Dunedin Smaller Cos. Investment Trust PLC Regulatory News (DNDL)

DUNEDIN SMALLER COMPANIES INVESTMENT TRUST PLC

ANNUAL FINANCIAL REPORT FOR THE YEAR ENDED 31 OCTOBER 2017

LEI: 213800CI43OQT8KBKE03

COMPANY OVERVIEW

The Company

Dunedin Smaller Companies Investment Trust PLC ("the Company") is an investment company with its Ordinary shares listed on the premium segment of the London Stock Exchange. The Company is an investment trust and aims to attract long term private and institutional investors wanting to benefit from the growth prospects of UK smaller companies by investment in a relatively risk averse investment trust.

Investment Objective

The Company's investment objective is to achieve long term growth from a portfolio of smaller companies in the United Kingdom.

Benchmark

The Company's benchmark index is the FTSE SmallCap Index (excluding Investment Companies).

Management

The investment management of the Company has been delegated by Aberdeen Fund Managers Limited ("AFML", the "AIFM" or the "Manager") to Aberdeen Asset Managers Limited ("AAML" or the "Investment Manager"). Both companies are wholly owned subsidiaries of Aberdeen Asset Management PLC (the "Aberdeen Group") which merged with Standard Life plc on 14 August 2017 to form Standard Life Aberdeen plc.

Website

Up-to-date information can be found on the Company's website: www.dunedinsmaller.co.uk

FINANCIAL HIGHLIGHTS

For further information, please contact:

Andrew Leigh

Aberdeen Asset Managers Limited 0207 463 6312

COMPANY OVERVIEW - CHAIRMAN'S STATEMENT

Overview

I am pleased to report a year of strong absolute and relative returns for your Company. The net asset value ("NAV") total return for the year ended 31 October 2017 was 32.8%, a significant outperformance of the benchmark, the FTSE SmallCap Index (ex Investment Companies), which delivered a total return of 21.9%. The share price total return for the year was 28.8%. The discount of the share price to the NAV per share at the year-end was 20.7%, which compared to 17.8% at the beginning of the year. The Board monitors the discount level on an ongoing basis. While the discount at the year end was disappointing, I am glad to report that it has narrowed to 15% at the time of writing.

The Company has continued to benefit from many of the factors highlighted in the Half Yearly Report. Notwithstanding the uncertainties caused by the Brexit vote and the triggering of Article 50 in March, markets rose as a result of increasing global growth and rising investor appetite for risk. In addition, the share prices of those companies with earnings derived from overseas benefited from the boost to corporate profitability caused by the depreciation in Sterling following the Brexit vote in 2016. Smaller companies have also benefited from a recognition that they had been trading at a valuation discount to their larger counterparts. This gap narrowed over the year as the earnings boost that benefited some larger companies that are exposed to recovering commodity prices worked its way through the system to smaller companies.

The positive performance was broadly spread across the portfolio. Areas deserving of special mention include the very strong performance from power converter business XP Power, and specialist electronic design and manufacturer Acal. The Household Goods sector was another area that delivered a material contribution to performance and it is pleasing to note that recent introductions, Cairn Homes and Victoria, both performed particularly strongly. Your Investment Manager seeks to invest for the long term and Dechra Pharmaceuticals is a company that has been in the portfolio for 14 years. It has featured as a significant contributor to performance in previous periods and has done so again this year. Another more recent introduction to the portfolio is litigation finance company Burford Capital. It has had an exceptional year, combining a material acquisition with strong underlying performance and outstanding performance from one asset in particular.

Real Estate is an area of the market that has suffered in the post-Brexit environment. However, the portfolio's exposure to this segment of the market is largely through companies that, whilst cyclical, are less exposed to office and retail markets which have been most severely affected. Consequently, the Company has benefited from being both underweight the sector relative to the benchmark and from its holdings performing more strongly than the benchmark.

More detailed information on performance for the year, including details on changes within the portfolio, is included within the Investment Manager's Review.

The outperformance during the year resulted in the payment of a performance fee to the Manager, details of which are contained in note 4 to the financial statements.

Earnings and Dividends

Revenue earnings per share for the year were 5.42p, compared to 5.98p for the previous year. The primary reasons for this decline were dividend cuts announced by Interserve and Fenner, and the non-recurrence of the special dividend that was paid by Stock Spirits in the prior year.

An interim dividend of 2.15p per share was paid on 28 July 2017. The Board proposes a final dividend of 4.24p per share (2016 - 4.00p) which, subject to approval at the Annual General Meeting, will be paid on 16 February 2018 to shareholders on the register on 19 January 2018.

When combined with the interim dividend, the total dividend for the year will amount to 6.39p (2016 - 6.15p), an increase of 3.9% for the year and in line with the rate of inflation. This is equivalent to a yield of 2.5% based on the year end share price of 253.0p.

As stated in previous Reports, whilst the Company's objective is to achieve long term growth, the Board recognises the importance of income to shareholders and, in order to grow or maintain the dividend in future years, the Board intends, if necessary, to use the Company's substantial revenue and capital reserves to support any portion of the dividend not covered by the year's earnings. Following the payment of the final dividend, revenue reserves per share will amount to 5.11p (2016 - 6.08p), representing 80.0% of the current annual dividend cost.

In addition to the revenue reserve, the Company also has the ability to fund dividend payments from its realised capital reserves which amounted to £80.7 million at the year-end.

Share Buy Backs

The Company did not purchase any of its own Ordinary shares during the period under review. As stated above, the discount at the year-end was 20.7%. The Directors monitor the Company's discount on an ongoing basis, compared to the Company's peer group and also the investment trust sector as a whole, and may use its share buyback powers, subject to market conditions, if it feels this to be appropriate. A resolution to renew the Company's share buy-back authority will be put to shareholders at the Annual General Meeting.

Gearing

The Company finished the year with net debt of £1.3 million representing a de minimis level of gearing. At the year end it had a £5 million revolving credit facility as well as a three year term loan facility of £5 million which was more than offset by cash balances held.

The loan facilities matured on 24 November 2017 and the Company has replaced them with new facility agreements entered into with Scotiabank Europe PLC (the "New Facilities"). The New Facilities are for a five year period to 24 November 2022 and, as with the previous facilities, comprise a £5 million fixed rate term loan and a £5 million revolving credit facility. The £5 million term loan has been fully drawn down at an all-in interest rate of 2.78% per annum. The revolving credit facility is currently undrawn but the Investment Manager will look to invest this as and when it considers it appropriate.

Board Composition

Having served as a Director since 1998 I will retire from the Board at the Annual General Meeting in 2019. The Board will seek to recruit two new independent Directors over the next two years.

Manager

The Board notes the recent completion of the merger between Aberdeen Asset Management PLC ("Aberdeen"), which is the parent company of the Manager, and Standard Life PLC whereby Aberdeen has become the wholly owned subsidiary of Standard Life Aberdeen plc. The Board will continue to monitor developments closely to ensure that satisfactory arrangements are in place for the continued effective management of the Company.

Annual General Meeting

The Annual General Meeting will be held at the offices of Aberdeen Asset Management PLC, 40 Princes Street, Edinburgh EH2 2BY on Thursday 8 February 2018 at 12 noon. In addition to the formal business of the meeting, our portfolio manager, Ed Beal, will provide a presentation on performance for the year and the outlook for smaller companies, and there will also be an opportunity for shareholders to meet informally with the Directors and representatives from the management team at the conclusion of the meeting. An invitation to the meeting is included with the Annual Report and shareholders are requested to complete and return this to the Company Secretary.

Outlook

The outlook for the UK economy is likely to continue to be impacted by the continuing uncertainties around the outcome of the Brexit negotiations. With the recent downgrading of growth forecasts and the expected reduction in inflation as the impact of the depreciation of Sterling works its way through the system, the prospects for further interest rate increases in the near term seem limited. The outlook for the global economy, however, remains reasonably positive and it appears likely that the major central banks will seek to tighten monetary conditions and reduce either the rate or absolute size of their stimulus packages.

With increasing earnings derived from abroad, many smaller companies in the UK are protected from the domestic economic uncertainties. However, following a strong period of performance for equity markets, valuations, particularly those of good quality companies, remain elevated. Although valuations are not stretched by historic standards, this could justify a degree of caution in the event of any form of economic disappointment.

The Investment Manager has continued with its focus of investing in good quality companies run by strong management teams. Notwithstanding any shorter term uncertainties, the Board believes that this approach will be beneficial over the long term and that smaller companies will continue to provide good long terms opportunities for shareholders.

N M Yarrow

Chairman

21 December 2017

STRATEGIC REPORT - OVERVIEW OF STRATEGY

Business Model

The business of the Company is that of an investment company which qualifies as an investment trust for tax purposes. The Directors do not envisage any change in this activity in the foreseeable future.

Investment Objective

The Company's investment objective is to achieve long term growth from a portfolio of smaller companies in the United Kingdom.

Investment Policy

The Company invests primarily in the equity securities of UK smaller companies, with an emphasis on investing in quality companies with good management, strong cash flow, a sound balance sheet and the prospect of dividend growth.

The Company does not typically acquire securities that are unquoted or unlisted at the time of investment (with the exception of securities which are about to be listed or traded on a stock exchange). However, the Company may continue to hold securities that cease to be quoted or listed if the Investment Manager considers this to be appropriate.

The Directors measure the performance of the portfolio relative to the FTSE SmallCap Index (ex Investment Companies) but the Company is unconstrained as to the market sectors in which it may invest. As a result the portfolio is likely to diverge, sometimes significantly, from the benchmark.

Risk Diversification

The Company maintains a diversified portfolio of investments, typically comprising in the region of 40 to 75 holdings (but without restricting the Company from holding a more or less concentrated portfolio from time to time). It is the policy of the Company to invest no more than 15% of its gross assets in any one company and no more than 15% of its gross assets in other listed investment companies (including listed investment trusts).

Gearing

The Directors are responsible for determining the gearing strategy of the Company. Gearing is used with the intention of enhancing long-term returns and is subject to a maximum level of 20% of gross assets at the time the gearing is incurred. Any borrowing, except for short-term liquidity purposes, is used for investment purposes.

Delivering the Investment Policy

The Directors are responsible for determining the investment objective and the investment policy of the Company. Day-to-day management of the Company's assets has been delegated, via the AIFM, to the Investment Manager.

Investment Process

The Investment Manager believes that, over the long term, share prices reflect underlying business fundamentals. A bottom-up investment process is followed, which is based on a disciplined evaluation of companies that includes visits by its fund managers. Company selection is the major source of added value. New investments are not made without the fund managers having first met management of the investee company, undertaken further analysis and written detailed notes to outline the underlying investment merits. A company's value is estimated in two stages: quality then price. Quality is defined with reference to management, business focus, balance sheet and corporate governance. Price is calculated relative to key financial ratios and business prospects.

The Investment Manager's portfolio construction relies upon diversification rather than formal controls guiding stock and sector weightings. The Investment Manager's portfolios are generally run conservatively, with an emphasis on traditional buy-and-hold, top-slicing/topping up being preferred to outright trading and this approach results in low turnover within portfolios. Typically, investee companies have a higher return on equity/assets and lower debt to equity than the market averages.

Benchmark

The Company's benchmark is the FTSE SmallCap Index (excluding Investment Companies).

Key Performance Indicators ("KPIs")

The Board uses a number of financial performance measures to assess the Company's success in achieving its objective and determining the progress of the Company in pursuing its investment policy. The main KPIs identified by the Board in relation to the Company, which are considered at each Board meeting, are shown in the following table:

Principal Risks and Uncertainties

There are a number of risks which, if realised, could have a material adverse effect on the Company and its financial condition, performance and prospects. The risks and uncertainties faced by the Company are reviewed by the Audit Committee in the form of a risk matrix and heat map, and the principal risks and uncertainties facing the Company at the current time, together with a description of the mitigating actions the Board has taken, are set out in the table below. The Board has carried out a robust assessment of these risks, which include those that would threaten its business model, future performance, solvency or liquidity. The principal risks associated with an investment in the Company's shares are published monthly on the Company's factsheet and they can be found in the pre-investment disclosure document ("PIDD") published by the Manager, both of which are on the Company's website.

Promoting the Company

The Board recognises the importance of promoting the Company to prospective investors both for improving liquidity and enhancing the value and rating of the Company's shares. The Board believes an effective way to achieve this is through subscription to and participation in the promotional programme run by the Aberdeen Group on behalf of a number of investment trusts under its management. The Company's financial contribution to the programme is matched by the Aberdeen Group. The Aberdeen Group Head of Brand reports quarterly to the Board giving analysis of the promotional activities as well as updates on the shareholder register and any changes in the make up of that register.

The purpose of the programme is both to communicate effectively with existing shareholders and to gain new shareholders with the aim of improving liquidity and enhancing the value and rating of the Company's shares. Communicating the long-term attractions of the Company is key and therefore the Company also supports the Aberdeen Group's investor relations programme which involves regional roadshows, promotional and public relations campaigns.

Board Diversity

The Board recognises the importance of having a range of skilled, experienced individuals with relevant knowledge in order to allow it to fulfill its obligations. The Board also recognises the benefits, and is supportive, of the principle of diversity in its recruitment of new Board members. However, in making new appointments, the Board's overriding priority is to appoint the most appropriate candidates, regardless of gender or other forms of diversity. The Board has not therefore set any measurable objectives in relation to its diversity.

At 31 October 2017, there were three male Directors and one female Director on the Board.

Employee, Social and Human Rights Issues

The Company has no employees as the Board has delegated day-to-day management and administrative functions to the Manager. There are therefore no disclosures to be made in respect of employees. The Company's socially responsible investment policy is set out below.

Socially Responsible Investment Policy

The Directors, through the Manager, encourage companies in which investments are made to adhere to best practice in the area of corporate governance and socially responsible investing. They believe that this can best be achieved by entering into a dialogue with company management to encourage them, where necessary, to improve their policies in both areas.

The Manager's ultimate objective, however, is to deliver superior investment returns for its clients. Accordingly, whilst the Manager will seek to favour companies which pursue best practice in these areas, this must not be to the detriment of the return on the investment portfolio.

UK Stewardship Code and Proxy Voting as an Institutional Shareholder

Responsibility for actively monitoring the activities of portfolio companies has been delegated by the Board to the Manager which has sub-delegated that authority to the Investment Manager.

The full text of the Company's response to the Stewardship Code may be found on its website.

Modern Slavery Act

Due to the nature of the Company's business, being a company that does not offer goods and services to customers, the Board considers that it is not within the scope of the Modern Slavery Act 2015 because it has no turnover. The Company is therefore not required to make a slavery and human trafficking statement. In any event, the Board considers the Company's supply chains, dealing predominantly with professional advisers and service providers in the financial services industry, to be low risk in relation to this matter.

Global Greenhouse Gas Emissions

The Company has no greenhouse gas emissions to report from the operations of its business, nor does it have responsibility for any other emissions producing sources under the Companies Act 2006 (Strategic Report and Directors' Reports) Regulations 2013.

Viability Statement

The Board considers the Company, with no fixed life, to be a long term investment vehicle but, for the purposes of this viability statement, has decided that three years is an appropriate period over which to report. The Board considers that this period reflects a balance between looking out over a long term horizon and the inherent uncertainties of looking out further than three years.

In assessing the viability of the Company over the review period, the Directors have focused upon the following factors:

- The principal risks and uncertainties set out above and the steps taken to mitigate these risks.

- The ongoing relevance of the Company's investment objective.

- The fact that the Company's portfolio is invested in listed securities.

- The level of gearing. This is closely monitored and the financial covenants attached to the Company's borrowings provide for significant headroom.

- The availability of loan facilities. Borrowings of £10 million are committed to the Company until 24 November 2022.

In making its assessment, the Board has considered that there are other matters that could have an impact on the Company's prospects or viability in the future, including a large economic shock, significant stock market volatility, a substantial reduction in the liquidity of the portfolio, and changes in regulation or investor sentiment. In considering these matters the Board has reviewed the impact of stress testing on the portfolio, including the effects of any substantial future fall in markets.

Taking into account the Company's current position and the potential impact of its principal risks and uncertainties, the Directors have a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due for a period of three years from the date of approval of this Report.

Outlook

The Board's view on the general outlook for the Company can be found in the Chairman's Statement whilst the Investment Manager's views on the outlook for the portfolio are included in its report.

On behalf of the Board

N M Yarrow

Chairman

21 December 2017

STRATEGIC REPORT - RESULTS

Financial Highlights

STRATEGIC REPORT - RESULTS

Performance

Dividends

Ten Year Financial Record

STRATEGIC REPORT - INVESTMENT MANAGER'S REVIEW

Market Review

Smaller companies had a very good year for the period ended 31 October 2017, posting gains that were in excess of twice those registered by their larger counterparts and which were very attractive in absolute terms. The year got off to a slightly weaker start but this was followed by steady progression.

The year began with Donald Trump's unexpected victory in the US Presidential elections, which brought with it an expectation of rising growth and inflation and hence a belief that interest rates would be increased further. This was a significant electoral shock and, coming on the back of the Brexit vote, it raised concerns among investors that there may be further populist disruptions throughout 2017. As it turned out these fears were largely misplaced. A number of European elections, most notably the French Presidential one, passed without major upset.

In the UK, companies were seeking clarity as to what Brexit was likely to mean. Although none was forthcoming, it was positive to see that, despite such uncertainty, the economy was performing rather more strongly than had been feared by some. Indeed, growth expectations for 2016 were increased during the autumn.

Corporate profitability and share prices were boosted by the continuing weakness of Sterling, providing a fillip to markets that might otherwise have been rather more concerned. This effect was evident amongst smaller companies despite much of the associated commentary focussing on the benefits that were accruing to the largest businesses. A corollary of this was that inflation began to pick up.

Markets were very strong as we approached the end of 2016 and it was notable that smaller companies were broadly keeping pace despite their lower exposure to resource stocks which performed well as commodity prices rose on the back of Chinese demand.

Entering the new year, as we considered what 2017 might hold, one thought that struck us was that, despite the wide-ranging geopolitical uncertainty, markets had been operating in a state of near perpetual uncertainty for almost a decade. Changes of government, bank bailouts and even national recapitalisations were not new. A focus on investing in good quality companies that could weather these changes had stood us well and we believed then, and now, that it would continue to do so.

Global growth looked set to pick up during 2017. Drivers of this included the strengthening labour markets in the US, UK and Europe and the improvements in the Brazilian and Russian economies. Meanwhile, wage growth and a higher oil price were pushing inflation upwards. Companies were beginning to talk of Europe being the region where they were performing most strongly and tapering began to creep into investors' thoughts.

Brexit was to the fore during the spring, with the introduction of the Brexit Bill and the triggering of Article 50. In reality this told us nothing and companies were unable to say much of significance regarding how they were planning for something that was accompanied by such uncertainty.

In March, the Federal Reserve increased US interest rates by 0.25% and markets took this in their stride. In the UK, inflation exceeded 3%, indeed it would reach 3.7% by early summer. There was, though, a hope that it would moderate once the impact of currency weakness annualised in the Autumn. Although the UK economy continued to outperform expectations, some caution was warranted because it was being driven by consumption rather than investment. This weak level of investment was a clear manifestation of a general lack of corporate confidence.

The decision by Theresa May to call a snap general election in June was intended to bring some certainty to the European negotiations. The result failed to deliver such clarity and indeed there was not even agreement as to whether it increased or decreased the likelihood of a so called hard or soft Brexit. Markets reacted quite calmly despite the clearly increased risks and equities were again boosted by a weakening of Sterling.

Companies reported first quarter trading statements that were generally positive and in line with, or even ahead of, expectations. Growth was broadly spread with most regions apart from the UK itself performing satisfactorily. Indeed there was evidence that the growth engines of China and the US were actually doing better than the official data suggested. In Europe, another milestone was reached as Italy recapitalised two of its most troubled banks without causing further disruption. In the UK the prognosis was less positive as expectations for future expansion moved firmly into downgrade territory.

By June, the Governor of the Bank of England, Mark Carney, had begun to signal that, despite concerns about pressures on the consumer, the timing of an increase in domestic interest rates was moving closer and, by the early autumn, the focus was clearly on the impact of rising inflation and falling unemployment. A change in policy was imminent.

In many ways, the year ended much as it started: widespread uncertainty as tensions rose between the US and North Korea, the Catalonians tried to secede from Spain, the UK Government flirted with collapse, and political interference in corporate ownership was touted by both the main political parties. But investors continued to focus on the facts, global growth was sound, corporate profitability was increasing and, despite the fact that valuations were some way from being cheap, there were few alternatives to equities for those who wanted a real return.

Portfolio Review

Key contributors to performance during the year included; Burford Capital, Dechra Pharmaceuticals, Smart Metering Systems, XP Power and Robert Walters.

Burford, Dechra and Smart Metering Systems were all significant drivers of performance in the prior financial year as well. Burford Capital has benefited from partial realisations of an asset it holds in the litigation that is ongoing between the Argentinian Government and the prior owners of the nationalised Repsol business. These transactions have indicated that Burford is likely to generate gains on this investment of many multiples of book value.

Dechra Pharmaceuticals has continued to successfully execute its strategy of taking a broader range of both companion and food producing animals' medicines into an increasing number of geographies and to complement this with acquisitions that bring new products and capabilities to add to their portfolio.

Smart Metering Systems is the largest independent installer and owner of smart meters for the domestic markets. This programme is gaining pace and the company has been very successful in winning new contracts which will provide it with a long term and inflation linked portfolio of cash flows.

XP Power have invested significantly in developing a suite of new product families in their core power convertor markets. These products typically operate at higher power levels and with higher levels of efficiency than the previous generations. The company has had considerable success in winning new design approvals, the mission critical nature of the convertors alongside the fact that they are designed in by the group's customers mean that these wins will provide them with long term and persistent revenues. The company has a strong balance sheet and is well positioned to make acquisitions that move them into adjacent markets.

Robert Walters is a recruitment consultancy. They have a very strong franchise in Asia and have therefore been benefitting from the growth in employment in many emerging markets. Additionally they have maintained their presence in European markets throughout the financial crisis. With these markets now recovering, often strongly, the company is reaping the rewards of its prior investment. Lastly, they have developed an outsourced human resource solution called Resource Solutions. They are the only meaningful operator in this market and have been successfully winning a range of blue chip clients.

Among the investments that detracted from performance were; Interserve, Dignity and Ultra Electronics.

Interserve is covered in more detail below.

Dignity are the UK's leading provider of funeral and cremation services. The company's share price has suffered as investors have become concerned that they are losing market share and the impact this may have on their strategy of premium pricing. However, we can think of no other business that has such certainty of demand. In addition this is an industry where word of mouth matters more than elsewhere. In that regard we are comforted that the business has maintained its commitment to the highest levels of service and we believe that there is a demand for these that supports a higher price point than that offered by some of the competition. Lastly, we note data from the Office for National Statistics that suggests that the death rate will gradually increase over time. So whilst the company may lose some share it will be in the context of a larger market.

Ultra Electronics is a defence company. The business has had a difficult few years, in common with many of its peers. Markets have been tough as the Ministry of Defence and, more importantly, the US Department of Defense have curtailed spending. Consequently the business has failed to deliver any organic growth for some time. This is understandable but it has coincided with overly optimistic guidance from the company which has meant that the eventual outcome has been frequent disappointment for investors. Whilst there is no suggestion that the company faces any of the more substantial structural issues that have proven so damaging to some other businesses in the industry, there is no doubt that investor patience has been tested to the limit and scepticism now prevails. Since the year end, the company has announced that it has parted ways with its CEO. We believe that it still has highly regarded products in its niche markets and that the US markets at least have recovered to be a more favourably environment.

Portfolio Activity

We introduced three new holdings during the year.

Victoria is a manufacturer of soft and hard flooring with operations in the UK and Australia.

The industry has some interesting and attractive characteristics. It is highly fragmented, with Victoria the market leader in the UK holding less than 10% share, and number two in Australia with 15%. The company sells largely to independent retailers, which results in very high brand loyalty and hence pricing power. As such, during periods of raw material volatility, Victoria has little difficulty in passing on prices. Because its product is shipped to order, the retailer will benefit from a favourable working capital profile as a result of the deposit they will have secured from the consumer. This cash flows through the supply chain and consequently Victoria have a favourable working capital profile, with a lower level of creditors than would normally be seen at a manufacturer.

The business has been growing through acquisition. As vendors seek an exit, generally through either retirement or a requirement for capital to grow their business, they have few options other than Victoria. Victoria only acquires well-invested assets and will seek to retain the vendor within the business if possible. This allows them to grow their business but to pay relatively lowly valuations. The management are very focussed on return on capital and a minimum of 15% is required. Sales synergies are few, but there are production efficiencies and the opportunity to rebrand acquired products across the existing brand portfolio.

The market is less cyclical than might be thought because of the replacement nature of the product and, crucially, the strength of Victoria's brands and service levels. This has allowed them to take share and continue to grow even when the market itself has struggled.

A buy and build strategy is sensible because there are only three significant carpet markets globally with the largest being the US which is dominated by two behemoths. So whilst acquisitions bring Victoria manufacturing and distribution opportunities they also deliver scale that at some point may be attractive to the larger consolidators in the industry. In the meantime, the favourable working capital dynamics result in a company that generates significant amounts of cash that will initially be used to fund further growth but will eventually be available to reward shareholders.

Subsequent to the year end, Victoria has made a sizeable acquisition in the Spanish ceramic tile market. This will provide them with an additional and meaningful market for growth.

Patisserie Holdings own and operate a number of casual dining brands. The concept revolves around the sale of high quality but artisanal cakes and patisserie to the eat-in and takeaway markets. Casual dining continues to experience structural growth in the UK. The company has a rigid focus on returns rather than store numbers. The products are viewed as a treat by consumers and sales are particularly strong amongst older customers; the 'grey pound' being a market with more resilience than many consumer-exposed industries and also one that is underserved in the casual dining space. The business is vertically integrated which allows them to retain control of the quality of their produce. The management are very experienced and the Chairman, Luke Johnson, who founded the company, ran and sold Pizza Express, and Paul May, the CEO, together own 44% of the company which gives us confidence that they will retain their focus on returns. As and when the brand reaches maturity it will be highly cash generative, the proceeds of which could be returned to investors or used to fund additional brands.

Gresham Technologies is a software company which has built a platform technology called Clareti. Financial institutions typically have to standardise transaction data into the correct format before inputting it onto the SWIFT system. This requires a lot of manual in-house IT work which in turn creates additional cost and, more importantly, adds an increased risk of human error. Regulators around the world are pushing financial institutions to have more robust reconciliation and reporting systems. The Clareti platform is agnostic with regards to the asset class or type of transaction involved and, as such, is well suited to serve the niche but still highly valuable markets that relate to non-standard trades. The company has won accounts with Tier 1 banks in Europe, Australia and, importantly, the US. These provide vital reference sites as they seek to drive sales of their software. Whilst nothing is certain, our expectation is that two of the three most significant hurdles to success have been overcome. Namely, they have successfully deployed their research and development capital to produce a product that works and that solves an existing problem, and they have sold it to a range of serious reference customers. We are hopeful that this will be followed by a material acceleration in sales wins.

We exited five holdings during the year.

Exova is a specialist testing company that we had first invested in during 2015 shortly after its Initial Public Offering. Trading had been tough for some time, especially in its oil and gas exposed operations, though we were content to look through this and focus on an anticipated recovery and future growth. However, the business was bid for by its peer, Element Materials. We engaged repeatedly with the company as we sought to maximise the value we would receive for a company that we had hoped to be invested in for the long term. In the end, the majority shareholder was content to accept the price offered by Element and we had little choice but to recognise that the transaction would proceed.

Berendsen is a European provider of workwear and linen for the hospitality industry and facilities services. The UK business had suffered from under-investment but a sound plan was being enacted by the recently appointed CEO that looked likely to yield a return to growth and solid returns on investment. The long term prospects for the business were recognised by other industry participants and the company was bid for by French competitor Elis. We viewed the bid as opportunistic and believed that it undervalued the business. We engaged with the board and indicated that we would be happy to support them as they executed their stated strategy. Alternatively, if they felt that a sale was the right thing to do then we would require a better price. Ultimately, Elis returned with an improved offer comprising both a higher price and a larger proportion being paid in cash.

Enquest is a North Sea based oil and gas producer. The company was hit very hard by the decline in the oil price which came at a particularly unfortunate time, coinciding with an extensive programme of capital expenditure and just prior to an expected increase in production that would have provided cash flow to service the cost base. The business conducted a rescue rights issue to buy themselves some breathing space as they sought to bring their recently developed Kraken oil field on stream. We participated in the fundraising alongside the debt holders who also granted them more favourable terms. Whilst this was successful in easing the immediate pressures, it still left a business whose fortunes were dependent on two factors. Firstly the oil price probably needed to be sustainably above $60 for there to be long term value for shareholders and, secondly, they needed to execute perfectly with respect to a ramp-up of output from their fields. Our experience is that the nature of this industry means that perfect execution is unusual. We therefore took the decision to exit the holding.

Huntsworth is an international provider of PR services. The company has been struggling for some time, resulting in a change of Chairman, CEO and Finance Director. This brought about a new strategy with a much greater focus on costs. As this improved performance was increasingly recognised by the market the share price responded strongly. Importantly, this was accompanied by much improved liquidity in the shares of this small company. We took this opportunity to exit the position.

Interserve is a construction and support services company with operations in the UK and the Middle East. They entered into a series of Energy for Waste construction contracts that lay outwith their traditional areas of competency. A confluence of events that included their key subcontractor going bankrupt and a very demanding client led to them recognising very significant losses on these projects. Arguably this situation was manageable, however when their core construction and support services businesses also turned down it became clear that their balance sheet was unacceptably strained and that the strategic options available to them were severely constrained. In light of this we took the decision to sell the holding, which completed after the year end.

Other than the placing conducted by Enquest referred to above, four of our holdings conducted equity raises during the year to help grow their businesses.

We participated in a fundraising conducted by life assurer Chesnara to facilitate their acquisition of Legal & General's Dutch business. This was in line with our expectations of their strategy and should allow them to leverage the platform they acquired with the earlier Waard acquisition.

We took part in a placing conducted by Acal, a designer, manufacturer and distributor of specialist electronic components, to help fund their acquisition of Variohm, a designer and manufacturer of switches and sensors. We were happy to support them with this acquisition as we believe that they have a good opportunity to consolidate a fragmented European market. The scale this will bring will be supportive for margins and we believe that it is right that we are prepared to provide equity to help our investments grow where the strategy makes sense to us.

We also participated in a placing conducted by Assura, a company that develops and owns facilities for general practitioners. The company is seeing increasing opportunities to both purchase and develop such facilities. This fundraising will allow them to accelerate the process of building up a portfolio of these assets which provide attractive yields, with growth in rents that are to all intents and purposes government-backed. It will also allow them to retain a suitably conservative balance sheet.

Lastly, we participated in the placing conducted by Ultra Electronics, a niche supplier to the aerospace and defence markets. The company raised equity to help fund its acquisition of Sparton Corporation. Ultra has a joint venture with Sparton for the production of sonobuoys for the US market. The deal will strengthen the company in an area of core competency, move them closer to an important customer and increase their exposure to an area of defence expenditure that is well set for long term growth.

Although not a placing to fund growth we supported Euromoney when their majority shareholder DMGT looked to sell its stake down to less than 50%. We believe that Euromoney is a high quality business capable of delivering long term growth and above average margins and returns. Whilst we have no complaints with DMGT's behaviour during their time as a majority shareholder, we believe that the reduction in their stake will give Euromoney greater strategic freedom in the future.

Stewardship

We believe that, as long term owners of the businesses in which we are invested, it is not sufficient merely to seek out assets that we believe to be undervalued. It is incumbent upon us to take a proactive approach to our stewardship of these companies. Therefore we engage extensively with our investee companies. By their very nature, these discussions often take place with a broader constituency than just the executive management team. They are frequently sensitive and it would be inappropriate to move beyond generalisations in this report. However, we believe it is useful to seek to illustrate the depth of our activity in this area. We have attended a range of meetings with Chairmen, non-executive directors and other stakeholders. Topics covered have included the board composition, an area where we have again successfully engineered change. Risk is a very broad subject that is interpreted in varying manners by different companies. However, by engaging on this subject we secure a deeper understanding of how the boards of our investee companies perceive and seek to manage these issues. Such interactions also enable us to push for improved disclosure and better management practices and on occasion different decisions where appropriate. We have had conversations regarding companies' financing choices. We find that it is always worthwhile communicating our preference for conservatively structured balance sheets that place a company's long term fortunes ahead of possible short term share price gains. Such activity is by its nature time-consumptive but we regard it as an integral aspect of our role as long term investors.

Our endeavours relating to corporate governance are not solely limited to interactions with companies. For instance, we provided a submission to the UK Business Select Committee's corporate governance inquiry.

Outlook

Prospects for the UK may be uncertain but the outlook for the global economy remains reasonably positive. Global growth is running in the region of 3.6% and is expected to strengthen marginally in 2018. In the US, the recovery is continuing, leading to an expectation that interest rates will rise again and that the Federal Reserve may begin to reverse some of the stimulus that it has been deploying. Indeed, the underlying data suggests that both the US and Chinese economies are displaying levels of economic activity consistent with a higher level of growth than that indicated by the current readings for Gross Domestic Product.

The US economy is performing strongly, as illustrated by expectations for a number of further interest rate increases in 2018. However, the political turmoil that surrounds the Trump Administration is raising the risk profile and the need to further extend the debt ceiling could prove problematic.

The Eurozone is increasingly healthy with growth running at its highest level since the start of the financial crisis. The European Central Bank has announced that it will begin tapering, by reducing its asset purchases to €30 billion per month in January. The region has come through a number of potentially damaging elections with its prospects intact and, as such, political risk has given the appearance of reducing over the course of the year, though at the time of writing, failure of the German coalition talks have raised the possibility that Angela Merkel's position will be further weakened.

In aggregate, emerging markets appear well positioned as they benefit from a synchronised increase in global growth. The Chinese economy has grown strongly during 2017 and, although there may be some efforts to curb credit growth, the recent 19th Party Congress suggested that stability and, hence, economic growth remain the priority.

In the domestic economy, inflation has reached 3% and the Bank of England raised interest rates for the first time in seven years. It was notable that the committee remained focussed on the risks to the economy and indicated that further increases were some way off. It is expected that, as the impact of the depreciation of Sterling works its way through the system, so the currency-induced inflationary pressures will begin to ease. The recent autumn budget brought with it a disappointing reduction in growth expectations with the economy now expected to expand by just 1.4% per annum over the next five years. That said, forecasting is implicitly imprecise and the potential ramifications of Brexit, both positive and negative, will almost certainly mean further revisions are necessary. In the meantime, the Chancellor's statement contained some supportive measures, with housing and infrastructure grabbing the headlines. In the absence of material interest rate increases, which do look unlikely from here, one might expect these measures to be supportive of growth even if the consumer will suffer a decline in real incomes until at least the end of 2018.

It is worth remembering that smaller companies are not just a proxy for the UK economy. In aggregate, this part of the market has become increasingly internationalised over the last decade. Although they may lack the breadth of overseas exposure that characterises their larger counterparts, smaller companies do benefit from an increasingly globalised earnings stream. When we consider the portfolio, we can see that it is overweight companies and sectors with a greater level of overseas exposure. Examples include the investments in the Biotechnology & Pharmaceuticals sector, where international research and development budgets, the rising levels of protein consumption in developed and emerging markets and the growth of companion animal care in the US are some of the key drivers. Similarly, when we consider some of the more cyclical industrial areas of the market we hold companies such as BBA Aviation, which is an almost entirely US driven business, or Victrex which derives in excess of 90% of its sales from outside the UK. Conversely, we are underweight areas of the market with more direct consumer or domestic economic exposure such as Real Estate, Leisure Goods, General Retail and Travel & Leisure. Businesses in these sectors may be more at risk from a weakening of consumer or business sentiment as a result of an unfavourable Brexit deal.

Although the major central banks are at different points in the interest rate cycle they are generally pointing towards a tightening of monetary conditions and a reduction in either the rate of or absolute size of their stimulus packages. All of which suggest that policymakers have a broadly favourable view of the outlook. However, we note that valuations, particularly for good quality companies, remain elevated, and any disappointment in the levels of growth has the potential to result in a de-rating of equity valuations.

Ed Beal

Aberdeen Asset Managers Limited

21 December 2017

GOVERNANCE - DIRECTORS' REPORT (EXTRACT)

The Directors present their report and the audited financial statements for the year ended 31 October 2017.

Results and Dividends

The financial statements for the year ended 31 October 2017 are contained below.

An interim dividend of 2.15p (2016 - 2.15p) per share was paid on 28 July 2017 and the Board recommends that a final dividend of 4.24p (2016 - 4.00p) per share is paid on 16 February 2018 to shareholders on the register on 19 January 2018. The ex-dividend date is 18 January 2018. A resolution in respect of the final dividend will be proposed at the Annual General Meeting.

Investment Trust Status

The Company is registered as a public limited company (registered in Scotland No. SC014692) and is an investment company within the meaning of Section 833 of the Companies Act 2006. The Company has been approved by HM Revenue & Customs as an investment trust subject to it continuing to meet the relevant eligibility conditions of Section 1158 of the Corporation Tax Act 2010 and the ongoing requirements of Part 2 Chapter 3 Statutory Instrument 2011/2999 for all financial years commencing on or after 1 November 2012. The Directors are of the opinion that the Company has conducted its affairs for the year ended 31 October 2017 so as to enable it to comply with the ongoing requirements for investment trust status.

Individual Savings Accounts

The Company has conducted its affairs in such a way as to satisfy the requirements as a qualifying security for Individual Savings Accounts. The Directors intend that the Company will continue to conduct its affairs in this manner.

Capital Structure

At 31 October 2017, the Company had 47,857,317 fully paid Ordinary shares of 5p each (2016 - 47,857,317 Ordinary shares). There have been no changes in the Company's issued share capital subsequent to the year end and up to the date of this Report. 

Voting Rights

Each Ordinary share holds one voting right and shareholders are entitled to vote on all resolutions which are proposed at general meetings of the Company. The Ordinary shares, excluding any treasury shares, carry a right to receive dividends. On a winding up or other return of capital, after meeting the liabilities of the Company, the surplus assets will be paid to Ordinary shareholders in proportion to their shareholdings.

There are no restrictions on the transfer of Ordinary shares in the Company other than certain restrictions which may be applied from time to time by law.

Management Agreement

The Company has appointed Aberdeen Fund Managers Limited ("AFML"), a wholly owned subsidiary of Standard Life Aberdeen plc, as its alternative investment fund manager. AFML has been appointed to provide investment management, risk management, administration and company secretarial services to the Company as well as to carry out promotional activities on the Company's behalf. The Company's portfolio is managed by Aberdeen Asset Managers Limited ("AAML") by way of a group delegation agreement in place between AFML and AAML. In addition, AFML has sub-delegated promotional activities to AAML and administrative and secretarial services to Aberdeen Asset Management PLC.

Details of the management fee and fees payable for promotional activities are shown in notes 4 and 5 of the financial statements. The management agreement may be terminated by either party on three months' written notice. In the event of termination by the Company on less than the agreed notice period, compensation is payable to the Manager in lieu of the unexpired notice period.

Substantial Interests

As at 31 October 2017 the following interests in the issued Ordinary share capital of the Company had been disclosed in accordance with the requirements of the FCA's Disclosure Guidance and Transparency Rules:

A Non-beneficial interest

The following changes have been notified to the Company since the end of the year:

- Standard Life Aberdeen plc: 6,620,334 shares (13.8%)

- 1607 Capital Partners LLC: 3,985,800 shares (8.3%)

- Derbyshire County Council: 819,000 shares (1.7%)

There have been no other changes notified to the Company as at the date of approval of this Report.

Corporate Governance

The Company is committed to high standards of corporate governance. The Board is accountable to the Company's shareholders for good governance and this statement describes how the Company applies the principles identified in the UK Corporate Governance Code (the "UK Code"), as published in April 2016 and effective for financial years commencing on or after 1 June 2016, which is available on the Financial Reporting Council's website: frc.org.uk.

The Board has also considered the principles and recommendations of the AIC Code of Corporate Governance as published in July 2016 (the "AIC Code") by reference to the AIC Corporate Governance Guide for investment Companies (the "AIC Guide"). The AIC Code, as explained by the AIC Guide, addresses all the principles set out in the UK Code, as well as setting out additional principles and recommendations on issues that are of specific relevance to investment trusts. The AIC Code and AIC Guide are available on the AIC's website: theaic.co.uk.

The Board considers that reporting in accordance with the principles and recommendations of the AIC Code, and by reference to the AIC Guide (which incorporates the UK Code), will provide better information to shareholders.

The Board confirms that, during the year, the Company complied with the recommendations of the AIC Code and the relevant provisions of the UK Code, except as set out below.

The UK Code includes provisions relating to:

- the role of the chief executive (A.1.2);

- executive directors' remuneration (D.1.1 and D.1.2); and

- the need for an internal audit function (C.3.6).

For the reasons set out in the AIC Guide, and as explained in the UK Code, the Board considers that these provisions are not relevant to the position of the Company, being an externally managed investment company. In particular, all of the Company's day-to-day management and administrative functions are outsourced to third parties. As a result, the Company has no executive directors, employees or internal operations. The Company has therefore not reported further in respect of these provisions.

The full text of the Company's corporate governance statement can be found on its website.

Directors' & Officers' Liability Insurance

The Company maintains insurance in respect of Directors' & Officers' liabilities in relation to their acts on behalf of the Company. Furthermore, each Director of the Company is entitled to be indemnified out of the assets of the Company to the extent permitted by law against all costs, charges, losses, expenses and liabilities incurred by them in the actual or purported execution and/or discharge of their duties and/or the exercise or purported exercise of their powers and/or otherwise in relation to or in connection with their duties, powers or office. These rights are included in the Articles of Association of the Company and the Company has granted indemnities to the Directors on this basis.

Management of Conflicts of Interest

The Board has a procedure in place to deal with a situation where a Director has a conflict of interest. As part of this process, each Director prepares a list of other positions held and all other conflict situations that may need to be authorised either in relation to the Director concerned or his or her connected persons. The Board considers each Director's situation and decides whether to approve any conflict, taking into consideration what is in the best interests of the Company and whether the Director's ability to act in accordance with his or her wider duties is affected. Each Director is required to notify the Company Secretary of any potential, or actual, conflict situations that will need authorising by the Board. Authorisations given by the Board are reviewed at each Board meeting.

No Director has a service contract with the Company although all Directors are issued with letters of appointment. There were no contracts during the year in which any Director was interested.

The Board takes a zero-tolerance approach to bribery and has adopted appropriate procedures designed to prevent bribery. The Manager also takes a zero-tolerance approach and has its own detailed policy and procedures in place to prevent bribery and corruption.

Going Concern

The Company's assets consist substantially of equity shares in companies traded on the London Stock Exchange which are, in most circumstances, realisable within a short timescale. The Board has set limits for borrowing and regularly reviews actual exposures, cash flow projections and compliance with banking covenants. Borrowings of £10 million are committed to the Company until 24 November 2022. As such, the Directors believe that the Company has adequate financial resources to continue in operational existence for the foreseeable future and at least 12 months from the date of this Report. For this reason, they continue to adopt the going concern basis in preparing the financial statements.

Accountability and Audit

Each Director confirms that, so far as they are aware, there is no relevant audit information of which the Company's Auditor is unaware, and they have taken all the steps that they could reasonably be expected to have taken as a Director in order to make themselves aware of any relevant audit information and to establish that the Company's Auditor is aware of that information.

Independent Auditor

The Company's Auditor, KPMG LLP, has indicated its willingness to remain in office. The Directors will place resolutions before the Annual General Meeting to re-appoint KPMG LLP as Auditor for the ensuing year and to authorise the Directors to determine its remuneration.

Relations with Shareholders

The Directors place a great deal of importance on communication with shareholders. Shareholders and investors may obtain up to date information on the Company through its website and the Manager's information service.

The Board's policy is to communicate directly with shareholders and their representative bodies without the involvement of the management group (either the Company Secretary or the Manager) in situations where direct communication is required and representatives from the Board meet with major shareholders on at least an annual basis in order to gauge their views.

In addition, the Company Secretary only acts on behalf of the Board, not the Manager, and there is no filtering of communication. At each Board meeting the Board receives full details of any communications from shareholders to which the Chairman responds personally as appropriate.

The Notice of the Annual General Meeting included within the Annual Report is sent out at least 20 working days in advance of the meeting. All shareholders have the opportunity to put questions at the Company's Annual General Meeting. 

Participants in the Aberdeen Investment Trust Share Plan and ISA, whose shares are held in the nominee name of the plan administrator, are given the opportunity to vote at the Annual General Meeting by means of a Letter of Direction enclosed with the Annual Report. When forwarded to the plan administrator, the voting instructions given in the Letter of Direction will in turn be reflected in the proxy votes lodged by the plan administrator.

By order of the Board

Aberdeen Asset Management PLC

Company Secretary

40 Princes Street

Edinburgh EH2 2BY

21 December 2017

STATEMENT OF DIRECTORS' RESPONSIBILITIES

The Directors are responsible for preparing the Annual Report and financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors are required to prepare the financial statements in accordance with UK accounting standards, including FRS 102 'The Financial Reporting Standard' applicable in the UK and Republic of Ireland.

Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of its profit or loss for that period.

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

- select suitable accounting policies and then apply them consistently;

- make judgements and 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;

- assess the Company's ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and

- use the going concern basis of accounting unless they either intend to liquidate the Company or to cease operations, or have no realistic alternative but to do so.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that its financial statements comply with the Companies Act 2006. They are responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error, and have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Company and to prevent and detect fraud and other irregularities.

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

The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company's website, but not for the content of any information included on the website that has been prepared or issued by third parties. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

We confirm that to the best of our knowledge:

- the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company; and

- the Strategic Report and Directors' Report include a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces.

The Directors consider that the Annual Report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's position and performance, business model and strategy.

On behalf of the Board

N M Yarrow

Director

21 December 2017

STATEMENT OF COMPREHENSIVE INCOME

STATEMENT OF FINANCIAL POSITION

STATEMENT OF CHANGES IN EQUITY

STATEMENT OF CASH FLOWS

NOTES TO FINANCIAL STATEMENTS