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Polar Capital Technology dragged down by tech retrenchment after last year’s outperformance

Polar Capital Technology dragged down by tech retrenchment after last year’s outperformance – Polar Capital Technology (PCT) has posted its final results for the year to 30 April 2022. Over the year, its NAV fell by 7.7% and the share price fell by 13.7% as the discount widened, both behind the index which fell by just under 1%.

The widening discount reflected the considerable change in sentiment towards technology stocks and market volatility generally. While PCT has no formal discount policy or a fixed target level for all times and circumstances, it will continue to exercise its discretion to buy back shares at a discount and to issue shares at a premium in order to seek to reduce the volatility of the share price. A total of 4,188,338 shares were repurchased in the year under review (amounting to 3% of the issued share capital) at an average price of 2,355.35 pence per share and an average discount of 9.6%.

UK investors were sheltered from the decline in the technology market by the appreciation of the US dollar against Sterling. Although the manager did hold some cash, the index performance was driven significantly by the very strong relative performance of Apple and Microsoft and the chair said that the most significant cause of underperformance was not having full 15% weightings in those two stocks.

While core themes (and PCT’s growth-centric approach) had previously mapped well to the pandemic, the team continued to realign the portfolio to better position it for reopening. This resulted in significantly reducing exposure to earlier work-from-home (WFH) beneficiaries, many of which suffered spectacular reversals.

This resulted in PCT exiting positions in Adyen, Avalara, Delivery Hero, Fiverr, Kahoot!, ON24, Peloton, Shimano, Wise and Zalando during the year. The company also significantly reduced exposure to longer-duration stocks post the Fed pivot in November, exiting Affirm, Pinduoduo and Sea.

On the positive side, PCT continued to add to its semiconductor exposure reflecting myriad thematic drivers (including AI and EV) as well as the ongoing demand-supply imbalance. Changes to the portfolio made during the year meaningfully ameliorated underperformance with the trust’s actual return more than 4.5% ahead of what a static (i.e. unchanged) portfolio would have delivered.

[It’s perhaps worth noting that in the year to April 2021, PCT’s NAV rose by 45.5%, following a ten-year period over which the net assets had grown from £468.7m, to £3.4bn, as technology stocks outperformed markets generally, on the back of extraordinary corporate growth and rising valuations. This year started with a significant move away from growth, and with that, technology stocks on inflation fears. Over the long-term, PCT still boasts impressive numbers.]

Statement from the manager:

As one of the largest beneficiaries of the pandemic, reopening was always going to generate crosscurrents for the technology sector. E-commerce normalisation has led to significant retracements within the internet and payment subsectors which are likely to take time to recapture. However, we are confident that secular tailwinds will reassert themselves, supported by favourable demographics. Software spending growth remains robust as companies digitally transform, automate workflows, gain insight from AI, secure themselves from cyberattacks and apply technology to drive productivity gains. Gartner believe software spending will increase 9.6% this year; IDC size digital transformation as a $10trn opportunity through 2025. And then there’s a myriad of other secular themes within technology to get excited about – AI, cybersecurity, electric vehicles (EVs), healthcare and clean energy to name a few, as well as optionality associated with autonomous vehicles, the metaverse and blockchain/ distributed computing. With macroeconomics currently dominating equity markets and near-term volatility high, it is easy to forget how good the long-term technology story is.

Long-term returns ultimately reflect economic value added, even if market disruptions and cyclical impulses can overwhelm the powerful underlying drivers of longer- term technological progress in the short term. If the past year has shown anything, it is the enormous risk associated with hubristic and Panglossian investment approaches: TAM, growth at any price, disregard for liquidity, and high conviction trumping risk management as the basis for portfolio construction. None of these things, however, alter the underlying criticality of technology (via its contribution to total factor productivity) to future economic growth, especially as the other two inputs to growth (capital and labour) may contribute less as they become relatively scarcer. As the OECD puts it (quoting Krugman): “Productivity isn’t everything, but in the long run it is almost everything.”. Technology is the handmaiden to productivity improvement, and so long as the sector can continue to help the economy become more productive and create economic value, we expect value to continue to accrue to equity holders in the most impactful companies enabling this change.

While valuations have now corrected back to medium-term averages, they are still susceptible to further downside given increased volatility, the growing influence of energy prices and real rates on equity markets as well as heightened recession risk. The current drawdown (c.21%) is already consistent with the average non-recessionary bear market (-18% over eight months). However, the average recessionary bear market has seen the market fall by c.33% over 17 months, suggesting the current correction may only be c. two-thirds complete in the event of a recession. That said, technology valuations have meaningfully corrected such that next generation software stocks now trade broadly in line with incumbents on a forward EV/sales basis. The last time this happened was 2015/2016 when the market was also significantly concerned about a hard landing, suggesting that technology stocks have begun to meaningfully price in recession risk. As such, we have begun to rebuild our exposure to higher-growth stocks while maintaining a modest amount of Nasdaq put protection and cash to help ameliorate the impact of further market weakness while ensuring the portfolio remains highly liquid.

PCT : Polar Capital Technology dragged down by tech retrenchment after last year’s outperformance

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