Annual Financial Report

The Scottish Investment Trust PLC

Annual Results for the year ended 31 October 2017.

The Scottish Investment Trust PLC invests internationally and is independently managed. Its objective is to provide investors, over the longer term, with above-average returns through a diversified portfolio of international equities and to achieve dividend growth ahead of UK inflation. Today it announces its results for the year to 31 October 2017.

Highlights

· Step change 48.1% increase in regular dividend to 20p.

· Additional special dividend of 5p.

· Total dividend increase of 11.1%.

· Share price total return +12.8% and NAV total return +11.0%.

Enquiries:

Alasdair McKinnon, Manager

0131 225 7781

Chairman's Statement

Performance

I am pleased to report that during the 12 months to 31 October 2017 a combination of capital appreciation and strong dividend income meant that the Company delivered another year of robust total returns. Over that period, the share price total return was 12.8% and the net asset value per share (NAV) total return (with borrowings at market value) was 11.0%.

The Company does not have a formal benchmark but, by way of comparison, the sterling total return of the international MSCI All Country World Index (ACWI) was 13.3% while the UK based MSCI UK All Cap Index total return was 13.5%. As noted in previous communications, elsewhere in this statement and in the Manager's review, we do not expect the Company's portfolio return to match any particular index return over any defined period due to the contrarian nature of the portfolio's composition. Our contrarian approach aims to achieve above average long-term performance. Given this focus and the fact that we expect to make more of our gains in particular market conditions, we believe that a period of at least five years is required to evaluate the Company's returns.

With the Company's portfolio rebalanced towards the high conviction, global contrarian approach described below, the Board now believes that the Company will generate a higher level of dividend income through an investment cycle than has previously been the case. The Board wishes to ensure that shareholders have greater clarity about their future dividend expectations and therefore recommends a positive step change increase in the regular dividend. I explain this later in this statement.

Low cost active management

Over the last three years, the Company has undertaken a significant process of change with our goal to continue to provide an attractive, low cost investment vehicle for our shareholders, who are mainly, and increasingly, individuals.

In the last year, we have reinvigorated our approach to marketing and communications, within our longstanding marketing budget. It is important that we raise the Company's profile, as we believe that our investment approach should appeal to a broad range of investors.

The ongoing charges figure for the year under review was 0.49%, which compares favourably with other actively-managed investment vehicles. As a self-managed investment trust, this figure represents the ongoing costs of running the Company as a proportion of net assets. We have reduced our costs in recent years, most notably by restructuring the investment team and by outsourcing a number of functions.

The ongoing charges figure has remained the same as last year, despite the reduction in net assets following the repurchase of Aviva's shareholding.

High conviction, global contrarians

The high conviction, global contrarian investment approach adopted by Alasdair McKinnon and his team clearly differentiates the Company from our global investment trust peers and from the vast array of passive investment products through which investors can 'track' stockmarket indices.

The approach reflects the investment team's natural style as independent thinkers and active, long-term investors who seldom follow the herd. The Manager believes that opportunities are created by the natural human tendency to focus on past performance as a predictor of future performance. Our approach aims to profit by investing in carefully selected, but unfashionable, companies which are undervalued as they are overlooked by other investors who prefer the comfort of investing with the crowd.

The portfolio reflects this contrarian philosophy and is constructed without reference to any benchmark or stockmarket index. Accordingly, we do not expect the portfolio return to be similar to a particular index return in any given year and we expect that the contrarian style will work differently depending on market conditions. For example, the Manager expects that the Company might not fully participate in more speculative market conditions as the investment team seeks to avoid investments that are sustained by overly enthusiastic positive sentiment. Likewise, we might expect better than average performance when market spirits are more tempered, as our holdings typically have less positive sentiment priced in.

During the year, the number of portfolio holdings was further reduced as the Manager believes that the best long-term returns will be generated by having the conviction to back the team's best investment ideas. The portfolio currently contains 54 listed equity holdings, which compares with 70 at the previous year end. The number of holdings will vary as the investment team unearths new opportunities.

Contrarian style boosts income generation

Over the past year earnings per share rose by 6.7% to 23.1p (2016: 21.6p).

In previous reports, I have noted that the Board wishes to maintain both the long track record of dividend increases and the aim of the Company to provide dividend growth ahead of UK inflation over the longer term. In recent years, this has been achieved by appropriate increases to the regular dividend, with any excess being distributed as a special dividend.

Since the adoption of the contrarian investment approach, income generated has been considerably more than that required to pay the regular dividend. The Board has discussed this extensively with the Manager and, despite the approach not explicitly targeting high yielding investments, we expect the contrarian investment style to generate a higher level of investment income through an investment cycle than was previously the case. A higher than average level of dividend income is often, but not always, a consequence of an investment in an unfashionable company.

Step change increase in the regular dividend

Given the above, the Board considers it is appropriate to make a significant step change increase in the regular dividend to make it clear to shareholders and prospective investors that the Company expects to generate a higher level of income through an investment cycle. A consequence of such a change will be that the Company is less likely to pay discretionary special dividends in future years and will not necessarily distribute income generated in excess of the requirements of the regular dividend.

One particular advantage of such a significant step change increase in the regular dividend is that it will give shareholders and potential investors a clearer indication of the income that they can expect to receive. This is because, when calculating the yield on ordinary shares, many investors ignore special dividends as they consider them non-recurring. The proposed step change increase in the regular dividend will, going forward, materially increase the stated yield of the Company's shares, which the Board believes will enhance their attraction to investors. Following the change, the Company will have one of the highest stated dividend yields among its global investment trust peers.

The Board recommends a final dividend of 14.5p per share which, if approved, will mean that the total regular dividend for the year will increase by 48.1% to 20.0p and will represent the 34th consecutive year of regular dividend increase.

The Board also recommends a special dividend of 5.0p per share in order to distribute the income generated in the year to 31 October 2017 in excess of the requirements of the proposed regular dividend. This recommendation reflects past indications made as to how the Board would likely deal with such balance of income generated in respect of the financial year. As mentioned previously, the Company is less likely to pay discretionary special dividends in future years. If approved, the total dividend for the year will increase by 11.1%.

It is worth clarifying that the Board has not changed its future intentions for regular dividend increases. The Board wishes, from this higher level, to continue the Company's long track record of dividend increases and its aim to provide dividend growth ahead of UK inflation over the longer term.

Importantly, the Board remains of the view that the composition of the portfolio should not be dictated by this change to dividend policy and recognises that there may be occasions when the portfolio will generate a lower level of income that does not necessarily cover the requirements of the regular dividend. This dividend policy is supported by the Company's healthy revenue reserves of 70.6p per share, which would currently cover more than three years of the proposed new higher regular dividend. The Board considers that it would be appropriate to utilise such revenue reserves as required to support such a policy, drawing from revenue reserves in some years to supplement earnings for that year and adding to revenue reserves in other years.

Move to quarterly dividend payments

I announced in the interim report that the Company intended to adopt a quarterly schedule of dividend payments starting in the 2017/18 financial year. The Board recognises that predictable, regular distribution of income is desirable for the majority of our shareholders.

The proposed final and special dividends, which, if approved, will be paid to shareholders in February 2018 will mark the last dividends of the current distribution schedule before we move to quarterly payments. The Board's target is to declare three quarterly interim dividends of 5.0p, in the year to 31 October 2018 and recommend a final dividend of at least 5.0p for approval by Shareholders at the Annual General Meeting in 2019. It is intended that the first quarterly dividend will be paid in May 2018. The second and third quarterly dividends are expected to be paid no later than August and November 2018. The final dividend will be reviewed in accordance with the Board's desire to continue the long track record of annual dividend increases and the aim of the Company to provide dividend growth ahead of UK inflation over the longer term.

Aviva share repurchase

As I noted in the interim report, in March the Company completed the repurchase and cancellation of the shareholding of Aviva, representing 11.9% of the Company's issued share capital at that time. Aviva had gained control of this substantial shareholding in November 2015 through its purchase of Friends Life. Aviva had not previously been a long-term investor in the Company, did not have a history of holding investment trusts and had indicated that it did not plan to retain this shareholding.

At a specially convened General Meeting, shareholders approved the repurchase for cancellation of 11.4m shares from Aviva at a 10.75% discount to the cum-income NAV (with borrowings at market value). The Board considered this transaction to be in the best interests of the Company and shareholders as it removed a known seller of a large block of shares and enhanced this NAV for the ongoing shareholders by 1.4%.

Gearing

Gearing ended the year largely unchanged at 5%. During the year, the Company briefly moved to a net cash position to facilitate the transaction with Aviva.

Buybacks and updated policy

During the year, 16.9m shares were purchased for cancellation (2016: 9.2m) at an average discount of 10.5% to the cum-income NAV with borrowings at market value (9.5% to the ex-income NAV) and a cost of £135.2m. Excluding the repurchase of the Aviva shares, 5.5m shares were repurchased for cancellation at an average discount of 9.7% to the cum-income NAV with borrowings at market value (8.1% to the ex-income NAV) and a cost of £44.9m.

As announced in the interim results, the Company's buyback policy has been adjusted to aim, in normal market conditions, to maintain the discount to the cum-income NAV (with borrowings at market value) at or below 9%. This is a change from the previous policy which aimed to control the discount to the ex-income NAV (with borrowings at market value). The Company was an early adopter of a buyback policy in 2006 and, since then, it has become more normal industry practice to use the cum-income NAV rather than the ex-income NAV.

Successful migration of savings schemes

The savings schemes previously offered by the Company have now been closed but scheme holders were offered an attractive alternative arrangement for their shareholding. I would like to thank those shareholders affected for their understanding throughout the transition.

The schemes were set up in an era when it was expensive and complicated, particularly for a smaller shareholder, to buy shares directly in a single company. However, in recent years, a number of ways to buy the Company's shares in a simple and cost effective manner have been developed and very few providers offer the infrastructure to support single company savings schemes.

Accordingly, when the savings schemes' administrator informed us that they intended to withdraw from this business area, we were, despite an extensive search, unable to identify a viable alternative scheme administrator.

The majority of scheme holders have now transferred to AJ Bell Youinvest. We look forward to working with AJ Bell Youinvest in continuing to communicate with our shareholders.

Board composition

I would like to welcome Karyn Lamont to the Board. Karyn was appointed as a non-executive director and Chair of the Audit Committee in October 2017. Karyn brings a wealth of specialist audit experience from her long career in the field and will stand for election at the Annual General Meeting.

Karyn replaced Ian Hunter who retired after three years of valuable service to the Company. The Board and I would like to extend our gratitude to Ian for his considerable contribution, particularly over the last eighteen months as the Company reorganised a number of its key administrative functions.

Hamish Buchan will retire at the AGM. The Company has benefited greatly from Hamish's knowledge and experience over the last fourteen years. On behalf of the Board, I should like to thank Hamish for his outstanding contribution. There is no current intention to replace Hamish as the Board considers that its membership will continue to ensure that the appropriate balance of skills, experience, independence and knowledge will be achieved.

Outlook

I have previously discussed the anti-establishment mood that seems to have characterised recent voting on both sides of the Atlantic. The most obvious examples are the Brexit vote, the election of Donald Trump and the unexpected result in the UK 'snap' election.

President Clinton's victory in the 1992 US Presidential election has often been attributed to the slogan "It's the economy, stupid" and this catchphrase remains highly relevant today. Large sections of the population, in a number of countries, feel disadvantaged in the current economic environment. Government policies have favoured asset prices with unintended consequences for the cost of living.

Markets do not operate in a vacuum and, to date, have generally interpreted this shift in the political climate as a positive development. This is justified, to some extent, as stimulatory measures to boost the 'real economy' may well improve the prospects of sections of the corporate sector. On the other hand, some of the more radical measures occasionally mooted, no doubt with the best of intentions, have potential to harm sections of the corporate sector and will not necessarily achieve their end purpose.

The US Federal Reserve, which sets the tone for global monetary policy, has continued to increase interest rates from a very low base and has started tentatively to reduce the stockpile of bonds purchased to lower long-term interest rates. Other central banks have taken this cue and have started either to reduce, or at least slow, the rate of increase in stimulatory measures. This is evidenced by the recent interest rate increase by the Bank of England and the planned reduction in European Central Bank bond purchases. Markets have undoubtedly benefited from low long-term interest rates and it remains to be seen how dependent these low rates are on central bank largesse.

As ever, there are a number of events which could potentially destabilise markets if the worst fears come to pass, or potentially boost markets if they are successfully resolved. Of the prominent events, tension in the Korean peninsula remains confined to sabre-rattling while some modest progress seems to have been made in the Brexit negotiations.

The Board is pleased with the progress made to transform the investment approach, to increase the regular dividend, to reduce the cost base and to improve the profile of the Company. It now believes that the Company is differentiated, competitive in costs and an attractive investment vehicle focused on delivering above-average returns and dividend growth over the longer term.

James WillChairman8 December 2017

Manager's Review

Our Contrarian Approach

Shareholders who have read my previous Manager's Reviews will be aware that a simple philosophy underpins our approach to investment. At the core of this philosophy is a recognition that investors, in aggregate, are not dispassionate calculating machines but, in fact, retain human emotions.

While this may not seem a particularly radical observation, it nonetheless flies in the face of a large body of scholarly research into finance and economics. Theory would argue that, while any individual can behave irrationally this is averaged out within a group so that a rational decision is reached. In contrast, we do not think that groups always make rational investment decisions and, to evidence this, would merely point to the numerous bubbles which have bedevilled markets over the years. Over the last 20 years, we have witnessed bubbles in emerging markets, euro convergence beneficiaries, dotcom stocks, house builders, property stocks, oil stocks, miners and emerging markets (again).

The reason for this difference of opinion perhaps arises because, in many human endeavours, the group does indeed reach a rational solution. In more arduous times, our very survival depended on working as a group and the crucial skill to develop as an individual was cooperation as part of this group. An isolated individual was vulnerable and, even if the group was pursuing an endeavour in a suboptimal manner, it was safer to remain part of the group.

Society as we know it today, which has built a great civilisation, continues to depend on this cohesive group approach. Most individuals subconsciously understand that they need to recognise the written and unwritten rules of society and therefore feel uncomfortable outwith the mainstream.

However, we believe that this crowding instinct does not usefully translate into financial markets. This is because the view of the crowd naturally gravitates towards what has recently been successful and shuns what has recently been unsuccessful. The challenge posed by financial markets is that, by the time an investment has performed sufficiently well (or badly) for it to become an accepted wisdom, conditions are ripe for the trend to change.

Business and investment cycles have operated throughout recorded human history. The specifics are always different but the principles remain the same. Initially, a conducive environment and opportunity attracts investment to a 'good thing' and initial and subsequent success attracts further and further investment, with later investors increasingly willing to suspend disbelief about the durability of future prospects. The 'upcycle' is hypnotic but it always ends. Excess investment destroys the scarcity of the 'good thing' while those propagating it become heady on their success and throw caution to the winds. The downcycle occurs when the bubble bursts and this process goes into reverse, eventually creating an opportunity again.

We think that to profit, an investor has to take a different stance and that the biggest challenge for an investor is to recognise when the voice of the crowd no longer suggests a sensible balance between risk and reward. We seek to avoid speculation, which we define as investing largely on the basis that somebody else will pay more for an already fully priced, popular asset.

We are, of course, stock market investors and even if we are very skilful with our stock picking, we are likely to be affected by wider market movements. However, we think that one of the most prudent ways to make money in the stock market is to invest when others are reluctant to do so. We actively seek unpopular areas because this is where the balance between risk and reward can be most favourable. We believe in cycles rather than perpetual trends and wish to purchase at depressed prices to improve our margin of safety.

Our style is distinct and we would expect other investors to ebb and flow in their support for the types of stocks we favour. We aim to achieve above-average long-term performance, although we do not expect this to be achieved in a linear manner. We are less likely to participate in the exhilarating latter stages of a bull market because we think it is vitally important to survive the down leg of an investment cycle.

NAV Absolute Performance AttributionYear to 31 October 2017

Gains and LossesYear to 31 October 2017

* Sold during the year.

To apply our approach, we divide the stocks in which we invest into three categories.

First, we have those that we describe as ugly ducklings - unloved shares that most investors shun. These companies have endured an extended period of poor operating performance and, for the majority, the near-term outlook continues to appear uninspiring. However, we see their out-of-favour status as an opportunity and can foresee the circumstances in which these investments will surprise on the upside.

The second category consists of companies where change is afoot. These companies have also endured a long period of poor operating performance but have recently demonstrated that their prospects have significantly improved. However, other investors continue to overlook this change for historical reasons.

In our third category, more to come, we have investments that are more generally recognised as good businesses with decent prospects. However, we see an opportunity as we believe there is scope for further improvement that is not yet fully recognised.

The Financial Year

Investment returns were again strong during the year. In contrast with last year, markets showed less favour towards a margin of safety based investment approach such as our own.

The election of President Trump represented a blow to the establishment but investors interpreted this positively, as it provided the theoretical basis for a new round of stimulatory policies. The slight conundrum is that Donald Trump was elected to improve the living standards of the mass of population, rather than boost asset prices. There is a risk that investors may discover that populist policies do not necessarily coincide with their interests.

Investors in general seem enthusiastic about the prospects for asset markets and exhibit a low level of scepticism about some of the most popular investment themes. Confidence has returned and there is now a lot of money seeking a return driven by low cash interest rates and the commensurate low cost of debt.

Central banks, led by the US Federal Reserve, have taken the first steps to unwind this era of ultra cheap money. Central banks clearly do not wish to unduly upset investors but this assumes that they have perfect control and, as suggested above, the political backdrop is shifting.

The most obvious sign of overly confident cheap money is the current boom in cryptocurrencies such as Bitcoin. We have concerns because, although the core technology has potential, there appears an unlimited supply of these currencies and governance appears very poor. Likewise, it is noteworthy that some of the largest US stocks have gained the moniker 'FANG' (an acronym of Facebook, Amazon/Apple, Netflix, Google). It is probably fair to say that by the time an investment theme gains an acronym it is so well established that a reasonable opportunity for a risk-adjusted return may no longer exist. The last 'acronym investment theme' you may recall was the 'BRICs' (Brazil, Russia, India, China), which did very well for the early entrants but less so for later participants who probably lost money.

The Portfolio

Portfolio turnover was elevated by the need to raise funds for the buyback transaction with Aviva. Rather than apply a pro-rata reduction across the portfolio, we took the opportunity to selectively reduce the number of holdings.

Given our focus on individual stock ideas, I thought it most useful to discuss the notable gains and losses, in total return terms, over the year.

Treasury Wine Estates (+£15.4m), the Australian wine producer continued to refocus on premium brands to drive higher profit margins. Having delivered outstanding performance since it was bought as an 'ugly duckling' in 2015, the company has now graduated through each of our three categories. We now see Treasury Wine Estates as one with 'more to come'.

Rentokil Initial (+£14.7m) also moved into the 'more to come' category after another year of excellent performance. Its transformation from an unloved and underperforming conglomerate to a business focused chiefly on the attractive market for pest control helped the group to deliver strong results.

We added to our holding in Nintendo (+£8.3m), as we were surprised by the muted investor reaction towards the new 'Switch' games console. The Switch is an excellent product but, later in the year, as other investors became more enthusiastic and as expectations of future success increased, we reduced our holding. We have also moved this company into the 'more to come' category.

Our bank holdings performed strongly, as they had previously been inexpensively valued and stood to benefit from the prospect of higher interest rates and stimulus policies designed to help the mainstream economy. Our biggest gain was from Dutch lender ING (+£7.8m), while we also saw strong gains from BNP Paribas (+£4.4m), Citigroup (+£4.1m), Intesa Sanpaolo (+£2.6m), Bank of Kyoto (+£2.1m), Citizens Financial (+£2.1m), Sumitomo Mitsui Financial Group (+£1.7m) and Standard Chartered (+£1.2m).

The continued rebound in commodities prices helped a number of our investments, with energy holdings a notable beneficiary later in the period. Royal Dutch Shell (+£4.6m), produced the biggest gain, as well as BHP Billiton (+£2.6m), BASF (+£1.8m), Total (+£1.7m), Suncor Energy (+£1.5m) and Diamond Offshore Drilling (+£1.4m). However, we lost money in Hess (-£1.1m) and Tourmaline Oil (-£1.7m).

German software provider SAP (+£3.6m) gained credit for an encouraging transition to a recurring subscription-based model. Vinci (+£2.7m) did well on an improved outlook for the European construction market. RSA Insurance (+£2.3m), was buoyed by the continued progress of a turnaround strategy. Good results from Johnson & Johnson's (+£2.2m) pharmaceuticals business helped the business to deliver a solid performance, while Adecco (+£2.0m) gained on the prospect of better conditions in the temporary staffing market.

We consider Tesco (-£3.7m), one of our 'ugly ducklings', an excellent turnaround opportunity but this was obscured by the proposed acquisition of wholesaler Booker. However, we think that other investors will pay more attention now that this transaction has been approved. Our holding in Marks & Spencer (+£1.2m) endured fluctuating fortunes but showed some signs of progress and has a senior management team committed to change. We sold our entire holding in Kingfisher (-£2.0m), prompted by a need to raise funds for the Aviva transaction but also because we preferred the outlook for Marks & Spencer.

General Electric (-£4.6m) performed poorly in anticipation of a strategy review update at which new leadership reset profit and dividend expectations. GlaxoSmithKline (-£3.1m), also delivered a negative return as the new CEO unnerved investors as to where the dividend lay on her list of priorities.

Our telecom holdings in BT (-£2.9m), KDDI (-£2.7m) and China Mobile (-£1.1m) did not prove fruitful over the year. BT depressed investors with a disappointing trading update but, in general, we think that these telecom stocks have suffered from a rotation away from the more defensive areas of the market.

We sold our entire holding in Microsoft (+£3.6m) as we thought that the turnaround in the company's fortunes was adequately reflected in the share price. We also completely sold Comcast (+£3.5m) as, although the company is likely to continue to benefit from greater demand for high-speed internet we judged that the valuation already reflected this.

Outlook

The late Andy Grove, founder and former CEO of Intel, distilled his thoughts about management into a book called "Only the Paranoid Survive". However, I've always thought this would make a good title for a book about investing.

The reason for this is that a successful investor has to continually question their every assumption because things can, and do, change. The political environment is never static, new competition can emerge, advances in technology can drive structural change, management can remove their focus on the core business and apparently successful business models can mask hidden flaws while apparently unsuccessful business models can evolve positively.

The views of the crowd are a particularly poor predictor of future investment performance because the crowd extrapolates recent history and assumes it is a constant.

We could debate whether particular asset classes are overly elevated but perhaps less in question is that there have been a number of years of good returns and there are now signs of complacency in investors' attitude to risk. To some extent this is understandable as the world is awash with cheap money and the curators of this capital are desperate for a return. Symptoms of this excess are the appearance of get-rich-quick schemes such as cryptocurrency investments and the fact that an acronym (FANG) has been attributed to a narrow group of stocks which are all viewed as sure-fire winners.

This is not to say that the wider market will fall but more to observe that the risks currently being taken in some areas may not be justified by the future returns. The spread of valuations across the market is wide and, accordingly, we continue to identify opportunities which we believe will generate good long-term returns for shareholders.

We are contrarian investors and, as such, we seek unfashionable and unpopular investments that we think can recover. We invest, but with our guard up, as hot money has less tendency to inhabit the areas we favour. As I have noted in previous Manager's Reviews, our investment approach is designed to anticipate and benefit from change and we will continue to seek out opportunities with potential to profit the long-term investor.

Alasdair McKinnonManager8 December 2017