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 April 2021
Market review
Global equity markets accelerated their gains in April as the MSCI All Country Global advanced 4.2% while the S&P 500 and DJ Euro Stoxx 600 increased by 5.1% and 4.6% respectively (all returns in sterling terms).
Investor sentiment remained positive in April as a continued economic recovery was combined with accelerating vaccine rollouts and reassurance from the major central banks that they are in no hurry to withdraw monetary stimulus. The IMF now projects real global GDP to grow 6% in 2021, up from c5.5% at the start of the year, led by strength in the US (+6.4%) and China (+8.4%). Early expectations for growth in 2022 are for c4.4% real GDP growth.
Against this backdrop, the major global equity indices reached new all-time highs. Japan and India were the notable exceptions as fresh waves of COVID-19 cases led to declines of 0.3% and 2.8% respectively for the Nikkei and Sensex indices.
Commodity prices continued to surge during the month. The Bloomberg Agriculture Spot Index gained 13.4% representing its biggest monthly gain since July 2012 and reaching a year-on-year return of 72.3%. Commodities closely aligned with the economic recovery also saw large monthly moves such as copper (+11.7%) and Brent Oil (+7.1%) to reach year-to-date gains of 26.7% and 30% respectively. The move in copper takes the metal to its highest level in a decade.
A further contributing factor behind the strong performance in April was the reversal of yields as the 10-year US Treasury yield ended the month -11bps lower, the biggest monthly decline since last July and ending a run of four consecutive monthly increases. At their recent policy meetings, both the Federal Reserve (Fed) and ECB kept monetary policy unchanged. The Fed has acknowledged the economy is performing better than expected and that inflation is rising but remains of the view that this is due to transient factors – largely base effects and supply bottlenecks which should be resolved with time.
In a positive development, US and European virus cases are fading with the number of daily infections down to a seven-month low in both regions. Successful vaccine programmes have coincided with these trends as the four largest euro area countries have now reached a new high of 12.7 million vaccine shots per week. This has now reached a similar pace to the US at c5% of the population per week and enabled just under one-third of the adult population to receive at least one dose. Based on the current vaccination pace and supply schedules, the four largest euro area countries are on track to vaccinate 70% of their total population by September.
In the US, meanwhile, the recent pace of vaccinations continues to slow to a weekly level of 16 million, down from a record 24 million in mid-April. The slowdown has been attributed to lower demand and the lack of availability of the Johnson & Johnson vaccine. Currently, 140 million Americans, or over 50% of the adult population, has received at least one vaccine dose. President Biden has set a target of 70% of US adults receiving at least one dose by 4 July and announced a shift in federal strategy away from mass vaccination sites to smaller venues to help persuade more citizens, particularly young people, to take up vaccines.
Tragically, the pandemic has established a new epicentre in India following the escalation of the country’s second wave which began in February. India surpassed the US for the highest recorded number of cases on a single day for any country. In early May the number of daily new cases exceeded 400,000 registered in a 24-hour period. Global daily cases have risen for nine consecutive weeks, as the continued surge in India outweighed declines in most other regions, with new infections in India now accounting for 40% of the global new cases. Hope now rests on global daily cases showing signs of plateauing at a peak of 825,000.
Economic activity indicators remain at or near highs across the manufacturing sector and continue to imply a robust expansion. The recovery began in China, followed by the US and now Europe, which initially lagged but has been gaining traction after recovering from the resurgence of COVID-19 cases at the beginning of the year. The eurozone manufacturing PMI improved to 63.3 in April, while the services index advanced to an eight-month high of 50.3, crossing into expansion territory. With the likely easing of lockdowns across most of Europe in May as the vaccination campaign continues to ramp up, further gains for the services sector are likely in the months to come.
Supply issues have been surfacing in the most recent economic survey data which represent a potential challenge to the current pace of the manufacturing and economic recovery. There is growing evidence of capacity constraints and price increases across many supply chains with supply shortages and challenges in transportation networks being widely reported by the survey panellists. The April US manufacturing ISM release detailed the highest readings ever recorded for order backlogs (68.2) and the lowest ever on customer inventories (28.4) which suggests factories could be playing catch-up for an extended period as a mismatch of supply and demand persists.
Technology review
The technology sector continued to rally in April, the Dow Jones Global Technology Index gaining 5.6% (in sterling terms), modestly ahead of broader equity markets, driven by lower treasury yields and a strong start to the earnings season. Mega-cap technology stocks rallied during the month in anticipation of strong results, driving significant large-cap outperformance – the Russell 1000 Technology Index rising 6.6%, while the small-cap Russell 2000 Technology Index returned just 0.7%. The internet and software sectors outperformed, the NASDAQ Internet Index and the Bloomberg Americas Software Index returning 5.7% and 5.8% respectively, while the semiconductor sector lagged, the SOX Semiconductor Index declining 0.7%.
First quarter technology earnings have been very strong, and the dominance of Big Tech has been clear. The combined yearly revenue of Apple, Amazon, Microsoft, Alphabet and Facebook reached $1.2tn, up 25% y/y as COVID-19 drove secular trends and advertising, corporate and consumer spending was supported by an improving economy. While tax and political/regulatory risks represent potential headwinds for many of these larger stocks, we believe these are largely reflected in valuations that do not appear to fully capture the potential for robust economic growth ahead.
Apple’s results were exceptionally strong, with revenue up 54% y/y, driven by robust performance from iPhones, iPads, iMacs and Services, which continue to benefit from stay-at-home demand, as well as a fresh round of stimulus checks in the US. China grew 87% y/y, while the gross margin at 42.5% was the highest since June 2012. No official guidance was given for the next quarter (again), but management commentary indicated double-digit y/y growth despite supply chain constraints, which are expected to have a negative $3bn-4bn impact.
In the internet sector, Amazon had a strong quarter with revenue growing 41% y/y (in constant currency – cc) and operating income +122% y/y (both metrics better than expected), with operational leverage across all segments despite COVID-19 cost headwinds (which came in lower than forecast). AWS was the standout positive with revenue growth accelerating to 32% y/y from 28% y/y last quarter, in contrast to deceleration at Microsoft Azure and Google Cloud. Q2 guidance for revenue of 22-28% y/y cc against a tough COVID-19 comp suggests that e-commerce strength will be enduring, although guidance was only in line when adjusted for the pull forward of Amazon Prime Day into Q2 this year.
Alphabet also delivered excellent results with revenue above expectations across nearly all segments. Core Search grew 30% y/y, driven by “elevated consumer activity online” and “broad-based growth in ad revenue”, while YouTube growth accelerated to 49% y/y. Google Cloud was the only blemish, decelerating 1pp to 46% y/y, but losses were greatly reduced helping drive Alphabet’s operating margin to 29.7% – the strongest since 2012. Management also authorized an additional $50bn buyback program.
We increased our exposure to Facebook with ad revenue up 42% y/y cc and Q2 growth to remain “stable or modestly accelerate” despite Apple IDFA risks. US DAUs were flat which was taken as a positive given the US reopening. With the buoyant economic environment, advertising markets should be robust for the remainder of 2021, while the stock has multiple upside vectors from Instagram, social commerce, WhatsApp, Messenger and Oculus VR, and trades at a very reasonable valuation.
Several smaller internet companies also beat expectations although guidance was mixed for some. Among the stronger reports, Snap (Snapchat) posted strong results and gave bullish Q2 guidance, with revenue expected to be +80-85% y/y despite disruptions expected from Apple’s IDFA privacy changes. Metrics on users, Spotlight and AR Lenses were strong. Snap is seeing a boost in Story posting and Snap Map engagement as the economy reopens.
While strong headline results and guidance was a common theme, some work from home (WFH) winners gave disappointing user growth or engagement commentary with the economy reopening. We sold our position in Netflix and reduced both Pinterest and Spotify as a result. Netflix management ascribed the slowdown to the pull forward of demand caused by COVID-19 in 2020 and a lighter content slate in 1H21 due to production delays rather than market share losses to Disney or HBO Max. Pinterest delivered better than expected revenue, ARPU and margins, and Q2 guidance for 105% y/y revenue growth hit the mark, but the beat and raise was overshadowed by guidance for US MAUs to fall by two million q/q based on engagement trends seen since restrictions were lifted in mid-March. Twitter also disappointed with an in-line quarter with 27% y/y cc revenue growth, but this was not enough to meet heightened expectations given the strong performance of advertising peers (Twitter is over-indexed to brand advertising). While we continue to expect robust growth from many of these stocks, they are likely to remain out of favour for now given the impact of reopening on engagement and more difficult comparisons.
Despite robust Q2 guidance from Facebook and Snap, the impact of Apple’s ad tracking/privacy changes also remains to be fully determined and both companies acknowledged a high degree of uncertainty. Reports suggest that Apple will expand its own advertising business by adding a second ad slot in the App Store search page and may also be planning to add social networking features to iMessage on iOS 15 this year, pointing to greater competition with Facebook.
The software sector continues to ride a wave of digital transformation accelerated by the pandemic, but investor expectations were commensurate with elevated valuations leading to muted stock reactions to positive reports, while any minor blemishes were punished in an unforgiving tape for growth stocks.
Microsoft reported a solid quarter, with Commercial Cloud bookings +38% y/y cc to a five-year high, as large companies continue to standardise work on the platform, but several metrics missed elevated expectations. Azure revenue growth decelerated slightly to a still impressive 46% y/y cc (versus consensus at 48% y/y cc) and on-prem Server products were flat y/y cc (versus guidance at up low to mid-single digits). During the month, Microsoft acquired Nuance Communications for $19.7bn, to augment its healthcare cloud products with voice documentation and transcription technologies. ServiceNow was another 'sell the news' print, with a solid if imperfect quarter amid high expectations. While the billings and CRPO growth metrics came in a above guidance, the Q2/Q3 billings outlook disappointed (management pointed to deal timing and product mix shift that will shift billings into 4Q21). Meanwhile, some mid-caps including Atlassian, HubSpot and Zendesk delivered stronger than expected results and guidance. In the security software subsector, Proofpoint* was acquired by private equity firm Thoma Bravo for $12.3bn, a 34% premium and c9.5x forward EV/sales which should be supportive for software valuations.
The semiconductor sector also lagged during the month despite a slew of strong results. While demand is continuing to outstrip supply in the near term, growth is limited by capacity constraints. We believe an inability to quickly add capacity (due to fab equipment supply constraints) combined with very lean channel inventories and strengthening global demand, will mean this cycle proves longer and stronger than most expect. Near term, the chip shortage has been exacerbated by a fire at a Renesas plant in mid-March (the recovery from which will take up to four months), power supply issues at Samsung, Infineon Technologies and NXP* fabrication plants in Texas (also impacting Qualcomm) and the possibility that China/US tensions and restricted supplier lists could also result in (permanently) higher levels of industry inventory.
The spill-over from semiconductor shortages is impacting many sectors. Ford recently revealed that its auto production would be reduced by 50% from its original plans in the June quarter, with lingering impact expected in H2 and probably next year. Intel’s* CEO believes the semi shortage could go on for “years”. This bodes well for chipmakers’ pricing and for their suppliers, and relatively well for key foundry customers such as Advanced Micro Devices (AMD), Xilinx* and MediaTek. AMD remains a core position for us, so it was encouraging that the company raised FY guidance to 50%+ revenue growth despite the shortages. ASML raised its 2021 outlook to 30% growth (from low double digits previously). We remain bullish on semiconductor capital equipment manufacturers, given that TSMC plans to spend $100bn in capex over the next three years (versus $25-28bn in 2021), Intel* plans to spend $20bn to build two new fabs in Arizona over the next two years and Samsung is spending $116bn over a decade to expand its foundry business. Geopolitical factors are driving the US, EU and India toward significant government incentives to support domestic semiconductor capacity.
Outlook
The inflation outlook remains the market’s central focus as market participants seemingly position for further inflationary pressures. Shortages are widespread as the global economy deals with a burst of demand from reopening, fiscal stimulus and the release of excess consumer savings. This demand has not been met by a comparable increase in the supply side of the economy across commodities, finished goods, services, housing and labour. Bloomberg’s composite commodity spot index has reached a decade high. The ongoing constraints in the labour supply are particularly striking given there are 9.7 million US workers who are unemployed, and perhaps another 4.6 million (per BoA) who left the labour force during the pandemic. US job openings (JOLTS) are almost back to pre-pandemic levels, many firms are reporting labour shortages, and Uber and Lyft* are reportedly having to pay sign-on bonuses to rehire drivers. This appears to be an environment ripe for upward pressure on wages, but also one in which investments in automation will appear increasingly attractive. We know from experience of prior recessions that the rate of job automation increases as the economy recovers and would expect this time to be no different.
The rate environment remains volatile and the intra-month reversal in the 10-year UST from 1.75% to 1.55% appears somewhat surprising in the context of strong US vaccination, retail sales and employment data. Extended positioning, aggressive Japanese investor buying and questions around the implied need for the Fed to control the yield curve amid higher future deficits have all been put forward as explanations. The OIS forward market is still pricing in a March 2023 rate hike, but growth equities remain sensitive to suggestions of earlier tapering and rate rise expectations such as Treasury Secretary Yellen’s (fairly innocuous) comments that “it may be that interest rates will have to rise somewhat to make sure our economy doesn’t overheat” on 5 May. The Fed itself is waiting patiently for the transitory factors driving higher inflation to pass and for an inclusive labour market recovery to appear.
There is widespread evidence from first-quarter earnings that technological adoption and digital transformation initiatives have accelerated, including sustained strength in e-commerce growth seen by Shopify* (GMV +114% y/y) and Amazon (NA Retail +40% y/y) and in online advertising (Alphabet Search revenues +30% y/y; Facebook ad revenue +46% y/y). We have witnessed muted share price reactions to many fundamentally strong technology earnings reports. As many as 75% of technology companies have traded down post-earnings, the worst of all GICS sectors, but it is notable that EPS revisions during the month have been greater in value than in growth indices. That said, the fact many stocks are not going up on such strong results is a little disconcerting and has led to subsequent selling pressure in early May. This dislocation between strong fundamentals and weak stock action may reflect concern that the current quarter represents a potential peak (driven by an unsustainable rebound in consumer spending/stimulus cheques) or, more likely, that investors are selling technology/growth in order to fund purchases elsewhere. Either way, we are a little more cautiously positioned, awaiting the opportunity to add to our favoured growth names on further weakness which, if it occurs, would likely prove divorced from fundamentals which remain in rude health based on the evidence of Q1 earnings season.
While we have adopted a more balanced portfolio position for now, it should be remembered that we are growth investors and, as such, our investment style may remain a headwind relative to our benchmark should current trends continue. How long this persists likely depends on how strong the economy is and where risk-free rates and inflation expectations settle. Regardless, we see potential for strong absolute returns in 2021 supported by robust underlying growth and a stronger economy. What is more difficult to predict is our sector’s relative progress versus value stocks and sectors, particularly if bond yields and/or inflationary pressures increase. We believe many large-cap technology companies remain attractively valued with good growth prospects while ultra-high growth stocks can quickly grow into their multiples. We intend to use further weakness should it occur to add/initiate positions in the best/most promising growth stocks.
With all eyes on inflation, we remain confident in a step up in technological innovation that often occurs after a crisis and a period of mass experimentation, which is what 2020 really was to our eyes. We think this ultimately translates into stronger growth for longer for the technology sector. At a high level, remote work has allowed the abstraction of work from the physical workplace, just like e-commerce allowed the abstraction of buying things from physical shops, and the cloud abstracted computation from the physical location of the servers. Once abstracted, companies can digitize, innovate and stratify products and services much more quickly and easily. This can take the form of the elimination of waste and inefficiency, but also allows companies to build experiences that were not possible before, whether that is around digital health combined with in-person visits, buying online and picking up in store, or even a mixture of remote and in-person events as we have been undertaking with our clients. It is ultimately this process of abstraction, digitization and innovation that will allow technology to penetrate addressable markets outside of the traditional IT spending markets and gives us great comfort that technology has a huge amount of growth ahead of it.
* 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