Herald Investment Trust PLC- Half-Year Report 2021

HERALD INVESTMENT TRUST plc

(the “Company”)

HALF-YEARLY FINANCIAL REPORT

For the six months ended 30 June 2021

SUMMARY OF PERFORMANCE

^A   Alternative Performance Measure (APM).

*  At 9 April 1996 being the date funds were first available for international investment.

^†   The Russell 2000 (small cap) Technology Index was rebased during 2009 following some minor adjustments to its constituents. The rebased index is used from 31 December 2008 onwards.

Past performance is not a guide to future performance.

CHAIRMAN'S STATEMENT

The Company's net assets per share grew by 14.0% during the first half of 2021. This comes on top of the 37.0% rise in 2020, which is particularly pleasing. The market rhetoric at the start of the year was “to switch from growth to value as the world recovers from the Covid trauma” and this resulted in a widening of the discount of the Company's share price to net asset value. Fortunately, the assets have continued to perform well resulting in the growth in total assets to £1.7bn. There has been some rotation in the performance of individual stocks within the portfolio.

The performance of the Company's investments by region is as follows:

^A   Alternative Performance Measure (APM).

The UK continues to be the largest element of the portfolio with 48.8% of net assets, a little below its historic level. The total UK return during the period of £121.2m represents 16.9% versus a total return of the Numis Smaller Companies plus AIM (excluding investment companies) Index of 16.4%. It also takes the cumulative total return from the UK portfolio to £1.186bn equating to a time-weighted return of 13.9% per annum since inception in 1994. This greatly exceeds the return of the wider UK market, and the US-based Russell 2000 Technology Index which has compounded at only 8.2% since inception on 1 July 1996. Future and Next Fifteen Communications, both long-held positions, each returned over £16m. However, in percentage terms the return on Audioboom, which earns revenues from podcast advertising, dwarfed others at 243.0%. Over the last five years £178m has been withdrawn from the UK portfolio, including £34m in this six-month period. We continue to find an entrepreneurial culture in the UK and many attractive companies in which to invest, but we have seen gradually declining liquidity over several years so further diversification overseas seems prudent. We are also very concerned about the potential for greatly increased regulation of our portfolio companies, notably resulting from the ongoing government consultation on future audit and corporate governance which further motivates us to invest overseas.

The North American portfolio weighting is 23.0%. This region delivered a return of 297.0% in the five years to 31 December 2020, and valuations had become stretched. We are pleased therefore to have returned a further 8.5% in the first half (slightly lagging the Russell 2000 Index total return by 1%) which required some rotation from last year's star performers. This combined with profits growth, means the average forward p/e of our holdings is somewhat lower than it was and valuations are correspondingly less stretched.

The Company's performance in Europe has continued to be very strong with a return of 28.3% in the period. This result was led by Nordic Semiconductor (+£9.4m, +55.5%), BE Semiconductor Industries (+£6.4m, +42.1%) and Esker (+£5.2m, +33.8%). In percentage terms Napatech, X-Fab Silicon Foundries, Adva Optical Networking and Datalex all returned over 50.0%. The EMEA weighting has modestly increased to 10.3% reflecting performance and a modest further investment of £9.2m.

Asia was the best region last year and has returned a further 16.9% so far this year. The Taiwanese company Momo.com was top of the leader board returning £6.7m (+195.0%) and the Australian company Mainstream with £5.4m (+163.6%) came next. Freelancer and eMemory Technology also appreciated more than 100.0%. The core markets in the Asian portfolio are Australia, Japan and Taiwan with about a quarter of the Asian weighting each. The respective returns for these countries were 7.9%, 5.8% and 42.3%, so Taiwan led again. We invested a further net £16.1m in Asia during the period and the weighting has now risen to 11.5%, reflecting our measured desire to reduce the UK weighting and add a greater number of Asian companies as they move further up the value chain.

The period has continued to be overshadowed by the Covid pandemic. Whilst last year our discussions with management focused on the mass transition to working from home and furlough schemes, this year they have focused on the supply chain. There have evidently been changes in consumer behaviour as those still in work have reduced expenditure on holidays, socialising and restaurants, and spent more on home improvements, computer games, internet TV subscriptions and the related devices. The technology sector has obviously benefited from this. There has also been a sharp rise in consumer savings. The latest reported ratio was 19.9% in the UK versus a range of 5-10% pre-Covid, while in the US it is now 12.4% which is double the pre-Covid level. This suggests that the increase in technology spending may not reverse too much when more normal behaviour resumes. Supply chain issues are however, our greatest short-term concern. Semiconductors have seen the most publicised and acute shortages with those used in the automotive industry a particular issue, but the problem is much wider than that. For example, there are huge increases in the cost of containers particularly from East to West and also delays. Therefore, some manufacturing companies might disappoint in the short term, but our long-term investment philosophy remains. We expect that boards the world over will be more focused on security of supply with increased inventory and more local or dual sourcing. Potential over ordering for this reason may now be flattering short term demand too. We also expect Governments to be thinking far more than they have historically, about strategically important products relating to basic requirements such as vaccines, food and security.

The key question all investors must ask is how much the changed trading patterns, and monetary growth, will lead to a broader and more sustained rise in inflation, prompting higher interest rates. The central bankers have an unenviable task of needing some inflation to erode consumer and government debt alike, without causing stresses from the expense of servicing higher debt levels and controlling inflation. The technology, media and communications sectors on which Herald is focused are relatively well placed with little financial leverage. Property, construction, housebuilding and automotive are clearly more vulnerable to higher interest rates. Generally, capital expenditure is weak when the cost of money goes up, and historically the technology sector has been driven by capital expenditure. However, technology spend is increasingly shifting to be a non-discretionary operating cost with monthly or annual charges for servers, storage, applications, subscriptions and so on. Meanwhile new technologies and opportunities continue to open up, and cyber threats continue to evolve. Whilst we believe that the sector now has more defensive demand characteristics, we note warily that valuations are higher than the long-run average and reflect high expected growth and unattractive bond yields.

In the first half of 2020 the dividend income we received halved in round numbers, but this year it has doubled back to the level of 2019. The negative interest rates available on cash still resulted in a small loss on the income statement. £18.7m has been spent to repurchase a further 1.3% of issued shares for cancellation, so cumulative buybacks now exceed the amount of outside capital raised by the Company since inception by £86m.

We are immensely grateful for the hard work of the Manager and the many individual management teams at investee companies, who have contributed to these excellent long-term results. I would also like to take this opportunity to thank my predecessor as Chairman, Ian Russell, for his contribution prior to stepping down earlier this year.

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While challenges in the world abound, we are fortunate to constantly have our fears diminished by seeing investee companies coping well, and generally delivering growth. We therefore remain attracted by the prospects of our core sectors and the positioning of the portfolio.