THE EUROPEAN INVESTMENT TRUST PLC - Annual Financial Report

Capital structure
As at 30 September 2016, the Company had 42,053,550 ordinary shares of 25p each in issue. As at 29 November 2016, the date of this report, there were 42,016,100 ordinary shares in issue.

Investing in the Company
The Company’s ordinary shares are traded on the London Stock Exchange and the New Zealand Stock Exchange and can be bought or sold through a stockbroker or financial adviser. The ordinary shares are eligible for inclusion in ISAs and SIPPs. The Company’s shares are also available on various share trading platforms.

AIC
The Company is a member of the Association of Investment Companies (“AIC”).

Alternative Investment Fund Manager
Edinburgh Partners AIFM Limited (the “AIFM”).

Investment Manager
The AIFM has delegated the function of managing the Company’s investment portfolio to Edinburgh Partners Limited (“Edinburgh Partners” or the “Investment Manager”).

Management fee
0.55% per annum of the Company’s equity market capitalisation payable monthly in arrears.

Ten Year Record

FINANCIAL SUMMARY

* Based on the weighted average number of shares in issue during the year.
** Proposed dividend for the year.

* In sterling.

The NAV Total Returns are sourced from Edinburgh Partners and include dividends reinvested. The index performance figures are sourced from Thomson Reuters Datastream. Past performance is not a guide to future performance.

* Based on total expenses, excluding finance costs and certain non-recurring items for the year and average monthly net asset value.

PORTFOLIO OF INVESTMENTS
as at 30 September 2016

Of the ten largest portfolio investments as at 30 September 2016, the valuations at the previous year end, 30 September 2015, were PostNL £10,732,000; Royal Dutch Shell A £8,999,000; Roche £11,253,000; Total £10,021,000; BNP Paribas £11,399,000; Stora Enso £8,325,000; Bayer £10,880,000; Novartis £10,649,000; Sanofi £9,373,000; ENI £10,037,000.

Distribution of Investments
as at 30 September 2016 (% of net assets)

Sector distribution

Geographical distribution

DIRECTORS

All of the Directors are non-executive and independent of the AIFM and the Investment Manager.

Douglas C P McDougall OBE (Chairman)
William D Eason
Michael W M R MacPhee
Michael B Moule (Senior Independent Director)
Dr Michael T Woodward

STRATEGIC REPORT

The Strategic Report has been prepared in accordance with Section 414A of the Companies Act 2006 (the “Act”). Its purpose is to inform members of the Company and help them assess how the Directors have performed their legal duty under Section 172 of the Act to promote the success of the Company.

CHAIRMAN’S STATEMENT

Results
After the negative returns seen in the prior year, the year under review was a positive period for UK investors in European equities. The most significant contribution to returns came from the weakness of sterling against the euro and other European currencies following the UK referendum vote in June 2016 to leave the European Union.

Over the year to 30 September 2016, the NAV per share increased by 12.3% from 742.2p to 833.8p. After taking account of dividends paid in the year of 16.0p per share, the NAV total return was 14.9%. This compares with the total return of 21.8% from the FTSE All-World Europe ex UK Index, adjusted to sterling. The disappointing relative return follows from the continued lack of favour in the markets for our value-based approach to stock selection.

Over the year, the Company’s share price increased by 7.4% from 673.0p to 722.5p. The share price discount to NAV rose from 9.3% to 13.4%. The share price total return was 9.8%.

From the appointment of Edinburgh Partners as Investment Manager on 1 February 2010, the share price total return to 30 September 2016 was 62.5% and the NAV total return 58.7%. Over the same period, the total return on the FTSE All-World Europe ex UK Index, adjusted to sterling, was 66.6%.

Revenue
The revenue return per share for the year to 30 September 2016 was 19.0p compared with 16.0p in the previous year, an increase of 18.7%. Revenue benefited from dividend growth, currency movements, utilisation of the borrowing facility and a reduction in management fee, which is based on market capitalisation. The ongoing charges ratio fell from 0.63% to 0.62%.

Dividends
The Board recommends a final dividend of 16.0p per share and a special dividend of 6.0p per share (which includes 3.0p arising from the settlement of a historic tax reclaim), giving a total of 22.0p per share. This compares with the prior year total dividend of 16.0p per share, which comprised a final dividend of 14.0p and a special dividend of 2.0p per share.

Our aim is to pay a final dividend which we regard as likely to be sustainable and to distribute any further earnings by way of a special dividend. Subject to the approval of shareholders at the forthcoming Annual General Meeting (“AGM”), these dividends will be paid on 31 January 2017 to shareholders on the register at the close of business on 6 January 2017. The ex-dividend date will be 5 January 2017.

Share buy backs
Against a background of a widening discount of the share price to NAV the Company bought back shares for cancellation during the year under review and subsequent to the year-end. Details of these purchases can be seen in the Directors’ Report in the full Annual Report and Financial Statements. The Directors will propose at the forthcoming AGM that the Company’s powers to make purchases of up to 14.99% of its shares in issue be renewed.

Borrowings
In February 2016, the Company entered into a euro 30 million bank overdraft credit facility with The Northern Trust Company, with the objective of using gearing to enhance shareholder returns. As at 30 September 2016, a total of euro 11,809,000, equivalent to 2.9% of net assets, had been drawn down under the facility.

Portfolio activity
The most significant changes in the portfolio were an increase in the industrial sector and a reduction in the technology sector. Geographically, the main changes were a reduction in Switzerland and an increase in France. For details of portfolio movements, please see the Investment Manager’s Report below.

The Board
I shall retire from the Board at the conclusion of the AGM on 24 January 2017, when Michael MacPhee will succeed me as Chairman of the Company. I have every confidence in the future of the Company under the direction of my colleagues.

Investment Manager
In August 2016, the Company announced that Edinburgh Partners had appointed Craig Armour as portfolio manager for the Company in succession to Dale Robertson. Craig joined Edinburgh Partners in 2009 after working for 18 years in investment banking and private equity. He is an Investment Partner, has been responsible for managing several European portfolios, and worked closely with Dale Robertson for several years. The change of portfolio manager has not led to any fundamental change in the style or composition of the portfolio.

Change of Auditors
The EU Audit Regulation and Directive, which came into force in the UK on 17 June 2016, introduced restrictions on the non-audit services which auditors can provide to their clients. As explained in the Report of the Audit and Management Engagement Committee in the full Annual Report and Financial Statements, the Board and PricewaterhouseCoopers LLP (“PwC”) have agreed that PwC will be unable to continue as auditors whilst providing non-audit services. As required, PwC have written a letter to the Company setting out their reasons for not seeking re-appointment as Auditors, a copy of which is enclosed with the full Annual Report and Financial Statements.

PwC and their predecessor companies have been Auditors since the Company’s launch in 1972 and I should like to thank them for their services to the Company over that period.

In October 2016, the Audit and Management Engagement Committee carried out an external audit tender process, details of which can be seen in the full Annual Report and Financial Statements. Following this, the appointment of BDO LLP as Auditors of the Company is recommended to shareholders for approval at the AGM.

Annual General Meeting
The AGM will be held at 11.00am on Tuesday, 24 January 2017 at Brewers’ Hall, Aldermanbury Square, London EC2V 7HR. I look forward to seeing as many as possible of you there.

Outlook
The low interest rate policy and monetary easing being pursued by the European Central Bank have resulted in high valuations being placed on stocks considered by European equity investors to be low risk in terms of earnings progress. Our managers have continued to invest in stocks where they believe valuations to be too low, in the expectation that the undervaluation will at some point be recognised by the market. There have been recent signs that investor sentiment may have shifted slightly towards our style. Over the 6 months to 25 November 2016, the NAV rose by 16.3%, which compares with the total return of 13.3% from the FTSE Europe All-World ex UK Index, adjusted to sterling.

Whilst there continue to be geo-political concerns, including the possibility of increasing trade barriers following Brexit and the US presidential election, the outlook for economic growth in Europe appears to be improving, which would benefit the cyclically-sensitive sectors to which the Company has a high exposure.

Douglas McDougall
Chairman

29 November 2016

INVESTMENT MANAGER’S REPORT

Economic and Market Overview
Since the financial crisis in 2008, the economic recovery has been supported by monetary stimulus, with central banks adopting quantitative easing through bond purchases alongside ultra-low interest rates. In Europe, the initial resistance to this approach was overcome and the European Central Bank followed its counterparts elsewhere in the developed world. While economic growth has been subdued compared to the period prior to the crisis, the policies adopted appear to have been largely successful in allaying fears of deflation and recession. There have been periodic bouts of concern but the evidence points to a global economy emerging intact from intensive care. Indeed there are tangible signs of inflation, partly from the recovery in commodity prices, but also from labour markets.

Recent years have been challenging for valuation-conscious investors. In an environment where the discount rate is based on artificially suppressed interest rates, the valuations of companies with stable and predictable earnings have been boosted, in stark contrast to many cyclical stocks. This is best captured by the premium rating of consumer staples relative to the rest of the equity market, which during the year reached levels comparable with the 2008 financial crisis. We believe that this premium rating is unwarranted given both ongoing economic growth and a subtle shift in the outlook for longer-term interest rates. Towards the end of the year under review, there was evidence that equity markets were starting to price in a restoration of more normal financial conditions.

The one area of almost perpetual uncertainty in Europe is politics. An election is always in sight at national level and the European Union as a collective takes time to gather a consensus and react to issues as they arise. The latest issue is of course Brexit, with the UK voting in June 2016 to leave the European Union. The UK faces a real challenge in implementing the result of the referendum without causing material damage to its economy. In that respect, the European Union and the UK have a shared economic interest, but the European Union is expected to resist an outcome which makes departure look attractive. To date, the principal economic impact from Brexit appears to have been the weakness of sterling, but a prolonged period of uncertainty will not be helpful to economies or equity markets.

Portfolio Strategy and Activity
At Edinburgh Partners, our valuation framework ensures that we retain our discipline through market cycles. In the prior year, we sold a number of stocks which had performed well and were trading at valuations which fully captured their growth prospects. In their place, we purchased stocks where the valuations were significantly lower, often due to depressed expectations or fear of a recession. In the current financial year, we have continued this process and we have also introduced gearing to the portfolio, using part of the euro 30 million bank overdraft facility to add to some of our most undervalued holdings.

An area of the equity market which has been out of favour for some time has been banking stocks. The challenges facing banks are well-known, including regulatory pressure to hold more capital, tepid loan demand, litigation and conduct charges and managing the transition to digital banking. Add in the margin squeeze from low interest rates and the return on equity across the sector has fallen substantially. However banks today have higher levels of capital, are better funded with improved liquidity and have more appropriate loan provisioning. Many of our holdings are trading at significant discounts to book value and have solid dividend yields. While banking stocks made a small positive contribution to performance during the year, the valuations remain attractive and the portfolio exposure at the year-end was 15.2% of net assets.

Our oil and gas holdings performed well in aggregate during the year. Our holdings in the major stocks such as Royal Dutch Shell and Total responded well to the recovery in the oil price and to the efforts of the companies to cut costs. Our holding in seismic testing company, Petroleum Geo-Services, continued to struggle against this backdrop of cost-cutting and performed poorly although, since the year-end, it has announced improved results, indicating that exploration activity is starting to improve. We retain a positive outlook on the sector which had a year-end portfolio weighting of 12.4% of net assets.

Our industrial stocks generally performed well, led by Dutch mail operator PostNL. With a stronger balance sheet after disposing of its stake in TNT Express, the company attracted bid interest from Belgian mail operator BPost. Another strong performer in industrials was Swiss engineer ABB and we sold this holding on valuation grounds.

We suffered a loss on our holding in asset manager GAM which issued a profit warning. After reviewing the prospects for the range of funds managed by the company and in particular, the outlook for performance fees from its flagship funds, we decided to sell the holding.

The stock with the greatest exposure to the UK is Ryanair, which earns around 25% of revenues in sterling. After a sharp fall in the aftermath of the vote in June 2016, the share price has recovered as it continues to deliver strong growth across its markets. As a low cost provider in a segment of the airline market which continues to gain market share, we believe Ryanair remains a solid long-term investment case.

We have continued to sell stocks where the valuations fully discount the prospects and replace them with stocks where we believe the growth prospects are not captured in the valuation. Examples include Swiss-based staffing company, Adecco, and aircraft manufacturer, Airbus. In the case of Airbus, which along with Boeing dominates the market, the long-term demand from Asia in particular underpins demand, and the absence of any new models over the next few years should benefit both margins and cash flow.

A steadily recovering economy in Europe remains our central case, supported by the European Central Bank policy. The recent moves in longer-term interest rates point to some normalisation of the valuation environment which would be negative for bond prices and their stock market equivalents such as consumer staples. It has been encouraging to see renewed takeover interest after the year-end in two of our holdings, PostNL and Delta Lloyd, and the portfolio retains a strong valuation focus.

Craig Armour
Edinburgh Partners

29 November 2016

Other Statutory Information

Objective

The objective of the Company is to achieve long-term capital growth through a diversified portfolio of Continental European securities.

Strategy and business model

Investment policy
The Board believes that investment in the diverse and increasingly accessible markets of this region provides opportunities for capital growth over the long term. At the same time, it considers the structure of the Company as a UK-listed investment trust, with fixed capital and an independent Board of Directors, to be well suited to investors seeking longer-term returns.

The Board recognises that investment in some European countries can be riskier than in others. Investment risks are diversified through holding a wide range of securities in different countries and industrial sectors. No more than 10% of the value of the portfolio in aggregate may be held in securities in those countries which are not included in the FTSE All-World European indices.

The Board has the authority to hedge the Company’s exposure to movements in the rate of exchange of currencies, principally the euro, in which the Company’s investments are denominated, against sterling, its reporting currency. However, it is not generally the Board’s practice to do this and the portfolio is not currently hedged.

No investments in unquoted stocks can be made without the prior approval of the Board. The level of gearing within the portfolio is agreed by the Board and should not exceed 20% in normal market conditions.

No more than 10% of the total assets of the Company may be invested in other listed investment companies (including investment trusts) except in such other investment companies which themselves have stated that they will invest no more than 15% of their total assets in other listed investment companies, in which case the limit is 15%.

The Investment Manager’s compliance with the limits set out in the investment policy is monitored by the Board and the AIFM.

Investment strategy
Investments are selected for the portfolio only after extensive research, which the Investment Manager believes to be key. The whole process through which an equity must pass in order to be included in the portfolio is very rigorous. Only a security where the Investment Manager believes that the price will be significantly higher in the future will pass the selection process. The Company’s Investment Manager believes the key to successful stock selection is to identify the long-term value of a company’s shares and to have the patience to hold the shares until that value is appreciated by other investors.  Identifying long-term value involves detailed analysis of a company’s earnings prospects over a five-year time horizon. The portfolio will normally consist of around 40 investments.

Business and status of the Company
The principal activity of the Company is to carry on business as an investment trust.

The Company is registered as a public limited company and is an investment company within the terms of Section 833 of the Act. The Company has been approved by HM Revenue & Customs (“HMRC”) as an investment trust under Sections 1158 and 1159 of the Corporation Tax Act 2010 (“CTA”), subject to there being no subsequent serious breaches of the regulations. In the opinion of the Directors, the Company has directed its affairs so as to enable it to continue to qualify for such approval.

The Company’s shares have a premium listing on the Official List of the UK Listing Authority and are traded on the main market of the London Stock Exchange. The Company has a secondary listing and its shares are traded on the New Zealand Stock Exchange.

The Company is a member of the AIC, a trade body which promotes investment companies and also develops best practice for its members.

Portfolio analysis
A detailed review of how the Company’s assets have been invested is contained in the Investment Manager’s Report above. A detailed list of all the Company’s investments is contained in the Portfolio of Investments above. The Portfolio of Investments details that the Company held 38 investments, excluding cash and other net current liabilities, as at 30 September 2016, with the largest representing 5.1% of net assets, thus ensuring that the Company has a suitable spread of investment risk. A sector and geographical distribution of investments is shown above.

Results and dividends
The results for the year are set out in the Income Statement and the Statement of Changes in Equity below.

For the year ended 30 September 2016, the net revenue return attributable to shareholders was £8.0 million (2015: £6.7 million) and the net capital return was £37.3 million (2015: -£24.9 million). Total shareholders’ funds increased by 12.3% to £350.7 million (2015: £312.2 million).

Details of the dividends recommended by the Board are set out above in the Chairman’s Statement and below.

Key performance indicators
At each Board meeting, the Directors consider a number of performance measures to assess the Company’s success in achieving its objective. The key performance indicators used to measure progress and performance of the Company over time are established industry measures and are as follows:

Net asset value
In the year to 30 September 2016, the net asset value per share increased by 12.3% from 742.2p to 833.8p. After taking account of dividends paid in the year of 16.0p, the net asset value total return was 14.9%. This compares with the total return of 21.8% from the FTSE All-World Europe ex UK Index, adjusted to sterling.

The net asset value total return since the appointment of Edinburgh Partners as Investment Manager on 1 February 2010 to 30 September 2016 was 58.7%. This compares with the total return of 66.6% from the FTSE All-World Europe ex UK Index, adjusted to sterling.

Share price
In the year to 30 September 2016, the Company’s share price increased by 7.4% from 673.0p to 722.5p. The share price total return, taking account of the 16.0p dividend paid in the year, was 9.8%.

Share price premium/discount to net asset value per share
The share price discount to net asset value per share widened from 9.3% to 13.4% in the year to 30 September 2016.

Revenue return per ordinary share
There was an increase in the revenue per share in the year to 30 September 2016 of 18.7% from 16.0p to 19.0p.

Dividends per ordinary share
The Directors are recommending a final dividend of 16.0p per ordinary share and a special dividend of 6.0p per ordinary share (which includes 3.0p arising from the settlement of a historic tax reclaim), making a total dividend of 22.0p per ordinary share. This compares with the prior year total dividend of 16.0p per ordinary share.

Ongoing charges
The Company continues to have low expenses. The ongoing charges ratio was 0.62% (2015: 0.63%) in the year to 30 September 2016.

The longer-term records of the key performance indicators are shown in the Ten Year Record in the full Annual Report and Financial Statements.

The Board also takes into consideration how the Company performs compared to other investment trusts investing in Europe.

Management Agreement
In order to comply with the Alternative Investment Fund Managers’ Directive (“AIFMD”), the Company appointed Edinburgh Partners AIFM Limited as its AIFM with effect from 17 July 2014. Edinburgh Partners AIFM Limited has been approved as an AIFM by the UK’s Financial Conduct Authority (“FCA”). With the approval of the Directors of the Company, the AIFM appointed Edinburgh Partners as Investment Manager to the Company pursuant to a delegation agreement with effect from 17 July 2014.

The AIFM receives a management fee of 0.55% per annum of the Company’s equity market capitalisation, payable monthly in arrears.

The Management Agreement may be terminated by either party giving three months’ written notice. No additional compensation is payable to the AIFM on the termination of this agreement other than the fees payable during the notice period. No performance fee will be paid. Further details relating to the agreement are detailed in note 3 of the Financial Statements below.

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