Investment Portfolio

Total Vacant Value
£122.7m

Objectives

We are seeking to achieve long-term growth in capital value from our investment portfolio through acquiring property-related assets at a discount to their vacant value and realising this discount as they mature. The returns on these assets are derived from a combination of the discounts at which the assets are bought (the actuarial element) and the performance of the properties in which we are invested.

Performance measures

The Board’s main measure of this activity is growth in embedded value per share (“EVPS”), which incorporates the reversionary surplus on the Group’s equity release assets at current vacant
property values. The change in net asset value per share (“NAVPS”), reflecting only the current reversion value of the property, is considered as a secondary measure. The calculation of EVPS and NAVPS is set out in the table below.

Each of these performance measures should be evaluated over a period of 5–10 years, given the long-term nature of these investments. In view of the change of accounting convention from UK GAAP to IFRS, a five year comparison is not yet possible, so performance has been shown over the period covered by IFRS statements.

During the year we achieved an increase in EVPS despite a falling property market; EVPS has grown by 7.4% compound per annum over the two year period since IFRS statements were introduced. NAVPS shows a 1.1% positive compound return per annum over this period.

Changes in investment portfolio

Investment philosophy

We believe that a strategy of regular investment in the UK residential property market will provide more satisfactory returns for Shareholders over the medium to long-term than any alternative strategy based on short-term market conditions. The gap between demand for new housing and its supply continues to widen. A result of the current economic downturn is that house builders have reduced their building programmes substantially, from levels which were already below annual demand. We therefore expect that, after the current period of readjustment, the long-term dynamic of increasing residential property prices will reassert itself.

We recognise that there will be short-term fluctuations in the residential property market which lead to assets being temporarily either over-priced or under-priced. In the last two years residential property has been over-priced by many of the conventional yardsticks. We are now seeing a rapid downwards adjustment, which we expect will take property prices back to the low point of the next upward cycle.

We do not allow our evaluation of short-term market trends to influence our policy of financing new reversions on a regular basis. However, we would expect to invest relatively less money in a strongly rising market and, correspondingly, more in a falling market; homeowners’ expectations of changes in the value of their property is a strong influence on demand for home reversions. This policy enables us to maintain investment momentum without impairing returns; the alternative of withdrawing entirely from the market for long periods will lead to higher costs when we wish to return to it. An advantage of this averaging approach is that we are consistently in the market for reversions, which improves our market penetration and positioning in periods of high activity.

Part of our strategy is to acquire equity release portfolios in the secondary market with their shorter actuarial expectations. We have been particularly successful over the years in achieving a good balance between primary and secondary market acquisitions. More than one-third of our equity release assets held at the balance sheet date were acquired in the secondary market.

As the residential market reached its recent peak, competition for portfolios increased and consequently it has not been entirely surprising that we have been outbid on a number of transaction in the last two years. We continue to be interested in acquiring portfolios in all market conditions, as pricing becomes materially more attractive in a falling market. We were pleased to complete the acquisition of the Welfare Dwellings Trust Ltd in March 2008.

The steady increase in the number of realisations reflects a combination of an increasing portfolio and management’s track record of continuing to identify and acquire maturing portfolios in the secondary market. In view of the wide range of equity values underlying each individual investment, the total value of realisations is likely to be more variable and has little correlation with the average value of our investments.

 Valuation

Equity release assets acquired prior to 31 January 2008, and the Welfare Dwellings Trust portfolio, which was acquired on 20 March 2008, have been independently valued by Allsop LLP (“Allsop”) as at 30 April 2008. In the case of Welfare Dwellings Trust this has meant valuing the properties on an individual basis and the write-off of all costs resulting in a small fall in value. Other equity release assets acquired since 31 January 2008 have been valued by the Directors. Our policy is to have one-third of our equity release assets inspected externally during the year, so that all properties are inspected over a three year period. Where properties were not inspected, Allsop has applied a composite average of relevant house price indices to the value when previously inspected by them.

In their valuation of the Group’s portfolio, the Directors have attempted to reflect the downward direction of the residential property market at 30 April 2008, to reflect realistic market conditions. Properties which were physically inspected by Allsop prior to the year end have been further indexed downwards to reflect any reduction in value between the date inspected and the end of the financial year. Allsop has also given particular consideration to the impact on valuation caused by the reduction in liquidity in the residential market on certain types of properties.

The Group’s investment properties held throughout the year and valued by Allsop on the basis of an external inspection outperformed the blended average of Halifax and Nationwide indices in every region of the UK with the exception of the East Midlands. Overall, the aggregate of values for properties inspected this year fell by an average 1.2% against previous year’s values which, in the current climate, was encouraging.