Monthly Commentary
January 2017

Market Review

Equity markets modestly extended their gains during the month, the FTSE World Index gaining +0.7% in GBP terms. January 2017 will likely best be remembered for the Inauguration of Donald Trump as 45th President of the United States.  To the surprise of many (who had hoped for a milder rhetoric once in office), President Trump wasted no time in following up on his campaign promises, signing a total of 22 executive orders within his first two weeks in office. For comparison, President Obama issued a total of 277 executive orders over his two terms.  Markets have remained resilient in the face of early evidence he intends to fulfil his main campaign pledges – regardless of how controversial they may be – and his unorthodox approach (tweeting many policy decisions).  This suggests investors are instead focusing on the underlying health of the US economy and the hope that the new President will deliver market-friendly policies including corporate tax reform, overseas cash repatriation, deregulation and fiscal stimulus. While these would likely prove supportive to markets, any announcements relating to a more protectionist agenda (border taxes/tariffs) or the removal of tax deductibility of interest payments would likely result in short-term volatility.

Economic data points continue to portray a robust US and European economic environment, albeit seemingly within a subdued growth trajectory. Fourth quarter US GDP came in at an annualised rate of +1.9% (+1.6% for the full-year 2016). On a brighter note, US industrial output rose at the fastest pace in more than two years in December (with the year-over-year (y/y) growth rate crossing back into positive territory). The December ISM Manufacturing purchasing managers index provided further evidence of improving factory output as the index hit 56.0, the highest point in two years. The US Dollar and inflation data produced arguably the most noteworthy moves. The trade-weighted US Dollar fell 2.6%, reversing some of its Q4 strength. There were also signs of inflation picking up in the US as December CPI reached +2.1% y/y, breaching 2% for the first time since 2014. In Europe CPI jumped to +1.1% in December, a high not seen for almost four years.  However, these moves are in part influenced by the oil-related base effect – due to the significant y/y declines in early 2016 – as such 10-year US Treasuries yields remained virtually unchanged at 2.45%.

Technology Review

The technology sector outperformed the broader market during the month as growth stocks recovered some ground lost during late 2016, the Dow Jones World Technology Index gaining +3.4% (in GBP terms). At time of writing we are in the thick of fourth-quarter earnings season with results thus far generally positive. Within hardware, Apple* returned to revenue growth this quarter and delivered iPhone units ahead of consensus estimates.  The company aims to double its services business over the next four years which will help to offset potential iPhone margin degradation. During the quarter its services business grew +18% y/y driven by the App store which grew +43% y/y. With guidance better than feared, Apple stock rallied post earnings as investors begin to anticipate the iPhone 8 cycle due to be launched in the autumn.  While we have de-emphasised the maturing smartphone theme over recent years, this could be a year where Apple delivers a more innovative iPhone upgrade (with OLED screens, new form factors and wireless charging all expected to make a debut).  As such, we have modestly increased our Apple exposure given that the stock remains inexpensive (trading at 13.1x FY18 consensus earnings, before adjusting for its balance sheet) with the potential for earnings and/or its multiple to move upwards over the next six months. 

Within the semiconductor sector, arguably the best turnaround story has been AMD* – its Q4 earnings and recent product release announcements providing evidence of another positive step towards recovery. After four consecutive years of PC chip market share loss (and nine-years of server market share loss) several new product launches have the potential to reverse this trend.  AMD's Naples server chip, Ryzen/RavenRidge desktop/notebook CPU and their Polaris/Vega GPU chips (for high performance computing and graphics) are now expected to regain share in their respective markets.  TSMC* also produced strong results as margins hit 19-year highs. Utilisation swings have been more moderate since 2010 than the last 2002-2007 cycle and TSMC's margins, like many semiconductor companies, have benefited from this trend.

In the Internet sector, Alphabet (Google)*, Facebook*, Alibaba* and Amazon* once again demonstrated the strength and durability of the key structural trends underpinning their business models – ecommerce, digital advertising and cloud computing. Alibaba* posted revenue growth of +54% y/y beating expectations. Both commission revenue and marketing services revenue contributed to the upside surprise. Active buyers grew +9% y/y to 443m while mobile MAUs grew +25% y/y to 493m, highlighting the scale and dominance of the platform. Cloud computing division AliCloud grew revenues +115% y/y off a low base (a very large market opportunity for Alibaba). Alphabet produced another impressive quarter with revenues growing +24% y/y (constant FX) with mobile search, YouTube and programmatic being the key drivers. An acceleration in Google's Paid Click growth to +43% y/y is very impressive considering the scale of the Google business. Operating margins continued their gradual progression higher as evidence of a more disciplined cost environment persisting.

Facebook* confounded sceptics with revenue growth of +51% y/y. A fifth consecutive quarter of growth in both Ad impressions and Price per Ad highlights the strong demand within its network.  Guidance for 2017 included an expectation that expenses could grow approximately 47%-57% compared to 2016, showing Facebook remains in investment mode.  This makes the Q4 +800bps y/y increase in GAAP operating margins even more impressive.  If there was a soft spot amongst the Internet behemoths it was Amazon*, which after a collection of recent blow out quarters delivered a relatively moribund set of results. In combination with a step up in investment spend the near term outlook appears somewhat subdued but it retains a dominant position in both ecommerce and Cloud Computing.  Whilst both slowed sequentially, North America Retail and International Retail grew +22% and 23% y/y (constant FX) respectively, alongside AWS at +47% y/y.

In Software, Microsoft* beat earnings but delivered slightly weaker guidance than expected. In the mid-cap space Proofpoint* and 8x8* both beat consensus revenue numbers although to a lesser extent than in prior quarters.  A more impressive performance was delivered by ServiceNow* which significantly beat the important billings and bookings metrics that are much studied by investors. This made two strong quarters in a row for ServiceNow and its share price was duly rewarded.  Post quarter end this trend has continued with robust results from many mid-cap software stocks including Medidata*, Paycom** and Zendesk*.  Software stocks also received a boost during the month from Cisco’s* acquisition of AppDynamics** for $3.7bn, one of the most expensive software acquisitions in recent history at 17.3x EV/trailing sales.  We believe this highlights the strategic value of many mid cap software stocks to growth-challenged incumbents, especially those with greater distribution capability, able to significantly scale acquired assets. We expect M&A to remain at elevated levels this year (as Cloud disruption intensifies), aided by a likely tax/repatriation bill from the new President. 

Outlook

This year has seen the sector (and our portfolio) get off to an encouraging start, aided by a robust earnings season and a partial reversal of the post-Trump reflation trade. While Q4’2016 was frustrating, the year-end valuation compression experienced by growth stocks has likely enhanced the set-up for 2017 with many higher growth sub-sectors ending the year below their five-year EV/sales valuation averages while the premium paid for growth in our sector is the narrowest we have seen for some time. Fortunately, along with strong results from many higher growth technology stocks, Cisco’s bid for AppDynamics has helped refocus investor attention on the considerable strategic value many small/mid-caps offer.

While we await greater clarity from President Trump and the Republicans regarding key corporation tax, repatriation and trade policies, the US appears to be strengthening naturally ahead of additional stimulus.  With inflation under control for now, we believe our interests remain aligned with policymakers while a stronger US economy should prove beneficial to many of our small/mid cap domestically orientated US holdings.  Whilst we expect continued volatility tied to policy announcements, we also remain constructive on the broader market believing that as the economy strengthens and bond yields rise (at a controlled pace) equities should benefit – particularly if accompanied by less regulation and lower taxes.

Against this backdrop – after a two-year period where higher growth stocks have suffered from multiple compression – we believe 2017 could mark a turning point, even if valuations only maintain current levels, allowing the underlying growth of our portfolio to drive absolute and relative returns.  It is becoming obvious now that technology is disrupting almost every traditional industry but the advent of artificial intelligence (AI) and machine learning (ML) is only likely to accelerate the pace of technological innovation. This is expanding our addressable market – allowing technology to attack the profit pools of many traditional indices – but along with low levels of stock correlations should provide a significant tailwind for stock pickers.  This may be particularly true in technology where market capitalisation weighted indices (on which most ETFs are based) are likely to face a headwind from smartphone maturity and the deflationary impact of cloud computing, now that adoption appears to have inflected. 

*Held

**Not held

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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