Annual Report and Financial Statements for the year ended 31 May M&G High Income Investment Trust P.L.C.

Transcription

1 M&G Investment Trust Annual Report and Financial Statements for the year ended 31 May 2015 M&G High Income Investment Trust P.L.C.

2 Contents Investment Objective Page 1 Financial Calendar Page 1 Financial Highlights Page 1 Company Profile Page 2 Chairman s Statement & Management Report Page 3 Investment Review Page 5 Portfolio of Investments and Statistics Page 7 Strategic Report Page 10 Directors Report Page 13 Corporate Governance Page 16 Directors Remuneration Report Page 20 Independent Auditors Report Page 22 Financial Statements Income Statement Page 25 Reconciliation of Movements in Shareholders Funds (Capital Shares) Page 25 Balance Sheet Page 26 Cash Flow Statement Page 27 Net Asset Values (per Share) Applicable to Each Class of Shareholding Page 27 Notes to the Financial Statements Page 28 Other Regulatory Disclosures Page 35 Notices of Meetings Page 36 Performance History Page 42 Shareholder Information Page 43

3 Investment Objective The investment objective of M&G High Income Investment Trust P.L.C. ( the Company ) is to achieve an above average and increasing income over the 20 year life of the Company while at the same time seeking to achieve capital growth. Financial Calendar Financial Highlights KEY DATES Year end 31 May 2015 Fourth interim dividend: Ex-dividend 30 July 2015 Share register close 31 July 2015 Payment 25 August 2015 Annual General Meeting 1 September 2015 FUTURE DIVIDEND TIMETABLE It is expected that dividends will be declared and paid quarterly as follows: Declaration date Ex-dividend date Payment date First interim 7 October October November 2015 Second interim 20 January January February 2016 Third interim 13 April April May 2016 Fourth interim 20 July July August 2016 TOTAL RETURNS for the year ended 31 May Package Unit (mid-market price) 10.7% 10.3% Package Unit (NAV) 8.8% 11.8% FTSE All-Share Index 7.5% 8.9% FTSE 350 Higher Yield Index 2.6% 8.5% Total returns include income reinvested. EARNINGS AND DIVIDENDS in respect of the year ended 31 May change Earnings per Package Unit (revenue) 6.44p 6.14p 4.9% Fourth interim dividend per Package Unit 2.00p 1.80p 11.1% Total dividend per Package Unit 6.60p 6.10p 8.2% Earnings per Package Unit were calculated using the weighted average shares in issue during the year. As at 31 May 2015 the amount standing to the revenue reserves is 1.09p per Package Unit. YIELDS as at 31 May Package Unit (mid-market price) 3.8% 3.7% Package Unit (NAV) 3.6% 3.5% FTSE All-Share Index 3.3% 3.3% FTSE 350 Higher Yield Index 4.7% 4.6% PERFORMANCE as at 31 May change Net assets attributable to all shareholders ( 000) 451, , % Package Unit mid-market price p p 6.7% Package Unit NAV p p 5.0% Package Unit discount 3.3% 4.9% An analysis of the Company s performance is set out in the Chairman s Statement & Management Report and the Investment Review on pages 3 to 6. The net asset value (NAV) applicable to each class of shareholding as at 31 May 2015 is set out on page 27, and the annual performance is set out on page 42. ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY

4 Company Profile Directors Fred Carr (70). Chairman. Appointed as a non-executive director in January 1997, he is also Chairman of India Capital Growth Fund Ltd. A Fellow of the Chartered Institute for Securities & Investment. William Nott (53). Appointed as a non-executive director in July 2010, he is also Chief Executive Officer of M&G Securities Limited. Alex Murray (67). Chairman of the Audit and the Remuneration and Management Engagement Committees. Appointed as a nonexecutive director in January Chairman of Silverdart Limited, a publishing company, and a director of Mallory Holdings Limited. Andrew Martin Smith (63). Appointed as a non-executive director in October An adviser to Guinness Asset Management Limited. He also holds a number of directorships including Atlantis Japan Growth Fund Limited, T.R. European Growth Trust PLC, Church House Investments Limited and Chairman of Parmenion Capital Management Limited. Capital structure The Company was incorporated on 23 December 1996 and is a split capital investment trust company with three share classes (Zero Dividend Preference Shares, Income Shares and Capital Shares). Shares may be purchased as individual share classes or as Package Units (comprising one Zero Dividend Preference Share, one Income Share and one Capital Share) or as Income & Growth Units (comprising one Income Share and one Capital Share). On winding-up, holders of Zero Dividend Preference Shares are entitled to receive p per share, or such lesser sum as remains, after the distribution of any balance standing to the revenue reserve, out of the final net assets of the Company on 17 March On winding-up, holders of Income Shares will be entitled to a return of capital of 70p per share, subject to the prior entitlement of the Zero Dividend Preference Shareholders, plus any balance standing to the revenue reserve. This means that a large proportion of their value lies in the future dividend stream of the Company. Capital Shareholders will be paid the balance of net assets after the prior capital and revenue entitlement of the Zero Dividend Preference and Income Shareholders has been met in full. Holders of Zero Dividend Preference Shares and Capital Shares are not entitled to receive dividends out of the revenue or any other profits of the Company. Full details of the entitlement and voting rights of each share class can be found in note 14 to the financial statements. Investment risk Investors should be aware that there can be no certainty that the predetermined capital entitlements for the Zero Dividend Preference Shares and Income Shares can be achieved on the planned windingup date. Investors should also be aware that the net asset value of the Income Shares and Capital Shares can fluctuate as can the market value of the underlying assets and that there can be no certainty that the investment objectives can be achieved. Winding-up As an investment company with a limited life, the Company will wind up on or immediately prior to 17 March Management company The investment manager is M&G Securities Limited, a subsidiary of M&G. M&G is one of the oldest and largest investment managers in the UK and is the investment management arm of Prudential plc in the UK and Europe. It had assets under management of over 269 billion as at 31 March Established in 1931, M&G introduced Britain s first ever unit trust and in 1971 launched M&G s first split capital investment trust. Since then a further five investment trusts and two closed-ended investment companies have been launched, including rollover vehicles for trusts that have come to the end of their lives. To date all M&G s investment trusts and closed-ended investment companies have been split capital companies which offer a wider range of investment opportunities for investors than single class companies. With effect from 21 July 2014, the Company appointed M&G Securities Limited as its Alternative Investment Fund Manager (AIFM) in order to comply with the requirements of the Alternative Investment Fund Managers Directive which came into effect on 22 July As the Company s AIFM, M&G Securities Limited s responsibilities include both portfolio and risk management. Also, on 21 July 2014, M&G Securities Limited appointed M&G Investment Management Limited (another M&G subsidiary) to undertake the portfolio management role, so the change to the contractual framework will not result in any change to roles and responsibilities in this connection. Management fee The management fee charged monthly on the Company s total assets less current liabilities is at the following tiered annual rates: 1% on the first 75m 0.9% on the next 125m 0.8% on the excess over 200m Individual Savings Accounts The affairs of the Company have been conducted so that its shares are qualifying investments for inclusion in Individual Savings Accounts. It is the intention of the directors that the Company s affairs will be managed so that the shares continue to enjoy this status. 2 ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY 2015

5 Chairman s Statement & Management Report Performance during the year The Company s revenue earnings for the period were 6.44p per Package Unit, 4.9% higher than the total of 6.14p reported at the same stage last year. This advance was derived from increases in ordinary dividends received over the review period from the majority of companies held by the Company, aided by the dollar s strength against sterling. As at the year end, the historic dividend yield on the mid-market price of the Company s Package Units was 3.8%, compared with the yield of 3.3% on the FTSE All-Share Index. On a net asset value (NAV) basis, each Package Unit delivered a total return of 8.8% over the 12 months to 31 May This was above the returns of the FTSE 350 Higher Yield Index and the FTSE All-Share Index, which rose 2.6% and 7.5% respectively over the same period. Over the review period, the discount to NAV narrowed from 4.9% to 3.3%, the mid-market price at the period end being 176.0p and the NAV p. On a mid-market price basis each Package Unit produced a total return of 10.7%. This performance continues the Company s impressive long-term record, which has seen its NAV return exceed that of the FTSE All-Share Index over one, two, three, four, five and 10 years, and since inception. For a detailed description of the management of the portfolio during the period, I refer you to the Investment Review on pages 5 and 6. Dividends During the 12 months to 31 May 2015, the Company has declared total dividends of 6.6p per Income share, comprising two interim dividends of 1.5p, a third interim of 1.6p and a fourth interim of 2.0p. This represents an increase of 8.2% compared with the total of 6.1p per Income share for the previous year. The increase is well above the latest annual rate of inflation (1.0% in May) as measured by the Retail Prices Index (RPI). Unhelpfully for dividend payouts, sterling strengthened against the dollar in the first half of 2014 and a significant proportion of UK companies report their earnings in the US currency. However, a currency headwind turned into a tailwind in the second half of 2014 and that has continued into the first half of 2015 as the dollar has strengthened. So far this year, dividend announcements have generally been positive and we have seen a continuation of the trend in special dividends, with, notably for the Company, Synthomer, Direct Line, Booker and Jupiter Fund Management all returning spare cash to shareholders. In addition, the market s dividend cover is positive and the outlook for corporate earnings growth remains encouraging, despite the prospect of curbs in government spending, the slowdown in the resources sectors and dividend cuts by the supermarket operators. Therefore, and in the absence of unforeseen circumstances, the Directors expect to increase dividend payments in the current year, enhanced by drawing further on the revenue reserves, which we plan to distribute in full when we declare the fourth interim dividend in Recent market conditions UK equities made satisfactory progress during the Company s financial year, but the market experienced some volatility in the process as concerns over global growth and monetary policy decisions challenged risk appetite. In particular, in 2014 share prices were in decline from the autumn, as falling commodity prices bore down on the resources sectors and investors worried about the extent of the slowdown in China and deflation taking hold in the eurozone. However, from the beginning of 2015 sentiment improved markedly, boosted by the European Central Bank s announcement of a huge monetary stimulus programme, which it has indicated will last well into next year. In addition, a weak first quarter for the US economy and a decline in inflation in the UK was treated as good news by investors as the data was interpreted as delaying the timing of the first upward move in interest rates since the financial crisis, with the US now expected to take the lead later this year. Notably in the UK, an important milestone was passed in March this year when the blue chip FTSE 100 Index of larger companies broke through the 7,000 mark, finally surpassing the high reached 15 years ago during the short-lived Dotcom boom. Changes to Investment Policy The Company is approaching the end of its planned life and is due to be wound up on 17 March The Board believes it would be beneficial to Shareholders as a whole, for the Company to have the ability to use derivatives, including equity index options, in certain market conditions during the run up to the wind-up date, so as to lock in a proportion of the value of the Company s assets while retaining exposure to a market increase, if it is in the best interests of Shareholders to do so. M&G has considerable expertise in the use of derivative instruments which are used across a broad range of its funds. The Board has instructed the manager to keep under review, and advise the Board upon, opportunities for the cost-effective employment of such instruments as described above while balancing the benefits of such protection against the costs of such a strategy. The aggregate exposure of the Company to derivatives will not exceed 35% of its gross assets at the time at which any derivative contract is entered into. The revised investment policy of the Company, with the proposed changes highlighted in green, can be found at pages 10 and 11. In order to approve the proposed changes to the investment policy of the Company, Shareholders will need to approve Ordinary Resolution 10 as set out in the Notice of Annual General Meeting (on page 39) together with each Special Resolution 1 as set out in the Notices of Separate General Meetings of each of the Zero Dividend Preference, Income and Capital Shareholders (on pages 36 to 38). The Board believes that these changes proposed to the investment policy of the Company are in the best interests of the Company, the Shareholders as a whole and each class of Shareholders, and it unanimously recommends that you vote in favour of the resolutions noted above on which you are entitled to vote. This does not imply any commitment to the eventual use of derivatives; we merely seek the ability to use these powers if it seems desirable. ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY

6 Chairman s Statement & Management Report VAT litigation In the 2014 Annual Report and Financial Statements, I reported that the Court of Appeal was due to hear an appeal in October 2014 in relation to the High Court judgement in the case being coordinated by PWC on behalf of a number of investment trusts in liquidation. The Court of Appeal heard the appeal and its judgement allows investment trusts to recover historic VAT payments on investment management fees directly from HMRC. However the Supreme Court has recently granted leave for an appeal against the Court of Appeal s judgement. It is hoped that the Supreme Court will hear the appeal in early 2016 and that by the time of the next Report and Accounts we will have had its judgement. The timing of the judicial process is however outside our control. Treasury shares Over the 12 months to 31 May 2015, no Package Units were bought by the Company to hold in treasury. There are currently no Package Units held in treasury. Outlook In May, the market briefly rallied in response to the re-election of the Conservatives with an overall majority for a new parliamentary term, as the result removed the prospect of increased levies and regulation on the corporate sector under a Labour administration. However, the outcome of the election means that the UK now faces further austerity measures and the potential consequences of a referendum on its continued membership of the European Union in at most two years time, and the possible effect on business of a vote in favour of an exit. In the short term, the remainder of 2015 is likely to prove quite testing as investors fret about US interest rates and Greece. Encouragingly, dividend announcements outside the resources sectors have generally been positive so far this year on the back of a satisfactory earnings season and a stronger US dollar. Companies also continue to return cash to shareholders in the form of special dividends and share buybacks, which is helping to underpin the market. A more broad-based recovery is likely to occur when companies start to increase their capital expenditure, which in turn should result in a pickup in productivity this remains low and was acknowledged by the Chancellor in a post-election speech to the CBI to be holding back the economy. Mergers and acquisitions have returned after two years of relative inactivity, as companies seek to take advantage of low borrowing costs and strong share prices, in a somewhat unsatisfactory alternative to organic growth, to increase their earnings. Against this backdrop, I remain confident that the Company s consistent investment approach and diversified portfolio is well placed to continue delivering above-market returns and increase its dividend again this year. F C Carr Chairman 22 July ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY 2015

7 Investment Review Although economic activity has slowed in the first quarter of 2015, this is thought to be temporary and followed the UK s strongest year of growth in 2014 since before the global financial crisis. Furthermore, in the three months to April, the unemployment rate was 5.5%, which is not far off the Bank of England s interpretation of full employment from an inflation perspective, while average weekly pay increased by 2.7% year on year. At the same time, the Consumer Prices Index, after a brief dip into deflation in April, rose by 0.1% in the year to May, largely due to falling fuel and food prices. In this environment, as a whole, UK stocks performed relatively well during the 12 months, although the first part of the reporting period in particular was somewhat volatile. The oil & gas and mining (resources) sectors, which represent around a fifth of the FTSE 100 Index, acted as the main drag on the market. Resources stocks have been affected by the impact of falling commodity prices since last summer, especially oil. In addition, economic weakness in the eurozone, the UK s major export market, was accompanied by the renewed threat of a Greek exit from the region with the election of an anti-austerity government in Athens in January on a mandate to renegotiate the terms of the bailout agreement. However, investors were able to shrug off the negative influences, with sentiment buoyed in particular by the European Central Bank s (ECB s) launch of a 1 trillion quantitative easing (QE) programme in March to fight deflationary forces in the eurozone. Furthermore, it seemed unlikely that UK interest rates would be raised anytime soon with inflation so low. There was a marked increase in merger and acquisition activity over the period, driving a strong performance in the insurance and telecoms sectors in particular. In the former, Aviva merged with Friends Life, and US-based XL acquired Lloyd s reinsurer Catlin. In the latter, BT bought EE to acquire a mobile phone network. Towards the end of the period, taking advantage of weak share prices in the energy sector, Royal Dutch Shell announced a 47 billion bid for BG in what could turn out to be the biggest deal this year. Reflecting moves in global equity markets, especially the US, the FTSE All-Share Index achieved an all-time high in April. In general, with the UK economy one of the fastest-growing in the G7 last year, more domestically focused, medium-sized companies outperformed the market. Similarly, more economically sensitive sectors, such as technology, industrials, consumer goods and financials excluding banks, tended to perform well. The latter were beset by scandals and fines from the regulators. On the other hand, aside from the telecoms and insurance sectors, more defensive and higher yielding sectors of the market achieved lower returns on average. Utilities, meanwhile, were affected by the announcement of an investigation by the Competition and Markets Authority and an Ofwat price review in the water sector. However, the worst performers were to be found amongst the resources sectors, which were under pressure from falling commodity prices. Fixed income investments also performed well during the review period, benefiting from subdued inflation and new monetary policies from the ECB which have kept downward pressure on interest rates. At the same time, world events, including the unrest in Ukraine and concerns over Greek solvency, led investors to favour safe-haven assets such as government bonds. The FTSE British Government All Stocks Gilt Index rose 10.2% during the period, with the yield on the 10-year gilt falling from 2.7% at the end of May 2014 to 1.8% at the end of the review period. Factors affecting performance Overall, the Company was positioned very well for the market conditions throughout the year, enabling it to deliver another solid return, to end the 12 months ahead of the FTSE All-Share Index. This was due to pursuing a successful strategy at the market capitalisation level, together with good sector allocation and stock selection. At the market capitalisation level, the Company benefited from an emphasis on medium-sized and smaller companies at the expense of larger ones, together with good stock selection, particularly in mid-cap industrials. Nevertheless, the income-producing, larger company element, which makes up the greater part of the portfolio, enabled the dividend to be increased over the Company s financial year. At a sector level, within financials, the Company benefited from a larger-than-market allocation to insurers and fund managers, which have seen their assets participate in the equity market s upward movement, and from a lower position in banks. In addition, there was a strong contribution from maintaining above-market weightings in economically sensitive sectors such as industrials and software, whilst keeping lower weightings in mining and energy companies. There was also a mixed performance from the consumer sectors. An emphasis on media companies whilst de-emphasising supermarket operators added value. However, the housebuilders subtracted value as they have been very strong over the past 12 months; the Company has some exposure to them, but is limited by the sector s generally low income-producing properties. Amongst the most notable performers for the Company at a stock level was speciality plastics manufacturer Essentra, the UK s largest software company, Sage, insurer Friends Life and doorstep lender Provident Financial. Essentra s performance was both resultsdriven and a reflection of a well-received acquisition. The market has been very impressed by Sage s new chief executive, Stephen Kelly, who has previously led Chordiant, a NASDAQ-listed technology group and helped to turn around Micro Focus. Friends Life was taken over by Aviva. Strong growth from Provident Financial s Vanquis Bank and the improving economic backdrop helped to lift the company s full-year results. Some value was lost at the stock level, however, and the principal companies involved were miner BHP Billiton, banknote printer De La Rue, electronic parts distributor Electrocomponents and pharmaceutical giant GlaxoSmithKline. The Company holds BHP Billiton, along with Rio Tinto, on value grounds as they are amongst the largest and most diversified miners with relatively low production costs compared to many other miners. De La Rue has come under pressure from overcapacity in the market and aggressive pricing by rivals. Electrocomponents experienced profit-taking after announcing disappointing results. GlaxoSmithKline continues to be overshadowed by bribery allegations in China and a poor drugs pipeline, but remains an important contributor to the Company s income generation. The fixed income portion of the portfolio, which is mainly invested in highly rated corporate bonds, delivered a positive return over the 12 months. With investment grade credit spreads broadly flat over the period, the strong underlying performance of government bond markets was the main driver of returns. High quality bonds also benefited from their safe haven qualities at certain points of the 12- month period, for example, in early 2015 when plummeting oil prices, negative inflation numbers, the snap election in Greece and the confirmation of a larger-than-expected QE package from the ECB temporarily drove investors to seek so-called safe haven assets. ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY

8 Investment Review Portfolio changes During the Company s reporting year, apart from a slight increase in the portfolio s exposure to medium-sized, or mid-cap, companies and a similar reduction in the larger company exposure, the broad thrust of the portfolio was unchanged. Most of the portfolio remains overweight in the more defensive and higher income-earning sectors of the market, whilst generally avoiding the lower yielding, higher beta segments. The preference for medium-sized, and for that matter smaller companies too, tends to reflect the portfolio s holdings in the industrials and chemicals sectors. Given the Company s income objective, much of the activity over the year under review was concentrated on growing the dividend. There was also a focus on increasing the portfolio s exposure to companies growing their dividends at a faster-than-average rate to improve the Company s future income prospects. Overall, activity on the portfolio remained relatively low, though. The opportunity was taken to realise profits in some of the larger company holdings that had outperformed, such as property group Land Securities, doorstep lender Provident Financial, food distributor Booker Group, aerospace & defence firm BAE Systems, Anglo-Dutch media group Reed Elsevier, water company United Utilities and consumer goods company Unilever. There was also the complete disposal of shares in supermarket operator Tesco after the accounting errors came to light. The Company had a lower-than-market weighting in the shares, which had been positive for performance in relative terms, although regrettably the value of the holding fell in absolute terms. The Company did not hold Sainsbury s or Morrisons, which also fell significantly over the reporting period. Examples of the theme of increasing the Company s exposure to companies growing their dividends at a faster-than-average rate to improve its future income prospects were two new holdings, mediumsized housebuilders Bellway and Bovis Homes. They also included retailer WH Smith, packaging manufacturer and recycler DS Smith, a bank, Close Brothers, and Lloyd s insurer Amlin, where existing positions were increased. Aside from the two housebuilders, which have decent land banks and are well placed to tap into the growing demand for housing, in the medium-sized company segment, small positions were also established in investment group Jupiter Fund Management, which represented a way of increasing the fund s exposure to non-bank financials, and N Brown, the outsize clothing retailer, where share price weakness enabled the Company to buy the shares at an attractive yield. Share price weakness was also used to top-up some of the Company s larger company holdings, including banking group Standard Chartered, miner BHP Billiton and Royal Dutch Shell. Trading activity was relatively light within the bond portion of the Company s portfolio, with an emphasis on more defensive areas such as the insurance, telecoms and retail sectors. The portfolio s overall level of credit risk was reduced slightly over the period through the sale, amongst others, of some bonds issued by Heineken and Deutsche Telekom following strong performance. With the proceeds, a position was increased in AAA rated supranational bonds issued by the European Investment Bank. The Company continues to hold a modest allocation to short-dated index-linked gilts; however, part of this position was switched to conventional gilts, given the likelihood that inflation will remain subdued in the short term. Outlook The UK economy has been growing at around its long-term trend and, once again, the all-important consumer is the main driving force, while manufacturing continues to trail behind as is the case with the US and across Europe. The last 12 months in the UK have witnessed a welcome pickup in wage growth combined with a reduction in unemployment and inflation. Although there are good reasons to expect the economy to slow a little, we believe that the sharp fall in the oil price and raw materials costs since last summer will boost household consumption and the corporate sector in Oil prices have staged a recovery this year, but by the end of May, Brent crude for example was still 45% below last summer s peak. The market has paused for breath, since achieving a new high towards the end of the reporting period. However, some retrenchment was to be expected after a strong start to 2015, the mixed nature of economic data releases and the eleventh-hour brinkmanship over Greece s bailout package. There are other factors that could cause uncertainty. These include the timing of the first increase in interest rates since the financial crisis, geopolitical tensions in the Middle East and Europe, the impact on the West of the sanctions regime against Russia which is due to be renewed, the slowing economy in China and the ending of the 35- year bull market in bonds. In the medium term, investors are likely to start worrying about the referendum on EU membership and what a potential exit from the union could mean for business. With regard to interest rates, an unexpected pickup in inflation money supply data in the US and Europe are pointing to incipient inflationary pressures six months to a year away could prompt central banks to start to tighten monetary policy sooner and by more than the markets are discounting. Growing awareness of this possibility has been blamed for some sharp upward moves in bond yields recently, albeit they still remain at historically very low levels. In this uncertain environment, we continue to rely on our tried and tested investment formula. The main strength of the Company s investment portfolio is its broad structure, with its emphasis on equities offering above-average yields based on sustainable dividends, together with a weighting of a little over 5% in good quality bonds. We place great importance on effective stockpicking, take a long-term investment view and tend to maintain a low level of portfolio turnover. Nevertheless, as active managers, we continue to closely monitor holdings, taking profits on those considered to be fully valued and reinvesting the proceeds into securities offering better value. By following these investing principles, we are confident that the Company will continue to deliver returns, which meet its stated objectives. The equity content is at a high point and the reduction in bonds over the last few years has benefited the Company. The intention this year is to move back towards our normal allocation of 15% in fixed income securities, positioned defensively in short-dated issues, while improving the liquidity of the equity portfolio. M&G Investment Management Limited 22 July ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY 2015

9 TOTAL RETURNS AS AT 31 MAY 2015 Package Unit Package Unit FTSE All-Share FTSE 350 Higher mid-market price NAV Index Yield Index Cumulative % % % % Six months One year Three years Five years Since inception Annualised % % % % Three years Five years Since inception Total return Portfolio of Investments and Statistics March 1997 = 100, plotted monthly Chart date 31 May Package Units (market price) Package Units (NAV) Source: M&G Statistics Department Total returns include income reinvested. Income growth March 1997 = 100, plotted annually Chart date 31 May Net dividend per year Past performance is not a guide to future performance. FTSE 350 Higher Yield Index FTSE All-Share Index UK Retail Prices Index HURDLE RATES & COVER The hurdle rates and cover in the table below can be compared to the annualised capital return on each Package Unit of 3.21% (2014: 3.10%). Zero Dividend Preference Shares as at 31 May Final entitlement hurdle rate % % Final entitlement cover 1.44x 1.36x Based on a final entitlement of p per Zero Dividend Preference Share. Income Shares as at 31 May Final entitlement hurdle rate 4.73% 4.98% Current market value hurdle rate 1.40% 3.25% Based on a final entitlement of 70p per Income Share and a current market value of 58.88p (2014: 61.00p) per Income Share. The hurdle rate represents the annual compound rate by which the net assets attributable to shareholders as at 31 May 2015 need to grow, if positive, or can fall by, if negative, each year in order to meet the above entitlements and takes account of expenses chargeable to capital until winding-up of the Company on 17 March The cover is the ratio of net assets attributable to shareholders to the final entitlement value and takes account of expenses chargeable to capital until the winding-up of the Company on 17 March PACKAGE UNITS Year for the year ended 31 May 2015 High Low end Mid-market price p p p NAV p p p Discount 0.58% 8.88% 3.30% TURNOVER LEVEL for the year ended 31 May Sales as a percentage of average net assets attributable to shareholders 9.0% 13.9% Sales excludes the movement of surplus cash placed into the Northern Trust Global Fund - Sterling. MAJOR PORTFOLIO CHANGES DURING THE YEAR ENDED 31 MAY 2015 Purchases 000 Sales 000 Standard Life 2,640 Verizon Communications 3,666 British Sky Broadcasting Group 1,958 Johnson Matthey 3,557 European Investment Bank FRN ,553 Standard Life 2,629 UBM 1,549 Unilever 1,988 Treasury 1.75% ,434 Provident Financial 1,942 Lloyds Banking Group 1,404 BBA Aviation 1,872 Acal 1,341 Tesco 1,561 Intermediate Capital Group 1,272 Treasury 1.25% IL ,435 Bovis Homes Group 1,208 Land Securities Group 1,243 Smith (D.S.) 1,144 GlaxoSmithKline 1,119 Ten largest aggregate purchases 15,503 Ten largest aggregate sales 21,012 Northern Trust Global Fund - Sterling [a] 34,174 Northern Trust Global Fund - Sterling [a] 31,509 Other purchases 19,766 Other sales 18,259 Total purchases [b] 69,443 Total sales 70,780 [a] Uncommitted surplus cash is placed into AAA rated money market funds with the aim of reducing counterparty risk. [b] Including transaction costs and stock dividends. ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY

10 Portfolio of Investments and Statistics TWENTY LARGEST HOLDINGS AS AT 31 MAY 2015 Holding 000 % [a] Sector Royal Dutch Shell B 18, Oil & gas producers GlaxoSmithKline 18, Pharmaceuticals & biotechnology HSBC Holdings 17, Banks BP 17, Oil & gas producers AstraZeneca 16, Pharmaceuticals & biotechnology Essentra 14, Support services British American Tobacco 14, Tobacco Vodafone Group 12, Mobile telecommunications Aviva 9, Life insurance BT Group 8, Fixed line telecommunications Ten largest holdings 149, Sage Group 8, Software & computer services Rio Tinto 8, Mining Legal & General Group 8, Life insurance Unilever 7, Food producers Imperial Tobacco 7, Tobacco Reed Elsevier 7, Media Close Brothers Group 7, Financial services BTG 7, Pharmaceuticals & biotechnology National Grid 7, Gas, water & multi-utilities United Utilities 6, Gas, water & multi-utilities Twenty largest holdings 225, [a] Percentage of total portfolio of investments. PORTFOLIO OF INVESTMENTS as at 31 May Holding 000 % % Oil & gas producers ,000 BG Group 3, ,825,000 BP 17, ,000 Royal Dutch Shell B 18, Chemicals ,000 Johnson Matthey 4, ,200,000 Synthomer 4, Mining ,000 BHP Billiton 6, ,000 Rio Tinto 8, ,000 South Aerospace & defence ,000 BAE Systems 2, Construction & materials ,000 Bellway 1, ,000 Carillion 1, ,650,000 Low & Bonar 3, ,000 Marshalls 2, Electronic & electrical equipment ,000,000 Acal 2, ,000 Halma 3, ,000 Morgan Advanced Materials 2, General industrials ,000 Smith (D.S.) 2, ,000 Smiths Group PORTFOLIO OF INVESTMENTS (continued) as at 31 May Holding 000 % % Industrial engineering ,000 Melrose Industries ,000 Vitec Group 5, Industrial transportation Support services ,000 Berendsen 6, ,000 Bunzl 4, ,300,000 Connect Group 2, ,000 De La Rue 1, ,400,000 Electrocomponents 3, ,500,000 Essentra 14, ,000 Premier Farnell 1, Beverages ,000 Britvic 2, ,000 Diageo 4, Food producers ,000 Tate & Lyle 2, ,000 Unilever 7, Household goods ,657 Bovis Homes Group 1, Leisure goods ,000 Games Workshop Group 1, Tobacco ,000 British American Tobacco 14, ,000 Imperial Tobacco 7, Pharmaceuticals & biotechnology ,000 AstraZeneca 16, ,000,000 BTG 7, ,250,000 GlaxoSmithKline 18, Food & drug retailers ,750,000 Booker Group 6, General retailers ,000 Brown (N.) Group ,000 Halfords Group 1, ,090 WH Smith 2, Media ,000 British Sky Broadcasting Group 4, ,000 Informa 2, ,000,000 Moneysupermarket.com 3, ,000 Pearson 3, ,000 Reed Elsevier 7, ,000 UBM 4, Travel & leisure ,000 Greene King 2, ,250,000 Marston s 3, ,000 National Express Group 2, ,150,000 William Hill 4, Fixed line telecommunications ,000,000 BT Group 8, ,750,000 KCOM Group 1, ,000 TalkTalk Telecom 2, Mobile telecommunications ,000,000 Vodafone Group 12, Gas, water & multi-utilities ,600,000 Centrica 4, ,000 National Grid 7, ,000 Severn Trent 5, ,000 United Utilities 6, Banks ,825,000 HSBC Holdings 17, ,750,000 Lloyds Banking Group 1, ,958 Standard Chartered 2, Equity investment instruments ,470 Finsbury Growth & Income Trust 1, ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY 2015

11 Portfolio of Investments and Statistics PORTFOLIO OF INVESTMENTS (continued) as at 31 May Holding 000 % % Financial services ,000 3i Group ,000 Ashmore Group 2, ,000 Close Brothers Group 7, ,000 Intermediate Capital Group 2, ,000 Jupiter Fund Management ,000 Provident Financial 5, ,000 Tullett Prebon 1, Life insurance ,782,000 Aviva 9, ,753 Chesnara 1, ,100,000 Legal & General Group 8, ,000,000 Old Mutual 2, ,000 Prudential 2, Non-life insurance ,000 Amlin 1, ,000,000 Direct Line Insurance Group 3, ,025,000 Standard Life 4, Real estate investment trusts ,000 Great Portland Estates 4, ,074 Hansteen Holdings 1, ,000 Land Securities Group 3, ,125,000 McKay Securities Group 2, ,000 Mucklow (A. & J.) Group 1, ,015,519 Raven Russia 1, ,295,673 Redefine International 1, ,024,237 Segro 4, Software & computer services ,500,000 Sage Group 8, Non-convertible preference shares ,500,000 Aviva 8.75% Cum. Irrd. Pref. 2, ,000 General Accident 8.875% Cum. Irrd. Pref. 1, ,435 Raven Russia 12.0% Cum. Irrd. Pref ,000 RSA Insurance 7.375% Cum. Irrd. Pref ,000 Standard Chartered 7.375% Non-cum. Irrd. Pref ,000 Standard Chartered 8.25% Non-cum. Irrd. Pref. 1, AAA credit rated bonds ,545,000 European Investment Bank FRN , ,000 KfW 5.55% ,000 Residential Mortgage Securities FRN ,120,000 Treasury 1.25% IL , ,416,000 Treasury 1.75% , ,000 Treasury 4.75% 2015 [b] AA credit rated bonds ,000 Rabobank Nederland 3.25% ,000 GE Capital UK 4.125% A credit rated bonds ,000,000 Anheuser-Busch InBev 6.5% , ,000 AT&T 5.875% ,000 British American Tobacco 5.5% ,000 Centrica 5.5% ,818 Granite Master Issuer FRN ,000 Hammerson 5.25% ,000 HSBC Holdings Var. Rate ,000 JPMorgan Chase 5.375% ,000 London Merchant Securities 6.5% PORTFOLIO OF INVESTMENTS (continued) as at 31 May Holding 000 % % A credit rated bonds (continued) 150,000 London Stock Exchange Var. Rate ,000 Motability Operations Group 5.25% ,000 National Grid Gas 6% ,000 Rolls-Royce 7.375% ,000 Segro 5.25% ,000 Standard Life Var. Rate Perp ,000 Wells Fargo 5.25% BBB credit rated bonds ,000 Bank of America 5.25% ,000 BSkyB Finance UK 5.75% ,000 Carlsberg Breweries 7.25% ,000 G4S Var. Rate ,000 Go-Ahead Group 5.375% ,000 Heathrow Funding 6.25% ,000 Imperial Tobacco Finance 5.5% ,000 London Power Networks 5.125% ,000 National Express 6.25% ,000 NEXT 5.875% ,000 Phoenix Natural Gas Finance 5.5% ,000 Reed Elsevier Investments 5.625% ,000 Rentokil Initial 5.75% ,000 Tesco 6.125% , ,000 United Business Media 6.5% Bonds with no credit rating ,000 John Lewis 6.125% ,000 Safeway 6.125% Unquoted / unlisted ,250 National Grid (Energis) 6% Conv Polestar (Exch Shs) - - AAA rated money market funds [a][b] ,495,000 Northern Trust Global Fund - Sterling 6, Total portfolio of investments 452, [a] Uncommitted surplus cash is placed into AAA rated money market funds with the aim of reducing counterparty risk. [b] Cash equivalents. ANALYSIS OF ECONOMIC SECTORS as at 31 May Economic sector % % Financials Industrials Healthcare Consumer goods Consumer services Oil & gas Short to long-dated instruments Telecommunications Utilities Basic materials Technology Portfolio of investments ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY

12 Strategic Report The directors present the strategic report for the Company for the year ended 31 May The strategic report has been prepared in accordance with the Companies Act 2006 (Strategic Report and Directors Report) Regulations Its purpose is to help shareholders assess how the directors have performed their duty to promote the success of the Company during the year under review. The strategic report should be read in conjunction with the Chairman s Statement and Management Report on pages 3 to 4, the Investment Review on pages 5 to 6 and the analyses on pages 7 to 9, which all form part of the strategic report. Together these give a detailed review of the investment activities for the year and an outlook for the future. Business review Business of the Company The Company was incorporated on 23 December 1996 and is a split capital investment trust company with three classes of share: Zero Dividend Preference Shares, Income Shares and Capital Shares. The Company is an investment company within the meaning of section 833 of the Companies Act 2006 and operates as such. HM Revenue & Customs have confirmed, on the basis of the information provided to them, the Company s status as an investment trust for the purposes of Section 1158 of the Corporation Tax Act 2010 for the financial year to 31 May Since 1 June 2014, the Company s affairs have been directed so as to enable it to continue to qualify for such approval. So far as the directors are aware, the Company is not a close company within the meaning of the Corporation Tax Act The activities of the Company are expected to be substantially unchanged in the forthcoming year. The Company s principal business activity of investment management is sub-contracted by the Company s Alternative Investment Fund Manager, M&G Securities Limited, to M&G Investment Management Limited (MAGIM) subject to the ultimate supervision of the board of directors. The Company s Articles of Association provide that the directors shall convene an extraordinary general meeting on or immediately prior to 17 March 2017, (or if that date is not a business day then on the immediately preceding business day) at which a resolution will be proposed requiring that the Company be wound-up voluntarily. Shortly before that date M&G may seek to put forward proposals which allow shareholders to maintain their investment should they wish to do so. The Company is a member of the Association of Investment Companies (AIC) and applies the Statement of Recommended Practice: Financial Statements of Investment Trust Companies issued in January 2009 to its financial statements. The Company announces its net asset values for all classes of shares and units to the London Stock Exchange at the end of each business day. Investment objective The Company s investment objective is to achieve an above average and increasing income over the 20 year life of the Company while at the same time seeking to achieve capital growth. Capital structure Full details of the entitlements and voting rights of each share class can be found in note 14 to the financial statements. Investment policy As noted in the Chairman s Statement on page 3, a proposal is being put forward at the Annual General Meeting of Shareholders and at the Separate General Meetings of each of the Zero Dividend Preference, Income and Capital Shareholders to seek approval from Shareholders to amend the investment policy of the Company. The existing policy is set out below with the proposed paragraph (iv) highlighted in green. For further details regarding the rationale behind the proposed changes, please refer to pages 3 and 14. (i) Asset allocation The Company s portfolio comprises mainly high yielding ordinary shares of UK companies listed on the London Stock Exchange. A significant proportion of the portfolio will be made up of companies outside the FTSE 100 Index. At any one time, such stocks shall represent between 5 and 35% of the portfolio; more typically they will represent between 10 and 25% of the portfolio. A small proportion of the portfolio may consist of convertible and other fixed interest securities. These will not exceed 30% of the portfolio and will more typically represent around 15%. The investment manager may invest in unquoted companies suitable for the Company s investment style. Such investments will not exceed 1% of the portfolio. (ii) Risk diversification In addition to the above high level asset allocation limits, the Company achieves risk diversification in a number of ways, inter alia: (a) The sector weightings for the Company s equities portfolio will not usually deviate from those of the FTSE All-Share Index by more than 10% but during periods of exceptional volatility this deviation may increase (whether inadvertently or advertently) by a further 5%. The equities portfolio will usually comprise between 60 and 120 holdings. (b) The fixed income portfolio may include both corporate bonds and gilts and all or part of the exposure to these asset classes may be gained through holdings in collective investment schemes. The weightings will be diversified by issuer, maturity, coupon and credit ratings and, in the case of corporate bonds, by industrial sector. (c) The Company would not expect its portfolio weighting in any one stock to exceed 10% except as a result of market movement and in any event, such weighting shall not exceed 15%. (d) The Company will not invest in any securities issued by split capital investment trusts or split capital investment companies. (e) The Company will also not invest more than 15% of its gross assets in other listed investment companies (including listed investment trusts). (iii) Gearing The Company s investment policy does not include gearing the portfolio. 10 ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY 2015

13 Strategic Report (iv) Derivatives The Company may use derivatives, including equity index options, to protect the capital value of the portfolio against downside equity market risk where such protection can be purchased for a reasonable price..the aggregate exposure of the Company to derivatives will not exceed 35% of its gross assets at the time at which any derivative contract is entered into. (v) Management fee We keep under review the allocation of the investment management fee between revenue and capital, in view of our expected long-term returns. (vi) Social responsibilities The directors have regard to the social responsibilities of the companies in the portfolio of investments but place no restriction on the scope of the investment manager with respect to its remit other than achieving above average returns in line with the investment policy. For details of the investment manager s corporate responsibility statement see page 19. Performance The Board takes a long-term view when measuring the Company s performance against its investment objective and uses a number of financial key performance indicators (KPIs). These KPIs measure the Company s performance over both the short and long term and include a review of total returns, dividend growth, discount to NAV, hurdle rates and cover. In addition, the Board has given careful consideration as to the selection of a suitable benchmark for the Company and has concluded that none of the available published indices provide on their own an ideal benchmark for direct comparison. However, the Board believes that comparison against the equity market as a whole using the FTSE All-Share Index is helpful provided that the Company s high income requirement is taken into account. The Board also believes that the FTSE 350 Higher Yield Index provides a useful indicator as to how high yielding stocks are performing, although it appreciates the need for caution in using this index given the extreme weightings within its composition. The Board has also selected a group of investment trusts and openended investment vehicles with broadly similar objectives to those of the Company against which the Company s performance is compared. The Board regularly reviews the composition of the group, so as to ensure that the selected trusts remain a suitable basis for comparison. Total return Since inception the total return from the Company s Package Units on a net asset value (NAV) basis has outperformed the FTSE All-Share Index. During the year to 31 May 2015 each Package Unit produced a total return of 8.8% on a NAV basis. This was ahead of the total returns of 2.6% from the FTSE 350 Higher Yield Index and 7.5% from the FTSE All-Share Index over the same period. Further details are disclosed on page 7. Dividend growth Apart from the reduction in dividend in 2011, the Company has increased its total dividends each year against the previous year since its launch in A graphical representation of this is shown on page 7. In addition, two special dividends totalling 1.50p were paid in 2008 and The directors have declared a fourth interim dividend of 2.0p per Income Share which, together with the three interim dividends already accounted for gives a total in respect of the year to 31 May 2015 of 6.6p per Income Share. As described on page 3 this was an increase on the total dividend of 6.1p for The fourth interim dividend will be paid on 25 August 2015 to Income Shareholders on the register on 31 July At the year end, the yields on the Company s Package Units and Income & Growth Units (mid-market price) were 3.8% and 10.7% respectively, compared with the yield of 3.3% on the FTSE All-Share Index. Revenue for the year The net revenue return on ordinary activities after taxation for the year was -4,911,000 (2014: 600,000) after accounting for dividends of 21,043,000 (2014: 14,780,000) and has been transferred from reserves. This, together with the balance brought forward of 7,630,000 (2014: 7,030,000), gives retained revenue reserves of 2,719,000 (2014: 7,630,000) after deduction of the fourth interim dividend. Discount The mid market price discount to the Package Unit NAV narrowed from 4.9% to 3.3% over the year, the mid-market price at the year end being p and the NAV p. There are currently no Package Units held in Treasury. Hurdle rates, cover and NAV Hurdle rates and cover measure the Company s ability to meet the redemption value of the Zero Dividend Preference Shares and the capital entitlement of the Income Shareholders on winding-up. As at 31 May 2015 the redemption value of the Zero Dividend Preference Shares of p was covered 1.44 times. This means that net assets attributable to shareholders could fall by 17.88% per annum before being unable to cover the redemption value. As at 31 May 2015 the Company s net assets attributable to shareholders would need to grow by 4.73% per annum in order for the Income Shareholders to receive a capital return of 70p on the winding-up of the Company. The NAV per Capital Share decreased from 5.07p to 4.61p over the year and the mid-market price decreased by 15.3%. Principal risks & uncertainties The key risks and uncertainties facing the Company are set out below. The Board reviews and considers the management of these risks at its quarterly board meetings. There are additional risk disclosures on page 10 and in note 18 on pages 32 to 34. ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY

14 Strategic Report Market risk Uncertainty about future market prices and other factors such as bond rates may affect the ability of the Company to meet its objective. Income / dividend risk The ability of the Company to meet its objective to achieve an increasing income over the Company s life is dependent on the income received from the portfolio of investments. This in turn is dependent on the profitability of the corporate sector and the general economic environment. These factors are monitored by the investment manager and income forecasts are reviewed by the Board quarterly. Performance risk Investment performance may not meet the Company s objective as a result of falling markets and the Company s shares may become unattractive to investors leading to a fall in the share prices and also a widening of the discount against NAV. To control performance risk, the investment manager monitors the portfolio s composition and relative exposure to the FTSE All-Share Index (the index that most closely reflects the returns available from the UK market). Subject to the income constraints, the investment manager keeps the sector and individual stock variances within reasonable levels and keeps cash balances to a minimum. The Board monitors the investment manager s performance and discusses portfolio changes and performance at its quarterly meetings. To reduce the impact of default by any one issuer, the investment manager invests in bonds issued by a broad spread of companies and institutions. Discount risk The level of discount of the Package Unit share price to its NAV is outside the Board s control. However, the share buy back policy in place may provide an effective mitigation by reducing any excessive discounts that may arise. Investment trust status The Board and the investment manager monitor compliance with Section 1158 of the Corporation Tax Act 2010 in order to ensure that the Company maintains its investment trust status. Loss of such status would result in investment gains becoming subject to capital gains tax. Control environment at service providers As an investment trust with no employees the Board places reliance upon the control environment of the Company s service providers. These controls are monitored through quarterly reporting by the investment manager and review of the control reports from service providers. Regulatory risk Unforeseen changes in the regulatory environment may affect the Company s structure and financial results. Gender representation At the year end there were four male directors on the Board. The Company has no employees and has not therefore reported further on gender representation within the Company. The Company s policy on diversity is detailed in the Corporate Governance Report on pages 16 to 19. Corporate responsibility The Board is conscious of its corporate responsibility but given that the Company s business is solely concerned with investments, it believes it is sufficient and appropriate to endorse the investment manager s corporate responsibility statement, an extract of which is set out on page 19. The Company has therefore not reported further on environmental matters, employees and social, community and human rights issues. The Company s annual and half year reports are printed on carbon balanced paper, whereby the carbon impact of the production and distribution process has been balanced, or offset, by the World Land Trust, an international conservation charity. Voting Rights and the Stewardship Code The Company delegates all voting rights arising from its investments to M&G Securities Limited, as its Alternative Investment Fund Manager, which in turn delegates voting rights to M&G Investment Management Limited, the investment manager, which is committed to active voting as an integral part of its investment approach, believing that the exercise of voting rights both adds value and protects the interests of shareholders. Further details of the investment manager s approach to voting and in particular its compliance with the Stewardship Code can be found on the M&G corporate website: Outlook The outlook for the Company is dependent upon the investment climate and the investment manager s ability to manage the portfolio within the guidelines set by the Board. Further details are given in the Investment Review on pages 5 and 6. Approved by the Board of Directors F C Carr Chairman Laurence Pountney Hill, London EC4R 0HH 22 July ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY 2015

15 Directors Report The directors present their report and the audited financial statements for the year ended 31 May Management arrangements The Board has considered carefully the continued appointment of M&G Securities Limited as Alternative Investment Fund Manager ( AIFM ) to the Company. In considering the appointment of M&G Securities Limited to this role, the Board has noted the robust processes which M&G Securities Limited has in place for risk management and investment oversight both in relation to its role as Authorised Corporate Director to M&G s range of open-ended funds and the Company s activities. Whilst M&G Securities Limited s responsibilities as the Company s AIFM include portfolio management, the Board notes that M&G Securities appointed M&G Investment Management Limited (MAGIM) to manage the Company s portfolio with effect from 21 July In this connection, the Board notes that MAGIM s consistent strategy of investing in a combination of high yielding equities and fixed income securities has borne fruit. Since inception, the strategy has delivered a higher total return than the FTSE All-Share Index. Apart from the reduction in dividend in 2011, the Company has increased its total dividend each year since its launch in The Company s investment management contract with M&G Securities Limited includes the following terms. M&G Securities Limited is entitled to an annual fee, payable monthly in advance. The management fee charged monthly on the Company s total assets less current liabilities is at the following tiered annual rates: 1% on the first 75m 0.9% on the next 125m 0.8% on the excess over 200m M&G Securities Limited s appointment may be terminated by not less than one year s written notice, although in certain circumstances it may be terminated with immediate effect. The independent directors are of the view that M&G Securities Limited is well placed to act as the Company s AIFM. State Street Bank ( State Street ) has responsibility for the Company s net asset calculations, tax and financial reporting functions. M&G Financial Services Limited (MGFS) provides company secretarial and related support to the Company. So long as a wholly owned subsidiary of M&G Limited (M&G) manages the investments of the Company, MGFS will not levy any charges on the Company for the provision of the services it continues to provide and will meet the costs levied by State Street. The Board is satisfied with the efficiency with which these administration services continue to be undertaken. Equiniti is the Company s registrar. In addition to the above-mentioned role, State Street acts as the Company s banker and custodian. National Westminster Bank (appointed by M&G Securities Limited in its role as the Company s AIFM) acts as the Company s depositary in relation to the Company s assets. The responsibilities of the depositary include cash monitoring, safe-keeping of assets, oversight duties and the delegation and segregation of assets held in custody. Employees The Company has no employees. Individual Savings Accounts The affairs of the Company have been conducted so that its shares are qualifying investments for inclusion in Individual Savings Accounts. It is the intention of the directors that the Company s affairs will be managed so that the shares continue to enjoy this status. Disclosures in accordance with Section 992 of the Companies Act 2006 The following information is disclosed in accordance with Section 992 of the Companies Act 2006: The Company s capital structure and details of voting rights attaching to shares are summarised on pages 31 and 32. Details of substantial shareholders are disclosed on page 17. Rules concerning the appointment and replacement of directors are contained in the Company s Articles of Association and are discussed on page 16. Amendments to the Company s Articles of Association and authority for the directors to issue or buy back the Company s shares require a special resolution of the shareholders. There are no restrictions regarding the transfer of the Company s securities, no special rights with regard to control attached to the Company s securities, no agreements between holders of the Company s securities regarding their transfer known to the Company, and no agreements to which the Company is party that might be affected by a change of control following a takeover bid. There are no agreements between the Company and its directors concerning compensation for loss of office. Authority for the directors to allot shares At the time of the launch of the Company investors were offered the opportunity to hold their Income & Growth Units (I&G Units) or Package Units in a Personal Equity Plan managed by MGFS either by way of a lump sum investment or a regular savings scheme. MGFS previously offered a similar facility for holding I&G Units or Package Units in an Individual Savings Account managed by MGFS (The M&G ISA), however with effect from 6 April 2013, M&G ceased offering the Company s I&G Units for future investment in The M&G ISA. Existing I&G Unit holdings within such accounts were unaffected, and M&G continues to offer the Company s Package Units for investment in The M&G ISA for all new and existing investors, as well as a facility for the reinvestment of dividends on such holdings. Where the prevailing market price is less than the net asset value per Package Unit, MGFS would normally operate the reinvestment option by buying Package Units in the market. Should at any stage the prevailing market price be not less than the net asset value per Package Unit, this demand may instead be met by MGFS subscribing for further Package Units from the Company. In the year to 31 May 2015, no Package Units were issued out of treasury in relation to the reinvestment of dividends. Over the forthcoming year, the Company wishes to be in a position to issue new shares to facilitate the above procedure in accordance with its undertaking in the original Prospectus. However, ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY

16 Directors Report it can only issue new shares if the directors of the Company are so authorised by the shareholders. Resolution 9 of the Notice of Annual General Meeting set out on page 39 would authorise the directors for a period until the earlier of the next Annual General Meeting or 30 November 2016, to allot 25,050,351 shares of each class of share capital in issue having a maximum nominal value in aggregate of 751,511 equivalent to 10% of the current issued share capital. Special Resolution 11 enables the directors to issue up to 12,525,175 shares of each class of share capital in issue by way of rights, or for cash up to an aggregate nominal amount of 375,755 (being 5% of the nominal value of all the shares currently in issue) otherwise than in accordance with the pre-emption rights conferred on shareholders by statute. This power, combined with the directors authority to allot shares, will facilitate the subscription by MGFS of shares for cash. The directors feel that it is in the Company s best interests for shareholders to vote in favour of these resolutions. Any money subscribed by MGFS would be invested by the Company, on behalf of all shareholders, in line with its investment objectives. Investment policy change The Company is approaching the end of its planned life and is due to be wound up on 17 March The Board believes it would be beneficial to Shareholders as a whole, for the Company to have the ability to use derivatives, including equity index options, in certain market conditions during the run-up to the wind-up date, so as to lock in a proportion of the value of the Company s assets while retaining exposure to a market increase, if it appears to be in the best interests of Shareholders to do so. For further details regarding the rationale behind the proposed changes to the investment policy, please refer to the Chairman s Statement at page 3. For the complete investment policy of the Company (including the proposed changes, which are highlighted in green) please refer to pages 10 and 11. The proposed addition to the investment policy of the Company is also set out below: (iv) Derivatives The Company may use derivatives, including equity index options, to protect the capital value of the portfolio against downside equity market risk where such protection can be purchased for a reasonable price. The aggregate exposure of the Company to derivatives will not exceed 35% of its gross assets at the time at which any derivative contract is entered into. The Board considers that the changes proposed to the investment policy of the Company are in the best interests of the Company, the Shareholders as a whole and each class of Shareholders, and it unanimously recommends that you vote in favour of the resolutions noted above on which you are entitled to vote. This does not imply any commitment to the eventual use of derivatives; we merely seek the ability to use these powers if it seems desirable. Authority for the directors to buy back shares The directors believe that the power to buy back and cancel Package Units provides an effective means of reducing the discount on their unit price. In the year to 31 May 2015 no units were repurchased and cancelled. The directors also believe that the authority to buy back shares to hold Package Units in treasury, as an alternative to their immediate cancellation, supplements market liquidity in the Package Units and provides a useful alternative to the allotment of new shares pursuant to Special Resolution 12 of the Notice of Annual General Meeting on page 40 for meeting demand for additional Package Units arising from the reinvestment facility referred to in the section Authority for the directors to allot shares above. In the year to 31 May 2015 no Package Units were repurchased and placed in treasury. If the powers set out in Special Resolution 12 of the Notice of Annual General Meeting on page 40 are renewed, Package Units held in treasury will be subject to the following restrictions: (1) Regulatory restrictions: (a) (b) a maximum of 10% of the Company s entire issued share capital (including Treasury Shares) may be held in treasury; and the maximum price payable for Treasury Shares acquired through the exercise of share buy back powers is 105% of the average of the prevailing mid-market price for the previous five business days. (2) Additional restrictions imposed by the Board: (a) (b) (c) Package Units will be sold from treasury at a narrower discount than the weighted average at which they were bought in and the aggregate dilution arising from reissue shall not exceed 0.5% of the Company s NAV in any 12 month period; Package Units held in treasury shall be automatically cancelled on the 12 month anniversary of their first being held in treasury; and Treasury Shares shall not be sold at a discount of greater than 4% to their prevailing net asset value. Special Resolution 12 together with each of the Special Resolutions in the Notices of Separate General Meetings of the Zero Dividend Preference, Income and Capital Shareholders set out on pages 36 to 38, will, if approved, authorise the Company (i) to buy back and cancel up to million of each of its issued Zero Dividend Preference Shares, Income Shares and Capital Shares (equivalent to 14.99% of the Company s shares in the market), and (ii) buy back and hold in treasury up to 10% of the Company s shares subject to the restrictions set out above. The directors consider that the proposal by the Company to have the ability to purchase its own shares is in the best interests of the shareholders taken as a whole. Recommendation and voting intentions The directors unanimously recommend all shareholders to vote in favour of each of the resolutions on which they are entitled to vote, as they intend to do so in respect of their own beneficial holdings of shares detailed on page 21. Special Resolution 13 of the Notice of Annual General Meeting set out on page 40 will, if approved, authorise the calling of general meetings (other than annual general meetings) on not less than 14 clear days notice in accordance with the requirements of the Companies (Shareholders Rights) Regulations The directors consider that it is in the interests of shareholders to vote in favour of this resolution, which will allow general meetings to be called on shorter notice periods than would otherwise be possible. 14 ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY 2015

17 Directors Report Action to be taken Enclosed are the relevant forms of proxy which relate to your holding. The forms of proxy concern (i) the Separate General Meetings of the Zero Dividend Preference Shareholders, Income Shareholders and Capital Shareholders, and (ii) the Annual General Meeting. The forms are in the following colours: Blue: for use by the Zero Dividend Preference Shareholders in relation to the Separate General Meeting of the Zero Dividend Preference Shareholders; Yellow: for use by the Income Shareholders in relation to the Separate General Meeting of the Income Shareholders; Green: for use by the Capital Shareholders in relation to the Separate General Meeting of the Capital Shareholders; and White: for use by the Income Shareholders and Capital Shareholders in relation to the Annual General Meeting. Holders of Package Units should complete all four forms. Holders of Income and Growth Units should complete the yellow, green and white forms. Whether or not you propose to attend any of the meetings, you are requested to complete and return the relevant forms of proxy as soon as possible in accordance with the instructions printed thereon. The completion and return of any forms of proxy will not prevent shareholders from attending and voting in person should they so wish. The forms of proxy should be returned as soon as possible to Equiniti, Aspect House, Spencer Road, Lancing, West Sussex BN99 6DA. CREST members who wish to appoint a proxy or proxies through the CREST electronic proxy appointment service may do so by using the procedures described in the CREST Manual. Directors responsibilities The directors are responsible for preparing the Annual Report, the Directors Remuneration Report and the Financial Statements in accordance with applicable law and regulations. Company law requires the directors to prepare financial statements for each financial year. Under that law the directors have prepared the financial statements in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law). Under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the net return / (loss) of the Company for that period. In preparing these financial statements, the directors are required to: select suitable accounting policies and then apply them consistently; make judgements and accounting estimates that are reasonable and prudent; and state whether applicable UK Accounting Standards have been followed, subject to any material departures, disclosed and explained in the financial statements respectively. The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company s transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements and the Directors Remuneration Report comply with the Companies Act They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. The financial statements are published at which is a website maintained by M&G. The maintenance and integrity of the website maintained by M&G or any of its subsidiaries is, so far as it relates to the Company, the responsibility of M&G. The work carried out by the auditors does not involve consideration of the maintenance and integrity of this website and accordingly, the auditors accept no responsibility for any changes that might occur to the financial statements following their initial presentation on the website. Visitors to the website need to be aware that legislation in the United Kingdom governing the preparation and dissemination of the financial statements may differ from legislation in their jurisdiction. The directors consider that the Annual Report and Financial Statements, taken as a whole, is fair, balanced and understandable, and provides the information necessary for shareholders to assess the Company s performance, business model and strategy. Each of the directors in office at the date the Directors Report is approved confirms that: so far as the director is aware, there is no relevant audit information of which the Company s auditors are unaware; and he has taken all the steps that 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. Each of the directors, whose names and functions are listed on page 2 confirm that, to the best of their knowledge: the Financial Statements, which have been prepared in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law), give a true and fair view of the assets, liabilities, financial position and net return /(loss) of the Company; and the Strategic Report contained in the Annual Report and Financial Statements includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces. Independent auditors A resolution to re-appoint Ernst & Young LLP as auditors will be proposed at the Annual General Meeting. Greenhouse gas emissions All of the Company s activities are outsourced to third parties. The Company therefore has no greenhouse gas emissions to report from its operations. By order of the Board of Directors of the Company J P McClelland Company Secretary Laurence Pountney Hill, London EC4R 0HH 22 July 2015 ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY

18 Corporate Governance Introduction Significant matters relating to the governance of the Company, including those in relation to the recommendations of the UK Corporate Governance Code (the Code), are noted below. Save as otherwise provided, the Company has complied throughout the financial year ended 31 May 2015 with the recommendations set out in the Code insofar as they are considered relevant to the management of the Company, and has adhered to the principles and recommendations in The AIC Code of Corporate Governance. Board of directors Functioning of the Board The Board of Directors, which currently consists of four non-executive directors, meets regularly throughout the year, usually quarterly, and has a Schedule of Matters reserved for its consideration or approval. There are no executive directors. The directors responsibilities are set out on page 15. The directors are experienced business people with a breadth of investment, commercial and professional experience, and accordingly no formal training has been given following their appointments, although a more formalised induction programme is available to new directors. All directors may take independent legal, accounting or other professional advice and training at the expense of the Company in the furtherance of their duties. The Company Secretary s advice and services are also available to all Board members. Any question of his removal is a matter for the Board as a whole. The Board has arranged Directors and Officers Liability Insurance through the investment manager. Contrary to the Code, the Board does not consider there to be any value to shareholders in appointing a senior independent director in view of its size and composition. Shareholders are, however, welcome to contact any member of the Board through the offices of the Company Secretary should they wish to raise any issues concerning the Company. Non-executive directors The Board has a formal procedure for nominating new directors. New directors are appointed until the following Annual General Meeting at which time they will offer themselves for election by shareholders. Thereafter, they will be engaged for fixed terms not exceeding three years. In addition to the requirements of the retirement by rotation provisions of the Company s Articles of Association, all directors will in any event be subject to re-election by shareholders at least every three years. Any director who has served for a period of more than nine years will automatically be subject to annual re-election thereafter. Although the Board is mindful of the requirements of the Code, in particular the need to refresh the Board and its Committees, it does not consider that length of service should in itself preclude a director from seeking re-election. Furthermore, given the limited remaining life of the Company and the effectiveness of its current governance arrangements, the Board is of the view that at this stage of the Company s life, a change to the current composition of the Board is not appropriate. Indeed, the retention of the current directors is expected to be particularly useful in dealing with the winding-up of the Company in None of the directors have contracts of employment or contracts for service with the Company and accordingly a director is not entitled to any minimum period of notice or to compensation in the event of their removal as a director. Throughout the year, the membership of the Board has included three directors (one of whom is the Chairman) independent of M&G Investment Management Limited (MAGIM), the investment manager. The only non-independent director is Mr W J Nott, Chief Executive Officer of M&G Securities Limited. The independent directors value Mr Nott s contribution to the Board and the wealth of investment management knowledge and experience he brings with him. He maintains the valuable link between the investment manager and the Board, and ensures that the latter is kept fully apprised of current issues affecting the investment management industry. In view of his relationship to the investment manager, Mr Nott is required to submit himself for, and be subject to, annual re-election by the shareholders. Accordingly, the independent directors unanimously recommend all shareholders to vote in favour of Mr Nott s re-election. As Mr Carr, Mr Martin Smith and Mr Murray have all served as directors for over nine years, they are now subject to annual reelection. All three directors are highly experienced and have a good understanding of the regulatory and administrative framework surrounding quoted companies. They also continue to demonstrate independence in their con tri butions to Board discussions. Accordingly, the independent directors unanimously recommend shareholders to vote in favour of their re-election. None of the independent directors have had any interest in the contracts or arrangements with the Company during the year. Performance evaluation The Board carries out an annual performance evaluation of the Board, its Committees and individual directors against a range of objectives. The evaluation takes the form of a questionnaire completed by each member of the Board. The results of these are reviewed by the Chairman except for the questionnaire relating to the Chairman which is reviewed by the Chairman of the Audit Committee. The results of this review are then discussed at the annual meeting of the Nomination Committee. If appropriate the Chairman will absent himself from the meeting where his performance is being evaluated. Remuneration of Directors The fees of the independent directors (including the Chairman) are borne by the Company. Mr Nott is not paid any fees by the Company for his services as a director. None of the directors are entitled to any performance related bonus, options or other benefits from the Company. The fees disclosed in the Directors Remuneration Report on page 21 comprise their only remuneration from the Company. All of the independent directors hold shares in the Company as disclosed on page 21. The Company keeps the level of fees paid to its independent directors under regular review. In this connection, advice is taken from the Company s brokers, Winterflood Investment Trusts, with a view to ensuring that the level of fees is sufficient to attract individuals of appropriate standing and calibre to serve as directors and to reflect fairly the demands placed upon the directors. 16 ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS May 2015

19 Corporate Governance Relations with shareholders The directors are always willing to consider representations from shareholders concerning the management of any aspects of the Company s business. Any such representations may be raised with the Board through the offices of the Company Secretary or directly at the Annual General Meeting at which shareholders have the opportunity to meet the non-executive directors and the investment manager. In addition, the investment manager communicates with large shareholders in order to understand any views they may have about the Company. Any issues raised will be duly notified to the Board. Notices of Annual General Meetings are always included in the Annual Report and Financial Statements which are posted so as to meet the 21 day notice period required by the Companies Act and the longer period of 20 working days notice recommended by the Code. The current Report and Financial Statements, which includes notice of the Company s nineteenth Annual General Meeting, will be posted on 31 July 2015 so as to meet this longer period. In addition to the formal business required to be dealt with, the Annual General Meeting is an opportunity to present to shareholders a review of the Company s investment performance and future strategy. At the forthcoming meeting, there will again be such a presentation. In accordance with the recommendations of the Code there will be a vote on each substantially separate issue at the meeting and the number of proxy votes will also be announced in respect of each resolution once it has been dealt with by the meeting on a show of hands. Substantial shareholdings At 31 May 2015 the directors had been notified that the following persons were interested in 3% or more of the Income Shares and Capital Shares of the Company. Prudential plc: Income Shares 136,200, % (2014: 147,119,067) (2014: 58.73%) Capital Shares 136,200, % (2014: 147,119,067) (2014: 58.73%) (on behalf of M&G Financial Services Limited ISA Accounts) At 22 July 2015 the directors had been notified that the following persons were interested in 3% or more of the Income Shares and Capital Shares of the Company. Prudential plc: Income Shares 135,922, % Capital Shares 135,922, % (on behalf of M&G Financial Services Limited ISA Accounts) Accountability and audit Financial reporting The Board is fully aware of its duty to present a fair, balanced and understandable assessment of the Company s position. It reviews all the annual and interim financial statements of the Company, including all quarterly statements. The Board s specific responsibilities for reporting to shareholders and for the assets of the Company are set out in the Directors Report on page 15. Internal control The Code requires the Board to review the effectiveness of internal controls. The directors have reviewed their internal control statements and the processes for internal control reporting in light of the Code and have established an ongoing process for identifying, evaluating and managing significant risks. Those services provided to the Company by subsidiaries of M&G, such as investment management and accounting, reflect the system of internal controls at M&G. The relevant control regime for other services, such as the custodian and registrar functions, reflect those of the respective service providers. In order for the directors to review their effectiveness insofar as they are relevant to the Company s business, a process of quarterly self certification by M&G and State Street management has been established and has operated throughout the year under review. This covers the key business, operational, compliance and financial risks affecting the Company and takes the form of exception reporting against any failures in the operation or the effectiveness of the relevant controls. The directors regularly carry out spot checks the day preceding Company Board meetings to require control owners to provide documentation to demonstrate the operation of evidencebased controls during the period under review. These controls relate to the following areas: Corporate strategy and investor communication The investment mandate, the level of the discount on the Company s Package Unit mid-market price against their net asset value and the terms of the investment management agreement are all reviewed regularly to ensure that the Company is able to respond to changes in market conditions in delivering long-term returns. Quarterly reviews are undertaken to ensure that the management of the Company s portfolio is in line with the investment objective. Financial results are reviewed by the directors quarterly. The preparation of financial statements is governed by a documented set of procedures and controls. The Board reports to shareholders on a half-yearly basis. The format and content of these reports is reviewed regularly to ensure that they are in line with industry best practice. Compliance and secretarial M&G operate a risk based programme to monitor relevant compliance requirements. As part of M&G s Legal and Compliance function, the Company Secretary is responsible for ensuring that the legal obligations affecting the Company s business, including its obligations under the UK Listing Rules, are being observed. Service providers For those services provided to the Company by M&G Securities Limited, the Board is provided annually with a report on the operation of MAGIM s internal control environment reported on by MAGIM s external auditors, KPMG LLP. A similar report is provided by State Street, reported on by its auditors. In addition, the Board obtains a report from M&G Financial Services Limited (a subsidiary of M&G) at the end of the Company s financial year that comments on the nature and operation of controls relevant to the Company. This report is supported by an independent review of the operation of those controls carried out by M&G s internal auditors. ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS May

20 Corporate Governance In addition to the appointment of M&G Securities Limited as the Company s Alternative Investment Fund Manager, compliance with the Alternative Investment Fund Managers Directive has also resulted in the following changes with effect from 21 July 2014: (i) (ii) The appointment by M&G Securities Limited of NatWest to act as depositary in relation to the Company s assets. The responsibilities of the depositary include cash monitoring, safe-keeping of assets, oversight duties and the delegation and segregation of assets held in custody; and the Company s existing custodian agreement with State Street Bank will terminate and will be replaced by a custodian agreement between NatWest as the Company s depositary and State Street Bank. The Company s registrar is Equiniti which provides the Board with an annual report on the operation of their internal controls. Investment management and business activity Automated reconciliations are performed and reviewed fortnightly for stock holdings and daily for cash; positions in both are also validated quarterly by the Custodian. The selection of brokers is subject to prior vetting for credit risk and the commission paid to each broker is monitored. Company performance is monitored against a relevant peer group. During the course of its review of internal controls the Board has not identified or been advised of any failings or weaknesses which have been determined as significant. Board committees The Board has established three separate committees of independent non-executive directors and the reports of each of these committees are included below. The terms of reference of each Committee are available on request through the offices of the Company Secretary and at the Company s AGM. Mr Murray is Chairman of both the Audit Committee and the Remuneration and Management Engagement Committee. Notwithstanding Mr Carr s role as Chairman of the Board, his membership of both the Audit and the Remuneration and Management Engagement Committees is considered appropriate given the number of independent non-executive directors on the Board. Mr Carr is also Chairman of the Nomination Committee. The number of Board and Committee meetings attended by each director during the year was as follows: Remuneration and Management Audit Nomination Engagement Board Committee Committee Committee Number of meetings in year F C Carr A E Martin Smith G A J Murray W J Nott [a] Audit Committee The Audit Committee comprises those directors (including the Chairman of the Board) independent of the investment manager. The Board is satisfied that collectively the Committee members have recent and relevant financial experience. The Committee meets on a six monthly basis (or more often if required) and provides a forum through which the Company s external auditors report to the Board, facilitating an assessment of the effectiveness of the external audit process. Its terms of reference include the review of the adequacy and effectiveness of the Company s internal controls, accounting policies and financial reporting including the review of the Company s draft annual and interim financial statements and any formal announcements relating to the Company s financial performance. The Committee is also responsible for approving and reviewing the appointment and retirement of the external auditors, and monitoring their continuing independence and effectiveness. In its review of the financial statements for the year ended 31 May 2015, the Committee undertook its usual year end review, which included consideration of current accounting policies and practices, areas of judgement, compliance with accounting standards, and the going concern assumption. It considered these to be appropriately reflected in the financial statements. In relation to the Annual Report and Financial Statements for the year ended 31 May 2015, the following significant matters were considered by the Committee: Significant matter How the matter was addressed The accuracy of the valuation of the The directors regularly review the controls investment portfolio in place at the Company s service providers over the accuracy of the valuation of the investment portfolio. Existence and ownership of investments The directors review reports from the Company s service providers on key controls over the assets of the Company. Any significant issues are reported by the Investment Manager to the Committee, which has access to the relevant personnel of the Investment Manager who have responsibility for internal audit. Recognition of income The directors regularly review the controls in place at the Company s service providers over the recognition of income. Compliance with Section 1158 of the The directors regularly consider the Corporation Tax Act 2010 controls in place to ensure that the regulations for ensuring investment trust status are observed at all times. The board, through the Audit Committee, annually review the performance of the external auditor. There are no contractual obligations restricting the choice of external auditor. The appointment of the auditor is under Company Law subject to shareholder approval at the AGM. Where the external auditors are engaged to supply non-audit services, the Committee has in place a process to ensure that auditor objectivity and independence are safeguarded. There were no nonaudit services provided by Ernst & Young LLP during the current financial year. [a] Mr Nott is not a member of the Audit, Remuneration and Management Engagement or Nomination Committees. 18 ANNUAL REPORT AND AUDITED FINANCIAL STATEMENTS MAY 2015