At the Annual General Meeting in 2012 shareholder approval was obtained for a simplified investment policy. This did not change the investment objective but provides a clear and appropriate set of up to date investment restrictions in line with the Financial Conduct Authority and HM Revenue and Customs current requirements.
The portfolio was managed under and in accordance with the old policy and restrictions in the year to 30 April 2012 and up to 4 September 2012 when the change was approved by shareholders.
Asset allocation
Technology may be defined as the application of scientific knowledge for practical purposes and technology companies are defined accordingly. While this offers a very broad and dynamic investing universe and covers many different companies, the portfolio of the Company (the “Portfolio”) is focused on companies which use technology or which develop and supply technological solutions as a core part of their business models. This includes areas as diverse as information, media, communications, environmental, healthcare, finance, e-commerce and renewable energy, as well as the more obvious applications such as computing and associated industries.
The Board has agreed a set of parameters which seek to ensure that investment risk is spread and diversified.
The Board believes that this provides the necessary flexibility for the Investment Manager to pursue the investment objective, given the dynamic and rapid changes in the field of technology, while maintaining a spread of investments.
The Company uses the Dow Jones Global Technology Index (total return, Sterling adjusted, with the removal of relevant withholding taxes) as the Benchmark against which Net Asset Value (NAV) performance is measured for the purpose of assessing performance fees. From 1 May 2013 the benchmark was calculated using a net basis which adjusts the Benchmark income element to reflect withholding taxes which would be suffered by a UK based investor.
However, the Benchmark is neither a target nor an ideal investment strategy. The purpose of the Benchmark is to set a reasonable return for shareholders of PCT above which the Investment Manager is entitled to a share of the extra performance it has delivered.
Risk diversification
PCT will at all times invest and manage its assets in a manner that is consistent with spreading investment risk and invests in a Portfolio comprised primarily of international quoted equities which is diversified across both regions and sectors. PCT will satisfy the following investment restrictions:
- PCT’s interest in any one company will not exceed 10 per cent. of the gross assets of PCT from time to time, save where the Benchmark weighting of any investee company in PCT’s portfolio exceeds this level, in which case PCT will be permitted to increase its exposure to such investee company up to the Benchmark ‘neutral’ weighting of that company or, if lower, 20 per cent. of PCT’s gross assets.
- PCT will have a maximum exposure to companies listed on emerging markets (as defined by the MSCI Emerging Markets Index) of 25 per cent. of its gross assets from time to time.
- PCT may invest in unquoted companies from time to time, subject to prior Board approval. Investments in unquoted companies in aggregate will not exceed 10 per cent. of the gross assets of PCT (measured at the time of acquisition of the relevant investment and whenever PCT increases the relevant holding).
In addition to the restrictions set out above, PCT is subject to Chapter 15 of the UK Listing Authority’s Listing Rules which apply to closed-ended investment companies with a premium listing on the Official List of the London Stock Exchange. In order to comply with the current Listing Rules, PCT will not invest more than 10 per cent. of its total assets at the time of acquisition in other listed closed-ended investment funds, whether managed by the Investment Manager or not. This restriction does not apply to investments in closed-ended investment funds which themselves have published investment policies to invest no more than 15 per cent. of their total assets in other listed closed-ended investment funds. However, PCT will not in any case invest more than 15 per cent. of its total assets in other closed-ended investment funds. PCT must not conduct any trading activity which is significant in the context of its group as a whole.
Borrowing, Cash and Derivatives
The Company may borrow money to invest in the Portfolio over both the long and short-term. Any commitment to borrow funds is agreed by the Board and the AIFM.
The Company’s Articles of Association permit borrowings up to the amount of its paid up share capital plus capital and revenue reserves but any net borrowings in excess of 20% of the Company’s net assets at the time of drawdown will only be made with the approval of the Board.
The Investment Manager may also use from time to time derivative instruments as approved by the Board such as financial futures, options, contracts-for-difference and currency hedges. These are used for the purpose of efficient portfolio management. Any such use of derivatives will be made in accordance with PCT’s policies on spreading investment risk as set out in this investment policy and any leverage resulting from the use of such derivatives will be subject to the restrictions on borrowings set out above.
Changes to investment policy
Any material change to the investment policy will require the approval of the Shareholders by way of an ordinary resolution at a general meeting. PCT will promptly issue an announcement to inform Shareholders and the public of any change of its investment policy.
The Board monitors the portfolio’s exposure to different geographical markets, sub-sectors within technology and the spread of investments across different market capitalisations. Cyclical changes in markets and new technologies will bring certain sub-sectors or companies of a particular size or market capitalisation into or out of favour.
Market parameters
Notwithstanding the ability to invest up to 100% of the portfolio in any one market, with current and foreseeable investment conditions the Portfolio will be invested in accordance with the objective across worldwide markets within the following geographical and market parameters:
- North America up to 85% of the Portfolio
- Europe up to 40% of the Portfolio
- Japan and Asia up to 55% of the Portfolio
- Rest of the world up to 10% of the Portfolio
The Board has set specific upper exposure limits for certain countries where they believe there may be an elevated risk.
Cash
From time to time PCT may hold cash or near cash equivalents if the Investment Manager feels that these will at a particular time or over a period enhance the performance of the Portfolio. The management of cash is through the purchase of appropriate government bonds, money market funds or bank deposits depending on the Investment Manager’s view of the investment opportunities.
Gearing
On 30 September 2020, the Company had drawn down the two, two-year fixed rate, term loans of JPY 3.8bn and USD 36m from ING Bank N.V. Both loans fall due for repayment on 30 September 2022. The JPY loan has been fixed at an all-in rate of 0.90% pa and the USD loan has been fixed at an all-in rate of 1.1% pa. The Company has repaid the two, two-year loan facilities with ING Bank N.V of USD 23.3m and JPY 5.2bn dated 2 October 2018.
Fund Manager Commentary As at 30 June 2021
Market review
Global equity markets compounded their gains in June as the MSCI All Country World advanced 4.3% while the S&P 500 and the DJ Euro Stoxx 600 gained 5.3% and 1.3% respectively (all returns in sterling terms). June represented the fifth consecutive positive monthly return for the S&P 500 and its second-best first-half return since 1998, although it has been characterised by short, sharp changes in both sector and factor leadership.
Performance in June was supported by continued progress on the global vaccination rollout and a modest reduction in new cases worldwide, although with significant regional variation. Despite the broader optimism, the rise of the higher-transmission Delta (and emerging Lambda) variants has led to rising concerns in some COVID-19-sensitive assets, especially around the return on cross-border travel, while the mid-month perceived shift in the US Federal Reserve’s stance proved to be a bullish event for growth assets.
Oil prices continued to make strong gains in June, in part due to the progress made with vaccinations and reopening alongside Iran’s delayed re-entry into crude markets. Brent oil rose 8.4% during the month and has now gained 45% year-to-date, while its crude oil peer WTI became the first major asset class to top 50% YTD.
Two noteworthy moves in June came from gold and the dollar, with contrasting moves following the FOMC meeting. Gold had its worst month since November 2016 as the Fed’s hawkish shift calmed concerns about the potential for runaway inflation. Conversely, the dollar enjoyed its best month since November 2016 as the FOMC meeting acted as a positive catalyst. The US Dollar Index (DXY) gained 2.9% as measured against the major world currencies, and was 3.1% higher against the euro in June.
The June Federal Reserve FOMC meeting proved to be market moving across a range of asset classes. In March, most Fed officials predicted that current rates would be maintained until at least 2024, but officials now expect to start raising interest rates in 2023, and the median ‘dot’ now implies two rate hikes in 2023. In the same month, seven of the 18 FOMC members predicted a first interest rate hike in 2023; by June this had increased to 13 members. Interestingly, and somewhat surprisingly, a more hawkish Fed has led to a decline in the US 10-year yield to c1.45% by month end (slipping below 1.3% since), perhaps reducing fears the Fed was behind the curve and would have to hike steeply later. This has improved investor appetite for longer duration growth/tech stocks.
A faster economic recovery from the pandemic is clearly implied by the shift in expectations of the FOMC members. The median of Fed officials’ estimates now forecasts GDP growth of 7% (up from 6.5% in March) and core inflation of 3%, sharply higher than the 2.2.% forecast in March. Despite the higher inflation forecast for 2021, Fed Chair Jerome Powell continues to believe that worries about overheating or sustained excess inflation risks are still unwarranted. This view is corroborated by the Fed’s official forecast of core inflation falling back to 2.1% in 2022. There was no mention of a shift in the closely scrutinised commentary on tapering. The FOMC kept its asset purchases steady at $120bn per month and noted that any adjustment would be communicated well in advance. Non-farm payrolls increased by 850,000 in June, ahead of a consensus of 615,000, driven by a rebound in virus-sensitive categories including leisure and hospitality (up by 343,000).
The pace of the European vaccination program was impressive in June as by the end of the month several European countries had joined the US, UK, Canada and a few smaller economies in having at least partially vaccinated more than half their population. The race to fully vaccinate populations has increased in importance as the higher-transmission Delta variant of COVID-19, first identified in India, is quickly becoming the dominant variant in a growing number of countries. In early July, the number of daily infections in the five major European countries reached 33,000, having doubled over the previous two weeks. The UK now accounts for 75% of daily EU-5 cases, although infections have also risen sharply in Spain and have started to increase in France and Italy. The world is now watching the UK closely to see how a country with an advanced vaccine programme will cope with an outbreak of a more contagious variant. Thankfully early indications are that vaccination programmes have succeeded in breaking the link between COVID-19 infections and deaths: in the UK, the ratio of reported cases to hospitalisations continues to decline (now below 2%, down from 13% in February) with the absolute level of daily hospital admissions remaining at a low level of 260.
Economic activity indicators remain firmly supportive, implying robust expansion and, in some cases, have reached multi-decade highs. Manufacturing indicators in the US and China have peaked but remain in expansion territory. The US ISM manufacturing PMI recorded its 13th consecutive month of growth, with new orders and backlogs seeing solid growth. China’s June manufacturing PMI inched down to 50.9 in June from 51 in May. This was modestly above the market consensus of 50.8 and impacted by shortages of chips, coal and electricity. Positively, the new orders component edged up to 51.5 from 51.3 last month. In Europe, growth has yet to peak as the Eurozone Manufacturing PMI of 63.4 set a record high for the fourth consecutive month. Underlying this strength was new orders which saw their third fastest ever reported increase, while backlogs almost reached a new record high. The June Eurozone composite PMI new orders index came in at 60, leaving the index less than two points below the all-time high of 61.8 reached in April 2000.
Technology review
The technology sector rallied strongly in June, the Dow Jones Global Technology Index returning 9%. Despite rising inflation, the sector benefitted from indications that this will be transitory in nature as well as lower long-term risk-free rates/a flatter yield curve. Towards the end of the month, the Fed’s hawkish tone was also taken as supportive for longer-duration growth assets.
There was broad strength across technology subsectors. The SOX Semiconductor Index gained 8.2% while the internet and software sectors both outperformed, the NASDAQ Internet Index climbing 10.9%, while the Bloomberg Americas Software Index rose 11.1%.
In the software sector, Zoom Video Communications (Zoom) and DocuSign’s results demonstrated the sustainability of work-from-home (WFH) trends. Zoom reported 191% y/y revenue growth and a 41% operating margin in the quarter and raised FY22 guidance to 50% y/y revenue growth (above consensus estimates) due to strong renewals in 1Q22. We added to our position after the results. Looking past the near-term reopening overhang, Zoom stands to benefit from a permanent shift towards a hybrid work environment. We were also encouraged by traction with Zoom Phone, which reached 1.5 million seats at the end of April, up from one million at the end of December. We also increased our holding in leading electronic signature solutions vendor DocuSign after a strong print, with billings accelerating to 54% y/y (albeit benefiting from the pull-forward of some renewals) and operating margins expanding to 20%, well ahead of expectations. The company raised full-year billings guidance and should continue to benefit from accelerating international sales.
Adobe posted strong results, with net new annual recurring revenue (ARR) at $518m (versus consensus at $450m), driven by solid execution across all three core segments and a tailwind from the ongoing macroeconomic and small-medium business (SMB) recovery. Smartsheet, a cloud-based platform for work execution and management, also posted robust results (billings growth 48% y/y) and raised full-year guidance. CEO Mark Mader commented that “these results demonstrate how no-code technologies like Smartsheet are becoming a critical part of the enterprise technology stack, enabling organisations to manage programs, processes, and projects at scale." The efficient orchestration of hybrid work remains a meaningful challenge for many businesses, and it seems certain that software will play a major role in solving it over time.
Cybersecurity platform provider CrowdStrike delivered another exceptional quarter with ARR growing 74% y/y, likely driven by incremental purchase activity associated with the current elevated threat environment, as well as new product adoption beyond endpoint security. The Kaseya ransomware attack in early July was the biggest global ransomware attack on record and has allegedly compromised more than one million computers. The hackers have offered a universal decryptor software key that would unscramble all affected machines in exchange for $70m in cryptocurrency.
In the internet sector, there is evidence that e-commerce adoption continues to grow quickly despite the reopening of the global economy. The President of e-commerce platform Shopify noted the company has seen “no slowdown whatsoever”, while weekly active users of top food delivery apps, such as UBER Eats* and DoorDash*, increased significantly according to App Annie, even as restrictions are eased. Amazon Prime Day results were reasonable but below some buy-side expectations, and Morgan Stanley estimate that Prime Day still contributed $6.8bn to GMV (+9%y/y) and $3.8bn revenue (+7% y/y). Amazon will soon launch same-day shipping, another opportunity for the company to reset consumer expectations around delivery and pressure competitors. This initiative should help Amazon to capture share of the $1.7trn of US consumer expenditure in consumer-packaged goods and grocery that remains offline.
In terms of digital consumer-related stocks, Peloton noted their average workouts per month metric is holding at 26, which suggests that engagement remains steady m/m and likely q/q into the reopening. The stock rallied after announcing a corporate wellness program and push into the wearables market with a new digital heart-rate monitoring armband. Games platform Roblox reported weaker than expected bookings in May, declining 11% m/m, but that was still up 25% y/y against a very tough comparison (the peak of the first lockdown). While near-term expectations may have got ahead of themselves, we remain bullish on the long-term opportunity for the company, which has enormous potential to grow users by expanding into international markets (China and Europe) and penetrating older demographics, as well as to grow monetization (advertising).
At its Worldwide Developers Conference, Apple doubled down on privacy enhancements post IDFA/ATT changes with the launch of a new App Privacy Report in Settings that shows how often apps use permission to access data, mail privacy protection that hides users’ IP addresses and allows them to block invisible pixel tracking, and iCloud+ traffic encryption called Private Relay that increases the value proposition on iCloud subscriptions. Alphabet is following Apple’s lead with Android privacy protections to limit ad tracking, but delayed plans to block third-party cookies from early 2022 to late 2023,an almost two-year delay of the 'cookie apocalypse'.
Nonetheless, regulatory risk intensified for Big Tech companies (Alphabet, Facebook, Amazon and Apple) as vocal tech critic Lina Khan was confirmed as Federal Trade Commission (FTC) Chair and House Democrats introduced five bipartisan billsto limit anticompetitive practices in Big Tech including blocking mergers, restricting 'self-preferencing' activities that favour their own products and prohibiting them from hobbling rivals – and possibly forcing sales of certain business lines. However, the odds of legislation passing that would break up the tech giants remain very low according to the legal/political experts. That said, we continue to monitor the political and legal backdrop given the risk to a number of technology behemoths posed by legislative change.
In a small win for Big Tech, and a setback for the FTC, a US district judge granted Facebook’s requests to dismiss lawsuits filed against the company. This was on the basis that the FTC and the 46 state Attorney Generals (AGs) provided insufficient evidence to prove Facebook was a monopoly and that the AGs waited too long to bring their claims. The FTC has the opportunity to file an amended lawsuit within 30 days, which they are almost certain to do. Meanwhile, such results serve to highlight the insufficiency of the current antitrust regulatory framework and increase the likelihood of (complex) potential new legislation.
More concerning to us, regulatory issues continue to spread across emerging markets, particularly in China where authorities ordered all app stores to remove ride-hailing service (and recent IPO) Didi’s* app citing violations around the collection and use of user data (perhaps the company only listing in the US did not help). Coupang (Korean e-commerce leader) is also being investigated by the Korean FTC around the use of search algorithms to prioritize its own products over third-party suppliers. We continue to monitor regulatory developments closely and have further reduced our exposure to both Alibaba and Tencent in favour of stocks such as Naver that are better insulated from the reach of Chinese regulators.
The semiconductor sector underperformed other subsectors modestly, with some investors concerned that we might be approaching the peak of the cycle as smartphone and PC demand wanes in the second half of 2021 and into 2022. The timing is difficult to call. Demand remains robust, inventory levels lean and pricing strong but, with margins at peak levels, stock returns could be more measured from here. That said, the sector should benefit from US government subsidies for domestic manufacturing, with the Senate passing the $250bn US Innovation and Competition Act (USICA) by an overwhelming margin. The bill includes $52bn for domestic semiconductor manufacturing allocated through public-private partnerships.
Marvell Technology reported a solid set of results despite continued softness in Chinese 5G deployments. The company continues to reposition its portfolio towards growth verticals and away from legacy/declining markets and remains our largest exposure to the 5G cycle. Hard disk drive manufacturer Seagate positively pre-announced revenue and earnings, citing broad-based demand, with upside driven by the distribution channel and a more positive tone around cloud customer demand. We view the company as an inexpensive cyclical play, with pricing power (a virtual duopoly), secular drivers (PC market post-pandemic/hybrid world, growth of data centre spending) and a little optionality in the form of Chia, a blockchain platform created by the inventor of BitTorrent and the first to be built on the basis of Proof of Time and Space (unused hard drive space) rather than power-hungry Proof of Work.
Outlook
Despite considerable scepticism, it is notable that many high-quality technology companies – which benefitted from the need for consumers and corporates alike to digitise their environments in 2020 – continue to deliver robust growth even against the tough comparisons of last year. This speaks to our thesis that the COVID-19 crisis represented a broadening and deepening of technology demand into industries and markets that have hitherto been relatively underpenetrated. The reopening or normalisation of economies around the world – as we learn to live alongside COVID-19 variants – should provide a richer backdrop for technology companies. Strong company fundamentals and widespread acceleration in the thematic drivers that underpin the portfolio give us confidence in the sector’s outlook.
The rate environment is an important component of equity valuation, and we have for some time been moderately concerned that high growth, long-duration companies might struggle to hold their elevated multiples in the context of a move higher in rates and a more reflationary environment in the near term. We are therefore encouraged by the market reaction to the June FOMC meeting, which suggested a more hawkish Fed given the shift up in the median dot, now implying two hikes in 2023 from zero in March. It was therefore something of a surprise to see growth outperform and a move lower in bond yields on the back of this. In part, the market is now expecting lift off in less than a year (per Cornerstone Macro), with three rate hikes per year until mid-2024 and the steeper trajectory has moved the terminal rate (how high the Fed will eventually have to raise rates) c25bps lower, which is good for growth assets. In addition, the Fed’s more hawkish posture has significantly reduced the perceived tail risk of runaway inflation given it signals their willingness and ability to move quickly to keep expectations well anchored.
With bond yields falling, investor interest in growth stocks is returning and our sector is performing better again. Given our constructive macroeconomic outlook (albeit likely to be bumpy in those economies lagging behind in vaccine rollouts), we still expect a gradual move higher in bond yields that may cap or compress the multiples of the highest growth, highest multiple assets. That said, we believe that over the medium term, the strong underlying growth of our holdings ought to mitigate or more than offset this resulting in solid absolute returns. Over the shorter term, there will likely be further volatility tied to gyrations in the rate environment and the path of COVID-19 infections/deaths, inflationary pressures and the labour market recovery that are entwined with it.
It is certainly conceivable that the acceleration in technological adoption brought about by this crisis, which we see clearly in our sector, will support an increase in longer-term productivity growth that could support strong economic growth without runaway inflation, although this will take many years to play out. In any case, the reality is that the market reaction function appears to have moved, for now, from strong macro data steepening the yield curve to strong macro data now pushing up real short-term rates and causing the yield curve to flatten.
Given much of the above is beyond our control, we continue to focus on company fundamentals and the core secular themes that underpin their growth rates. Our team of 10 technology analysts and portfolio managers has completed more than 100 company meetings, conferences and presentations since the start of the quarter. This has increased/sustained our confidence that demand remains very strong and full-year estimates comfortably achievable (more so, the stronger the economic outlook). This is what gives us the confidence to remain relatively fully invested here. We have initiated a number of new positions in high-growth companies and sold some stocks that were less well suited to this backdrop. We also stand ready to rotate further back to our most disruptive growth names should a broad selloff in growth assets occur, as has happened periodically.
* not held
Ben Rogoff
Ben joined Polar Capital in May 2003. He is lead manager of Polar Capital Technology Trust plc and is a Fund Manager of the Polar Capital Global Technology Fund and Polar Capital Automation and Artificial Intelligence Fund.
Historical Fact Sheets