Herald Investment Trust has announced its annual results for the year ended 31 December 2015. During the period, the company’s NAV grew by 8.4% to 881.8p per share, whilst its share price grew by 13.1% to 745.3p reflecting a narrowing of the discount from 19.0% to 15.5%. Both the share price and the NAV beat the performances of both the Numis Smaller Companies Index plus AIM (ex. investment companies) and the Russell 2000 (small cap) Technology Index (in sterling terms), which returned 5.4% and 6.2% respectively. The trust finished the period with total assets of £709.1m.
The managers say that, in the early part of the year, momentum led Asian, European and North American stocks higher, while UK stocks were in the doldrums after heavy redemptions in UK smaller companies funds in 2014 and political apprehension ahead of the election. In the second quarter the geographic differences reversed, and the UK made steady progress for the rest of the year, while the rest of the world corrected sharply before rallying a little towards the year end.
In terms of performance attribution, the company says that takeovers were once again important. Significant takeovers during the year were Kofax, Opsec, Phoenix IT, Chime and Hellermann Tyton. Collectively these five UK takeovers increased the trust’s assets by £19.1m.Completed takeovers totalled £94m and these transactions delivered half the return of the whole portfolio during the year. The company says that the return on the UK element of its portfolio, which accounts for 64% of the Company’s net assets at the year-end, was 10.4% versus the Numis Smaller Companies Index (extended to include AIM, excluding investment companies) total return of 8.6%. The North American return was 8.7% versus a sterling return of 6.6% for the Russell 2000 Technology Index, and North America accounted for 22.5% of the Company’s net assets at the year end. Europe, the Middle East and Africa returned 11.8%, while Asia returned 1.4%. The company says that global uncertainties led them to run net cash positions for most of the year.
The company says that the performance of investee companies has generally been steady. From the UK portfolio, GB Group performed particularly well, returning £8.6m (83.5%), whilst Imagination and Toumaz were amongst our poorest UK stocks in 2015. Imagination has experienced difficult trading, but the valuation is now less than the last three year’s expenditure on R&D, which has all been expensed. The managers fear the market has lost confidence that this development will be productive, while the customer base for the existing core products is increasingly dominated by Apple. They say that the outlook for Toumaz is better. Recent discussions in the US with a memory supplier to Toumaz were encouraging.
From the US portfolio, long-held holdings that fared well were Advent Software (it was taken over), Silicon Motion, Descartes and Pegasystems. In contrast Nimble Storage, Radware and Vasco disappointed for company-specific reasons.
In terms of outlook, the managers note that volume growth has evaporated for mobile phones, and PCs have experienced a sharp decline, which has put pressure on many Asian companies that dominate the supply chain. However, in spite of Herald’s global mandate, the Company has only 5% of its assets in this region reflecting what the managers see as poor investment attractions. They say that many Asian companies have a concentrated customer list, poor pricing power and poor governance. As such the managers prefer to remain focused on the UK and to a lesser extent North America. However, regarding the US, the managers say that, whilst the US continues to lead with innovation, they have found valuations full. In comparison, they say that the UK has for a number of years been good value and the performance has been enhanced by many takeovers.
Over the last 9 years, 66 UK portfolio companies have been acquired. However, the managers say that, whilst some consolidation is appropriate and helpful, the serious shortage of capital in the UK market has meant that there have been no UK consolidators, so most companies have been sold to overseas buyers and a few to private equity. The company has previously commented on this problem but they now say that the flight of capital from the quoted UK equity market has now reached a point where they must consider reallocating capital. In their view, there is no shortage of entrepreneurialism and innovation in the UK, but an evident shortage of capital. As a solution, the company says that it has considered investing in private companies, but they see a worldwide problem of too much capital being tied up in private companies with the quoted markets currently unwilling to provide exits. In the public markets, the larger companies are acquired and at the small end they are fearful of being too exposed to too many early stage companies, with few willing co-investors.
Looking at the US, this has seen a marked contraction in the number of small technology companies and IPOs (initial public offerings) since Sarbanes Oxley but the private venture market, which has surged, seems to be hitting a wall, in the managers view. They say that investors are now marking down valuations of private technology companies and that there is promising potential that a number of companies in the US will come to market at sensible valuations. The managers also say that a further problem is that commissions have been driven down to a point where it seems the market can no longer function as it has done historically. Until four or five years ago, US IPOs had a roadshow in London. Now rarely do they bother. In light of this, the Manager has decided to open a research office in New York.
In terms of outlook, the company says that as the more professional investors desert small capitalisation equities in favour of ETFs, Index trackers, hedge funds, private equity and bonds, they see richer potential pickings for those focussed on bottom up stock selection. They say that it feels as though there will be greater returns from stock picking than asset allocation as money and research evaporates in long only investment in the medium term.
Herald benefits heavily from takeovers, more focus on the US going forward : HRI