The Sceptre UK Fund was down by 2.4% in December compared to a rise of 0.2% for the FT All Share index. The month was another strong one for the commodity sector and larger capitalisation stocks in general. Our underperformance is despite the fund’s holdings being focussed on high cashflow generating businesses with low (or zero) debt levels based in very solid business sectors.

Over the year of 2007 the Sceptre UK Fund declined by 8.5% (all coming in the last two months of the year) compared to the level of the FT All Share index being some 2.0% higher by the end of the year. In contrast to this, the FTSE Small Cap index was down almost 20% in the second half of 2007 having been unchanged at the end of June. Whilst we are surprised at the underperformance of the fund in the past two months we are encouraged by the number of potential new stocks getting close to our buy targets and the great businesses that we have within the portfolio that are now trading on single digit multiples of free cash flow. In addition, we have a broad-based portfolio of companies that are exposed to several different sectors but have strong market positions/niches which should afford pricing power and margin retention. Whilst we appreciate that our companies are exposed to the economic cycle and future earnings will be affected by reduced spending by consumers and businesses alike, our valuations are based on very conservative numbers, low debt levels and our time horizon is measured in years rather than months. The management teams in most of our companies have been in place for many years and have managed through slowdowns and recessions before, we expect they are sufficiently experienced to manage through any future economic slowdown.

Over the last 12 months we have moved from a position of about 15% cash weighting in the fund to just under 7% cash at 31st December 2007 and, whilst we have changed some of the 15 names in the portfolio, 5 of the top 7 names remain the same as a year ago. These are all businesses that are leaders in their own specific sectors, highly cash generative, low levels of leverage, with experienced and long serving senior management teams and are all growing their profits. They are all companies that we want to own for the very long term – depending of course on how the stock market values them in the future.

We switched 3% out of our best performing stock where the upside is declining (due to this performance) into two of our other (existing) holdings as their prices declined in December.

Whilst it is unpleasant for the fund to decline, we will always have an exposure to the market swings. The current trend for large fund managers is “safety” and it is primarily their resulting flow of funds to “safe havens” of large cap and commodity/utility stocks, together with the short selling of underperformers which we believe is resulting in overselling in many of our classic areas of real “value”. We strongly believe that this short term “pain” is always necessary when we want to find and add some real value to the portfolio, whilst the front line stocks in the market are trading little changed in recent months, many others have fallen by 50% or more. We are not looking to call a market bottom but will simply allocate more cash into the market as stocks fall into our conservative buying zones.

As always, if you have any questions about our investment approach or the fund, please let us know.

Chris Broadhurst
CEO