Monthly Commentary
October 2017

Market Review

Equities continued their strong run during October with returns aided by a modest recovery in the British Pound, the FTSE World Index rising 2.9% (in GBP terms) during the month. Equity markets across the globe participated in the positive move for risk assets, although Japan was a stand out as the Nikkei Index gained +8.1% in local terms following Prime Minister Abe’s election victory. The S&P 500 Index has now delivered a positive total return every month during 2017 – the first time that this has happened in over ninety years, according to Deutsche Bank. The run now extends to 12 consecutive months in total and highlights the remarkably low volatility witnessed in recent times. 

Macroeconomic data continues to come in-line to above expectations, providing a robust tailwind to global growth. In the US third-quarter (Q3) GDP positively surprised at a 3.0% annualised rate, which when combined with the Q2 rate of 3.1% marks the strongest consecutive set of quarters since 2014. In Europe Q3 GDP was also higher than expected at +0.6% quarter-on-quarter which was the strongest quarter of growth since 2011. The Eurozone Manufacturing PMI printed at 58.6 and marked a new ten-year high while the Eurozone Services PMI came in below expectations but remained at a healthy 54.9 indicating continued economic expansion in the service sector.

It was the European Central Bank’s (ECB) turn to take centre stage in October. As expected it announced a tapering by slowing asset purchases from €60bn to €30bn from January 2018 but left the finish date for quantitative easing (QE) open-ended with assurances that asset purchases will not stop suddenly, which was received positively by equity markets. While the next several ECB meetings are now likely to be uneventful, the same is not true of the US Federal Reserve who are expected to raise rates once again this year at their upcoming December meeting. 

Technology Review

The technology sector strongly outperformed the broader market, the Dow Jones World Technology Index TR gaining 8.2% (in GBP terms) during the month. The semiconductor sub-sector once again impressed with a return of +8.9% as measured by the Philadelphia Semiconductor (SOX) Index. The return to form of the mega-cap companies aptly summarises Q3 earning season-to-date, many of which experienced explosive one day moves post earnings. This has seemingly lifted sentiment for the whole technology sector where we have witnessed positive share price moves for both next generation growth companies alongside some incumbent/value names.

In Internet, the bellwethers shared a common theme of accelerating top-line revenue growth that surprised investors. Alphabet (aka Google) delivered revenue growth of +24% year-on-year (yoy), exceeding expectations with both Google sites and Network revenues contributing to the beat. The strong revenue growth was accompanied by expanding operating margins which helped neutralise the headwinds arising from increasing traffic acquisition costs (TAC).   Paypal* also continued its run of solid beat and raise quarters. Continued improvements were shown again in all engagement metrics, while mobile as a percentage of Total Payment Volume ticked up to 35% in Q3. The acceleration in net new active accounts to a gain of +8.2m over the quarter was particularly impressive.

Amazon* produced a consensus beat on both revenues and earnings. Impressively, North American Retail grew +28% yoy (ex-Whole Foods) while International Retail grew +29% yoy. Contributing factors to the retail strength were a very strong Prime day and an earlier than usual Diwali holiday in India. Additionally, its Cloud business AWS held its growth rate at +42% yoy and reversed the margin fall from last quarter. Although overall operating margins continue to show the impacts of Amazon investing for growth, operating income beat lowered expectations. Importantly, fourth-quarter operating income guidance was above expectations, easing concerns Amazon may be on the cusp of another US investment cycle following the Whole Foods acquisition.

In software Microsoft* beat significantly on revenue, earnings and cashflow. Commercial Cloud gross margins improved +800bps yoy as the benefits of the Azure business maturing are starting to be seen. Azure revenues grew +89% yoy, Office 365 Commercial revenue +42% yoy and Dynamics 365 +69% highlighting several strong growth areas within the organisation.  ServiceNow* delivered a strong quarter with total billings and subscription billings beating expectations.  Proofpoint* posted a solid quarter, beating across all key metrics including billings and free cash flow (FCF), although this was slightly offset by what appears a conservative but not unusual first guide for 2018 of 27% revenue growth.

The semiconductor and semiconductor equipment sector experienced another strong quarter of earnings which was reflected in the robust performance of the SOX index. Intel** delivered a beat and raise, aided by improved execution within its Data Center Group and lower Opex. However, we remain zero-weighted in the name and were surprised by the magnitude of the post-earnings stock move given that much of the upside came from the PC and ‘other’ segments. Meanwhile, Xilinx* produced an in-line quarter which included guidance ahead of consensus as strength in industrial and auto end markets continued, although communication infrastructure remains soft. ASML* delivered a strong quarter across all metrics with the absence of any new EUV equipment orders the only blemish.

Unfortunately, our position in Advanced Micro Devices* disappointed despite posting an in-line quarter as management guided to softer crypto-currency related demand and a lack of gross margin progress for Q4. We still expect multiple new product ramps to fuel market share gains in the coming quarters for both CPUs and GPUs. Encouragingly during the quarter, Baidu, Microsoft Azure, and Tencent all announced plans to deploy EPYC-based server products into their hyperscale environments, and Hewlett Packard Enterprise and Dell plan to bring EPYC-based platforms to market in Q4. 

Dolby* produced a mixed earnings report with a beat on EPS but a miss on revenue expectations. Forward guidance further disappointed due to a modest growth outlook for the legacy segments, however new initiatives such as Dolby Vision, Dolby Voice and Dolby Cinema continue to gain momentum and we anticipate these businesses will reach credible scale in 2018.  

Outlook

Despite the recent central bank tapering announcements, we continue to believe that the current investment backdrop remains unique, with accommodative policy and the prevailing rate of inflation supportive of current equity valuations. Post month-end, the nomination of Jay Powell to the position of Federal Reserve chair – a centrist said to agree with Janet Yellen’s dovish approach to interest rates and unwinding the Fed’s balance sheet – was supportive of the idea of gradualism. Likewise, the recent interest rate hike by the Bank of England (BoE) – its first in more than a decade – was accompanied by notably dovish commentary, with minutes from the MPC’s meeting indicating that the central bank was in “no hurry to raise interest rates again and that further increases will be limited”[i]. Akin to arriving late to a party to much fanfare only to announce that you won’t be staying long, the 25bps BoE hike led to a sharp reversal in Sterling as markets pushed out the next expected rate rise to August 2018[ii]. In the absence of an inflation shock (we remain focused on ten-year US Treasury yields and TIPS spreads as indicators most likely to herald a change in investment backdrop) we expect policymakers to continue to tread carefully on the path of normalisation, reflecting a recovery that while broadening, remains shallow.

Fortunately, for now we remain in a so-called Goldilocks scenario where growth is ‘just right’ – strong enough to allow corporates to deliver earnings progress but insufficient to feed through into prices. In addition to these favourable economic conditions we continue to find ourselves in a period of extremely low levels of volatility, reflected by the VIX index that continues to hover around the 10 level. Against this backdrop we remain near fully invested (with most of our current cash required to offset our AMD and Apple delta adjusted call option exposure), a position further supported by strong next-generation results thus far during third-quarter earnings season.

While equity markets have experienced strong year-to-date gains, we remain constructive and continue to see significant opportunities within the technology sector for 2018. In contrast, many commentators instead remain focused on the downside risks associated with our sector while some believe technology stocks are in the midst of another bubble. Our sense is that the 1990s parallel is too easy, while over-exuberance appears contained to a few emerging areas (such as cryptocurrencies/blockchain) where remarkable returns have been driven by the long-term promise of technologies that remain nascent today. Rather than signalling a return to bubble-like conditions, we see this excitement as normal fare for a sector where adoption often resembles Gartner’s hype-cycle where heightened expectations are usually followed by disillusionment as mainstream adoption takes much longer than originally forecast.

Underpinning our own excitement is a new cycle thesis that appears to be gathering strength with every earnings season, with a growing divergence between incumbents and next-generation companies now that the Cloud has become the default computing platform. This bifurcation is likely to intensify from here as workloads continue to gravitate towards the public cloud, while emerging technologies such as artificial intelligence (AI) – where the Internet platforms enjoy a leadership position – are likely to accelerate this trend. As such, we believe our jaundiced view of the value of incumbency is likely to continue to be rewarded as these growth-challenged winners of yesterday struggle to meet expectations, maintain margins and engage in greater M&A in order to remain relevant.

More than half of the team are currently away at overseas conferences and feedback from company meetings remains supportive. I have also just returned from Gartner’s annual symposium held in Barcelona and was struck by the uptick in urgency on the part of IT leaders (CIOs) to transform themselves into ‘digital’ companies. This likely reflects the accelerated pace of disruption occurring across a myriad of sectors fuelled by transformational technologies including cloud computing, smartphones, the Internet of Things and artificial intelligence. While Amazon’s disruption of retail is well documented (and ongoing), many other industries are also being reshaped with new winners emerging. AI is likely to accelerate this further, driven by a million-fold improvement in massively parallel hardware between 2008-2016 and plentiful data to train deep neural networks. This is likely to open up a plethora of new opportunities for technology reinvention, particularly where machines prove able to automate tasks previously carried out by humans.

As such our longer-term confidence is grounded not in the macro but in a new cycle thesis we first articulated almost a decade ago, driven by a belief that the Internet would reorder the technology landscape.  If our thesis is indeed playing out, it should provide a multi-year tailwind for our growth centric investment approach at a time when technology indices may be weighed down by smartphone maturity and exposure to legacy technologies. We remain excited by 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. 

Ben Rogoff

* Held 

** Not held 

[i] Financial Times

[ii] http://www.telegraph.co.uk/business/2017/11/02/markets-await-first-bank-england-interest-rate-rise-decade/

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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