The Merchants Trust PLC Annual Financial Report for the year ended 31 January 2012 Information advantage The Merchants Trust PLC ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Investment Policy Overview Financial Summary Chairman’s Statement Investment Manager’s Review Performance Graphs Investment Manager’s Review Listed Holdings Distribution of Total Assets Historical Record Directors’ Review Directors, Investment Manager and Advisers Directors’ Report Statement of Directors’ Responsibilities Audit Committee Report Directors’ Remuneration Report Financial Statements Independent Auditor’s Report to the Members of The Merchants Trust PLC Income Statement Reconciliation of Movements in Shareholders’ Funds Balance Sheet Cash Flow Statement Statement of Accounting Policies Notes to the Financial Statements Investor Information Investor Information Notice of Meeting 1 3 4 7 8 16 18 20 22 23 36 37 38 41 42 43 44 45 46 48 66 70 The Merchants Trust aims 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 Merchants Trust The Merchants Trust was incorporated on 16 February 1889. It was launched by Robert Benson & Co., predecessors of the current Investment Manager, RCM (UK) Ltd, and originally invested mainly in American railroads. The initial capital was £2 million, of which half was subscribed. ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Investment Policy The Company’s investment performance is assessed by comparison with other investment trusts within the UK Growth and Income sector. Performance is benchmarked against the FTSE 100 Index, reflecting the emphasis within the portfolio. Financial Highlights Net asset value per ordinary share Earnings per ordinary share Dividend 402.1p 2011 427.1p -5.9% 22.0p 2011 21.2p +3.7% 23.0p 2011 22.8p +0.9% 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, the gearing has been in the form of long-term, fixed-rate debentures. The Board monitors the level of gearing and makes decisions on the 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 market sectors, with no one sector comprising more than 35% of the portfolio. 1 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Overview 2 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Financial Summary Revenue Income Net revenue return attributable to Ordinary Shareholders Net revenue return per Ordinary Share Ordinary dividends per Ordinary Share Assets Total Assets less Current Liabilities Net Assets Net Assets (Debt at market value) Net Asset Value per Ordinary Share Net Asset Value per Ordinary Share (Debt at market value) Ordinary Share Price FTSE 100 Index FTSE 350 Higher Yield Index Discount of Ordinary Share Price to Net Asset Value Discount (Debt at market value) For the year ended 31 January 2012 For the year ended 31 January 2011 £27,305,462 £25,740,859 £22,712,211 £21,900,146 22.00p 23.00p 21.22p 22.80p % change +6.1 +3.7 +3.7 +0.9 2012 2011 Capital return % change Total return % change £526,045,683 £552,031,290 £415,024,704 £440,846,016 £377,993,834 £420,377,881 402.1p 366.2p 363.0p 5,681.8 3,050.2 9.7% 0.9% 427.1p 407.3p 406.9p 5,862.9 3,087.2 4.7% 0.1% -4.7 -5.9 -10.1 -5.9 -10.1 -10.8 -3.1 -1.2 n/a n/a - - - -0.5* -5.5* -5.2 0.4 3.5 - - * NAV total return reflects both the change in net asset value per ordinary share and the net ordinary dividends paid. Performance Attribution Analysis against FTSE 100 Index Return of Index Relative return from portfolio Return of portfolio Impact of gearing on portfolio Revenue deficit* Expenses charged to capital Other Change in Net Asset Value per Ordinary Share * Dividends paid on Ordinary Shares amounted to £23,532,668 (refer to Note 6). This exceeds the revenue return for the period by £820,457. Capital Return % Total Return % -3.1 0.4 -2.7 -0.9 -0.2 -1.7 -0.4 -5.9 0.4 1.5 1.9 -0.9 0.0 -1.7 0.2 -0.5 3 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Chairman’s Statement This is our thirtieth year of rising dividends, an to 363.0p. The total return on the Trust’s shares important milestone in Merchants’ history. The Trust including dividends was -5.2%. At 29 March 2012, has maintained this record during a period in which the Trust’s ordinary shares yielded 6.0% compared income has been impacted materially by the global with the yield on the FTSE 100 Index of 3.6%. financial crisis and the cut in BP’s dividend in 2010. There is more detail on the major contributors to our Our underlying income rose 6.1% during the year performance in our Investment Manager’s Review resulting in a significantly lower drawdown on reserves, starting on page 8 of the Annual Financial Report. despite the increased dividend pay out and despite last year benefiting from the release of a deferred tax provision. Market Background It has been a difficult year for financial markets with Western economies suffering from a combination of high debt levels and weak economic growth. Against that background the UK stock market produced an overall return close to zero after falling in the summer as the outlook deteriorated. High yielding and relatively resilient shares, where Merchants has a large exposure, generally outperformed the broader index, whilst financials and economically cyclical shares fell back. Strong performance from government bonds, particularly in response to central bank liquidity injections have lowered borrowing costs and raised the market value of our debt. Net Revenue Return per share Net Revenue Return per share rose by 3.7% to 22.00p. Excluding the release of the deferred tax liability provision of £862,086 in 2011 the underlying Net Revenue Return rose by 8.0%. Dividends The Board is recommending a final ordinary dividend of 5.8p per share, payable on 14 May 2012 to Shareholders on the register on 13 April 2012. This payment would give a total of 23.0p 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 £1,026,885 (1.0p per share) from our revenue reserves, compared to a transfer of £1,632,522 (1.6p per share) last year. As at 31 January 2012 and after providing for this transfer, the Trust’s revenue reserves amounted to £11,748,687 (11.4p per share). Results The investment portfolio produced a capital return of The outlook for dividend growth is reasonable, with many companies having rebuilt their balance sheets -2.7%, slightly ahead of the -3.1% return on the FTSE and dividend cover since the economic downturn. The 100 Index. Including Income, the total return of the Board and the Manager continue to remain focused investment portfolio was +1.9% which was further on providing long-term steady income growth. ahead of the +0.4% total return on the FTSE 100 Index, reflecting the high yield nature of the portfolio. The Net Asset Value per share fell by 5.9% to 402.1p, reflecting principally the cost of finance and the impact of financial gearing. The net asset value total return per share, including dividends paid, was -0.5%. With bond yields and interest rates falling over the year, the company’s debt has increased in value and, using the market value of debt, the Net Asset Value per share declined by 10.1% or by 5.5% including dividends. The full performance breakdown is shown on page 20 of the Annual Financial Report. Over the year, the Trust’s share price fell by 10.8% from 406.9p Benchmark The Board has reviewed the Benchmark indices that are used for assessing the company’s performance in addition to a peer group comparison. Whilst the Board believes it is right to assess performance against both the FTSE 100 Index and the FTSE 350 Higher Yield Index, we think that the FTSE 100 Index should be regarded as the primary benchmark and the Higher Yield index should be a secondary benchmark. There are several reasons for this. The FTSE 100 index is more diversified, reflecting a wider range of investment opportunities as well as having a lower concentration 4 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Chairman’s Statement (continued) in the largest companies. This feature also makes it a investment policy and process, including the use of This is our thirtieth preferable benchmark for the Fund Manager to set the derivatives, dividends policy and reserves, our market portfolio’s long term positioning against. The FTSE 100 position and peer group ratings and our share capital Index is subject to less material constituent changes and structure. We use these sessions to challenge the thus does not encourage significant portfolio turnover way we think and set objectives for ourselves and the year of rising dividends, an when used as a benchmark, whereas the Higher Yield managers. Index can change significantly at its June rebalancing each year, depending upon the yield on each large company. Also the FTSE 100 Index is more widely recognised and better understood. Paul Yates was appointed to the Board in March 2011. Paul has over thirty years’ experience in investment management having worked at UBS for much of his career. He was CEO of UBS Global Asset Management We do not anticipate any alterations in the portfolio (UK) Ltd until 2005. Dick Barfield retired in May 2011, structure as a result of this change, which more closely having been on the Board for twelve years. We thank reflects the way the portfolio is managed already. The Dick very much for his deep understanding of the investment objective remains unchanged. investment markets and his invaluable contribution important milestone in the history of The Merchants Trust. Derivatives As set out in the previous report, we have continued our policy of selectively writing call options on a limited number of the Trust’s holdings. Writing options has provided helpful additional income in a period where revenues have been under pressure and has also been profitable. A more detailed explanation is set out in the Investment Manager’s Review. Retail Distribution Review We anticipate great potential advantages in the Retail Distribution Review (‘RDR’) when investment trusts become available through investment platforms next year and we are working with our managers to identify ways of taking advantage of this development. Gearing The Trust continues to have long-term debt amounting to £111 million. This is all deployed in the market for investment purposes. At the end of the year our gearing level was 26.8% compared to 25.2% at the start of the year. The Board The current Board has four directors and although it is a small board, as you will see from our biographies on page 22, the directors have a range of professional and industrial backgrounds and experience. We meet annually specifically to consider strategy with our managers and advisers, covering topics such as over many years. We are each standing for re-election this year and will continue to do this annually. Annual General Meeting The Annual General Meeting of the Company will be held on Wednesday 9 May 2012 at 12.00 noon at Holborn Bars, 138-142 Holborn, London EC1N 2NQ and we look forward to seeing as many shareholders then as are able to attend. Outlook Although there is considerable uncertainty over the economic outlook with over-indebted governments and consumers, many businesses are in good shape. The larger, high yielding companies in the FTSE 100 Index, which represent a large proportion of your portfolio, generally have strong balance sheets, reasonable prospects and trade at realistic valuations. Income growth is expected to be healthy, supporting Merchants 30 year dividend growth track record. The Trust will continue to focus on delivering long-term growth in capital and income. Simon Fraser Chairman 29 March 2012 5 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Investment Manager’s Review Merchants has paid increasingly higher dividends year-on-year for the last 30 years – from 4.2 pence per share in 1982 to 23 pence per share in 2012 – providing shareholders with a growing source of income in the form of regular quarterly payments. 66 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Performance Graphs The Merchants Trust 10 Year Cumulative Return compared to key UK equity indicies* 200 ) % ( n r u t e R l e v i t a u m u C 60 2002 The Merchants Trust1 The Merchants Trust2 FTSE 1003 FTSE 350 HY4 2012 The Merchants Trust 10 Year Net Dividend Growth compared to inflation** 140 d e x e d n I % 100 2002 Net Div RPI 2012 The Merchants Trust 10 Year Discount/Premium to Net Asset Value as at 31 January** 10 % -15 2002 -4.9 -4.4 -3.0 -6.8 -7.7 3.3 0.0 7.6 2.4 2.1 -11.9 -5.8 -7.9 -2.2 -4.7 -10.5 -9.6 -11.7 -13.7 -9.7 2012 Discount/Premium Debt at Par Discount/Premium Debt at Market 1 The Merchants Trust (Share Price) (TR) (GBP). 2 The Merchants Trust (NAV) (TR) (GBP). 3 FTSE 100 (TR) (GBP). 4 FTSE 350 HY (TR) (GBP). *Source: RCM / Datastream in GBP. ** Source: RCM / Datastream. 7 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Investment Manager’s Review Economic Background In the 1993 film Groundhog Day, weatherman Bill Murray is forced to re-live the same day over and over again, struggling to find a way out of his repetitive existence. This bears a striking resemblance to financial markets in recent years. the governments themselves became the focus of concerns regarding debt levels and solvency. Clearly peripheral European countries like Greece are in a desperate situation but even the USA and France have lost their coveted Standard & Poor’s AAA credit ratings. Periodic bouts of optimism that politicians and Economic growth has generally been modest central bankers can agree a rescue package for against this difficult background, with the USA the Eurozone periphery, the banking system or the showing signs of improvement in activity and Simon Gergel is Head US housing market are followed by a realisation employment in recent months after a weaker that the problems are even more intractable patch in the middle of 2011. Europe has generally than originally believed and that lower growth seen weak growth expectations reduced even of the RCM Value & Income Team based in expectations are exacerbating the fundamental further over the last year, particularly in the London. problem of over-indebtedness. peripheral Eurozone countries, with the UK slipping The debt problems started in the consumer, housing and property development sectors in the US, UK and several European countries but quickly spread to the banking system which financed the borrowing. In turn the banking system had to be supported and bailed out by governments and central banks. In the last year, back into contraction in the last quarter of 2011. Even Germany, which had shown robust growth earlier in the year has slowed in recent months. Emerging markets have fared better but have not been immune to the environment, with growth rates slowing in China, India and Brazil. “There was a clear divergence between investment styles during the year, with lower risk, defensive and high dividend yield shares performing better, as shown by the +3.5% return on the FTSE 350 Higher yield Index.” 8 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Investment Manager’s Review (continued) Market trends The UK stock market traded in a narrow range for the first half of the year, as concerns about the difficult economic environment and the continuing Eurozone crisis were counterbalanced by low share valuations and robust company results. However fears gained the upper hand in August, as poor US economic data releases raised the spectre of a double-dip contraction in this key economy. The market fell sharply and remained volatile until late November when a fragile recovery in There was a clear divergence between investment The FTSE 100 index styles during the year, with lower risk, defensive and high dividend yield shares performing better, as shown by the +3.5% return on the FTSE 350 Higher yield Index. Conversely higher risk, cyclical and financial shares and smaller companies performed worse, with the FTSE 250 Mid Cap closed the year close to its starting point and produced a total return, including income, of Index (ex. Investment Trusts) returning -3.3%. +0.4%. The polarisation between high and low risk shares reversed somewhat in the last two months of the year with the rebound in investor optimism. risk appetite began. Towards the end of the year The best performing sectors were tobacco, the pendulum swung back towards the optimistic beverages and pharmaceuticals, whilst the laggards camp with markets buoyed by a huge liquidity included banks, financial services, food retail and injection into the European banking system, mining. hopes of an agreement on the Greek sovereign debt problem and a modest improvement in US economic statistics. The FTSE 100 index closed the year close to its starting point and produced a total return, including income, of +0.4%. 9 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Investment Manager’s Review (continued) Investment Performance The Merchants Trust portfolio produced a capital return of -2.7%, compared to the capital return of -3.1% on the FTSE 100 Index. The portfolio yield is significantly higher than the yield in the broader stock market. Including income received, the total return was +1.9% compared to the total return of +0.4% on the FTSE 100 Index. The portfolio’s outperformance reflected its higher yield bias and defensive positioning. The largest active disappointing market expectations. The Trust was not immune to this factor with Man Group, Inmarsat and Mothercare being hit hard in response to trading issues. Also certain economically sensitive, medium sized companies were derated, including Hays, Premier Farnell, DMGT and UBM. The final material negative contributors were Diageo, SABMiller and Autonomy, which were not owned and performed well. stock positions made a significant contribution The portfolio’s performance lagged the FTSE 350 to this outperformance, with GlaxoSmithKline, Higher Yield Index return reflecting the particular Unilever, SSE and National Grid all producing structure of this benchmark and the strong double digits returns. The other major performance outperformance of high dividend stocks. This index driver was having only a modest exposure to the is highly concentrated in a few sectors like oil, mining and banks sectors as they both fell heavily, pharmaceuticals and tobacco and benefitted last depressing the index returns. year from having no mining shares or domestically Whilst the overall portfolio return was strong, a nervous stock market de-rated many cyclical companies and severely punished companies focused banks which were particularly poor performers. Contribution to Investment Performance relative to FTSE 100 Index Positive Contribution GlaxoSmithKline Lloyds Banking Group Xstrata Unilever Rio Tinto SSE Anglo American National Grid Barclays Bunzl % 0.9 0.6 0.4 0.4 0.4 0.4 0.4 0.3 0.3 0.3 Over/under weight + Negative Contribution Man Group - - + - + - + - + Inmarsat Hays Diageo SABMiller Mothercare Premier Farnell DMGT UBM Autonomy % -0.7 -0.7 -0.4 -0.4 -0.4 -0.3 -0.3 -0.3 -0.3 -0.2 Over/under weight + + + - - + + + + - Over / under weight: Whether proportion of portfolio in stock is higher (+) or lower (-) than its weighting in the FSTE 100 Index. 10 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Investment Manager’s Review (continued) Portfolio Changes In the first half of the year, with the market range-bound, most of the activity was driven by stock specific considerations. As reported in the interim report we sold out of a number of cyclical companies, taking profits on WPP, Melrose and British Land. We accepted the takeover offer for Brit Insurance and cut the holding in Home Retail Group following a change in view. We also introduced three companies Carnival, London & Stamford Property and Mothercare and we have continued to build up these positions. Early in the second half of the year, as economic news from the USA in particular started to deteriorate, we positioned the portfolio more defensively, reducing positions in the mining, industrial and financial sectors and adding to food retailers and utilities. In particular we added Sainsbury (J) to the portfolio as the business was performing well with a quality and value offering that was gaining traction in a difficult environment. The valuation and yield were attractive with the shares further supported by a considerable property portfolio. The other new investment, later in the year, was Close Brothers, a diversified financial services company. The core of the business is a specialist bank which is conservatively financed and focused on niche asset backed lending, generating high returns with significant barriers to competition. It is seeing reduced competition as large banks retrench and pull money out of non-core activities. Close was lowly valued despite an excellent record, with a well covered 7% dividend yield which has been maintained through the financial crisis and grown over the long term. There were two other complete sales from the portfolio. Both had been disappointing investments and were relatively small positions that were not paying a dividend. Pendragon was sold after a rights issue challenged our hope that shareholders would benefit from a turnaround strategy without recourse to external funds. Lloyds Banking Group was also sold towards the end of the year. Although the valuation of the bank was low, there was considerable risk to the business from the regulatory and economic background and little hope for a meaningful dividend in the medium term. Largest Net Purchases Largest Net Sales Company Sainsbury (J) Centrica Britvic BP London & Stamford Property Carnival UBM Reckit Benckiser Mothercare Tesco £m 8.1 8.0 7.7 5.5 4.9 4.9 4.6 4.6 4.1 4.1 Company Aviva BHP Billiton GlaxoSmithKline Unilever British Land British American Tobacco AstraZeneca Royal Dutch Shell ‘B’ Brit Insurance WPP £m 7.0 6.8 6.5 6.3 6.2 5.6 5.4 5.4 4.7 4.4 11 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Investment Manager’s Review (continued) As well as new investments we added to Other significant sales included taking profits We built up the position companies with sound long term prospects that on part of the holding in cyclicals such as BHP were oversold on trading concerns. These included Billiton and Meggitt and reducing exposure to UBM, DMGT and Britvic. We built up the position some of the higher risk financials including Aviva in BT Group, where we have confidence in the and Barclays. We also reduced the position in turnaround strategy, and in BP, where the shares pharmaceutical stock AstraZeneca on concerns were still over-discounting the likely impact from about a deteriorating medium term outlook, with in BT Group, where we have confidence in the turnaround strategy, and in BP, where the Macondo incident in the Gulf of Mexico. several key products losing patent protection over the shares were still over-discounting the likely impact from the Macondo incident in the Gulf of Mexico. In contrast, we took profits on many defensive shares particularly later the year as they had performed well and offered less value. Such partial sales included GlaxoSmithKline, British American Tobacco, Royal Dutch Shell, SSE and Unilever. However there were exceptions. After initially selling out of Centrica, we made significant purchases later in the year as the the next five years. Derivatives Strategy The Trust operates a covered call overwriting strategy on a limited proportion of the portfolio to generate additional income. In “writing” or selling an option, the Trust gives the purchaser the right to buy a specific number of shares in a company valuation fell to more attractive levels and it lagged at an agreed “strike” price within a fixed period. In other defensive, high yielding shares. Similarly we exchange the Trust receives an option premium increased Reckitt Benckiser, Reed Elsevier and which is taken to the income account. The Trust Tesco which had also lagged their peers and were gets the full benefit of any move in the share lowly valued. The Tesco position was reduced this price up to the strike price but not beyond. If the January after their profit warning challenged our fundamental view of the company’s competitive positioning. share price rises above the strike price, there is a potential “opportunity” cost (but not cash cost) to the Trust as the option holder can exercise their option to buy the shares at the strike price. 12 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Investment Manager’s Review (continued) In its second year, the call overwriting strategy strike price, provided that the premium income The valuations of has again generated both income and a net received is sufficiently attractive. The options profit for the Trust. Additional income of around written are typically short dated with most under £1,860,000 has been accrued and a net profit 4 months duration. The total exposure is closely of just over £950,000 earned taking into account monitored and limited to 15% of the portfolio the opportunity cost associated with any exercised value with all option positions “covered” by shares options. Our approach to option writing is selective held within the portfolio. From a holistic view it defensive shares have risen significantly. Whilst a year ago many of these stocks traded on and driven by the investment fundamentals on can be argued that the overwriting strategy slightly low absolute valuation each stock rather than by a separate derivatives reduces the Trust’s gearing to the equity market, rationale. We write calls on portions of share neutralising some of the financial leverage. holdings that we would be happy to sell at the metrics and offered clear value compared to the wider market, the situation has changed. Constructing a portfolio - achieving the right balance Constructing a portfolio in the current environment has particular challenges. As described in the Investment Manager’s Review, share price movements have polarised with sharply divergent performance between perceived defensive and cyclical equities as investors have reacted to macro- economic news in “risk-on” and “risk-off” phases. There is a strong argument that it is best to focus on classically defensive companies with robust balance sheets, strong cash flow and globally diversified exposures. Indeed the Trust has held a significant bias towards these businesses over the last year. However there are also several arguments for looking more broadly for investment opportunities. The defensive industries themselves are not risk free, particularly as governments and consumers struggle to balance their spending against limited incomes. Risks include rising excise duties on tobacco and alcohol, greater pressure from governments on pharmaceutical pricing, utility taxes and competitive pricing pressure in telecommunications. These risks are compounded by the limited diversification available from a relatively small number of perceived defensive sectors. The valuations of defensive shares have risen significantly. Whilst a year ago many of these stocks traded on low absolute valuation metrics and offered clear value compared to the wider market, the situation has changed. Currently many defensive shares trade close to their long term average valuations and at a premium to the wider market. The shares may not be expensive in absolute terms but their relative attractions are less clear cut. Another consideration relates to the macroeconomic and market outlook. Whilst our central view is cautious, it is possible that we are wrong and that a stronger economic recovery takes hold, or a workable solution is found for the Eurozone region. Even without that happening, stock markets could rally significantly as valuations are not high and many other asset classes look expensive. If we see a sharp stock market rally it is likely that defensive shares would lag most cyclical and financial stocks. Ultimately however, the main reason for looking at more cyclical investments is that we are finding specific companies which have robust competitive positions trading on attractive valuations due to the de-rating of these businesses over the last year. We focus our analysis in these situations on the long term potential and the operating or financial risks to the business model. 13 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Investment Manager’s Review (continued) Future Policy Following the theme of Groundhog Day, the current outlook is in many ways similar to last year. Once again industrial confidence surveys and unemployment trends seem to be improving, at least in the USA. The financial system is still functioning after huge liquidity injections. The peripheral Eurozone countries are putting a strain on the stronger core, whilst Middle East tensions the recent Greek debt agreement, the situation The outlook for remains unpredictable and there remains the risk of contagion into Portugal and elsewhere. Rising social pressures, youth unemployment and income inequalities are causing a backlash against business, banking and mainstream politicians. This raises the risk of populist economic policies being emerging markets is better than in the West but they have their own challenges and pursued and the worrying prospect of increasingly they are not immune to influential extremist groups. the wider global trade environment. (in Syria and Iran rather than Egypt and Libya) are The outlook for emerging markets is better than in keeping the oil price high. However just like last the West but they have their own challenges and year, the problem of the debt burden has not been they are not immune to the wider global trade addressed in a convincing and sustainable way. environment. Japan is caught in its own endless Whilst tentative signs of recovery in the US economy and its depressed housing industry are to be welcomed, there is political deadlock in Washington ahead of this year’s election with an almost guaranteed drag from austerity next year. The UK and major European economies are showing little if any growth with even Germany recently reporting a negative quarter. Despite cycle of stuttering growth with high debt levels. Our overall view remains that growth in the UK and Western economies will be below trend, at best, for a considerable period as the huge debt burden is worked off. Furthermore the risks seem asymmetrically biased to the downside due to austerity measures and rising social and political tensions. “We have recently been taking a more balanced approach to stock selection and where possible adding specific cyclical or financial companies which meet our investment criteria.” 14 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Investment Manager’s Review (continued) In sharp contrast to the economic outlook, most Within the media industry the Trust owns several of the non-financial corporate sector is surprisingly lowly priced, cash generative companies with robust with modest debts and high levels of strong competitive positions. They have exposure profitability. The large UK companies which make to a corporate sector that is in robust financial up the FTSE 100 index are globally spread and health and thus likely to gradually increase diversified across industries, many of which are in spending on activities like exhibitions, data good health. Valuations have increased recently information and marketing. Themes within the portfolio include a preference for companies able to deliver above average growth, for example but remain fair on a longer term basis, with low interest rates and government bond yields making equities look attractive in relative terms. The problem for equities is the challenging outlook. The European Union and the USA are important end markets for most large British businesses and pressures in these regions provide a difficult backdrop. In addition, the oil, mining and related industrial sectors make up around a third of the stock market value and have benefitted from high commodity prices and strong resources demand. The outlook for these industries would be worse if Chinese growth disappoints expectations. Looking at the overall portfolio structure, we continue to favour large, diversified and strongly financed shares in defensive industries like pharmaceuticals and food producers given our concerns over the economic outlook. However, as set out in ‘Constructing a portfolio - achieving the right balance’ on page 13, we have recently been taking a more balanced approach to stock selection and where possible adding specific cyclical or financial companies which meet our investment criteria. The Trust also owns selected consumer related companies. The outlook for the consumer is difficult, with a severe squeeze on disposable through exposure to incomes. However the squeeze should incrementally improve from here if food and utility emerging markets. price inflation subsides and the companies in Also, we continue to the portfolio have strong market positions, clear and successful strategies and trade at attractive valuations. Areas where the portfolio has relatively limited exposure include the mining industry where we remain concerned about the sustainability of commodity prices in a tough economic environment and where dividend yields are low. find opportunities amongst defence and construction companies as we feel the clear pressures on Also there is only a small exposure to the domestic public expenditure are banks, where the outlook remains particularly uncertain and dividends are restricted, although widely understood and there is a large holding in HSBC which has a more than priced into strong funding position and attractive emerging market exposure. We see good value in many other high yielding financial stocks across a diversity of end markets, including real estate, insurance and investment management. many shares. Themes within the portfolio include a preference Simon Gergel for companies able to deliver above average RCM (UK) Limited growth, for example through exposure to emerging markets. Also, we continue to find opportunities amongst defence and construction companies as we feel the clear pressures on public expenditure are widely understood and more than priced into many shares. 15 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Listed Holdings at 31 January 2012 Equities Name Royal Dutch Shell ‘B’ GlaxoSmithKline BP HSBC Vodafone BAE Systems SSE Unilever British American Tobacco National Grid Top Ten Holdings BT Group Reed Elsevier Resolution Reckitt Benckiser UBM Britvic Compass Group Centrica BHP Billiton Daily Mail & General Trust ‘A’ AstraZeneca Imperial Tobacco Sainsbury (J) Bunzl Tesco Balfour Beatty Cobham IG Group Aviva Greene King Carnival Hammerson Premier Farnell Inmarsat Value (£) 43,822,256 37,196,705 37,185,224 33,494,513 29,664,971 18,892,589 17,460,300 16,470,300 16,460,339 16,166,020 % of Listed holdings 8.6 7.3 7.3 6.5 5.8 3.7 3.4 3.2 3.2 3.2 Principal Activities Oil & Gas Producers Pharmaceuticals & Biotechnology Oil & Gas Producers Banks Mobile Telecommunications Aerospace & Defence Electricity Food Producers Tobacco Gas, Water & Multiutilities 266,813,217 52.2 15,606,415 14,140,957 13,936,637 12,982,200 11,390,486 11,319,664 11,191,000 10,793,440 9,909,740 9,786,560 9,357,417 7,941,500 7,757,960 6,870,427 6,392,000 6,378,408 6,032,400 6,000,140 5,939,800 5,413,100 4,536,000 4,506,345 4,373,560 4,206,265 Fixed Line Telecommunications Media Life Insurance Household Goods & Home Construction Media Beverages Travel & Leisure Gas, Water & Multiutilities Mining Media Pharmaceuticals & Biotechnology Tobacco Food & Drug Retailers Support Services Food & Drug Retailers Construction & Materials Aerospace & Defence General Financial Life Insurance Travel & Leisure Travel & Leisure Real Estate Investment Trust Support Services Mobile Telecommunications 3.1 2.8 2.7 2.5 2.2 2.2 2.2 2.1 1.9 1.9 1.8 1.6 1.5 1.3 1.2 1.2 1.2 1.2 1.2 1.1 0.9 0.9 0.9 0.8 16 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Listed Holdings (continued) at 31 January 2012 Name Meggitt London & Stamford Property Hiscox Man Group Barclays Catlin Group Close Brothers Legal and General Interserve Ashmore Group Hays Mothercare Total Equities Written Call Options Value (£) 4,132,967 4,129,684 3,810,000 3,809,999 3,442,500 3,360,670 3,262,586 3,098,880 2,716,175 2,333,212 2,244,375 2,124,900 % of Listed holdings Principal Activities 0.8 0.8 0.7 0.7 0.7 0.7 0.6 0.6 0.5 0.5 0.4 0.4 Aerospace & Defence Real Estate Investment Trust Non-life Insurance General Financial Banks Non-life Insurance General Financial Life Insurance Support Services General Financial Support Services General Retailers 512,041,586 100.0 As at 31 January 2012, the market value of the outstanding options positions was £(291,625), resulting in an underlying exposure to 7.1% of the portfolio (valued at strike price). 17 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Distribution of Total Assets Total Assets (less creditors due within one year) £526,045,683 (2011 - £552,031,290) Percentage of total assets at 31 January 2012 Percentage of total assets at 31 January 2011 Oil & Gas Oil & Gas Producers Basic Materials Mining Industrials Aerospace & Defence Construction & Materials Industrial Engineering Support Services Consumer Goods Beverages Food & Drug Retailers Food Producers Household Goods & Home Construction Tobacco Health Care Pharmaceuticals & Biotechnology Consumer Services General Retailers Media Travel & Leisure 15.4 15.4 1.9 1.9 5.5 1.2 - 3.1 9.8 2.2 2.7 3.1 2.5 4.6 15.1 8.9 8.9 0.4 6.7 4.0 11.1 14.3 14.3 3.3 3.3 6.0 1.3 0.7 4.2 12.2 0.9 0.9 3.6 1.5 4.8 11.7 9.2 9.2 0.7 6.2 2.7 9.6 18 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Distribution of Total Assets (continued) Telecommunications Fixed Line Telecommunications Mobile Telecommunications Utilities Electricity Gas, Water & Multiutilities Financials Banks General Financial Life Insurance Non-Life Insurance Real Estate Total Investments Net Current Assets Total Assets Percentage of total assets at 31 January 2012 Percentage of total assets at 31 January 2011 3.0 6.4 9.4 3.3 5.1 8.4 7.0 2.9 4.4 1.4 1.6 17.3 97.3 2.7 100.0 2.0 6.4 8.4 3.6 3.7 7.3 9.1 3.0 5.7 2.2 2.4 22.4 98.4 1.6 100.0 19 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Historical Record year ended 31 January 2012 Revenue and Capital 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Income (£’000s) Net Revenue Return per Ordinary Share Dividends per Share 22,101 22,247 22,675 24,714 27,750 28,495 31,730 23,687 25,741 27,305 17.26p 17.34p 17.58p 19.44p 22.17p 22.86p 27.25p 18.91p 21.22p 22.00p 17.20p 17.60p 18.00p 18.90p 20.00p 21.60p 22.80p 22.50p 22.80p 23.00p Ordinary Dividend per Share 17.20p 17.60p 18.00p 18.90p 20.00p 21.60p 22.30p 22.50p 22.80p 23.00p Special Dividend per Share Tax Credit per Share Gross Dividend per Share Total Net Assets attributable to Ordinary Capital (£’000s) Net Asset Value per Ordinary Share NAV Total Return (%)* Retail Price Index Increases (%)** - - - - - - 1.91p 1.96p 2.00p 2.10p 2.22p 2.40p 0.50p 2.53p - - - 2.50p 2.53p 2.56p 19.11p 19.56p 20.00p 21.00p 22.22p 24.00p 25.33p 25.00p 25.33p 25.56p 273,407 357,442 424,511† 514,713 588,835 506,187 314,804 384,747 440,846 415,025 267.8p 350.1p 415.8p† 504.1p 567.5p 492.3p 306.2p 372.8p 427.1p 402.1p -30.9 +2.7 +37.3 +20.8† +25.6 +16.4 +2.4 +2.1 +2.3 +4.2 -9.6 +4.1 -33.4 +0.1 +29.2 +20.7 +4.6 +5.1 -0.5 +3.9 Notes * 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. 20 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Directors’ Review 21 21 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Directors, Investment Manager and Advisers Directors The current Directors’ details are set out below. All Directors are non-executive and independent of the Manager. Simon Fraser (Chairman) Joined the Board in August 2009. He is Chairman of Foreign & Colonial Investment Trust PLC and a non-executive director of Barclays PLC, Barclays Bank PLC, Ashmore Investment Manager RCM (UK) Limited Represented by Simon Gergel, Portfolio Manager, and Melissa Gallagher, Head of Investment Trusts Henry Staunton (Senior Independent Director) Joined the Board in May 2008. He is Vice- Secretary and Registered Office Kirsten Salt BA (Hons) ACIS, Chairman and the Senior Independent 155 Bishopsgate, Director of Legal & General Group plc and London EC2M 3AD. a non-executive director of Standard Bank Telephone: 020 7065 1513, Plc, Capital and Counties Properties plc and Email: kirsten.salt@uk.rcm.com W H Smith PLC. He was previously Finance Director at ITV plc and Granada Group plc. He was also a non-executive director of Independent Auditors PricewaterhouseCoopers LLP, Chartered Accountants and Statutory Auditors 7 More London Riverside, London SE1 2RD Bankers HSBC Bank, Barclays Bank Stockbroker JPMorgan Securities Limited Legal Advisers Herbert Smith LLP Group plc, Fidelity European Values PLC and Ladbrokes plc, Emap plc, BSkyB, Independent Fidelity Japanese Values PLC. He spent his Television News Limited, Vector Hospitality plc career at Fidelity International Limited, where and Ashtead Group plc, of which he was also he held a number of positions, including Chairman between 2001 and 2004. He is a Chief Investment Officer from 1999-2005, Chartered Accountant. 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. Paul Yates Joined the Board in March 2011. He is a non-executive partner of 33 St James’s and is a non-executive director of Edinburgh UK Tracker Trust plc. He has had a long career in investment management beginning at Samuel Montagu & Co in 1980. He joined Phillips and Drew in 1985 – the year that it was acquired by UBS. He held a number of positions at UBS, covering management, Mike McKeon (Chairman of the Audit Committee) 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 portfolio management, pensions, strategy and various senior roles at Rolls-Royce plc from client service. He was CEO of UBS Global 1997 to 2000. He has extensive experience Asset Management (UK) Ltd between 2001 in a number of overseas positions, having and 2005. After undertaking a number of worked at CarnaudMetalbox, Elf Atochem and global roles at UBS he retired in 2007. PricewaterhouseCoopers. He is a Chartered Accountant. 22 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Directors’ Report T he Directors present their report and the audited financial statements of the Company for the year ended 31 January 2012. Business Review Business and Status of the Company The Company is an investment company as regulatory environment in the year ahead as well as information on investment activity and the Company is preparing itself for within the Company’s portfolio. implementation of the Alternative Investment Fund Managers Directive (AIFMD), the Retail Distribution Review (RDR) and the Foreign Account Tax Compliance Act (FATCA). The Board has appointed RCM (UK) Limited to carry out investment management, 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 defined in Section 833 of the Companies Act accounting, secretarial and administration indices 2006. services on behalf of the Company. The The Company’s performance is The Company carries on business as an investment trust and was approved by HM Revenue & Customs as an investment trust in accordance with Section 1158 of the Company has no employees or premises of its own. Investment Objective and Policies The Company’s objective is to provide an benchmarked against the FTSE 100 Index. This is the most important KPI by which performance is judged. Performance against the Company’s Corporation Tax Act 2010 for the year ended above average level of income and income peers 31 January 2011. In the opinion of the Directors, the Company has subsequently growth together with long term growth of capital through a policy of investing mainly conducted its affairs so that it should continue in higher yielding UK FTSE 100 companies. The Board also monitors the Company’s performance with reference to its investment trust peer group. to qualify. The Company will continue to seek approval under Section 1158 of the The Company’s investment performance Performance Attribution is assessed by comparison with other The performance attribution is considered Corporation Taxes Act 2010 each year. The investment trusts within the UK Growth and Company is not a close company for taxation Income sector. In addition, it is benchmarked purposes. against the FTSE 100 Index. 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 been advised of changes to the 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. Together with the proposed dividend, the dividend has increased every year for the past thirty years and details of historic dividend payments are set out on page 20. Performance In the year to 31 January 2012 the NAV per Share fell by 5.9%. This compares with the capital return on the Company’s benchmark, FTSE 100 Index, of -3.1%. At 31 January 2012 the value of the Company’s investment portfolio was £512.1m. The Investment Manager’s review on pages 8 to 15 includes a review of developments during the year 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 2012 is given on page 3. 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 2012 the shares traded between a discount of -0.9% and a premium of 12.3% with debt at fair value. Total expense ratio (“TER”) The most significant expense for the Company is the cost of the management 23 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Directors’ Report (continued) fee and the costs of interest on the the past ten years of the Net Asset Value of future. For this reason the Directors continue Company’s borrowings. Other expenses the Company’s Ordinary Shares against the to adopt the going concern basis in preparing include the costs of investment Company’s benchmark indices, the growth the financial statements. transactions, directors’ fees and insurance, in net ordinary distributions made by the professional advice and regulatory fees Company against the Retail Price Index, and and the costs of production of the reports the Company’s discount to Net Asset Value to shareholders. The TER is calculated by over the same period. Net Asset Value The Net Asset Value of the Ordinary Shares of 25p at the year end was 402.1p as compared with a value of 427.1p at 31 respectively have been paid during the year. the outlook for the Company’s portfolio in his Since the year end the third interim dividend report beginning on page 8. 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 2012 was 0.47% (2011 – 0.46%). Revenue The net return attributable to Ordinary Shareholders for the year amounted to £22,712,211 (2011 – £21,900,146). Net revenue return per ordinary share amounted to 22.00p. The first and second interim dividends of 5.7p and 5.7p of 5.8p has been paid. The final proposed dividend of 5.8p is payable on 14 May 2012. 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 18 and 19, and the historical record of the Company’s revenue, capital and invested funds over the past ten years is shown on page 20. Graphs appear on page 7 showing the performance on a total return basis over Invested Funds Sales of investments during the year resulted January 2011. in net gains based on historical costs of £4,753,833 (2011 – gains of £25,156,875). Provisions contained in the Finance Act 2010 exempt approved Investment Trusts from corporation tax on their chargeable gains. Share Buy Back There were no shares bought back during the year (2011– nil). 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 (2011 – £nil). Future Development The future development of the Company is dependent on the success of the Company’s Donations and Subscriptions There were no charitable donations and investment strategy against the economic subscriptions in respect of the year (2011 environment and market developments. The – £nil). No political donations were made investment manager discusses his view of during the year. The Board also believes that the Retail Distribution Review offers opportunities to generate more interest in investment trusts and to demonstrate the advantages over open-ended investments. This should lead to the Company raising its profile with new investors. Final Dividend Subject to the final dividend being approved by shareholders at the Annual General Meeting, payment will be made on 14 May 2012 to shareholders on the Register of Members at the close of business on 13 April 2012 at the rate of 5.8p per Ordinary Share. Further details are provided in Note 6 on page 51. 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 Capital Structure The Company’s capital structure is summarised on page 55. The details of the 4% Perpetual Debenture Stock and the 3.65% Cumulative Preference Stock are provided in Notes 10(iv) and 10(v) respectively on page 55. 24 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Directors’ Report (continued) Principal Risks and Uncertainties The principal risks identified by the Board are set out in the table on this page, together with the actions taken to mitigate these risks. A more detailed version of this table, in the form of a Risk Matrix, is reviewed and updated by the Board twice yearly. The principal risks and uncertainties faced by the Company relate to the nature of its objectives and strategy as an investment company and the markets in which it operates. Description Mitigation Investment Activity and Strategy An inappropriate investment strategy, e.g., 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. asset allocation or the level of gearing, may RCM (UK) Limited (“RCM”) provides the Directors with management information lead to under-performance against the including performance data and reports and shareholder analyses. The Board monitors Company’s benchmark index and peer group the implementation and results of the investment process with the investment manager, companies, and also in the Company’s who attends all board meetings, and reviews data which show risk factors and how they shares trading on a wider discount. affect the portfolio. The Board reviews investment strategy, including gearing, at each board meeting. Corporate Governance and Shareholder Relations Shareholder discontent could arise if there The Board receives reports on shareholder activity and on shareholder sentiment on a regular basis and contact is maintained with major shareholders. Details of the Company’s compliance with Corporate Governance best practice, including information on relations is weak adherence to best practice in with shareholders, are set out in the Corporate Governance Statement on pages 27 to corporate governance and which could 31. result in potential reputational damage to the Company. 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 58 to 63. In addition to the specific principal risks identified in the table above, the Company faces risks to the provision of services from third parties and more general risks relating to compliance with accounting, tax, legal and regulatory requirements, which could have an impact on reputation and market rating. These risks are formally reviewed by the Board twice each year. 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 within the Directors’ Report beginning on page 27. The Board’s reviews of the risks faced by the Company also include an assessment of the residual risks after mitigating action has been taken. 25 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Directors’ Report (continued) Voting Rights in the Company’s Shares The voting rights at 29 March 2012 were: Share class Ordinary Shares of 25p 3.65% Cumulative Preference Stock of £1 Total Number of shares issued Voting rights per share Total Voting Rights 103,213,464 1,178,000 104,391,464 1 1 103,213,464 1,178,000 104,391,464 Every member on a show of hands has one vote. On a poll every member who is present in person or by proxy or representative has one vote for every £1 in nominal amount of Preference Stock or one vote for every Ordinary Share of 25p. 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. Interests in the Company’s Share Capital As at 29 March 2012 the following had declared a notifiable interest in the Company’s issued share capital: Ordinary Shares Name Legal & General Group PLC Lloyds Banking Group PLC Axa SA This represents no significant change since the year end. Number of shares Percentage of Voting Rights 4,099,823 4,086,614 3,664,667 3.97 3.96 3.55 Directors Biographical details of the current Directors are shown on page 22 and, except where noted, all Directors served throughout the financial year under review. All of the Directors are retiring by rotation at the Annual General Meeting (‘AGM’) and each offers himself for re-election. The Board considers each director to be independent of the Manager and has the full support of the Board in standing 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, have the appropriate skills and have demonstrated commitment and the necessary time to his role. All Directors attended all board and relevant committee meetings during the year. 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. Directors’ and officers’ liability insurance cover is held by the Company and deeds of indemnity have been entered into with the Directors. 26 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Directors’ Report (continued) The current Directors and their beneficial interests in the share capital of the Company as at 31 January 2012 and 31 January 2011 are listed below: Simon Fraser Mike McKeon Henry Staunton Paul Yates* Ordinary shares of 25p 2011 2012 20,000 20,000 450 10,000 10,000 450 10,000 - * Joined the Board in March 2011 and held 1,000 shares on appointment. Dick Barfield held 2,440 Ordinary Shares at 31 January 2011 and at his retirement on 10 May 2011. There have been no changes to directors’ interests since the year end. Management Contract and Management Fee The management contract with RCM (UK) Limited (‘RCM’) provides for a fee of 0.35% per annum (2011 – 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 (2011 – 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. 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 AIC Code of Corporate Governance (“AIC Code”) and been guided by the AIC Corporate Governance Guide for Investment Companies (“AIC Guide”). Both documents can be found on the AIC website www.theaic.co.uk. As confirmed by the Financial Reporting Council following the AIC Corporate Governance Guide enables investment company boards to meet their obligations under the UK Corporate Governance Code and Listing Rules. The Company has complied with the recommendations of the AIC Code and the relevant provisions of UK Corporate Governance Code, except in relation to the UK Corporate Governance Code provisions relating to: the role of the chief executive; executive directors’ remuneration; and the remuneration committee. For the reasons set out in the AIC Guide, and in the preamble to the UK Corporate Governance 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. 27 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Directors’ Report (continued) AIC Code Principles How the principles are applied THE BOARD 1 The chairman should be Simon Fraser joined the Board as a non-executive director in August 2009 and he has been independent. Chairman of the Company since May 2010. The Board, under the leadership of the Senior Independent Director, Henry Staunton, formally reviews the Chairman each year and it considers that Simon Fraser is independent both in character and in judgement and that there are no relationships or circumstances which are likely to affect, or could appear to affect, his judgement. The Senior Independent Director can provide a sounding board for the Chairman and serve as an intermediary for the other directors when necessary. 2 A majority of the board The Board is composed of four non-executive directors and all are considered to be independent should be independent of the of the Manager. None of the directors has any former association with the Manager and each is manager. considered to be independent in character and judgement. 3 Directors should be submitted All directors will stand for re-election at each Annual General Meeting. The Board reviews the composition of the Board and board committees every year. Further information on the activities of the Nomination Committee is on page 32. for re-election at regular intervals. Nomination for re-election should not be assumed but be based on disclosed procedures and continued satisfactory performance. 4 The board should have a Directors’ appointments are reviewed annually. No director has a contract of service and a policy on tenure, which is director may resign by notice in writing to the board at any time. A performance review of the disclosed in the annual report. board and the individual directors is conducted annually. The Company is a member of the FTSE 350 Index and therefore complies with the AIC Code principle concerning the annual re-election of all directors. The Board aims to refresh its composition from time to time; a new appointment was made in March 2011 and there is a plan to make further changes over the next two years. 5 There should be full disclosure The directors’ biographies on page 22 demonstrate a breadth of investment, industrial of information about the commercial and professional experience and expertise. board. 28 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Directors’ Report (continued) AIC Code Principles How the principles are applied 6 The board should aim to have The composition and balance of the Board is continuously under review and these matters are a balance of skills, experience, taken into account as part of every recruitment process. length of service and knowledge of the company. 7 The board should undertake During the year, the effectiveness of the Board was assessed through interviews conducted a formal and rigorous by the Chairman with each director. The Chairman also discussed individual training and annual evaluation of its own development needs with each director. The Chairman’s own performance was evaluated by performance and that of its the other directors who met under the leadership of Henry Staunton, the Senior Independent committees and individual Director. The results of the effectiveness assessment, performance evaluation and development directors. planning have been presented to the Board. The Board will consider the use of external facilitators to carry out Board evaluation in the future. 8 Director remuneration The Directors’ Remuneration Report is on pages 38 and 39. should reflect their duties, responsibilities and the value of their time spent. 9 The independent directors The Nomination Committee, composed of all the independent directors and therefore the full should take the lead in the current board, considers the recruitment of new directors and all directors will meet a shortlist of appointment of new directors candidates. As part of the most recent recruitment process, consultants were appointed to draw and the process should be up a shortlist to include as wide a spectrum of candidates as possible, including taking gender disclosed in the annual report. into account. 10 Directors should be offered When a new director is appointed there is an induction process carried out by the Manager. relevant training and induction. 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. 11 The chairman (and the board) This principle does not apply to the Company as it is a long established investment company. should be brought into the process of structuring a new launch at an early stage. 29 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Directors’ Report (continued) AIC Code Principles How the principles are applied BOARD MEETINGS AND THE RELATIONSHIP WITH THE MANAGER 12 Boards and managers should The Board met six times in the year and also held an annual strategy meeting. Representatives operate in a supportive, of the Manager, including senior executives of the management company and the investment co-operative and open managers, together with the Company Secretary attend every meeting and other investment environment. professionals and marketing executives join the meetings from time to time. The Chairman encourages participation and discussion at the meetings. 13 The primary focus at regular Full investment and performance reports are received and discussed at every board meeting board meetings should and matters such as gearing, asset allocation, marketing and investor relations, peer group be a review of investment information and industry issues are all matters that are covered by the agenda. performance and associated matters such as gearing, asset allocation, marketing/ investor relations, peer group information and industry issues. 14 Boards should give sufficient The Board conducts a formal strategy review each year and continues to monitor the matters attention to overall strategy. discussed throughout the year. 15 The board should regularly The Management Engagement Committee considers the performance of the manager and the review both the performance contractual terms of engagement. Further information on the activities of the Committee are on of, and contractual page 32. arrangements with, the manager. 16 The board should agree The investment management contract covers the provision of operational matters and the Board policies with the manager discusses with the manager and agrees policies concerning key operational matters such as covering key operational corporate governance issues and voting in respect of portfolio holdings, performance reporting issues. methodology including matters such as benchmarking, gearing, share buy backs and investment restrictions. 17 Boards should monitor The share price is monitored and the net asset value is reported on a daily basis. The Board the level of the share price receives reports on these issues at each Board meeting. The Company has a share buy back discount or premium (if any) programme which includes in its aims the intention to reduce discount volatility. The Company and, if desirable, take action to has also taken powers to issue limited numbers of shares in certain circumstances (see page 34). reduce it. 18 The board should monitor The Audit Committee receives and considers internal controls reports from third party service and evaluate other service providers and the manager and Company Secretary report to the Committee on their monitoring providers. and evaluation of these services. 30 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Directors’ Report (continued) AIC Code Principles How the principles are applied SHAREHOLDER COMMUNICATIONS 19 The board should regularly The Chairman works with the manager to ensure that there is effective communication with monitor the shareholder the Company’s shareholders. There is a process for monitoring and analysing the shareholder profile of the company and register and this is reported at each Board meeting. Visits to institutional shareholders and private put in place a system for client brokers are offered and carried out in a rolling programme. There is an opportunity for canvassing shareholder views shareholders to meet and communicate with the directors and managers at the Company’s and for communicating the Annual General Meeting, at which the portfolio manager gives a presentation. The Senior board’s views to shareholders. Independent Director provides another point of contact for Shareholders. 20 The board should normally The Board, or a Committee of the Board, reviews all major communications by the Company. take responsibility for, and have a direct involvement in, the content of communications regarding major corporate issues even if the manager is asked to act as spokesman. 21 The board should ensure that The Board agrees with the Manager every year a budget for and programme of marketing shareholders are provided activity to communicate with investors and to reach a wider audience. In addition to the Annual with sufficient information and half-yearly report, both of which are sent to all shareholders and those others who have for them to understand the registered to receive them, the Company publishes online and makes available in hard copy a risk:reward balance to which monthly factsheet and publishes daily on its website (www.merchantstrust.co.uk) the net asset they are exposed by holding value of the Company’s shares and many other details of interest to investors. the shares. Attendance by the current directors at formal Board and committee meetings during the year was as follows: Director No. of meetings Simon Fraser Mike McKeon Henry Staunton Paul Yates Board Audit Committee Nomination Committee Management Engagement Committee 6 6 6 6 6 2 2† 2 2 2 1 1 1 1 1 1 1 1 1 1 † Invited to attend meetings, although not a committee member. Dick Barfield attended all meetings during the year until his retirement from the Board on 10 May 2011. 31 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Directors’ Report (continued) Special Rights Disclosure There are no restrictions concerning the decision and that in taking the decision the Management Engagement Committee Directors will act in a way they consider, in The Management Engagement Committee transfer of securities in the Company; no good faith, will be most likely to promote meets at least once each year to review the special rights with regard to control attached the Company’s success. The Board is able Management Agreement and the Manager’s to securities; no agreements between holders to impose limits or conditions when giving performance. It has defined terms of of securities regarding their transfer known authorisation if it thinks this is appropriate. reference and consists of the non-executive 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. The Board confirms that its powers of authorisation are operating effectively and that the agreed procedures have been followed. Board Committees Audit Committee The Company is not aware of any The Audit Committee Report is on page 37. agreements between holders of securities with regard to control of the Company which may result in restrictions on voting rights. Nomination Committee The Nomination Committee meets at least Directors and would exclude any Directors previously employed by the Manager. It is chaired by Simon Fraser, the Chairman of the 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. Conflicts of Interest The Companies Act 2006 sets out directors’ general duties. 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. 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 once each year and makes recommendations The Board has not constituted a on the appointment of new Directors and Remuneration Committee; all Directors are the re-election of existing Directors by non-executive and remuneration matters are shareholders. The committee also determines dealt with by the whole Board. the process for the annual evaluation of the Board. The committee is chaired by Simon Fraser, the Chairman of the Board. Financial Reporting The Statement of Directors’ Responsibilities in All Directors serve on the committee and respect of the financial statements is on page consider nominations made in accordance 36. The Independent Auditor’s Report can be with an agreed procedure. The recruitment found on page 41. process for new directors is for the Board to appoint external consultants to nominate candidates for the committee to consider. The Board has issued a statement giving Auditors’ Information Each of the persons who is a Director at the date of approval of this report confirms that: support to the intention of the Davies Review (a) in so far as the Director is aware, there ‘Women on Boards’ to encourage diversity is no relevant audit information of which on the boards of companies. There are four the Company’s auditors are unaware; and directors on the board and as each has served no more than four years there are no current plans to recruit new directors. In the last recruitment exercise, as described in the previous annual report, the Board sought to identify a wide spectrum of candidates and to take gender into account. The Board’s aim is to continue with a policy of shortlisting women in the search for new directors. (b) 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. 32 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Directors’ Report (continued) Internal Control The Directors have overall responsibility for and company secretarial services to The Audit Committee has received reports the Company. The Manager therefore from each of its service providers on the the Company’s system of internal control. maintains the internal controls associated anti-bribery policies of these third parties. Whilst acknowledging their responsibility for with the day to day operation of the It receives reports at each meeting on the system of internal control, the Directors Company. These responsibilities are compliance with the Manger’s anti-bribery are aware that such a system is designed included in the Management Agreement policy. to manage rather than eliminate the risk of between the Company and the Manager. a failure to achieve business objectives and The Manager’s system of internal control can provide only reasonable but not absolute includes organisation arrangements with assurance against material misstatement or clearly defined lines of responsibility and 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 Audit Committee and accords with the Turnbull guidance and it is believed that the appropriate framework is in place to meet the requirements of the AIC Code. 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 (see page 25). 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 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. 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 There is a regular review by the Board of meeting. 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. The Manager meets with institutional shareholders on a regular basis and reports to the Board on matters raised at these meetings. The Chairman and, where appropriate, other Directors, are available to meet with shareholders to discuss governance and strategy and to understand Authorisation and exposure limits are set their issues and concerns. All correspondence and maintained by the Board. with shareholders is reviewed by the Board. that good systems of internal control and The Audit Committee assesses the Shareholders who wish to communicate risk management are embedded in the Manager’s and Custodian’s systems of directly with the Chairman, the Senior operations and culture of the Company controls by reviewing Internal Control Independent Director or other Directors may and its key suppliers. reports provided by the Managers and third write care of the Company Secretary at 155 The appointment of RCM (UK) Limited (‘RCM’) as the Manager provides investment management, accounting party service providers, including those of Bishopsgate, London EC2M 3AD. the Company’s Registrars, Capita Registrars, and Custodian, HSBC Bank plc. 33 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Directors’ Report (continued) The Notice of Meeting sets out the business The Board has noted the Manager’s of the meeting and special resolutions are statement of its corporate governance aims explained more fully in the Directors’ Report. and objectives, summarised as: Annual General Meeting Allotment of New Shares and Disapplication of Pre-emption Rights Approval is sought for the renewal of the Separate resolutions are proposed for each substantive issue. The UK Stewardship Code and 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 “Our primary corporate aim is to maximise shareholder value through the securing of Directors’ authority to allot relevant securities, corporate performance whilst protecting this in accordance with Section 551 of the value through operating within established Companies Act 2006, up to a maximum 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. number of 34,401,047 Ordinary Shares, representing approximately 33% of the existing Ordinary Share capital. This authority is renewable annually and will expire at the conclusion of the Annual General Meeting in 2013. A resolution was passed at the Annual General Meeting held on 10 May 2011 in accordance with Section 570 of the Companies Act 2006, 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 2012. 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 a maximum number of 10,321,346 Ordinary Shares, 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 the Manager, RCM (UK) Limited (RCM). The RCM votes in all markets wherever possible, UK Stewardship Code sets out good practice on engagement with investee companies. It and strives actively to encourage both improved levels of disclosure among provides an opportunity to bring together UK companies and proper voting infrastructure and overseas investors committed to the high among custodians and agents globally.“ quality dialogue with companies needed to underpin good governance. By creating a sound basis of engagement it should create a much needed stronger link between governance and the investment 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 process, and support the concept of “comply take into account international codes of or explain” as applied by listed companies. corporate governance from a number of The FRC therefore sees it as complementary sources, including Employment Retirement to the UK Corporate Governance Code for listed companies. The Company’s Income Security Act (ERISA) legislation and Department of Labor recommendations in Manager, RCM (UK)’s policy statement on the U.S. where appropriate. the Stewardship Code can be found on its website: www.rcm.com/london/pdf/ Stewardship_Policy.pdf. The Board has reviewed this policy statement and is satisfied that the Company’s delegated voting powers are being properly executed and is working 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. on 9 May 2012. with RCM (UK) to assess the effectiveness of An extract from the Company’s voting record the Stewardship Code in practice. in the previous year will be available for inspection at the annual general meeting each year. 34 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Directors’ Report (continued) The Directors may allot shares under these UK Listing Authority (‘Listing Rules’) limit the The authority in accordance with Section authorities to take advantage of opportunities price which may be paid by the Company 701 of the Companies Act 2006, will last in the market as they arise but only if they to 105% of the average middle-market until the Annual General Meeting of the believe it would be advantageous to the quotation for an Ordinary Share on the five Company to be held in 2013 or the expiry Company’s existing shareholders to do so. business days immediately preceding the of 18 months from the date of the passing The Directors confirm that no allotment of date of the relevant purchase. The minimum of this resolution, whichever is the earlier. new shares will be made unless the lowest price to be paid will be 25p per Ordinary The authority will be subject to renewal by market offer price of the Ordinary Shares is at Share (being the nominal value). Overall, this shareholders at subsequent annual general least at a premium to net asset value, valuing proposed share buy-back authority, if used, meetings. debt at market value. 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. 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. Independent Auditors The Directors will place a resolution before the Annual General Meeting to re-appoint PricewaterhouseCoopers LLP as statutory 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. 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 By Order of the Board Kirsten Salt Secretary 29 March 2012 Where purchases are made at prices below to 14.99% of its issued share capital. For the prevailing net asset value of the Ordinary this reason, the Company is limiting its Shares, this will enhance net asset value for renewed authority to make such purchases the remaining shareholders. It is therefore to 15,471,698 Ordinary Shares, representing intended that purchases would only be 14.99% of the issued share capital, provided made at prices below net asset value, with that there is no change in the issued share the purchases to be funded from the capital capital between the date of this report and reserves of the Company (which are currently the Annual General Meeting to be held on 9 in excess of £380 million). The rules of the May 2012. 35 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Statement of Directors’ Responsibilities T he Directors are responsible for preparing the Annual Financial Report, the Directors’ The Directors confirm that they have complied with the above requirements in Statement under DTR 4.1.12 The Directors at the date of approval of this Remuneration Report and the financial preparing the financial statements. Report, each confirm to the best of their statements in accordance with applicable law The Directors are responsible for keeping knowledge that: and regulations. adequate accounting records that are the financial statements, which have Company law requires the directors to sufficient to show and explain the company’s been prepared in accordance with United prepare financial statements for each financial transactions and disclose with reasonable Kingdom Generally Accepted Accounting year. Under that law the Directors have accuracy at any time the financial position Practice (United Kingdom Accounting elected to prepare the financial statements of the company and enable them to ensure Standards and applicable law), give a in accordance with United Kingdom that the financial statements and the true and fair view of the assets, liabilities, Generally Accepted Accounting Practice Directors’ Remuneration Report comply with financial position and net return of the (United Kingdom Accounting Standards and the Companies Act 2006. They are also company; and applicable law). Company law also requires responsible for safeguarding the assets of the that the directors must not approve the company and hence for taking reasonable financial statements unless they are satisfied steps for the prevention and detection of that they give a true and fair view of the fraud and other irregularities. the Annual Financial Report includes a fair review of the development and performance of the Company and the position of the Company, together with state of affairs of the company and of the net return of the company for that period. In preparing these financial statements, the directors are required to: The financial statements are published on a description of the principal risks and www.merchantstrust.co.uk, which is a website uncertainties that it faces. maintained by the Company’s investment manager, RCM (UK) Limited. The Directors select suitable accounting policies and then are responsible for the maintenance and apply them consistently; integrity of the company’s website. The For and on behalf of the Board 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. prepare the financial statements on the going concern basis unless it is inappropriate to presume that the company will continue in business. work undertaken by the Auditor does not involve consideration of the maintenance Simon Fraser Chairman and integrity of the website and, accordingly, 29 March 2012 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. 36 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Audit Committee Report T he principal role of the Audit Committee is to assist the Board in relation to the reporting from the Compliance Officer on the operation of financial controls relating to the Company and of financial information, the review of financial the proper conduct of its business in accordance controls and the management of risk. The with the regulatory environment in which both committee has defined terms of reference and the Company and the Manager operate. The duties and the terms of reference are published committee also considered the Auditors’ report on on the Company’s website. These include the annual accounts, the planning and the process responsibility for the review of the annual financial of the audit and the Auditors’ independence report and the half yearly financial report, the and objectivity. It has also considered the non- nature and scope of the external audit and the audit services provided by the Auditors and findings therefrom and the terms of appointment determined that they have had no impact on of the auditors, including their remuneration and the Auditors’ independence and objectivity. The the provision of any non-audit services by them. Audit Committee believes the performance of Non-audit services of £3,500 in the year were for the Auditors is satisfactory and recommended the Auditors’ certification of borrowing covenants their reappointment to the Board. The Audit (2011 - £3,020). These fees are considered Committee reviews the Company’s accounting by the Audit Committee to be proportionate to policies and considers their appropriateness. The the fees for audit services of £23,056 (2011 - Committee also reviews the terms of appointment £23,949). The Board reviews the composition of the Audit Committee and considers that, collectively, the committee members have sufficient recent and relevant financial experience to discharge their responsibilities fully. The Audit Committee of the Auditors together with their remuneration. 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. consists of all of the independent non-executive As the Company has no employees it does not Directors, with the exception of the Chairman, and have a formal policy concerning the raising, in has defined terms of reference and duties. The confidence, of any concerns about improprieties, committee considers that, collectively, its members whether in matters of financial reporting have sufficient recent and relevant financial or otherwise, for appropriate independent experience to discharge their responsibilities investigation. However, any matters concerning the fully: two of the three committee members are Company may be raised with the Chairman or the Chartered Accountants. During the year the Senior Independent Director. The Audit Committee committee met twice during which the annual has, however, received and noted the Manager’s financial report and the half yearly financial policy on this matter. report respectively were reviewed in detail. These meetings were attended by representatives of the Manager including their Compliance Officer. Mike McKeon At each meeting the committee received a report Audit Committee Chairman 29 March 2012 37 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Directors’ Remuneration Report T his report is submitted in accordance with the Large and Medium Sized Companies The Company’s Articles of Association limit the aggregate fees payable to the Board of Directors and Groups (Accounts and Reports) Regulations to a total of £150,000 per annum. Subject to this 2008, Schedule 8, for the year ended 31 January overall limit, it is the Board’s policy to determine 2012. An ordinary resolution for the approval the level of Directors’ fees having regard to the of this report will be put to shareholders at the level of fees payable to non-executive Directors forthcoming Annual General Meeting. in the investment trust industry generally, the 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 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. Remuneration During the year the Chairman’s fees were £30,000 Directors carry out reviews from time to time of per annum, the Directors’ fees were £20,000 per the fees paid to the directors of other investment annum and an additional £3,000 was paid to the trusts. Audit Committee Chairman. 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 These fees have been in place since 1 February 2011 and prior to that the Chairman had been paid at the rate of £27,500, and the Directors at £18,000 per annum, with a further £3,000 for the Audit Committee Chairman. Since the year end the Board reviewed the fees and in order for the directors’ remuneration to keep pace and remain competitive with the fees in the peer group and wider investment company sector, the fees have performance, nor to the performance of the Board been increased with effect from 1 February 2012, as a whole. to £31,500 for the Chairman, £21,000 for the other directors and an additional £3,250 for the Chairman of the Audit Committee. 38 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Directors’ Remuneration Report (continued) Directors’ Emoluments (Audited) The Directors’ Emoluments during the year and in the previous year are as follows: Simon Fraser Mike McKeon Henry Staunton Paul Yates** Dick Barfield~ Lord Sassoon# Sir Hugh Stevenson# Totals 2012 £ 31,883* 23,000 20,000 17,359 5,538 - - 97,780 Directors’ fees 2011 £ 24,543 20,115 18,000 - 18,000 6,556 7,615 94,829 * Includes a National Insurance Contributions refund of £1,883. ** Appointed to the Board March 2011. ~ Retired from the Board May 2011. # Retired from the Board May 2010. 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. 120 100 80 60 40 20 d e x e d n I 0 2007 By Order of the Board Kirsten Salt Secretary 29 March 2012 The Merchants Trust (Share Price) (TR) The Merchants Trust (NAV) (TR) FTSE 100 Source: RCM / Datastream 2008 2009 2010 2011 2012 39 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Financial Statements 40 4040 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Independent Auditor’s Report to the Members of The Merchants Trust PLC W e have audited the financial statements of The Merchants Trust PLC (the “company”) for the year ended 31 January 2012 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 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 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 of: whether the accounting policies are following: appropriate to the company’s circumstances Under the Companies Act 2006 we are and have been consistently applied and required to report to you if, in our opinion: adequately disclosed; the reasonableness of adequate accounting records have not been significant accounting estimates made by the kept, or returns adequate for our audit have directors; and the overall presentation of the not been received from branches not visited financial statements. In addition, we read all by us; or the financial and non-financial information the financial statements and the part of in the annual financial report to identify the Directors’ Remuneration Report to of Directors’ Responsibilities set out on material inconsistencies with the audited be audited are not in agreement with the page 36, the directors are responsible for financial statements. If we become aware accounting records and returns; or the preparation of the financial statements of any apparent material misstatements or certain disclosures of directors’ remuneration and for being satisfied that they give a true inconsistencies we consider the implications specified by law are not made; or and fair view. Our responsibility is to audit for our report. and express an opinion on 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. Opinion on financial statements In our opinion the financial statements: we have not received all the information and explanations we require for our audit. Under the Listing Rules we are required to review: give a true and fair view of the state of the the directors’ statement, set out on page company’s affairs as at 31 January 2012 and 24, in relation to going concern; of its net return and cash flows for the year the parts of the Corporate Governance This report, including the opinions, has been then ended; Statement relating to the company’s prepared for and only for the company’s have been properly prepared in accordance compliance with the nine provisions of the members as a body in accordance with with United Kingdom Generally Accepted UK Corporate Governance Code specified Chapter 3 of Part 16 of the Companies Act Accounting Practice; and for our review; and 2006 and for no other purpose. We do not, have been prepared in accordance with the certain elements of the report to in giving these opinions, accept or assume requirements of the Companies Act 2006. shareholders by the Board on directors’ 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. 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 remuneration. Kelvin Laing-Williams (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP, Chartered Accountants and Statutory Auditor, London 29 March 2012 41 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Income Statement for the year ended 31 January Net (losses) gains on investments at fair value Income Investment management fee Administration expenses 2012 2012 Revenue £ Capital £ 2012 Total Return £ 2011 2011 Revenue £ Capital £ 2011 Total Return £ - (17,682,904) (17,682,904) - 63,626,410 63,626,410 Notes 8 1 27,305,462 - 27,305,462 25,740,859 - 25,740,859 2 3 (657,637) (1,221,325) (1,878,962) (634,796) (1,178,909) (1,813,705) (611,230) (2,641) (613,871) (714,775) (3,442) (718,217) Net return before finance costs and taxation 26,036,595 (18,906,870) 7,129,725 24,391,288 62,444,059 86,835,347 Finance costs: interest payable and similar charges 4 (3,324,384) (6,093,985) (9,418,369) (2,491,142) (4,815,949) (7,307,091) Net return on ordinary activities before taxation 22,712,211 (25,000,855) (2,288,644) 21,900,146 57,628,110 79,528,256 Taxation 5 - - - - - - Net return on ordinary activities attributable to Ordinary Shareholders 22,712,211 (25,000,855) (2,288,644) 21,900,146 57,628,110 79,528,256 Net return per Ordinary Share (basic and diluted) 7 22.00p (24.22)p (2.22)p 21.22p 55.83p 77.05p Dividends in respect of the financial year ended 31 January 2012 total 23.00p (2011 - 22.80p), amounting to £23,739,096 (2011- £23,532,668). Details are set out in Note 6 on page 51. 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 46 to 64 form an integral part of these Financial Statements. 42 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Reconciliation of Movements in Shareholders’ Funds for the year ended 31 January Net Assets at 31 January 2010 Revenue Return Dividends on Ordinary Shares Capital Return Net Assets at 31 January 2011 Net Assets at 31 January 2011 Revenue Return Dividends on Ordinary Shares Capital Return Net Assets at 31 January 2012 Called up Share Capital £ Share Capital Premium Redemption Reserve Account £ £ Capital Reserve £ Revenue Reserve £ Total £ 25,803,366 8,523,195 292,853 324,056,586 26,071,214 384,747,214 - - - - - - - - - 21,900,146 21,900,146 - (23,429,454) (23,429,454) - 57,628,110 - 57,628,110 Notes 6 25,803,366 8,523,195 292,853 381,684,696 24,541,906 440,846,016 25,803,366 8,523,195 292,853 381,684,696 24,541,906 440,846,016 6 - - - - - - - - - 22,712,211 22,712,211 - (23,532,668) (23,532,668) - (25,000,855) - (25,000,855) 25,803,366 8,523,195 292,853 356,683,841 23,721,449 415,024,704 The Notes on pages 46 to 64 form an integral part of these Financial Statements. 43 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Balance Sheet at 31 January Fixed Assets Investments held at fair value through profit or loss 8 512,069,555 543,239,476 Notes 2012 £ 2012 £ 2011 £ Current Assets Debtors Cash at bank Creditors – Amounts falling due within one year Derivative financial instruments Net Current Assets Total Assets less Current Liabilities 10 3,047,069 13,398,772 16,445,841 (2,178,088) (291,625) (2,469,713) 10 8 2,034,330 9,257,041 11,291,371 (2,191,610) (307,947) (2,499,557) 13,976,128 8,791,814 526,045,683 552,031,290 Creditors – Amounts falling due after more than one year 10 (111,020,979) (111,185,274) Net Assets 415,024,704 440,846,016 Capital and Reserves Called up Share Capital Share Premium Account Capital Redemption Reserve Capital Reserve Revenue Reserve Total Shareholders’ Funds Net Asset Value per Ordinary Share (basic and diluted) 11 12 12 12 12 13 13 25,803,366 25,803,366 8,523,195 8,523,195 292,853 292,853 356,683,841 381,684,696 23,721,449 24,541,906 415,024,704 440,846,016 402.1p 427.1p The financial statements of The Merchants Trust PLC, company number 28276, were approved and authorised for issue by the Board of Directors on 29 March 2012 and signed on its behalf by: Simon Fraser Chairman The Notes on pages 46 to 64 form an integral part of these Financial Statements. 44 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Cash Flow Statement for the year ended 31 January Net cash inflow from operating activities Return 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 Purchases of fixed asset investments Sales of fixed asset investments Net cash inflow from capital expenditure and financial investment Dividends paid on Ordinary Shares Increase in cash Notes 16 2012 £ 2012 £ 2011 £ 23,792,303 22,695,223 (9,545,602) (42,996) (9,537,094) (21,498) (9,588,598) (9,558,592) (114,624,382) 128,095,076 (131,542,358) 142,181,040 6 17 13,470,694 10,638,682 (23,532,668) (23,429,454) 4,141,731 345,859 The Notes on pages 46 to 64 form an integral part of these Financial Statements. 45 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Statement of Accounting Policies for the year ended 31 January 1 The financial statements have been principal risks and uncertainties it faces, generally recognised within the Income prepared under the historical cost together with the factors likely to affect Statement as revenue. Where, however, basis, except for the measurement at its future development, performance the Company is required to take up a fair value of investments and derivative and position are set out in the Directors’ proportion of the shares underwritten, financial instruments, and in accordance Report, Business Review section on the same proportion of the commission with the United Kingdom Law and pages 23 to 34. United Kingdom Generally Accepted Accounting 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 (AIC). 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 In order to better reflect the activities requirements of the standard are set out of an investment trust company and in Note 18 of the financial statements. in accordance with guidance issued Comparatives are not required. 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 2 Revenue – Franked, unfranked and overseas dividends received on equity shares are accounted for on an ex- dividend basis. UK dividends are shown net of tax credits. trust company under Sections 833 and Special dividends are recognised on an 834 of the Companies Act 2006, net ex-dividend basis and treated as a capital capital returns may not be distributed by or revenue item depending on the facts way of a dividend. The accounting policies adopted in preparing the current year’s financial and circumstances of each dividend. The Board review special dividends and their treatment at each meeting. statements are consistent with those of Where the Company has elected to received is recognised as capital, with the balance recognised as revenue. 3 Investment management fees and administration 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 income returns. The split is reviewed annually. Other administration 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 accrual basis. 4 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 previous years. The Directors believe that 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 receive its dividends in the form of additional shares rather than in cash, the equivalent of the cash dividend is performance of these investments on recognised as income. Any excess in a fair value basis in accordance with its the value of the shares received over investment strategy, and information the amount of the cash dividend is about the investments is provided on this recognised in capital reserves. basis to the Board of Directors. liabilities. Accordingly, the Directors Deposit interest receivable and Investments held at fair value through believe that the Company has adequate stocklending fees are accounted for on profit or loss are initially recognised at financial resources to continue in an accruals basis. Commissions in respect fair value. After initial recognition, these operational existence for the foreseeable of underwriting are recognised when continue to be measured at fair value, future. The Company’s business, the the underwritten issue closes and are which for quoted investments is either 46 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Statement of Accounting Policies (continued) for the year ended 31 January the bid price or the last traded price accrued finance costs to date. Finance 8 Foreign currency – In accordance depending on the convention of the costs are calculated over the term of the with FRS 23 ‘The Effect of changes in exchange on which the investment is debt on the effective interest rate basis. Foreign Currency Exchanges Rates’, the listed. Gains or losses on investments are recognised in the capital column of the Income Statement. Purchases and sales of financial assets are recognised on the trade date, being the date which the Company commits to purchase or sell the assets. 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 5 Derivatives – Options may be investment policy and prospective split of purchased or written over securities 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. 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 monetary 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 held in the portfolio for generating or protecting capital returns, or for generating or maintaining revenue returns. 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 or exercised the gain or loss is accounted for as capital. Where the purpose of the option is the generation of income, the premium is treated as a revenue item. The value of the option is subsequently marked to market to reflect the fair value of the option based on traded prices. Premiums received on written options are amortised to revenue over the period to expiry. Unamortised premiums on exercise date are taken to capital. 6 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 7 Taxation – Where expenses are Income Statement and taken to the allocated between capital and revenue, Capital Reserve. 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. 9 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. 10 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 within Gains (Losses) on Sales of Investments. 11. 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. 47 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notes to the Financial Statements for the year ended 31 January 1. Income Income from Investments * Franked equity dividends from UK investments # Unfranked dividends from UK investments Equity dividends from overseas investments Other Income Premiums on derivative contracts Underwriting commission Total income * All equity dividends are derived from listed investments. # Includes special dividend of £694,730 (2011 - £nil) 2012 £ 2012 £ 2011 £ 24,789,614 22,729,612 295,060 344,320 205,075 580,702 25,428,994 23,515,389 1,858,059 18,409 2,059,837 165,633 1,876,468 2,225,470 27,305,462 25,740,859 During the year, the Company received premiums totalling £1,998,313 (2011 - £2,124,301) for writing covered call options for the purpose of revenue generation, of which £1,858,059 were amortised to income (2011 - £2,059,837). All derivatives transactions were based on FTSE 100 stocks or the related index. At the year end there were fourteen open positions with a liability value of £291,625 (2011 - £307,947). 2. Investment Management Fee 2012 Revenue £ 2012 Capital £ 2012 Total £ 2011 Revenue £ 2011 Capital £ 2011 Total £ Investment management fee 657,637 1,221,325 1,878,962 634,796 1,178,909 1,813,705 Total 657,637 1,221,325 1,878,962 634,796 1,178,909 1,813,705 The management contract with RCM (UK) Limited (‘RCM’), terminable at one year’s notice, provides for a management fee based on 0.35% (2011 - 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 managed by RCM. Under the contract, RCM provides the company with investment management, accounting, secretarial and administration services. VAT has not been charged on management fees since May 2007. 48 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Notes to the Financial Statements (continued) for the year ended 31 January 3. Administration Expenses Auditors’ remuneration for audit services for certification of borrowing covenants VAT on auditors’ remuneration Directors’ fees Marketing costs Other administration expenses 2012 £ 2011 £ 23,056 23,949 3,500 5,311 3,020 5,294 31,867 32,263 97,780 170,814 310,769 94,829 234,451 353,232 611,230 714,775 (i) The above expenses include value added tax where applicable. (ii) Directors’ fees are set out in the Directors’ Remuneration Report on page 39. (iii) In addition to the above, custodian handling charges of £2,641 were charged to capital (2011 - £3,442). 4. Finance Costs: Interest Payable and Similar Charges On Stepped Rate Interest Loan repayable after more than five years Release of provision (see below) On Fixed Rate Interest Loan repayable after more than five years On 4% Perpetual Debenture Stock repayable after more than five years On 5.875% Secured Bonds repayable after more than five years On 3.65% Cumulative Preference Stock repayable after more than five years On Sterling overdraft 2012 Revenue £ 2012 Capital £ 2012 Total £ 2011 Revenue £ 2011 Capital £ 2011 Total £ 1,335,440 2,480,103 3,815,543 1,361,040 2,527,647 3,888,687 - - - (862,086) (1,331,625) (2,193,711) 1,335,440 2,480,103 3,815,543 498,954 1,196,022 1,694,976 1,301,309 2,416,717 3,718,026 1,304,676 2,422,970 3,727,646 19,250 35,750 55,000 19,250 35,750 55,000 625,377 1,161,415 1,786,792 625,265 1,161,207 1,786,472 42,997 11 - - 42,997 42,997 11 - - - 42,997 - 3,324,384 6,093,985 9,418,369 2,491,142 4,815,949 7,307,091 The prior year charge for the stepped rate interest benefited from the release of a provision in respect of a deferred tax liability accruing to First Debenture Finance (‘FDF’) in the year ended 31 January 2011. The release of this frozen tax charge was a result of the election by the directors of FDF to be taxed under the Securitisation Companies Regulations 2006 for the accounting period commencing 1 October 2007 and all subsequent accounting periods. Amounts of £862,086 and £1,331,625 were released to income and capital respectively. 49 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notes to the Financial Statements (continued) for the year ended 31 January 5. Taxation (i) Analysis of tax charge for the year Overseas taxation Current tax charge 2012 Revenue £ 2012 Capital £ 2012 Total £ 2011 Revenue £ 2011 Capital £ - - - - - - - - - - 2011 Total £ - - (ii) Factors affecting current tax charge for the year The tax assessed for the year is lower than the standard rate of corporation tax in the UK (26.33%) (2011 – 28%). Reconciliation of tax charge Return on ordinary activities before taxation 22,712,211 (25,000,855) (2,288,644) 21,900,146 57,628,110 79,528,256 Tax on return on ordinary activities at 26.33% (2011 - 28%) 5,980,125 (6,582,725) (602,600) 6,132,041 16,135,871 22,267,912 Reconciling factors Non taxable income Non taxable capital losses (gains) Accrued income taxable on receipt Disallowable expenses (6,617,765) - (6,617,765) (6,526,888) - (6,526,888) - 4,655,909 4,655,909 - 20,537 - - (17,815,395) (17,815,395) - - 1,460 13,730 (220,590) (357,433) (578,023) 20,537 12,270 Excess of allowable expenses over taxable income 604,833 1,925,356 2,530,189 615,437 2,036,957 2,652,394 Current tax charge - - - - - - 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. As at 31 January 2012, the Company had accumulated surplus expenses of £152.4 million (2011 - £142.8 million). As at 31 January 2012 the Company has not recognised a deferred tax asset of £36.6 million (2011 - £38.5 million) in respect of the accumulated expenses, based on a prospective corporation tax rate of 24% (2010 – 27%). The reduction in the standard rate of corporation tax was substantively enacted on 26 March 2012 and is effective from 1 April 2012. Further reductions to the main rate are proposed to reduce the rate by 1% each year down to 22% by April 2014. Provided the Company continues to maintain its current investment profile, it is unlikely that these expenses will be utilised and that the Company will obtain any benefit from this asset. The Company will continue to seek approval under Section 1158 of the Corporation Tax Act 2010 for the current year and the foreseeable future. The Company has not therefore provided for deferred tax on any capital gains and losses arising on the disposals of investments. 50 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Notes to the Financial Statements (continued) for the year ended 31 January 6. Dividends on Ordinary Shares Dividends on Ordinary Shares of 25p Third interim dividend 5.7p paid 18 February 2011 (2010 - 5.6p) Final dividend 5.7p paid 13 May 2011 (2010 - 5.7p) First interim dividend 5.7p paid 17 August 2011 (2010 - 5.7p) Second interim dividend 5.7p paid 11 November 2011 (2010 - 5.7p) 2012 £ 2011 £ 5,883,167 5,779,954 5,883,167 5,883,166 5,883,167 5,883,167 5,883,167 5,883,167 23,532,668 23,429,454 Dividends payable at the year end are not recognised as a liability under FRS 21 ‘Events After Balance Sheet Date’ (see page 47 - Statement of Accounting Policies). Details of these dividends are set out below. Third interim dividend 5.8p paid 23 February 2012 (2011 - 5.7p) Final proposed dividend 5.8p payable 14 May 2012 (2011 - 5.7p) 2012 £ 2011 £ 5,986,381 5,883,167 5,986,381 5,883,167 11,972,762 11,766,334 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 purchases and cancellations of shares by the Company settled subsequent to the year end. 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 or additional rate will have further tax to pay. 7. Net Return per Ordinary Share 2012 Revenue £ 2012 Capital £ 2012 Total Return £ 2011 Revenue £ 2011 Capital £ 2011 Total Return £ Net return after taxation attributable to Ordinary Shareholders 22,712,211 (25,000,855) (2,288,644) 21,900,146 57,628,110 79,528,256 Net return per Ordinary Share (basic and diluted) 22.00p (24.22)p (2.22)p 21.22p 55.83p 77.05p The weighted average number of shares in issue during the year was 103,213,464 (2011 - 103,213,464). 51 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notes to the Financial Statements (continued) for the year ended 31 January 8. Investments Listed on the London Stock Exchange at market valuation Unlisted at fair value Fixed asset investments Derivative financial instruments - written call options Total investments Market value of investments brought forward Investment holding (gains) losses brought forward Derivative holding losses brought forward Cost of investments held brought forward Additions at cost Disposals at cost Cost of investments held at 31 January Investment holding gains at 31 January Derivative holding losses at 31 January Market value of investments held at 31 January Net (losses) gains on investments Net gains on sales of investments based on historical costs Adjustment for net investment holding gains recognised in previous years 2012 £ 2011 £ 512,041,586 543,212,051 27,969 27,425 512,069,555 543,239,476 (291,625) (307,947) 511,777,930 542,931,529 542,931,529 488,295,791 (38,259,082) 155,017 476,634 216,723 504,827,464 488,989,148 114,624,382 130,908,403 (123,392,280) (115,070,087) 496,059,566 504,827,464 15,724,039 38,259,082 (5,675) (155,017) 511,777,930 542,931,529 4,753,833 25,156,875 (6,942,954) (2,001,815) Net (losses) gains on sales of fixed asset investments based on carrying value at previous balance sheet date (2,189,121) 23,155,060 Net losses on derivative financial instruments Net (losses) gains on sales of investments based on carrying value at previous balance sheet date Net investment holding (losses) gains arising in the year Net derivative holding gains arising in the year Net (losses) gains on investments (51,037) (327,887) (2,240,158) 22,827,173 (15,592,088) 40,737,531 149,342 61,706 (17,682,904) 63,626,410 Transaction costs and stamp duty on purchases amounted to £750,078 (2011 - £773,955) and transaction costs on sales amounted to £158,471 (2011 - £154,872). 52 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Notes to the Financial Statements (continued) for the year ended 31 January 9. Investments in other companies The Company held more than 10% 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’) Fintrust Debenture PLC (‘Fintrust’) Class of Share held ‘A’ Shares ‘B’ Shares ‘C’ Shares ‘D’ Shares Ordinary Shares % Equity 50.0 50.0 50.0 50.0 50.0 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 FRS 9 and are therefore included in the balance at the Director’s valuation. FDF and Fintrust are the lenders of the Company’s Stepped Rate Interest 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 Accrued income Other debtors Creditors: Amounts falling due within one year Other creditors Interest on borrowings 2012 £ 2011 £ 3,015,885 1,995,817 31,184 38,513 3,047,069 2,034,330 843,259 850,846 1,334,829 1,340,764 2,178,088 2,191,610 53 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notes to the Financial Statements (continued) for the year ended 31 January Interest on outstanding borrowings consists of: Stepped Rate Interest Loan Fixed Rate Interest Loan 5.875% Secured Bonds 2029 4% Perpetual Debenture Stock 3.65% Cumulative Preference Stock 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 312,004 780,470 207,105 13,751 21,499 313,728 783,545 208,243 13,750 21,498 1,334,829 1,340,764 10(i) 34,034,109 34,034,112 10(ii) 45,268,411 45,457,833 10(iii) 29,165,459 29,140,329 10(iv) 1,375,000 1,375,000 10(v) 1,178,000 1,178,000 111,020,979 111,185,274 (i) The Stepped Rate Interest Loan of £34,034,109 (2011- £34,034,112) comprises adjustable Stepped Rate Interest Loan Notes of £5,133,520 and Stepped Rate Interest Bonds of £20,534,079. The Loan Notes and Bonds were issued in 1987 at 97.4% and are repayable on 2 January 2018, together with a premium of £8,366,510. The initial interest rate 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%. This stepped interest rate, when combined with the accrual of the premium, results in an effective interest rate of 11.28% per annum. Interest on the Loan Notes and bonds 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’). FDF has a liability to its Debenture Stockholders to repay principal and interest on its £52.2 million of 11.125% Severally Guaranteed Debenture Stock 2018. The Company has guaranteed the repayment of principal and interest on £34.0 million of FDF’s Debenture Stock. This is in proportion to the principal amounts raised by the Company in 1987 in respect of the Loan Notes and Bonds. 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. (ii) The Fixed Rate Interest Loan of £42,000,000 is due to Fintrust Debenture PLC (‘Fintrust’). It comprises a loan of £30,000,000 taken out in 1993, and a further amount of £12,000,000 assumed in 1998 from another of Fintrust’s borrowers. This loan is repayable on 20 May 2023 and carries interest at 9.25125% per annum on the principal amount. Interest is payable in May and November each year. As security for this loan, the Company has granted a floating charge over its assets in favour of the lender. This charge ranks pari passu with the floating charge noted in 10(i) above. The loan of £30,000,000 taken out in 1993 is stated at £29,901,038 (2011 - £29,896,568), being the net proceeds of £29,858,947 plus accrued finance cost of £42,091 (2011 - £37,621). The effective interest rate of this portion of the loan is 9.51%. 54 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Notes to the Financial Statements (continued) for the year ended 31 January On assuming the additional loan of £12,000,000 in 1998, the Company also received a premium of £5,286,564 to ensure that the finance costs on this additional loan were comparable to existing market interest rates. This premium is being amortised over the remaining life of the loan. At 31 January 2012, the loan is stated at £15,367,373 (2011 - £15,561,265), being the principal amount of £12,000,000 plus the unamortised premium of £3,367,373 (2011 - £3,561,265). The effective interest rate of this portion of the loan is 6.00%. (iii) The £30,000,000 of 5.875% Secured Bonds is stated at £29,165,459 (2011 - £29,140,329), being the net proceeds of £28,942,800 plus accrued finance costs of £222,659 (2011 - £197,529). The Bonds are repayable on 20 December 2029 and carry interest at 5.875% per annum on the principal amount. Interest is payable in June & December each year. The effective interest rate of this loan is 6.23% per annum. As security for this loan, the Company has granted a floating charge over its assets ranking pari passu with the floating charges referred to in Note 10(i) and 10(ii) above. (iv) The 4% Perpetual Debenture Stock of £1,375,000 is secured by a floating charge on the assets of the Company, which ranks prior to any other floating charge. Interest is payable on 1 May and 1 November each year. (v) 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 Preference Stock holders to receive payments is not calculated by reference to the Company’s net return and, in the event of a return of capital is limited to a specific amount, being £1,178,000. Dividends on the Preference Stock are payable on 1 August and 1 February each year. 11. Called up Share Capital Allotted and fully paid 2012 £ 2011 £ 103,213,464 Ordinary Shares of 25p (2011 - 103,213,464) 25,803,366 25,803,366 The directors are authorised by an ordinary resolution passed on 10 May 2011 to allot relevant securities, in accordance with Section 551 of the Companies Act 2006, up to a maximum of 34,401,044 Ordinary Shares of 25p each. This authority expires on 9 May 2012 and accordingly a renewed authority will be sought at the Annual General Meeting on 9 May 2012. 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. 55 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notes to the Financial Statements (continued) for the year ended 31 January 12. Reserves Capital Reserve* Share Premium Account £ Investment Capital Gains (Losses) on sales of Holding Investments Gains (Losses) £ Redemption Reserve £ £ Revenue Reserve £ Balance at 1 February 2011 Net losses on sales of fixed asset investments Net losses on derivative financial instruments Net movement in fixed asset investment holding losses Net movement in derivative holding gains Transfer on sale of investments Investment management fee Finance costs of borrowings Other capital expenses Dividends appropriated in the year Revenue retained for the year Balance at 31 January 2012 8,523,195 292,853 343,580,631 38,104,065 24,541,906 - - - - - - - - - - - - - - - - - - - - (2,189,121) (51,037) - - - - (15,592,088) 149,342 6,942,954 (6,942,954) (1,221,325) (6,093,985) (2,641) - - - - - - - - - - - - - - - (23,532,668) 22,712,211 8,523,195 292,853 340,965,476 15,718,365 23,721,449 *Under the terms of the Company’s Articles of Association the Capital Reserve is distributable only by way of redemption or purchase of the Company’s own shares, for so long as the Company carries on business as an Investment Company. The Institute of Chartered Accountants in England and Wales (ICAEW), in its technical guidance TECH 02/10, states that investment holding gains arising out of a change in fair value of assets may be recognised as realised provided they can be readily converted into cash. Securities listed on a stock exchange are generally regarded as being readily convertible into cash and hence profits in respect of such securities, currently included within the Investment Holding Losses of the Capital Reserve above, may be regarded as realised under Company Law. 13. Net Asset Value per Share Ordinary Shares of 25p Ordinary Shares of 25p Net Asset Value per Share attributable 2011 2012 402.1p 427.1p Net Asset Value attributable 2011 2012 £415,024,704 £440,846,016 The net asset value per ordinary share is based on 103,213,464 ordinary shares in issue at the year end (2011 - 103,213,464). 14. Contingent Assets At 31 January 2012 there were no outstanding contingent assets (2011 - nil). 56 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Notes to the Financial Statements (continued) for the year ended 31 January 15. Contingent Liabilities and Commitments At 31 January 2012 there were no outstanding contingent liabilities or capital commitments (2011 - nil). Details of the guarantee provided by the Company as part of the terms of the Loans are provided in Note 10(i), 10(ii) and 10(iii) ‘Current Assets and Creditors’ on pages 54 and 55. 16. Reconciliation of Net 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 losses (gains) on investments at fair value Increase in debtors (Decrease) Increase in creditors Net cash inflow from operating activities 2012 £ 2011 £ 7,129,725 86,835,347 17,682,904 (63,626,410) 24,812,629 23,208,937 (1,012,739) (634,973) (7,587) 121,259 23,792,303 22,695,223 17. Reconciliation of Net Cash Flow to Movement in Net Debt (i) Analysis of net debt At 31 January 2011 Movement in year At 31 January 2012 Stepped and Fixed Rate Loans £ 5.875% Secured Bonds 2029 £ 4% Perpetual Debenture Stock £ 3.65% Preference Stock £ Cash £ Net Debt £ 9,257,041 (79,491,945) (29,140,329) (1,375,000) (1,178,000) (101,928,233) 4,141,731 189,425 (25,130) - - 4,306,026 13,398,772 (79,302,520) (29,165,459) (1,375,000) (1,178,000) (97,622,207) (ii) Reconciliation of net cash flow to movement in net debt Net cash inflow Decrease in long term loans Movement in net funds Net debt brought forward Net debt carried forward 57 2012 £ 2011 £ 4,141,731 345,859 164,295 2,272,998 4,306,026 2,618,857 (101,928,233) (104,547,090) (97,622,207) (101,928,233) ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notes to the Financial Statements (continued) for the year ended 31 January 18. Financial Risk Management Policies and Procedures The Company invests in equities and other investments in accordance with its investment policy as stated on page 1. In pursuing its investment policy, 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 price risk, market yield risk, 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, implements 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 period. (a) 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, market yield risk, 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 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. A schedule of the Company’s listed holdings is shown on pages 16 and 17. Where put options are purchased, the market value of such options can be volatile but the maximum loss on any contract is limited to the original investment cost. Further explanation of this derivative strategy is included in the Investment Manager’s Review on pages 12 and 13. 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 63. 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 2012 was as follows: Listed investments held at fair value through profit or loss Derivative financial instruments - written call options Total listed investments 2012 £ 2011 £ 512,041,586 543,212,051 (291,625) (307,947) 511,749,961 542,904,104 The following table illustrates the sensitivity of the return after taxation for the year and the net assets to an increase or decrease of 20% (2011: 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 recent years. The sensitivity analysis on the net return after tax is based on the impact of a 20% increase or decrease in the value of the Company’s listed equity investments at each closing balance sheet date and the consequent impact on the investment management fees for the year, with all other variables held constant. 58 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Notes to the Financial Statements (continued) for the year ended 31 January 2012 2012 20% Increase 20% Decrease in fair value £ in fair value £ 2011 2011 20% Increase 20% Decrease in fair value £ in fair value £ 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 Management of market price risk (125,450) 125,450 (133,087) 133,087 102,349,992 (102,349,992) 108,580,821 (108,580,821) (232,979) 232,979 (247,161) 247,161 101,991,563 (101,991,563) 108,200,573 (108,200,573) 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 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 15% of gross assets at the time of writing the call. (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 (2011 - no significant exposure). Any income denominated in foreign currency is converted into sterling on receipt. The Company does not hedge against foreign currency exposure. (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. 59 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notes to the Financial Statements (continued) for the year ended 31 January 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. Financial Assets Financial Liabilities 2012 Fixed rate interest £ 2012 Floating rate interest £ 2012 2012 Nil interest £ Total £ 2011 Fixed rate interest £ 2011 Floating rate interest £ 2011 2011 Nil interest £ Total £ - 13,398,772 512,069,555 525,468,327 - 9,257,041 543,239,476 552,496,517 (111,020,979) - (291,625) (111,312,604) (111,185,274) - (307,947) (111,493,221) Net Financial (Liabilities) Assets (111,020,979) 13,398,772 511,777,930 414,155,723 (111,185,274) 9,257,041 542,931,529 441,003,296 Short term debtors and creditors Net Assets per the Balance Sheet 868,981 415,024,704 (157,280) 440,846,016 As at 31 January 2012, the interest rates received on cash balances or paid on bank overdrafts, was nil and 1.35% per annum respectively (2011 - nil and 1.35% per annum). The fixed rate interest bearing liabilities bear the following coupon and effective rates as at 31 January 2012 and 31 January 2011. First Debenture Finance PLC (‘FDF’) - Bonds First Debenture Finance PLC (‘FDF’) - Notes Fintrust Debenture PLC (‘Fintrust’) - Original Loan Fintrust Debenture PLC (‘Fintrust) - Additional Loan 5.875% Secured Bonds 2029 4% Perpetual Debenture Stock 3.65% Cumulative Preference Stock Maturity date Amount borrowed £ 02/01/2018 5,133,520 02/01/2018 20,534,079 Coupon rate 14.75% 14.75% 20/11/2023 30,000,000 9.25125% 20/11/2023 12,000,000 9.25125% 20/12/2029 30,000,000 5.875% n/a n/a 1,375,000 1,178,000 100,220,599 4.00% 3.65% Effective rate since inception* 11.28% 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. 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% (2011 - 8.54%) and the weighted average period to maturity of these liabilities is 12.2 years (2011 - 13.2 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. 60 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Notes to the Financial Statements (continued) for the year ended 31 January 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 2012, 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. The financial assets have minimal exposure to interest rate risk. The Company finances its operations through a mixture of share capital, retained revenue 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 presented in the accounts, as all the borrowings of the Company are subject to fixed rates of interest. (b) 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 table below presents the future cash flows payable by the Company in respect of its financial liabilities. Cash flows in respect of the principal and interest on the Stepped Rate Interest Loan, Fixed Rate Interest Loan and 5.875% Secured Bonds 2029 reflect the maturity dates as set out in Note 10 on pages 54 and 55. The loans are each governed by a trust deed and only if the covenants are breached would early repayment be enforced. Therefore their repayment is not considered to be a likely short term liquidity issue. Cash flows in respect of the 4% Perpetual Debenture Stock and 3.65% Cumulative Preference Stock, which have no fixed repayment date, assumes maturity of 20 years from the balance sheet date. Cash flows have not been discounted. 2012 Creditors - Amounts falling due within one year Finance costs of borrowings Other creditors Derivative financial instruments Creditors - Amounts falling due after more than one year Amounts payable on maturity of borrowings Finance costs of borrowings 2011 Creditors - Amounts falling due within one year Finance costs of borrowings Other creditors Derivative financial instruments Creditors - Amounts falling due after more than one year Amounts payable on maturity of borrowings Finance costs of borrowings 3 months or less £ Not more than one year £ Between one and five years £ More than five years £ Total £ 21,499 9,510,471 843,259 291,625 - - - - - - - - - - - - 9,531,970 843,259 291,625 - 108,587,109 108,587,109 38,127,880 55,307,929 93,435,809 1,156,383 9,510,471 38,127,880 163,895,038 212,689,772 £ £ - 9,531,970 850,846 307,947 - - - - - - £ - - - £ - - - £ 9,531,970 850,846 307,947 - 108,587,112 108,587,112 38,170,877 64,796,902 102,967,779 1,158,793 9,531,970 38,170,877 173,384,014 222,245,654 Other creditors includes trade creditors only, no accrued finance costs are included. 61 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notes to the Financial Statements (continued) for the year ended 31 January Management of liquidity risk Liquidity risk is not considered to be significant as the Company’s assets mainly comprise realisable securities, which can be sold to meet funding requirements if necessary. Short term flexibility can be achieved through the use of overdraft facilities, where necessary. As at the 31 January 2012, the Company had an undrawn committed borrowing facility of £10 million (2011 - £10 million). (c) Credit Risk Credit risk is the risk of default by a counterparty in discharging 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 approved counterparties, thus minimising the risk of default during settlement. The credit ratings of brokers are reviewed quarterly by the Investment Manager. 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 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, 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 Accrued income Other debtors Cash at bank 2012 £ 2011 £ 3,015,885 1,995,817 31,184 38,513 3,047,069 2,034,330 13,398,772 9,257,041 16,445,841 11,291,371 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 including interest on outstanding borrowings due within one year 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 2012 Book value £ 2012 Fair value £ 2011 Book value £ 2011 Fair value £ 34,346,113 48,862,727 34,347,840 46,039,027 46,048,881 63,590,059 46,241,378 56,017,459 29,372,564 35,127,308 29,348,572 29,323,808 1,388,751 1,016,707 1,388,750 1,199,499 789,877 1,199,498 908,553 705,326 112,355,808 149,386,678 112,526,038 132,994,173 The net asset value per Ordinary Share with debt at fair value is 366.2p (2011 - 407.3p). * The fair value has been derived from the closing market value as at 31 January 2012 and 31 January 2011. 62 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Notes to the Financial Statements (continued) for the year ended 31 January FRS 29 ‘Financial Instruments: Disclosures’ has been expanded to include a fair value hierarchy for the disclosure of fair value measurement of financial instruments. As at 31 January 2012, the financial assets at fair value through profit and loss of £511,777,930 (2011 - £542,931,529) are categorised as follows: Level 1 Level 2 Level 3 2012 £ 2011 £ 511,749,961 542,904,104 - - 27,969 27,425 511,777,930 542,931,529 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. 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 comprises: 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 2012 £ 2011 £ 111,020,979 111,185,274 111,020,979 111,185,274 25,803,366 25,803,366 389,221,338 415,042,650 415,024,704 440,846,016 526,045,683 552,031,290 21.1% 20.1% 63 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notes to the Financial Statements (continued) for the year ended 31 January 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 bank 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. The terms of the debenture trust deeds have various covenants which prescribe that moneys borrowed should not exceed the adjusted total of the capital and reserves. These are measured in accordance with the policies used in the annual financial statements. The Company has complied with these. 20. Transaction with the Investment Manager and related parties The amounts paid to the Investment Manager together with details of the investment management contract are disclosed in Note 2. The existence of an independent board of directors demonstrates that the Company is free to pursue its own financial and operating policies and therefore, under FRS8: Related Party Disclosures, the Investment Manager is not considered to be a related party. The Company’s related parties are its directors. Fees paid to the Company’s Board are disclosed in the Directors Remuneration Report on page 39. There are no other identifiable related parties at the year end, an as of 29 March 2012. 64 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Investor Information 65 6565 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Investor Information The Manager RCM (UK) Limited, which is authorised and Market and Portfolio Information The Company’s Ordinary Shares are listed on regulated by the Financial Services Authority, is the London Stock Exchange. The market price, part of Allianz Global Investors, one of the largest price range, gross yield and net asset value are fund managers in the world. As at 31 December shown daily in The Financial Times and The Daily 2011, Allianz Global Investors had combined Telegraph. The net asset value of the Ordinary assets under management of €1,499 billion. RCM Shares is calculated daily and published through (UK), through its predecessors, has a heritage of the London Stock Exchange Regulatory News investment trust management expertise in the UK Service. The geographical spread of investments stretching back to the nineteenth century and at and ten largest holdings are also published 31 March 2012 it had £1.07 billion assets under monthly by the London Stock Exchange Regulatory management in a range of investment trusts. News Service. They are also available from the The Company’s Ordinary Shares are listed on the London Stock Exchange. The market price range, gross yield and net asset value are shown daily in the Financial Website: www.rcm.co.uk Registered Number 28276 Financial Calendar Year end 31 January. Full year results announced and Annual Financial Report posted to Shareholders in April. Annual General Meeting held in May. Interim Management Statements announced in May and November. Full year results announced and Half-Yearly Financial Report posted to Shareholders in September. Ordinary Dividends It is anticipated that dividends will be paid as follows: 1st Quarterly August 2nd Quarterly November 3rd Quarterly February Final May Preference Dividends Payable half-yearly 30 June and 31 December. Investment Manager’s Investors Helpline on Times and The Daily Telegraph under the headings ‘Investment Companies’ and ‘Investment Trusts’, respectively. 0800 389 4696 or via the Manager’s website: www.rcm.com/investmenttrusts. Share Price The share price for 31 January 2012 was 363.0p. Website Further information about the The Merchants Trust PLC, including monthly fact sheets, daily share prices and performance, is available on the Manager’s website: www.rcm.com, which can also be reached via www.merchantstrust.co.uk. 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 389 4696 or on the Managers’ website: www.rcm.com/ investmenttrusts, or from Alliance Trust Savings Customer Services Department on 01382 573737 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 66 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Investor Information (continued) Capita Registrars also offers shareholders an Capita Registrars 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 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; register for e-comms, 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. offer shareholders a free online service called The Share Portal, enabling shareholders to access a comprehensive range of shareholder at their registered address unless other instructions Shareholders can access these services at www. have been given. capitashareportal.com and selecting Share Portal related information. 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 low-cost dealing arrangement. Capita enclose a copy of the Terms and Conditions (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. Registrars and Shareholders’ Enquiries Capita Registrars The Registry, 34 Beckenham and a personalised application form with each Road, Beckenham, Kent BR3 4TU are the dividend payment. Share Dealing Services and Share Portal Capita Registrars, the Company’s Registrars, operate both on-line and telephone dealing facilities for UK resident shareholders with share certificates. 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. 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 by email: ssd.capitaregistrars.com.or by Facsimile: 020 8639 2342. Their website is www. capitaregistrars.com. 67 General enquiries about the Company should be directed to the Company Secretary, The Merchants Trust PLC, 155 Bishopsgate, London, EC2M 3AD. ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Investor Information (continued) Changes of name and address must be notified to the registrars in writing. CREST Proxy Voting Shares held in uncertificated form (i.e., in CREST) Any general enquiries about the Company should may be voted through the CREST Proxy Voting be directed to the Company Secretary, The Service in accordance with the procedures set out Merchants Trust PLC, 155 Bishopsgate, London, in the CREST manual. EC2M 3AD. Telephone: 020 7065 1513. Email: kirsten.salt@uk.rcm.com International Payment Services Capita Registrars, the Company’s registrars, operate an international payment service for shareholders, whereby they can elect either for their dividend to be paid by foreign currency draft or they can request an international bank mandate. This 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 service is only available for dividend payments of www.theaic.co.uk. £10 or more. AIC Category: UK Growth and Income. The International Payment Service will generally cost less than the fees charged by your local bank to convert your sterling dividend into your local Warning to Shareholders We are aware that some shareholders may currency. A £5 administration fee per dividend have received unsolicited telephone calls payment applies. Your dividends are paid as or correspondence concerning investment cleared funds directly into your bank or sent to you matters. These are typically from overseas based as a draft. Capita Registrars, working in partnership with Travelex, will arrange for your dividend to be exchanged into your local currency at competitive rates based on actual market rates. 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 To use this service you will need to register online a discount. at: www.capitaregistrars.com/international or by contacting Capita Registrars as detailed below. For further information on these services please contact: +44 20 8639 3405 (from outside of the UK) or 0871 664 0385 (in the UK) (Calls cost 10p per minute plus network extras. Lines are open between 9.00am and 5.30pm, Monday to Friday) or email IPS@capitaregistrars.com. 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 on the numbers provided above. 68 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Investor Information (continued) 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 Ordinary Shares held Number % 000’s % 2012 2011 2012 2011 2012 2011 2012 2011 6,640 2,471 112 25 9 7 4 44 6,970 3,147 132 28 10 8 3 53 71.3 26.5 1.2 0.3 0.1 0.1 0.0 0.5 67.3 30.4 1.3 0.3 0.1 0.1 0.0 0.5 18,288 79,347 3,081 416 1,764 43 15 259 18,904 78,787 2,758 445 1,651 48 13 607 17.7 76.9 3.0 0.4 1.7 0.0 0.0 0.3 18.3 76.3 2.7 0.4 1.6 0.1 0.0 0.6 9,312 10,531 100.0 100.0 103,213 103,213 100.0 100.0 Based on an analysis of the Ordinary Share register at 22 March 2012 (2011 – 31 March). 69 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notice of Meeting Notice is hereby given that the Annual the Company to allot relevant securities before the expiry of that power which General Meeting of The Merchants Trust PLC (within the meaning of the said would or might require equity securities will be held at Holborn Bars, 138-142 Holborn, Section) up to a maximum number of to be allotted after such expiry and the London EC1N 2NQ on Wednesday 9 May 34,401,047 Ordinary Shares provided Directors may allot equity securities in 2012 at 12 noon to transact the following that: business. (i) the authority granted shall expire one pursuance of such offer or agreement as if that power had not expired. Routine Business 1 To receive and adopt the Report of the Directors and the Financial Statements for the year ended 31 January 2012 together with the Auditors’ Report thereon. 2 To declare a final dividend of 5.8p per Ordinary Share. 3 To re-elect Simon Fraser as a Director. 4 To re-elect Mike McKeon as a Director. year from the date upon which this 12 That the Company be and is hereby Resolution is passed but may be revoked generally and unconditionally authorised or varied by the Company in general in accordance with Section 701 of the meeting and may be renewed by the Companies Act 2006 (the ‘Act’) to make Company in general meeting for a further market purchases (within the meaning of period not exceeding one year; and Section 693(4) of the Act) of Ordinary (ii) the authority shall allow and enable the Directors to make an offer or agreement before the expiry of that authority which Shares of 25p each in the capital of the Company (‘Ordinary Shares’), provided that: would or might require relevant securities (i) the maximum number of Ordinary Shares to be allotted after such expiry and the hereby authorised to be purchased shall Directors may allot relevant securities be 15,471,698; 5 To re-elect Henry Staunton as a Director. in pursuance of any such offer or 6 To re-elect Paul Yates as a Director. 7 To approve the Directors’ Remuneration Report. 8 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. 9 To authorise the Directors to determine 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 the remuneration of the Auditors. provided that: (ii) the minimum price which may be paid for an Ordinary Share is 25p; (iii) 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 (i) the power granted shall be limited to time; Special Business To consider and if thought fit to pass the the allotment of equity securities wholly for cash up to a maximum number of following resolutions. Resolution 10 will 10,321,346 Ordinary Shares; (iv) the authority hereby conferred shall expire at the conclusion of the Annual General Meeting of the Company in be proposed as an Ordinary Resolution and Resolutions 11 and 12 as Special Resolutions: (ii) the power granted shall (unless 2013 or, if earlier, on the expiry of previously revoked or renewed) expire 18 months from the passing of this at the conclusion of the next Annual resolution, unless such authority is 10 That for the purposes of Section 551 of General Meeting of the Company after renewed prior to such time; and the Companies Act 2006 the Directors the passing of this resolution; and (v) the Company may make a contract to be generally and unconditionally authorised to exercise all the powers of (iii) the said power shall allow and enable the purchase Ordinary Shares under the Directors to make an offer or agreement authority hereby conferred prior to the 70 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 THE MERCHANTS TRUST PLC Notice of Meeting (continued) expiry of such authority which will or 5. Duly completed forms of proxy must Companies Act 2006 (“nominated may be executed wholly or partly after reach the office of the Registrars at least persons”). Nominated persons may have the expiration of such authority and may 48 hours (excluding non-business days) a right under an agreement with the make a purchase of Ordinary Shares before the Meeting. pursuant to any such contract. 155 Bishopsgate, London, EC2M 3AD 29 March 2012 6. 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. By Order of the Board euroclear.com/CREST). Kirsten Salt Secretary Notes: 7. 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 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. 1. Members entitled to attend and vote at Company’s Register of Members by close this Meeting may appoint one or more of business on Friday 4 May 2012 (“the 10. Corporate representatives are entitled proxies to attend, speak and vote in their record date”). 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. 8. 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 2. A proxy must vote in accordance with to attend and vote (and for the purpose any instructions given by the member by of determining the number of votes they whom the proxy is appointed. A proxy may cast) at the adjourned Meeting. If, has one vote on a show of hands in all however, the Meeting is adjourned for cases (including where one member a longer period then, to be so entitled, has appointed multiple proxies), except Members must be entered on the where he is appointed by multiple Company’s Register of Members at the members who instruct him to vote in time which is 48 hours before the time different ways, in which case he only has fixed for the adjourned Meeting or, if one vote for and one vote against the the Company gives new notice of the resolution. adjourned Meeting, at the record date 3. A personalised form of proxy is provided specified in that notice. with the Annual Financial Report. Any 9. The right to appoint a proxy does not replacement forms must be requested apply to persons whose shares are held direct from the Registrar. 4. Completion of the form of proxy does not exclude a Member from attending the Meeting and voting in person. on their behalf by another person and who have been nominated to receive communications from the Company in accordance with Section 146 of the 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. 11. 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. 71 ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 JANUARY 2012 Notice of Meeting (continued) 12. Members satisfying the thresholds in 13. As at 29 March 2012, the latest 14. Further information regarding the Section 527 of the Companies Act 2006 practicable date before this Notice is meeting which the Company is required can require the Company, at its expense, given, the total number of Ordinary by Section 311A of the Companies Act to publish a statement on the Company Shares and Preference Stock in the 2006 to publish on a website in advance website setting out any matter which Company in respect of which members of the meeting (including this Notice), relates to the audit of the Company’s are entitled to exercise voting rights was can be accessed at www.rcm.com/ accounts that are to be laid before the 103,213,464 Ordinary Shares of 25p investmenttrusts. meeting. Any such statement must also each and 1,178,000 3.65% Cumulative be sent to the Company’s auditors no Preference Stock of £1 each. Each carries later than the time it is made available on the right to one vote and therefore, the website and must be included in the the total number of voting rights in the business of the meeting. Company is 104,391,464. 15. Contracts of service are not entered into with the Directors, who hold office in accordance with the Articles of Association. Annual General Meeting venue d a l d ’ s R b o e h T e n w e l l R d k r C l e H a t t o n Holborn Bars G a r d e n Holborn H i g h H o l b o r n Holborn Chancery Lane C h a n c e r y L a n e 72 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