Annual Financial Report

RNS Number : 0721Q
Herald Investment Trust PLC
16 February 2023
 

ANNUAL FINANCIAL REPORT for the year ended

31 December 2022 (audited)

 

This is the Annual Financial Report of Herald Investment Trust plc as required to be published under DTR 4 of the UKLA Listing Rules.

 

Results and dividend

The net asset value (NAV) of the Company as at 31 December 2022 was 2,099.1p per ordinary share (2021 - 2,719.3p). This represented a decrease of 22.8% during the year, compared to a decrease in the comparative total return indices of 21.9% (Numis Smaller Companies plus AIM (ex. investment companies) Index) and a decrease of 28.4% (Russell 2000® Technology Index (small cap) (in sterling terms)). The discount at year end was 15.1% (2021 - 7.9%).

 

The directors do not recommend a dividend for the year ended 31 December 2022 (2021 - nil).

 

The financial information set out in this Annual Financial Report does not constitute the Company's statutory accounts for 2021 or 2022. Statutory accounts for the years ended 31 December 2021 and 31 December 2022 have been reported on by the Independent Auditor. The Independent Auditors' Reports on the annual report and financial statements for 2021 and 2022 were unqualified, did not draw attention to any matters by way of emphasis, and did not contain a statement under 498(2) or 498(3) of the Companies Act 2006. The Company's statutory accounts for the year ended 31 December 2021 have been filed with the Registrar of Companies. The Company's statutory accounts for the year ended 31 December 2022 will be delivered to the Registrar in due course.

 

The financial information in this Annual Financial Report has been prepared using 'FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland' (FRS102), which forms part of Generally Accepted Accounting Practice ('UK GAAP') issued by the Financial Reporting Council. The financial statements have also been prepared in accordance with The Companies Act 2006 and with the Statement of Recommended Practice 'Financial Statements of Investment Trust Companies and Venture Capital Trusts' issued by the Association of Investment Companies ('AIC') in July 2022.

 

 

 



 

STATISTICS AND PERFORMANCE - YEAR'S SUMMARY

 


31 December 2022

31 December 2021

% change

Total net assets

£1,305.0m

£1,760.9m


Shareholders' funds

£1,305.0m

£1,760.9m


Net asset value per ordinary shareA

2,099.1p

2,719.3p

-22.8

Share priceA

1,782.0p

2,505.0p

-28.9

Numis Smaller Companies plus AIM (ex. investment companies) Index (capital only)

5,406.8

7,116.5

-24.0

Russell 2000® Technology Index (small cap) (in sterling terms) (capital only)B

3,814.1

5,340.9

-28.6

Dividend per ordinary share

-

-


Profit/(loss) per ordinary share (revenue)

0.21p

(8.33p)


Ongoing chargesA

1.05%

1.02%


Discount to NAVA

15.1%

7.9%


 

Year to 31 December

2022

2022

2021

2021

Year's high and low

High

Low

High

Low

Share price

2,570.0p

1,560.0p

2,630.0p

2,045.0p

Net asset valueA per ordinary share

2,719.0p

1,978.7p

2,849.1p

2,285.0p

DiscountA

25.2%

4.1%

16.8%

1.8%

 

At 31 December

2022


2021

(Loss)/profit per ordinary share

 



Revenue

0.21p


(8.33p)

Capital

(641.23p)


439.51p

Total

(641.02p)


431.18p

 

A   Alternative Performance Measure - see page 82.

B  Investments and indices valued at USD/GBP exchange rate of 1.209 at 31 December 2022 (1.354 31 December 2021).

® Russell Investment Group.

 

CAPITAL RETURN SINCE INCEPTION

A  Alternative Performance Measure - see page l.

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

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

Chairman's Statement AND REVIEW OF 2022

 

Recent stock market declines have inevitably affected the Company and it is disappointing to report a decline in net asset value ('NAV') per share of 22.8% in 2022. The decline was surprisingly uniform across all four of our regions (UK, North America, Continental Europe and Asia). More positively, we have seen profits growth in aggregate within the portfolio and generally resilient trading in investee companies. As clearly set out in the Manager's report, price to earnings ('p/e') valuations have been reverting to more normal levels (17.8x) having been elevated in recent years as we highlighted at the time. However, it should be noted that share price declines often precede forecast downgrades.

Market-= induced valuation volatility is one dimension to performance. The more important one for the long term is investing in successful growth companies. The aims of this Company and its Manager are to achieve capital appreciation by providing primary capital and being active in the secondary market in smaller quoted companies in the telecommunications, multimedia and technology sectors. In 2022, a further £21.4m was invested in primary capital (both new issues and follow-on fundraisings by companies), which takes the cumulative total to £645m since inception in 1994. That compares with just £95m of capital that the Company itself has raised in total (1994: £65m and 1996: £30m). Our belief is that good companies will grow whatever the economic backdrop, and that technology will continue to open up new markets. Early-stage capital is always scarce and by ensuring that we identify and research good companies ahead of others we can benefit from this.

Technology spend used to be mainly a capital expenditure decision, and demand was vulnerable to economic cycles. However, today businesses cannot run without information systems which are increasingly provided as a service on a rental basis, in effect outsourcing capital expenditure. This also means that more technology spend, across datacentres and communications infrastructure as well as software, has become non-discretionary. Importantly it means many technology companies are less exposed to cyclical demand and have defensive characteristics like utilities. Furthermore, businesses and governments alike are faced with other inflating costs, and the UK and North America in particular have very tight labour markets, so there is greater pressure than ever to find efficiencies, driving further demand for technology investment. The consumer, although wedded to the internet, is perhaps more fickle and may reduce expenditure on content and consumer electronics in uncertain times. Equally, inflationary pressures may squeeze advertising demand which is showing signs of weakness, but digital media continues to gain share. Business-facing subscription content should be more resilient.

Companies manufacturing technology products such as semiconductors are more exposed to softening demand than software companies. They have suffered from supply chain issues associated with Covid and capacity constraints, particularly in the semiconductor industry. This has left many companies with record order backlogs so short-term demand is assured, but for those higher up the supply chain the inventory cycle could produce adverse impacts.

Takeovers have continued to be a strong feature this year. There were thirty one takeovers of portfolio companies completed or yet to be completed, with an aggregate value of £161m. Of these, thirteen were in the United States (£73m) and nine in the UK (£57m). In contrast, IPOs were few and far between, with stock markets virtually closed to new entrants. These takeovers, together with the Manager's purposeful rotation into lower-rated stocks over the last couple of years, have helped offset the losses in the portfolio. In addition, the Manager has adopted a defensive stance by holding a lower proportion of early-stage loss-making stocks (12.0%) than in the past, and by retaining high cash balances. At the end of the year, cash and short-dated government bonds were 12.1% of net assets (£158.1m). This is a near record level and provides plenty of ammunition to invest at lower valuations in the coming year.

Current year losses in the portfolio have been mitigated by the weakening of sterling, relative to the dollar in particular, which has reduced the losses on overseas holdings, and (albeit on a delayed basis) will improve revenues and profits for UK companies with exports and overseas subsidiaries. In addition, the Company bought back more of its stock in 2022: some 2.6m shares, or 4.0% of the outstanding capital at the start of the year, with an aggregate cost of £50m. During the year, the discount widened from 7.9% on 31 December 2021 to 15.1% at year end, but with such dramatic market movements during the year, this is not altogether surprising.

The income statement is showing a marginal profit after several years of losses. This reflects a growth in dividends received of 16%, increased interest income on cash and government bonds, and reduced costs reflecting the lower asset value.

Whilst we remain confident about the longer-term prospects for the majority of the investee companies, we have concerns about the state of financial markets particularly for smaller companies. The UK smaller quoted companies market is the most challenged with particularly poor liquidity. This is an existential threat. It is very sad when over the life of the Company the UK listed investments have delivered a return in excess of £1bn including nearly £400m of profits on AIM holdings. The returns from investing in smaller UK technology companies have been first class over the longer term, bettering those of the index of US smaller technology companies (Russell 2000® Technology Index) by over 1,000% since 1 July 1996. The Company's capital is much needed in the UK. The entrepreneurial early-stage part of the market, which the Company addresses, is on the frontline in the conflict between regulation and economic growth. Whilst we respect the need for regulation, it appears to us that the process of reducing risk from the markets seems also to be reducing the available risk capital. This is surely an unintended and undesirable outcome and a major factor in our gradually decreasing exposure to the UK market.

As previously announced, after ten years I shall retire from the board at the forthcoming AGM. It has been a great honour to serve as Chairman of a company which has served its shareholders so well and, at the same time, has made such a significant contribution to the UK technology sector. I would like to thank our excellent manager, Katie Potts, and the entire team at HIML for their unstinting efforts on your behalf. Equally, my fellow board members have made my time at Herald very straightforward with their ever-ready support and constructive contributions. Andrew Joy joined the Board last October and will replace me as Chairman in April. Andrew has already demonstrated that he will add a great deal and I am sure I am leaving you in good hands.

Whilst the current economic and geopolitical challenges seem likely to continue for some time, I am very confident that the Company is well-placed to benefit and even thrive in such uncertain times. Your Board remains excited by the investment opportunities in the sector and looks forward with confidence.

 

TOM BLACK

Chairman

15 February 2023

 



 

Investment Manager's Report

The factors behind the disappointing decline in the Company's NAV per share of 22.8% are multiple. Clearly the biggest negative that had not been factored into valuations at the start of the year was Russia's invasion of Ukraine. It has been a catalyst to end the era of virtually free money and exposed the strains of the excess government debt associated with Covid, welfare, health and defence expenditure, and energy subsidies. The p/e compression witnessed is a direct and inevitable by-product of rising bond yields.

Price to Earnings and IRR

Source: Bloomberg. Analyst earnings estimates, where available, are aggregated using the Bloomberg weighted harmonic average calculation. This excludes loss-making companies from the p/e calculation. A weighted harmonic average will normally be lower than a geometric or arithmetic average. By way of comparison the 2022 Total Company weighted average arithmetic p/e (47.8x) or median p/e (21.0x).

Although the regional returns are all down between 20% and 28% there are variations in the underlying drivers of these falls between regions.

UK

The UK remains the largest region at 44.1% of net assets (47.7% at 31 December 2021). It has delivered a disappointing return of -25.9%, which is a little worse than the Numis Smaller Companies plus AIM (ex. investment companies) Index which returned -21.9% on a total return basis. In part this reflects stocks that outperformed during Covid but are now lagging. The Company's UK portfolio returned 48.7% total return over the five years encompassing the Covid trauma, against the index returning only 1.1%. There are also more stock-specific reasons to this year's declines which are discussed below.

Seven stocks returned an aggregate loss of £101.1m (each in excess of £10m) which is nearly half the region's loss for the year. However, during our entire period of ownership, these seven stocks have still delivered a positive return of £123.2m notwithstanding this year's setback. Losses would have been much greater had we not already realised aggregate gains of £90.0m, with some gains realised from each of the seven investments. Historically, the pattern was to realise profits in successful holdings as a source of cash to reinvest in smaller companies. Due to liquidity it has become increasingly challenging to reduce positions at the larger end, and we realise there is now a structural issue exacerbated by MiFID (Markets in Financial Instruments Directive) and other recent regulation. I find that smaller company investing is now a separate world from large company investing with different brokers and different analysts, so companies can no longer seamlessly transition their shareholder register to larger investors as they grow. As successful small caps outperform, they are left with overexposed shareholders, who struggle to sell their holdings and are constrained from providing further capital. It is therefore more difficult for companies to raise additional capital.

The first of the significant lossmakers in the period is BATM Advanced Communications, a UK-listed Israeli company which soared in Covid supplying ventilators and tests. That particular market has since disappeared. The second is Future. I am delighted to say we contributed needed capital of £250,000 in 2015 at 10p (or £1.50/share on a split-adjusted basis), a further £2m at £12.75 in 2019, and made other market purchases so the peak book value was £6.3m. Fortunately in 2021 we sold £24.2m of stock at an average price of £28.59 in 22 transactions realising gains of £21.0m. The share price fell to end the year at £12.67. But, with a prospective p/e of 8.1x on current market forecasts, the company continues to deliver growth. The third is GB Group, which has been a wonderful long-term investment, but painful for the last two years following a difficult placing to fund an acquisition. Additionally, results from the highly valued acquisition have disappointed a little, mainly reflecting reduced demand for identity solutions for the opening of cryptocurrency accounts. Ilika, an early-stage company with leading edge technology for solid-state batteries, soared on the green bubble, and then plunged on manufacturing challenges. ITM Power also soared on the green bubble in 2020. Fortunately, £20.2m gains had already been realised, but again the business had execution challenges, so delivered negative returns for a second year. Rapidly made profits in S4 Capital evaporated, in part from self-inflicted pain of book-keeping issues delaying the audit, but also an economy-induced negative sentiment in the advertising world. The seventh is YouGov, where again, £11.0m in gains had been realised because we felt that the valuation had become inflated. Trading is still fine, but the market anticipates a slowdown in growth.

There were some successes in the year as well. ZOO Digital has performed best. This is a particularly gratifying one because we supported the business through a difficult transition from DVDs to on-line streaming. When no other investors would support, other than the chief executive, we put in convertible loan stock and went to 20% of the equity, making an unusual exception (which was sanctioned by the board), when our general limit is 10% of outstanding capital. We now have a total return over £20m since inception. WANdisco has also done well this year. It is still loss-making but has announced some encouraging orders.

The nine takeovers with an aggregate value of £57.2m have also produced positive returns including Euromoney Institutional Investor, Ideagen, Avast and EMIS. This pace of takeovers in relation to a portfolio of £575.5m seems a normal rate.

REGIONAL ALLOCATION CHANGES (STERLING THOUSANDS)

 

*  Equities includes convertibles and warrants.

+  The total assets figure comprises assets less current liabilities.

The sector performance in the table above highlights that the media sector was the weakest, having reversed the stellar performance of 66.1% in 2021. Fortunately, material profits had been taken or the damage would have been greater. I also observe that UK technology valuations have been more resilient than those of other regions because they had lower initial levels from which to fall. The table also shows a decline in the value of the UK portfolio greater than the negative returns because there were net sales from the UK portfolio of £43.3m. This takes the cash withdrawal from the UK portfolio to over £210m over the last 6 years, and more than £300m since inception. The positive is that the portfolio of £575.5m effectively has a negative book cost of £308.8m. It has been our deliberate strategy to reduce the UK weighting due to the risk of poor liquidity and lack of co-investors.

The UK has a creative and entrepreneurial spirit, with many interesting investment opportunities. However, we feel the risks of investing in early-stage loss makers in the quoted market has risen. We have experienced situations where we alone have provided follow-on funding, and others where we would have provided funding but found there were insufficient co-investors. We expect to continue to support existing investments, and remain open to new ones, but I expect the UK to diminish as a percentage of the assets of the Company unless there is a political will to redress the regulatory burden and improve liquidity.

North America

For smaller technology companies, the North American market has probably been the worst in 2022. However, due to our well positioned portfolio, our North American holdings have declined less than the other regions. The return of -19.9% compares favourably with the Russell 2000® Technology Index return of -28.4% in sterling terms. The dollar decline in the index was -36.1%, and the sterling return (for an unweighted basket of stocks between $100m and $3bn market capitalisation in Bloomberg's technology and communication sector) was -40%. This makes the Company's NAV decline gratifyingly small. Superficially, the prospective p/e of 17.9x would seem to make the North American market cheap. However, we regard this as rather meaningless given that forecast earnings are generally made on an adjusted basis versus GAAP (Generally Accepted Accounting Principles), which excludes share-based payments. In the software sector in particular it is not uncommon to see 5% or more of the outstanding capital issued each year, the value of which is often a material percentage of revenues, let alone profit, and this inevitably dilutes shareholders substantially. In addition, it has been a growing concern that valuations were ridiculously high in the US and we have withdrawn capital from this market to the tune of £31m in 2022 and £126m over six years. In fact, like the UK, the US portfolio of £284.5m at the year end has effectively a negative book value (£117m).

The outstanding sector in North America has been technology hardware. Fabrinet, a Thailand-based but Nasdaq-quoted contract manufacturer in the optical space has done well. The star performer, not just in North America, but the whole portfolio has been Super Micro Computer which returned £14.2m. It is the largest North American holding and was the second-best performing stock in the Russell 2000® Technology Index (i.e. small and large companies). It is also pleasing that we held Agilisys, the third best performer in this 344 stock index. An element of the market's significant derating reflects the fact that lower rated hardware companies have performed better than the overvalued software companies. In contrast, long held Pegasystems has been extremely disappointing, largely due to the loss of a trade secrets misappropriation lawsuit for a seemingly bizarre level of damages. They are appealing, but in the meantime the investment was devalued by £16.3m.

The other obvious contributor to the good relative performance has been takeovers. The thirteen takeovers in the year, with an aggregate value of £73m, is a significant proportion of the North American portfolio. Furthermore, the aggregate value of takeovers is £191m over the last five years, which is extraordinary compared to the market value of the North American portfolio of only £207m at the end of 2017. Over that time, takeovers have significantly contributed to the region's IRR of 130%, in contrast to the sterling return of the index of 56%.

2020 and 2021 saw a deluge of IPOs and SPACs (Special Purpose Acquisition Companies) at unattractive valuations, offsetting the wave of takeovers. The result is that a third of the addressable market by number of companies is new to the market since 2020. The average local currency return is --38% for these technology IPOs, and SPAC returns are much worse. The team has focused on meeting many of these companies this year and expects interesting opportunities to appear in a dislocated market.

Along with a binge in share-based compensation, generally with minimal vesting criteria, there has also been a US obsession with valuing revenue growth rather than profits. The US has been good at recognising the importance of market dominance, and the required land grab, but it seems companies had taken this way too far, to the point of ignoring fundamentals like return on capital and profitability. Retained losses in many software companies are often in excess of $1bn which is generally a red flag. We prefer companies where founders retain worthwhile stakes because they will not dilute themselves unnecessarily and are motivated to control costs. The most exciting thing about this bear market is that not only have valuations come down, but business models are changing to include a greater focus on cost control. This should also mean a less tight labour market and returns actually going to shareholders rather than only to directors and staff. The really successful mega-caps such as Alphabet, Microsoft and Apple have been able to generate huge revenues and margins per employee, and thus been able to pay for key skills well. Smaller companies have been caught between these scaled businesses and venture capitalists offering equity. In order to compete, they have doled out RSUs (restricted stock units) and over-rewarded the workforce.

Europe Middle East and Africa

The EMEA return of -27.5% is disappointing, but must be viewed in light of the three year return from the region which is 60.3%, and the five year return of 79.6% despite the decline in 2022. Furthermore, the positive and negative returns have been dominated by the three biggest holdings Esker, BE Semiconductor Industries (BESI) and Nordic Semiconductor. Over time they have collectively delivered a total return of £63.6m despite losing £33.0m in 2022, which was over 60% of the overall EMEA decline. The Company benefited from BESI and Nordic Semiconductor being two of the largest semiconductor investments in the global portfolio. Semiconductors had a good year in 2021, and there are few ways to invest in this sub-sector in North America and the UK, hence the overweight positions in Europe were retained.

Demonstrating the power of clustering expertise, the Netherlands has retained a strong semiconductor hub spawned from Philips, led by ASML and NXP, with BESI as the smaller player. Germany has Infineon Technologies and STMicro is the other main European player. Sweden and Finland have clusters around Ericsson and Nokia, but both companies seem past their prime.

European governments are in general more strategic in supporting industry than the UK, and demonstrably they want the public markets for smaller companies to prosper and to provide capital. CAST, Generix and ADVA Optical Networking ('ADVA') have all been taken over for an aggregate value of £17.8m, albeit ADVA for US listed shares. Nevertheless, takeovers are less prevalent, and stock-based compensation is a non-issue in Europe. Although the European economy is challenging, we expect to find stock specific opportunities as we have in the past.

Asia

The Asia return has been -27.4%. The significant distinct markets are Taiwan, Japan, South Korea and Australia, as well as other small ones. Taiwan has been the most successful market for the Company. Taiwan benefitted from the cluster effect from Taiwan Semiconductor Manufacturing Company, which originally used Philips technology, but was also the hub for US companies to manufacture PCs and servers. They are therefore used to trading with listed US giants who have high business standards and in consequence have transparency and strong ESG credentials. South Korea has Samsung and LG, but is much less transparent and has weaker corporate governance. Australia is more analogous to the UK as a market. Japan is a relatively new market for the Company. For a number of years it seemed lacking in entrepreneurialism, lost ground to Korea and China in consumer electronics and to Taiwan and others in semiconductors, and had limited software companies. More recently there have been a large number of IPOs, and Japan seems to have a dynamic smaller companies stock market. In consequence our weighting there has increased, but it is too early for us to see meaningful returns.

Australia had a poor year with a negative 43.1% return, reflecting retail and institutional investors fleeing small technology companies and weak business performance in a number of cases. Taiwan declined 24.8% but benefitted from a strong performance from Lanner Electronics. Over the last five years, the return in Taiwan has been an exceptional 212.8%, which has been masked by less good returns in newer Asian markets where investment has been made more recently. We have increased the focus on the Asian region because we feel that opportunities lie here.

China is an important market for the sector's supply chain. However, we choose to have limited exposure, reflecting political risk and the uncertainty of outside shareholders seeing returns. The case of 51Job, which was a Chinese holding taken over at an unpalatable price, is a good illustrative example. The Chinese economy has challenges including a fragile property market, a leadership which is unsympathetic to business, a 17% urban unemployment rate for 16-24 year olds and the US trying to make China's move to self-sufficiency in semiconductors as challenging as possible. The threat of an invasion of Taiwan by China is the scariest of all possible prospects.

Market Background

We are privileged to meet many management teams throughout the world on a recurring basis and this gives us an interesting perspective from which to assess our market background. Everyone thinks their own economic problems are worst. The UK has a particularly negative view of its own position, perhaps driven by recent political turmoil and media negativity on a wide range of problems. Thus far, profit expectations for companies in the UK portfolio have been particularly resilient, perhaps benefiting from sterling weakness relative to the dollar, and more conservative management of growth expectations. US businessmen are depressed by their country's social tensions and excessive fiscal and trade deficits, which dwarf the UK's. In contrast to the UK, in North America expectations for revenue growth are visibly weakening, and many companies have faced currency headwinds on their overseas revenues. The Chinese seem alarmed by their financial leverage, ageing population and a leadership unsympathetic to business. The manufacturing orientation of the sector in Asia means it is visibly more exposed to a cyclical slowdown in demand. Europe has the additional challenge of its proximity to Russia/Ukraine, energy supply issues, and most significantly the different countries in the Eurozone operating under one central bank, but no fiscal union. It is hard to find optimism in the current landscape.

As our home market, and still accounting for over 40% of the portfolio, the UK is of prime importance to the Company today. Despite the myriad problems, the UK has the advantage of its own central bank, debt in its own currency, domestic gas production to meet half of its need and a significant capacity to generate electricity from wind with huge further potential. Perhaps due to the high cost of land and labour the UK has become a knowledge-based economy which is a significant positive and produces a large trading surplus in services, which are not energy-dependent. In addition, in a world of conflict and increased tensions, the UK does still have a defence industry which benefits a number of companies in the supply chain.

Beyond our home market, there continue to be opportunities for us in all of our markets. We have a strong focus on the United States which has scaled some software companies brilliantly, delivering high margins. As evidenced by the takeover volumes the Company has experienced, the scale of North American private equity activity has shrunk the size of the addressable listed market, albeit in recent years offset by a wave of speculative new issues. Whereas the AIM market in London has had numerous IPOs and secondary placings to raise development capital, US IPOs tend to have been exits for venture capitalists and private equity. Furthermore, there was a fashion for crossover funds or public company investors participating in late-stage venture rounds. This category of investor seems to have disappeared. As interest rates normalise, the extent to which these trends continue, and how they achieve exits, remains to be seen. Europe as a region is perhaps less easy to categorise and will remain a stock-specific market for the Company. Asia clearly the primary region for new listings, with its technology sector having emerged as a low-cost manufacturing location and now progressively moving up the value chain.

There are key areas of change which always open up opportunities for smaller companies. For many years there was a trend for manufacturing to migrate to China, with its lower labour costs. As salaries and skillsets in China rose and, more recently, as political concerns about China's direction of travel have grown, other emerging economies such as Vietnam and Mexico have become more important as manufacturing hubs. Whilst this shift has been underway for some years, 2022 has added a further dramatic twist. The Ukraine war and the related supply chain issues have magnified concerns about security of supply. 'Just in time' and lowest cost is no longer the buyer's prime motivation. 'Just in case' has become the new mantra. In addition, the increasing tensions between China and Taiwan are of great concern and any conflict there would dwarf the Ukraine impact on the technology sector given the central role played by Taiwan in semiconductor manufacturing.

The major disruption of Covid has also led to a change in the employment market. There has been a rise in working from home as well as a significant reduction in the proportion of working age people available to work in developed countries. Despite the obvious attractions of avoiding the cost of offices and employing people more cheaply from far corners of the earth, we are unsure what long-run effect this will have. Many of the companies in our portfolio are based in knowledge clusters such as San Francisco, Seattle, Boston and London, where knowledge feeds on itself. Can this be sustained with working from home? Will centres of excellence become less relevant? These remain unanswered questions at this time. There is some evidence that the tightness of the labour market is receding, and employees are coming back to the office so perhaps the working from home trend may not be so acute as we once thought.

Outlook

There are many reasons to be anxious as we look forward. Excess government leverage globally in an environment where the cost of capital is normalising, geopolitical tensions across the globe and energy market turmoil all play their part. In this environment it is challenging to reduce risk in any portfolio. However, against this background smaller companies with genuine growth prospects and intellectual property seem appealing. This is where the Company operates, and the best returns have been made from investments in 2002-3 post the internet boom and 2008-9 in the financial crisis. We are optimistic there will be good buying opportunities ahead.

Sector Performance*

(Sterling Millions)

Source: BICS (Bloomberg Industry Classification Standard).

 

Katie Potts

15 February 2023

 



 

Classification of investments

 

 

 

North

Japan & Asia

2022

2021

 

UK

EMEA

America

Pacific

Total

Total

Classification*

%

%

%

%

%

%

COMMUNICATIONS

10.4

0.8

1.3

1.5

14.0

17.0

Advertising and Marketing

5.2

0.1

0.1

0.1

5.5

7.1

Entertainment Content

1.0

-

-

-

1.0

1.0

Internet, Media and Services

1.6

0.6

0.4

1.1

3.7

4.2

Publishing and Broadcasting

1.7

-

0.2

-

1.9

2.2

Telecommunications

0.9

0.1

0.6

0.3

1.9

2.5

CONSUMER DISCRETIONARY

0.2

-

-

0.2

0.4

0.5

Automotive

0.1

-

-

-

0.1

-

E-Commerce Discretionary

-

-

-

0.2

0.2

0.4

Wholesale - Discretionary

0.1

-

-

-

0.1

0.1

CONSUMER STAPLES

-

-

-

-

-

0.1

Retail - Consumer Staples

-

-

-

-

-

0.1

ENERGY

0.6

-

-

-

0.6

1.7

Renewable Energy

0.6

-

-

-

0.6

1.7

FINANCIALS

1.0

-

-

0.7

1.7

1.4

Asset Management

0.2

-

-

-

0.2

0.3

Equity Investment Instruments

0.7

-

-

-

0.7

0.5

Specialty Finance

0.1

-

-

0.7

0.8

0.6

HEALTH CARE

0.8

0.4

-

-

1.2

1.7

Biotechnology and Pharmaceutical

0.1

-

-

-

0.1

0.9

Health Care Facilities and Services

0.2

-

-

-

0.2

0.2

Medical Equipment and Devices

0.5

0.4

-

-

0.9

0.6

INDUSTRIALS

4.7

0.3

0.3

0.4

5.7

6.1

Aerospace and Defence

-

-

0.3

-

0.3

0.1

Commercial Support Services

1.2

-

-

-

1.2

1.0

Electrical Equipment

1.5

0.3

-

0.2

2.0

2.9

Industrial Intermediate Production

2.0

-

-

0.2

2.2

2.1

MATERIALS

0.2

-

-

0.2

0.4

0.4

Chemicals

0.1

-

-

0.2

0.3

0.2

Forestry, Paper and Wood Products

0.1

-

-

-

0.1

0.2

TECHNOLOGY

24.5

9.3

20.2

8.2

62.2

63.9

Semiconductors

1.6

2.9

3.1

1.6

9.2

8.7

Software

13.2

3.8

9.6

3.2

29.8

34.1

Technology Hardware

4.7

1.1

6.9

2.0

14.7

12.4

Technology Services

5.0

1.5

0.6

1.4

8.5

8.7

UTILITIES

1.7

-

-

-

1.7

0.4

Electricity and Gas Marketing and Trading

1.4

-

-

-

1.4

-

Gas and Water Utilities

0.3

-

-

-

0.3

0.4

TOTAL EQUITIES (including convertibles and warrants)

44.1

10.8

21.8

11.2

87.9

-

Total equities - 2021 (including convertibles and warrants)

47.7

11.4

22.3

11.8

-

93.2

BONDS

3.4

-

2.5

-

5.9

2.4

NET LIQUID ASSETS**

2.3

0.5

2.2

1.2

6.2

4.4

TOTAL NET ASSETS

49.8

11.3

26.5

12.4

100.0

-

Total net assets - 2021

49.8

11.4

26.5

12.3

-

100.0

SHAREHOLDERS' FUNDS

49.8

11.3

26.5

12.4

100.0

-

Shareholders' Funds - 2021

49.8

11.4

26.5

12.3

-

100.0

Number of equity investments (including convertibles and warrants)

144

36

77

88

345

356

*   Source: Bloomberg Industry Classification Standard.

** Cash, current assets and liabilities.

 

 

 

 

 



 

Top 20 Equity Holdings

AS AT 31 DECEMBER 2022

 

A brief description of the twenty largest equity holdings in companies is as follows:

 

Next15

 

 

Next Fifteen Communications ('Next 15') is a group of businesses designed to help companies grow. Next 15 perceive themselves as more than marketing consultants and as growth consultants. They help their clients in four different ways. Firstly, they use data to generate the insights that help businesses understand the opportunities and challenges they face and arm them with the knowledge they need to make the best decisions. Secondly, they help their customers optimise their brand reputation and build the mission-critical digital assets businesses need to engage with their audiences. Thirdly, they use creativity, data, and analytics to create the connections with customers to drive sales and other forms of customer interaction. Finally, Next 15 help customers redesign their business model or create new ventures to maximise the value of their organisation.

 

£ 29.1m  Valuation

2.2%  of total assets

3.0%  of issued share   capital held

£2.4m  Book Cost

 

 

Super Micro

 

 

Super Micro Computer ('Supermicro') is a leading provider of application-optimised, high-performance server and storage solutions that address a broad range of computational-intensive workloads. With over 20 years of hardware design experience, Supermicro's server Building Block Solutions, coupled with extensive in-house design and manufacturing, enables the Company to rapidly develop, build, and test server and storage systems, subsystems, and accessories with unique configurations. This capability gives customers an unparalleled breadth of choice in dynamic markets, including Edge/5G, data centers, public/private cloud, and artificial intelligence; plus, Supermicro offers world-class software and service.

 

£27.1m  Valuation

2.1%  of total assets

0.8%  of issued share   capital held

£7.8m  Book Cost

 

 

 

Diploma

 

 

Diploma is an international group supplying specialised products and services to a wide range of end segments in three sectors of controls, seals and life sciences. Diploma's businesses are focused on supplying essential products and services which are critical to customers' needs, providing recurring income and stable revenue growth. By supplying essential solutions, Diploma builds strong long term relationships with customers and suppliers, which support attractive and sustainable margins. An entrepreneurial culture and decentralised management structure ensures that decisions are made close to the customer and that the businesses are agile and responsive to changes in the market and the competitive environment. The Group employs ca. 2,900 employees and its principal operating businesses are located in the UK, Northern Europe, North America and Australia.

 

£25.9m  Valuation

2.0%  of total assets

0.7%  of issued share   capital held

£0.7m  Book Cost

 

 

YouGov

 

 

YouGov is an international online research data and analytics technology group. Their mission is to supply a continuous stream of accurate data and insight into what the world thinks, so that companies, governments and institutions can make informed decisions. YouGov's innovative solutions help the world's most recognised brands, media owners and agencies to plan, activate and track their marketing activities better. At the core of the platform is an ever-growing source of consumer data that has been amassed over twenty years of operation. All products and services draw upon this detailed understanding of 22 million registered panel members to deliver accurate, actionable consumer insights. With operations in the UK, the Americas, Europe, the Middle East, India and Asia Pacific, YouGov has one of the world's largest research networks.

 

£20.4m  Valuation

1.6%  of total assets

1.8%  of issued share   capital held

£2.0m  Book Cost

 

 

Idox

 

 

Idox develops specialist software for government and industry, with an established track record serving tightly regulated markets including local authorities, health, engineering, transport and property. Built around the needs of the user and designed in collaboration with experts, the company's software delivers exceptional functionality and reliability to critical operations and embeds workflows that drive efficiency and best practice.

 

£19.7m  Valuation

1.5%  of total assets

6.8%  of issued share   capital held

£5.1m  Book Cost

 

 

Silicon Motion

 

 

Silicon Motion Technology ('Silicon Motion') is a global leader in developing NAND flash controllers for SSDs and other solid state storage devices and has over 20 years of experience developing specialised processor ICs that manage NAND components and deliver high-performance storage solutions widely used in data centers, PCs, smartphones and commercial and industrial applications. Silicon Motion has one of the broadest portfolios of NAND controller intellectual property enabling the design of unique, highly optimised configurable IC plus related firmware controller platforms and complete turnkey controller solutions. More NAND flash components, including current and up-coming generations of 3D flash produced by Kioxia, Micron, Samsung, SK Hynix, Solidigm, Western Digital and YMTC, are supported by Silicon Motion controllers than any other company. Customers include NAND flash makers, module makers, hyperscalers and OEMs. Silicon Motion are the world's leading supplier of SSD controllers used in PCs and other client devices and is a leading merchant supplier of eMMC/UFS controllers used in smartphones and IoT devices. Silicon Motion also supplies custom-designed high-performance Open-Channel data center SSDs to China's leading hyperscalers and customised small single-chip form factor SSDs for industrial, commercial and automotive applications. Silicon Motion was founded in 1995 in San Jose, California and now operate from corporate offices in Hong Kong, Taiwan and the US. In May 2022, MaxLinear announced a takeover offer for Silicon Motion which has yet to close.

 

£19.2m  Valuation

1.5%  of total assets

1.1%  of issued share   capital held

£1.7m  Book Cost

 

 

Nordic

 

 

Nordic Semiconductor ('Nordic') is a Norwegian fabless semiconductor company specialising in wireless communication technology that powers the Internet of Things (IoT). Nordic was established in 1983 and has more than 1300 employees across the globe. Nordic's Bluetooth Low Energy solutions pioneered ultra-low power wireless, making them the global market leader. The technology range was later supplemented by ANT+, Thread and Zigbee, and in 2018 they launched low power, compact LTE-M/NB-IoT cellular IoT solutions to extend the penetration of the IoT. The Nordic portfolio was further complemented by Wi-Fi technology from Imagination Technologies in 2021. Nordic's Bluetooth LE solutions are used by the world's leading brands in a variety of products, including wireless PC peripherals, gaming, sports and fitness, mobile phone accessories, consumer electronics, toys, healthcare and automation.

 

£18.7m  Valuation

1.4%  of total assets

0.7%  of issued share   capital held

£4.2m  Book Cost

 

 

Telecom Plus

 

 

Telecom Plus, which owns and operates the Utility Warehouse brand, is the UK's only fully integrated provider of a wide range of competitively priced utility services spanning the energy, broadband, mobile and insurance markets. Customers benefit from the convenience of a single monthly bill, consistently good value across all their utilities and good levels of service. The business relies on word of mouth recommendation by existing satisfied customers and partners in order to grow its market share.

 

£17.9m  Valuation

1.4%  of total assets

1.0%  of issued share   capital held

£3.1m  Book Cost

 

 

Descartes Systems

 

 

Descartes Systems ('Descartes') is a leader in providing on-demand, software-as-a-service solutions focused on improving the productivity, performance and security of logistics-intensive businesses. Customers use Descartes' modular, software-as-a-service solutions to route, schedule, track and measure delivery resources; plan, allocate and execute shipments; rate, audit and pay transportation invoices; access global trade data; file customs and security documents for imports and exports; and complete numerous other logistics processes by participating in the world's largest, collaborative multimodal logistics community. Descartes headquarters are in Waterloo, Ontario, Canada and they have offices and partners around the world.

 

£17.9m  Valuation

1.4%  of total assets

0.4%  of issued share   capital held

£0.6m  Book Cost

 

 

Zoo

 

 

ZOO Digital ('ZOO') supports major Hollywood studios and streaming services to globalise their content and reach audiences everywhere, by providing world-leading, technology-enabled localisation and media services. Founded in 2001, ZOO operates from hubs in Los Angeles, London, Dubai, Turkey, South Korea, India and Denmark with a development and production centre in Sheffield, UK. The Group provides media services through its platforms that include: ZOOsubs, ZOOdubs and ZOOstudio. Its full-service proposition delivers the end-to-end services required to prepare both original and catalogue content for digital distribution; these services include dubbing, subtitling & captioning, metadata creation & localisation, mastering, artwork localisation and media processing. Alongside this offering, ZOO also provides its customers with management platforms and strategic solutions to support their own internal globalisation operations. ZOO helps its customers to reduce time to market, lower costs and deliver high quality products to their global audiences. The business has frameworks in place with all major Hollywood studios and streaming services. Its customers include Disney, NBCUniversal, HBO and Paramount Global.

 

£17.8m  Valuation

1.4%  of total assets

11.4%  of issued share   capital held

£3.0m  Book Cost

 

 

fabrinet

 

 

Fabrinet is a leading provider of advanced optical packaging and precision optical, electro-mechanical, and electronic manufacturing services to original equipment manufacturers of complex products, such as optical communication components, modules and subsystems, industrial lasers and sensors. Fabrinet offers a broad range of advanced optical and electro-mechanical capabilities across the entire manufacturing process, including process design and engineering, supply chain management, manufacturing, advanced packaging, integration, final assembly and test. Fabrinet focuses on production of high complexity products in any mix and volume. Fabrinet maintains engineering and manufacturing resources and facilities in Thailand, the United States, and the People's Republic of China.

 

£17.6m  Valuation

1.4%  of total assets

0.5%  of issued share   capital held

£2.1m  Book Cost

 

 

Besi

 

 

BE Semiconductor Industries ('Besi') is a leading supplier of semiconductor assembly equipment for the global semiconductor and electronics industries offering high levels of accuracy, productivity and reliability at a low cost of ownership. Besi develops leading edge assembly processes and equipment for leadframe, substrate and wafer level packaging applications in a wide range of end-user markets including electronics, mobile internet, computer, automotive, industrial, LED and solar energy. Customers are primarily leading semiconductor manufacturers, assembly subcontractors and electronics and industrial companies.

 

£17.0m  Valuation

1.3%  of total assets

0.4%  of issued share   capital held

£0.9m  Book Cost

 

 

GBG

 

 

GB Group ('GBG') is a global leader in digital location, identity and managing fraud risk and compliance. GBG helps organisations across the globe eliminate customer friction and fraud from their digital experiences. GBG develop and deliver digital identity, address verification, fraud prevention and compliance software to businesses globally. Through the combination of the latest technology, the most accurate data and its expertise, GBG helps organisations ranging from start-ups to the largest consumer and technology brands in the world deliver seamless experiences, so their customers can transact online with greater confidence.

 

£14.5m  Valuation

1.1%  of total assets

1.8%  of issued share   capital held

£4.5m  Book Cost

 

 

bango

 

 

The world's largest online merchants, including Amazon, Google, and Microsoft, use Bango technology to acquire more paying users. Bango has developed unique purchase behaviour technology that enables millions more users to buy the products and services they want, using innovative payment methods, including carrier billing, digital wallets, and subscription bundling. Bango harnesses this purchase activity into valuable marketing segments called Bango Audiences. Merchants use these audiences to target their marketing at paying customers based on their purchase behaviour. Better targeting increases spend through the Bango payments business, in turn generating more data insights, creating a powerful virtuous circle that drives growth.

 

£14.3m  Valuation

1.1%  of total assets

10.4%  of issued share   capital held

£6.8m  Book Cost

 

 

Esker

 

 

Esker was founded as a software company in 1985 with a direct and simple vision in mind - to help businesses deliver their paper documents electronically. Today, Esker's strategy is focused on developing and selling a cloud-based software platform for the automation of enterprise back-office processes. These solutions cover both the order-to-cash (from the customer order to invoice collection) and procure-to-pay processes (from the selection of suppliers to the payment of invoices). The Company is focused on accelerating organic growth largely through a direct sales force. Over the past 38 years, Esker has grown into one of the leading document processing automation solution providers, with more than 1,000 employees in 15 subsidiaries worldwide.

 

£13.9m  Valuation

1.1%  of total assets

1.7%  of issued share   capital held

£4.4m  Book Cost

 

 

Kainos

 

 

Kainos is a UK-headquartered IT provider with expertise across three divisions - Digital Services, Workday Services, and Workday Products. Kainos Digital Services division develops and supports custom digital service platforms for public sector, commercial, and healthcare customers. The Workday Services division specialises in the deployment of Workday Inc.'s Finance, HR and Planning products to leading organisations across Europe and North America. Kainos are one of Workday's most respected partners, experienced in complex deployments. The Workday Products division develops products that complement Workday. These include the Smart product suite, including Smart Test (for automated testing), Smart Audit (for compliance monitoring), and Smart Shield (for data masking), are used by more than 350 customers globally to safeguard their Workday systems. Kainos employs more than 2,900 people in 22 countries across Europe and the Americas.

 

£13.1m  Valuation

1.0%  of total assets

0.7%  of issued share   capital held

£1.5m  Book Cost

 

 

Radware

 

 

Radware is a global leader of cyber security and application delivery solutions for physical, cloud, and software defined data centers. Its award-winning solutions portfolio secures the digital experience by providing infrastructure, application, and corporate IT protection and availability services to enterprises globally. Radware's solutions empower more than 12,500 enterprise and carrier customers worldwide to adapt to market challenges quickly, maintain business continuity and achieve maximum productivity while keeping costs down.

 

£13.0m  Valuation

1.0%  of total assets

1.8%  of issued share   capital held

£6.0M  Book Cost

 

 

Volex

 

 

Volex is a leader in integrated manufacturing for performance-critical applications and a supplier of power products. The company serves a diverse range of markets and customers, with particular expertise in cable assemblies, higher-level assemblies, data centre power and connectivity, electric vehicles, and consumer electricals. Volex are headquartered in the UK and operate from 18 manufacturing locations with a global workforce of over 6,900 employees across 22 countries. Products are sold through internal locally based sales teams and via authorised distributor partners to Original Equipment Manufacturers ('OEMs') and Electronic Manufacturing Services ('EMS') companies worldwide. Volex products and services provide power and connectivity to a range of products, from the most common household items to the most complex medical equipment.

 

£12.6m  Valuation

1.0%  of total assets

3.2%  of issued share   capital held

£5.4M  Book Cost

 

 

Seeing Machines

 

 

Seeing Machines, a global company founded in 2000 and headquartered in Australia, is an industry leader in vision-based monitoring technology that enable machines to see, understand and assist people. Seeing Machines' technology portfolio of AI algorithms, embedded processing and optics power products that need to deliver reliable real-time understanding of vehicle operators. The technology spans the critical measurement of where a driver is looking, through to classification of their cognitive state as it applies to accident risk. Reliable "driver state" measurement is the end-goal of driver monitoring systems (DMS) technology. Seeing Machines develops DMS technology to drive safety for automotive, commercial fleet, off-road and aviation. The company has offices in Australia, the U.S., Europe and Asia, and supplies technology solutions and services to industry leaders in each market vertical.

 

£12.0m  Valuation

0.9%  of total assets

4.8%  of issued share   capital held

£8.6M  Book Cost

 

 

CentralNic

 

 

CentralNic is a London ‐ based AIM ‐ listed company which drives the growth of the global digital economy by developing and managing software platforms allowing businesses globally to buy subscriptions to domain names, used for their own websites and email, as well as for protecting their brands online. These platforms can also be used for distributing domain name related software and services, an opportunity that contributes significantly to CentralNic's organic growth. The Company's inorganic growth strategy is identifying and acquiring cash ‐ generative businesses in its industry with annuity revenue streams and exposure to growth markets and migrating them onto the CentralNic software and operating platforms. CentralNic operates globally with customers in almost every country in the world. It earns recurring revenues from the worldwide sales of internet domain names and other services on an annual subscription basis.

 

£11.6m  Valuation

0.9%  of total assets

2.6%  of issued share   capital held

£3.5m  Book Cost

 

 



 

INCOME STATEMENT

For the year ended 31 December 2022

There is no final dividend proposed (2021 - nil).

The total column of this statement is the profit and loss account of the Company, prepared in accordance with UK Accounting Standards.

The (loss)/profit after taxation is the total comprehensive income and therefore no additional statement of comprehensive income is presented. The supplementary revenue and capital columns are presented for information purposes in accordance with the Statement of Recommended Practice issued by the Association of Investment Companies. All items in the above statement derive from continuing operations of the Company. No operations were acquired or discontinued in the year.



 

BALANCE SHEET

At 31 December

 



 

STATEMENT OF CHANGES IN EQUITY

For the year ended 31 December 2022

For the year ended 31 December 2021



 

CASH FLOW STATEMENT

For the year ended 31 December 2022

 

Cash flow from operating activities includes interest received of £1,078,000 (2021 - £777,000) and dividends received of £12,924,000 (2021 - £11,269,000).

As the Company did not have any long term debt at both the current and prior year ends, no reconciliation of the net debt position is presented.

 

 



 

INCOME

Included within dividend income are special dividends of £655,000 (2021: £706,000). Included within deposit interest is interest received of £449,000 (2021: £nil), and interest paid of £5,000 (2021: 20,000).



 

STATUS

The Company is an investment company within the meaning of s833 of the Companies Act 2006 and operates as an investment trust in accordance with s1158 of the Corporation Tax Act 2010 as amended ('s1158'). The Company is subject to the Listing Rules of the Financial Conduct Authority and governed by its articles of association, amendments to which must be approved by shareholders by way of a special resolution. The Company obtained approval from HM Revenue and Customs of its status as an investment trust under s1158 and the directors are of the opinion that the Company has and continues to conduct its affairs in compliance with s1158 since this approval was granted.

BUSINESS MODEL

The Company has appointed Herald Investment Management Limited ('HIML') as the Alternative Investment Fund Manager to provide all portfolio management and risk management services. HIML is authorised and regulated by the Financial Conduct Authority both for investment management and as an Alternative Investment Fund Manager.

Administration of the Company and its investments has been delegated by HIML to the Bank of New York Mellon International Limited ('BNYMIL') and company secretarial duties have been delegated to Apex Listed Companies Services (UK) Limited ('Apex'), formerly Sanne Fund Services (UK) Limited.

BNYMIL is the depositary under a tripartite agreement between HIML, the Company and BNYMIL. The depositary is also responsible for custody activities.

OBJECTIVE

The Company's objective is to achieve capital appreciation through investments in smaller quoted companies in the areas of telecommunications, multimedia and technology.

INVESTMENT POLICY - STRATEGY

While the policy is global investment in smaller quoted companies in TMT, the approach is to construct a diversified portfolio through the identification of individual companies which offer long-term growth potential, typically over a five-year horizon or more. The portfolio is actively managed and does not seek to track any comparative index. With a remit to invest in smaller companies with market capitalisation generally below $3bn at the point of purchase, there tends to be a correlation with the performance of smaller companies, as well as that of the technology sector. A degree of volatility relative to the overall market should be expected.

The risk associated with the illiquidity of smaller companies is reduced by generally restricting the stake in any one company to less than 10% of the shares in issue.

A number of investments are in early-stage companies, which have a higher stock specific risk but the potential for above average growth. Stock specific risk is reduced by having a diversified portfolio.

In addition, to contain the risk of any one holding, the Manager generally takes profits when a holding reaches more than 5% of the portfolio. The Manager actively manages the exposure within the constraint that illiquid positions cannot be traded for short-term movements.

The Company has a policy not to invest more than 15% of gross assets in other UK-listed investment companies.

From time to time, fixed interest holdings, non-equity or unlisted investments may be held on an opportunistic basis.

The Company recognises the long-term advantages of gearing and has a maximum gearing limit of 50% of net assets. Borrowings are invested primarily in equity markets but the Manager is permitted to invest in other securities in the companies in the target areas when it is considered that the investment grounds merit the Company taking a geared position. The board's intention is to gear the portfolio when appropriate. Gearing levels are monitored closely by the Manager and reviewed by directors at each board meeting.

The Company may use derivatives which will be principally, but not exclusively, for the purpose of efficient portfolio management (i.e. for the purpose of reducing, transferring or eliminating investment risk in its investments, including protection against currency risk).

PRINCIPAL RISKS AND UNCERTAINTIES

The audit committee, on behalf of the board, regularly undertakes a robust assessment of the principal, including emerging, risks facing the Company. These include those that would threaten its business model, future performance, solvency or liquidity. Principal risks are also considered as part of the board's annual strategy meeting. The principal risks that follow are those identified by the board after taking account of mitigating factors.

All risks are documented on a risk register and are grouped into six main categories: strategic risk; market, economic and geopolitical risk; investment management risk; operational risk; emerging/external risk; and regulatory risk. Risks are rated by impact and likelihood of occurrence, with the ratings charted on two risk matrices: a pre-mitigation and a post-mitigation one. Mitigation takes into account processes, procedures and internal controls, and the post-mitigation matrix is used to identify the Company's principal risks. The risk register is reviewed on an ongoing basis, in an attempt to capture all risks and ensure appropriate mitigation is in place, and to enable directors to concentrate on principal risks whilst ensuring all risks are considered.

As part of the risk review, the board considered the challenging global economic and geopolitical environment including the impact of the Russian-Ukraine war, which has magnified uncertainty in global financial markets, together with the ongoing secondary effects of Covid including supply chain issues and China's now historic zero Covid policy. Inflation and the resultant volatility that it created in the global stock markets was a key risk during the financial year. Tensions between the US and China were also considered by the board.

A. MARKET RISK

(i)  Other price risk, being the risk that the value of investment holdings will fluctuate as a result of changes in market prices caused by factors other than interest rate or currency rate movement;

(ii)  Interest rate risk, being the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates; and

(iii)  Foreign currency risk, being the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates.

B. CREDIT RISK

Being the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.

The Company is exposed to counterparty credit risk from the parties with which it trades and will bear the risk of settlement default. Counterparty credit risk to the Company arises from transactions to purchase or sell investments held within the portfolio.

There were no past due nor impaired assets as of 31 December 2022 (2021 - nil).

The counterparties engaged with the Company are regulated entities and of high credit quality.

C. LIQUIDITY RISK

Being the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities.

These risks and the policies for managing them have been applied throughout the year and are summarised below.

A. MARKET RISK

(i) Other Price Risk

The Company's investment portfolio is exposed to market price fluctuations which are monitored by the Manager in pursuance of the corporate objective. Listed securities held by the Company are valued at bid prices, whereas material unlisted investments are valued by the directors on the basis of the latest information in line with the relevant principles of the International Private Equity and Venture Capital Valuation Guidelines (Accounting Policy 1(c)). These valuations represent the fair value of the investments.

Other Price Risk Sensitivity

14.9% of the Company's total equity investments at 31 December 2022 (2021 - 15.6%) were listed on the main list of the London Stock Exchange and a further 34.1% (2021 - 35.0%) on AIM. The NASDAQ Stock Exchange accounts for 21.5% (2021 - 20.9%), New York Stock Exchange for 3.6% (2021 - 3.2%) and other stock exchanges or unlisted 25.9% (2021 - 25.3%). A 10% increase in equity investment prices at 31 December 2022 would have increased total net assets and profit & loss after taxation by £114,687,000 (2021 - £164,123,000). A decrease of 10% would have the exact opposite effect. The portfolio does not target any exchange as a comparative index, and the performance of the portfolio has a low correlation to generally used indices.

The shares of Herald Investment Trust plc have an underlying NAV per share. The NAV per share of Herald Investment Trust plc fluctuates on a daily basis. In addition, there is volatility in the discount/premium the share price has to NAV.

(ii) Interest Rate Risk

The majority of the Company's assets are equity shares and other investments which neither pay interest nor have a maturity date. However, the Company does hold convertible bonds and government bonds, the interest rate and maturity dates of which are detailed below. Interest is accrued on cash balances at a rate linked to the UK base rate.

The interest rate risk profile of the financial assets and financial liabilities at 31 December was:

FINANCIAL ASSETS

The benchmark rates which determine the interest payments received on cash balances are the Bank of England base rate, the European Central Bank rate and the United States Federal Reserve rate.

Interest rate risk sensitivity

(a) Cash

An increase of 100 basis points in interest rates as at 31 December 2022 would have a direct effect on net assets. Based on the position at 31 December 2022, over a full year, an increase of 100 basis points would have increased the profit & loss after taxation by £804,000 (2021 - £746,000) and would have increased the net asset value per share by 1.29p (2021 - 1.15p). The calculations are based on the cash balances as at the respective balance sheet dates and are not representative of the year as a whole.

(b) Fixed rate bonds

An increase of 100 basis points in bond yields as at 31 December 2022 would have decreased total net assets and profit & loss after taxation by £224,000 (2021 - £388,000) and would have decreased the net asset value per share by 0.36p (2021 - 0.60p). A decrease in bond yields would have had an equal and opposite effect. The convertible loan stocks having an element of equity are not included in this analysis as given the nature of the businesses and the risk profile of their balance sheets; they are considered to have more equity like characteristics.

(iii) Foreign Currency Risk

The Company's reporting currency is sterling, but investments are made in overseas markets as well as the United Kingdom and the asset value can be affected by movements in foreign currency exchange rates.

Furthermore many companies trade internationally both through foreign subsidiaries, and through exports. The greatest foreign currency risk occurs when companies have a divergence in currencies for costs and revenues. A much less risky exposure to currency is straight translation of sales and profits. The list of investments on pages 21 to 28 breaks down the portfolio by geographic listing. However the location of the stock market quote only has a limited correlation to the costs, revenues and even activities of those companies, and so this note should not be regarded as a reliable guide to the sensitivity of the portfolio to currency movements. For example, the holdings in the portfolio that would suffer most from US$ weakness are UK companies with dollar revenues and sterling costs.

The Company does not hedge the sterling value of investments that are priced in other currencies. Overseas income is subject to currency fluctuations. The Company does not hedge these currency fluctuations because it is impossible to quantify the effect for the reasons stated above. However, from time to time the Manager takes a view by holding financial assets or liabilities in overseas currencies.

Exposure to currency risk through asset allocation by currency of listing is indicated below:

At 31 December 2022

At 31 December 2021

Foreign currency risk sensitivity

At 31 December 2022, had sterling strengthened by 10% (2021 - 10%) in relation to all currencies, with all other variables held constant, total net assets and profit & loss after taxation would have decreased by the amounts shown below based on the balances denominated in foreign currency. A 10% (2021 - 10%) weakening of sterling against all currencies, with all other variables held constant, would have had the exact opposite effect on the financial statement amounts. However, companies whose cost base diverges in currency terms from its sales will in the longer term have a significantly greater effect on valuation than simple translation. In the short term investee companies generally cover their currency exposure to varying degrees. There is insufficient publicly disclosed information to quantify this, but in the long term this effect is expected to dwarf simple translation of foreign listings in terms of both risk and reward, because many investee companies trade globally. Furthermore, the country of listing is not necessarily an indication of the geography of some or even any operational activities for investee companies. The Manager does not use financial instruments to protect against currency movements. From time to time financial leverage has been made using debt in overseas currencies.

B. Credit Risk

Credit risk is the risk that a counterparty to a financial instrument will fail to discharge an obligation or commitment which it has entered into with the Company. The Manager monitors counterparty risk on an ongoing basis.

The Company has investments in convertible loan stocks that have an element of equity. These securities are viewed as having a risk profile similar to the equity holdings. This is because the convertibles held are in nascent technology companies that may be loss-making and may have weak balance sheets. For this reason these stocks are categorised as equity holdings and for risk management purposes excluded from the credit risk analysis.

Credit Risk Exposure

The exposure to credit risk at 31 December was:

During the year the maximum exposure in fixed interest investments was £85,394,000 (2021 - £42,722,000) and the minimum £27,013,000 (2021 - £41,518,000). The maximum exposure in cash was £91,114,000 (2021 - £85,096,000) and the minimum £50,164,000 (2021 - £58,031,000) .

C. Liquidity Risk

The Company's policy with regard to liquidity is to provide a degree of flexibility so that the portfolio can be repositioned when appropriate and that most of the assets can be realised without an excessive discount to the market price.

Equity Securities

The Company's unlisted investments are not readily realisable, but these only amount to 1.1% of the Company's total assets at 31 December 2022 (2021 - 0.6%).

In practice, liquidity in investee companies is imperfect, particularly those with a market value of less than £100 million. To reduce this liquidity risk it is the policy to diversify the holdings and generally to restrict the holding in any one company to less than 10% of the share capital of that company. Furthermore the guideline is for no single investment to account for more than 5% of the assets of the Company.

The market valuation of each underlying security gives an indication of value, but the price at which an investment can be made or realised can diverge materially from the bid or offer price depending on market conditions generally and particularly to each investment. 13.9% (£158 million) (2021 - 9.0% (£147 million)) of the listed equities in the portfolio are invested in stocks with a market capitalisation below £100 million, where liquidity is expected to be more limited. If these stocks had on average a realisable value 20% below the bid price the value of the total fund would be adversely affected by 2.4% (2021 - 1.7%).

Liquidity Risk Exposure

Contractual maturities of the financial liabilities at the year end, based on the earliest date on which payment can be required are as follows:

Fair Value of Financial Instruments

The Company's investments, as disclosed in the Company's balance sheet, are valued at fair value.

Nearly all of the Company's portfolio of investments are disclosed in the Level 1 category as defined in FRS 102. Categorisation is based on the lowest level input that is significant to the fair value measure in its entirety.

The three levels set out in FRS102 follow:

Level 1 - The unadjusted quoted price in an active market for identical assets or liabilities that the entity can access at the measurement date.

Level 2 - Inputs other than quoted prices included within Level 1 that are observable (i.e. developed using market data) for the asset or liability, either directly or indirectly.

Level 3 - Inputs are unobservable (i.e. for which market data is unavailable) for the asset or liability.

The investment Manager considers observable data to be that market data that is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market.

The analysis of the valuation basis for the financial instruments based on the hierarchy as at 31 December is as follows:

At 31 December 2022

At 31 December 2021

A reconciliation of fair value measurements in Level 3 is set out below:

At 31 December 2022

 

VIABILITY STATEMENT

The directors' view of the Company's viability has not changed since last year. The Company, as an investment trust, is a collective investment vehicle designed and managed for the long term. The directors consider that three years is an appropriate forward-looking time period. This recognises the Company's current position, the investment strategy, which includes investment in smaller companies, some of which are early stage and for which a three-year horizon is a meaningful period over which to judge prospects, the board's assessment of the main risks that threaten the business model and the relatively fast-moving nature of the sectors in which the Company invests. Inevitably, investment in smaller and early-stage companies carries higher risks, both in terms of stock liquidity and longer-term business viability and this risk is accepted by the board as necessary to seek to deliver high returns.

There are no current plans to amend the investment strategy, which has delivered good investment performance for shareholders over many years and, the directors believe, should continue to do so. The investment strategy and its associated risks are kept under constant review by the board. The board undertook a robust assessment of the risks pertaining to the Company, including risks to the Company's viability, and this is set out in the principal risks and uncertainties section. This included emerging risks such as rising global tensions - for example between China and the US over Taiwan and the war in Ukraine - and climate change. As part of this, the board considered several severe but plausible scenarios, including the impact of significant market movements.

Other items relevant in the directors' assessment of the Company's viability were: income and expenses projections and the expectation that the majority of the Company's investments comprise readily realisable securities as substantiated by liquidity analysis of the portfolio; any borrowing facilities in place - noting there were none at the year end; and the fact that as a closed ended investment company the Company is not affected by the liquidity issues of open-ended companies caused by large or unexpected redemptions. The board also takes account of the triennial shareholder vote on whether the Company should continue as an investment trust. At the AGM in April 2022, 99.99% of votes cast were in favour of continuation. The next continuation vote will be at the AGM to be held in 2025.

The directors confirm that, based on the above and on reviews conducted as part of the detailed internal controls and risk management processes set out, they have a reasonable expectation that the Company will continue to maintain its status as an investment trust, to implement its investment strategy and to operate and be able to meet its liabilities as they fall due for at least the next three financial years.

Statement of Directors' Responsibilities

The directors are responsible for preparing the annual report and the financial statements in accordance with applicable law and regulations.

Company law requires the directors to prepare financial statements for each financial year. Under that law the directors have elected to prepare the financial statements in accordance with applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice), including FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland". Under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, the directors are required to:

· select suitable accounting policies and then apply them consistently;

· make judgements and accounting estimates that are reasonable and prudent;

· state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the financial statements; and

· prepare the financial statements on the going concern basis, unless it is inappropriate to assume that the Company will continue in business.

The directors have delegated responsibility to the Manager for the maintenance and integrity of the Company's page of the Manager's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

The directors are responsible for the keeping of adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements and the directors' remuneration report comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The work carried out by the auditor does not involve any consideration of these matters and, accordingly, the auditor accepts no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the website.

Each of the directors confirm that, to the best of their knowledge:

· the financial statements, which have been prepared in accordance with applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice), give a true and fair view of the assets, liabilities, financial position and loss of the Company;

· the annual report and financial statements includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces and the directors' report contains those matters required to be disclosed by applicable law; and

· they consider that the annual report and financial statements, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's position, performance, business model and strategy.

 

 

On behalf of the board

 

TOM BLACK

Chairman

15 February 2023

 

Copies of the Company's annual report and financial statements will be available shortly from the Company's registered office or at www.heralduk.com .

 

On behalf of the board

Apex Listed Companies Services (UK) Limited

Company Secretary

15 February 2023

 

 

 

 

 

 

 

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