Monthly Commentary
August 2017

Market Review

While equity markets were subdued in August – both the FTSE World Index and the S&P 500 Index ended the month essentially flat in US Dollar (US$) terms – further weakness in the British Pound saw global equities rise 2.4% in Sterling terms. August moves reflected a typically quiet final month of summer, punctuated by geopolitical events that dominated headlines as a series of missile tests and an escalation in North Korea’s show of force unsettled markets. These periods resulted in brief ‘risk-off’ moments but markets proved resilient and able to regain lost ground following minor pullbacks.

The broad-based recovery in global growth continues as North America, Europe and Asia all delivered robust economic data. The revised estimate of US second-quarter (Q2) GDP climbed to +3% annualised, making it the strongest quarter since Q1 2015 and a strong rebound from the modest +1.2% annualised seen in Q1. At the annual Jackson Hole Economic Symposium, speeches by Chair of the Federal Reserve Janet Yellen and ECB President Mario Draghi proved uneventful, with limited insight into upcoming monetary policy from the two key central banks.  The absence of concerns around recent Euro strength was perhaps the only noteworthy element.  The devastating effects of Hurricane Harvey have also likely lowered the risk of political posturing over the US debt ceiling (at least until December) due to the urgent need for emergency funding approval.

The key macro question of why the low unemployment level is not sparking higher inflation remains unanswered and remains a risk to be monitored, although implied inflation expectations do not currently foresee any destabilising change anytime soon.  The US Federal Reserve’s favoured inflation measure, Personal Consumption Expenditure Index (PCE), underwhelmed with the July reading at +1.4% year-on-year (y/y). This was the lowest rate since December 2015 and well below the Federal Reserve’s target of 2%.  For now, both the ECB and Federal Reserve continue to be willing to look through the recent weaker data and not extrapolate it as reflective of weak underlying aggregate demand (the deflationary impact of technology is likely playing a part!).

Technology Review

The technology sector outperformed the broader market during the month, the Dow Jones World Technology Index TR advancing 5.1% (in GBP terms). As second quarter earnings season concluded, reporting companies generally fared well.

In hardware, the standout performer during August was Apple*, the stock gaining +10% on healthy guidance that implies management confidence in the upcoming product launch, scheduled for 12 September 2017. Expectations for the new products are high, with many touting a potential “super cycle”.  Three new iPhones are expected to be unveiled, in-line with supply chain commentary and channel checks. Facial recognition, wireless charging and an OLED display are some of the rumoured new features. A new Apple Watch is also expected which may, for the first time, contain a cellular chip and can therefore be untethered from an iPhone. This could materially improve user experience and functionality.

In Networking, incumbent Cisco ** delivered an in-line quarter with revenues declining year-over-year for the seventh straight quarter. Switching and Routing were both down -9% y/y alongside a decelerating Security segment. According to management, only part of the decline can be attributed to the shift to subscription revenue highlighting ongoing headwinds associated with the new cycle. Cisco’s guidance implies a continuation of revenue decline next quarter. 

In semiconductors, Broadcom* posted a ‘beat and raise’ but after a strong run the magnitude of the beat came in short of buy-side expectations. Data centre, ASICs and wireless continue to be the growth drivers and more than offset the weakness in HDD, enterprise networking and China broadband. Significant content growth in the upcoming iPhone is driving the strong wireless performance enabling guidance of flat revenues quarter-on-quarter in wireless, which was ahead of expectations for down double-digits.

In semiconductor equipment, one of our core holdings, Applied Materials* delivered a beat and raise quarter, continuing the run of strong results within the sub-sector.  The display spending environment remains strong driven by OLED and 10.5G LCD investments. Noteworthy was management’s prediction that wafer fab equipment spending will grow again in 2018 on increased DRAM and Logic demand in combination with strength in NAND and Foundry.

In Internet, two of our larger Chinese holdings Alibaba* and Tencent* both produced impressive earnings reports with accelerating advertising revenues, a common positive.  Alibaba saw strong +56% y/y revenue growth alongside unexpected operating margin expansion. Core Commerce at +58% y/y and Cloud Computing at +96% y/y were the stand-out segments this quarter. Within Core Commerce the ad revenue helped to drive operating leverage and enabled Alibaba to exceed consensus margin expectations. Tencent exceeded top-line expectations with +59% y/y revenue growth, the fastest in seven years. Strong gaming and advertising revenues were the main contributors to the impressive quarter. In gaming, Honor of Kings helped mobile gaming revenue grow +54% y/y, while the advertising growth was driven by a combination of video advertising in media sales and increased ad loads in social advertising via WeChat.  

In Software, companies reporting at the tail end of earnings season generally produced robust results including five of our holdings.  Salesforce.com* delivered billings that beat alongside a raised revenue guidance, offset modestly by a conservative Q3 billings guide plus earnings and cash flow guidance that stayed in-line with consensus, as the company continues to emphasise investments.  Splunk* beat consensus estimates on every metric and provided guidance ahead of expectations. A rebound in billings and license revenue was well received along with better execution in EMEA after a soft Q1. Management commentary on adoption of Splunk Cloud was positive as full-year cloud revenue guidance was maintained.  Box* delivered slightly mixed results with a beat on revenues, billings and EPS offset by light guidance. Nevertheless, a second consecutive quarter of billings growth above 30% impressed, especially off a tough y/y comparison, as new products continue to ramp.  Autodesk* also beat expectations across the board, exceeding on revenue, operating margin and EPS. This came alongside strong growth in annual recurring revenue and a big beat on net subscriber adds. The subscription transition remains on course with a healthy 30% of subscriptions coming from new customers as the addressable market expands.  Software as a Service leader Workday* printed a beat and raise with subscription revenues +41% y/y, the fourth straight quarter of growth above 40%.

At the end of the month Amazon* closed its acquisition of Whole Foods Market. Almost immediately Amazon stamped their mark on the business by implementing a series of price cuts with the aim of making Whole Food’s prices more competitive and accessible on everyday items. The move was likely timed, at least in part, for maximum PR effect, but nevertheless it is an early sign of how disruptive Amazon may prove to the US grocery market. The integration of the bricks and mortar retail chain by Amazon will be closely watched and offers a fascinating case study of the merging of two contrasting business models. It will also show how Amazon’s core competencies of logistics and merchandising can be leveraged in an omni-channel world.

Outlook

While equity markets have added to their year-to-date gains, we continue to see significant opportunities within the technology sector over the next 12 months. That said, technology stocks have performed strongly year-to-date due to a combination of robust growth and some multiple expansion (off depressed levels) so a period of short-term consolidation would not be a surprise. Fortunately, valuations for higher growth companies (with a few exceptions) do not appear overly stretched and fundamentals remain supportive. Nick and Xuesong have recently travelled to the US and Asia respectively and feedback from their (and other recent) company meetings gives us confidence that fundamental strength experienced during the first-half of the year should extend into the third-quarter.  In addition, we believe that the current investment backdrop remains unique, with accommodative policy and the prevailing rate of inflation supportive of current equity valuations. 

As ever, there are risks to our relatively sanguine view both to the upside and downside. North Korea remains a wildcard with the international community yet to agree on an appropriate remediation strategy (assuming one exists). Although we do not anticipate actual conflagration, the risk of unintended conflict appears to be increasing.  Both the Federal Reserve and ECB are holding meetings in the coming weeks, and any commentary regarding tapering and balance sheet unwind could cause further volatility.  With geopolitical risk elevated and market technicals softening somewhat, we have purchased a small amount (15bps of premium) of out of the money S&P 500 ETF (SPY) put options with the aim of reducing our beta in the event of a short-term market sell-off.  With the Fund essentially fully invested, this is nothing more than a short-term risk reduction exercise as our longer-term confidence remains grounded in a new cycle thesis we first articulated almost a decade ago. If our thesis is indeed playing out, it should provide a multi-year tailwind for our ‘active’ growth centric investment approach at a time when technology indices may be weighed down by smartphone maturity and disproportionate 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 

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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