QuotedData Annual overview | Investment companies 07 December 2017 Herald Investment Trust Sector Small cap TMT Who wants to be a billionaire? Ticker HRI LN Base currency GBP Herald, the small cap technology, communications and Price 1195p multimedia trust, recently passed a remarkable NAV 1348.5p milestone. It has created more than £1bn for investors Premium/(discount) (11.4%) Yield Nil since it launched in 1994. Katie Potts, who has managed the fund over its entire life, points out that £98m was raised from investors (at launch and in Share price and discount Time period 31//10/2012 to 05/12/2017 subsequent issues). All of this and more has been 1,200 -10 returned via share buy-backs, yet Herald still has net 1,000 -15 assets of £952.3m (up from £791m at the start of 2017). 800 -20 2017 has been good to Herald and to the sector in 600 -25 general; the trust’s share price is up 35.4% year-to- 400 -30 2012 2013 2014 2015 2016 2017 date. Katie thinks that the UK stocks that form the core Price (LHS) Discount (RHS) of the portfolio are still not excessively valued, Source: Morningstar, Marten & Co especially given their potential for future profit growth. She says that it is this fact that distinguishes the current run of good performance from previous technology bull Performance over five years Time period 30/11/2012 to 30/11/2017 markets. 300 260 Small-cap technology, communications and multi- 220 media 180 140 Herald seeks to achieve capital appreciation through investments in 100 smaller quoted companies, in the areas of technology, 60 2012 2013 2014 2015 2016 2017 communications and multimedia. Investments will be made globally, Price (TR) NAV (TR) although the portfolio has a strong position in UK stocks. Bberg Wrld Tech (TR) Numis SC+AIM xIC Year Share NAV Numis B’berg MSCI Source: Morningstar, Bloomberg, Marten & Co ended price total ex IC World World total return plus Tech Index Domicile United Kingdom return AIM TR TR Inception date 21 February 1994 (%) (%) (%) (%) (%) Manager Katie Potts 30/11/13 38.4 29.2 31.6 15.6 23.7 Market cap 843.9m 30/11/14 (3.5) (0.7) (2.5) 29.5 13.9 Shares outstanding 70.622m 30/10/15 11.1 13.3 8.2 5.2 3.3 Daily vol. (1-yr. avg.) 96,866 shares 30/11/16 11.6 17.1 7.9 31.5 24.3 Net cash 9.4% 30/11/17 43.1 29.7 23.6 30.1 14.1 Click here for our most recent update note Source: Morningstar, Bloomberg, Marten & Co NB: Marten & Co was paid to produce this note on Herald Investment Trust and it is for information purposes only. It is not intended to encourage the reader to deal in the security or securities mentioned in this report. Please read the important information at the back of this note. QuotedData is a trading name of Marten & Co Limited which is authorised and regulated by the FCA. Marten & Co is not permitted to provide investment advice to individual investors. QuotedData Herald Investment Trust Contents 3 Fund profile 3 Management arrangements 4 An overview of the technology sector 5 Investment process 5 Idea generation 5 Searching for companies with sustainable advantages 6 The importance of diversification 6 Portfolio construction 7 Sell discipline 7 Asset allocation 8 Performance 9 Major drivers of performance 10 IQE 10 Blue Prism 10 Sophos 10 Zoo Digital 11 Dividend 11 Discount 12 Fees and costs 12 Capital structure and life 13 Board 13 Management team 14 Previous research publications Annual overview │ 07 December 2017 Page | 02 QuotedData Herald Investment Trust Fund profile A global, small-cap technology Herald invests globally in small technology, communications and multimedia fund, unique in the listed companies with the aim of achieving capital growth. It is the only listed fund of its type. investment company sector The trust invests globally, but has a strong bias towards the UK, which further distinguishes it from other global technology funds, that tend to be biased towards the US. Herald launched in 1994 with £65m, topped that up with a further £30m in 1996 and the proceeds of a warrant exercise in 2003. Today Herald has net assets of £952m. Investors at launch had made more than 13.5 times their money at the end of October 2017 while, over the same period, the MSCI World Index returned just 4.4 times. New investments in the fund will typically have a market capitalisation of $2bn or less, but are generally much smaller when the first investment is made (the manager, Herald Investment Management Limited or HIML, tells us that the median market cap is currently £190m). If successful, these companies can grow to be a multiple of their original valuation. This type of investing is inherently longer term in nature and so the trust tends to have relatively low turnover. Reflecting the risks inherent in this type of investing, the trust maintains a highly diverse portfolio of investments (typically in excess of 250 holdings) to help mitigate this risk. Fund manager in place since Herald has had the same lead fund manager since launch, close to 24 years ago: Katie launch in 1994 Potts (the manager or Katie). She was a highly regarded technology analyst at Warburg (later UBS) prior to launching the fund. Katie owns a substantial stake in the company and a significant minority stake in the management company. Previous notes from QuotedData have noted the important role that Herald plays as a provider of much needed capital to listed technology companies looking for expansion capital (see page 14 for details of QuotedData’s earlier notes). Management arrangements You can access the fund’s Herald owns a 15.4% stake in its management company, Herald Investment website at www.heralduk.com Management Limited (HIML). HIML manages an OEIC, The Herald Worldwide Technology Fund, which has more exposure to large cap companies than the trust and had assets of c£27m at the end of June 2017, and two venture capital funds which have ceased to make new investments. Seven-strong team with a Katie leads a team of six analysts, five of whom are based in London and one in New presence in London and New York. US companies do not come to the UK as much as they used to, and Herald feels York it necessary to have a US presence to enable frequent contact with companies. The HIML team can also draw on the knowledge of three consultants. We have included some biographical details on the team at the end of this note. Research responsibilities are organised along sector lines but Katie has also delegated responsibility for managing the Asian portfolio to Fraser Elms (the deputy manager) and Hao Luo, and the continental European portfolio to Taymour Ezzat and Peter Jenkin. Significant ‘skin in the game’ Katie owns a substantial stake in Herald (404,877 shares as at 31 December 2016) and a significant minority stake in HIML. Annual overview │ 07 December 2017 Page | 03 QuotedData Herald Investment Trust An overview of the technology sector The technology sector has been having a good run. Katie thinks that, for a large part, this is because investors are attracted to the growth potential of the underlying stocks rather than because investors are in a rush to embrace the technology sector. There was a rush of takeovers in the last three months of 2016 but this did not carry over into 2017. Katie feels that, in retrospect, the market was too cheap at the end of last year and this situation has now been rectified. Along the way, some of the more attractive, cash generative companies were snapped up. In addition, major corporations are being more cautious and potential buyers may be waiting to see how Brexit pans out. As mentioned in the last report, US companies appear to be poaching staff rather than buying whole companies. Katie was concerned that, as the UK lost its largest IT companies to bids, this might impact our ability to train the next generation of business leaders. However, the US giants have been investing in the UK. The likes of Amazon and Google are nurturing talent here. Katie believes that big data and cloud based computing are powering a new growth phase for the sector. Amazon has been driving down the cost of its servers (even going as far as to bypass the server manufacturers and buying components to build their own). This is driving down the barriers to entry for technology start-ups. The availability of cheap data storage and much faster processing speeds is also fuelling the growth of artificial intelligence (AI). Firms such as Google and Microsoft have been making some of their Al technology open source, to encourage developers to write apps for their platforms (to entice people into their universe). The growth of AI is allowing the emergence of new opportunities such as apps that can interpret images and improvements in speech recognition. Figure 1: Herald portfolio historic price/earnings ratio by region 45.0 40.0 35.0 30.0 25.0 20.0 price/earnings ratio 15.0 10.0 5.0 0.0 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13 Dec 13 Jun 14 Dec 14 Jun 15 Dec 15 Jun 16 Dec 16 Jun 17 Asia EMEA North America UK Source: Herald Investment Management After such a good run for the sector, it might be reasonable to ask how close we are to the peak in markets.