Monthly Commentary

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August 2019

Market Review

Global equity markets consolidated in August, the MSCI All Country World falling 2%. The US continued to outperform, the S&P 500 declining only 1.2% while the Shanghai Composite and the DJ Euro Stoxx 600 declined 4.8% and 2.2% respectively, all in sterling terms.

The US remains a relative haven in a softening global economy.  Non-farm payrolls increased 164,000 in July, in line with expectations, average hourly earnings rose by 0.3% while the unemployment rate remained at 3.7%, close to 50-year lows. The FOMC minutes maintained the “favourable” tone set by Fed Chairman Jerome Powell in July, but slower global growth and trade tensions warranted a 25bp rate cut to mitigate risk. However, the minutes showed the committee was divided and policymakers did not choose to give the minutes a dovish tilt (despite increased tariffs) underscoring previous remarks that they would not calibrate monetary policy around trade policy.  President Trump was not impressed by the lack of action however, questioning whether Powell – his own appointment – was a “bigger enemy” to the US than China’s president Xi Jinping.

Trump’s consternation may have been influenced by softer US data including the IHS Flash Manufacturing PMI which fell to 49.9 in August, indicating the first month of contraction in the manufacturing sector since 2009 while August saw a downward revision to the University of Michigan's Consumer Sentiment index to 89.8. The bond market also appears to be signalling slower growth ahead, the US 30-year yield falling below 2% for the first time ever, taking the entire US treasury yield curve with it. However, this may say more about the scarcity of yield elsewhere, with almost $17trn of negative yielding debt globally. Indeed, the US fed funds rate is currently the highest interest rate in the developed world.

In Europe, economic conditions remain weak with political uncertainty continuing to weigh on sentiment. In Italy, the government collapsed again after Matteo Salvini withdrew his League party from its fractious alliance with the anti-establishment Five Star Movement (M5S), attempting to bring about a snap election. However, Giuseppe Conte, the Italian prime minister, has accepted a mandate to build a coalition between M5S and long-standing enemies the centre-left Democratic Party, to prevent a far-right government taking power. This could mark a turning point in Italy’s fractured relations with the EU, over this year’s budget and the country’s huge public debt, as Conte has repeatedly said that Italy would respect EU budgetary rules and has twice managed to avert sanctions. In contrast, the risk of a no-deal Brexit appears to have increased with Prime Minister Boris Johnson adopting a more belligerent approach to EU intransigence.

In China, industrial production increased 4.8% y/y in July, the weakest gain since February 2002, while retail sales and fixed-asset investment slid more than expected. The Caixin Manufacturing PMI indicated there was modest improvement during August, rising to 50.4 – the strongest pace of expansion in the manufacturing sector since March – but this improvement may prove short-lived as US-China trade tensions deteriorated as the month progressed. China allowed the yuan to depreciate beyond the psychologically key level of seven against the dollar (an 11-year low) prompting the US Treasury to label China a currency manipulator. China retaliated by increasing tariffs on $75bn of US exports ahead of the 10% tariffs due to be imposed by the Trump administration on an additional $112bn of Chinese goods at month end. This prompted a ‘tweetstorm’ from Trump in which he announced that the US will raise tariffs on all Chinese products by a further 5% as well as ordering US companies to leave China. In between these staccato moments, both sides attempted to appear conciliatory which helped the market recover half its losses by month end.

Technology Review

The technology sector declined in August, modestly underperforming the broader market. The Dow Jones Global Technology Index fell 2.4% in sterling terms. Small and mid-cap stocks trailed, the Russell 2000 Technology Index declining 4.3%. Growth and value performed broadly in line, although the software sector proved a relative safe haven, the Bloomberg Americas Software Index declining only 0.5%.

Q2 earnings season concluded with results from the late reporting and off-quarter companies. Notably, several of the off-quarter August reporting companies including Autodesk, Cisco and NetApp (not held) made cautious comments regarding demand deterioration in July related to macroeconomic uncertainty. This was not the case with SaaS leader Salesforce.com which delivered a strong earnings report, solid bookings growth and raised FY20 revenue guidance. Current bookings growth of 25% in constant currency was above guidance while the next quarter guidance for 24-25% implies an organic growth rate of c20%. These data points helped relieve fears of a slowdown in end market demand for Salesforce’s solutions. In contrast, Autodesk disappointed with a lowered FY20 guidance outlook. Pockets of weakness in the UK, Germany and China were blamed, although management denied they were seeing a broader macro slowdown. Cashflow and cloud ARR growth were both above consensus but the implied heightened risks of a manufacturing slowdown drove the subsequent stock pull-back.

Staying with software, Splunk also delivered a mixed quarter as billings and revenues beat consensus estimates but this was overshadowed by a substantial cut to FY20 cashflow guidance, which was slashed from a positive $250m to minus $300m. This was primarily due to a quicker than expected transition from perpetual to rateable revenue – we trimmed our position before and following this unexpected development, the second consecutive cut to cashflow guidance. Human capital management software leader Workday also disappointed investors despite beating expectations on billings, revenues, margins and cashflow. While guidance was increased, management commented that there was “uncertainty in the air”, although they had yet to see any macro impact on their own pipeline. The Trust initiated a starter position in Workday following the earnings result and negative stock price reaction. Business data management platform Yext delivered a mixed quarter with higher investments in sales and product development resulting in lighter adjusted EBITA which, together with billings deceleration (to 19% y/y) overshadowed revenue upside. Despite the billings’ mismanagement the company raised full-year revenue guidance and won 10 deals with $1m+ in total contract value during the quarter. We trimmed our position following results.

Elsewhere, NVIDIA delivered another mixed quarter, but against lowered expectations the stock price responded strongly. The gaming segment continued along its path to recovery with a key contribution in the quarter coming from growth in shipments of the second-generation Nintendo Switch. Datacentre sales were disappointing, but management remains confident in inference growth and indicated broad-based strength outside a few key customers. Gross margins impressed as they moved above 62% and drove the EPS beat. Although NVIDIA was able to shake off a moribund report, the same was not the case for Cisco (not held) despite an undemanding headline valuation, as service provider weakness and China uncertainty weighed on guidance resulting in the stock falling sharply.

Outlook

The market remains in something of a holding pattern with investors hoping for bluer skies and a smooth landing while actual conditions continue to deteriorate. This is apparent from 2019 IMF global growth forecasts that by July had fallen to 3.2% having started the year at 3.7%, as the imposition of tariffs and trade war uncertainty place strain on the global economy. The global manufacturing PMI was once again below 50 – for the fourth consecutive month, its longest in contractionary territory since 2012 – while new orders decreased at the quickest pace since September 2012. With new tariffs being implemented from 1 September, risks of a global recession remain elevated with 84% (on a PPP-weighted basis) of the global economy reporting a manufacturing PMI below 50[i]. Furthermore, the latest data also suggests the US economy may be beginning to converge with the rest of the world. Fortunately, the continued absence of headline inflation has allowed policymakers to deliver looser financial conditions with the Fed acting and the ECB opening the door for further action. Cornerstone Macro estimate that the People’s Bank of China has actioned 91 easing moves since June 2018 with further room for manoeuvre, if required, as evidenced by the reserve requirement ratio cut in early September.

While the continued alignment of investor and policymaker interests (the bedrock of this cycle) has supported risk assets, a consequence has been plunging risk-free rates such that almost $17trn of the world’s sovereign debt now trades with a negative yield. During the month, Germany sold a 30-year zero coupon bund for 103.5 while a Danish bank introduced the world’s first negative interest rate mortgage, both of which served to remind how deep into uncharted territory monetary policy is today. The US yield curve is beginning to show the strain too, with the two to 10-year briefly inverted while the three month to 10-year spread is at its most extreme level in 19 years. While we are wary of the yield curve inversion (one of the few reliable predictors of recession, albeit with a lag), the resurgent treasury market may just reflect yield scarcity, given that 95% of the world’s investment grade debt delivering any yield is now US-based. Whatever the reason, the net result is that US stocks today boast a higher (dividend) yield than 30-year US treasuries – the first time this has happened since the financial crisis and only the second time in the past 40+ years[ii].

Although the juxtaposition of equity markets near highs and PMIs at lows is disconcerting (and indicative of elevated risk), it is not entirely without logic either. After all, the root cause of the recent divergence – trade war – is more likely be resolved once both sides begin to feel the pinch. For now, the Chinese appear to be playing the long(er) game using stimulus to prop up their economy, unencumbered (unlike the US president) by the need to win re-election in just over one year’s time. Given our view that both sides ultimately believe a trade deal is both necessary and desirable, the recent deterioration/ongoing brinksmanship should prove relatively short-lived. A date for the next round of talks has now been agreed, supportive of this view, while muted investor sentiment (-16% bull/bear spread) suggests the so-called ‘pain trade’ may still be higher.

Despite our elevated cash level and a modest amount of Nasdaq puts (reflecting top-down risks and the potential for bumpier than expected progress on trade), we remain constructive on our portfolio and hopeful that worst case outcomes will be avoided. Digital transformation – the need for companies to reinvent themselves and remain relevant in the smartphone/generation Z age – remains a business imperative. The US/China tariff spat still dominates the top-down chatter so, while the core of the portfolio remains the same, we have been looking at trade war de-escalation beneficiaries. We have never been believers in mean reversion within the technology sector, although access to cheap capital has seen many legacy companies limp off into the private domain rather than suffer the ignominy of becoming irrelevant in plain sight. That said, an improvement in trade war sentiment and/or fundamentals is likely to have a disproportionate impact on those companies with the greatest exposure to China and/or global growth which largely explains our increased exposure to the likes of Apple, Qualcomm and other 5G-related assets. As ever, we remain focused on our core investment themes and next-generation winners but only where valuations do not appear to already capture much of the potential upside.

[i] MS

[ii] Matt Topley, Fortis Wealth

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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The information contained within this website is issued by Polar Capital Technology Trust plc (‘Polar Capital Technology Trust’) and is provided for reference purposes only. Nothing herein is intended to be construed as an offer, invitation or inducement to engage in investment activity, or investment advice or recommendation, in relation to the shares of Polar Capital Technology Trust and should not be relied upon as such by any person. Prospective investors should take advice from their financial or other professional advisers before making any investment decision.

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Please remember that past performance of an investment is not necessarily a guide to future performance. The value of an investment and the income from it can fall as well as rise as a result of market and currency fluctuations and you may not get back the amount originally invested. The market value of the shares of Polar Capital Technology Trust may not reflect the underlying net asset value of the investments held by Polar Capital Technology Trust. Polar Capital Technology Trust is able to borrow to raise further funds for investment purposes if the fund manager and the board of directors consider that it may be commercially advantageous to do so. This is generally described as “gearing”. An investment trust which has made investments as a result of gearing may have a more volatile share price as a result; gearing can increase shareholder returns in rising markets but conversely can increase the extent to which the value of the funds attributable to shareholders decreases in falling markets. Tax assumptions may change if the law changes, and the value of tax relief (if any) will depend upon your individual circumstances. Investors should consult their own tax advisers in order to understand any applicable tax consequences.

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