SUMMARY OF PERFORMANCE
|CAPITAL RETURN||At inception|
30 June 2019
31 December 2018
31 December 2018
|Net asset value per ordinary share (including current year income)||98.7p||1,532.6p||1,307.9p||17.2%||1,452.8%|
|Net asset value per ordinary share (excluding current year income)||98.7p||1,532.2p||1,307.8p||17.2%||1,452.4%|
|Numis Smaller Companies Index plus AIM(ex.investment companies)||1,750.0||5,321.1||4,917.9||8.2%||204.1%|
|Russell 2000 (small cap)Technology Index (in sterling terms)||688.7*||3,184.0||2,599.3||22.5%||362.3%|
* At 9 April 1996, being the date funds were first available for global investment.
I am pleased to report growth in net asset value per share of 17.2% in the first half of 2019 with the regional portfolios outperforming their relevant indices in the UK and the US. The North American portfolio returned 27.6%, with the performance benefiting from a remarkable number of takeover bids during the period. In contrast, cash and treasuries, which were relatively helpful in the weak fourth quarter of 2018, proved a drag. The cash levels were slightly higher than the Manager planned, largely because of the continued spate of takeovers of portfolio companies.
The UK remains the largest geographical exposure, with 52.4% of assets. The total return was 15.8% which compares favourably with the total return of 9.8% from the Numis Smaller Companies Index plus AIM (ex investment companies). The UK portfolio also included the best performing investments in sterling terms: Future, GB Group and Next Fifteen Communications. There have been five takeovers in the UK portfolio valued in total at c£14m, which is a 51% premium to the aggregate value of the holdings at the start of the year. In the UK, the Company only participated in two initial public offerings of primary capital, although we also participated in twenty placings for follow-on offerings of primary capital. It has been a particularly busy period for such offerings, with no discernible slow-down associated with political uncertainty. AIM is conspicuously more active for small companies raising development capital than is the case in the US market. By contrast, there remains limited venture capital in the UK, but there are much deeper venture pockets in the US, who are funding companies to a much later stage. Private equity remains conspicuous in paying higher valuations for profitable, cash generative businesses reflecting the greater availability of cash and the use of financial leverage in both the UK and US. AIM stocks account for 35.6% of the portfolio’s assets with total return of 14.2%, while stocks with a full listing on the London Exchange returned 21.4% (total return).
The North American investments delivered a total return of 27.6%, which compares well with the Russell 2000 (small cap) Technology Index sterling total return of 23.0%. Stocks reflecting 20% of the value of the North American portfolio at the start of the year have received completed or incomplete takeovers with a combined value 43% higher than the value of those stocks at the start of the year. The aggregate value of these takeovers is c£58m and recent receipt of some completions is reflected in the high cash balances at the period end. The Manager has yet to reinvest these proceeds.
Significantly, two of the US takeovers became, in turn, the largest position in the North American portfolio – Attunity and Mellanox Technologies. Both are suppliers to the booming data-centre market. Long held Pegasystems was the strongest contributor in North America, but in percentage terms Hydrogenics, Intellicheck, Veritone and Digimarc all appreciated more than 100%.
The number of smaller US listed companies has shrunk significantly since the Sarbanes Oxley Act was introduced. It elevates the cost of being listed on US exchanges to $2-3m per annum for small companies. Takeovers and the ready availability of private finance have shrunk the US public market dramatically. The number of companies in the US with market capitalisation between $20m and $3bn – i.e. companies within the Company’s defined technology, media and communications remit – has fallen by 6% in the first half of 2019 to 570. In the US there is now considerable political concern about the shrinking stock market. By contrast, in the UK a vibrant AIM market has significantly replenished the number of companies, although the tendency is for larger companies to be acquired and replaced by smaller ones.
The smaller Asia and European portfolios have both performed well this year. The EMEA sterling total return was 19.9%. The most significant positive contributors were long held holdings, Isra Vision, Esker, BE Semiconductor Industries and Data Respons based in Germany, France, Netherlands and Norway respectively while the Irish company Datalex disappointed. The Asian total return was 23.4%. Realtek in Taiwan, Kingdee in Hong Kong and Afterpay in Australia were the strongest contributors. The Asian portfolio accounts for 6.7% of the Company’s assets, and within that the largest countries are Taiwan 28%, Australia 25% and China 20%. The Taiwanese return was 29.8%, Australia 33.1% and China 18.2%.
At the AGM in April, Julian Cazalet retired from the board, which he chaired for the last nine years. The board is very grateful for his leadership and his very substantial contribution to Herald’s success.
The investment strategy allows the Manager from time to time to hold on an opportunistic basis fixed interest holdings, non-equity or unlisted investments. Following the Manager’s statement in the last annual report that consideration was being given to allocating a small portion of the portfolio to private companies, the board has agreed that the maximum amount which may be invested in companies not quoted on a public market shall for the time being not exceed 5% of the net assets of the Company, measured at the time of purchase. At the current time the total of such holdings is less than 2% of net assets, including fixed interest holdings, non-equity or unlisted investments.
During the period the Company repurchased 566,191 shares for £6.7m, which represented 0.8% of the outstanding capital. The dividend income was flat in UK and North America, but this result disguises a significant shift in the source of dividends. While income was lost from holdings taken over, such as Fidessa, this was offset by significantly increased income from other holdings. Dividend income declined in Asia and Europe reflecting a reduced payment from BE Semiconductor Industries and portfolio changes.
In spite of the political turmoil in a number of places, the market background for both the stock market and the underlying trading in the portfolio companies in general has been benign. The economic upturn is now a decade long. Unquestionably the most recurrent issue in meetings with the portfolio companies is staff turnover and upward wage pressure – particularly in Northern California and to a lesser degree in London, but wage pressure has abated in China.
In addition, big markets such as mobile phones have seen softer demand, and the capacity shortages seen in semiconductors has passed, so prices have eased. There was a particular squeeze in capacitor supplies last year, and there are still significant lead times for these. The automotive industry has also been pressured by the sharp reduction in demand for diesel cars, while demand for electric cars has not yet arrived in volume. This has been exacerbated by political and media comments, which has also affected demand for certain capital equipment. These challenged markets are only marginally relevant to the portfolio, which in general has structural growth.
The US continues with an extremely loose fiscal policy, while Europe has free capital, so thus far consumer spending continues to be firm in most countries. The sixty four million-dollar question is how long easy money can continue. From the micro perspective of a small cap technology fund it is when the tightness in the labour market feeds through to inflation.
The biggest issue affecting the sector is the US/China trade war. The US seems to have softened its position on prohibiting sales to Huawei by US companies, but the broader trade conflict may continue in unexpected ways. Again, the portfolio has limited exposure to these challenges and the Manager remains positive relative to other asset classes, with the caveat that the number of investable smaller quoted companies continues to shrink in the important markets of the UK and the US.
18 July 2019
The Half Yearly Financial report will be posted to shareholders on or around 2 August 2019 and published on the Manager’s website: www.heralduk.com