SLF Features. Who Can Invest. Entry/Exit Sri Lanka Fund. Auditors KPMG Cayman Islands. Administrators Carsons Management Services (Private) Limited

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1 Annual Report 2012 [][] [] [ ][][][][][][][][

2 SLF Features Auditors KPMG Cayman Islands Administrators Carsons Management Services (Private) Limited Lawyers Maples & Calder, Cayman Islands Fee Structure Management Fee 1.5% of NAV Front End 1.5% - 2% depending on value, over USD 100,000 Negotiable Custodian Cost 0.15% of NAV or Minimum of USD 16,000 Legal, Audit & Other direct Expenses borne by Fund Who Can Invest International Funds, Institutional Investors, Companies or Individuals not resident in Sri Lanka. Sri Lankans holding Foreign Currency Accounts who are not resident in Sri Lanka. Entry/Exit Sri Lanka Fund Investment to the fund is by way of subscription to units of the fund Applications for over USD 10,000 and will carry front end fees: USD 10,000 50, % USD 50, , % Above USD 100,000 negotiable Redemption is by way of notification to the Manager within the dealing period Application forms listed on the web Forms to be forwarded to Fund Managers or Custodian KYC details to be submitted along with the application Money transfer done directly to/from custodian Dealing day: Every other Tuesday of the month subscription/redemption will be accepted on this day price. Dealing period: Period within which applications for subscriptions/redemption must be received in order to be dealt with on succeeding dealing day. Subscription/Redemption must be received 5 business days prior to dealing day.

3 Managers Review Market The All Share Index (ASI) declined by 7.10% for CY2012 while the S&P 20 SL closed the year relatively flat at 0.70%. Overall market activity was subdued on local participation throughout the year largely on account of higher interest rates. However, foreign activity was buoyant for 2012 with a record inflow of Rs billion which included the entry of Malaysia s sovereign wealth fund, Khazanah, investing an initial Rs billion into John Keells Holdings. Foreign activity was focused on specific counters displaying strong fundamentals. Overall market activity with respect to average daily turnover of Rs. 883 million was relatively low compared to 2011 of Rs.2,286 million. The ASI started the year at 6, which was the highest point for the year and recorded declines of 10.77% and 8.38% for 1Q2012 and 2Q2012 respectively. It was in 2Q2012 where the market hit its lowest point for the year of 4, which was a drop of 22.01% from its peak at the start of the year. The ASI gathered upward momentum thereafter and gave a return of 20.26% in 3Q2012. However, short lived retail participation saw the market declining in the last quarter by 5.51%. The ASI as at July of 2013 increased by 14.39% for YTD 2013, led by large cap counters such as John Keells Holdings, Ceylon Tobacco Company, Nestle and Lanka Lubricants. Net foreign purchases persisted in 2013 with foreign inflows of Rs. 17 billion. Average daily turnover has improved marginally to Rs. 942 million in comparison to the 2012 value of 883 million. The Colombo Bourse underperformed most major regional equity markets in the year under review including the BSE Sensex, Hang Seng, Straits Times and the Nikkei. The CSE had historically performed well relative to other regional indices historically as seen in the prior two years. Tighter monetary policy experienced in 2012 resulted in the economic deceleration cascading into market returns. However, with the policy rate cuts and further anticipated monetary easing economic growth is expected to once again accelerate creating a positive market sentiment for Colombo Stock Exchange Turnover (Rs. Mn) ASI S&P 20 SL Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec-12 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Rs. Mn. The Sri Lanka Fund Annual Report

4 Managers Review The top performing sectors for 2012 were beverage, food & tobacco, health care and telecommunications. A surge in defensive counters related to food, beverage and tobacco such as Ceylon Tobacco and Nestle saw this sector provide extraordinary returns. The most significant sectors to see price declines were land and property, manufacturing and hotels and travels. Declines in these sectors were largely attributable to higher interest rates, rising energy prices and growth in tourist The key sectors that will benefit from performance going forward are Banks, Finance & Insurance sector, Diversified sector, Beverage, Food and Tobacco sector and Healthcare. An overall sustained drop in interest rates and stable economic climate is required to push forward corporate expansion plans and reactivate retail investor participation. At the same time, rising energy and fuel costs which are inflationary would negatively affect corporate earnings. Rs.19,000 mn outflow (YE 2011),Rs. 33,607 mn inflow (YE 2012) Month Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Turnover - Domestic vs Foreign 82% 82% 65% 78% 71% 89% 70% 77% 85% 68% 57% 62% 18% 18% 35% 22% 29% 11% 30% 23% 15% 32% 43% 38% T/O Domestic T/O Foreign Net Foreign inflow (Rs. Mn) 472 1,907 17, , ,449 (2,235) 3,063 2,401 1,544 3,175 arrivals not filtering to higher occupancy levels. The top performing sectors for the YTD July 2013 were Beverage, Food & Tobacco, Manufacturing, Land & Property which increased by 21.6%, 16.5% and 14%. The lowest contributing sectors for YTD 2013 were IT, Trading and Plantations which declined by 51.5%,10.6% and 10.2%. The Equity market outlook shows significant potential in the medium to long term with listed companies benefitting from the accelerated development of the country and its bright economic prospects. Sector Performance Beverage Food and Tobacco 36.68% Health Care 4.15% Telecommunications 1.70% Diversified Holdings -1.39% Plantations -7.49% Banks Finance and Insurance -7.49% Hotels and Travels -9.41% Construction and Engineering % Manufacturing % Land and Property % Oil Palms % Motors % All share Index -7.10% 2

5 Country Index Sri Lanka ASPI (8.46) (7.10) Pakistan Karachi Index (4.93) Malaysia KLCI (0.80) Indonesia JSX Composite India BSE Sensex (24.64) Thailand SET (0.86) Hong Kong Hang Seng 5.32 (19.97) Singapore Straits Times (17.62) USA Dow Jones UK FTSE (6.69) 8.65 Japan Nikkei (1.91) (18.81) China SSE Composite (13.93) (22.60) 4.40 MSCI Frontier Markets (22.94) 4.47 MSCI Emerging Markets (20.60) Outlook for Sri Lanka The Sri Lankan economy recorded a GDP growth of 6.5% for the year 2012 amidst unfavorable weather conditions, higher interest rates and the impact of poor global economic conditions. GDP grew below the 8% levels achieved over the prior two years which was achieved with the end to the 30 year war in the country. The first quarter of 2013 saw GDP growing by 6.0%. The central bank tightened monetary policy in 1Q2012 revised the exchange rate policy to a more market driven policy. The resulting sudden and steep depreciation in the exchange rate, subdued global demand and higher interest costs resulted in the overall slow-down of economic activity. Agriculture recorded slower growth of 5.8% for 2012 compared to the previous year where the sector recorded 7.0%. The delay in the north-west monsoon rainfall saw the sector output decline by -0.5% in the 3Q 2012 where Paddy Real GDP - Quarterly growth Percentage Agriculture Industry Services GDP 1Q2007 2Q2007 3Q2007 4Q2007 1Q2008 2Q2008 3Q2008 4Q2008 1Q2009 2Q2009 3Q2009 4Q2009 1Q2010 2Q2010 3Q2010 4Q2010 1Q2011 2Q2011 3Q2011 4Q2011 1Q2012 2Q2012 3Q2012 4Q2012 The Sri Lanka Fund Annual Report

6 Managers Review output fell by 38.2%. The Industry sector which makes up approximately 29% of the economy grew by 10.30% growth in 2012 in line with the previous year. The largest contributing sub-sector to industry was manufacturing where growth slowed to 5.2% 2012 from 7.9% in 2011.This sub-sector slowed down largely due to higher domestic energy prices, tightening of monetary policy, significant rupee depreciation and subdued demand for Sri Lankan exports due global economic factors. The construction sub-sector was buoyant in 2012 recording 21.6% on the back of large scale construction projects such as hotels, apartment complexes and road construction. The Service sector which contributes approximately 59% slowed down significantly to 4.6% from 8.6% in the previous year. The sub-sectors of whole sale and retail trade and also transport & communication were key contributors to the slower growth rate achieved by this sector. The whole sale and retail trade recorded a growth of 3.7% for 2012 compared to 10.3% in Sri Lanka has yet to witness the full benefits of post war economic activity by way of high levels of investment largely due to global economic concerns. The Central Bank aggressively adjusted policy rates upwards in February and April of 2012 in order to reduce the external pressure on the Rupee and to address the high credit growth that was prevailing at the start of the year. Furthermore, the Central Bank imposed a ceiling on credit expansion for commercial banks. The adoption of a more flexible exchange rate policy saw the rupee depreciate by 10.3% for As at July 2013, the rupee has depreciated by 3.4% for the year to date. The weighted average 364 day Treasury bill announced at the weekly auctions started the year at 9.31% reached a high of 13.36% in September 2012 and closed the year at 11.69%. As at July 2013 the 364 day Treasury bill was 10.56%. The liquid five year bonds were trading at approximately 9.93% at the start of the year and reached a high of 14.38% levels in August before closing the year at 11.85%. As at July 2013 the 5 year bond was trading at 11.30%. In December 2012, the Monetary Board was of the view that the slowdown in credit utilization, expected moderation in inflation and the need to support the economy to realize its growth potential required a reduction in policy rates by 25 basis points for both the repo and reverse repo and the removal of the credit ceiling. This stance was further supplemented by a reduction in policy rates by 50 basis points in May-2013 and a 2.0% cut in the Statutotry Reserve Requirement in June SLRs. Per unit as at 31stDec11 SLRs. Per unit as at 30thJun12 SLRs. Per unit as at 30thDec12 SLRs. Per unit as at 30thJun13 Appreciation / (Depreciation) for CY 2012 US$ (10.31%) STG (14.17%) Euro (12.28)% Yen % 4

7 We believe the Sri Lankan economy can maintain a growth rate of 7.0% to 8.0% over the medium term as it continues to benefit from major infrastructure development projects and increased economic activity from post war developments. Other economic indicators such as inflation are likely to be maintained at single digit level as the Central Bank follows appropriate policies to contain inflation caused by pressure from global commodity price inflation that may put pressure on the Colombo Consumer Price Index (CCPI). The trade deficit in 2011 which had exerted pressure on the Balance of Payments saw a YOY reduction of 4.1% to US$ 9.3 billion for Exports declined YOY by 7.4% in 2012 to US$ 9.8 billion with a drop in all key export categories. Imports expenditure declined to US$ 19.1 billion which was a drop of 5.8% from Policy actions introduced at the start of the year with an aim to curtail imports were very effective particular on the import of consumer goods which recorded a drop of 18% in Worker Remittances continues to help offset the large trade deficit by displaying strong growth in 2012 with an increase of 16.3% to US$ 6.0 billion. As the fund is focused purely on Sri Lankan Equities any exchange rate devaluations will have a negative impact on the dollar denominated Net Asset Value. Portfolio Review The year under review saw the Sri Lanka Fund s NAV per share decline by 9.64% in comparison to the All Share Price Index and Milanka Price Index decline of 15.97%1and 12.26%1 respectively. The fund out-performed the All Share Price Index by 6.33% and out-performed the Milanka Price Index by 2.62% during the period under review. The Sri Lanka Fund from inception has focused on fundamentally strong counters which show significant medium to long term growth potential. The net asset value of the Sri Lanka Fund attend December 2012 was USD 0.75 in comparison to USD 0.83 at end December The total value of the Sri Sector-wise Exposure Banking, Finance & Insurance 29.48% Diversified Holdings 26.31% Hotels & Travels 7.79% Manufacturing/Construction 0.02% Beverage, Food & Tobacco 32.62% Health Care 3.78% The Sri Lanka Fund Annual Report

8 Managers Review Lanka Fund inclusive of cash and cash equivalents amounted to US$2.20 million at end December The fund has been structured to represent key growth sectors of the economy in Sri Lanka such as diversified, banking, finance& insurance, hotels, manufacturing & construction. Our investment process is driven by fundamental analysis and in depth research. We believe in an aggressive style of bottom up stock selection of companies with good management, competitive business models and attractive valuations. In the event the macroeconomic fundamentals weaken and the market continues to correct the fund will look to reduce exposure to Equity and invest in more short term fixed income investments. The total participating shares in issue as at end December 2012 was 2,927,131. The Fund vs. The Market Fund (NAVPS)* ASPI Index** MPI Index** Composite % -5.06% % 60 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 * NAVPS - Net Asset Value Per Share ** Source: (adjusted for the movements in foreign exchange rates) ***Portfolio was restructured after infusion of seed capital by the promoters in August 2010 Historic Performance Period Fund ASPI* MPI* S&P SL 20 I Month 7.14% 7.28% 6.18% 6.71% 3 Months 1.35% -1.46% -4.28% -0.26% YTD % % % % Since Relaunch -5.06% -2.07% % -4.41% 6

9 Five Largest Investments Our Top 5 Holdings as at 31st December 2012 Value of the holding Rs.mn Portfolio Weight % Price movement % John Keells Holdings - A diversified company with interests in ports & related activities, transportation, property development, tourism, financial services and consumer products in Sri Lanka and now moving into the South Asian region % 29.2% Cargills - Leading player in the retail super market trade, commanding 50% of the market share. Also has manufacturing operations in the food sector and operates the KFC franchise in Sri Lanka % -28.3% Distilleries - The leader in the hard liquor industry with a market share of 65% and diversified business interests in tourism, tea and rubber plantations, telecom and insurance % 12.8% Commercial Bank- One of the largest commercial banks in Sri Lanka with a wide branch network of over 100 branches spread island wide % 3.0% Nestle - Is a subsidiary of the renowned Swiss multinational snack, food and health related consumer goods company % 81.7% Top 5 Holdings % Total Portfolio % The Sri Lanka Fund Annual Report

10 Profile of the Manager Guardian Fund Management Limited (GFM) and the investment companies it manages (Ceylon Guardian Investment Trust PLC and Ceylon Investment PLC) are subsidiaries of Carson Cumberbatch PLC, a diversified conglomerate listed on the Colombo Stock Exchange with business interest in brewing, oil palm plantations and real estate in addition to its investment holdings. Carson s businesses span across Sri Lanka, South Asia and South East Asia. It is among the top 5 listed check companies on the Colombo Bourse by Market Capitalization. GFM is registered as an Investment Manager with the Securities and Exchange Commission of Sri Lanka since 2006 while the listed investment companies are registered as underwriters. GFM also manages client funds of Rs.2.0 billion update and entered into a joint venture with a local investment bank to manage and market unit trusts to retail investors. The products are distributed through one of Sri Lanka s leading private sector commercial banks, the HNB, through a branch network comprising 65 outlets. The Fund Manager also manages a private equity portfolio of approximately Rs.1.3 billion comprising unlisted Sri Lankan companies engaged in key economic sectors of the country, which are expected to go public within the short to medium term. The track record of performance of GFM is best illustrated by the performance record of the Guardian Fund. CAGR of portfolio taking a five year horizon is % compared to the benchmark All Share Index of %. The bulk of the funds under management is invested in long term listed equities which cover an investment horizon of 3-5 years. The investment style adopted is weighted towards Value Investing where bottom up approach of stock selection is done where individual company valuations are given precedence over asset and sector allocations of the portfolio. 8

11 Directors Profiles Ruvini Fernando Ruvini Fernando is the Director and CEO of Guardian Fund Management Limited, the Fund Management Company of the Carsons Group and a Director of The Sri Lanka Fund. Director of Guardian Acuity Asset Management Limited, a joint venture company of the Guardian Group, responsible for operating and managing licensed unit trusts. She Counts over 23 years work experience in the fields of Management Accounting, Finance, Research Analysis, Strategic Planning and Investments, within the Hayleys Group and Carson Cumberbatch Group. Ruvini was a former visiting faculty member of the Postgraduate Institute of Management in the MBA programme. A Member of the Regaining Sri Lanka Tourism Steering Committee, a key policy making forum of the government from January 2002 to January Fellow of the Chartered Institute of Management Accountants, UK and the Association of Chartered Certified Accountants, UK. Has a Masters Degree in Business Administration from the Postgraduate Institute of Management (PIM), University of Sri Jayawardenapura, Sri Lanka. Adrian Collins Adrian Collins has worked in the fund management business for over 35 years, a large part of which was at Gartmore Investment Management where, latterly, he was the Managing Director. He has had a number of positions in the Fund Management industry over the years and is currently the Chairman of Liontrust Asset Management PLC and Bahamas Petroleum plc. He is also on the boards of City Natural Resources High Yield Trust plc, New City High Yield Fund and a number of other companies both in the UK and overseas. Chandima Gunawardena Chandima Gunawardena serves as a Non-Independent, Non-Executive Director of Carson Cumberbatch PLC and in most of the Carsons Group Companies in Sri Lanka and overseas. He is also a Director of Bukit Darah PLC. Since assuming Non-Executive status in the group in 2011, he serves as an advisor to the group s Strategic Planning and Management forums in Sri Lanka and serves on Board Committees including the Audit Committees of the Group in Sri Lanka and overseas covering all operating sectors of the group. Mr. Gunawardena has over four decades of experience in varied fields of business and commercial activities and has held senior positions in Corporate, Mercantile and State Institutions. He was appointed to the Carsons Group Directorate in He has served on the Management Committee of The Ceylon Chamber of Commerce for over 10 years and was a Founder Council member of the Sri Lanka Institute of Directors (SLID) and continued to serve in the council for over 10 years. He is a Fellow of the Chartered Institute of Management Accountants, UK. The Sri Lanka Fund Annual Report

12 Our Team Ruvini Fernando Please refer Directors Profiles Krishna Selvanathan Krishna Selvanathan is a Director of Carsons Management Services (Private) Limited, Lion Brewery (Ceylon) PLC and the Investment Sector Companies of the Carsons Group. He is also a Director of Carlsberg India (Pvt) Ltd. He holds a BA Degree in Accounting & Finance and Business Administration from the University of Kent, U.K. Niloo Jayatilake Niloo Jayatilake is a Director of Guardian Fund Management Limited and heads the portfolio management division of the management company. Alternate Director in Guardian Acuity Asset Management Limited. She counts over 17 years of experience in the investments field. Prior to joining the Carsons Group she worked as Fund Manager at The Unit Trust Management Company Limited, managers of Ceybank Unit Trust Funds in Sri Lanka. She is a Fellow Member of the Chartered Institute of Management Accountants, UK and Associate Member of the Institute of Chartered Secretaries and Administrators, UK. Sumith Perera Fund Manager, Guardian Fund Management Ltd. Has over 9 years of experience in the field of Asset Management working as a Fund Manager for CAAM Saudi Fransi LLC (Kingdom of Saudi Arabia), Investment Analyst for Eagle NDB Fund Management (Sri Lanka) and as a Financial Analyst for John Keells Stockbrokers (Sri Lanka). He holds a Bsc (Hons) in Economics and Business Finance from Brunel University, UK and is an Associate Member of the Chartered Institute of Management Accountants. Vibath Wijesinghe Financial Controller of Carsons Management Services (Private) Limited the management support service provider to the Carson Cumberbatch Group. He began his career at M/s. KPMG, Sri Lanka and has over ten years of experience in the fields of finance, corporate finance and auditing. He joined Carson Cumberbatch Group in He is an Associate Member of the Institute of Chartered Accountants of Sri Lanka, Chartered Institute of Management Accountants (UK) and of the Society of Certified Management Accountants of Sri Lanka. He also holds a Masters degree in Business Administration from Postgraduate Institute of Management University of Sri Jayewardenepura. Tharinda Jayawardana Head of Research of Guardian Fund Management Ltd. He has over 6 years experience in investment research. Prior to joining the Carson Cumberbatch Group he worked as a financial analyst at JB Securities (PVT) Ltd.. He is a CFA Charter Holder and an Associate Member of the Chartered Institute of Management Accountants (UK). He also has a first class B.Sc (Hons) in Finance from the University of Sri Jayewardenepura. 10

13 Asanka Jayasekera Manager Research, Guardian Fund Management Ltd. He has over 6 years of experience in investment research. Prior to joining the Carson Cumberbatch Group, he worked as a financial analyst at JB Securities Ltd. He is an associate member of the Chartered Institute of Management Accountants (UK) and holds a B.Sc degree from the University of Sri Jayewardenepura specializing in Finance. Lakmal Wickramaarachchi Accountant, Guardian Fund Management Limited. He commenced his career at KPMG, Chartered Accountants, prior to joining the Carsons Group. He counts over six years of experience in auditing and accounting. Lakmal is an Associate Member of the Institute of Chartered Accountants of Sri Lanka. He Holds a B.Sc. Finance (Special) Degree from the University of Sri Jayewardenepura, Sri Lanka. The Sri Lanka Fund Annual Report

14 Report of the Directors The Directors hereby submit their annual report together with the audited financial statements of The Sri Lanka Fund (the Fund) for the year ended 31st December The Company The Company is an open-ended investment company, incorporated as an exempt company in the Cayman Islands with limited liability. The Sri Lanka Fund was launched via a prospectus and currently the Fund represented by class A shares of the Company. The Articles of the Company permit the creation of new classes of shares to accommodate subordinated funds, though no such subordinated funds have been created as at 31st December The Fund s investment objective is to achieve long-term capital growth by investing in a diversified portfolio of equity securities, including convertible bonds and warrants listed on the Colombo Stock Exchange and those issued outside Sri Lanka by any corporation organised in and under the laws of Sri Lanka and which has its shares listed on the Colombo Stock Exchange and equity securities issued by listed investment companies and funds, wherever established, which invest primarily in equity issued by Sri Lankan companies listed on the Colombo Stock Exchange. Results and Dividends The results of the Fund for the year ended 31st December 2012 are set out in the Annual Report. The Directors do not recommend the payment of a dividend for the year ended 31st December Share capital The details of changes in the issued share capital including subscriptions and redemptions of shares for cash during the year are set out in the Statement of Changes in Net Assets Attributable to Holders of Participating Shares and Note 4 to the financial statements. Directors The Directors during the year and up to the date of this report were: Don Chandima Rajakaruna Gunawardena Adrian John Reginald Collins Mrs. Wedage Yasanthi Ruvini Fernando Directors and their interests Mrs. W.Y.R. Fernando is a Director of Guardian Fund Management Limited, the Investment Manager of the Fund. Apart from the above, as at 31st December 2012, none of the Directors had any interest in the share capital of the Company or any interest in any material contracts or contracts for the provision of services during the year significant to the business of the Company. All Directors are entitled to an annual fee. However, Mr. D.C.R. Gunawardena and Mrs. W.Y.R. Fernando have waived their Directors fee for the year. 12

15 Auditors The Company s Auditors during the year under review were Messrs. KPMG, Chartered Accountants. The retiring Auditors being eligible, offer themselves for reappointment. A resolution for the reappointment of Messrs. KPMG as Auditors of the Company is to be proposed at the forthcoming Annual General Meeting. By order of the Board (Sgd). D.C.R. Gunawardena Director 25 June 2013 The Sri Lanka Fund Annual Report

16 14 Report of the Independent Auditors

17 Statement of Comprehensive Income For the year ended 31st December Note US$ US$ Income Dividend income 53,821 57,427 Interest on fixed deposit 7,115 6,470 Realized loss on sale of investments 3 (80,274) (16,838) Loss on re-measurement of investments 3 (113,962) (580,651) Foreign exchange losses (11,514) (502) Payable balances write back - 10,000 Net investment income (144,814) (524,094) Expenses Investment manager s fees 7 (30,939) (43,930) Custodian s fees 8 (15,945) (16,000) Administrator s fee 7 - (5,850) Legal and professional fees (4,279) (11,203) Auditors remuneration (12,972) (12,260) Directors remuneration 7 (5,000) (5,000) Brokerage expenses (14,753) (43,824) Sundry expenses (2,713) (4,499) Operating expenses (86,601) (142,566) Change in net assets attributable to holders of participating shares resulting from operations (231,415) (666,660) The accompanying notes form an integral part of these financial statements. The Sri Lanka Fund Annual Report

18 Statement of Changes in Net Assets Attributable to Holders of Participating Shares For the year ended 31st December US$ US$ Balance as at 01st January 2,431,289 3,097,949 Change in net assets attributable to holders of Participating shares resulting from operations for the year (231,415) (666,660) Redemption of participating shares during the year - - Issue of participating shares during the year - - Balance as at 31st December 2,199,874 2,431,289 The accompanying notes form an integral part of these financial statements. 16

19 Statement of Financial Position As at 31st December Note US$ US$ Assets Cash and cash equivalents 339,534 61,731 Interest receivable of investments Dividend receivable of investments 1,031 5,533 Non pledged financial assets at fair value through profit or loss 3, 6, 9 1,902,880 2,422,888 Total assets 2,243,504 2,490,208 Liabilities Redemption payable (1,498) (1,498) Accruals and other payables (42,132) (57,421) Total liabilities (excluding net assets attributable to holders of participating shares) (43,630) (58,919) Net assets attributable to holders of participating shares 4,5 2,199,874 2,431,289 Net asset value per share, based on 2,927,131 ( ,054/-) shares outstanding 4, The accompanying notes form an integral part of these financial statements The financial statements were approved and authorised for issue by the Board of Directors and are signed on their behalf. (Sgd). D.C.R. Gunawardena Director (Sgd). W.Y.R.Fernando Director 25 June 2013 The Sri Lanka Fund Annual Report

20 Cash Flow Statement For the year ended 31st December US$ US$ Operating Activities Dividend received 58,323 51,894 Interest income received 7,113 6,508 Operating expenses paid (101,891) (161,733) Proceeds on sale of shares 815,842 2,136,294 Proceeds from fixed deposit - 172,382 Payments for purchase of shares (482,957) (1,981,668) Investment in fixed deposits (7,113) (172,597) Foreign exchange loss (11,514) (502) Cash flows from operating activities 277,803 50,578 Financing activities Payment for redemption of participating shares - - Proceeds from issue of participating shares - - Cash flows from financing activities - - Net increase in cash and cash equivalents 277,803 50,578 Cash and cash equivalents as at 1st January 61,731 11,153 Cash and cash equivalents as at 31st December 339,534 61,731 The accompanying notes form an integral part of these financial statements. 18

21 Notes to the Financial Statements For the year ended 31st December Organization The Sri Lanka Fund ( the Fund ) is an open-ended investment fund incorporated as an exempt company under the Companies Law (Revised) of the Cayman Islands on 21st October 1993 and registered under the Mutual Funds Law on 26th July The objective of the Fund is to provide shareholders with above average returns over the medium to long term through both capital growth and income. The Fund aims to deliver this objective mainly by investing in highly diversified portfolios of equity securities including convertible bonds and warrants listed on the Colombo Stock Exchange and those issued outside Sri Lanka by any corporation organized in and under the laws of Sri Lanka and which has its shares listed on the Colombo Stock Exchange, and equity securities issued by listed investment companies and funds, wherever established, which invest primarily in equity of Sri Lankan companies listed on the Colombo Stock Exchange. In doing so, it applies techniques more fully defined in the Fund s Offering Memorandum. The investment activities of the Fund are managed by Guardian Fund Management Limited ( the Investment Manager ) and the administration of the Fund is delegated to Carsons Management Services (Private) Limited ( the Administrator ). The registered office of the Fund is located at P.O. Box 309, Ugland House, Grand Cayman KY1-1104, Cayman Islands. 2. Significant Accounting Policies (a) Statement of Compliance The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs). (b) Basis of preparation The financial statements are presented in United States Dollars and not the local currency of the Cayman Islands reflecting the fact the shares of the Fund are issued and redeemed in United States Dollars. They are prepared on a fair value basis for the financial assets and financial liabilities at fair value through profit or loss. Other financial assets and liabilities are stated at amortized cost or redemption amount (redeemable shares). The preparation of the financial statements in conformity with IFRSs requires management to make judgments, estimates and assumptions that affect the applications of policies and the reported amounts of the assets and liabilities, income and expense. The estimates and associated assumptions are based on historical experience and various other factors that are believed to be reasonable in the circumstances, the results of which form the basis of making the judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. The Sri Lanka Fund Annual Report

22 Notes to the Financial Statements For the year ended 31st December 2012 The estimates and underlying assumptions are reviewed on an ongoing basis. Revision to accounting estimates are recognized in the period in which the estimates were revised if the revision affect only that period, or in the period of the revision and the future period if the revision affect both current and future periods. The accounting policies have been applied consistently by the Fund and are consistent with those used in the prior year. (c) Foreign currencies translation Transactions in foreign currencies are translated at the foreign currency exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated to United State Dollars at the foreign currency closing exchange rate ruling at the statement of financial position date. Foreign currency exchange differences arising on translation and realized gains and losses on disposal or settlement of monetary assets and liabilities are recognized in the statement of comprehensive income. Nonmonetary assets and liabilities denominated in foreign currencies that are measured at fair value are translated to United States Dollars at the foreign currency exchange rates ruling at the dates that the fair values were determined. Foreign currency exchange differences relating to investments at fair value through profit or loss are presented separately. (d) Financial Instruments (i) Classification The Fund designates all its equity investments into the financial assets at the fair value through profit or loss category. Financial instruments are designated at fair value through profit or loss upon initial recognition. These include equity securities including convertible bonds and warrants listed on the Colombo Stock Exchange, securities issued outside Sri Lanka by any corporation organized in and under the laws of Sri Lanka which has its shares listed on the Colombo Stock Exchange, and equity securities issued by listed investment companies and funds wherever established, which invest primarily in equity of Sri Lankan companies listed on the Colombo Stock Exchange. Financial liabilities that are not at fair value through profit or loss include accruals and other payables, redemption payable and financial liabilities arising on redeemable shares. (ii) Recognition The Fund recognizes financial assets and financial liabilities on the date it becomes a party to the contractual provisions of the instruments. A regular purchase of financial assets is recognized using trade accounting. From this date any gains and losses arising from changes in fair value of the financial assets or financial liabilities are recorded. 20

23 (iii) Measurement Financial instruments are measured initially at fair value (transaction price) plus, in case of a financial asset or financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. Transaction costs on financial assets and financial liabilities at the fair value through profit or loss are expensed immediately, while on other financial instruments they are amortized. Subsequent to the initial recognition, all instruments classified at the fair value through profit or loss, are measured at the fair value with changes in their fair value recognized in the statement of comprehensive income. Other financial assets are measured at amortized cost. Financial liabilities, other than those at fair value through profit or loss, are measured at amortized cost using the effective interest rate. Financial liabilities arising from the redeemable shares issued by the Fund are carried at the redemption amount representing the investor s right to a residual interest in the Fund s assets. (iv) Fair value measurement principles The fair value of financial instruments is based on their quoted market prices at the statement of financial position date without any deduction for estimated future selling cost. Financial assets are priced at the current bid prices. If quoted market prices are not available on a recognized stock exchange or from a broker / dealer for non-exchange traded financial instruments, the fair value of the instrument is estimated using valuation techniques, including use of recent arm s length market transactions, reference to the current fair value of another instrument which is substantially the same, and discounted cash flow techniques that provides a reliable estimate of prices obtained in actual market transactions. (v) Impairment Financial assets that are stated at cost or amortized cost are reviewed at each statement of financial position date to determine whether there is objective evidence of impairment. If any such indication exists, an impairment loss is recognized in the statement of comprehensive income as the difference between the assets carrying amount and the present value of estimated future cash flows discounted at the financial assets original effective interest rate. If in a subsequent period the amount of impairment loss recognized on a financial asset carried at amortized cost decreases and the decrease can be linked objectively to an event occurring after the write-down, the write-down is reversed through the statement of comprehensive income. The Sri Lanka Fund Annual Report

24 Notes to the Financial Statements For the year ended 31st December 2012 (vi) De-recognition The Fund derecognizes a financial asset when the contractual rights to the cash flows from the financial asset expire or it transfers the financial asset and the transfer qualifies for de recognition in accordance with IAS 39. The Fund uses the weighted average method to determine realized gains and losses on de-recognition. A financial liability is derecognized when the obligation specified in the contract is discharged, cancelled or expired. (vii) Specific Instruments Cash and cash equivalents Cash comprises current deposits with banks. Cash equivalents are short term highly liquid investments that are readily convertible to known amount of cash, are subject to an insignificant risk of changes in value, and are held for the purpose of meeting short term cash commitments rather than for investments or other purposes. (e) Interest Income Interest income and expenses are recognized in the statement of comprehensive income as they accrue, using the original effective interest rate of the instruments calculated at the acquisition or origination date. (f) Dividend Income Dividend income relating to exchange traded equity investments is recognized in the statement of comprehensive income on the exdividend date. In some cases, the Fund may receive or choose to receive dividends in the form of additional shares rather than cash. In such cases the Fund recognizes the dividend income and a corresponding additional investment for the amount of the cash dividend alternative. (g) Expenses All expenses, including management fee and custodian fees, are recognized in the statement of comprehensive income on an accrual basis. Included in sundry expenses are registar s fees paid by the Fund, safe custody charges and bank charges and printing and advertising. (h) Foreign Exchange Gains and Losses Foreign exchange gains and losses on financial assets and financial liabilities at fair value through profit or loss are recognized together with other changes in the fair value. (i) Taxation Under the current system of taxation in Cayman Islands the Fund is exempt from paying taxes on income, profits or capital gains. The Fund has received an undertaking from Governor in Cabinet of the Cayman Islands authorities exempting it from income tax for a period of 20 years. Accordingly, no tax provision is recorded in these financial statements. 22

25 Dividend and interest income received by the Fund may be subject to withholding tax imposed in the country of origin. (j) Founder and Participating 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. The Fund has two classes of shares in issue: founder shares and participating shares. The founder shares are non-redeemable, have no entitlements to dividends and are the most subordinate class in issue. Consequently, founder shares are classified as equity in accordance with IAS 32. The participating shares issued by the Fund 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 the redemption date and also in the event of the Fund s liquidation. Because the founder shares are subordinate to the participating shares, the participating shares are classified as financial liabilities and are measured at the present value of the redemption amounts. The Sri Lanka Fund Annual Report

26 Notes to the Financial Statements For the year ended 31st December US$ US$ 3. Non pledged financial assets at fair value through profit & loss Balance at the beginning of the year 2,422,888 3,174,789 Additions during the year 490,070 2,154,265 Disposals during the year (815,842) (2,308,677) Realised loss (80,274) (16,838) Unrealized depreciation in value (113,962) (580,651) Fair value (Note 9) 1,902,880 2,422, Share Capital Number of Number of Shares Shares Authorised Founders shares (US $ 1 each) Participating Shares (US $ 0.01 each) 89,990,000 89,990,000 89,990,100 89,990,100 Issued and fully paid Founders shares of US $ 1 each Participating Shares of US$ 0.01 each Balance at the beginning of the year 2,927,131 2,927,131 Issued during the year - - Redeemed during the year - - Balance at the end of the year 2,927,131 2,927,131 24

27 4. Share capital (continued) Founder Shares Founder shares confer upon the holders thereof rights in a winding up or repayment of capital in accordance with the Articles of Association of the Fund but confer no other rights to participate in the profits or assets of the Fund. The holder of a founder share has no right to receive notice of or to attend and vote as a shareholder of the Fund at any General Meeting of the Fund. The issued founder shares are held by the Investment Manager. The founder shares are classified as equity. Participating Shares Participating shares may be redeemed on every Tuesday of the month or such other dates as the Board of Directors shall from time to time determine (Dealing Day) at the net asset value per share based on mid-market prices. The mid-market price is not materially different from the bid/ask price. Participating shares have the right to receive notice of or to attend and vote as a shareholder of the Fund at any General Meeting of the Fund. Participating shares confer upon the holders of their right of a winding up or repayment of capital in accordance with the Articles of Association of the Fund. They also have the right to share in all profits or assets of the Fund in excess of the value of the issued share capital of the founder shares. The Fund does not have any externally imposed capital requirements. 5. Net Asset Value per Ordinary Share The calculation of Net Asset Value per participating share is based on the net asset value attributable to participating shareholders of US$ 2,199,874 (2011: US$ 2,431,289) and on the total number of 2,927,131 (2011: 2,927,131) participating shares in issue at the statement of financial position date. The Sri Lanka Fund Annual Report

28 Notes to the Financial Statements For the year ended 31st December Financial Instruments and Associated Risks Financial assets of the Fund include cash and marketable securities. Financial liabilities include accruals and other payables. (a) Market Risk The Fund s investment activities expose it to various types of market risk, which are associated with the markets in which it invests, to the extent of the amount invested in equity and debt securities. The Fund invests in equity securities including convertible bonds and warrants listed on the Colombo Stock Exchange, securities issued outside Sri Lanka by any corporation organized in and under the laws of Sri Lanka which has its shares listed on the Colombo Stock Exchange, and equity securities issued by listed investment companies and funds wherever established, which invest primarily in equity of Sri Lankan companies listed on the Colombo Stock Exchange which may experience greater volatility than those companies in Western economies. The Fund also invests in Sri Lankan Government debt securities. (b) Foreign Exchange Risk The Fund is exposed to foreign exchange risk from its investments and receivables and payables denominated in currencies other than United States Dollars, to the extent of the amount invested, receivables and payables. The Fund s total net exposure to fluctuations in foreign currency exchange rates at the statement of financial position date was as follows. Sensitivity Analysis Since the Fund s investments were not made in US Dollars the returns on the investments depend on the fluctuation of the exchange rate at the time they are traded in the market. As at 31st December 2012, if the US Dollar appreciated by 5%, in relation to the LKR, then the fair value of the investments would decline by US $86,205 (2011: US $ 121,144). An equal change in the opposite direction would have increased the fair value of the investments by the same amount. All amounts are stated in US $ Fair Value Fair Value Assets Investments Sri Lankan Rupee 1,902,880 2,422,888 1,902,880 2,422,888 Cash and cash equivalents Sri Lankan Rupee 254,726 61,028 US Dollars 84, ,534 61,731 26

29 6. Financial Instruments and Associated Risks (Contd.) (c) Interest Rate Risk Interest bearing financial assets consist mainly of bank deposits and a Sri Lankan Government debt security that mature or re price in the short-term, no longer than twelve months. As a result, the Fund is not subject to significant interest rate fluctuations and accordingly no interest rate sensitivity is presented. (d) Credit Risk Financial assets which potentially expose the Fund to credit risk consist principally of marketable securities and cash balances. Investments in Sri Lanka expose the Fund to risk of illiquidity and volatility. The extent of the Fund s exposure to risk in respect of these financial assets approximates their carrying value as recorded in the Fund s statement of financial position. The Fund limits its exposure to credit risk by transacting the majority of its securities and contractual commitment activity with broker-dealers, banks and regulated exchanges with high credit ratings that the Fund considers to be well established. (e) Fair Values of Financial Instruments Investment securities are carried at market values unless the directors have determined that a discount is required to arrive at fair value. The Fund s other assets and liabilities include cash and cash equivalents and amounts due on open transactions which normally settle within a few days and other receivables which are realized or settled within a short period of time. The carrying values of these other assets and liabilities approximate their fair values. (f) Price Risk The Fund s investment portfolio exposes it to the price risk, which is associated with the relevant markets in which the Fund has made its investments. The Fund is in possession of investments for which broker quotes are available (Sri Lankan Government debt securities) and securities which are listed in the Colombo Stock exchange, from which, based on the market value available for each security, the respective investments are being reflected at fair value. Thus the fluctuation in the fair value of securities reflected in the Fund s Investment portfolio are caused by factors affecting similar securities traded in each market, such as interest rates, exchange rates, taxation, inflation etc. The Sri Lanka Fund Annual Report

30 Notes to the Financial Statements For the year ended 31st December Financial Instruments and Associated Risks (Contd.) (f) Price Risk (Contd.) Sensitivity Analysis As at 31st December 2012, if the price of Sri Lankan debt and equity securities increased by 5%, resulting from the above mentioned general economic factors (except for the impact from the exchange rate fluctuations mentioned under Foreign Exchange Risk), it would increase the net assets attributable to holders of participating shares by US $ 86,205 (2011: US $ 121,144). An equal change in the opposite direction would have decreased the net asset value of the Fund by the same amount. (g) Liquidity Risk The financial position of the Fund reflects its ability to meet its accrued expenses and accounts payable due to the availability of the investments made by the Fund in listed securities which are readily realizable since they are being traded in active markets. The financial liabilities of the Fund consist of the accruals and other payables and redemptions payable as at 31st December Accruals and other payables have a maturity date of 1 to 3 months except Directors fees, which have maturity date of more than one year. The redemption payable has a maturity date of more than one year and liability on participating shares fall due as and when a share holder requests to redeem. 7. Related Parties Investment Manager The Fund appointed Guardian Fund Management Limited ( GFML ), an investment management company incorporated in Sri Lanka, to implement the investment strategy. Under the Investment Management Agreement, the Investment Manager receives a management fee equivalent to 1.5% per annum of the net asset value of the Fund, a fee of 0.5% of the redemption price of each share redeemed, and a performance fee of 20% of any increase in net asset value per share of the Fund in excess of the increase in the US dollar value performance of the Colombo Stock Exchange s All Share Price Index during the year. No performance fee was payable for the year ended 31st December 2012 (2011: US$ Nil). Total Investment Manager s Fee for the year ended 31st December 2012 was US$ 30,939 (2011: US$ 43,930). Administrator Carsons Management Services (Private) Limited ( CMSL ), the present administrator, and a fellow affiliate of GFML, receives an administrative fee of 0.2% per annum of the average weekly net asset value of the Fund until the termination of its administration agreement with the Fund. The Company has ceased the payment of Administrator fees since 1st January Therefore the total Administrator s Fee paid to CMSL during the year was US$ Nil (2011: US$ 5,850). 28

31 7. Related Parties (Contd.) Directors fee The directors fee is disclosed in the statement of comprehensive income. Ms. W. Y. R. Fernando a Director of the Fund is also a Director of GFML. 8. Custodian Deutsche Bank AG, as Custodian with effect from 1 April 2009, was paid a fee of 0.15% per annum of the net asset value of the Fund, subject to a minimum annual fee of US$ 6,000 (2011: US$ 6,000). In addition, the custodian was entitled to an annual administration fee of US$ 10,000 (2011: US$ 10,000). 9. Fair Value Information 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. The Sri Lanka Fund Annual Report

32 Notes to the Financial Statements The table below analyses financial instruments, measured at fair value at the end of the reporting period, by the level in the fair value hierarchy into which the fair value measurement is categorised: 31st December 2012 Level 1 Level 2 Total Financial assets at fair value through profit and loss Equity Securities Listed Securities 1,724,093-1,724,093 Non Listed Securities Debt Securities Fixed Deposits - 178, ,787 1,724, ,787 1,902,880 31st December 2011 Level 1 Level 2 Total Financial assets at fair value through profit and loss Equity Securities Listed Securities 2,251,214-2,251,214 Non Listed Securities Debt Securities Fixed Deposits - 171, ,674 2,251, ,674 2,422,888 During the year, there were no significant transfers between Level 1, Level 2 or Level 3 of the fair value hierarchy. As at 31st December 2012, and during the year then ended, the Fund did not hold any Level 3 securities. 30

33 9. Fair Value Information (continued) 9.1 Equity securities - listed securities No of Market No of Market shares value shares value US $ US $ Banks, Finance and Insurance Commercial Bank of Ceylon PLC 234, , Commercial Bank of Ceylon PLC - Non-voting , ,483 Central Finance PLC 86, , Peoples Leasing and Finance PLC 1,031, ,024 1,031, ,827 Sampath Bank PLC 64, ,976 99, , , ,429 Beverage, Food and Tobacco Cargills (Ceylon) PLC 163, , , ,932 Distilleries Company of Sri Lanka PLC 152, , , ,712 Nestle Lanka PLC 14, ,439 20, , , ,637 Diversified CT Holdings PLC 79,825 77,841 79, ,448 Expolanka Holdings PLC 1,133,600 62,403 1,133,600 89,572 John Keells Holdings PLC 181, , , , , ,775 Hotels and Travels Aitken Spence Hotel Holding PLC 233, , , , , ,968 Healthcare Ceylon Hospitals PLC 90,000 65, ,114 - Manufacturing Tokyo Cement Company (Lanka) PLC Non voting , ,156 Lanka Floortiles PLC , , ,405 1,724,093 2,251,214 The Sri Lanka Fund Annual Report

34 Notes to the Financial Statements 9.2 Debt securities - Fixed deposits Fair value Fair value US $ US $ Fixed deposits 178, , , , Events occurring after the Statement of Financial Position date There have been no material events occurring subsequent to 31st December 2012 that require adjustments to or disclosure in the financial statements. 32

35 Notes The Sri Lanka Fund Annual Report

36 34

37

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