Monthly Commentary
June 2017

Market Review

While equity markets edged higher in June, US Dollar weakness left the FTSE World Index -0.6% lower in Sterling terms. Although the global economic backdrop appears robust, US data remained mixed during the month. It therefore surprised some to see a 25bp hike in the Fed Funds rate and commentary from the Federal Reserve laying out a framework for normalisation of the Fed’s balance sheet (unwinding of QE).  That said, whilst first-quarter GDP was weak (+1.2%) the expectation is that second-quarter GDP should be stronger (+2.7%, according to the Atlanta Fed).  Retail sales, auto/housing, industrial production and economic surprise data has certainly been lacklustre but other factors such as employment, ISM surveys, SMB confidence and seasonality suggest a pickup is likely in the second-half of the year. This expectation likely explained the muted reception to a softer-than expected non-farm payroll report (NFP) (138,000 jobs created versus 185,000 expected), aided by  unemployment at 4.3% (a 16 year low) and average hourly earnings which increased by 0.2% (supportive and not indicative of inflationary pressures).

UK elections stole the spotlight during the month with Theresa May’s Conservative government losing its majority in UK elections. Intended to strengthen the government’s Brexit negotiating position the result instead weakened it, forcing an uneasy alliance (‘confidence and supply’) with the DUP. Despite new uncertainty in the UK, Europe appears on much firmer footing following the decisive victory of pro-EU centrist Emmanuel Macron in recent French Presidential elections. With the European recovery continuing to broaden, it seems likely that 2018 will mark the end of QE and the commencement of interest rate hikes, a view supported by recent commentary from ECB President Mario Draghi who referred to an “upbeat” outlook for both growth and inflation in the region. As such it seems likely that monetary policy will continue to tighten in both the US and Eurozone in 2018. This realisation saw ten-year US Treasury yields rebound from recent lows, a trend that continued into July. In contrast, Brent Crude oil fell by 4.5% during the month which we believe reflects supply/inventories rather than demand weakness. Previous Dollar strength continued to unwind, the trade-weighted basket falling a further 1.3% during the month. 

Technology Review

June marked a lacklustre end to a strong first-half of 2017 for the technology sector and the Trust, although the Trust NAV outperformed its benchmark, falling 1.6% versus the Dow Jones World Technology Index TR which fell 2%.  Over the first half, returns were much stronger with the Trust NAV rising 19.3%, outperforming its benchmark by c.500bps, while the sector delivered significant outperformance versus both US and global equities. Technology underperformance during the month was part of a broader market rotation away from growth into value (likely linked to bond market weakness) and the EU decision to fine Google €2.42 billion for allegedly breaking competition law. 

Although June is generally a quiet month for earnings ahead of second-quarter (Q2) reporting season, which gets underway in mid-July, those that did report were generally positive, especially in the software space.  RedHat* beat expectations and raised guidance with mid-teens billings growth even after adjusting for FX movements and contract durations. Adobe* also reported a strong quarter with revenue +27% year-on-year (y/y) and Digital Media annual recurring revenue (ARR) beating expectations. Oracle ** also beat expectations as legacy database license declines slowed to -4% y/y (from -15% y/y in the prior quarter) helped by a new 12C/R2 database release which, along with solid Cloud growth, drove EPS + 10% y/y.  Next generation software stocks Palo Alto Networks** and Workday** also reported solid quarters. Optical related stocks fared well with a strong quarter from Ciena**, while a weak quarter from Finisar** was accompanied by an upbeat outlook.

There were also a few disappointments, although most had limited direct or indirect impact on our portfolio. While Accenture** reported a small revenue beat, disappointing guidance reflected softer US financial and healthcare spending (the latter tied to policy uncertainty).  Hewlett Packard** disappointed on server/storage demand and margin pressure due to memory price increases (the reason why we are currently running such a large Samsung position). The one disappointment which did impact the Fund was Cloudera*, a recent IPO and new addition to our portfolio which reported a solid first-quarter with revenue and guidance well ahead of consensus, marred by disappointing billings growth which management explained as being tied to deal timings, which can cause quarterly fluctuations.

However, the most significant technology news during the quarter was related to Amazon* which announced the US$13.7bn acquisition of high-end retailer Whole Foods – an aggressive move into groceries which led to pronounced stock price weakness at a number of traditional retailers. In addition, the company introduced Amazon Wardrobe which offers free delivery and returns for Prime subscribers on up to 15 items of clothing with 10%+ discounts if you keep 3-4 items.  Why now?  We believe advances in machine vision/sensors, artificial intelligence and scale is enabling Amazon to extend its dominance of ecommerce into traditional retail. We see clothing and groceries as just the start of a wider transformation.  In short, almost every industry will be disrupted by the combination of automation/robotics/sensors and artificial intelligence (AI) over coming years. We expect Amazon and Google to play leading roles in this transformation and many of our other holdings to be direct beneficiaries of it.

In other news, Paul Johnson attended the E3 gaming conference in Los Angeles which left him and others impressed with the quality of the game pipeline over the coming months and years.  AMD* launched its long awaited EPYC server CPU chipset and Vega Frontier Edition GPU for the data centre market.  Early endorsements for EPYC from public cloud players such as Microsoft and Baidu, along with OEM’s such as Dell, Hewlett Packard and Apple (on the GPU) suggest AMD remains very well placed for share gains against both Nvidia* and Intel** over the next eighteen months explaining our outsized position. We also increased our exposure to Nintendo due to favourable reviews and strong demand for its new Switch product.  We reduced our Criteo exposure on the back of Apple’s worldwide developer conference (WWDC) where they announced a new intelligent ad blocking solution for Safari. We still see Criteo as well placed but see some near-term headwinds as they adjust to this new technology. 

Outlook

Although equity markets have enjoyed a strong start to 2017, we are hopeful they can add to their gains during the second-half of the year. While valuations have trended higher, the investment backdrop remains favourable and the prevailing inflation rate remains broadly supportive of current equity valuations. That said, we expect equity returns to become increasingly dependent on underlying earnings (which should suit our growth-centric approach). Fortunately, the US is experiencing its fastest pace of earnings growth in five years with S&P 500 earnings forecast to increase 10% this year, with potentially more to come in 2018 if the new Administration delivers on its tax reform pledge. While investor focus remains on downside risks associated with above-average valuations, full employment and the duration of the current bull market, we feel there remains significant upside risk too, not least because bull markets tend to go out with a bang not a whimper!

We remain focused on US bond yields as an imperfect proxy for growth and/or inflation expectations, particularly now that the US is rolling back some of its earlier accommodation and the market is anticipating similar action from the ECB and BOE. While we do not currently expect yields to retest US election highs, the second-half of the calendar year has begun with an echo of the earlier so-called Trump-trade. Having performed strongly so far this year (and with the EU/Google fine an additional catalyst) we understand why investors may be tempted to lock in some gains. However, while we may have to weather some volatility tied to such another growth/value rotation, we are not changing tack. Instead, we believe inflation (and inflation expectations) remain well contained which, together with softer oil prices, mean that any significant move in US bond yields would likely reflect an improving economic outlook which will be welcomed by most of our companies. It could also mark the end of the most remarkable bond bull market and a potential ‘Great Rotation’ (from bonds to equities). While our sector may lag more cyclical sectors in this scenario, we would still expect it to deliver strong absolute returns.

As such, recent technology underperformance is best understood as profit-taking and part of an adverse rotation that may or may not persist. However, we strongly reject any comparison between today and the late 1990s technology bubble. Unlike the earlier period when the forward PE of the sector peaked at 48x in March 2000, this time our sector’s progress has been primarily driven by earnings. For instance, Alphabet has seen its earnings per share increase 23-fold while its stock has increased 12-fold since its IPO. Likewise Texas Instruments** recently revisited its 2000 share price high with earnings expected to exceed US$4 in 2017 as compared to 90c in FY99. However, Amazon’s recently announced acquisition of Whole Foods is perhaps the best example of why we believe the 1990s parallel is too easy and ultimately fallacious. At the height of the Dotcom bubble, America Online (AOL) – then the world’s leading Internet Service Provider (ISP) acquired the venerable Time Warner for US$182bn. At the time, AOL boasted revenues of US$4.8bn, 20m (most narrowband) subscribers and a market capitalisation of US$163bn. While the market cap of Amazon (US$480bn) and the US$13.7bn purchase of a ‘bricks and mortar’ company by an online leader may rhyme with the late 1990s, Amazon today has 28x more revenues and 15x the user base than AOL at its peak. Most telling is that AOL used stock to fund its deal which subsequently fell almost 90% over the coming years as the Internet bubble burst and AOL’s business model imploded. In contrast, and in a sign of how far the Internet has come since the late 1990s, Amazon is paying cash.

As usual we took advantage of the time between earnings seasons to get out and visit companies, the team meeting with well over 100 companies during the month.  The feedback from these meetings was very similar to those earlier in the year with management teams optimistic about their growth outlook, aided by a robust/potentially improving economic backdrop. This, together with strong off-quarter reports suggests that second-quarter earnings season should prove supportive to our overall thesis. To recap, we continue to focus on eight core secular themes which include eCommerce and digital payments, digital marketing and advertising, cyber and physical security, Cloud computing and artificial intelligence (AI), software as a service (SaaS), digital content and gaming, robotics and automation and rising semiconductor complexity. We are also fascinated by artificial intelligence (AI) and machine learning (ML) which offer the potential to further reshape the technology landscape over the coming years. The next two weeks of ‘pre-announcement season’ can often be testing (because news flow is usually skewed to the downside) and there may be further volatility linked to bond market gyrations. However, we remain fairly fully invested, excited about the portfolio and a buyer of any pre-announcement season related weakness should it materialise. 

Ben Rogoff

* Held 

** Not held 

Disclaimer

Important Information: This document is provided for the sole use of the intended recipient and is not a financial promotion. It shall not and does not constitute an offer or solicitation of an offer to make an investment into any Fund or Company managed by Polar Capital. It may not be reproduced in any form without the express permission of Polar Capital and is not intended for private investors. This document is only made available to professional clients and eligible counterparties. The law restricts distribution of this document in certain jurisdictions; therefore, it is the responsibility of the reader to inform themselves about and observe any such restrictions. It is the responsibility of any person/s in possession of this document to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. Polar Capital Technology Trust plc is an investment company with investment trust status and as such its ordinary shares are excluded from the FCA’s (Financial Conduct Authority’s) restrictions which apply to non-mainstream investment products. The Company conducts its affairs and intends to continue to do so for the foreseeable future so that the exclusion continues to apply. It is not designed to contain information material to an investor’s decision to invest in Polar Capital Technology Trust plc, an Alternative Investment Fund under the Alternative Investment Fund Managers Directive 2011/61/EU (“AIFMD”) managed by Polar Capital LLP the appointed Alternative Investment Manager. In relation to each member state of the EEA (each a “Member State”) which has implemented the AIFMD, this document may only be distributed and shares may only be offered or placed in a Member State to the extent that (1) the Fund is permitted to be marketed to professional investors in the relevant Member State in accordance with AIFMD; or (2) this document may otherwise be lawfully distributed and the shares may otherwise be lawfully offered or placed in that Member State (including at the initiative of the investor). As at the date of this document, the Fund has not been approved, notified or registered in accordance with the AIFMD for marketing to professional investors in any member state of the EEA. However, such approval may be sought or such notification or registration may be made in the future. Therefore this document is only transmitted to an investor in an EEA Member State at such investor’s own initiative. SUCH INFORMATION, INCLUDING RELEVANT RISK FACTORS, IS CONTAINED IN THE COMPANY’S OFFER DOCUMENT WHICH MUST BE READ BY ANY PROSPECTIVE INVESTOR.

Statements/Opinions/Views: All opinions and estimates constitute the best judgment of Polar Capital as of the date hereof, but are subject to change without notice, and do not necessarily represent the views of Polar Capital. This material does not constitute legal or accounting advice; readers should contact their legal and accounting professionals for such information. All sources are Polar Capital unless otherwise stated.

Third-party Data: Some information contained herein has been obtained from third party sources and has not been independently verified by Polar Capital. Neither Polar Capital nor any other party involved in or related to compiling, computing or creating the data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any data contained herein. 

Holdings:  Portfolio data is “as at” the date indicated and should not be relied upon as a complete or current listing of the holdings (or top holdings) of the Company. The holdings may represent only a small percentage of the aggregate portfolio holdings, are subject to change without notice, and may not represent current or future portfolio composition. Information on particular holdings may be withheld if it is in the Company’s best interest to do so. It should not be assumed that recommendations made in future will be profitable or will equal performance of the securities in this document.  A list of all recommendations made within the immediately preceding 12 months is available upon request.  This document is not a recommendation to purchase or sell any particular security.  It is designed to provide updated information to professional investors to enable them to monitor the Company.

Benchmarks: The following benchmark index is used: Dow Jones World Technology Index (Total Return). This benchmark is generally considered to be representative of the Technology Equity universe. This benchmark is a broad-based index which is used for comparative/illustrative purposes only and has been selected as it is well known and is easily recognizable by investors. Please refer to www.djindexes.com for further information on this index. Comparisons to benchmarks have limitations as benchmarks volatility and other material characteristics that may differ from the Company. Security holdings, industry weightings and asset allocation made for the Company may differ significantly from the benchmark. Accordingly, investment results and volatility of the Company may differ from those of the benchmark. The indices noted in this document are unmanaged, are unavailable for direct investment, and are not subject to management fees, transaction costs or other types of expenses that the Company may incur. The performance of the indices reflects reinvestment of dividends and, where applicable, capital gain distributions. Therefore, investors should carefully consider these limitations and differences when evaluating the comparative benchmark data performance. Information regarding indices is included merely to show general trends in the periods indicated, it is not intended to imply that the Company was similar to the indices in composition or risk.

Regulatory Status: Polar Capital LLP is a limited liability partnership number OC314700. It is authorised and regulated by the UK Financial Conduct Authority (“FCA”) and is registered as an investment adviser with the US Securities & Exchange Commission (“SEC”). A list of members is open to inspection at the registered office, 16 Palace Street, London, SW1E 5JD. FCA authorised and regulated Investment Managers are expected to write to investors in funds they manage with details of any side letters they have entered into. The FCA considers a side letter to be an arrangement known to the Investment Manager which can reasonably be expected to provide one investor with more materially favourable rights, than those afforded to other investors. These rights may, for example, include enhanced redemption rights, capacity commitments or the provision of portfolio transparency information which are not generally available. The Company and the Investment Manager are not aware of, or party to, any such arrangement whereby an investor has any preferential redemption rights. However, in exceptional circumstances, such as where an investor seeds a new fund or expresses a wish to invest in the Company over time, certain investors have been or may be provided with portfolio transparency information and/or capacity commitments which are not generally available. Investors who have any questions concerning side letters or related arrangements should contact the Polar Capital Desk at the Registrar on 0800 876 6889. The Company is prepared to instruct the custodian of the Company, upon request, to make available to investors portfolio custody position balance reports monthly in arrears.

Information Subject to Change: The information contained herein is subject to change, without notice, at the discretion of Polar Capital and Polar Capital does not undertake to revise or update this information in any way.

Forecasts: References to future returns are not promises or estimates of actual returns Polar Capital may achieve. Forecasts contained herein are for illustrative purposes only and does not constitute advice or a recommendation. Forecasts are based upon subjective estimates and assumptions about circumstances and events that have not and may not take place. 

Performance/Investment Process/Risk: Performance is shown net of fees and expenses and includes the reinvestment of dividends and capital gain distributions. Factors affecting the Company’s performance may include changes in market conditions (including currency risk) and interest rates and in response to other economic, political, or financial developments. The Company’s investment policy allows for it to enter into derivatives contracts. Leverage may be generated through the use of such financial instruments and investors must be aware that the use of derivatives may expose the Company to greater risks, including, but not limited to, unanticipated market developments and risks of illiquidity, and is not suitable for all investors. Those in possession of this document must read the Company’s Investment Policy and Annual Report for further information on the use of derivatives.  Past performance is not a guide to or indicative of future results. Future returns are not guaranteed and a loss of principal may occur. Investments are not insured by the FDIC (or any other state or federal agency), or guaranteed by any bank, and may lose value. No investment process or strategy is free of risk and there is no guarantee that the investment process or strategy described herein will be profitable.

Allocations: The strategy allocation percentages set forth in this document are estimates and actual percentages may vary from time-to-time. The types of investments presented herein will not always have the same comparable risks and returns. Please see the private placement memorandum or prospectus for a description of the investment allocations as well as the risks associated therewith. Please note that the Company may elect to invest assets in different investment sectors from those depicted herein, which may entail additional and/or different risks. Performance of the Company is dependent on the Investment Manager’s ability to identify and access appropriate investments, and balance assets to maximize return to the Company while minimizing its risk. The actual investments in the Company may or may not be the same or in the same proportion as those shown herein. 

Country Specific disclaimers: The Company has not been and will not be registered under the U.S. Investment Company Act of 1940, as amended (the "Investment Company Act") and the holders of its shares will not be entitled to the benefits of the Investment Company Act. In addition, the offer and sale of the Securities have not been, and will not be, registered under the U.S. Securities Act of 1933, as amended (the "Securities Act"). No Securities may be offered or sold or otherwise transacted within the United States or to, or for the account or benefit of U.S. Persons (as defined in Regulation S of the Securities Act). In connection with the transaction referred to in this document the shares of the Company will be offered and sold only outside the United States to, and for the account or benefit of non U.S. Persons in "offshore- transactions" within the meaning of, and in reliance on the exemption from registration provided by Regulation S under the Securities Act. No money, securities or other consideration is being solicited and, if sent in response to the information contained herein, will not be accepted. Any failure to comply with the above restrictions may constitute a violation of such securities laws.

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Important Legal Information

Launched in 1996, Polar Capital Technology Trust plc (“PCT”) has grown to become a leading European investor with a multi-cycle track record. Managed by a team of dedicated technology specialists, the PCT aims to maximise long-term capital growth by investing in a diversified portfolio of technology companies from around the world. The managers’ core belief in rigorous fundamental analysis, and being unconstrained by not following a benchmark, enables PCT to deliver global equity market outperformance through exposure to a universe of over 3,000 companies.

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