Annual Report and Accounts

RNS Number : 4372I

Herald Investment Trust PLC

11 March 2010

Regulatory Announcement

HERALD INVESTMENT TRUST plc

ANNUAL REPORT AND ACCOUNTS AND PROPOSED NEW ARTICLES OF ASSOCIATION

Copies of the Annual Report and Accounts for the year ended 31 December 2009 and the proposed new articles of association of the Company have been submitted to the UK Listing Authority and will shortly be available for inspection at the UK Listing Authority's Document Viewing Facility, which is situated at:

Financial Services Authority
25 The North Colonnade
Canary Wharf
London
E14 5HS

Tel: +44 (0)20 7066 1000

The Annual Report and Accounts for the year ended 31 December 2009 including the Notice of Annual General Meeting is also available on the Herald Investment Trust page of the Managers website at:

www.heralduk.com

At the annual general meeting to be held on 21 April 2010, it is proposed that new articles of association be adopted in order to update the Company's existing articles of association to take account of changes in UK company law brought about by the coming into force of the final parts of the Companies Act 2006 and the implementation of the Shareholders' Rights Directive. A summary of the proposed changes to the existing articles of association is set out in the Appendix to the Notice of Annual General Meeting within the Annual Report and Accounts for the year ended 31 December 2009. The new articles of association are available for inspection at the offices of Herald Investment Management Limited, 10-11 Charterhouse Square, London, EC1M 6EE during normal business hours on any day (Saturdays, Sundays and public holidays excepted) until the conclusion of the AGM.

The unedited full text of those parts of the Annual Report and Accounts for the year ended
31 December 2009 which require to be published by DTR 4.1 is set out on the following pages.

Baillie Gifford & Co

Company Secretaries

11 March 2010

CHAIRMAN'S STATEMENT

The total return was 70.1% in 2009. However, this reflects some recovery from the oversold position at the end of 2008, when market valuations reflected distressed sellers rather than any normal valuation of the underlying investee companies. A more relevant statistic is to report that the Herald Investment Trust net asset value per share declined 3.2% since the end of 2006, which was the end of the financial period prior to the onset of the credit squeeze. Encouragingly, over this three year period the portfolio's share of profits per share in underlying investee companies has grown by 20% and the p/e of the portfolio remains modest by historic standards, particularly versus the low yields on cash and bonds.

The total return on the UK portfolio has been 63.5%, which compares with the return of the most relevant index the HGSCI (Hoare Govett Smaller Companies Index including AIM), of 61.4%. The North American portfolio returned 67.8% in US dollars ('$') terms versus a rebased Russell 2000 Technology Index rise of 60.7%. However, sterling ('£') appreciated relative to the $ dragging the US portfolio £ return to 49.6%. The Far East return was 136.8% in £ having declined the most, 41.0% in 2008, while the European portfolio returned 42.3% in local currencies or 32.0% in £. The overall return further benefited from a recovery in the year-end mark to market position of the swap, which reflected a non-cash loss of £15.1m at 31 December 2008, but of only £6.3m at the end of 2009. In addition, the portfolio has been fully invested or modestly geared throughout the year leading to a greater performance for the net asset value per share. The total return of the benchmark was 55.8% giving 14.3% outperformance, and this follows outperformance of 2.6% relative to the benchmark in 2008. In practice the swap masked the degree of portfolio outperformance in 2008 by 4-5% and flattered the outperformance in 2009 by a similar amount. Whilst the negative effect of the swap has been disappointing the borrowing facility has enabled the Company to exploit the rally to the full.

The year has distinctly split into three parts. The first quarter saw continued distressed selling particularly from hedge funds deleveraging or facing redemptions combined with uncertainty about the instability of the banking system. The second and third quarters then saw steady asset appreciation in the smaller company market albeit on low volumes as selling pressures abated. During this period market activity in terms of primary and secondary issues was very low. However, a wall of activity occurred in November when there was a torrent of secondary offerings as brokers identified a window of opportunity that overwhelmed the market and stopped the rally in its tracks. While the new issue market remained closed in the UK, and was only just ajar in the US, the real activity related to the evident squeeze on bank credit lines to small quoted businesses. The majority of Herald's portfolio companies do not have debt, so the impact was largely only the secondary effect of a further small company market liquidity squeeze, and indeed led to a period of outperformance. This did provide opportunities to acquire or increase positions at good valuations, which had been expected to occur, but not in such a concentrated way in one month. It is particularly fulfilling that the borrowing facility has enabled the Trust to support worthwhile fund raisings in a small company market so evidently lacking capital, at valuations that seem extremely promising for Herald investors. The flow of takeovers in the portfolio has continued, but at a more normal rate than in 2007-8, when vultures swooped on a market so willing to realise cash. There was modest year end net gearing of 105.

Earnings per share for the year, including a further small VAT repayment, were 0.39p and the Board is proposing a dividend of 0.30p. Capital appreciation remains the goal of the investment strategy.

Trading in general for portfolio companies has been solid. There have clearly been headwinds from the economy, so that while profits have fallen for some companies, others have continued to grow, albeit at a slower rate than had been anticipated two years ago. In aggregate the profits from consistently profitable companies seem to be more or less flat for 2009, while for the whole portfolio there is some growth. Furthermore analysts' forecasts for growth for financial years ending in calendar year 2010 are quite robust with Herald Investment Trust's share of net profits in always profitable companies expected to be c£23m in 2010. On this basis profits per share are forecast to be 38% higher in 2010 than in 2006, the year end before the credit crunch. This is significantly better than the wider market and the Company's share price and bodes well for the future performance of the portfolio.

Further asset appreciation seems probable while the low level of interest rates encourages cash into what are perceived as riskier asset classes such as small company shares. However 2009 benefited from profit upgrades throughout the year reflecting excessive pessimism when forecasts were set at the start of the year. Consensus analysts' forecast for 2010 average 15.2% for the portfolio. The challenging macroeconomic environment suggests this upgrade pattern will not be repeated in 2010. Nevertheless, we remain optimistic that the technology sector which this portfolio targets offers greater potential for resilient profits than the wider market, which is more vulnerable to a constrained outlook for credit and for consumer and Government spending.

The Company's Articles of Association first gave shareholders the right to vote at the Annual General Meeting (AGM) on 14 April 2004 (and at AGMs to be held in every third year thereafter) as to whether the Company should continue to operate as an investment trust. Accordingly, an ordinary resolution, Resolution 7 in the Notice of Annual General Meeting, is being proposed at the AGM of the Company to be held on 21 April 2010 to the effect that the Company should continue as an investment trust. Herald Investment Trust is one of the largest investment trusts specialising in technology, communications and multi-media and is one of the best performing investment trusts since its launch in February 1994. Furthermore it is the only specialist technology orientated investment trust with a material exposure to the United Kingdom. The Herald Board believes that the focus of the Trust on smaller capitalisation companies provides exposure to some of the most rapidly growing companies within the Trust's target sectors and should continue to provide attractive long term investment opportunities. The Directors believe that the prospects for investment in the technology and media sectors remain positive and the Company is managed by one of the most experienced and successful managers in the sector. Your Board strongly recommends that shareholders vote in favour of the resolution and intend to vote their own shareholdings in favour of the resolution for the Company to continue as an investment trust.

Martin Boase retired in September 2009 after 16 years as Chairman of the Trust. During this period the assets per share grew by a factor of four. Both the Board and the Manager are very grateful for his expert guidance and wise counsel during his tenure as Chairman and we wish him well for the future.

Julian Cazalet

Chairman

25 February 2010

INVESTMENT MANAGER'S REPORT

Herald's aspiration has been to provide a low risk way of gaining exposure to early stage companies with high growth potential, by having a broad portfolio to reduce the stock specific risk. I had not envisaged an environment where share prices could diverge quite so radically from profits performance en masse. Whilst I had the ongoing reassurance of meetings and results from portfolio companies, which filled me with confidence and excitement, because we had some liquidity to exploit bargain valuations, I am sensitive to the fact that many of our shareholders did not have the benefit of such reassurance. I am particularly sympathetic to the professional fund managers with their own reporting requirements, with the valuation decline magnified by a widening discount. As I have tried to reassure my colleagues during the darkest days, you cannot expect to have a wonderful time to buy and sell at the same time. It remains a 'buyers' market, albeit not quite as compelling as it was. As in 2000 when I wish I had managed to sell more of the portfolio in the first quarter, so I wish we had invested a little more in the first quarter of 2009. The defence is that, firstly I think in both periods we were moving decisively in the right direction and secondly, it was easy to be fully (100%) invested, but it seemed foolhardy to invest on debt.

Sector Background

Technology

There are suggestions emerging in the market that the sector should be considered positively, after a dull

decade, so a top down view seems appropriate. Simplistically the first market to appear in the information technology world was mainframe computers. When I started following the sector 25 years ago there were still a multitude of names - ICL, Bull, DEC, Data General, Unisys and more that have faded from the memory. IBM accelerated growth starting with its 360 Series which was launched in 1964 and was a bet on compatibility so that users could upgrade. It used strong cash flows from maintenance to diversify effectively. When a new market emerges, following some technological development, it is quite normal for multiple players to address it. It is equally normal for a consolidation process to take place thereafter. Some will fail, others will be acquired and a few become great companies. IBM won the mainframe market and now has a c$170bn market value. The next seismic event was the emergence of the personal computer and the killer applications were word processing and spreadsheets. IBM's use of Microsoft's operating system in 1981 was so successful that it led to Microsoft's operating system becoming a standard and subsequently its word processing and spreadsheet became standard too. Names such as Visicalc, Ashton Tate, Wordperfect are but distant memories and Microsoft's market value is now c$270bn. The next major market was the development of standard networking protocol. Again names have disappeared, but Ethernet became the standard and Cisco the winner for routers and switches. This enabled PCs to communicate, share data and access centralised computer applications initially across a local area network (LAN) and then a wide area network, with telephone links between offices. Cisco's value is now c$140bn. If the 1990s was the decade of the LAN it also saw the emergence of the e-mail, but it is this century that the internet has become the killer application, albeit the stock market recognised its importance in late 1999. This has led to an upgrade cycle for the telephone networks as well as the companies already mentioned, but the outstanding commercial success has been Google, with a market value of $200bn, because they have fended off other search engines such as Yahoo, Alta Vista and Microsoft to become the dominant search

engine for the World Wide Web and monetised it accordingly. Whilst these four companies have been the successes in these huge markets, there have been a plethora of other companies that have enabled their success. Significant ones include Intel (microprocessors, c$115bn market value), EMC (storage, $35bn), Oracle (databases, c$125bn), Adobe (creative software, $20bn), SAP (accounting software, $60bn), Symantec (security), HP (printers and PCs) and Dell (PCs). In addition there are many manufacturing companies in Taiwan, Korea and China, producing components, screens and assembles. In parallel has been the emergence of the mobile phone sector with names such as Qualcomm with a market value of c$80bn,Vodafone ($120bn), RIM ($40bn) and Nokia ($50bn) emerging.

None of these stocks are held in Herald Investment Trust. The questions that are being asked by those less close to the sector are (i) now that penetration of PCs, mobile telephones and the internet is so great

is the sector ex-growth compounded by continual price deflation and a cash constrained world? (ii) how can small companies flourish going forwards?

Firstly, preliminary market research by Gartner estimates cite 22.1% YOY volume growth in Q4 for PC

volumes, which is scarcely ex-growth for a sluggish economy, ahead of expectations and suggests that Windows 7 is a worthwhile upgrade, after the failure of Vista. However, if IBM was the growth stock of

the 1960s, the evolution of the sector has enabled continued growth for a long time. Each of Microsoft, Cisco, Google and Qualcomm were small companies at their IPO and they have demonstrated the greatest growth in their early days when they have exploited a new market as small companies. Going forward there will be greater opportunities for investment profits in emerging markets which young companies tend to exploit, but the incumbent players will continue to profitably dominate their maturing markets. So are there new markets? I draw the analogy with the electricity industry. When houses and offices first received electricity no one imagined the growth in electrical applications that buildings would have. Electricity had to precede TVs, microwaves, PCs et al. Equally cable suppliers have long since been ex-growth, albeit growth has continued in emerging markets. The same cable that used to light a few bulbs is often carrying an order of magnitude more for different applications without further infrastructure investment. It seems inevitable that the internet will mirror this. The telcos are the electricity utilities, Cisco the equivalent of Switchgear. The dynamic markets currently include a revolutionary progression of power efficient internet access from Netbooks and mobile phones. Arguably Apple is at the vanguard of technology innovation currently. Whilst building blocks were being put in place with faster networks, better battery life, power efficient graphics, it was the iPhone and its 'applications' that demonstrated that there was a use for data on mobile phones other than e-mails (Blackberry for investment bankers!). I am 100% confident from some of the early stage companies that we have invested in that there are more big markets in the pipeline, which will exploit the networked world. I am less certain that the companies in which Herald Investment Trust has invested primary capital will necessarily be the commercial victors and the more concerned because of the shortage of available early stage capital in the UK, which is fertile in thought leadership. I suspect we will get adequate returns from takeovers by the well capitalised US sector. Secondly, the major players have in turn opened up an abundance of smaller markets which have been profitably exploited in Herald Investment Trust and will continue to be. For example, there are an array of niche software applications that have been developed for the PC and more for a networked world. There are hundreds of companies that have emerged to supply components and services. Applications that early stage companies are addressing in the portfolio include RF technology, for near field communication to be used in the mobile phone, and in the healthcare sector. Currently most devices on the internet are PCs, but increasingly it will be devices with embedded processors, that will rely on an IP address for remote control and communication.

Media

The media sector has fallen to 10% of the total portfolio currently. This reflects the long held view that traditional media is challenged by structural changes associated with satellite, cable and the internet and

is further challenged by the cyclical downturn and fragmentation of the advertising market. The portfolio has for some time been skewed away from advertising led companies and targeted at holdings that can exploit new media rather than be threatened by them.

Portfolio Valuation

Earnings growth %	UK	US	EMEA	Asia Pac	Total
2009: Companies always profitable (2008 and 2009)	(4.8%)	15.1%	1.4%	35.3%	0.4%
2010: Companies always profitable (2008 and 2009)	11.7%	20.3%	23.1%	33.6%	15.2%
2010: Companies unprofitable in 2008 and profitable in 2009	14.5%	161.1%	-	18.9%	23.1%
Earnings growth %
Total portfolio 2009*	25.0%	(25.5%)	0.6%	288.7%	21.6%
Total portfolio 2010*	32.9%	60.4%	27.5%	53.9%	38.8%
P/E of profitable stocks in 2008
2008	11.9x	22.0x	26.0x	17.6x	14.3x
2009	13.6x	30.3x	26.0x	13.5x	16.2x
2010	11.8x	20.8x	20.7x	9.7x	13.3x
P/E of all stocks with estimates
2008	22.6x	33.0x	38.2x	378.4x	27.3x
2009	17.8x	37.1x	27.1x	14.1x	20.3x
2010	13.4x	22.6x	21.3x	9.2x	14.6x

* The calculation for 2009 and 2010 earnings growth is based only on companies with data available in each of the respective years.

Source: JCF Group and brokers' estimates

We repeat the exercise of evaluating the earnings growth and p/e for the portfolio on a sum of the parts basis. The changing mix in the portfolio and the vagaries of accounting make the accuracy of the numbers somewhat spurious. Broadly those companies that have continued to grow have offset the profit declines seen in certain companies. For us the recession has been more evident in share prices and the Company's own wide discount than it has in the operational performance of portfolio companies.

The NAV was stable during the first quarter, outperforming the wider index and 10% ahead of the FTSE

Small Cap reflecting a strong results season. While the portfolio rallied strongly over the next two quarters, it underperformed the FTSE Small Cap index by 15% and then outperformed again in Q4 when the FTSE Small Cap index declined. This reflected a wall of fund raisings in the UK small cap sector, reflecting a difficult market for bank debt. Few companies in the Herald portfolio have debt, hence the outperformance.

Total Return	% Change Q1 2009	% Change Q2-3 2009	% Change Q4 2009	% Change 2009
Herald	5.5%	52.7%	5.8%	70.1%
HGSC plus AIM	2.9%	54.8%	1.2%	61.4%
FTSE Small Cap	(4.7%)	67.8%	(3.3%)	54.7%
Russell 2000 Technology Index	0.0%	40.9%	3.3%	45.5%
Benchmark	1.6%	50.2%	2.0%	55.8%

UK (2009 capital return £81.4m)

The UK total return of 63.5% is marginally ahead of the HGSC Index including AIM of 61.4%, but marginally behind the weighted return of the targeted sectors of 65.9%. This follows 2008 when the Company's UK portfolio outperformed the target sectors and the wider HGSC Index by c12%, so although the absolute return is much better than 2008, the relative return is less satisfactory. The portfolio was repositioned, as much as liquidity would permit, to be more defensive in the fourth quarter of 2007. While this contributed to the strong outperformance in 2008, there were a number of cyclical companies which were not held that bounced strongly in 2009. I do not chastise myself for missing out on some of these moves, and firmly believe that in an uncertain world, with illiquid holdings, it is right to focus on quality companies. The strategy has been to be fully invested and marginally geared in companies which will survive uncertainties in the short term and for the time being this strategy will remain.

In 2007 the worst performing stock in monetary terms was Detica and it was the best in 2008. In 2008 the worst performing stock was Imagination and in 2009 it was the best. Imagination's valuation in the portfolio appreciated by £22.2m in 2009 versus a loss of £7.8m in 2008. The market seems to be recognising the strength of its market position thanks to Intel and Apple both increasing their stakes. However 20 stocks in the UK portfolio appreciated by more than 100%.

The stream of acquisitions has somewhat abated. However we were disappointed by the loss of Research Now to its US competitor eResearch and particularly concerned that the management were able to roll half their holding into the acquiring entity, whereas other shareholders were not. The private equity firm TA Associates were backing the deal with leverage and the chief executive of Research Now will run the group. If capital markets were on a level playing field, Research Now should have acquired eResearch and we consider the ability for management to receive different terms from outside shareholders a worrying travesty. We faced a similar situation on the acquisition of Business Control Solutions.

The UK smaller companies market remains fragile, with few institutions participating in sub £100m market capitalisation companies. Whilst this lack of interest provides exciting valuation anomalies, the time they take to correct can be frustrating. Imagination is the largest holding, and materially increases the average p/e of the portfolio at nearly 60x 2009 earnings. It is a measure of how cheap the UK remains on an average prospective p/e of 11.8x. We are currently enjoying the harvest from investments made in 2002 into loss making companies, such as Imagination, SDL and Alterian, which had raised enough money in the technology bubble to have the resources to become proper businesses. There were further companies seeded by the AIM bubble in 2005-6, which have yet to come through. I am confident that these holdings provide a solid base for progress for the time being. However, I am worried about the

starvation of capital into early stage companies to provide a next generation in five to ten years' time. Perhaps the portfolio will be migrating more overseas. The chronic shortage of sector expertise in the London market is both an opportunity and a problem. As a taxpayer I certainly regard it more as a problem, because from my narrow perspective the only hope for the UK economy is export led growth and we have to invest in these sorts of companies if that is to be achieved.

US (2009 capital return £29.4m)

The US portfolio has grown 67.8% in $, some 7.0% ahead of the benchmark (The Russell 2000 Technology Index which has been rebased). This year currency has dragged the £ return down to 49.5%. The performance has been broadly based with 16 investments appreciating in value by more than 100%. Again there was recovery from oversold positions. It is a struggle to be enthused by valuations in the US

now, but the US economy seems more broadly based than the UK, and seems more likely to recover. The sector insights gained from covering the US are unquantifiably helpful in guiding us to brave decisions in the UK. Aladdin, Wind River, Omniture and Starent were all acquired by corporates, which contributed to a £3.5m net cash withdrawal from the US. The strength of balance sheets in the technology sector implies takeovers will be a continuing feature. While interest rates are so low, acquisitions can be earnings enhancing for the acquirer and a reasonable price for the seller.

Europe and Far East (2009 capital return: Europe £2.7m, Far East £17.3m)

The European portfolio is small and returned 42.3% in local currency, and 32% in £. The interruption of

meetings we were having in the Paris bourse by demonstrating unions in September are stark reminders of the socialist excesses that still prevail in France. Although there are some interesting technology companies, shareholders are not important. I hope the evident capitalist excesses in the UK do not swing

too far in the direction of the Continent! However all the European holdings made a positive return in 2009.

The Far East return was the best of all. Having declined 41.0% in £ last year, the portfolio grew 136.8%

in 2009. The Far East portfolio remains dominated by holdings in Korea and Taiwan. They are both countries that seem to have progressed up the value chain in an entrepreneurial way, with a cost base challenging for Japan, where we have no exposure. The South Korean portfolio appreciated 220.6% in £, while Taiwan gained 95.0%. KH Vatec has been the most significant performer rising 333% during the year and accounting for a third of the Korean portfolio. In all eight investments in the Far East appreciated 200% and a further seven holdings appreciated 100-200%. In general the Far East portfolio experienced profits downgrades in 2008, but figures exceeded initial expectations in 2009 after the destocking in Q4 2008 and Q1 2009, when demand recovered better than worst fears. The Far East portfolio is skewed to component manufacturing, an area where the Far East now dominates.

Summary

The portfolio seems solid and the prospects for a resumption of economic growth in 2010 make progress

probable for portfolio profits and share prices, particularly when valuations remain so low by historic standards and versus interest rates.

We have acquired for cancellation a further 2.4m shares (£6m), taking total buy-backs to 7.4% over the last three years. It seemed entirely rational for the discount to widen to 20% when the market was declining and the portfolio totally illiquid. The worst is past, but the liquidity remains extremely limited. We are confident that patience will be rewarded.

I should particularly like to thank Martin Boase who retired as Chairman of the Trust last year. He was the founder Chairman and bravely agreed to take the Chair before a pound had been raised let alone invested. He has given me time beyond the call of duty and contributed on a scale unparalleled by any other individual over the life of Herald. However, he leaves a strong Board in the Trust and a much stronger infrastructure at Herald Investment Management, so I am confident we remain well placed. The ambition is to quadruple the assets per share again.

PERFORMANCE ATTRIBUTION (in sterling terms)
	Benchmark allocation			Herald asset allocation		Performance*		Contribution to relative	Contribution attributable to: Stock Asset
Equity markets	01.01.09 %		31.12.09 %	01.01.09 %	31.12.09 %	Herald %	Benchmark %	return %	selection %	allocation† %
UK	66.7		66.7	60.3	66.2	63.5	61.4	0.6	0.9	(0.3)
Europe ex. UK	-		-	3.2	3.4	32.0	-	(0.5)	-	(0.5)
Americas	33.3		33.3	29.5	25.7	49.6	43.1	1.3	1.2	0.1
Asia Pacific ex Japan JJJaJapan		-	-	7.1	8.5	136.8	-	3.1	-	3.1
Emerging Markets	-		-	0.4	0.4	75.0	-	0.1	-	0.1
Bonds				15.5	7.7	2.2	-	(4.6)	-	(4.6)
Cash	-		-	15.0	4.7	3.1	-	(3.4)	-	(3.4)
Swap	-		-	(7.2)	(1.9)	n/a	-	5.0	-	5.0
Loans	-		-	(23.8)	(14.7)	3.4	-	7.8	-	7.8
Total	100.0		100.0	100.0	100.0	70.1	55.8	9.2	2.1	7.0

Past performance is not a guide to future performance.

Source: HSBC.

*The above returns are calculated on a total return basis with net income reinvested. Dividends and interest are reinvested on a cash basis, unlike the NAV calculation where income is recognised on an accruals basis. Relative performance may differ as a result.

Contributions cannot be added together, as they are geometric; for example, to calculate how a return of 70.1% against a benchmark return of 55.8% translates into a relative return of 9.2%, divide the portfolio return of 170.1 by the benchmark return of 155.8 and subtract one.

†Asset allocation includes the contribution attributable to currency movements.

Katie Potts

25 February 2010

DISTRIBUTION OF ASSETS

		At 31 December 2009 %	At 31 December 2008 %
Equities:	United Kingdom	56.7	45.9
	Continental Europe	2.9	2.5
	Americas	22.0	22.4
	Asia Pacific	7.3	5.4
	Emerging Markets	0.3	0.3
Total equities		89.2	76.5
Sterling denominated bonds		5.0	5.4
Norwegian krone denominated bonds		-	3.6
EUR denominated bonds		-	-
US$ denominated bonds		1.6	2.7
Net current assets		4.2	11.8
Total assets (before deduction of bank loans and derivative financial instruments)		100.0	100.0

TOP TWENTY HOLDINGS

at 31 December 2009

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

Imagination Technologies Group
Imagination creates market-leading embedded graphics, video and display acceleration, multithreaded processing and multi-standard receiver technologies and licences this IP (Intellectual Property) to global semiconductor and system companies. These technologies are used in the following markets: digital radio and audio, mobile phone multimedia, personal media player, car navigation and driver information, personal navigation, mobile internet device (MID), digital TV and set-top box, and mobile TV. Imagination has been particularly successful in selling graphics technology to the mobile phone and LCD TV sectors and is a pioneer in developing Digital Audio Broadcasting Technology (DAB). Imagination Technology incorporates this technology in its "Pure Digital" radio brand which is the number one supplier of radios in the UK. The adoption of digital radio in other countries, France and Germany in particular, is opening up a bigger international market and they have launched an internet radio range for the US market. The group has a highly skilled workforce of over 500 people, of which over 80% are R&D engineers.	Country United Kingdom % of total assets 5.6 % of issued share capital held 3.8 31/12/09 31/12/08 Valuation (£m) 22.25 9.29 Shares (m) 9.23 14.98
SDL
SDL is the leader in Global Information Management (GIM) solutions that help organisations to accelerate the delivery of high-quality multilingual content to global markets with products and services. Global industry leaders that rely on SDL include: ABN-Amro, Best Western, Bosch, Canon, Chrysler, CNH, Hewlett-Packard, Microsoft, Philips, SAP, Sony, SUN Microsystems and Virgin Atlantic. SDL has implemented more than 500 enterprise GIM solutions, deployed over 150,000 translation software licenses and provides access to on-demand translation portals for 10 million customers per month. Over 1,000 service professionals deliver consulting, implementation and language services through its global infrastructure of more than 50 offices in 32 countries. They have expanded through acquisition into content management and workflow. SDL is in Gartner's leader quadrant for web content management.	Country United Kingdom % of total assets 3.8 % of issued share capital held 4.8 31/12/09 31/12/08 Valuation (£m) 15.23 9.49 Shares (m) 3.71 4.23

Phoenix IT Group
Phoenix IT was established in 1980. The Group provides a growing range of complementary IT infrastructure support services including systems management, communications, remote telephone support, high-touch field services, project and consultancy services as well as business continuity and disaster recovery services. Often these services are sold and delivered as a managed service where Phoenix manages complex IT infrastructures to agreed levels of service under long term contracts. In May 2007 Phoenix acquired ICM for £130m in cash and shares, ICM had been a portfolio holding since 2002.	Country United Kingdom % of total assets 2.1 % of issued share capital held 4.1 31/12/09 31/12/08 Valuation (£m) 8.21 4.97 Shares (m) 3.10 2.95
Telecom Plus
Telecom Plus supplies fixed wire and mobile telecommunications services, gas and electricity to 300,000 residential and small business customers in the United Kingdom with a unified billing system. Telecom Plus was incorporated in 1996 and began operations in 1997 providing a unique range of low-cost telephony services to the residential and SOHO markets. They use the collective buying power of individual users to negotiate bulk buying deals with major suppliers, passing the benefit back to their customers. Telecom Plus does not advertise and has no shops. Instead, they rely on word of mouth recommendations from satisfied customers and from a network of Independent Distributors. The advanced billing system means the customer receives a single monthly bill covering all the services provided.	Country United Kingdom % of total assets 2.0 % of issued share capital held 4.0 31/12/09 31/12/08 Valuation (£m) 8.06 8.08 Shares (m) 2.74 2.64
Group NBT
Group NBT is a leading provider of domain names, managed hosting solutions and other internetrelated services. With five market-leading brands, Group NBT is now made up of the following companies: NetBenefit, providing high quality managed hosting services in both the UK and Continental Europe; NetNames, providing registration services for every top level domain available and providing corporate domain name management to large organisations through its industry leading NetNames Platinum Service, which is now used by over 30% of the FTSE 100; Easily.co.uk, a top UK provider of cost effective web hosting and domain name services to UK businesses and consumers; Speednames, the dominant provider of domain name services in Denmark; Ascio, which is responsible for the provision of domain name services indirectly through more than 300 partnerships including telecom operators, web hosting companies, internet access providers and IP law firms; and Envisional, whose services monitor the internet for brand abuse, fraud, counterfeiting and piracy. Group NBT currently has over 280 employees world-wide, with offices in London, Copenhagen, New York, Nice, Munich, Zurich and Oslo.	Country United Kingdom % of total assets 2.0 % of issued share capital held 9.8 31/12/09 31/12/08 Valuation (£m) 7.98 3.97 Shares (m) 2.53 2.03
Alterian
Alterian features in Gartner's Enterprise Marketing Management (EMM) Quadrant. It focuses on campaign management, marketing resource management and online marketing with the use of proprietary databases. It distributes through a number of marketing service providers including Acxiom, Experian, Epsilon, Harte-Hanks, Merkle, Allant, Donnelley Marketing and KnowledgeBase Marketing. It generally licences the products on a one year term. It has some direct customers too. In July 2008 Alterian acquired Mediasurface, a web content management business for £18m in cash and shares; Mediasurface had been a portfolio holding since 2006. Alterian's acquisition of Techrigy in July 2009 augmented Alterian's technology portfolio with a social media monitoring and analytics solution, this enables marketers to get a full view of their marketing landscape by listening to their consumers online.	Country United Kingdom % of total assets 1.9 % of issued share capital held 7.1 31/12/09 31/12/08 Valuation (£m) 7.66 2.46 Shares (m) 4.14 4.31
StatPro Group
StatPro is a leading provider of portfolio analytics and data solutions for the global asset management industry. Having grown from a one-product company, StatPro now offers clients eight core products. Over the past 15 years, StatPro has developed its products in close collaboration with international asset managers and can offer data and software solutions for risk management, fixed income analysis, performance measurement, attribution analysis, GIPS compliance and reporting. StatPro has around 400 client contracts in 25 countries with 11 offices worldwide. StatPro has grown its annualised rental revenue from less than £1 million in 1999 to £28.3 million at end June 2009. Statpro generally experiences a 94% renewal rate. 2010 will see the delivery of StatPro's next generation Software as a Service (SaaS) solution, enabling service delivery to a broader market more cost effectively.	Country United Kingdom % of total assets 1.8 % of issued share capital held 11.7 31/12/09 31/12/08 Valuation (£m) 6.98 2.58 Shares (m) 6.98 6.98
Advent Software
Advent supplies investment management companies with integrated software products and services in portfolio administration, including workflows within the managers and external portfolio reporting. Each solution focuses on specific mission-critical functions of the front, middle and back offices and is designed to meet the needs of the particular client, as determined by size, assets under management and complexity of the investment environment. With more than 4,500 client firms, Advent has established itself as a leading provider of mission-critical applications to meet the demands of investment management operations around the world. It has adopted a rental model.	Country USA % of total assets 1.6 31/12/09 31/12/08 Valuation (£m) 6.30 2.78 Shares (m) 2.50 0.20
Euromoney Institutional Investor
Euromoney is a leading international business-to-business media group focused primarily on the international finance, metals and commodities sectors. It publishes more than 100 magazines, newsletters and journals, including Euromoney, Institutional Investor and Metal Bulletin. It also runs an extensive portfolio of conferences, seminars and training courses and is a leading provider of electronic information and data covering international finance, metals and emerging markets. Its main offices are in London, New York and Hong Kong and nearly half its revenues are derived from the United States.	Country United Kingdom % of total assets 1.5 31/12/09 31/12/08 Valuation (£m) 5.88 2.42 Shares (m) 1.35 1.10
Diploma
Diploma is a group of specialised distribution businesses serving industries with long term growth potential and with the opportunity for sustainable superior margins through the quality of customer service, depth of technical support and value-adding activities. The three sectors the company focuses on are life sciences, seals and controls.	Country United Kingdom % of total assets 1.4 31/12/09 31/12/08 Valuation (£m) 5.64 4.21 Shares (m) 3.20 3.45
Websense
Websense is a global leader in integrated web, data and e-mail security solutions, providing information security to approximately 40,000 customers with 43 million individual seats. Distributed through its global network of channel partners, Websense software, appliance and Software as a Service (SaaS) security solutions help organisations block malicious code, prevent the loss of confidential information and enforce internet use and security policies. In March 2007 Websense acquired its main competitor SurfControl for $400m in cash; SurfControl had been a portfolio holding since 1998.	Country USA % of total assets 1.3 31/12/09 31/12/08 Valuation (£m) 5.03 4.82 Shares (m) 4.65 0.47
Toumaz
Toumaz has patented AMx (advance mixed signal silicon devices) which provides a system-on-chip (SOC) signal processing solution. It has a dynamically re-configurable mixed signal architecture with analogy elements embedded in a digital fabric. This enables ultra low power consumption and a dramatic reduction in battery size for portable devices, and months or years of active life from a single battery. It also offers reduced complexity and silicon area. The company is currently addressing two markets, wireless medical devices and consumer electronics. The technology was developed at Imperial College.	Country United Kingdom % of total assets 1.3 % of issued share capital held 15.5 31/12/09 31/12/08 Valuation (£m) 5.01 1.50 Shares (m) 71.62 24.07
Intec Telecom Systems
Intec is one of the principal global suppliers of business support systems (BSS), systems that assist customers with mediation, customer care, charging, billing and wholesale business management. A global business, Intec serves over 60 of the world's top 100 telecommunications companies, which they support with 1,600 employees working from 31 offices in 24 countries. Intec's telecommunications customers include: AT&T, The Carphone Warehouse (UK), China Mobile, Deutsche Telekom, Verizon and Vodafone. Intec's technology is also utilised in the billing and settlement needs of many other types of businesses, including transportation and financial services companies.	Country United Kingdom % of total assets 1.2 31/12/09 31/12/08 Valuation (£m) 4.60 0.96 Shares (m) 4.44 3.61
Fidessa Group
Fidessa supplies trading systems to the world's financial markets. It is the leading supplier of multiasset trading, portfolio analysis, decision support, compliance, market data and connectivity solutions. Fidessa's products and services make it easier to buy, sell and own financial assets of all types on a global basis and uniquely, serves both the buy-side and sell-side communities globally. Fidessa has developed all its products itself from the ground up over 28 years, investing heavily in their continual evolution. Fidessa's products are used by over 85% of tier-one, global financial institutions. Headquartered in London and with regional operations across Europe, North America, Asia and the Middle East, Fidessa supports over 24,000 users across 730 clients, serving a broad spectrum of customers from major investment banks and asset managers through to specialist niche brokers and hedge funds. The product is supplied on a rental basis.	Country United Kingdom % of total assets 1.2 31/12/09 31/12/08 Valuation (£m) 4.57 1.92 Shares (m) 0.39 0.39
Electrocomponents
Electrocomponents is the leading high service distributor of electrical, electronic and industrial supplies. Starting in 1937 in London selling spare parts for radios, the Group now has operations in 27 countries. Turnover is around £975m, with 43% of sales via e-commerce at September 2009. Electrocomponents trades as RS in the UK, most of Europe and Asia, Radiospares in France, Radionics in Republic of Ireland and Allied Electronics in North America. In total Electrocomponents offers 500,000 products which are sold to 1.5m customers.	Country United Kingdom % of total assets 1.1 31/12/09 31/12/08 Valuation (£m) 4.30 3.70 Shares (m) 2.66 2.66
SQS Software Quality Systems
SQS Group ('SQS') was founded in Cologne, Germany, in 1982. SQS is the largest independent provider of software testing and quality management services in the world. The company tests web, e-commerce, infrastructure, security and client server applications. With more than 5,000 successfully completed projects under its belt, SQS has a strong customer base, including half of the DAX 30 companies, almost one third of the STOXX-50 companies and 36 FTSE 100 companies. SQS has around 1,450 employees worldwide. The clients include Barclays, BP, Credit Suisse, Daimler, Deutsche Bank, Deutsche Post, Dresdner Bank, T-Mobile, T-Systems and Zurich Group.	Country United Kingdom % of total assets 1.1 % of issued share capital held 7.2 31/12/09 31/12/08 Valuation (£m) 4.23 4.17 Shares (m) 1.97 1.94
KH Vatec
KH Vatec, a Korean company, was founded in 1992 and is a global leader in miniature die-casting and precision module assembly. The majority of KH Vatec's manufacturing is now based in China. The company's products are used in mobile phones and personal digital assistants (PDAs), audio (MP3) players and Web pads, amongst others. The company produces parts in zinc, magnesium and aluminium. The zinc parts include external components such as laptop hinges and electromagnetic interference (EMI) shields. Magnesium parts include internal and external components and EMI shields. Aluminium parts include external components and stamping parts. Vatec also provides complete assembled modules, Nokia is the main module customer.	Country Korea % of total assets 1.0 31/12/09 31/12/08 Valuation (£m) 4.11 0.99 Shares (m) 0.16 0.16
Allocate Software
Allocate Software is the leading workforce optimisation and scheduling software provider for global organisations with large, multi-skilled workforces. With over 18 years' experience, Allocate ensures customers can match operational demands with workforce supply. Continually developing workforce optimisation software for new industries, Allocate specialises in resource scheduling solutions for the healthcare, defence, maritime, offshore engineering and cruise and ferry sectors. Over 1,000,000 people are deployed globally using Allocate Software. Customers include: the British Army, NATO, P&O Cruises, A.P. Moller Maersk, HCA, NHS Professionals and over 180 NHS Trusts.	Country United Kingdom % of total assets 0.9 % of issued share capital held 12.3 31/12/09 31/12/08 Valuation (£m) 3.62 1.08 Shares (m) 5.49 3.09
M&C Saatchi
M&C Saatchi is a global marketing services business working for clients across a wide variety of industry sectors. The Company was founded in 1995. Starting with a strong base in the UK and Australia, Saatchi have added new agencies and disciplines in Asia, USA and Europe and employ over 1,100 staff in 15 countries.	Country United Kingdom % of total assets 0.9 % of issued share capital held 7.2 31/12/09 31/12/08 Valuation (£m) 3.52 2.62 Shares (m) 4.40 3.40
Ffastfill
Ffastfill provides software and services to the global financial community. Headquartered in London with offices in Chicago, Prague and Sydney the company supports over 80 financial institutions worldwide using the suite of Ffastfill applications. The company's main expertise and knowledge is in exchange traded derivative instruments, although the multi-asset clearing and trading functionality meets many clients with equity, fixed income, foreign exchange, CFD and OTC needs. The full trade cycle through front, middle, back and risk are covered though the Ffastfill product set and all are delivered through a Software as a Service (SaaS) medium.	Country United Kingdom % of total assets 0.9 % of issued share capital held 10.8 31/12/09 31/12/08 Valuation (£m) 3.43 - Shares (m) 42.90 -

Note: A figure is presented for % issued share capital held only if greater than 3%.

PRINCIPAL RISKS AND UNCERTAINTIES

In accordance with the corporate objective of maximising capital appreciation the Company invests in securities on a worldwide basis. The Company makes use of gearing to achieve improved performance in rising markets and has an interest rate swap, the purpose of which is to hedge the variability in cash flows arising from interest rate fluctuations on bank loans. The Company's other financial instruments consist of cash, short term debtors and creditors.

The main risks arising from the Company's financial instruments are:

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 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.

C. Liquidity Risk, being the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities.

These risks and the policy 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. 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. These valuations also represent the fair value of the investments, see below.

An analysis of the investment portfolio by broad industrial or commercial sector and a review of the 20 largest equity investments by their aggregate market value, are shown above.

Other Price Risk Sensitivity

34.7% of the Company's equity investments at 31 December 2009 (2008 - 33.4%) were listed on the main list of the London Stock Exchange and a further 27.9% (2008 - 25.2%) on AIM. The NASDAQ Stock Exchange accounts for 23.9% (2008 - 28.5%) and other stock exchanges 12.6% (2008 - 11.6%). A 10% increase in stock prices at 31 December 2009 would have increased total net assets and net return on ordinary activities after taxation by £35,000,000 (2008 - £21,000,000). A decrease of 10% would have had an equal but opposite effect. The portfolio does not target any exchange as a benchmark, 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 Securities, the interest rate and maturity dates of which are detailed below. Interest is accrued on sterling cash balances at a rate linked to the UK base rate.

The Company has borrowings, from time to time. The aim of the use of gearing is to enhance long term returns to shareholders by investing borrowed funds in equities and other assets. Gearing is actively managed. How and where borrowings are invested is reviewed by the Board in consultation with the Manager at every Board meeting. In light of the decisions made, appropriate adjustments to the gearing position are then made by the Manager.

At the year end the Company had borrowings of £50 million (2008 - £50 million). Under the terms of an interest rate swap, the interest payable on the bank loans has been fixed.

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

Financial Assets

		2009			2008
	Fair value £'000	Weighted average interest rate/interest rate	Weighted average period until maturity/ maturity date	Fair value £'000	Weighted average interest rate/interest rate	Weighted average period until maturity/ maturity date
Fixed rate:
UK bonds	19,620	4.7%	5 years	14,900	4.1%	5 years
European bonds	-	-	-	10,027	5.5%	4 months
US bonds	6,407	4.5%	11 months	7,470	4.5%	2 years
UK convertible bonds	769	6.9%	4 years	405	7.0%	3 years

Cash:
Other overseas currencies	1,041			563
Sterling	17,510	0.3%		30,984	4.6%
	18,551			31,547

The cash deposits generally comprise call or short term money market deposits with original maturities of less than 3 months which are repayable on demand. The benchmark rate which determines the interest payments received on cash balances is the bank base rate.

Financial Liabilities

		2009			2008
	£'000	Net Interest rate paid	Loan Facility expires	£'000	Net Interest rate paid	Loan Facility expires
Bank loan	25,000	2.3%	May 2011	25,000	6.5%	May 2011
	25,000	2.4%	May 2013	25,000	6.6%	May 2013
	50,000	2.4%		50,000	6.6%
Swap	50,000	3.2%		50,000	(1.0%)
		5.6%			5.6%

The effective fixed rate of interest on the loans of 5.6% (2008 - 5.6%) reflects a weighted average variable interest rate paid of 2.4% (2008 - 6.6%), with a further weighted average of 3.2% paid on the swap (2008 - (1.0%) received from the swap). The Company's facilities are rolling on a quarterly basis with the facility on a £25 million tranche expiring in May 2011 and a £25 million tranche expiring in May 2013. While the 30 year swap remains in place, the net interest payable will effectively be fixed for the duration of the term of the facility.

2009

2008

Notional contract amount

£'000

Fair value assets £'000

Fair value liabilities £'000

Fair value balance £'000

Notional contract amount

£'000

Fair value assets £'000

Fair value liabilities £'000

Fair value balance £'000

Total derivative assets/(liabilities) held for trading

50,000

34,211

(40,509)

(6,298)

50,000

31,054

(46,133)

(15,079)

Interest rate risk sensitivity

(a) Cash

An increase of 100 basis points in interest rates as at 31 December 2009 would have a direct effect on net assets. Based on the position at 31 December 2009, over a full year, an increase of 100 basis points would have increased the net return on ordinary activities after taxation by £186,000 (2008 - increased net return on ordinary activities after taxation by £315,000) and would have increased the net asset value per share by 0.23p (2008 - increased the net asset value per share by 0.38p). A decrease of 100 basis points would have had an equal but opposite effect. 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 2009 would have decreased total net assets and total return on ordinary activities by £803,000 (2008 - decreased total net assets and total return on ordinary activities by £825,000) and would have decreased the net asset value per share by 0.99p (2008 - decreased the net asset value per share by 0.99p). 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 the balance sheets they are considered to have more equity like characteristics.

The effect of an increase or decrease of 100 basis points in 3 month LIBOR interest rates as at 31 December 2009 on the interest cost of the bank loans and the net income return has been eliminated through a 30 year floating interest rate to fixed interest rate swap. The swap generates payments or charges that offset changes in the 3 month LIBOR interest rate, so that the interest payable on the bank loans is effectively converted to a fixed rate loan at 4.8975% (2008 - 4.8975%) plus margin cost. The initial term of the swap on commencement at 30 years did not match the term of the loans, therefore, hedge accounting is not used and mark to market gains or losses on the swap are captured in the net return on ordinary activities as set out in (d) below.

(d) Floating interest rate to fixed interest rate swap

A decrease of 100 basis points on 30 year interest rates as at 31 December 2009 would have a direct mark to market effect on the value of the swap and net assets. Based on the position as at 31 December 2009, over a full year, a decrease of 100 basis points would have decreased the gains on investments and net return on ordinary activities after taxation by £9,059,000 (2008 - decreased the gains on investments and net return on ordinary activities after taxation by £10,994,000) and would have decreased the net asset value per share by 11.18p (2008 - decreased the net asset value per share by 13.18p). An increase of 100 basis points would have had an equal but opposite effect.

(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 16 to 20 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 have suffered 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 2009

	Investments £'000	Cash and deposits £'000	Loans £'000	Other debtors and creditors* £'000	Net exposure £'000
US dollar	94,068	-	-	47	94,115
Taiwan dollar	12,583	1,010	-	-	13,593
Korean won	12,451	31	-	36	12,518
Euro	8,420	-	-	7	8,427
Other overseas currencies	8,215	-	-	-	8,215
Exposure to currency risk on translation of valuations of securities listed in overseas currencies	135,737	1,041	-	90	136,868
Sterling	244,720	17,510	(50,000)	(8,202)	204,028
	380,457	18,551	(50,000)	(8,112)	340,896

*Includes net non-monetary assets of £28,000.

At 31 December 2008

	Investments £'000	Cash and deposits £'000	Loans £'000	Other debtors and creditors* £'000	Net exposure £'000
US dollar	69,489	23	-	41	69,553
Norwegian krone	10,312	-	-	344	10,656
Taiwan dollar	7,021	540	-	-	7,561
Korean won	4,686	-	-	-	4,686
Euro	4,151	-	-	19	4,170
Other overseas currencies	6,191	-	-	9	6,200
Exposure to currency risk on translation of valuations of securities listed in overseas currencies	101,850	563	-	413	102,826
Sterling	141,426	30,984	(50,000)	(14,526)	107,884
	243,276	31,547	(50,000)	(14,113)	210,710

*Includes net non-monetary assets of £29,000.

Foreign currency risk sensitivity

At 31 December 2009, had sterling strengthened by 10% (2008: 10%) in relation to all currencies, with all other variables held constant, total net assets and net return on ordinary activities after taxation would have decreased by the amounts shown below based solely on translation of securities quoted in currencies overseas. A 10% (2008: 10%) weakening of sterling against all currencies, with all other variables held constant, would have had an equal but 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.

	2009	2008
	£'000	£'000
US dollar	9,411	6,955
Taiwan dollar	1,359	756
Korean won	1,252	469
Euro	843	417
Other overseas currencies	822	1,686
	13,687	10,283

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.

The fixed interest securities held are UK and US Government securities and UK corporate bonds.

Credit Risk Exposure

The exposure to credit risk at 31 December was:

	2009	2008
	£'000	£'000
Fixed interest investments	26,027	32,397
Cash and short term deposits	18,551	31,547
Debtors and prepayments	1,593	1,803
	46,171	65,747

The maximum exposure in fixed interest investments was £28,417,000 (2008 - £24,772,000) and the minimum£15,948,000 (2008 - £2,874,000). The maximum exposure in cash was £32,900,000 (2008 - £61,128,000) and the minimum £13,008,000 (2008 - £10,046,000). None of the Company's financial assets are past due or impaired.

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. The Company's unlisted investments are not readily realisable, but these only amount to 0.9% of the Company's total assets at 31 December 2009 (2008: 1.1%).

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. 36% (£135 million) (2008: 36% (£88 million)) of the portfolio is 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 7.1% (2008: 7.2%).

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:

			2009					2008
	One year or less £'000	In more than one year but not more than two years £'000	In more than two years but not more than five years £'000	Five years or more £'000	Total £'000	One year or less £'000	In more than one year but not more than two years £'000	In more than two years but not more than five years £'000	Five years or more £'000	Total £'000
Bank loans	737	26,184	26,853	-	53,774	2,061	1,592	53,351	-	57,004
Derivative financial instruments	2,042	1,243	1,017	6,335	10,637	717	1,187	2,018	19,321	23,243
Other creditors	2,888	-	-	-	2,888	228	-	-	-	228
	5,667	27,427	27,870	6,335	67,299	3,006	2,779	55,369	19,321	80,475

Fair Value of Financial Instruments

Fair values are measured using the following fair value hierarchy:

Level 1: reflects financial instruments quoted in an active market.

Level 2: reflects financial instruments whose fair value is evidenced by comparison with other observable current market transactions in the same instrument or based on a valuation technique whose variables includes only data from observable markets.

Level 3: reflects financial instruments whose fair value is determined in whole or in part using a valuation technique based on assumptions that are not supported by prices from observable market transactions in the same instrument and not based on available observable market data.

The valuation techniques used by the Company are explained in the accounting policies on page 40 of the Annual Report.

The table below sets out the fair value measurements using the fair value hierarchy.

At 31 December 2009

	Level 1 £'000	Level 2 £'000	Level 3 £'000	Total £'000
Financial assets
Equity investments	351,319	162	2,949	354,430
Government debt securities	20,916	-	-	20,916
Other debt securities	5,111	-	-	5,111
Current assets	20,144	-	-	20,144
Total assets	397,490	162	2,949	400,601

Financial liabilities
Bank loans	50,000	-	-	50,000
Derivatives	-	6,298	-	6,298
Current liabilities (excluding bank loans)	3,407	-	-	3,407
Total liabilities	53,407	6,298	-	59,705

Total net assets	344,083	(6,136)	2,949	340,896

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

At 31 December 2009

	Equity Investments £'000
Opening balance at 1 January 2009	2,898
Purchases	815
Sales	(1,738)
Transfers into Level 3	1,607
Total gains or losses:
- on assets sold during the year	(1,639)
- on assets held at 31 December 2009	1,006
Closing balance at 31 December 2009	2,949

Transfers into Level 3 relate to investments for which listing has been suspended during the year.

Other Risks

Other risks faced by the Company include the following:

Regulatory Risk - failure to comply with applicable legal and regulatory requirements could lead to suspension of the Company's Stock Exchange Listing, financial penalties or a qualified audit report. Breach of Section 842 of the Income and Corporation Taxes Act 1988 could lead to the Company being subject to tax on capital gains. The Manager's Compliance Officer and Baillie Gifford's Heads of Business Risk & Internal Audit and Regulatory Risk provide regular reports to the Audit Committee on their monitoring programmes. The Manager monitors investment movements and the Secretary monitors the level of forecast income and expenditure to ensure the provisions of Section 842 are not breached.

Operational/Financial Risk - failure of the Secretary's accounting systems or those of other third party

service providers could lead to an inability to provide accurate reporting and monitoring or a misappropriation of assets. The Audit Committee reviews the Secretary's Report on Internal Controls and the reports by other key third party providers are reviewed by the Secretary on behalf of the Audit Committee.

Discount Volatility - the discount at which the Company's shares trade can widen. The Board monitors the level of discount and the Company has authority to buy back its own shares.

Gearing Risk - the Company may borrow money for investment purposes (sometimes known as 'gearing'). If the investments fall in value, any borrowings will magnify the extent of this loss. If borrowing facilities are not renewed, the Company may have to sell investments to repay borrowings.

All borrowings require the prior approval of the Board and gearing levels are discussed by the Board and Managers at every meeting. The majority of the Company's investments are in quoted securities that are readily realisable.

STATEMENT OF DIRECTORS' RESPONSIBILITIES

The Directors are responsible for preparing the Annual Report, the Directors' Remuneration 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). 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; and

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

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 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.

Each of the Directors, whose names and functions are listed within the Directors, Manager and Advisers

section 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 net return of the Company; and

· the Directors' Report 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.

By order of the Board

Julian Cazalet

25 February 2010

INCOME STATEMENT

	For the year ended 31 December 2009			For the year ended 31 December 2008
	Revenue £'000	Capital £'000	Total £'000	Revenue £'000	Capital £'000	Total £'000
Gains/(losses) on investments	-	139,718	139,718	-	(126,592)	(126,592)
Currency gains	-	311	311	-	54	54
Income (note 3)	6,077	-	6,077	7,629	-	7,629
Investment management fee	(2,773)	-	(2,773)	(2,808)	-	(2,808)
VAT Recovered (note 4)	292	-	292	2,506	-	2,506
Other administrative expenses	(313)	-	(313)	(321)	-	(321)
Net return before finance costs and taxation	3,283	140,029	143,312	7,006	(126,538)	(119,532)
Finance costs of borrowings	(2,875)	-	(2,875)	(2,128)	-	(2,128)
Net return on ordinary activities before taxation	408	140,029	140,437	4,878	(126,538)	(121,660)
Tax on ordinary activities	(84)	-	(84)	(136)	-	(136)

Net return on ordinary activities after taxation	324	140,029	140,353	4,742	(126,538)	(121,796)
Net return per Ordinary share (note 5)	0.39p	169.95p	170.34p	5.59p	(149.07p)	(143.48p)

Dividend per Ordinary share (note 6)	0.30p			1.55p
Special dividend per Ordinary share (note 6)	-			3.45p

The total column of this statement is the profit and loss account of the Company.

All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued during the year.

A Statement of Total Recognised Gains and Losses is not required as all gains and losses of the Company have been reflected in the above statement.

BALANCE SHEET

	At 31 December 2009	At 31 December 2008
	£'000	£'000
FIXED ASSETS Investments held at fair value through profit or loss	380,457	243,276
CURRENT ASSETS
Debtors	1,593	1,803
Cash and short term deposits	18,551	31,547
	20,144	33,350
CREDITORS: Amounts falling due within one year (note 7)	(53,407)	(50,837)
Derivative financial instruments (note 7)	(6,298)	(15,079)
	(59,705)	(65,916)
Net current liabilities	(39,561)	(32,566)

TOTAL NET ASSETS	340,896	210,710
CAPITAL AND RESERVES
Called-up share capital	20,263	20,852
Share premium	73,738	73,738
Capital redemption reserve	1,689	1,100
Capital reserve	243,064	109,072
Revenue reserve	2,142	5,948
SHAREHOLDERS' FUNDS	340,896	210,710

Net asset value per Ordinary share (including income)	420.58p	252.63p

Net asset value per Ordinary share (excluding income)	420.19p	247.04p

Ordinary shares in issue (note 8)	81,053,283	83,408,123

RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' FUNDS

For the year ended 31 December 2009

	Called-up share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve* £'000	Revenue reserve £'000	Shareholders' funds £'000

Shareholders' funds at 1 January 2009	20,852	73,738	1,100	109,072	5,948	210,710
Net return on ordinary activities after taxation	-	-	-	140,029	324	140,353
Shares bought back	(589)	-	589	(6,037)	-	(6,037)
Dividends paid during the year	-	-	-	-	(4,130)	(4,130)
Shareholders' funds at 31 December 2009	20,263	73,738	1,689	243,064	2,142	340,896

*Capital reserve as at 31 December 2009 included investment holding gains of £14,807,000.

For the year ended 31 December 2008

	Called-up share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve* £'000	Revenue reserve £'000	Shareholders' funds £'000

Shareholders' funds at 1 January 2008	21,743	73,738	209	246,171	1,636	343,497
Net return on ordinary activities after taxation	-	-	-	(126,538)	4,742	(121,796)
Shares bought back	(891)	-	891	(10,561)	-	(10,561)
Dividends paid during the year	-	-	‑	-	(430)	(430)
Shareholders' funds at 31 December 2008	20,852	73,738	1,100	109,072	5,948	210,710

* Capital reserve as at 31 December 2008 included investment holding losses of £123,711,000.

SUMMARISED CASH FLOW STATEMENT
	For the year ended 31 December 2009		For the year ended 31 December 2008
	£'000	£'000		£'000	£'000
NET CASH INFLOW FROM OPERATING ACTIVITIES		3,729			6,092
NET CASH OUTFLOW FROM SERVICING OF FINANCE		(2,871)			(1,614)
FINANCIAL INVESTMENT
Purchase of investments	(59,037)			(100,426)
Sale of investments	55,350			76,331
NET CASH OUTFLOW FROM FINANCIAL INVESTMENT		(3,687)			(24,095)
EQUITY DIVIDEND PAID		(4,130)			(430)
NET CASH OUTFLOW BEFORE FINANCING		(6,959)			(20,047)
FINANCING
Shares repurchased	(6,037)			(10,561)
Loans drawn down (note 7)	-			50,000
NET CASH (OUTFLOW)/INFLOW FROM FINANCING		(6,037)			39,439
(DECREASE)/INCREASE IN CASH		(12,996)			19,392

RECONCILIATION OF NET CASH FLOW TO MOVEMENT IN NET DEBT
(Decrease)/increase in cash for period		(12,996)			19,392
Net cash inflow from bank loans (note 7)		-			(50,000)
MOVEMENT IN NET DEBT IN PERIOD		(12,996)			(30,608)
NET (DEBT)/FUNDS AT 1 JANUARY		(18,453)			12,155
NET DEBT AT 31 DECEMBER		(31,449)			(18,453)

RECONCILIATION OF NET RETURN BEFORE FINANCE COSTS AND TAXATION TO NET CASH INFLOW FROM OPERATING ACTIVITIES
Net return on ordinary activities before finance costs and taxation		143,312			(119,532)
(Gains)/losses on investments		(139,718)			126,592
Currency gains		(311)			(54)
Amortisation of fixed interest book cost		(5)			148
Changes in debtors and creditors		225			(976)
Income tax suffered		(1)			(4)
Overseas tax suffered		(84)			(136)
Realised currency profit		311			54
NET CASH INFLOW FROM OPERATING ACTIVITIES		3,729			6,092

NOTES

1.		The financial statements for the year to 31 December 2009 have been prepared on the basis of accounting policies which are consistent with those set out in the Company's Annual Financial Statements at 31 December 2008. The Directors consider the Company's functional currency to be sterling as the Company's shareholders are predominantly based in the UK and the Company is subject to the UK's regulatory environment.
2.		Related party transactions The Directors' fees for the year are detailed in the Directors' Remuneration Report contained within the Annual Report. No Director has a contract of service with the Company. During the year no Director was interested in any contract or other matter requiring disclosure under the Companies Act 2006. Herald Investment Management Limited is appointed as investment manager under a management agreement which is terminable on twelve months' notice. Their fee is calculated on a monthly rate of 0.08333% of the Company's net asset value based on middle market prices. The management fee is levied on all assets except the holding in Herald Ventures II Limited Partnership managed by Herald Investment Management Limited.
			31 December 2009 £'000		31 December 2008 £'000
3.	Income
	Income from investments and interest receivable		6,051		7,597
	Other income		26		32
			6,077		7,629

4.	VAT Recovered In 2007 the European Court of Justice ruled that investment management fees should be exempt from VAT. During the year, HMRC has accepted the Manager's repayment claims for the period from 1994 to 1996. £292,000 of VAT together with £171,000 of interest was reimbursed to the Company in respect of this period and recognised in the current year. In the year to 31 December 2008, £2,506,000 of VAT together with £370,000 of interest was received by the Company in respect of the repayment claims for the period from 2001 to 2007.
			31 December 2009 £'000	31 December 2008 £'000
5.	Net return per ordinary share
	Revenue return		324	4,742
	Capital return		140,029	(126,538)
	Total return		140,353	(121,796)

	Net return per Ordinary share is based on the above totals of revenue and capital and on 82,397,262 Ordinary shares (2008 - 84,885,186) being the weighted average number of Ordinary shares in issue during the year. There are no dilutive or potentially dilutive shares in issue.

NOTES (Ctd)

			31 December				31 December
			2009		2008		2009 £'000		2008 £'000
6.	Dividends

	Amounts recognised as distributions in the period:
	Previous year's final (paid 30 April 2009)		5.00p		0.50p		4,130		430

	Set out below are the total dividends payable in respect of the financial year, which is the basis on which the requirements of Section 842 of the Income and Corporation Taxes Act 1988 are considered. The revenue available for distribution by way of dividend for the year ended 31 December 2009 is £324,000 (2008 - £4,742,000).
	Dividends paid and proposed in the period:
	Proposed final dividend per Ordinary share	0.30p		1.55p		243		1,293
	Proposed special dividend per Ordinary share^#	-		3.45p		-		2,877
		0.30p		5.00p		243		4,170
	Adjustment to provision for 2008 final dividend re shares bought back					-		(40)
						243		4,130

	The current year's proposed dividends will be paid on 29 April 2010 to all shareholders on the register at the close of business on 9 April 2010. The ex-dividend date is 7 April 2010.
	^#In 2008 the special dividend of 3.45p represented the recovery of VAT from HMRC (see note 4).
7.	The Company has a £75 million multi-currency variable rate loan facility with The Royal Bank of Scotland plc, which comprises three £25 million tranches expiring on 31 May 2010, 2011 and 2013. At 31 December 2009, there were outstanding drawings of £50 million (2008 - £50 million). Interest on the loans is payable in quarterly instalments in January, April, July and October. A non-utilisation fee of 0.30% is payable on the £25 million undrawn. The estimated repayment value of the loan at 31 December 2008 was £50 million. The indicative costs of repaying the loan as at 31 December 2009 were not material in the context of the above figures. The interest on £50 million of this facility has been fixed for the long term through a 30 year interest rate swap but may vary on periodic renewals of the debt facility to the extent that the mark up over LIBOR charged by a lending bank varies. The fair value of the interest rate swap contract at 31 December 2009 was an estimated liability of £6 million (2008 - £15 million) which was based on the marked to market value.
8.	At the Annual General Meeting in April 2009, Shareholders granted the Company authority to purchase shares in the market up to 12,382,957 Ordinary shares (equivalent to 14.99% of its issued share capital at that date). In the year to 31 December 2009, a total of 2,354,840 (2008 - 3,562,887) Ordinary shares with a nominal value of £588,710 (2008 - £890,722) were bought back at a total cost of £6,037,000 (2008 - £10,561,000). At 31 December 2009 the Company had authority to buy back a further 10,828,117 Ordinary shares. Under the provisions of the Company's Articles share buy-backs are funded from the capital reserve. The Company does not have any externally imposed capital requirements.
9.	During the period transaction costs on purchases amounted to £339,000 (2008 - £546,000) and transaction costs on sales amounted to £141,000 (2008 - £189,000).
10	The financial information set out above does not constitute the Company's statutory accounts for the year ended 31 December 2009. The financial information for 2008 is derived from the statutory accounts for 2008 which have been delivered to the Registrar of Companies. The Auditors have reported on the 2008 accounts, their report was unqualified and did not contain a statement under section 237(2) or (3) of the Companies Act 1985. The audit report for the financial statements for the year ended 31 December 2009 has yet to be signed but it is expected that the statutory accounts for 2009 will be finalised on the basis of the financial information presented in this preliminary announcement and will be delivered to the Registrar of Companies following the Company's Annual General Meeting.

NOTES (Ctd)

The Report and Accounts for the year ended 31 December 2009 will be available on the Managers' website www.heralduk.com on or around 11 March 2010.

None of the views expressed in this document should be construed as advice to buy or sell a particular investment.

This information is provided by RNS

The company news service from the London Stock Exchange

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DISTRIBUTION OF ASSETS

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PRINCIPAL RISKS AND UNCERTAINTIES

STATEMENT OF DIRECTORS' RESPONSIBILITIES

INCOME STATEMENT

BALANCE SHEET

RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' FUNDS

SUMMARISED CASH FLOW STATEMENT

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