Absolute Return Alternative Income Fund Segregated Portfolio (a Segregated Portfolio of FA SPC)

Transcription

1 Absolute Return Alternative Income Fund Segregated Portfolio Financial Statements (Expressed in Pounds Sterling) For the period from November 17, 2009 (commencement of operations) to June 30, 2010 Prepared by IFIT Fund Services AG Audited by BDO 1

2 Financial Statements 2010 Contents Fund Organization 3 Independent Auditors Report 4 Statement of Financial Position 5 Statement of Comprehensive Income 6 Statement of Changes in Net Assets Attributable to Holders of Redeemable Participating Shares 7 Statement of Cash Flow 8 Notes to the financial statements 9 1 Reporting entity Basis of preparation Significant accounting policies Financial risk management Use of estimates and judgments Financial assets and liabilities Accounting classifications and fair values Share capital Related parties and other key contracts Subsequent events

3 Financial Statements 2010 Fund Organization Directors Investment Manager Investment Advisor Sponsor and Distributor Administrator, Registrar and Transfer Agent Auditor Legal Adviser Prime Broker Banker Listing Sponsor Exchange Listing David M.L. Roberts, Cayman Islands Mark S. Kay, Cayman Islands Maurice P. Erb, Zurich, Switzerland Fund Advisers Group SA, Geneva, Switzerland From June 1, 2010: Multi Asset Portfolio Holdings, Cayman Islands Vexus Derivatives LLC, New York, USA Absolute Return Capital Management LLP, Richmond, UK IFIT Fund Services AG, Hünenberg, Switzerland BDO, Cayman Islands Priestleys, Attorneys-at-Law, Cayman Islands EFG Bank, Cayman Islands Royal Bank of Canada (Suisse), Geneva, Switzerland Cannon Secretaries Limited, Guernsey, Channel Islands Channel Islands Stock Exchange 3

4 Tel: +1 (345) Fax: +1 (345) PO Box nd Floor Building 3 Governors Square 23 Lime Tree Bay Avenue Grand Cayman KY Cayman Islands Independent Auditors Report To The Shareholders of Segregated Portfolio (a Segregated Portfolio of FA SPC) Grand Cayman, Cayman Islands We have audited the accompanying financial statements of Absolute Return Alternative Income Fund Segregated Portfolio (the Fund ), which comprise the statement of financial position as of June 30, 2010 and the statements of comprehensive income, changes in net assets attributable to holders of redeemable participating shares and cash flow for the November 17, 2009 (commencement of operations) to June 30, 2010, and the notes to financial statements. Management s responsibility for the financial statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances. Auditors responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Segregated Portfolio (a Segregated Portfolio of FA SPC) as of June 30, 2010, and of its financial performance and cash flows for the period then ended in accordance with International Financial Reporting Standards. January 28, BDO Cayman Islands, a Cayman Islands partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.

5 Financial Statements 2010 Statement of Financial Position (expressed in Pounds Sterling) Note June 30, 2010 ASSETS Financial assets at fair value through profit or loss 4 7'067'893 Cash and cash equivalents 1'349'199 Due from brokers 497'552 Accrued interest 102'932 Other assets 124'128 TOTAL ASSETS 9'141'704 LIABILITIES Deferred subscriptions 271'579 Accrued expenses and other payables 27'687 Redemptions payable 709'184 Total liabilities (excluding net assets attributable to holders of redeemable participating shares) 1'008'450 Net assets attributable to holders of redeemable 7 8'133'254 participating shares TOTAL LIABILITES (including net assets attributable to holders of redeemable participating shares) 9'141'704 Net asset values per share are disclosed in Note 7. See accompanying notes to financial statements. The financial statements were approved by the Directors on January 27, 2011 David M.L. Roberts Director 5

6 Financial Statements 2010 Statement of Comprehensive Income (expressed in Pounds Sterling) Period from November 17, 2009 to June 30, 2010 Note Income Interest 101'848 Realized gain on financial assets and liabilities at fair value through profit or loss 74'392 Commission income 64'268 Dividend income (net of withholding taxes) 18'792 Total income 259'300 Expenses Unrealized loss on financial assets and liabilities at fair value through profit or loss 16'202 Management fees 8 59'620 Performance fees 8 34'315 Professional fees 15'000 Administration fee 8 10'531 Other 9'877 Distribution fees 6'734 Bank charges and custody fees 6'533 Brokerage fees and commissions 4'191 Organizational costs 2'883 Net loss on foreign currency 2'191 Total expenses 168'077 Increase in net assets attributable to holders of redeemable participating shares 91'223 6

7 Financial Statements 2010 Statement of Changes in Net Assets Attributable to Holders of Redeemable Participating Shares (expressed in Pounds Sterling) Period from November 17, 2009 to June 30, 2010 Number of shares Amount Net assets attributable to holders of redeemable participating shares, beginning of period - - Issuance of shares 88' '891'125 Redemption of shares -8' '514 Equalized shares '580 Increase in net assets attributable to holders of redeemable participating shares from operations 91'223 Net assets attributable to holders of redeemable participating shares, end of year 80' '133'254 7

8 Financial Statements 2010 Statement of Cash Flow (expressed in Pounds Sterling) Period from November 17, 2009 to June 30, 2010 Cash flows from operating activities: Increase in net assets attributable to holders of redeemable participating shares 91'223 Cost of purchases of financial assets and liabilities at fair value through profit or loss -7'296'046 Gross proceeds from sale of financial assets and liabilities at fair value through profit or loss 286'343 Adjustments for items not affecting cash: Net change in unrealized gain on financial assets at fair value through profit or loss 16'202 Realized gain on financial assets at fair value through profit or loss -74'392 Performance fees through equalizations -1'580 Changes in operating assets and liabilities: (Increase) decrease in other assets -124'128 (Increase) decrease in due from brokers -497'552 (Increase) decrease in accrued interest -102'932 Increase (decrease) in accrued expenses and other payables 27'687 Net cash provided by / used in operating activities -7'675'175 Cash flows from financing activities: Proceeds from redeemable shares issued 8'891'125 Payments for redeemable shares redeemed -138'330 Proceeds from deferred subscriptions 271'579 Net cash provided by / used in financing activities 9'024'374 Net increase in cash and cash equivalents during the period 1'349'199 Cash and cash equivalents, beginning of period - Cash and cash equivalents, end of period 1'349'199 Supplemental Cash Flow Information Interest received Interest paid - - Dividends received 16'500 Dividends paid - 8

9 Notes to the financial statements 1 Reporting entity FA SPC (the Company ) was incorporated on June 6, 2007 as an exempted segregated portfolio company under the Companies Law of the Cayman Islands. The Company was registered under the Mutual Funds Law of the Cayman Islands on August 14, 2007 and is regulated by the Cayman Islands Monetary Authority. The Company may offer separate classes of shares each representing interest in a separate segregated portfolio (a Segregated Portfolio ). Each Segregated Portfolio will have a separate and distinct portfolio of investments and a separate class of shares will be issued in respect of any such Segregated Portfolio. Separate books and records have been maintained for each Segregated Portfolio. At June 30, 2010, there were two Segregated Portfolios in existence: Absolute Return Alternative Income Fund Segregated Portfolio and Absolute Return Vexus Multi Strategy Fund Segregated. These financial statements pertain only to Segregated Portfolio (the Fund ). The primary investment objective of the Fund is to provide investors with a long term investment solution for the fixed income and alternative investment component of their investment portfolio. The Fund is designed to deliver attractive income yields compared to more traditional investment strategies by investing into longer term strategic higher yielding income opportunities secured against very good collateral, but critically diversified across a multi asset class portfolio. In the reporting period the Fund s investment activities were managed by Fund Advisers Group SA (from commencement of operations until May 31, 2010) and Multi Asset Portfolio Holdings (from June 1, 2010) (the Investment Manager ) and advised via an agreement with the Investment Advisor by Vexus Derivatives LLC (the Investment Advisor ). The Fund s administration is delegated to IFIT Fund Services Ltd. (formerly: Fund Advisers Admin SA) (the Administrator ). The registered office of the Fund is FA SPC c/o Cayman Management Ltd., Ground Floor, Harbour Centre, P.O. Box 1569 George Town, Grand Cayman KY1-1110, Cayman Islands. As at June 30, 2010, the Fund had no employees. 9

10 2 Basis of preparation (a) Statement of compliance The financial statements of the Fund as at and for the period ended June 30, 2010 have been prepared in accordance with International Financial Reporting Standards ( IFRS ) as issued by the International Accounting Standards Board ( IASB ). The financial statements were authorized for issue by the board of directors on January 27, (b) Basis of measurement The financial statements have been prepared on the historical cost basis except for financial instruments at fair value through profit or loss which are measured at fair value. (c) Functional and presentation currency These financial statements are presented in Pounds Sterling (GBP) ( ), which is the Fund s functional currency. (d) Use of estimates and judgments The preparation of the financial statements in accordance with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected. Information about significant areas of estimation uncertainty and critical judgments in applying accounting policies that have the most significant effect on the amounts recognized in the financial statements are described in notes 4 and 5. (e) Changes in accounting policies There were no changes in accounting policies which had an impact on the Fund s financial statements during the reporting period. (f) (i) Other accounting developments Disclosures pertaining to fair values and liquidity risk for financial instruments The Fund has applied Improving Disclosures about Financial Instruments (Amendments to IFRS 7), issued in March 2009, that require enhanced disclosures about fair value measurements and liquidity risk in respect of financial instruments. The amendments require that fair value measurement disclosures use a three-level fair value hierarchy that reflects the significance of the inputs used in measuring fair values of financial instruments. Specific disclosures are required when fair value measurements are categorized as Level 3 (significant unobservable inputs) in the fair value hierarchy. The amendments require that any significant transfers between Level 1 and Level 2 of the fair value hierarchy be disclosed separately, distinguishing between transfers into and out of each level. Furthermore, changes in 10

11 valuation techniques from one period to another, including the reasons therefore, are required to be disclosed for each class of financial instruments. Revised disclosures in respect of fair values of financial instruments are included in note 5. Further, the definition of liquidity risk has been amended and it is now defined as the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or another financial asset. The amendments require disclosure of a maturity analysis for non-derivative and derivative financial liabilities, but contractual maturities are required to be disclosed for derivative financial liabilities only when contractual maturities are essential for an understanding of the timing of cash flows. For issued financial guarantee contracts, the amendments require the maximum amount of the guarantee to be disclosed in the earliest period in which the guarantee could be called. Revised disclosures in respect of liquidity risk are included in note 4. (ii) Presentation of financial statements Effective from its commencement of operations, the Fund has applied revised IAS 1 Presentation of Financial Statements (2007). The revised standard requires all owner changes in equity to be presented in the statement of changes in equity, whereas all non-owner changes in equity are presented in the statement of comprehensive income. The application of the revised standard did not have any impact on the Fund s financial statements as the Fund has no equity and no components of comprehensive income other than profit or loss for the period. (iii) Puttable financial instruments and obligations arising on liquidation Effective from its commencement of operations, the Fund has applied amendments to IAS 32 Financial Instruments: Presentation and IAS 1 Presentation of Financial Statements Puttable Financial Instruments and Obligations Arising on Liquidation that provide exemptions from financial liability classification for: puttable financial instruments that meet certain conditions; and certain instruments, or components of instruments, that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation. The application of the amended requirements did not have any impact on the Fund s financial statements. While the redeemable shares issued by the Fund are puttable instruments, they continue to be classified as financial liabilities as they do not meet the conditions for equity classification under the amendments. 11

12 3 Significant accounting policies The accounting policies set out below have been applied consistently to all periods presented in these financial statements. (a) Foreign currency Transactions in foreign currencies are translated into GBP at the spot exchange rate at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies at the reporting date are retranslated into GBP at the spot exchange rate at that date. Non-monetary assets and liabilities denominated in foreign currencies that are measured at fair value through profit or loss are retranslated into euro at the spot exchange rate at the date that the fair value was determined. Nonmonetary assets and liabilities that are measured in terms of historical cost in a foreign currency are translated using the exchange rate at the date of the transaction. Foreign currency differences arising on retranslation are recognized in profit or loss in the net foreign exchange loss line. (b) Interest Interest income and expense, including interest income from non-derivative financial assets at fair value through profit or loss, are recognized in profit or loss using the effective interest method. The effective interest rate is the rate that exactly discounts the estimated future cash payments and receipts through the expected life of the financial asset or liability (or, where appropriate, a shorter period) to the carrying amount of the financial asset or liability. When calculating the effective interest rate, the Fund estimates future cash flows considering all contractual terms of the financial instrument, but not future credit losses. The calculation of the effective interest rate includes all fees and points paid or received that are an integral part of the effective interest rate. Transaction costs include incremental costs that are directly attributable to the acquisition or issue of a financial asset or liability. Interest is presented in the following lines in the statement of comprehensive income: interest receivable in Interest line interest payable in Interest expense line. (c) Dividend income and dividend expense Dividend income is recognized when the right to receive income is established. Usually this is the ex-dividend date for equity securities. Dividend income from equity securities designated at fair value through profit or loss is recognized in the dividend income line in the income statement. The Fund incurs expense on short positions in securities equal to the dividends due on these securities. Such dividend expense is recognized in profit or loss as operating expense when the shareholders right to receive payment is established. (d) Net gain from financial instruments at fair value through profit or loss Net gain from financial instruments at fair value through profit or loss includes all realized and unrealized fair value changes and foreign exchange differences, but excludes interest and dividend income, and dividend expense on short positions. 12

13 (e) Fees, commission and other expenses Fees, commission and other expenses are recognized in profit or loss on an accrual basis. (f) Income tax expense Under the current system of taxation in Cayman Islands the Fund is exempt from paying income taxes. The Company has received an undertaking from the governor of the Cayman Islands exempting it from income tax until August 14, Dividend and interest income received by the Fund may be subject to withholding tax imposed in the country of origin. Investment income is recorded net of such taxes. (g) Dividends to holders of redeemable shares Dividends to holders of redeemable shares are recognized in profit or loss as finance costs when they are authorized and no longer at the discretion of the Fund. (h) (i) Financial assets and financial liabilities Recognition The Fund initially recognizes financial assets and financial liabilities measured at amortized cost on the date at which they are originated. All other financial assets and liabilities are initially recognized on the trade date at which the Fund becomes a party to the contractual provisions of the instrument. A financial asset or financial liability is measured initially at fair value plus, for an item not at fair value through profit or loss, transaction costs that are directly attributable to its acquisition or issue. (ii) Classification The Fund has adopted the following classifications for financial assets and financial liabilities: Financial assets: Trading derivative financial instruments Designated as at fair value through profit or loss debt and equity securities Loans and receivables cash and cash equivalents, balances due from brokers, receivables from reverse repurchase agreements and other receivables. Financial liabilities: Trading short positions in securities and derivative financial instruments Other liabilities balances due to brokers, payables under repurchase agreements, redeemable shares and other payables. A financial instrument is classified as held for trading, if: it is acquired or incurred principally for the purpose of selling or repurchasing in the near term; on initial recognition it is part of a portfolio that is managed together and for which there is evidence of a recent pattern of short-term profit taking; or 13

14 it is a derivative, other than a designated and effective hedging instrument. A non-derivative financial asset with fixed or determinable payments may be classified as a loan and receivable unless it is quoted in an active market, or it is an asset for which the holder may not recover substantially all of its initial investment, other than because of credit deterioration. The Fund has designated certain financial assets at fair value through profit or loss when the assets are managed, evaluated and reported internally on a fair value basis. Note 6 provides a reconciliation of line items in the statement of financial position to the categories of financial instruments, as defined by IAS 39. The categories of financial instruments are further discussed in accounting policies 3 (i), (j), (k), (l) and (m). (iii) Derecognition The Fund derecognizes a financial asset when the contractual rights to the cash flows from the financial asset expire, or when it transfers the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred or in which the Fund neither transfers nor retains substantially all the risks and rewards of ownership and does not retain control of the financial asset. Any interest in transferred financial assets that qualify for derecognition that is created or retained by the Fund is recognized as a separate asset or liability in the statement of financial position. On derecognition of a financial asset, the difference between the carrying amount of the asset (or the carrying amount allocated to the portion of the asset derecognized), and the consideration received (including any new asset obtained less any new liability assumed) is recognized in profit or loss. The Fund enters into transactions whereby it transfers assets recognized on its statement of financial position, but retains either all or substantially all of the risks and rewards of the transferred assets or a portion of them. If all or substantially all risks and rewards are retained, then the transferred assets are not derecognized. Transfers of assets with retention of all or substantially all risks and rewards include, for example, securities lending and repurchase transactions. The Fund derecognizes a financial liability when its contractual obligations are discharged or cancelled or expire. (iv) Offsetting Financial assets and liabilities are offset and the net amount presented in the statement of financial position when, and only when, the Fund has a legal right to set off the recognized amounts and it intends either to settle on a net basis or to realize the asset and settle the liability simultaneously. (v) Amortized cost measurement The amortized cost of a financial asset or liability is the amount at which the financial asset or liability is measured at initial recognition, minus principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between the initial amount recognized and the maturity amount, minus any reduction for impairment. (vi) Fair value measurement Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction on the measurement date. When available, the Fund measures the fair value of an instrument using quoted prices in an active market for that instrument. A market is regarded as active if quoted prices are readily and regularly 14

15 available and represent actual and regularly occurring market transactions on an arm s length basis. If a market for a financial instrument is not active, the Fund establishes fair value using a valuation technique. Valuation techniques include using recent arm s length transactions between knowledgeable, willing parties (if available), reference to the current fair value of other instruments that are substantially the same, discounted cash flow analyses and option pricing models. The chosen valuation technique makes maximum use of market inputs, relies as little as possible on estimates specific to the Fund, incorporates all factors that market participants would consider in setting a price, and is consistent with accepted economic methodologies for pricing financial instruments. Inputs to valuation techniques reasonably represent market expectations and measures of the risk-return factors inherent in the financial instrument. The Fund calibrates valuation techniques and tests them for validity using prices from observable current market transactions in the same instrument or based on other available observable market data. The best evidence of the fair value of a financial instrument at initial recognition is the transaction price, i.e. the fair value of the consideration given or received, unless the fair value of that instrument is evidenced by comparison with other observable current market transactions in the same instrument (i.e. without modification or repackaging) or based on a valuation technique whose variables include only data from observable markets. When the transaction price provides the best evidence of fair value at initial recognition, the financial instrument is initially measured at the transaction price and any difference between this price and the value initially obtained from a valuation model is subsequently recognized in profit or loss on an appropriate basis over the life of the instrument but not later than when the valuation is supported wholly by observable market data or the transaction is closed out. Assets and long positions are measured at a bid price; liabilities and short positions are measured at an asking price. (vii) Identification and measurement of impairment At each reporting date the Fund assesses whether there is objective evidence that financial assets not carried at fair value through profit or loss are impaired. A financial asset or a group of financial assets is (are) impaired when objective evidence demonstrates that a loss event has occurred after the initial recognition of the asset(s), and that the loss event has an impact on the future cash flows of the asset(s) that can be estimated reliably. Objective evidence that financial assets are impaired can include significant financial difficulty of the borrower or issuer, default or delinquency by a borrower, restructuring of a loan or advance by the Fund on terms that the Fund would not otherwise consider, indications that a borrower or issuer will enter bankruptcy or other observable data relating to a group of assets such as adverse changes in the payment status of borrowers or issuers in the group, or economic conditions that correlate with defaults in the group. Impairment losses on assets carried at amortized cost are measured as the difference between the carrying amount of the financial asset and the present value of estimated future cash flows discounted at the asset s original effective interest rate. Impairment losses are recognized in profit or loss and reflected in an allowance account against loans and receivables. Interest on impaired assets continues to be recognized through the unwinding of the discount. When a subsequent event causes the amount of impairment loss to decrease, the decrease in impairment loss is reversed through profit or loss. The Fund writes off financial assets carried at amortized cost when they are determined to be uncollectible. 15

16 (i) Cash and cash equivalents Cash and cash equivalents comprise deposits with banks with original maturities of less than three months, other than cash collateral provided in respect to derivatives, securities sold short and securities borrowing transactions. (j) Financial assets and financial liabilities at fair value through profit or loss Financial assets and financial liabilities at fair value through profit or loss are initially recognized and subsequently measured at fair value in the statement of financial position, with transaction costs recognized in profit or loss. All changes in fair value are recognized in Unrealized gain/loss from financial instruments at fair value through profit or loss line of the statement of comprehensive income. (k) Balances due from brokers Balances due from brokers comprise deposits with brokers with original maturities of less than three months, including cash collateral provided in respect to derivatives, securities sold short and securities borrowing transactions. The Fund has brokerage agreements with multiple brokers to carry its accounts as a customer. The brokers have custody of the Fund s securities and, from time to time, cash balances which may be due from these brokers. These securities and/or cash positions serve as collateral for any amounts due to broker. The securities and/or cash positions also serve as collateral for potential defaults of the Fund. The Fund is subject to credit risk if the brokers are unable to repay balances due or deliver securities in their custody. (l) Balances due to brokers Balances due to brokers derived from the borrowing for purchases of additional financial instruments are stated at cash value at the time of purchase, including any accrued interest. (m) Redeemable shares The Fund classifies financial instruments issued as financial liabilities or equity instruments in accordance with the substance of the contractual terms of the instruments. As at June 30, 2010 the Fund had one class of redeemable shares in issue: GBP Class. It is the most subordinate class of financial instruments in the Fund. The redeemable shares provide investors with the right to require redemption for cash at a value proportionate to the investor s share in the Fund s net assets at each monthly redemption date and also in the event of the Fund s liquidation. The redeemable shares are classified as financial liabilities and are measured at the net amount of the fair values of the assets less liabilities. In accordance with the Fund s Offering Memorandum, the redemption amounts of the redeemable shares are calculated using the closing prices of the Fund s underlying investments/short positions. On the other hand, in accordance with the Fund s accounting policies, assets and long positions are measured at a bid price and liabilities and short positions are measured at the asking price (see note 3(h)(vi)). At June 30, 2010, the valuation of the Fund s investments using bid and ask prices did not result in a material difference and no adjustment was made to the Fund s net asset value calculated in accordance with the Offering Memorandum. 16

17 (n) New standards and interpretations not yet adopted A number of new standards, amendments to standards and interpretations in issue are not yet effective for the year ended June 30, 2010, and have not been applied in preparing these financial statements. None of these will have an effect on the financial statements of the Fund, with the possible exception of IFRS 9 Financial Instruments, published on November 12, 2009 as part of phase I of the IASB s comprehensive project to replace IAS 39. IFRS 9 deals with classification and measurement of financial assets and its requirements represent a significant change from the existing requirements in IAS 39 in respect of financial assets. The standard contains two primary measurement categories for financial assets: amortized cost and fair value. A financial asset would be measured at amortized cost if it is held within a business model whose objective is to hold assets in order to collect contractual cash flows, and the asset s contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding. All other financial assets would be measured at fair value. The standard eliminates the existing IAS 39 categories of held to maturity, available for sale and loans and receivables. For an investment in an equity instrument which is not held for trading, the standard permits an irrevocable election, on initial recognition, on an individual shareby-share basis, to present all fair value changes from the investment in other comprehensive income. No amount recognized in other comprehensive income would ever be reclassified to profit or loss. However, dividends on such investments are recognized in profit or loss, rather than other comprehensive income unless they clearly represent a partial recovery of the cost of the investment. Investments in equity instruments in respect of which an entity does not elect to present fair value changes in other comprehensive income would be measured at fair value with changes in fair value recognized in profit or loss. The standard requires that derivatives embedded in contracts with a host that is a financial asset within the scope of the standard are not separated; instead the hybrid financial instrument is assessed in its entirety as to whether it should be measured at amortized cost or fair value. The standard is effective for annual periods beginning on or after January 1, Earlier application is permitted. The Fund is currently in the process of evaluating the potential effect of this standard. The standard is not expected to have a significant impact on the financial statements since the majority of the Fund s financial assets are designated at fair value through profit or loss.. 17

18 4 Financial risk management (a) Introduction and overview The Fund has exposure to the following risks from financial instruments: credit risk liquidity risk market risk operational risk This note presents information about the Fund s exposure to each of the above risks, the Fund s objectives, policies and processes for measuring and managing risk, and the Fund s management of capital. (i) Risk management framework The Fund maintains positions in a variety of derivative and non-derivative financial instruments in accordance with its investment management strategy. The Fund s investment portfolio comprises quoted and non-quoted equity investments and debt securities, derivative financial instruments and investments in non-quoted investment funds that it intends to hold for an indefinite period of time. Asset purchases and sales are determined by the Fund s Investment Manager, who has been given discretionary authority to manage the distribution of the assets to achieve the Fund s investment objectives. Compliance with the target asset allocations and the composition of the portfolio is monitored by the board of directors on a monthly basis. (b) Credit risk Credit risk is the risk that a counterparty to a financial instrument will fail to discharge an obligation or commitment that it has entered into with the Fund, resulting in a financial loss to the Fund. It arises principally from debt securities held, and also from derivative financial assets, cash and cash equivalents and balances due from brokers. For risk management reporting purposes the Fund considers and consolidates all elements of credit risk exposure (such as individual obligor default risk, country and sector risk). (i) Management of credit risk The Fund s policy over credit risk is to minimize its exposure to counterparties with perceived higher risk of default by dealing only with counterparties meeting the credit standards set out by the Investment Manager. The Fund s credit risk is monitored on a monthly basis by the board of directors. (ii) Exposure to credit risk The Fund s maximum credit risk exposure (before collateral and other credit enhancements) at the statement of financial position date is represented by the respective carrying amounts of the financial assets in the statement of financial position. 18

19 (iii) Investments in debt securities The Fund may also invest in unrated debt securities whereby the Investment Manager assigns a credit rating to these securities using a methodology that is consistent with that used by the credit rating agency. As at June 30, % of the Fund s total assets were invested in unrated and unlisted highyield debt securities. (iv) Derivative financial instruments The Fund enters in two types of derivative transactions exchange-traded derivatives and overthe-counter ( OTC ) derivatives. Credit risk arising from exchange-traded derivatives are mitigated by margin requirements and futures exchanges generally have low credit risk. OTC derivatives expose the Fund to the risk that the counterparties to the derivative financial instruments might default on their obligations to the Fund. As at June 30, 2010 the Fund held one position in OTC derivatives which was valued at GBP Nil. (v) Balances due from brokers Balances due from brokers result from cash and margin accounts, cash collateral for borrowed securities and sale transactions awaiting settlement. Credit risk relating to unsettled transactions is considered small due to the short settlement period involved and the high credit quality of the brokers used. As at the reporting date 100% of the balances due from brokers were held with one broker, whose credit rating was A2. The Investment Manager monitors the financial position of the brokers on a quarterly basis. (vi) Cash and cash equivalents The Fund s cash and cash equivalents are held mainly with Royal Bank of Canada (Suisse) which is rated AA based on rating agency Fitch ratings. The Investment Manager monitors the financial position of used banks on a semi-annual basis. (vii) Settlement risk The Fund s activities may give rise to risk at the time of settlement of transactions. Settlement risk is the risk of loss due to the failure of an entity to honour its obligations to deliver cash, securities or other assets as contractually agreed. For the vast majority of transactions the Fund mitigates this risk by conducting settlements through a broker to ensure that a trade is settled only when both parties have fulfilled their contractual settlement obligations. Settlement limits form part of the credit approval and limit monitoring processes described earlier. (c) Liquidity risk Liquidity risk is the risk that the Fund will encounter difficulty in meeting obligations arising from its financial liabilities that are settled by delivering cash or another financial asset, or that such obligations will have to be settled in a manner disadvantageous to the Fund. (i) Management of liquidity risk The Fund s policy and the Investment Manager s approach to managing liquidity is to have sufficient liquidity to meet its liabilities, including estimated redemptions of shares, as and when due, without incurring undue losses or risking damage to the Fund s reputation. 19

20 The Fund s constitution provides for the monthly creation and cancellation of shares and it is therefore exposed to the liquidity risk of meeting shareholder redemptions at each redemption date. The Fund s financial assets include unlisted equity investments, which generally are illiquid. In addition, the Fund holds investments in unlisted open-ended investment funds, which are exposed to the risk of side pockets or redemption restrictions being imposed. As a result, the Fund may not be able to liquidate quickly some of its investments in these instruments in order to meet its liquidity requirements. The Fund s listed securities are considered to be readily realizable as they are all listed on major European or American stock exchanges. The Fund s liquidity risk is managed on a daily basis by the Investment Manager in accordance with policies and procedures in place. The Fund s overall liquidity risks are monitored on a monthly basis by the board of directors. The Fund s redemption policy only allows for redemptions on the last day of each month and shareholders must provide 10 days notice. It is the Investment Manager s policy to have liquid assets comprising cash and cash equivalents equal to at least 105 percent of monthly anticipated redemptions. (ii) Maturity analysis The table below summarizes the maturity profile of the Fund s assets and liabilities based on contractual undiscounted payments as at June 30, 2010: No scheduled maturity Less than 1 month 1 to 3 months 3 to 59 months Assets Financial assets at fair value through profit or loss 4'402' '664'952 Cash and cash equivalents 1'349' Due from brokers 497' Accrued interest '932 Other assets '128 6'249' '892'012 Liabilities Deferred subscriptions - 271' Redemptions payable 709' Accrued expenses and other payables - 27' '008' '249'692-1'008'450-2'892'012 20

21 (d) Market risks Market risk is the risk that changes in market prices, such as interest rates, equity prices, foreign exchange rates and credit spreads (not relating to changes in the obligor s/issuer s credit standing) will affect the Fund s income or the value of its holdings of financial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, while optimizing the return on risk. (i) Management of market risks The Fund s strategy for the management of market risk is driven by the Fund s investment objective. The Fund s market risk is managed on a daily basis by the Investment Manager in accordance with policies and procedures in place. The Fund s market positions are monitored on a quarterly basis by the board of directors. An overview of the Fund s investment portfolio at the statement of financial position date is set out below: Cost Market Value Structured Bonds 426' '402 Convertible Debt 2'212'850 2'283'550 ETFs 1'596'116 1'592'508 Hedge Funds 2'064'988 2'038'024 Investment Funds - Equity 366' '639 Investment Fund - Fixed Income 416' '770 7'084'095 7'067'893 The Fund may use derivatives to manage its exposure to foreign currency, interest rate and equity market risks. The instruments used may include interest rate swaps, forward contracts, futures and options. The Fund does not apply hedge accounting. (ii) Exposure to market price risks Price risk is the risk that the value of the investments will fluctuate as a result of changes in market prices, whether caused by factors specific to an individual investment, its issuer or all factors affecting all instruments traded in the market. As the majority of the Fund s financial instruments are carried at fair value with fair value changes recognized in the income statement, all changes in market conditions will directly affect net investment income. The market price risk of the Fund s financial asset and liability positions is monitored by the Investment Manager on a daily basis. If the last market prices at June 30, 2010 had increased by 5% with all other variables held constant, this would have increased net assets attributable to holders of participating shares by approximately GBP Conversely, if the if the last sale prices at June 30, 2010 had decreased by 5% with all other variables held constant, this would have decreased net assets attributable to holders of participating shares by approximately GBP (iii) Exposure to interest rate risk The Fund is exposed to the risk that the fair value or future cash flows of its financial instruments will fluctuate as a result of changes in market interest rates. A summary of the Fund s interest rate gap position, categorized by the earlier of contractual repricing or maturity date, is as follows: 21

22 As at June 30, 2010 Interest bearing Non-interest bearing Total Assets Financial assets at fair value through profit or loss 2'664'952 4'402'941 7'067'893 Cash and cash equivalents - 1'349'199 1'349'199 Due from brokers - 497' '552 Accrued interest and other assets 227' '060 2'664'952 6'476'752 9'141'704 Liabilities Deferred subscriptions - 271' '579 Accrued expenses and other payables - 27'687 27'687 Redemptions payable 709' '184-1'008'450 1'008'450 Total interest sensitivity gap 2'664'952 5'468'302 8'133'254 (iv) Exposure to currency risk The Fund invests in financial instruments and enters into transactions that are denominated in currencies other than its functional currency. Consequently, the Fund is exposed to risks that the exchange rate of its currency relative to other foreign currencies may change in a manner that has an adverse effect on the fair value or future cash flows of that portion of the Fund s financial assets or liabilities denominated in currencies other than the Pound Sterling. The Fund s currency risk is managed on a daily basis by the Investment Manager in accordance with policies and procedures in place. The Fund s currency positions and exposures are monitored on a monthly basis by the board of directors. 22

23 At the reporting date the carrying value of the Fund s financial assets and liabilities held in individual foreign currencies were as follows: United States Dollars Euros Total Assets Financial assets at fair value through profit or loss 3'978' '639 4'332'466 Due from brokers 11'215 2'814 14'029 3'990' '453 4'346'495 Liabilities Total currency risk exposure 3'990' '453 4'346'495 (e) Operational risks Operational risk is the risk of direct or indirect loss arising from a wide variety of causes associated with the processes, technology and infrastructure supporting the Fund s operations either internally within the Fund or externally at the Fund s service providers, and from external factors other than credit, market and liquidity risks such as those arising from legal and regulatory requirements and generally accepted standards of investment management behaviour. Operational risks arise from all of the Fund s activities. The Fund s objective is to manage operational risk so as to balance limiting of financial losses and damage to its reputation with achieving its investment objective of generating returns to investors. The primary responsibility for the development and implementation of controls over operational risk rests with the board of directors. This responsibility is supported by the development of overall standards for the management of operational risk, which encompasses the controls and processes at the service providers and the establishment of service levels with the service providers, in the following areas: requirements for appropriate segregation of duties between various functions, roles and responsibilities requirements for the reconciliation and monitoring of transactions compliance with regulatory and other legal requirements documentation of controls and procedures requirements for the periodic assessment of operational risks faced, and the adequacy of controls and procedures to address the risks identified contingency plans ethical and business standards 23

24 risk mitigation, including insurance where this is effective. The directors assessment over the adequacy of the controls and processes in place at the service providers with respect to operational risks is carried out via ad hoc discussions with the service providers and a review of the service providers reports on internal controls, where available. 24

25 5 Use of estimates and judgments These disclosures supplement the commentary on financial risk management (see note 4). (a) (i) Key sources of estimation uncertainty Determining fair values The determination of fair value for financial assets and liabilities for which there is no observable market price requires the use of valuation techniques as described in note 3(h)(vi). For financial instruments that trade infrequently and have little price transparency, fair value is less objective, and requires varying degrees of judgement depending on liquidity, concentration, uncertainty of market factors, pricing assumptions and other risks affecting the specific instrument. See also Valuation of financial instruments below. (b) Critical accounting judgments in applying the Fund s accounting policies Critical accounting judgments made in applying the Fund s accounting policies include: (i) Valuation of financial instruments The Fund s accounting policy on fair value measurements is discussed in note 3(h)(vi). The Fund measures fair values using the following fair value hierarchy that reflects the significance of the inputs used in making the measurements: Level 1: Quoted market price (unadjusted) in an active market for an identical instrument. Level 2: Valuation techniques based on observable inputs, either directly (i.e. as prices) or indirectly (i.e. derived from prices). This category includes instruments valued using: quoted market prices in active markets for similar instruments; quoted prices for identical or similar instruments in markets that are considered less than active; or other valuation techniques where all significant inputs are directly or indirectly observable from market data. Level 3: Valuation techniques using significant unobservable inputs. This category includes all instruments where the valuation technique includes inputs not based on observable data and the unobservable inputs have a significant effect on the instrument s valuation. This category includes instruments that are valued based on quoted prices for similar instruments where significant unobservable adjustments or assumptions are required to reflect differences between the instruments. Fair values of financial assets and financial liabilities that are traded in active markets are based on quoted market prices or dealer price quotations. For all other financial instruments the Fund determines fair values using valuation techniques. Valuation techniques include net present value and discounted cash flow models, comparison to similar instruments for which market observable prices exist, Black-Scholes and polynomial option pricing models and other valuation models. Assumptions and inputs used in valuation techniques include risk-free and benchmark interest rates, credit spreads and other premia used in estimating discount rates, bond and equity prices, foreign currency exchange rates, equity and equity index prices and expected price volatilities and correlations. The objective of valuation techniques is to arrive at a fair value determination that reflects the price of the financial instrument at the reporting date that would have been determined by market participants acting at arm s length. 25