Herald Investment Trust plc
Annual Financial Report
For the year ended 31 December 2023
Results and dividend
The net asset value (‘NAV’) of the Company as at 31 December 2023 was 2,219.2p per ordinary share (2022 – 2,099.1p). This represented an increase of 5.7% during the year, compared to an increase in the comparative total return indices of 3.2% Numis Smaller Companies plus AIM (ex. investment companies) Index and an increase of 21.0% Russell 2000® Technology Index (small cap) (in sterling terms). The discount at year end was 13.4% (2022 – 15.1%).
The directors do not recommend a dividend for the year ended 31 December 2023 (2022 – nil) as the revenue reserve is in deficit.
STATISTICS AND PERFORMANCE – YEAR’S SUMMARY
| 31 December 2023 | 31 December 2022 | % change | |
| Total net assets | £1,245.8m | £1,305.0m | |
| Shareholders’ funds | £1,245.8m | £1,305.0m | |
| Net asset value per ordinary shareA | 2,219.2p | 2,099.1p | +5.7 |
| Share priceA | 1,922.0 | 1,782.0p | +7.9 |
| Numis Smaller Companies plus AIM (ex. investment companies) Index (capital only) | 5,404.7 | 5,406.8 | 0.0 |
| Russell 2000® Technology Index (small cap) (in sterling terms) (capital only)B | 4,605.3 | 3,814.1 | +20.7 |
| Dividend per ordinary share | – | – | |
| Profit per ordinary share (revenue) | 6.79p | 0.21p | |
| Ongoing chargesA | 1.07% | 1.05% | |
| Discount to NAVA | 13.4% | 15.1% |
| Year to 31 December | 2023 | 2023 | 2022 | 2022 |
| Year’s high and low | High | Low | High | Low |
| Share price | 1,950.0p | 1,596.0p | 2,570.0p | 1,560.0p |
| Net asset valueA per ordinary share | 2,283.5p | 1,911.4p | 2,719.0p | 1,978.7p |
| DiscountA | 17.3% | 11.4% | 25.2% | 4.1% |
| At 31 December | 2023 | 2022 | |
| Profit/(loss) per ordinary share | |||
| Revenue | 6.79p | 0.21p | |
| Capital | 74.35p | (641.23p) | |
| Total | 81.14p | (641.02p) |
A Alternative Performance Measure
B Investments and indices valued at USD/GBP exchange rate of 1.275 at 31 December 2023 (1.209 31 December 2022).
® Russell Investment Group.
CAPITAL RETURN SINCE INCEPTION
| Inception | |||
| 31 December | 16 February | ||
| 2023 | 1994 | % change | |
| Net asset value per ordinary share (including | |||
| current year revenue)A | 2,219.23p | 98.70p | 2,148.46 |
| Net asset value per ordinary share (excluding | |||
| current year revenue)A | 2,212.06p | 98.70p | 2,141.20 |
| Share price | 1,922.00p | 90.90p | 2,014.41 |
| Numis Smaller Companies plus AIM (ex. investment | |||
| companies) Index | 5,404.69 | 1,750.00 | 208.84 |
| Russell 2000® Technology Index (small cap) | |||
| (in sterling terms)† | 4,605.25 | 688.70* | 568.69 |
A Alternative Performance Measure (APM). See Glossary of Terms and Alternative Performance Measures in the financial report for details of the explanation and reconciliations of APMs.
* At 9 April 1996 being the date funds were first available for international investment.
† The Russell 2000® Technology Index (small cap) was rebased during 2009 following some minor adjustments to its constituents. The rebased index is used from 31 December 2008 onwards.
CHAIRMAN’S STATEMENT AND REVIEW OF 2023
This is my first annual statement since assuming the chairmanship of the Company in April 2023. I would like to thank my predecessor Tom Black and my board colleagues for entrusting me with the role and making my job much easier through their constructive and collegiate approach.
The Herald Investment Trust has a remarkable long-term record. Had you bought shares at inception in 1994, you would have made 22 times your money, a compound annual return comfortably into double figures. Since 1996 the Company has not issued any new shares and has bought back more than £340m worth of its own shares. The successive boards of the Company, and the Manager, have exercised commendable capital discipline, recognising that the size of the Company should not outgrow the strategy of investing only in smaller technology and communication companies worldwide. In the year to 31 December 2023 alone the Company bought back £107.4m of shares, representing some 9.7% of the outstanding shares at the start of the year.
Stepping back, the purpose of an investment trust remains the same as it was when the vehicle was invented in the 19th century: to allow savers, whether directly or indirectly through, for example, pension funds, to gain exposure to a portfolio of shares, expertly managed, which they would almost certainly be unable to do on their own. The Herald Investment Trust represents a classic use of the vehicle. In the Company’s case, its investment strategy inevitably involves investing in stocks which are comparatively illiquid by virtue of their small capitalisations. Part of the reason for the Company’s success is that it can take a long-term view of growth and value, and not be looking over its shoulder for short-term liquidity. A closed-end vehicle is well adapted to that role, with selling of the Company’s own shares representing the way for shareholders to realise cash if needed, as opposed to redemptions of units, which would require the Company to sell the underlying shares to effect the redemptions. The Company’s strategy cannot be successfully executed through an open-ended fund, which would compel the Company either to sell illiquid shares at a forced seller’s price to finance redemptions, and/or change its successful strategy and invest only in the larger, more liquid, segment of the target market, which would run counter to the long-term interests of the Company and its shareholders.
There will be times when the focus of the Company on smaller stocks leads to underperformance against the wider stock market. 2023 was one such year. Growth in the Company’s NAV per share was 5.7% against stronger returns from the global stock markets. As detailed in the Manager’s Report, the main cause of the Company’s sluggish relative performance is illustrated by the divergence between the performance of the Company’s larger stocks and smaller ones, which was extreme in 2023. The 39 investments with a market cap of greater than $3bn delivered returns of 72.1% in the year against -9.2% for the 283 companies capitalised at less than $3bn. This reflects a similar, if less exaggerated, divergence within the wider stock markets of the world. This in turn reflects in part a stage in the interest rate cycle: after many years of very low rates, with the cost of capital similarly very low, rates have returned to ‘reality’ leading to the current reversal of popularity between small cap stocks and larger companies, whose current valuations are less dependent than smaller cap companies on a terminal value many years out which is then discounted at the prevailing cost of capital. Savers were also for the first time for many years able to earn a material return on cash deposits. The divergence was enhanced by the fact that 40% or so of the Company’s holdings by value are in the UK. With 2023 seeing an underperformance in wider markets for the UK against the rest of the world, the Company’s portfolio suffered from a ‘double whammy’ of focus on smaller stocks and the UK. Again, the Manager’s Report sets out the relative underperformance of the UK, driven not by poor performance overall of the stock picks, but by a contraction in price to earnings (‘p/e’) multiples applied to the earnings, against a material expansion in p/e multiples in all other regions.
As is typical of cycles, the underperformance of both small cap and the UK will turn: eventually their relative good value will be hard to ignore. In the meantime patience is needed. The factors at work are the subject of frequent dialogue between the Company’s board and the Manager: it is right to question the fundamental tenets of the investment strategy when there is underperformance. Part of this underperformance may result from a structural shift as an increased share of investment dollars is taken by index tracker funds, which do not invest in small and micro stocks. However, the board remains confident that the Company is operating in a sector of the capital markets, namely small cap technology and communications (in which there are more than 5,000 public companies globally) which is going to continue to prosper in the long run by comparison with many other sectors. The typical investor has few options to gain exposure to the sector on a global basis – for example there is no way to invest in that sector through an ETF – and the Company fulfils that requirement, with the added benefit of the Manager’s proven investment process and stock picking skills. Similarly the Company plays a vital role in providing primary capital to companies especially in the UK. Because Herald is ‘one of a kind’, it is in a position to pick and choose the companies it will support, and as deal flow picks up, it will be the destination of choice for relevant companies wishing to raise equity capital.
The Company’s performance in the various geographies is discussed in the Manager’s Report. Although there was underperformance by some measures against the market in smaller companies in the UK, albeit not versus the AIM Technology sector, there was a strong outperformance in the US. Needless to say, over the longer term the Company compares very well on every measure.
On the income account, the Company itself benefitted from higher rates of interest receivable on its cash and near cash. However, with a deficit in revenue reserves, no dividend is payable.
The Manager details in its report that selling pressure in the Company’s own shares has been the greatest in its history. Again this reflects a wider market phenomenon, driven largely by the changed interest rate background, with selling of investment company shares and redemptions from open-ended funds, both pretty universal and at an elevated level. In the case of UK investment companies, the position is not helped by certain regulatory challenges, most notably a perverse requirement to aggregate investment companies’ charges (already discounted in share prices) with the wealth or fund manager’s own costs. The practical effect has been to drive away what should be natural sources of demand for the Company’s shares and deny the ultimate retail investor the opportunity to invest in a sector otherwise tailor-made for them. Hopefully 2024 will see sense prevail amongst the authorities.
The Company has entered 2024 with over £100m cash and near cash, representing some 8.5% of net asset value. Having avoided over-priced opportunities in recent years, this cash will allow the Company to take advantage of placings and perhaps IPOs at the more sensible valuation levels now prevailing. In that same time, as detailed in the Manager’s Report, the Company has taken advantage of many takeover bids for its holdings, not unusually at 100% or more of the undisturbed price, and these have been the primary source of the Company’s current liquidity.
The board is confident that long-term shareholders, who form the significant majority, will continue to be well served by the Company, and their investment aspirations of long-term growth will be fulfilled.
In December we welcomed Priya Guha MBE to the board. As detailed in the annual report, Ms Guha brings wide experience in the technology sector and a history of working across the UK private and public sectors. The latter is relevant for the Company, given the need for improvement at the regulatory level on a number of fronts to ensure a healthy market in smaller tech companies in the UK.
Karl Sternberg will not be standing for re-election at the forthcoming AGM, having served a nine year term. The board wish to record its appreciation for his many and varied valuable contributions since he joined the board in 2015, a period during which there have been many changes to the markets in which the Company operates, and which has seen the Company grow to become a constituent of the FTSE 250.
ANDREW JOY
Chairman
21 February 2024