encouraged to attend. The annual general meeting is attended by the Chairman of the Board and the Chairman of the Audit Committee, and the Investment Manager makes a presentation at the meeting. The number of proxy votes cast in respect of each resolution will be made available at the annual general meeting. The Manager meets with institutional shareholders on a regular basis and report to the Board on matters raised at these meetings. All correspondence with shareholders is reviewed by the Board. 24 The Merchants Trust PLC Directors’ Report Shareholders who wish to communicate directly with the Chairman, the Senior Independent Director or other Directors may write care of the Company Secretary at 155 Bishopsgate, London EC2M 3AD. The Notice of Meeting sets out the business of the meeting and special resolutions are explained more fully in the Directors’ Report. Separate resolutions are proposed for each substantive issue. Corporate Social Responsibility and Environmental Policy The Investment Manager has been directed by the Board to take account of companies’ corporate social responsibility and environmental performance when taking investment decisions. The Board has noted the Manager’s views on Social Responsibility that it adheres to in engaging with the underlying investee companies and in exercising its delegated responsibilities in voting. These are that: “We believe that good corporate governance includes the management of the company’s impacts on society and the environment, as these are increasingly becoming a factor in contributing towards maximising long term shareholder value.” Exercise of Voting Powers The Company’s investments are held in a nominee name. The Board has delegated discretion to discharge its responsibilities in respect of investments, including the exercise of voting powers on its behalf, to the Manager. The Board has noted the Manager’s statement of its corporate governance aims and objectives, summarised as: “Our primary corporate aim is to maximise shareholder value through the securing of corporate performance whilst protecting this value through operating within established rules of conformance. Our primary investment management aim is to meet or exceed our clients’ expectations through generating first class returns within the constraint of their risk tolerance. RCM votes in all markets wherever possible, and strives actively to encourage both improved levels of disclosure among companies and proper voting infrastructure among custodians and agents globally.“ In the UK, RCM is a member of the National Association of Pension Funds (NAPF) and the International Corporate Governance Network (ICGN), and abides by these organisations’ founding principles. These guidelines also take into account international codes of corporate governance from a number of sources, including Employment Retirement Income Security Act (ERISA) legislation and Department of Labor recommendations in the U.S. where appropriate. Where Directors hold directorships on the boards of companies in which the Company is invested, they do not participate in decisions made concerning those investments. An extract from the Company’s voting record in the previous calendar year will be available for inspection at the annual general meeting each year. Annual General Meeting Adoption of new Articles of Association In Resolution 9 in the Notice of Meeting on page 54 the Company proposes to adopt new Articles of Association (‘new Articles’) to replace the current Articles of Association (‘current Articles’). The new Articles incorporate amendments to the current Articles to reflect the provisions of the Companies Act 2006 (the ‘2006’ Act) and also the Companies (Shareholders’ Rights) Regulations 2009 (“Shareholders’ Rights Regulations”), and otherwise generally update the current Articles for current law, regulation and market practice. The new Articles, showing all the changes to the current Articles, are available for inspection at the registered office during normal business hours at the Company’s Registered Office, 155 Bishopsgate, London EC2M 3AD from the date of this report up until the close of the AGM. Copies will also be available at 20 Moorgate, London EC2R 6DA being the place of the Annual General Meeting, for 15 minutes prior to, and during, the meeting. The material changes necessary and recommended due to the entering into force of the Companies Act 2006 and the Shareholders’ Rights Regulations include: removing the Chairman’s casting vote at Shareholder meetings; the removal of the Company’s ability to give notice of meetings by advertisement when the post is not available; the removal of references to authorised but unissued shares; the additional manner in which the Company’s name can be changed by way of board resolution; the deletion of the ability to close the register; the removal of specific 25 The Merchants Trust PLC Directors’ Report authorities no longer required on capital reduction or buy backs; the addition of a provision confirming that there is no requirement to check that the proxy is voting according to his instructions; provisions relating to the administration of the Company; and minor changes to proceedings at general meetings. Purchase of Own Shares The Board is proposing that the Company should be given renewed authority to purchase Ordinary Shares in the market for cancellation. The Board believes that such purchases in the market at appropriate times and prices are a suitable method of enhancing shareholder value. The Company would make either a single purchase or a series of purchases, when market conditions are suitable, with the aim of maximising the benefits to shareholders and within guidelines set from time to time by the Board. Where purchases are made at prices below the prevailing net asset value of the Ordinary Shares, this will enhance net asset value for the remaining shareholders. It is therefore intended that purchases would only be made at prices below net asset value, with the purchases to be funded from the capital reserves of the Company (which are currently in excess of £250 million). The rules of the UK Listing Authority (‘Listing Rules’) limit the price which may be paid by the Company to 105% of the average middle-market quotation for an Ordinary Share on the five business days immediately preceding the date of the relevant purchase. The minimum price to be paid will be 25p per Ordinary Share (being the nominal value). Overall, this proposed share buy-back authority, if used, should help to reduce the discount to net asset value at which the Company’s shares currently trade. The Board considers that it will be most advantageous to shareholders for the Company to be able to continue to make such purchases as and when it considers the timing to be most favourable and therefore does not propose to set a timetable for making any such purchases. Under the Listing Rules, the maximum number of shares which a listed company may purchase through the market pursuant to a general authority such as this is equivalent to 14.99% of its issued share capital. For this reason, the Company is limiting its renewed authority to make such purchases to 15,411,738 Ordinary Shares, representing 14.99% of the issued share capital, provided that there is no change in the issued share capital between the date of this report and the Annual General Meeting to be held on 11 May 2010. The authority was previously in Section 166 of the Companies Act 1985 and the equivalent authority which is in Section 701 of the Companies Act 2006, will last until the Annual General Meeting of the Company to be held in 2011 or the expiry of 18 months from the date of the passing of this resolution, whichever is the earlier. The authority will be subject to renewal by shareholders at subsequent annual general meetings. Allotment of New Shares and Disapplication of Pre-emption Rights Approval is sought for the renewal of the Directors’ authority to allot relevant securities, in accordance with Section 551 of the Companies Act 2006, up to a maximum aggregate nominal amount of £8,567,788, representing approximately 33% of the existing Ordinary Share capital. This authority is renewable annually and would expire at the conclusion of the Annual General Meeting in 2011. This authority is equivalent to the previous authority in Section 80 of the Companies Act 1985. A resolution was passed at the Annual General Meeting held on 12 May 2009 under Section 95 of the Companies Act 1985, to authorise the Directors to allot Ordinary Shares for cash other than pro rata to existing shareholders. The authority is renewable annually and expires at the conclusion of the Annual General Meeting in 2010. The equivalent authority under the Companies Act 2006 is in Section 570. A Special Resolution is therefore proposed under special business at the forthcoming Annual General Meeting to renew this authority for a further year. This power is limited to the aggregate nominal amount of £2,570,336 Ordinary Share capital, being approximately 10% of the issued Ordinary Share capital of the Company as at the date of this report, provided that there is no change in the issued share capital between the date of this report and the Annual General Meeting to be held on 11 May 2010. The Directors may allot shares under these authorities to take advantage of opportunities in the market as they arise but only if they believe it would be advantageous to the Company’s existing shareholders to do so. The Directors confirm that no allotment of new shares will be made unless the lowest market offer price of the Ordinary Shares is at least at a premium to net asset value, valuing debt at market value. Authority to hold a general meeting on 14 days’ clear notice This resolution is required to reflect the implementation in August 2009 of the EU Shareholder Rights Directive (the “Directive”), which has increased the notice period for all general meetings of the Company to 21 days’ clear notice. The Company was previously able to call general meetings (other than an Annual General Meeting) on 14 days’ clear notice and would like to preserve this ability. Under the Directive, Companies are permitted to seek shareholder approval, on an annual basis and by way of a special resolution, for general meetings (other than the annual general meeting) to be called on 14 days’ clear notice. This authority will only be used if it is in the best interests of shareholders and will be 26 The Merchants Trust PLC Directors’ Report effective until the Company’s next Annual General Meeting, when it is intended that a similar resolution will be proposed. Furthermore, in order to use this authority, all shareholders must be given the opportunity (but not the obligation) to vote at such a general meeting by electronic means. Annual general meetings will continue to be held on at least 21 days’ clear notice. Auditors The Directors will place a resolution before the Annual General Meeting to re-appoint PricewaterhouseCoopers LLP as Auditors for the ensuing year. A resolution to authorise the Directors to determine the Auditors’ remuneration will also be proposed at the Annual General Meeting. By Order of the Board K. J. Salt Secretary 7 April 2010 27 The Merchants Trust PLC Statement of Directors’ Responsibilities The Directors are responsible for preparing the Annual Financial Report, the Directors’ Remuneration Report and the financial statements in accordance with applicable law and regulations. Company law requires the directors to prepare financial statements for each financial year. Under that law the Directors have elected to prepare the financial statements in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law). Under that law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the company and of the profit or loss of the company for that period. In preparing these financial statements, the directors are required to: • • • • select suitable accounting policies and then apply them consistently; make judgements and 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 respectively; prepare the financial statements on the going concern basis unless it is inappropriate to presume that the company will continue in business. The Directors confirm that they have complied with the above requirements in preparing the financial statements. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the company’s transactions and disclose with reasonable accuracy at any time the financial position of the company and enable them to ensure that the financial statements and the Directors’ Remuneration Report comply with the Companies Act 2006. 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. The financial statements are published on www.merchantstrust.co.uk, which is a website maintained by the Company’s investment manager, RCM (UK) Limited. The Directors are responsible for the maintenance and integrity of the company’s website. The work undertaken by the Auditor does not involve consideration of the maintenance and integrity of the website and, accordingly, the Auditor accepts no responsibility for any changes that have occurred to the financial statements since they were initially presented on the website. Visitors to the website need to be aware that legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Statement under DTR 4.1.12 The Directors at the date of approval of this Report, each confirm to the best of their knowledge that: • • the financial statements, which have been prepared in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law), give a true and fair view of the assets, liabilities, financial position and profit or loss of the company; and the Annual Financial Report includes a fair review of the development and performance of the Company and the position of the company, together with a description of the principal risks and uncertainties that it faces. For and on behalf of the Board Hugh Stevenson Chairman 7 April 2010 28 The Merchants Trust PLC Directors’ Remuneration Report This report is submitted in accordance with the Large and Medium Sized Companies and Groups (Accounts and Reports) Regulations 2008, Schedule 8, for the year ended 31 January 2010. An ordinary resolution for the approval of this report will be put to shareholders at the forthcoming Annual General Meeting. The Board The Board of Directors is composed solely of non-executive Directors and the determination of the Directors’ fees is a matter dealt with by the whole Board. The Board has not been provided with advice or services by any person to assist it to make its remuneration decisions, although the Directors carry out reviews from time to time of the fees paid to the directors of other investment trusts. Policy on Directors’ Remuneration No Director has a service contract with the Company. The Company’s policy is for the Directors to be remunerated in the form of fees, payable half-yearly in arrears. There are no long term incentive schemes, bonuses, pension benefits, share options or other benefits and fees are not related to the individual Director’s performance, nor to the performance of the Board as a whole. The Company’s Articles of Association limit the aggregate fees payable to the Board of Directors to a total of £150,000 per annum. Subject to this overall limit, it is the Board’s policy to determine the level of Directors’ fees having regard to the level of fees payable to non-executive Directors in the investment trust industry generally, the role that individual Directors fulfil, and the time committed to the Company’s affairs. The Board believes that levels of remuneration should be sufficient to attract and retain non-executive directors to oversee the Company. Directors’ and officers’ liability insurance cover is held by the Company. As permitted by the Company’s Articles of Association, deeds of indemnity have been entered into with the Directors. Remuneration The policy is to review Directors’ fees from time to time, but reviews will not necessarily result in a change to the rates. In accordance with this policy the Board reviewed the fees during the year and agreed not to increase the fees at that time. As disclosed in last year’s report, with effect from 1 June 2008 the Directors were paid at a rate of £18,000 per annum, with an additional £3,000 payable to the Audit Committee Chairman, and the Chairman of the Board was paid at a rate of £27,500 per annum. Directors’ Emoluments (Audited) The Directors’ Emoluments during the year and in the previous year are as follows: H. A. Stevenson R. A. Barfield S. J. Fraser* Sir Bob Reid† M. J. E. McKeon Sir James Sassoon P. J. Scott Plummer~ H. E. Staunton Totals * Appointed to the Board 1 August 2009. † Retired from the Board May 2008. ~ Retired from the Board May 2009. Directors’ fees 2010 £ 27,500 18,000 9,000 – 18,000 21,000 5,358 18,000 116,858 2009 £ 26,667 17,000 – 4,269 13,500 19,667 17,000 13,500 111,603 29 The Merchants Trust PLC Directors’ Remuneration Report Performance Graph The graph below measures the Company’s share price and net asset value performance against its benchmark index of the FTSE 100 Index and is re-based to 100. The Company’s performance is measured against the FTSE 100 Index as this is the most appropriate comparator in respect of its asset allocation. An explanation of the Company’s performance is given in the Chairman’s Statement and the Investment Manager’s Review. 170 160 150 140 130 120 110 100 90 80 70 31 Jan 2005 31 Jan 2006 31 Jan 2007 31 Jan 2008 31 Jan 2009 31 Jan 2010 The Merchants Trust Share Price The Merchants Trust NAV FTSE 100 By Order of the Board K. J. Salt Secretary 7 April 2010 30 The Merchants Trust PLC Independent Auditors’ Report to the Members of The Merchants Trust PLC We have audited the financial statements of The Merchants Trust PLC for the year ended 31 January 2010 which comprise the Income Statement, the Reconciliation of Movements in Shareholders’ Funds, the Balance Sheet, the Cash Flow Statement, the Statement of Accounting Policies and the related notes. The financial reporting framework that has been applied in their preparation is applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice). Respective responsibilities of directors and auditors As explained more fully in the Statement of Directors’ Responsibilities set out on page 28, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. This report, including the opinions, has been prepared for and only for the company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing. Scope of the audit of the financial statements An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements. Opinion on financial statements In our opinion the financial statements: • • • give a true and fair view of the state of the company’s affairs as at 31 January 2010 and of its net return and cash flows for the year then ended; have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice; and have been prepared in accordance with the requirements of the Companies Act 2006. Opinion on other matters prescribed by the Companies Act 2006 In our opinion: • • the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and the information given in the Directors’ Report for the financial year for which the financial statements are prepared is consistent with the financial statements. Matters on which we are required to report by exception We have nothing to report in respect of the following: Under the Companies Act 2006 we are required to report to you if, in our opinion: • • adequate accounting records have not been kept, or returns adequate for our audit have not been received from branches not visited by us; or the financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or certain disclosures of directors’ remuneration specified by law are not made; or • • we have not received all the information and explanations we require for our audit. Under the Listing Rules we are required to review: • • the directors’ statement, set out on page 19, in relation to going concern; and the parts of the Corporate Governance Statement relating to the Company’s compliance with the nine provisions of the June 2008 Combined Code specified for our review. Ian Armfield (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 7 April 2010 31 The Merchants Trust PLC Income Statement for the year ended 31 January 2010 2010 Revenue Return £ 2010 Capital Return £ 2010 Total Return £ 2009 Revenue Return £ 2009 Capital Return £ 2009 Total Return £ Notes Net gains (losses) on investments at fair value Income Investment management fee Investment management fee VAT refund Administrative expenses Net return before finance costs and taxation Finance costs: interest payable and similar charges Net return on ordinary activities before taxation Taxation Net return on ordinary activities attributable to Ordinary Shareholders Return per Ordinary Share (basic and diluted) 8 1 2 2 3 4 5 7 – 23,686,655 (560,552) 416,080 (659,180) 22,883,003 79,416,688 – (1,041,025) 772,720 (3,915) 79,416,688 23,686,655 (1,601,577) 1,188,800 (663,095) 79,144,468 102,027,471 31,729,754 (658,425) 966,622 (599,808) – (189,593,060) (189,593,060) 31,729,754 – (1,881,213) (1,222,788) 1,172,472 205,850 (602,775) (2,967) 31,438,143 (190,612,965) (159,174,822) (3,384,935) 19,498,068 – (6,206,422) 72,938,046 – (9,591,357) 92,436,114 – (3,420,245) (9,692,207) (6,271,962) 28,017,898 (196,884,927)(168,867,029) – – – 19,498,068 72,938,046 92,436,114 28,017,898 (196,884,927)(168,867,029) 18.91p 70.73p 89.64p 27.25p (191.50p) (164.25p) Dividends in respect of the financial year ended 31 January 2010 total 22.50p (2009 – 22.80p), amounting to £23,223,029 (2009 – £23,441,469). Details are set out in Note 6 on page 40. The total return column of this statement is the profit and loss account of the Company. The supplementary revenue return and capital return columns are both prepared under the guidance published by the Association of Investment Companies. All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued in the year. 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. The Notes on pages 36 to 50 form an integral part of these Financial Statements. 32 The Merchants Trust PLC Revenue Reserve £ 24,660,480 28,017,898 (22,516,148) Total £ 506,187,213 28,017,898 (22,516,148) – (196,884,927) 30,162,230 314,804,036 Reconciliation of Movements in Shareholders’ Funds for the year ended 31 January 2010 Net Assets at 31 January 2008 Revenue Return Dividends on Ordinary Shares Capital Return Net Assets at 31 January 2009 Net Assets at 31 January 2009 Revenue Return Dividends on Ordinary Shares Capital Return Shares issued during the year Net Assets at 31 January 2010 Called up Share Capital £ 25,703,366 – – – 25,703,366 25,703,366 – – – 100,000 25,803,366 Notes 6 6 11 Share Capital Premium Redemption Reserve Account £ £ 7,527,047 – – – 7,527,047 Capital Reserve £ 292,853 448,003,467 – – – – – (196,884,927) 251,118,540 292,853 7,527,047 – – – 996,148 8,523,195 292,853 – – – – 30,162,230 19,498,068 314,804,036 251,118,540 19,498,068 – – (23,589,084) (23,589,084) 72,938,046 – 1,096,148 – 26,071,214 384,747,214 72,938,046 – 292,853 324,056,586 The Notes on pages 36 to 50 form an integral part of these Financial Statements. 33 The Merchants Trust PLC Balance Sheet as at 31 January 2010 Fixed Assets Investments held at fair value through profit or loss Current Assets Derivative financial instruments Debtors Cash at bank Creditors – Amounts falling due within one year Derivative financial instruments Other creditors Net Current Assets Total Assets less Current Liabilities Creditors – Amounts falling due after more than one year Total Net Assets Capital and Reserves Called up Share Capital Share Premium Account Capital Redemption Reserve Capital Reserve Revenue Reserve Equity Shareholders’ Funds Net Asset Value per Ordinary Share Notes 2010 £ 2010 £ 2009 £ 8 8 10 10 8 10 10 11 12 12 12 12 13 13 83,125 3,681,322 8,911,182 12,675,629 (101,850) (2,682,809) (2,784,659) 488,314,516 411,795,591 – 3,877,216 14,511,020 18,388,236 – (1,906,701) (1,906,701) 16,481,535 428,277,126 (113,473,090) 314,804,036 25,703,366 7,527,047 292,853 251,118,540 30,162,230 314,804,036 306.2p 9,890,970 498,205,486 (113,458,272) 384,747,214 25,803,366 8,523,195 292,853 324,056,586 26,071,214 384,747,214 372.8p The financial statements of The Merchants Trust PLC, company number 28276, were approved and authorised for issue by the Board of Directors on 7 April 2010 and signed on its behalf by: Hugh Stevenson Chairman The Notes on pages 36 to 50 form an integral part of these Financial Statements. 34 The Merchants Trust PLC Cash Flow Statement for the year ended 31 January 2010 Net cash inflow from operating activities Returns on investment and servicing of finance Interest paid Dividends on Cumulative Preference Stock Net cash outflow from servicing of finance Capital expenditure and financial investment Purchase of investments Sale of investments Net cash inflow from capital expenditure and financial investment Dividends paid on Ordinary Shares Net cash (outflow) inflow before financing Financing Proceeds from issue of Ordinary Shares Share issue costs Net cash inflow from financing (Decrease) Increase in cash Notes 16 6 11 17 2010 £ (9,563,178) (42,997) (112,115,497) 113,383,975 2010 £ 2009 £ 25,230,795 27,864,495 (9,606,175) (9,586,923) (42,997) (9,629,920) (152,890,966) 165,738,174 1,268,478 12,847,208 (23,589,084) (6,695,986) (22,516,148) 8,565,635 1,116,000 (19,852) 1,096,148 (5,599,838) – – – 8,565,635 The Notes on pages 36 to 50 form an integral part of these Financial Statements. 35 The Merchants Trust PLC Statement of Accounting Policies for the year ended 31 January 2010 1 The financial statements have been prepared under the historical cost basis, except for the measurement at fair value of investments, and in accordance with the United Kingdom Law and United Kingdom Generally Accepted Acounting Practice (UK GAAP) and the Statement of Recommended Practice - ‘Financial Statements of Investment Trust Companies and Venture Capital Trusts’ (SORP) issued in January 2009 by the Association of Investment Companies. In order to better reflect the activities of an investment trust company and in accordance with guidance issued by the AIC, supplementary information which analyses the Income Statement between items of a revenue and capital nature has been presented alongside the Income Statement. In accordance with the Company’s status as a UK investment trust company under sections 833 and 834 of the Companies Act 2006, net capital returns may not be distributed by way of dividend. The accounting policies adopted in preparing the current year’s financial statements are consistent with those of previous years. The Directors believe it is appropriate to continue to adopt the going concern basis in preparing the financial statements as the assets of the Company consist mainly of securities which are readily realisable and significantly exceed liabilities. Accordingly, the Directors believe that the Company has adequate financial resources to continue in operational existence for the foreseeable future. The Company’s business, the principal risks and uncertainties it faces, together with the factors likely to affect its future development, performance and position are set out in the Directors’ Report, Business Review section on pages 17 to 19. FRS 29 ‘Financial Instruments: Disclosures’ introduces additional disclosures relating to financial instruments. This standard does not have any impact on the classification and/or valuation of the Company’s financial instruments. The additional disclosures provided in accordance with the requirements of the standard are set out in Note 18 to the financial statements. Comparatives are not required. 2 Revenue – Dividends on equity shares are accounted for on an ex-dividend basis. UK dividends are shown net of tax credits. Special dividends are recognised on an ex-dividend basis and treated as a capital or revenue item depending on the facts and circumstances of each dividend. Where the Company has elected to receive its dividends in the form of additional shares rather than in cash, the equivalent of the cash dividend is recognised as income. Any excess in the value of the shares received over the amount of the cash dividend is recognised in capital reserves. Deposit interest receivable and stocklending fees are accounted for on an accruals basis. Commissions in respect of underwriting are recognised when the underwritten issue closes and are generally recognised within the Income Statement as revenue. Where, however, the Company is required to take up a proportion of the shares underwritten, the same proportion of the commission received is recognised as capital, with the balance recognised as revenue. Investment management fees and administrative expenses – The investment management fee is calculated on the basis set out in Note 2 to the financial statements and is charged to capital and revenue in the ratio 65:35 to reflect the Board’s investment policy and prospective split of capital and revenue returns. Other administrative expenses are charged in full to revenue, except custodian handling charges on investment transactions which are charged to capital. All expenses are recognised on an accruals basis. Valuation – As the Company’s business is investing in financial assets with a view to profiting from their total return in the form of increases in fair value, financial assets are designated as held at fair value through profit or loss in accordance with FRS 26 ‘Financial Instruments: Recognition and Measurement’. The Company manages and evaluates the performance of these investments on a fair value basis in accordance with its investment strategy, and information about the investments is provided on this basis to the Board of Directors. Investments held at fair value through profit or loss are initially recognised at fair value. After initial recognition, these continue to be measured at fair value, which for quoted investments is either the bid price or the last traded price depending on the convention of the exchange on which the investment is listed. Investment holding gains (losses) reflect differences between fair value and book cost. Net gains or losses arising on sale of investment are recognised in the capital column of the income statement and taken to the Capital Reserve. 3 4 36 The Merchants Trust PLC Statement of Accounting Policies for the year ended 31 January 2010 5 Derivatives – Options are purchased or written over securities held in the portfolio for either generating or protecting capital returns, or for generating or maintaining revenue returns. Premium received on written options held to generate or maintain revenue returns, are amortised to revenue over the period to expiry. Where the purpose of the option is the maintenance of capital the premium is treated as a capital item. The value of the option is subsequently marked to market to reflect the fair value of the option based on traded prices. When an option is closed out the gain or loss is accounted for as capital. Unamortised premiums form part of the gain or loss. Gains or losses on exercised options are accounted for as capital. 6 7 8 9 10 11 Finance costs – In accordance with the FRS 25 ‘Financial Instruments: Disclosure and Presentation’ and FRS 26 ‘Financial Instruments: Recognition and Measurement’, long term borrowings are stated at the amortised cost being the amount of net proceeds on issue plus accrued finance costs to date. Finance costs are calculated over the term of the debt on the effective interest rate basis. Where debt is issued at a premium, the premium is amortised over the term of the debt on the effective interest rate basis. Finance costs net of amortised premiums are charged to capital and revenue in the ratio 65:35 to reflect the Board’s investment policy and prospective split of capital and revenue returns. Dividends payable on the 3.65% Cumulative Preference Stock are classified as an interest expense and are charged in full to revenue. Taxation – Where expenses are allocated between capital and revenue, any tax relief obtained in respect of those expenses is allocated between capital and revenue on the marginal basis using the Company’s effective rate of corporation tax for the accounting period. 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. A deferred tax asset is recognised when it is more likely than not that the asset will be recoverable. Deferred tax is measured on a non- discounted basis at the rate of corporation tax that is expected to apply when the timing differences are expected to reverse. Foreign currency – In accordance with FRS 23 ‘The Effect of changes in Foreign Currency Exchanges Rates’, the Company is required to nominate a functional currency, being the currency in which the Company predominately operates. The functional and reporting currency is sterling, reflecting the primary economic environment in which the Company operates. Transactions in foreign currencies are translated into sterling at the rates of exchange ruling on the date of the transaction. Foreign currency assets and liabilities are translated into sterling at the rates of exchange ruling at the balance sheet date. Profits and losses thereon are recognised in the capital column of the income statement and taken to the Capital Reserve. Dividends – In accordance with FRS 21 ‘Events After the Balance Sheet Date’, the final dividend proposed on Ordinary Shares is recognised as a liability when approved by shareholders. Interim dividends are recognised only when paid. Shares repurchased and subsequently cancelled - Share Capital is reduced by the nominal value of the shares repurchased, and the Capital Redemption Reserve is correspondingly increased in accordance with Section 733 Companies Act 2006. The full cost of the repurchase is charged to the Capital Reserve. Shares issued – Share Capital is increased by the nominal value of shares issued. The proceeds net of expenses are allocated to the Share Premium Account. 37 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 1. Income Income from Investments:* Franked equity income from UK investments+ Unfranked equity income from UK investments Stock dividends from UK investments Equity income from overseas investments Other Income: Deposit interest Other interest # Premiums on derivative contracts Underwriting commission Stocklending fees Total income 2010 £ 7,936 59,879 17,564 606,561 – 2010 £ 22,766,477 147,878 – 80,360 22,994,715 691,940 23,686,655 2009 £ 29,441,527 – 877,888 – 30,319,415 321,993 839,281 – 235,500 13,565 1,410,339 31,729,754 * All equity income is derived from listed investments. + Includes special dividends of £nil (2009 – £170,891). # Interest on investment management fee VAT refund for the period 2001 to 2007 (2009 – £839,281). During the year, the Company received premiums totalling £113,928 for writing covered call options for the purpose of revenue generation, of which £17,564 were amortised to revenue (2009 – nil). All derivative transactions were based on FTSE 100 stocks or the related index. At the year end there were thirteen open option positions. Six of these were held to generate revenue returns and were valued at £74,450 (2009 – £nil). 2. Investment Management Fee Investment management fee Investment management fee VAT refund: – financial years 1990 – 1994 – financial years 1995 – 1996 – financial years 2001 – 2007 Total 2010 Revenue £ 560,552 – – (416,080) (416,080) 144,472 2010 Capital £ 2010 Total £ 1,041,025 1,601,577 – – (772,720) (772,720) 268,305 – – (1,188,800) (1,188,800) 2009 Revenue £ 658,425 (760,772) (205,850) – (966,622) 2009 Capital £ 2009 Total £ 1,222,788 1,881,213 – (205,850) – (205,850) (760,772) (411,700) – (1,172,472) 412,777 (308,197) 1,016,938 708,741 The management contract with RCM (UK) Limited (‘RCM’), terminable at one year’s notice, provides for a management fee based on 0.35% (2009 – 0.35%) per annum of the value of the Company’s assets calculated monthly after deduction of current liabilities, short term loans under one year and any funds within the portfolio management by RCM. Under the contract, RCM provides the company with investment management, accounting , secretarial and administration services. As a consequence of the European Court of Justice ruling in the VAT case on 28 June 2007, VAT has not been charged on management fees since 1 May 2007. Following the ruling, settlement has been reached with RCM in respect of the recovery of overpaid VAT in past years. On 3 November 2009, a VAT refund for the period 2001 to 2007 totalling £1,188,800 along with interest of £59,879, was received from HM Revenue & Customs. These amounts are included in the Company’s Income Statement for the year ended 31 January 2010. 38 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 3. Administrative Expenses Auditors’ remuneration: for audit services for other assurance services for legal services Directors’ fees Marketing costs Other administrative expenses 2010 £ 25,220 10,350 41,250 76,820 116,858 119,928 345,574 659,180 2009 £ 24,725 10,500 2,056 37,281 111,603 106,490 344,434 599,808 The above expenses include value added tax where applicable. Directors’ fees are set out in the Directors’ Remuneration Report on page 29. Auditors’ remuneration includes VAT of £3,756 (2009 – £5,031). Amounts paid to Auditors for other assurance services consists of £6,900 for accounting advice and £3,450 for certifications of borrowing covenants (2009 – £10,500). Legal services relate to advice regarding the recovery of VAT of £41,250 (2009 – £2,056). Auditors’ remuneration includes VAT of £6,730 (2009 – £1,870). Transaction costs of £3,915 (2009 – £2,967) were charged to capital. (i) (ii) (iii) (iv) 4. Finance Costs: Interest Payable and Similar Charges 2010 Capital £ 2,593,933 2,416,434 35,750 1,160,305 – – 6,206,422 On Stepped Rate Interest Loan On Fixed Rate Interest Loan On 4% Perpetual Debenture Stock On 5.875% Secured Bonds On 3.65% Cumulative Preference Stock On Sterling overdraft 2010 Revenue £ 1,396,733 1,301,156 19,250 624,780 42,997 19 3,384,935 2010 Total £ 3,990,666 3,717,590 55,000 1,785,085 42,997 19 9,591,357 2009 Revenue £ 1,411,594 1,321,641 19,250 624,725 42,997 38 3,420,245 2009 Capital £ 2,621,532 2,454,476 35,750 1,160,204 – – 6,271,962 2009 Total £ 4,033,126 3,776,117 55,000 1,784,929 42,997 38 9,692,207 39 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 5. Taxation 2010 Revenue £ – – 2010 Capital £ – – 2010 Total £ – – 2009 Revenue £ – – 2009 Capital £ – – 2009 Total £ – – 19,498,068 72,938,046 92,436,114 28,017,898 (196,884,927) (168,867,029) Overseas taxation Current tax charge Reconciliation of tax charge Return on ordinary activities before taxation Tax on return on ordinary activities at 28% (2009 – 28.33%) 5,459,459 20,422,653 25,882,112 7,937,470 (55,777,500) (47,840,030) Reconciling factors: Non taxable income Non taxable capital (gains) losses Disallowable expenses Excess of allowable expenses over taxable income Current tax charge (6,397,114) – 30,371 – (22,236,673) 25,586 (6,397,114) (22,236,673) 55,957 (8,589,490) – 31,705 – 53,711,714 37,749 (8,589,490) 53,711,714 69,454 907,284 – 1,788,434 – 2,695,718 – 620,315 – 2,028,037 – 2,648,352 – The Company’s taxable income is exceeded by its tax allowable expenses, which include both the revenue and capital elements of the management fee and finance costs of borrowing. The Company has surplus expenses carried forward of £133.3 million (2009 – £125.6 million). Given the Company’s current investment strategy, it is unlikely to generate sufficient UK taxable profits to relieve these expenses. As at 31 January 2010 there is an unrecognised deferred tax asset measured of £37.3 million (2009 – £35.1 million). This unrecognised deferred tax asset relates to the current and prior year unutilised expenses. It is considered unlikely that there will be a liability in the future against which the deferred tax asset can be offset. Therefore the asset has not been recognised. Due to the Company’s status as an investment trust and the intention to continue meeting the conditions to obtain approval in the foreseable future, the Company has not provided deferred tax on any capital gains and losses arising on the disposal of investments. 6. Dividends on Ordinary Shares Dividends on Ordinary Shares of 25p: Third interim dividend 5.6p paid 20 February 2009 (2008 – 5.4p) Final dividend 5.6p paid 15 May 2009 (2008 – 5.4p) Special dividend 0.5p paid 15 May 2009 (2008 – nil) First interim dividend 5.6p paid 19 August 2009 (2008 – 5.5p) Second interim dividend 5.6p paid 12 November 2009 (2008 – 5.6p) 2010 £ 5,757,554 5,757,554 514,068 5,779,954 5,779,954 23,589,084 2009 £ 5,551,927 5,551,927 – 5,654,740 5,757,554 22,516,148 Dividends payable and proposed at the year end are not recognised as a liability under FRS 21 ‘Events After Balance Sheet Date’ (see page 37 – Statement of Accounting Policies). Details of these dividends are set out below. Third interim dividend 5.6p paid 19 February 2010 (2009 – 5.6p) Special dividend £nil (2009 – 0.5p) Final proposed dividend 5.7p payable 14 May 2010 (2009 – 5.6p) 40 2010 £ 5,779,954 – 5,883,167 11,663,121 2009 £ 5,757,554 514,067 5,757,554 12,029,175 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 The proposed final dividend accrued is based on the number of shares in issue at the year end. However, the dividend payable will be based on the numbers of shares in issue on the record date and will reflect any allotments, purchases and cancellations of shares by the Company settled subsequent to the year end. 7. Return per Ordinary Share 2010 Revenue £ 2010 Capital £ 2010 Total £ 2009 Revenue £ 2009 Capital £ 2009 Total £ Return after taxation attributable to Ordinary Shareholders Return per Ordinary Share (basic & diluted) 19,498,068 18.91p 72,938,046 70.73p 92,436,114 89.64p 28,017,898 27.25p (196,884,927) (191.50p) (168,867,029) (164.25p) The weighted average number of shares in issue during the year was 103,117,026 (2009 – 102,813,464). 8. Investments Listed on the London Stock Exchange at market valuation Unlisted at fair value Fixed asset investments Derivative financial instruments – purchased put options Derivative financial instruments – written call options Total investments Market value of investments brought forward Investment holding losses (gains) brought forward Cost of investments held brought forward Additions at cost Disposals at cost Cost of investments held at 31 January Investment holding losses at 31 January Derivative holding losses at 31 January Market value of investments held at 31 January Net gains (losses) on investments Net losses on sales of fixed asset investments based on historical costs Adjustment for net investment holding losses (gains) recognised in previous years Net gains (losses) on sales of fixed asset investments based on carrying value at previous balance sheet date Net gains on derivative financial instruments Net gains (losses) on sales of investments based on carrying value at previous balance sheet date Net investment holding gains (losses) arising in the year Net derivative holding losses arising in the year Net gains (losses) on investments 2010 £ 488,287,091 27,425 488,314,516 83,125 (101,850) 488,295,791 411,795,591 134,498,602 546,294,193 112,749,452 (170,054,497) 488,989,148 (476,634) (216,723) 488,295,791 (54,672,814) 77,965,659 23,292,845 284,257 23,577,102 56,056,309 (216,723) 79,416,688 2009 £ 411,768,166 27,425 411,795,591 – – 411,795,591 608,450,967 (16,644,526) 591,806,441 152,890,966 (198,403,214) 546,294,193 (134,498,602) – 411,795,591 (38,449,932) (3,841,501) (42,291,433) – (42,291,433) (147,301,627) – (189,593,060) Transaction costs and stamp duty on purchases amounted to £647,513 (2009 – £878,184) and transaction costs on sales amounted to £144,771 (2009 – £221,763). Stocklending Aggregate value of securities on loan at year end Maximum aggregate value of securities on loan during the year Fee income from stocklending during the year 2010 £nil £nil £nil 2009 £nil £59.3m £13,565 41 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 In respect of securities on loan at the year end, the Company held £nil (2009 – £nil) as collateral, the value of which exceeded the value of the loan securities by £nil (2009 – £nil). In respect of the maximum aggregate value of securities on loan during the year, the Company held £nil (2009 – £62.2m) as collateral, the value of which exceeded the value of securities on loan by £nil (2009 – £3.0m). During the year the Company did not engage in any stocklending activities. Investments in Other Companies 9. The Company held more than 3% of the share capital of the following companies, both of which are incorporated in Great Britain and registered in England and Wales: Company First Debenture Finance PLC (‘FDF’) Total Net Assets* £ (382,502) Fintrust Debenture PLC (‘Fintrust’) 21,973 Class of Shares held ‘A’ Shares ‘B’ Shares ‘C’ Shares ‘D’ Shares Ordinary % of Class held 39.2 59.2 45.6 53.3 50.0 % Equity 49.2 50.0 * As at the date of the latest published financial statements of FDF or Fintrust, as appropriate. In the opinion of the Directors, the Company is not in a position to exert significant influence over the financial operating policies of FDF or Fintrust, either through voting rights or through agreement with those companies’ other shareholders, due to provisions in FDF and Fintrust’s Articles of Association and in certain contracts between the Company and each of FDF and Fintrust. Accordingly, FDF and Fintrust are not considered to be associate undertakings as per FRS9 and are therefore included in the balance sheet at the Director’s valuation. FDF and Fintrust are the lenders of the Company’s Stepped Rate Loan and Fixed Rate Interest Loan, as detailed in Notes 10(i) and 10(ii), respectively. Apart from the finance costs, there were no other transactions between FDF, Fintrust and the Company during the year. 10. Current Assets and Creditors Debtors Sales for future settlement Accrued income Other debtors Cash at bank Creditors – Amounts falling due within one year Purchases for future settlement Other creditors Interest on borrowings Creditors – Amounts falling due after more than one year Stepped Rate Interest Loan Fixed Rate Interest Loan 5.875% Secured Bonds 2029 4% Perpetual Debenture Stock 3.65% Cumulative Preference Stock 42 2010 £ 2,281,965 1,360,380 38,977 3,681,322 8,911,182 633,955 729,587 1,319,267 2,682,809 36,152,901 45,635,714 29,116,657 1,375,000 1,178,000 113,458,272 2009 £ – 2,662,531 1,214,685 3,877,216 14,511,020 – 587,434 1,319,267 1,906,701 36,022,070 45,803,649 29,094,371 1,375,000 1,178,000 113,473,090 10(vi) 10(i) 10(ii) 10(iii) 10(iv) 10(v) The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 (i) The effective interest rate on the Stepped Rate Interest Loan over its terms is 11.28% per annum. The Stepped Rate Interest Loan comprises adjustable Stepped Rate Interest Loan Notes of £5,133,520 and Stepped Rate Interest Bonds of £20,534,079 issued at 97.4%. These amounts are repayable on on 2 January 2018 exclusive of any redemption expenses, together with a premium of £8,366,513. The initial interest rate in 1987 on the Loan Notes and Bonds was 7.16% per annum. This increased annually by 7.5% compound until January 1998 when it reached its current rate of 14.75%. However, the combined effect of this interest charge and the accrual of the premium referred to above results in an effective interest rate of 11.28% per annum. Interest is payable in January and July each year. Interest on the Loan Notes is variable in accordance with the terms of the agreement with the lender, First Debenture Finance PLC (‘FDF’). The Company has guaranteed the repayment of £34,012,852, being its proportionate share (65.15%) of the required amount to enable FDF to meet all of its liabilities to repay principal and interest on its £52.2 million of 11.125% Severally Guaranteed Debenture Stock 2018. There is a floating charge on all the Company’s present and future assets to secure this obligation. The Company has also agreed to meet its proportionate share of any expenses incurred by FDF, including any tax liability which may accrue to FDF generally or as a result of the redemption or earlier transfer of the Stepped Rate Loan Notes and Bonds held by FDF. The accounting treatment adopted in respect of the stepped rate interest and redemption premiums is set out in the Statement of Accounting Policies. (ii) The Fixed Rate Interest Loan of £42,000,000 is due to Fintrust Debenture PLC (‘Fintrust’). This loan is repayable in 2023 and carries interest at the rate of 9.25125% per annum on the principal amount payable in arrears by equal half yearly instalments in May and November each year. As security for this loan, the Company has granted a floating charge over all its undertakings, property and assets in favour of the lender. This charge ranks pari passu with the floating charge noted in 10(i) above. The original loan from Fintrust is stated at net proceeds (being the principal amount of £30,000,000 less issue costs of £141,053) plus accrued finance costs. Following the liquidation of Kleinwort Overseas Investment Trust plc (‘KOIT’) in March 1998, the Company assumed £12,000,000 of KOIT’s obligations to Fintrust. Both the interest cost and repayment terms of this additional borrowing were identical to the Company’s existing loan of £30,000,000. In order that the finance costs on this new borrowing be comparable to existing market rates at that time, the Company also received a premium payment from KOIT of £5,286,564. This premium is being amortised over the remaining life of the loan, as set out in the Statement of Accounting Policies. At 31 January 2010, the unamortised premium included with the Fixed Rate Interest Loan balance of greater than one year amounted to £3,743,232 (2009 – £3,914,898). The £30,000,000 5.875% Secured Bonds, repayable on 20 December 2029, carry interest at the rate of 5.875% per annum on the principal amount payable in arrears by equal half yearly instalments in June and December each year. As security for this loan the Company has granted a floating charge ranking pari passu with the floating charges referred to in Note 10(i) and 10(ii) above over the whole of the present and future undertakings, property, assets and rights of the Company. The accounting treatment adopted in respect of the Bonds is set out in the Statement of Accounting Policies. The 4% Perpetual Debenture Stock is secured by a floating charge on the assets of the Company, which ranks prior to any other floating charge. Interest is repayable in arrears by equal half yearly instalments in May and November each year. The 3.65% Cumulative Preference Stock is recognised as a creditor due after more than one year under the provisions of FRS25 ‘Financial Instruments: Disclosure and Presentation’. The right of the Stock to receive payments is not calculated by reference to the Company’s profits and, in the event of a return of capital are limited to a specific amount, being £1,178,000. Dividends on the Preference Stock are payable half yearly on 1 August and 1 February each year. (iii) (iv) (v) (vi) Interest on outstanding borrowings consists of: Stepped Rate Interest Loan Fixed Rate Interest Loan 5.875% Secured Bonds 2029 4% Perpetual Debenture Stock 2010 £ 313,728 783,546 208,243 13,750 1,319,267 2009 £ 313,728 783,545 208,244 13,750 1,319,267 43 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 11. Called up Share Capital Allotted and fully paid 103,213,464 Ordinary Shares of 25p (2009 – 102,813,464) 2010 £ 2009 £ 25,803,366 25,703,366 The directors are authorised by an ordinary resolution passed on 12 May 2009 to allot relevant securities, up to a maximum of 34,271,152 Ordinary Shares of 25p each. This authority expires on 11 May 2010 and accordingly a renewed authority will be sought at the Annual General Meeting on 11 May 2010. On 29 April 2009 the Company issued 400,000 Ordinary Shares at a price of 279p per share. After deducting expenses of £19,852, the net cash proceeds were for value £1,096,148. During the year the Company did not repurchase any Ordinary Shares for cancellation or holding in treasury. Nor have any Ordinary shares been repurchased since the year end. 12. Reserves Capital Share Redemption Reserve £ 292,853 – – – – – – – – – – – – – 292,853 Premium £ 7,527,047 – – – – – 1,016,000 (19,852) – – – – – – 8,523,195 Balance at 1 February 2009 Net gains on sales of fixed asset investments Net gains on derivative financial instruments Net movement in fixed asset investment holding gains Net movement in derivative holding losses Transfer on sale of investments Issue of 400,000 new Ordinary Shares Ordinary Share issue expenses Investment management fee Investment management fee VAT refund Finance costs of borrowings Other capital expenses Dividends appropriated in the year Retained profit for the year Balance at 31 January 2010 13. Net Asset Value per Share The net asset value per share was as follows: Ordinary Shares of 25p Ordinary Shares of 25p Gains on sales of (cid:2) Capital Reserve (cid:3) Investment holding – Investments gains (losses) £ (134,498,602) – – 56,056,309 (216,723) 77,965,659 – – – – – – – – (693,357) £ 385,617,142 23,292,845 284,257 – – (77,965,659) – – (1,041,025) 772,720 (6,206,422) (3,915) – – 324,749,943 Revenue Reserve £ 30,162,230 – – – – – – – – – – – (23,589,084) 19,498,068 26,071,214 Net Asset Value per Share attributable 2010 372.8p 2009 306.2p Net Asset Value attributable 2009 £314,804,036 2010 £384,747,214 The net asset value per ordinary share is based on 103,213,464 ordinary shares in issue at the year end (2009 – 102,813,464). 44 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 14. Contingent Assets At 31 January 2010, there were no outstanding contingent assets. At 31 January 2009, the Company had a contingent asset as at the balance sheet relating to VAT recoverable. The contingent asset had arisen as a result of the European Court of Justice ruling on 28 June 2007 in the VAT case, brought by JP Morgan Fleming Claverhouse Trust plc in conjuction with the AIC concerning VAT exemption on management expenses for investment trusts. At the time it was not possible to calculate an accurate monetary estimate of the amount recoverable. 15. Contingent Liabilities and Capital Commitments At 31 January 2010 there were no outstanding contingent liabilities or capital commitments (2009 – nil). Details of the guarantee provided by the Company as part of the terms of the Stepped Rate Loan are provided in Note 10(i) ‘Current Assets and Creditors’ on page 42. 16. Reconciliation of Return on Ordinary Activities before Finance Costs and Taxation to Net Cash Flow from Operating Activities Net return before finance costs and taxation Less: Net (gains) losses on investments at fair value Decrease (increase) in debtors Increase (decrease) in creditors Net cash inflow from operating activities 17. Reconciliation of Net Cash Flow to Movement in Net Debt (i) Analysis of changes in net debt 2010 £ 102,027,471 (79,416,688) 22,610,783 2,477,859 142,153 25,230,795 2009 £ (159,174,822) 189,593,060 30,418,238 (2,328,170) (225,573) 27,864,495 Stepped and Fixed Rate Loans £ (81,825,719) 37,104 (81,788,615) 5.875% Secured Bonds 2029 £ (29,094,371) (22,286) (29,116,657) 4% Perpetual Debenture Stock £ (1,375,000) – (1,375,000) 3.65% Preference Stock £ (1,178,000) – (1,178,000) Net Debt £ (98,962,070) (5,585,020) (104,547,090) Cash £ 14,511,020 (5,599,838) 8,911,182 At 1 February 2009 Movement in year At 31 January 2010 (ii) Reconciliation of net cash flow to movement in net debt Net cash (outflow) inflow Decrease (increase) in long term loans Movement in net funds Net debt brought forward Net debt carried forward 2010 £ (5,599,838) 14,818 (5,585,020) (98,962,070) (104,547,090) 2009 £ 8,565,635 (59,299) 8,506,336 (107,468,406) (98,962,070) 45 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 18. Financial Risk Management Policies and Procedures The Company invests in equities and other investments in accordance with its investment objective as stated on page 2. In pursuing its investment objective, the Company is exposed to certain inherent risks that could result in either a reduction in the Company’s net assets or a reduction in the profits available for distribution by way of dividends. The main risks arising from the Company’s financial instruments are: market risk (price and yield), liquidity risk and credit risk. The Directors determine the objectives and agree policies for managing each of these risks, as set out below. The Investment Manager, in close co-operation with the Directors, implement the Company’s risk management policies. The Company’s policy allows the use of derivative financial instruments to moderate risk exposure and to generate additional revenue. These policies have remained substantially unchanged during the current and preceding year. Market Risk The Investment Manager assesses the exposure to market risk when making each investment decision, and monitors the risk on the investment portfolio on an ongoing basis. Market risk comprises market price risk (price and yield), foreign currency risk and interest rate risk. (i) Market Price Risk Market price risk arises mainly from the uncertainty about future prices of financial instruments held. It represents the potential loss the Company might suffer through holding market positions in the face of price movements. Where put options are purchased, the market value of such options can be volatile but the maximum realised loss on any contract is limited to the original investment cost. Where call options are sold (written), in all cases a sufficient position is maintained in the underlying equity to cover any potential option exercise. Whilst the option value can be volatile, price movements should to some extent be offset by opposing movements in the value of the underlying equity. If options are retained until expiry they will either expire worthless or be exercised. The effect of any option exercise is to sell the underlying shares at the strike price of the option, thus limiting the liability of the exposure. A schedule of the Company’s listed holdings is shown on page 11. Falls in stock market valuations lead to changes in gearing ratios. The Board’s procedure for monitoring the gearing of the company is set out in Note 19 on page 50. This takes into account the Investment Manager’s view on the market, covenant requirements and the future prospects of the Company’s performance. Market price risk sensitivity The value of the Company’s listed investments (i.e fixed asset investments, excluding unlisted equities) which were exposed to market price risk as at 31 January 2010 was as follows: Listed investments held at fair value through profit or loss Derivative financial instruments – purchased put options Derivative financial instruments – written call options Total listed investments 2010 £ 488,287,091 83,125 (101,850) 488,268,366 2009 £ 411,768,166 – – 411,768,166 The following illustrates the sensitivity of the return and the net assets to an increase or decrease of 20% (2009 – 20%) in the fair values of the Company’s listed investments. This level of change is considered to be reasonably possible based on observation of market conditions in the year. The sensitivity analysis is based on the impact of a change to the value of the Company’s listed equity investments at each balance sheet date and the consequent impact on the investment management fees for the year, with all other variables held constant. Revenue return Investment management fees Capital return Net gains (losses) on investments at fair value Investment management fees Change in net return and net assets 2010 20% Increase in fair value £ 2010 20% Decrease in fair value £ 2009 20% Increase in fair value £ 2009 20% Decrease in fair value £ (119,626) 119,626 (100,883) 100,883 97,653,673 (222,162) 97,311,885 (97,653,673) 222,162 (97,311,885) 82,353,633 (187,355) 82,065,395 (82,353,633) 187,355 (82,065,395) Management of market price risk The Directors meet regularly to consider the asset allocation of the portfolio in order to minimise the risk associated with particular industry sectors. A dedicated investment manager has the responsibility for monitoring the existing portfolio selection in accordance with the Company’s 46 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 investment objectives and to ensure that individual stocks meet an acceptable risk reward profile. Call options are only written on stock owned within the portfolio with a maximum exposure of 20% of gross assets at the time of writing. (ii) Market Yield Risk Market yield risk arises from the uncertainty about the Company’s ability to maintain its income objectives due to systematic decline in corporate dividend levels. Management of market yield risk The Directors regularly review the current and projected yield of the investment portfolio, and discuss with the Investment Manager the extent to which it will enable the Company to meet its investment income objective. (iii) Foreign Currency Risk Foreign currency risk is the risk of the movement in the values of overseas financial instruments as a result of fluctuations in exchange rates. Management of foreign currency risk The Company invests predominantly in UK listed equities and has no significant exposure to currencies other than sterling (2009 – no significant exposure). Any income denominated in foreign currencies is converted into 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. (iv) Interest rate risk Interest rate risk is the risk of movements in the value of financial instruments as a result of fluctuations in interest rates. Interest Rate Exposure The table below summarises in sterling terms the financial assets and financial liabilities whose values are directly affected by changes in interest rates. 2010 Fixed rate interest £ – (113,458,272) 2010 2010 2010 Floating rate interest £ Nil interest £ 2009 Fixed rate interest £ – (101,850) (113,560,122) (113,473,090) Total £ 8,911,182 488,397,641 497,308,823 – 2009 Floating rate interest £ 14,511,020 – 2009 2009 Nil Interest £ 411,795,591 Total £ 426,306,611 – (113,473,090) (113,458,272) 8,911,182 488,295,791 383,748,701 (113,473,090) 14,511,020 411,795,591 312,833,521 998,513 1,970,515 (113,458,272) 8,911,182 488,295,791 384,747,214 (113,473,090) 14,511,020 411,795,591 314,804,036 Financial assets Financial liabilities Net financial (liabilities) assets Short term debtors and creditors Net (liabilities) assets per balance sheet As at 31 January 2010, the interest rates received on cash balances or paid on bank overdrafts was nil and 1.35% per annum respectively (2009 – 1.00% and 2.35% per annum). The fixed rate interest bearing liabilities bear the following coupon and effective rates as at 31 January 2010 and 31 January 2009. First Debenture Finance PLC (‘FDF’) – Loan notes and Bonds Fintrust Debenture PLC (‘Fintrust’) – Original Loan Fintrust Debenture PLC (‘Fintrust) – New Loan 5.875% Secured Bonds 2029 4% Perpetual Debenture Stock 3.65% Cumulative Preference Stock Maturity date 02/01/2018 20/11/2023 20/11/2023 20/12/2029 n/a n/a Amount borrowed £ 25,667,599 30,000,000 12,000,000 30,000,000 1,375,000 1,178,000 100,220,599 Coupon Rate 14.75% 9.25125% 9.25125% 5.875% 4.00% 3.65% Effective rate since inception* 11.28% 9.51% 6.00% 6.23% 4.00% 3.65% * The effective rates are calculated in accordance with FRS 26 ‘Financial Instruments: Recognition and Measurement’ as detailed in the Statement of Accounting Policies. 47 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 The details in respect of the above loans have remained unchanged since the previous accounting period. The weighted average effective rate of the Company’s fixed interest bearing liabilities (excluding the 3.65% Cumulative Preference Stock and the 4% Perpetual Debenture Stock) is 8.54% (2009 – 8.54%) and the weighted average period to maturity of these liabilities is 14.2 years (2009 – 15.2 years). The above year end amounts are reasonably representative of the exposure to interest rates during the year, as the level of exposure does not change materially. Therefore the Company’s net return and net assets, are not significantly affected by changes in interest rates. Management of interest rate risk The Company invests predominantly in equities, the values of which are not directly affected by changes in prevailing market interest rates. In the year to 31 January 2010, the Company held no fixed interest securities. The Company’s policy is to remain substantially fully invested and thus does not expect to hold significant cash balances, therefore the financial assets have minimal exposure to interest rate risk. The Company finances its operations through a mixture of share capital, retained earnings and long term borrowings. Movement in interest rates will not have a material effect on the finance costs and financial liabilities of the Company as all the borrowings of the Company are subject to fixed rates of interest. Liquidity Risk Liquidity risk relates to the capacity to meet liabilities as they fall due and is dependent on the liquidity of the underlying assets. Maturity of financial liabilities The contractual maturities of the financial liabilities at 31 January 2010, based on the earliest date on which payment can be required to be made was as follows: 2010 Creditors – Amounts falling due within one year Debt interest due within one year Other creditors Derivative financial instruments Creditors – Amounts falling due after more than one year Debt due after more than one year 2009 Creditors – Amounts falling due within one year Debt interest due within one year Other creditors Creditors – Amounts falling due after more than one year Debt due after more than one year Three months or less £ – 1,363,542 101,850 Not more than one year £ 1,319,267 – – – 1,465,392 – 1,319,267 Three months or less £ – 587,434 – 587,434 Not more than one year £ 1,319,267 – – 1,319,267 Between one year and five years £ – – – – – Between one year and five years £ – – – – More than five years £ Total £ – – – 1,319,267 1,363,542 101,850 113,458,272 113,458,272 113,458,272 116,242,931 More than five years £ Total £ – – 1,319,267 587,434 113,473,090 113,473,090 113,473,090 115,379,791 48 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 Management of liquidity risk Liquidity risk is not significant as the Company’s assets mainly comprise realisable securities, which can be sold to meet funding requirements if necessary and significantly exceed liabilities. Short term flexibility can be achieved through the use of overdraft facilities, where necessary. As at the 31 January 2010, the Company has an undrawn committed borrowing facility of £10 million (2009 – £10 million). Credit Risk Credit risk is the risk of default by a counterparty to discharge its obligations under transactions that could result in the Company suffering a loss. Management of credit risk Outstanding settlements are subject to credit risk. Credit risk is mitigated by the Company through its decision to transact with counterparties of high credit quality. The Company only buys and sells investments through brokers which are considered to be approved counterparties, thus minimising the risk of default during settlement. The Company is also exposed to credit risk through the use of banks for its cash position. Bankruptcy or insolvency of banks may cause the Company’s rights with respect to cash held by these banks to be delayed or limited. The Company’s cash balances are held by HSBC Bank PLC, rated Aa2 by Moody’s rating agency. The Directors believe the counterparties the Company has chosen to transact with are of high credit quality and that therefore the Company has minimal exposure to credit risk. The table below summarises the credit risk exposure of the Company as at 31 January: Debtors: Outstanding settlements Accrued income Other debtors Cash at Bank 2010 £ 2,281,965 1,360,380 38,977 8,911,182 12,592,504 2009 £ – 2,662,531 1,214,685 14,511,020 18,388,236 Fair Values of Financial Assets and Financial Liabilities With the exception of those financial liabilities measured at amortised cost, the financial assets and financial liabilities, are either carried at their fair value or the balance sheet amount is a reasonable approximation of their fair value. The financial liabilities measured at amortised cost have the following fair values*: Stepped Rate Interest Loan Fixed Rate Interest Loan 5.875% Secured Bonds 2029 4% Perpetual Debenture Stock 3.65% Cumulative Preference Stock 2010 Book value £ 36,466,629 46,419,260 29,324,900 1,388,750 1,178,000 114,777,539 2010 Fair value £ 45,923,101 55,584,569 28,601,651 895,510 695,130 131,699,961 2009 Book value £ 36,335,798 46,587,194 29,302,615 1,388,750 1,178,000 114,792,357 2009 Fair value £ 49,394,452 60,852,470 31,156,210 1,095,498 786,668 143,285,298 The net asset value per Ordinary Share, with the FDF and Fintrust loans at fair value is 356.4p (2009 – 278.5p). * The fair value has been derived from the closing market value of the debt and accrued interest as at 31 January 2010 and 31 January 2009. FRS 29 ‘Financial Instruments: Disclosures’ has been expanded to include a fair value hierarchy for the disclosure of fair value measurement of financial instruments. 49 The Merchants Trust PLC Notes to the Financial Statements for the year ended 31 January 2010 As at 31 January 2010, the financial instruments at fair value through profit and loss of £488,295,791 (2009 – £411,795,591) were categorised as follows: Level 1 Level 2 Level 3 2010 £ 488,268,366 – 27,425 488,295,791 2009 £ 411,768,166 – 27,425 411,795,591 Categorisation within the hierarchy has been determined on the basis of the lowest level input that is significant to the fair value measurement of the relevant assets as follows: Level 1 – valued using quoted prices in active markets. Level 2 – valued by reference to valuation techniques using observable inputs other than quoted prices included in Level 1. Level 3 – valued by reference to valuation techniques using inputs that are not based on observable market data. Hedging Instruments At the year end, the Company had no hedging arrangements in place (2009 – nil). The Company does not enter into speculative interest contracts. 19. Capital Management Policies and Procedures The Company’s objective is to provide an above average level of income and income growth together with long term capital growth. The Company’s capital at 31 January 2010 comprised: Debt Creditors – Amounts falling due after more than one year Equity Called up Share Capital Share Premium Account and Other Reserves Total Capital Debt as a percentage of total capital 2010 £ 113,458,272 113,458,272 25,803,366 358,943,848 384,747,214 498,205,486 22.8% 2009 £ 113,473,090 113,473,090 25,703,366 289,100,670 314,804,036 428,277,126 26.5% The Board, with the assistance of the Investment Manager, monitors and reviews the broad structure of the Company’s capital on an ongoing basis. The level of gearing is monitored, taking into account the Investment Manager’s view on the market and the future prospects of the Company’s performance. Capital management also involves reviewing the difference between the net asset value per share and the share price (i.e. the level of share price discount or premium) to assess the need to repurchase shares for cancellation. The Company is subject to several externally imposed capital requirements; the banks borrowings under the overdraft facility are not to exceed £10m, and as a public company the minimum share capital is £50,000. The Company’s objective, policies and processes for managing capital are unchanged from the preceding accounting period, and the Company has complied with them. 50 The Merchants Trust PLC Investor Information & Contact Details The Manager RCM (UK) Limited is part of RCM, a global asset management company operating from six international offices – San Francisco, London, Frankfurt, Hong Kong, Tokyo and Sydney. Through its predecessors RCM (UK) has a heritage of investment trust management expertise in the UK reaching back to the nineteenth century and at 31 March 2010 it had £1.06 billion assets under management in a range of investment trusts. RCM (UK) Limited is authorised and regulated by the Financial Services Authority. RCM is a company of Allianz Global Investors which, with £1,046 billion assets under management at 31 December 2009, is one of the largest global asset management groups. Website: www.rcm.co.uk Registered Number 28276 Results Half-year Report posted to shareholders in September Annual Financial Report posted to shareholders in April Annual General Meeting held in May Ordinary Dividends First quarterly paid in August Second quarterly paid in November Third quarterly paid in February Final usually paid in May Ordinary dividends paid by the Company carry a tax credit at a rate of 10%. The credit discharges the tax liability of shareholders subject to income tax at less than the higher rate. Shareholders liable to pay tax at the higher rate will have further tax to pay. Preference Dividends Payable half-yearly on 1 August and 1 February Market and Portfolio Information The Company’s Ordinary Shares are listed on the London Stock Exchange. The market price, price range, gross yield and net asset value are shown daily in The Financial Times and The Daily Telegraph. The net asset value of the Ordinary Shares is calculated daily and published through the London Stock Exchange Regulatory News Service. The geographical spread of investments and ten largest holdings are also published monthly by the London Stock Exchange Regulatory News Service. They are also available to any enquirer of Allianz Global Investors, either via Investor Services on 0800 317 573 or on the Manager’s website: www.allianzglobalinvestors.co.uk. Share Price The share price for 31 January 2010 was 329.1p. Website Further information about the The Merchants Trust PLC is available on the website: www.merchantstrust.co.uk. Association of Investment Companies (AIC) The Company is a member of the AIC, the trade body of the investment trust industry, which provides a range of literature including fact sheets and a monthly statistical service. Copies of these publications can be obtained from the AIC, 9th Floor, 24 Chiswell Street, London EC1Y 4YY, or at www.theaic.co.uk. AIC Category: UK Growth and Income. 51 The Merchants Trust PLC Investor Information & Contact Details How to invest Alliance Trust Savings Limited (“ATS”) is one of a number of providers offering a range of products and services, including Share Plans, ISAs and pension products. ATS also maintains services including online and telephone-based dealing facilities and online valuations. More information is available from Allianz Global Investors either via Investor Services on 0800 317 573 or on the Managers’ website: www.rcm.com/investmenttrusts, or from Alliance Trust Savings Customer Services Department on 01382 321185 or by e-mail: contact@alliancetrust.co.uk A list of other providers can be found on the RCM Investment Trusts website: www.rcm.com/investmenttrusts Registrars The Company’s Registrars, Capita Registrars, can be contacted at Northern House, Woodsome Park, Fenay Bridge, Huddersfield, West Yorkshire HD8 0GA. Payment of Dividends Direct to Bank Accounts Cash dividends will be sent by cheque to first-named shareholders at their registered address together with a tax voucher. Dividends may be paid directly into shareholders’ bank accounts. Details of how this may be arranged can be obtained from the Registrars, Capita Registrars. Dividends mandated in this way are paid via BACS (Bankers’ Automated Clearing Service). Tax vouchers will then be sent directly to shareholders at their registered address unless other instructions have been given. Dividend Reinvestment Plan for Ordinary Shareholders A Dividend Reinvestment Plan is operated by the Company’s Registrars, Capita Registrars. The Plan offers Ordinary Shareholders the opportunity to use their cash dividend to buy further shares in the Company under a special low-cost dealing arrangement. Capita will enclose a copy of the Terms and Conditions and a personalised application form with each future dividend payment. Share Dealing Services and Share Portal Capita Registrars, the Company’s Registrars, operate an on-line and telephone dealing facility for UK resident shareholders with share certificates. Stamp duty may also be payable on purchases. For further information on these services please contact: www.capitadeal.com for on-line dealing or 0871 664 0454 for telephone dealing. Lines are open 8.00 a.m. to 4.30 p.m. Monday to Friday. Calls to the 0871 664 0454 number are charged at 10 pence per minute plus any of your service providers’ network extras. Different charges may apply to calls made from mobile telephones and calls may be recorded and monitored randomly for security and training purposes. Capita Registrars offer shareholders a free on-line service called The Share Portal, enabling shareholders to access a comprehensive range of shareholder related information. Through The Share Portal, shareholders can: view their current and historical shareholding details; obtain an indicative share price and valuation; amend address details; view details of dividend payments; and apply for dividends to be paid directly to a bank or to change existing bank details. Shareholders can access these services at www.capitaregistrars.com and selecting Share Portal (Shareholders) from the drop down menu, or alternatively via the Portals: Quick Links, and selecting Share Portal. Shareholders will need to register for a Share Portal Account by completing an on-screen registration form. An email address is required. Shareholders’ Enquiries Capita Registrars are the Company’s registrars and maintain the share register. In the event of queries regarding their holdings of shares, lost certificates, dividend cheques, registered details, etc., shareholders should contact the registrars on 0871 664 0300 or +44 20 8639 3399 if calling from overseas. Lines are open 8.30 a.m. to 5.30 p.m. (London time) Monday to Friday. Calls to the 0871 664 0300 number are charged at 10 pence per minute plus any of your service providers’ network extras. Calls to the helpline number from outside the UK are charged at applicable international rates. Different charges may apply to calls made from mobile telephones and calls may be recorded and monitored randomly for security and training purposes. Capita Registrars can also be contacted at ssd.capitaregistrars.com. Changes of name and address must be notified to the registrars in writing. 52 The Merchants Trust PLC Investor Information & Contact Details Any general enquiries about the Company should be directed to the Company Secretary, The Merchants Trust PLC, 155 Bishopsgate, London EC2M 3AD. Telephone: 020 7065 1513. Email: kirsten.salt@uk.rcm.com Analysis of Share Register Private holders Nominees Limited Companies Investment Trusts and Funds Bank and Bank Nominees Insurance Companies Pension Funds Other holders Shareholder Accounts Number % Ordinary Shares held 000’s % 2010 7,326 3,213 138 37 11 8 4 57 10,794 2009 7,571 3,718 155 43 9 10 4 63 11,573 2010 67.9 29.8 1.3 0.3 0.1 0.1 0.0 0.5 100.0 2009 65.4 32.2 1.3 0.4 0.1 0.1 0.0 0.5 100.0 2010 19,755 78,053 2,768 490 1,871 49 20 207 103,213 2009 19,885 77,988 2,464 516 1,577 54 20 309 102,813 2010 19.1 75.6 2.7 0.5 1.8 0.1 0.0 0.2 100.0 2009 19.3 75.9 2.4 0.5 1.5 0.1 0.0 0.3 100.0 Based on an analysis of the Ordinary Share register at 31 March 2010 (2009 – 27 March). CREST Proxy Voting Shares held in uncertificated form (i.e., in CREST) may be voted through the CREST Proxy Voting Service in accordance with the procedures set out in the CREST manual. Warning to Shareholders We are aware that some shareholders may have received unsolicited telephone calls or correspondence concerning investment matters. These are typically from overseas based organisations who target UK shareholders offering to sell them what often turn out to be worthless or high risk shares in US or UK investments. They can be extremely persistent and extremely persuasive. Shareholders are therefore advised to be very wary of any unsolicited advice or offers to buy shares at a discount. Please note that it is most unlikely that either the Company or the Company’s Registrar, Capita Registrars, would make unsolicited telephone calls to shareholders. Any such calls would only ever relate to official documentation already circulated to shareholders and never in respect of investment ‘advice’. If you are in any doubt about the veracity of an unsolicited telephone call, please call either the Company Secretary or the Registrar at the numbers provided on pages 16 and 52 of this Report. 53 The Merchants Trust PLC Notice of Meeting Notice is hereby given that the Annual General Meeting of The Merchants Trust PLC will be held at 20 Moorgate, London EC2R 6DA, on Tuesday 11 May 2010 at 12.00 noon to transact the following business. Routine Business 1 To receive and adopt the Report of the Directors and the Financial Statements for the year ended 31 January 2010 together with the Auditors’ Report thereon. 2 3 4 5 6 7 8 To declare a final dividend of 5.7p per Ordinary Share. To re-elect Mr R. A. Barfield as a Director. To re-elect Sir James Sassoon as a Director. To elect Mr S. J. Fraser as a Director. To approve the Directors’ Remuneration Report. To re-appoint PricewaterhouseCoopers LLP as Auditors of the Company, to hold office until the conclusion of the next general meeting at which financial statements are laid before the Company. To authorise the Directors to determine the remuneration of the Auditors. Special Business To consider and if thought fit to pass the following resolutions. Resolution 10 will be proposed as an Ordinary Resolution and Resolutions 9, 11, 12 and 13 as Special Resolutions: 9 10 To adopt new Articles of Association. That for the purposes of Section 551 of the Companies Act 2006 the Directors be generally and unconditionally authorised to exercise all the powers of the Company to allot relevant securities (within the meaning of the said Section) up to an aggregate nominal amount of £8,567,788 provided that: (i) (ii) the authority granted shall expire five years from the date upon which this Resolution is passed but may be revoked or varied by the Company in general meeting and may be renewed by the Company in general meeting for a further period not exceeding five years; and the authority shall allow and enable the Directors to make an offer or agreement before the expiry of that authority which would or might require relevant securities to be allotted after such expiry and the Directors may allot relevant securities in pursuance of any such offer or agreement as if that authority had not expired. 11 That the Directors be empowered in accordance with Section 570 of the Companies Act 2006 to allot equity securities (within the meaning of Section 560 of the Act) for cash pursuant to the authority conferred by Resolution 10 as if sub-section (1) of Section 561 of the Act did not apply to any such allotment provided that: (i) (ii) (iii) the power granted shall be limited to the allotment of equity securities wholly for cash up to an aggregate nominal amount of £2,570,336; the power granted shall (unless previously revoked or renewed) expire at the conclusion of the next Annual General Meeting of the Company after the passing of this resolution; and the said power shall allow and enable the Directors to make an offer or agreement before the expiry of that power which would or might require equity securities to be allotted after such expiry and the Directors may allot equity securities in pursuance of such offer or agreement as if that power had not expired. That the Company be and is hereby generally and unconditionally authorised in accordance with Section 701 of the Companies Act 2006 (the ‘Act’) to make market purchases (within the meaning of Section 693(4) of the Act) of Ordinary Shares of 25p each in the capital of the Company (‘Ordinary Shares’), provided that: 12 54 The Merchants Trust PLC Notice of Meeting (i) the maximum number of Ordinary Shares hereby authorised to be purchased shall be 5,411,738; (ii) the minimum price which may be paid for an Ordinary Share is 25p; (iii) (iv) (v) the maximum price which may be paid for an Ordinary Share is an amount equal to 105% of the average of the middle-market quotations for an Ordinary Share taken from the London Stock Exchange Official List for the five business days immediately preceding the day on which the Ordinary Share is purchased or such other amount as may be specified by the London Stock Exchange from time to time; the authority hereby conferred shall expire at the conclusion of the Annual General Meeting of the Company in 2011 or, if earlier, on the expiry of 18 months from the passing of this resolution, unless such authority is renewed prior to such time; and the Company may make a contract to purchase Ordinary Shares under the authority hereby conferred prior to the expiry of such authority which will or may be executed wholly or partly after the expiration of such authority and may make a purchase of Ordinary Shares pursuant to any such contract. 13 That a general meeting, other than an annual general meeting, may be called on less than 14 days’ clear notice. 155 Bishopsgate London EC2M 3AD 7 April 2010 Annual General Meeting Venue By Order of the Board K. J. Salt Secretary 55 The Merchants Trust PLC Notice of Meeting Notes: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 56 Members entitled to attend and vote at this Meeting may appoint one or more proxies to attend, speak and vote in their stead by completion of a personalised form of proxy. Full details on how to complete the form of proxy are set out on the form of proxy. The proxy need not be a Member of the Company. A proxy must vote in accordance with any instructions given by the member by whom the proxy is appointed. A proxy has one vote on a show of hands in all cases (including where one member has appointed multiple proxies), except where he is appointed by multiple members who instruct him to vote in different ways, in which case he only has one vote for and one vote against the resolution. A personalised form of proxy is provided with the Annual Financial Report. Any replacement forms must be requested direct from the Registrar. Completion of the form of proxy does not exclude a Member from attending the Meeting and voting in person. Duly completed forms of proxy must reach the office of the Registrars at least 48 (excluding non-business days) hours before the Meeting. Shares held in uncertificated form (i.e. in CREST) may be voted through the CREST Proxy Voting Service in accordance with the procedures set out in the CREST manual on the Euroclear website (www.euroclear.com/CREST). To be entitled to attend and vote at the Meeting (and for the purpose of determination by the Company of the number of votes they may cast), Members must be entered on the Company’s Register of Members by close of business on Friday 7 May 2010 (“the record date”). If the Meeting is adjourned to a time not more than 48 hours after the record date applicable to the original Meeting, that time will also apply for the purpose of determining the entitlement of Members to attend and vote (and for the purpose of determining the number of votes they may cast) at the adjourned Meeting. If, however, the Meeting is adjourned for a longer period then, to be so entitled, Members must be entered on the Company’s Register of Members at the time which is 48 hours before the time fixed for the adjourned Meeting or, if the Company gives new notice of the adjourned Meeting, at the record date specified in that notice. The right to appoint a proxy does not apply to persons whose shares are held on their behalf by another person and who have been nominated to receive communications from the Company in accordance with Section 146 of the Companies Act 2006 (“nominated persons”). Nominated persons may have a right under an agreement with the registered shareholder who holds the shares on their behalf to be appointed (or to have someone else appointed) as a proxy. Alternatively, if nominated persons do not have such a right, or do not wish to exercise it, they may have a right under such an agreement to give instructions to the person holding the shares as to the exercise of voting rights. Nominated persons should contact the registered member by whom they were nominated in respect of these arrangements. Corporate representatives are entitled to attend and vote on behalf of the corporate member in accordance with Section 323 of the Companies Act 2006. Pursuant to the Companies (Shareholders’ Rights) Regulations 2009 (SI 2009/1632), multiple corporate representatives appointed by the same corporate member can vote in different ways provided they are voting in respect of different shares. Members have a right under Section 319A of the Companies Act 2006 to require the Company to answer any question raised by a member at the AGM, which relates to the business being dealt with at the meeting, although no answer need be given (a) if to do so would interfere unduly with the preparation of the meeting or involve disclosure of confidential information; (b) if the answer has already been given on the Company’s website; or (c) it is undesirable in the best interests of the Company or the good order of the meeting. Members satisfying the thresholds in Section 527 of the Companies Act 2006 can require the Company, at its expense, to publish a statement on the Company website setting out any matter which relates to the audit of the Company’s accounts that are to be laid before the meeting. Any such statement must also be sent to the Company’s auditors no later than the time it is made available on the website and must be included in the business of the meeting. As at 6 April 2010, the latest practicable date before this Notice is given, the total number of shares in the Company in respect of which members are entitled to exercise voting rights was 103,213,464 Ordinary Shares of 25p each and 1,178,000 3.65% Cumulative Preference Shares. Each Ordinary Share and each Preference Share carry the right to one vote and therefore the total number of voting rights in the Company on 7 April 2010 is 104,391,464. Further information regarding the meeting which the Company is required by Section 311A of the Companies Act 2006 to publish on a website in advance of the meeting (including this Notice), can be accessed at www.rcm.com/investmenttrusts. Contracts of service are not entered into with the Directors, who hold office in accordance with the Articles of Association. A copy of the New Articles is available for inspection at the registered office of the Company, 155 Bishopsgate, London, EC2M 3AD. sterling 128644 128644 Merchants Report Cover 7/4/10 5:17 pm Page IFC1 Printed on FSC-certified paper from well-managed forests and recycled wood or fibre, using vegetable based inks. 128644 Merchants Report Cover 7/4/10 5:17 pm Page BC1 The Merchants Trust PLC Annual Financial Report for the year ended 31 January 2010 RCM UK Limited, 155 Bishopsgate, London EC2M 3AD T: +44 (0)20 7859 9000 F: +44 (0)20 7859 3507 www.rcm.com RCM UK Limited is a company of Allianz Global Investors www.merchantstrust.co.uk 

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