Herald Investment Trust plc Half-Year Report 2022

HERALD INVESTMENT TRUST Plc

(The “Company”)

Half-Yearly Financial Report For the Six Months Ended 30 June 2022

Summary Of Performance

^A   Alternative Performance Measure (APM).

*  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.

Past performance is not a reliable indicator of future returns.

Chairman's Statement

It is disappointing to report a decline in net asset value per share of 25.1% in the first half of 2022 which translates into a total decline of 10.9% since the start of 2021. As we have highlighted in previous reports, there had been a period of expanding valuations but this has now gone into reverse. However, the eighteen month performance is more resilient than it first appears, since the price/earnings ratio of the profitable stocks within the portfolio has fallen from c31x to c17x (Bloomberg) over this period such that the shares are on average 45% cheaper on this valuation basis. When viewed in this 18 month period context, the limited NAV decline demonstrates that profits grew strongly for the majority of the Company's investee companies, despite the challenges of Covid, supply chain issues, a tight labour market, and other rising input prices. There has also been a benefit from a rotation from concept stocks with high multiples to lower value stocks.

Share prices have fallen similarly in all regions and across all sub-sectors within the targeted telecommunications, multimedia and technology sector. Rising energy prices, labour shortages, inflation and therefore interest rate rises are now well established, not only in the UK but in all regions where the Company invests. Looking ahead, it appears that the UK and North America may be better placed to cope with the gas shortage exacerbated by the Ukrainian war than Germany and other European countries with no indigenous supplies. The UK is also less exposed to trade with Russia, and capital goods exports to China. However consumer spending will inevitably be squeezed globally by inflation and rising interest rates, and some companies will suffer from reduced demand and an inability to pass price rises through to customers. We therefore expect profits growth to slow and some downgrades to forecasts, albeit we are endeavouring to minimise exposure to the most vulnerable consumer-facing companies. However, there will also be some bright spots and the US and UK will benefit from an already evident upturn in demand for defence equipment, which stimulates demand across a broad technology supply chain.

The table below shows the portfolio returns by region.

^  Alternative Performance Measurement (APM).

The UK remains the largest region with 46.4% of net assets. With the Company's technology focus, the return of -27.9% was 6.5% worse than the Numis Smaller Companies plus AIM (ex. investment companies) Index which includes a broad range of industries and which declined 21.4%. The media companies, which performed so well in 2021, led the decline. We had taken some profits, but liquidity was challenging when a sale seemed obvious on valuation grounds. The positive performers included Euromoney Institutional Investor, Ideagen and Emis, which all have had takeover approaches. The Euromoney and Ideagen bids are both from private equity houses, underlining that these investors are significant players in the market. At this point, the Brexit vote is now more than six years ago, and there has been no evident effect, positively or negatively, within the Company's portfolio companies.

North America, which is the second largest regional exposure of the portfolio (23.4% of net assets) declined 20.5% which was somewhat more resilient than the fall of sterling return of the Russell 2000® Technology Index (small cap) (£)  of -26.0%. While the dollar's strength softened the declines for us, a stream of takeovers helped the performance relative to the index. Of the ten takeovers, long-held Mimecast, Silicon Motion Technology and SailPoint Technologies were the most significant. The aggregate value of American takeovers that have completed this year or remain to be completed is £84m, which is remarkable in relation to the value at the period end of the North American portfolio of £301m. This is very different from the time of the 2000 technology crash when takeovers were generally made using shares with inflated valuations rather than cash.

The EMEA (Europe, Middle East and Africa) return was -33.3%. Having been the strongest region in 2021, gains evaporated with Esker and Nordic Semiconductor leading the declines by value, however Cast and Generix received takeover approaches. The Asian return was -29.9%, and the Australian component was particularly weak at -44.7%. Japan continued to be difficult with a return of -34.3% but, in contrast, Korea, Taiwan and Singapore only fell between 20.9-23.3%. The small exposure to China was only down 1.9%, partly due to the fact that 51Jobs was acquired.

Net dividends received were 24.6% higher than in the first half of 2021, such that the Company's H1 loss narrowed relative to last year. As interest rates rise, the income should improve further although capital gains, of course, remain our investment objective. Nevertheless, the improved income position is reassuring given the difficult share price performance. The Company continues to buy back shares opportunistically and a further 1.6m shares have been purchased for cancellation during the period for £32.7m.

The economic and political background is bleak. The Ukrainian war is a damaging headwind for Europe in particular. The UK faces public sector pay awards which the country can ill afford. We face a potential hard landing in the US, with New York and San Francisco seemingly much more damaged by Covid than London. The longer-term impacts of Covid are manifest with a significant resistance from staff to return to the office in the US, and China's zero tolerance approach is causing serious economic harm.

In spite of all the bad news, we are reassured to see some evident bubbles deflating: cryptocurrencies, SPACs (special purchase acquisition vehicles) and overpriced IPOs especially in the US. More fundamentally, metal prices are declining sharply which should help inflation, albeit oil and gas are still a problem. The labour market has been tight in the technology sector for several years, leading to excessive pay and share-based payments. We have expressed concern about this for some time, and feel a downturn was overdue. We note the lay-offs and hiring freezes in California as the crazy fashion for revenue growth at any cost seems to be ending. Too many investors strayed into late-stage venture funding which made capital raising too easy; but as this money disappears, cash flow will inevitably become the priority concern. There will be companies that fail, while others will be desperate for cash and we have positioned ourselves for this eventuality. Back in 2002-3, we retained resources to provide follow-on funding to businesses, which had been initially funded in the dot.com bubble, and we managed to invest at sensible valuations. There was a similar good buying opportunity in 2008-9, when funding was scarce in the financial crisis. We believe the coming period may present us with similar opportunities. The Company ended the period under review with £114.0m in cash including short-dated Government bonds. Although £38.3m has already been received in cash from the takeovers described above, a further £109.5m is anticipated, and this will significantly enhance our buying firepower if they all complete. Depending on how markets develop, the closed-end structure of the Company would allow us to deploy leverage but we have no plans to do this at the present time. We are excited to have this war chest and envisage another bout of good buying opportunities in the coming months.

We view the outlook with both apprehension and excitement. It will be a stock pickers' market.

Tom Black

Chairman

20 July 2022