Athelney Trust Plc – Annual Financial Report

Dear Shareholder

I am pleased to present the Annual Financial Report for the year to 31 December 2020.

The Strategic Report section of this Annual Report has been prepared to help Shareholders understand how the Company operates and assess its performance.

Overview

Athelney Trust plc (the 'Company' or 'Trust') faced unprecedented market conditions resulting from the global COVID-19 pandemic declared in March, subsequent disruption to life, business and the economy from two national lockdowns, and vaccine announcements in November and December.  The company performed well in this context, with unusually large market swings and uncertainty leading to increased share price volatility.  The key performance points are as follows:

• At 31 December 2020, audited Net Asset Value (NAV) was 255.3p per share (2019: 266.9p), a decrease of 4.3% over the year as compared to a 6.4% decline in the FTSE 250 and a 14.3% decline in the FTSE 100.
• The Trust's investment performance over 12 months as measured by NAV total return, which is the change in NAV plus the dividend paid, was -0.22% (2019: 22.2%). Long term performance represented by the Trust's average 10-year total shareholder return of +112% lagged the FTSE 100 (+119%) and lagged the FTSE 250 (+194%).
• The 12-month revenue return per ordinary share was 5.9p (2019: 9.1p), a decrease of 35%.
• The first interim dividend of 1.7p per share was paid on 25 September 2020.
• Your Board recommend a final dividend of 7.7p per share making a total dividend payable for the year of 9.4p (2019: 9.3p) an increase of 1%.  UK Inflation for the year of 2020 was 0.8% (Office for National Statistics).

· This is the 18th successive year of progressive dividend and importantly returns the Trust to a top position in the dividend yield league table for Investment Companies as well as keeps us in the Next Generation of Dividend Heroes list maintained by the AIC (the trust was top of the list in February 2021).

Board and Governance

The Board places significant importance on corporate governance and compliance with the AIC and UK Corporate Governance Codes.  Full details are set out in the Corporate Governance section on pages 14 to 17.

An Independent Board

The Directors in place at the time of signing these accounts are:

• Myself, Frank Ashton – Non-Executive Chairman
• Simon Moore – Non-Executive Director, Chair of Audit Committee, Chair of Remuneration Committee
• Dr Manny Pohl – Managing Director, Fund Manager

We currently have three directors who together make up an independent Board under the AIC Code of Governance 2020.  I have no current or prior connection with any major shareholder of the Company and maintain I am an independent Chairman.  The Board is also agreed that Simon Moore was independent at 31 December 2020.

Capital Gains

During the year the Company realised capital profits before expenses arising on the sale of investments in the sum of £223,957 (2019: £262,480).

Portfolio Review

Holdings Purchased

Holdings of Clinigen and Yougov were purchased for the first time.

Additional holdings of 4imprint, Abcam, AEW UK, Begbies Traynor, Churchill China, Clarke (T), Fevertree, Homeserve, Jarvis Securities, JD Sport, Lok'n Store, Rightmove, Smart Metering were also acquired.

Holdings Sold or Trimmed

Andrews Sykes, Biffa, Boohoo, Camellia, Costain, Custodian REIT, Greencore, Hill & Smith, Marstons, Mountview Estates, Picton Property, Randall & Quillter, Regional REIT, Vianet, Vitec, VP, Wilmington

Corporate Activity

The holding of Hansteen was subject to a Tender Offer during the year at a capital profit of 15%.

Dividend

In line with the majority of investment trusts and after consulting shareholders, the board decided the Trust should pay a dividend more frequently than once a year. During the year the Company paid its first interim dividend of 1.7p on 25 September 2020.

The Board is very pleased to recommend a final dividend of 7.7p per ordinary share making the total dividend this year 9.4p (2019: 9.3p). This represents an increase of 1% over the previous year. Subject to shareholder approval at the Annual General Meeting on 30 March 2021, the dividend will be paid on 6 April 2021 to shareholders on the register on 12 March 2021 .

Review

It is hard to conceive what else, short of banking collapse or world war, might in a single year have the same impact and longer-term implications for the world today as COVID-19; hardly any UK business has been untouched by related challenges including huge, panic-driven market swings.  In addition, economic uncertainty was exacerbated by a drawn-out US Presidential election plus perhaps an inevitable last-minute UK-EU agreement to a Brexit deal. 

The darkest cloud however arrived in the last quarter, with a resurgence of the virus in more transmissible form in several countries.  It may not be more deadly; however, it means the UK and other major economies must consider lockdown for longer and hope that mutations do not dim the hope that mass vaccination provides. 

I am very pleased therefore to report that NAV outperformed both the FTSE 100 and 250 markets over the year by 10 and 2.1 percentage points respectively.  In the past 18-24 months Manny Pohl has shown focus and efficiency in shaping a portfolio that continues to deliver today and promises much for tomorrow.  The Board is very grateful for his efforts in a difficult year, leading market research and a team approach that is founded on strong basic financial and value filters.  Some companies and sectors have benefited from the conditions in 2020 (mostly the big tech names, plus precious metals) while others seem stuck with a valuation that defies logic.  Finding a balance in the portfolio, now even more focused to 30+ companies, to provide growth over time, at the same time as delivering the usual Trust income during such a pandemic-affected market has been a challenge in 2020.

Our status as a closed-ended fund provides a key advantage over open-ended funds; we can use reserves created in good years to smooth out dividend payments through better and leaner years. 2020 was most definitely lean as UK dividends fell by 44% to £61.9bn, the lowest annual total since 2011.  The Bank of England's PRA lifted the prohibition on banking dividends in December, which since March had resulted in the financial sector accounting for 40% of the cuts, and the beleaguered oil sector for another fifth.  Protection is now in place since December to prevent excessive bank dividends being paid.  Some dividend suspensions were reversed in the last quarter, however the year's meagre results have triggered renewed interest in value-creation and cash-generative businesses, as income investors follow the inevitable correction.  Our revenue return of 5.9p per share was 35% down compared to last year, and comparatively speaking, a good outcome. 

Against this backdrop I am delighted to tell you that your Board recommends a final dividend payment of 7.7p (total 9.4p).  This shares the benefits of prudence in previous good years and increases our dividend once more, subject to approval at the AGM.  At a share price of 215p on 31 December, this represents a dividend yield of 4.37% (better than the average 2020 yield from FTSE 100 companies of 3.77% and much better than the FTSE 250). 

In terms of costs the Trust has continued to be prudent and has not added a fourth Board member to replace David Lawman who retired by rotation at the April AGM; total remuneration reduced by 14% compared to 2019.  Non-executive Director's fees remain at £10,500.  Other Trusts reduced management and Directors' fees through this year.  I believe that along with a reduced management fee of 0.75% since January 2019, we have managed ongoing costs very effectively in 'normal operating conditions' and compared to the very unusual year of 2019, our ongoing charges figure has fallen from 4.30% to 2.45%. As detailed on page 33 in note 3, nearly every line item represented a cost reduction on the prior year.

Outlook

All hope for a swift return to normal dividend payments, however some expect this will not take place during 2021, especially with the further COVID-19 restrictions while UK vaccinations take place for the most vulnerable groups in the first quarter.  Link Group expects a best-case UK dividend increase of 8.1% (excluding special payments) and a slow start to the dividend year while a great deal of uncertainty still lingers.  Much depends on vaccination success leading to our gaining a meaningful release from lockdown that lasts long enough to deliver sustained growth in GDP after what seems likely to be shortly announced as a UK double-dip recession in 2020.

There may well be pent-up enthusiasm from retail shoppers and investors alike.  Some, maybe many might go on a spending spree, and the Bank of England believes there is upside risk from this.  Current talk of negative interest rates may come to nothing, but the UK economy needs stimulating as we plan to exit lockdown in four stages between 8 March and 21 June this year.  Investors have long waited for the time where neither Brexit nor COVID-19 uncertainties keep foreign investors away, and some dislocated shares can return to par from their 'cheap comparative valuations'.  If true, this now seems most likely to happen in 2021 and will present further opportunities for the Trust focusing on the UK Small Companies sector. 

Good companies at fair prices are still overlooked by house analysts.  Those with commitment to a proven system, prepared to analyse fully and act on conviction, will come out on top in the long run.  Our Managing Director and Fund Manager has many years' experience relevant to operating successfully in the conditions of 2021 – this bodes well for your Trust.

Our AGM in 2020 was held virtually, with no shareholders present, as movement restrictions and the safety of our investors and staff made a physical meeting impossible.  We will be holding a similar event for the AGM this year on 30 March 2021 at 9.00am.  Shareholder engagement and opinion is very important to us, so there are plans in place to give you the opportunity to engage with the Board by sending your questions to us in advance and making sure there is a proxy for your vote.  Details of the proposed AGM can be found in the Notice to the AGM publication.

I leave you with the simple words of one of the inspirations of 2020 – Captain Sir Tom Moore, who after a remarkable 100^th year, sadly recently died from COVID-19.  “Things will get better. The sun will shine again”.  

Frank Ashton

Non-Executive Chairman

24 February 2021

Fund Manager's Review

Reflecting on 2020, an extraordinary year

The Global Scene

Reflecting on the year that was, it can be confidently said, it was one like no other! This year we saw our world turn upside down with the unimaginable coming to the fore.  We've seen the full gamut of external factors impact Global markets, including raging bushfires, a deadly pandemic, never-before-seen stimulus packages, trade wars and an election that tested the Democratic system of the United States.

Before I begin with this year's review, I'd like to acknowledge those who have worked tirelessly throughout this year for the benefit of our society – nurses, doctors, police and members of the defence forces. While we have all managed the significant challenges and pressures COVID-19 has placed upon us, this crisis has certainty provided each of us with some timely lessons: to cherish the physical times we have with loved ones, enjoy our social connections and to embrace our lives outdoors. Cafes and conference rooms were replaced by the disquiet of working from home, separated from our colleagues and families as we all complied with social distancing. 

Businesses needed to adapt to survive – gin distilleries became hand sanitiser producers, event staging manufacturers built flat-pack office desks, and nearly every service organisation implemented a work from home program.  Five years' worth of technology adoption occurred within weeks as businesses worked out new ways of connecting staff and customers, we created discussion channels on Slack and attended Board meetings with our pets.  This recent explosion in the use of technology is highlighted by the fact that in the five-year period from 2010 to 2015 the global market capitalisation of vertical software companies increased by £90bn from £50bn to £140bn, whereas in the period from 2015 to 2020 their market capitalisation increased by a further £340bn to £480bn.

However, something in this technology focused world was missing: the face-to-face interaction and mentoring that occurs within the office environment.  For business leaders, these items have become the next challenge for those who need to engage with their teams and provide purpose and a sense of community when normal social interactions are not possible. To ensure business success through these times, leaders need to ensure their companies adopt change-orientated capabilities that help firms redeploy and reconfigure their resource base while ensuring they remain responsible to all stakeholders and as investors, we need to ensure that we are able to identify these companies.

The Markets and Our Portfolio

Global markets rose across the board over the last quarter with most markets trending up since the April 2020 lows. After initially under-performing the US tech stocks, UK stocks advanced strongly on the news of a vaccine and a Brexit trade agreement. The pound rose to its highest level against the USD since March 2020.  Without doubt, some areas of the global market look expensive when viewed historically but it was the year of   technology as mentioned previously and the stock markets are merely reflecting the rapid changes taking place in the economy. The FTSE-250 hit a record high of 22,114.30 on 2^nd of January 2020 before collapsing by 44.1% over the next 2 months.  It then increased by 66% over the next nine months to close the year at 20,488.3, down 6.4% over the year. By comparison, our portfolio increased by 3.5% (adjusting for outflows on a time weighted basis) over the same period.

While the FTSE-250 only declined by 6.4% this is a capitalisation weighted index and one should not lose sight of the fact that there are many more smaller businesses in trouble, evidenced in the latest Red Flag Alert research report by Begbies Traynor for 2020, which reported that 630,000 businesses in the UK are recorded to be in significant distress at the end of the fourth quarter, the largest quarterly increase (73,000) in financially distressed companies since the second quarter of 2017. This 13% increase (from 557,000 in Q3 2020) comes as the UK is plunged into another nationwide lockdown and clearly these figures would have been much worse had it not been for Government support.  The sad truth is that for many companies this will provide little more than a stay of execution as debt levels become unmanageable and structural changes across many sectors take their toll.

While the majority of the stocks in the portfolio contributed to the outperformance of the portfolio versus the market, a handful of names performed exceptionally well, which included Games Workshop (LSE: GAW), Jarvis Securities (LSE: JIM) and Treatt (LSE: TET); a brief description of these 3 companies follows.  The biggest detractors from returns over the year included 4IMPRINT (LSE: FOUR), Forterra (LSE: FORT) and Paypoint (LSE: PAY). At an aggregate level, all of our alpha was generated through stock selection, as opposed to sector selection and this is consistent with our style as a bottom-up, benchmark unaware, high conviction manager.

Games Workshop Group plc (LSE: GAW)

Games Workshop designs, manufactures, distributes and markets a hobby based upon collecting, modelling, painting and tabletop gaming with model soldiers. Its key brands are the high fantasy Warhammer and dark future Warhammer 40,000 game systems which it has been able to expand out to encompass video games, books and new campaigns. Games Workshops' competitive advantage is driven by the fact that it has limited competition with the games voraciously supported by a legion of fans worldwide, who will go to great lengths (and expense) to produce their own accompaniments to add to the series lore and backstory. The company generates most of its income in North America and during the COVID-19 lockdown, the majority of the 529 retail stores were restricted or closed but normal trading did resume in the period that the stores were allowed to trade.

Jarvis Securities plc (LSE: JIM)

Jarvis offers retail execution-only stockbroking, ISA and SIPP investment wrappers, savings schemes, and financial administration, settlement and custody services to other stockbrokers and investment firms as well as individuals. It offers Dial-n-Deal for clients wanting to open an account over the telephone and sell shares in certificated form while sellmysharecertificates.com is a share sale postal service. It also offers outsourced services to investment professionals and other financial intermediaries and its subsidiary, Jarvis Investment Management Ltd, is an outsourced investment administration and Model B settlement services provider.  We believe that this business model should be able to offset the effects of the depressed market conditions and through organic growth be able to translate increased trade volumes into improved profits.

Treatt plc (LSE: TET)

Treatt manufactures and supplies various natural extracts and ingredients to the flavour, fragrance, beverage, and consumer product industries from their bases in the UK, the US and China. It has a diverse product portfolio with particular expertise in citrus, tea and sugar reduction. The company also provides ingredient applications for beverage and household products; and fragrance ingredients that are the result of over a century of knowledge and innovation.  The business has continued partnering with customers to develop exciting products in the fast-evolving beverages market and some material new business wins have been achieved including in the global alcoholic seltzer category which is continuing to grow strongly. Treatt is well positioned as a supplier of natural extracts and with its technical expertise enables it to add significant value to customers across a growing range of applications resulting in margin expansion as well as revenue growth.  

Investment Philosophy

As far as portfolio investments are concerned, our investment philosophy is clear:

 I. The economics of a business drives long-term investment returns; and

 II. Investing in high quality, growth businesses that have the ability to generate predictable, above-average economic returns will produce superior investment performance over the long-term.

In essence, this means that in assessing potential investments we:

1.  Value long-term potential, not just performance

2.  Choose high-quality, growing businesses; and

3.  Ignore temporary market turbulence.

The key attributes that will define our investments are:

• Organic Sales Growth: Quality franchises organically growing sales above GDP growth that can do so (sustainably) because they have a large, growing market opportunity and compelling competitive advantage which will drive ongoing market share gains are attractive.
• A Proven Track Record: This encompasses both the management's capability and the strength of the business' model. Generally, a firm that consistently delivers a Return on Equity of greater than 15% indicates a Quality Franchise for us. Our investment philosophy is built on the belief that a stock's long-term return to shareholders is driven by the return on capital of the underlying business.
• Company's Future Profits: In essence we are backing a proven management team and a successful business model. Management are the key decision makers regarding the company's strategy and its competitive position in the marketplace and it is critical that we have confidence in the company's ability to sustainably execute its strategy and grow their earnings, even in a tough environment like the current COVID-19 and Brexit conundrum.
• Low Leverage: We require investments to operate with low levels of debt, which ensure that they have sufficient resources to execute on their strategy. An Interest Coverage above 4x provides sufficient bandwidth in times of economic trouble. As a long-term investor, capital preservation is the highest priority. There is nothing that changes a management team's focus toward the short term quicker than impending debt refinancing when market conditions suddenly change for the worse. We need to be comfortable that this will not happen and that the company has a strong enough balance sheet so that it will retain optionality and can quickly and efficiently execute its strategy over the long-term.

Sleep Well rather than Eat Well

As our process aims to find high-quality businesses that we own for the very long-term, our portfolio turnover remains low. Through time we continue to have investments that we have held for over ten years, however, this doesn't mean we aren't always looking for new investments. As mentioned in our monthly reports, the focus this year has been to continue to restructure the portfolio to align it with our investment philosophy while cognisant of the need to maintain the dividend paid to shareholders.

Investment management is more than merely generating alpha in excess of a benchmark.  While that is a core part of our mandate, other very important qualitative issues are central to what we do.  For example, we recognise that capital allocation is a vehicle through which to drive change.  We have the opportunity to demand specific standards of corporate governance, decide whether specific social and ethical issues are acceptable and, if they are not, we vote with our feet.

For us, the integrity and credibility of any management team is a founding principle to our investment process. We need to trust that management has the best interests for all stakeholders at heart, and we have faith that they will make sound strategic decisions and have substantial experience and capabilities in their chosen field. As custodians of our capital, we must ensure that we are doing whatever we can to preserve capital and grow it over time.  We allocate capital to investments which we believe are sustainable in the long-term, and finding trustworthy, values-based management that aligns with our core values and beliefs will ensure above-average economic portfolio returns. Sustainability of investment performance or the improvement of the wellbeing of broader society hinges upon ethical, transparent, and honest leadership and in cases where we feel we can add something to the conversation, we engage with the company. 

Looking Forward

While the COVID epidemic has affected most businesses negatively, our investment philosophy is based on the belief the long-term economics of a business drives long-term investment returns. The long-term financial metrics of our portfolio companies, including organic sales growth, earnings and dividend growth, should provide the impetus for improvement in valuations or at least be supportive of the current valuations in the future. Our companies have strong business models with capable and experienced management teams which we expect will continue to deliver above-average returns to shareholders.  Dividends are expected to be re-instated where they have been cut or withheld, with the Athelney dividend supported in the short-term by the reserves we have built up in the good times and by the distributions from the high yielding property trusts. Over time we expect that the dividends from the high growth quality companies in the portfolio will increase sufficiently so that the property trusts can be replaced by other high growth quality companies without jeopardising our AIC dividend hero status.

While we do feel that the markets are relatively fully valued and do not see a significant improvement in the P/E ratings of the market, for many of the companies in the portfolio our estimates and forecasts for total portfolio return remain promising.