The Sceptre UK Fund was up by 0.5% in July which compares with a fall of 3.4% for the FT All Share index in the month, an outperformance of 3.9%. It is very pleasing to not only outperform but to also achieve a positive return for the Fund in such a market sell-off.

You will remember that the Sceptre UK Fund underperformed in June mainly due to our crystallising the loss on a position that we exited in the month and it is therefore more illustrative to combine the two months and compare performance. On this basis the Fund was down 3.6% and the FT All Share index was down by 4.4%, an outperformance of 0.8%. The daily volatility of the fund has been a good deal lower than that of the benchmark, partly due to our cash weighting but something that might be unexpected in a 13 stock portfolio. Over the medium term our stock selection process and “margin of safety” approach is showing a solid and consistent outperformance.

Much has been written recently about how the “Sub-prime debt problems” will impact capital markets around the world and, as the weeks go by, we hear more facts about losses at financial institutions and funds across many countries and have seen increased uncertainty and volatility in the equity markets. We do not know when these concerns will diminish but there is clearly less appetite for risk and lenders seem finally to be moving the price of debt back towards more logical levels which better reflect the risk and return expectations. The immediate effect of this for the equity markets is a reduction in the number of speculated and/or potential takeover candidates as the cost of debt becomes more expensive and a general “trimming” of leveraged investments across all markets which has been fuelled by high liquidity and currency “carry trades”.

We believe that our approach to investment leads us to take less “risk” than many other categories of investor – although people have many differing views on risk and how to measure it we think in terms of potential to lose capital and failure to achieve satisfactory returns on our capital. Our focus on the cash generation and balance sheet strength of the small number of companies which make up the portfolio naturally results in a modest level of financial gearing. The fund itself is unleveraged and will remain managing limited capital in order to achieve good liquidity in it investments allowing us to accumulate and divest positions in a relatively short period.

Financial leverage in times of cheap money supply such as the conditions which have existed over the last few years often allows significant out performance by leveraged entities, but as credit conditions tighten the fact that leverage often allows 10% pa excess returns to be acheived becomes less important than the fact that this comes with 10% chance of losing one’s entire capital.

Six of our holdings have net cash on their balance sheets and the others have a “conservative” amount of net debt to Enterprise Value ranging from 15% to 33% and averaging 26%. These companies are all highly cash generative and the ratios of their Net debt/EBITDA range from 0.2x to 3.2x and averages 1.9x. We consider that these amounts of debt compared to the ability to pay it back and to the amount of equity and tangible fixed assets in the respective balance sheets are extremely conservative.

Whilst the overall NAV of the fund has made little progress in the first 7 months of 2007, we are conscious that our companies continue to make good progress in increasing turnover, operating profits and generating solid cashflows which is adding value to them and to our portfolio. The increase in market volatility will increase the potential for us to find new holdings for the fund as stock prices are reduced across the board and we have several potential new holdings on our buy list should their share prices fall to our buying levels over the next few weeks/months.

As always, if you have any questions on our approach or performance, please let us know.

Chris Broadhurst
CEO