Monthly Commentary
February 2017

Market Review

Equity markets made further gains in February; the FTSE World Index increased 3.9% (in GBP terms). Volatility remained subdued and markets ground higher, supported by robust economic data. The US economy is performing well: the New York Federal Reserve’s real-time estimates suggest 3.1% GDP growth in Q1 and consumer prices are rising at the fastest rate since 2012 whilst small business optimism and hiring intentions have spiked sharply (NFIB surveys at 12-year highs). As a result, the US Federal Reserve is taking an increasingly hawkish tone. FOMC Vice Chair Bill Dudley summarised “the case for monetary tightening has become a lot more compelling”. Financial markets moved to reflect this – the implied probability of a March rate hike has increased from 50% to 90%. Economists now estimate this may be the first of three or four rate hikes this year. The US Dollar rose 1.6% in the month.

Global economic data was also robust. The JP Morgan Global PMI rose for a fifth consecutive month and hit a 22-month high in January. Economic expansion was fastest in developed markets as the pace of Eurozone growth picked up. February saw the largest monthly rise in Eurozone employment since 2007, and the Markit flash PMI hit 56, the highest since April 2011. Chinese economic data remains harder to read. While China’s composite PMI fell, corporate business confidence hit its highest level in a year, suggesting that the recent slowdown may only be temporary. January’s new loans in China were the second highest ever at 2.03 trillion Yuan while new data showed that Chinese bank assets grew 15.8% in 2016 (to 312% of GDP).   

US reporting season is now largely complete, with both revenues and profits coming in modestly ahead of expectations. Donald Trump reminded investors that tax reform is still on the table, announcing that he would announce something ‘phenomenal’ in the next two or three weeks whilst he is also expected to sign an executive order that could lead to an uplift in cybersecurity spend.

Technology Review

The technology sector outperformed during February, the Dow Jones World Technology Index rising 5.3% (in GBP terms). Sector strength was broad-based, with both next-generation stocks and legacy names performing well. Apple, the world’s largest company by market-cap, was a particular outlier, rising 13% in the month. Investors have begun to speculate on the potential new features in the iPhone 8 (or iPhone X as it may be called) and are anticipating another large upgrade cycle. A glass/aluminium chassis, OLED screen, wireless and rapid charging, 3D sensing, facial recognition and potential augmented reality (AR) are all being touted as possible features in Apple’s tenth anniversary edition with the highest specification device expected to price at over US$1000. Morgan Stanley speculated on a so-called iPhone super-cycle and raised their FY 2018 iPhone unit forecasts to +21% year-over-year (y/y) unit growth. Unsurprisingly Apple’s supply chain rallied amid the excitement of this major re-platforming. Fortunately, as discussed last month, we had pre-empted this and increased our Apple exposure via common equity, and also an out of the money call option position which had a notable positive impact on performance during the month.

February was another excellent month for next-generation technology fundamentals. Amazon won FastCompany’s most innovative company of 2017 with Jeff Bezos cooing ‘I have the best job in the world because I get to work in the future’. He highlighted Amazon’s focus on streaming, saying ‘our customers listen to a lot of music and we have a couple of freight trains kind of pulling the business along. One is Prime and the other is Echo and Alexa. It was revealed that Amazon is in early discussion to launch a paid channel to rival HBO, while Amazon Studios won its first Oscar as Manchester by the Sea scooped the top prizes for best actor and best original screenplay. Meanwhile, as Amazon’s Go concept-store continues to send ripples across traditional retail, Jeff Bezos was forced to deny an article which claimed that a planned two story supermarket may be staffed by as few as three on site personnel. Most importantly, Amazon reported strong quarterly results, with AWS its cloud computing business growing at a healthy 47% (impressive given its annualised US$14bn run rate). It is no wonder legacy IT providers are struggling with cloud deflation with Amazon, Microsoft, Google and Alibaba all offering computing on demand, at circa a fraction of the total cost of ownership (TCO) of traditional on-premise architectures.

Amazon is not alone in reshaping (digital) media consumption. Netflix beat expectations with c.93million+ subscribers – making substantial gains in viewership in January – its audiences were 38% above the average of 2016. Music streaming leader and IPO candidate Spotify hit 50million subscribers in February. Facebook is in talks to live-stream one major league baseball game a week next season, Mark Zuckerberg sharing his view that video is a ‘megatrend’. He also wrote a new mission statement for the company, calling for Facebook to become a ‘social infrastructure’ for users. Facebook reported excellent results, revenues grew 54% in constant currency as it hit 1.9 billion monthly active users (MAU), 1.23 billiom of whom are daily active users (DAUs). In a sign of strength, for the fifth consecutive quarter both ad impressions and the effective price per ad increased together. Facebook’s WhatsApp hired its first COO, as it starts to monetise its 1 billion+ MAUs. Facebook rival Snapchat came public on a lofty multiple during the month – signalling that the IPO window for next-generation assets is emphatically open. We chose to sidestep the deal because we only participate in a small number of IPOs where we have high conviction.

There was also a significant amount of positive news flow relating to Machine Learning (ML) and Artificial Intelligence (AI) - another theme (like Cloud computing) that we believe will transcend most industries.  In a 20 day competition, an AI developed by Carnegie Mellon University beat four of the best Texas hold’em poker players globally. At the end of the competition Libratus had gained US$1.7m in chips, while all the other players were in negative territory. This victory is another major milestone in AI with implications across technology, both in the short-term (web search, advertising, ecommerce, finance & media, as well as online gambling!) and in the medium/long-term (software, security, medicine, robotics and pretty much every knowledge based industry).  Industry expert and COO of Baidu, Andrew Ng, summed up the growing excitement in an article for the Harvard Business Review, ‘I have a hard time thinking of an industry we cannot transform with AI’. Google has released its production-ready machine learning TenserFlow software while making Nvidia Graphics Processing Units (GPUs) available on its Google Cloud Platform – a move replicated by Amazon leveraging both GPU and Xilinx Field Programmable Gate Arrays (FPGA’s) - enabling users to accelerate a variety of computing and analytical workloads. In its quarterly results, Nvidia announced its data center revenues grew over 200% y/y, driven by the growth in AI and cloud computing.  AMD beat expectations and guided strongly, riding the same secular trend in GPU compute and share-gains from a revitalised Central Processing Unit (CPU) and GPU product roadmap.

February was also a busy month in the payments industry. AppleInsider revealed that Apple Pay is now accepted by 36% of US merchants, while Amazon revealed that its proprietary Amazon Payments service was used by 33 million customers last year (c. 10% penetration of Amazon’s user base). Visa reported strong numbers as core revenues accelerated. Tencent’s WeChat users sent 46 billion digital red packets over Chinese New Year (+43% YoY), a new record. New data from iResearch showed that there were US$4.4 trillion in Chinese mobile payments in 2016, almost 50x more than in the US. Elsewhere in Asia, Softbank announced it has nearly closed its US$100bn tech fund while Samsung scion Jay Y Lee was questioned by investigators in a Korean graft scandal. Despite the noise Samsung’s shares hit an all-time high on strong DRAM/NAND pricing and expectations of a significant ramp in OLED revenue/profitability (tied to the next Apple iPhone).

Small and mid-cap company fundamentals were solid in February. ServiceNow delivered a break-out quarter, as non IT Service Management (ITSM) products inflected higher. New Relic billings grew 33% as it broadened out beyond Application Performance Management (APM). Hubspot, Shopify & Talend all beat and raised, while Zendesk got back on track with a billings reacceleration. Splunk grew revenues 39% and reiterated its US$2bn 2020 revenue target. MindBody delivered strong growth and has begun to position itself to bring significantly greater value to its customers. Two of our smaller holdings in security proved the only weak spot as Palo Alto Networks guided down blaming changes in the sales organisation, and Vasco disappointed (both subsequently sold). Among legacy players, Cisco reported its fifth straight quarter of revenue declines and Intel took a knock as it was revealed that Apple are developing ARM-based chips to work alongside Intel chipsets in their Mac laptop range.

Outlook

In a sign of the times, Lady Gaga used a swarm of drones as her ‘backing’ in her half-time performance at the Super Bowl. New technologies are emerging and being adopted at an ever faster rate. Fourth-quarter earnings season and fundamental data-points in February bore testament to this acceleration in technology proliferation. Winning companies are creating huge value as they ride disruptive technology trends. After years in the wilderness it is becoming increasingly clear that artificial intelligence (AI) and machine learning are emerging as the next great technology platform – they are already beginning to disrupt most industries. One AI expert argued this month that ‘AI is the new electricity’. Tech companies such as Google, Facebook, Microsoft, NVIDIA and Baidu are the early leaders/disruptors – they will continue to reap the benefit of these explosive trends along with others such as AMD, Xilinx and Salesforce.com (who a few days ago announced a collaboration with IBM Watson around AI). On the other side of this trade, legacy companies look increasingly stranded as they are unable to participate in this new world of computing.

After two years of multiple compression we feel confident that our portfolio is well positioned with our excess growth likely to manifest as outperformance should valuation multiples hold constant or expand from here. Although the US market is at highs, many of the higher growth technology sub-sectors (Internet, Software as a Service (SaaS), Cybersecurity and Cloud software) are trading at or below their five-year averages. Current premiums paid for secular growth appears low at a time when technology is becoming increasingly disruptive.  This likely explains the elevated level of M&A last year which after a brief Q4 pause (around US elections) has recently resumed with Cisco buying AppDynamics for US$3.7bn (a 100% premium to its expected IPO price) and Hewlett Packard’s acquisition of Nimble Storage for US$1bn, a 45% premium. Technology’s expanded addressable market significantly enhances the opportunity-set for leaders exploiting disruptive technologies to go after historically sheltered profit pools of other industries. At some point it seems likely that this will lead to the re-rating of our secular growth stocks. As a result, despite a strong start to the year, we remain optimistic that we can deliver good absolute and relative returns in 2017 and beyond – as such we intend to remain relatively fully invested and will look to use any market setbacks to add to our preferred positions.   

Ben Rogoff

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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