Herald Investment Trust (HRI) has released its annual results for the 12 month period ending 31 December 2023.
- Over the year HRI generated a NAV total return of 5.7%, compared to the 3.2% Numis Smaller Companies plus AIM (ex. investment companies) Index and the 21.0% Russell 2000® Technology Index (in sterling terms).
- A major factor in HRI’s “sluggish” performance was the extreme divergence between the performance of the company’s larger stocks and smaller ones, whereby the largest companies substantially outperformed. HRI’s 39 investments with a market cap of greater than $3bn delivered returns of 72.1% in the year against -9.2% for the 283 companies capitalised at less than $3bn.
- HRI comments that this may be a reflection of the current interest rate cycle, rather then an issue of company fundamentals and also that because of the nature of cycles, “the underperformance of both small cap and the UK will turn: eventually their relative good value will be hard to ignore”.
- There was also regional disparity within HRI, as its US allocation generated strong outperformance relative to the UK. HRI’s UK allocation, which makes up c.40% of the portfolio, fell by -8.7% on the year, underperforming the UK benchmark, while its US allocation generated returns of 31.3%, outperforming the US benchmark.
- There were 14 takeovers announced in the year, in respect to HRI’s holdings.
- HRI has a large cash balance, currently 12%, which benefited from higher levels of interest payable on these deposits. This liquidity is intended to be used to capitalise on the opportunities illiquid stocks can present.
- HRI’s discount narrowed over the last 12 months, from 15.1% as of 31 December 2022 to 13.4% as of 31 December 2023.
- There was a record level of buybacks made by HRI over the year, totalling £107m.
Katie Potts, HRI’s manager, commented:
“Maintaining wealth, let alone creating wealth, will be a challenge in a world with so much government debt and in which fiscal deficits will have to be both funded and reduced. Money will be sucked into bond markets and consumers and businesses will be squeezed by higher tax. It seems obvious that good returns may only be achieved through growing markets, and that technology continues to evolve, and that innovation creates new markets offering more potential than other sectors. Entrepreneurial management can exploit these opportunities but need access to capital to do this. Equally growth will occur where people work for $2/hour and there is evident migration of labour-intensive manufacturing to countries like Indonesia and Vietnam. The outlook for Europe including the UK seems challenging because labour is too expensive for low-cost manufacturing and there is limited availability of capital.
“At the time of writing, the markets have taken the negative effect of conflicts in the Ukraine and Israel lightly. There could be an upside surprise from peace in these regions, but continued and even increased tensions seem more likely. This will drive increased defence spending, and investment in technology led defence solutions, not least in cybersecurity.
“UK investors are acutely aware of the challenges faced by the UK economy following the explosion of Government spending and the high debt levels. It seems they are less aware that these challenges are faced in almost all developed counties. I fear they may move money to North America where valuations are high and the widespread use of adjusted earnings per share excluding share-based payments which is effectively understating both the costs of running a company and the price/earnings ratio. In the technology sector in particular share-based payments can be material. We are privileged to meet management teams around the world on a daily basis, and aware of the widespread challenges. The greatest concern is that the bond markets will force fiscal discipline, particularly in the United States, which will make global growth challenging. The key is to find strong management teams addressing growth markets to offset these headwinds.
“I suspect there will be more takeovers in the UK in particular. The US IPO market may open up if there is not an upset like the failure of Silicon Valley Bank in 2023. There are headwinds from corporate debt costs rising, trade tensions with China and elections with difficult choices in several countries. Although the macro environment is uncertain, we retain our belief in the growth prospects for the technology and communications sectors and that we will continue to discover entrepreneurial management teams that merit backing with the Company’s capital.”