Herald Investment Trust Plc – Latest Annual Financial Report

ANNUAL FINANCIAL REPORT for the year ended

31 December 2021 (audited)

This is the Annual Financial Report of Herald Investment Trust plc as required to be published under DTR 4 of the UKLA Listing Rules.

Results and dividend

The net asset value (NAV) of the Company as at 31 December 2021 was 2,719.3p per ordinary share (2020 – 2,285.3p). This represented an increase of 19.0% during the year, compared to an increase in the comparative total return indices of 17.8% (Numis Smaller Companies plus AIM (ex. investment companies) Index) and an increase of 15.2% (Russell 2000® Technology Index (small cap) (in sterling terms)). The discount at year end was 7.9% (2020 – 1.8%).

The directors do not recommend a dividend for the year ended 31 December 2021 (2020 – nil).

The financial information set out in this Annual Financial Report does not constitute the Company's statutory accounts for 2020 or 2021. Statutory accounts for the years ended 31 December 2020 and 31 December 2021 have been reported on by the Independent Auditor. The Independent Auditors' Reports on the annual report and financial statements for 2020 and 2021 were unqualified, did not draw attention to any matters by way of emphasis, and did not contain a statement under 498(2) or 498(3) of the Companies Act 2006. The Company's statutory accounts for the year ended 31 December 2020 have been filed with the Registrar of Companies. The Company's statutory accounts for the year ended 31 December 2021 will be delivered to the Registrar in due course.

The financial information in this Annual Financial Report has been prepared using 'FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland' (FRS102), which forms part of Generally Accepted Accounting Practice ('UK GAAP') issued by the Financial Reporting Council. The financial statements have also been prepared in accordance with The Companies Act 2006 and with the Statement of Recommended Practice 'Financial Statements of Investment Trust Companies and Venture Capital Trusts' issued by the Association of Investment Companies ('AIC') in October 2019.

STATISTICS AND PERFORMANCE – YEAR'S SUMMARY

^A   Alternative Performance Measure.

^B   Investments and indices valued at USD/GBP exchange rate of 1.354 at 31 December 2021 (1.368 at 31 December 2020).

^®   Russell Investment Group

LONG TERM PERFORMANCE SUMMARY

^A Alternative Performance Measure.

* 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 2021

I am delighted to report another year of excellent progress with the net asset value per share appreciating 19.0%. There has been rotation in the performance of the portfolio, with some of the star performers in 2020 ceding some of their gains, and other holdings enhancing theirs. The media sector accounted for only 13.3% of net assets at the start of the year and contributed one third of the overall return, delivering 54.8% mainly in the UK; but the largest sector, software, which accounted for 36.3% of the Company's net assets at the start of the year delivered a return of only 7.2%. Many stocks in this sector had become too expensive and a correction is wholesome and reduces the overall risk in the portfolio. The semiconductor sector also had a very strong year with well-publicised capacity shortages providing unprecedented pricing power.

The UK equity investments now account for 47.7% of net assets (down from 49.3% at the end of 2020). The UK return of 23.3% was ahead of the Numis Smaller Companies plus AIM (ex. investment companies) Index whose total return was 20.0%. The board considers this result to be satisfactory given that the technology sectors lagged the index as a whole.

The North American equity portfolio now accounts for 22.3% of net assets. It returned 11.0%, which lagged the Russell 2000® Technology Index by 4.2%. This small cap index itself returned dramatically less than the Russell 1000® Technology Index, which returned 38.3% in sterling terms. Furthermore, companies too small to be included in the Russell 2000® Technology Index have performed even more poorly.

There is a perception that it has been a bull market for technology stocks. This is indeed true for the likes of Microsoft, Apple and Alphabet and the semiconductor companies, but there has been a bear market in software companies with the Bloomberg Software Sector for small cap stocks (between $100m and $3bn) delivering a median return of -16.3% for North America. Unfortunately, software was the heaviest weighting in our portfolio, although some judicious profit-taking limited the damage. There had evidently been unrealistic momentum in the software sector and valuations had become too stretched, particularly in light of the significant dilution in this sector from stock-based compensation. Often, revenue growth has been favoured over profitability and the outperformance we have delivered in this sector and this year reflects the value the Manager places on management teams who take a balanced view of profits and growth.

The EMEA (Europe, Middle East and Africa) portfolio has delivered an exceptional performance during 2021 returning 46.3% in sterling terms. The three largest holdings – Nordic Semiconductor, Esker and BE Semiconductor – all performed well. The weighting in this region has risen significantly to 11.4% from 8.6% at the end of 2020, usefully assisting us in maintaining appropriate geographical diversification.

The Asian return was 19.0%. Whereas in the UK the return was dominated by media stocks, in Asia the strong performance resulted from technology hardware and semiconductors, mainly in Taiwan. In fact, Taiwan delivered a remarkable return of 89.8% due in large part to heavily publicised supply-chain issues which clearly benefited some companies in the portfolio. It is difficult to tell how much inventory building has flattered demand and we might well expect to see some unwinding of this outperformance in the coming year. The Asian equity element of the portfolio has grown to 11.8% from 10.1% of the Company's net assets at the end of 2020.

The portfolio is, of course, focused on growth companies, and only a subset of the portfolio pays a dividend. Nonetheless, such income is welcome, and I am pleased to report that the net dividends received by the Company grew by 41.3% from the previous year although, as noted last year, they were heavily depressed in 2020 by lockdown uncertainty. Nonetheless, dividends have still appreciated 14.8% from pre-Covid 2019.

We continue to buy back our own shares opportunistically and 1,029,306 shares were bought back during the year for cancellation at a cost of £22.9m which equates to 1.6% of the outstanding capital as at 31 December 2020.

ESG (environmental, social and governance) has continued to be a focus of attention during the year. Herald Investment Management's 2020 Stewardship Report was approved by the Financial Reporting Council. This was a significant achievement given that many higher profile names were not awarded the same accolade. The renewable energy elements of the portfolio had a very strong year in 2020 and ceded some of those gains in 2021, but we remain interested in a plethora of companies innovating to generate, store and save renewable energy. In discussions with numerous investee companies, we have learnt that their ESG efforts consume considerable resources, and therefore represent a material expense for shareholders, for the benefit of the wider society. We remain concerned that the ever-increasing wave of regulation in all its various forms has become a disincentive for companies to raise new capital via the public markets, whilst others are tempted by funds from private equity where the regulatory burden is lighter.

The AGM will be held on the 19th April 2022 and we expect to return to the normal practice of welcoming shareholders in person. This is, of course, subject to government restrictions. This will be my first AGM as chairman and it will be a great pleasure to hold this meeting under more normal circumstances. I would like to take this opportunity to mention my predecessor as chairman, Ian Russell, and to thank him sincerely for his contribution to the Company. This particular AGM provides shareholders with an opportunity to vote on the continuation of the Company, as the articles of association require every third year. The board has also carried out a review of our articles to ensure that they reflect current best practice and legislative changes and a number of modifications are proposed as a result. Your board strongly recommends that shareholders vote in favour of both the continuation resolution and the changes to the articles.

2021 has been a mixed year with an unusually small proportion of the portfolio delivering the returns. More positively we are pleased that the portfolio has proved resilient through the second year of Covid. The Net Asset Value per share has appreciated 63.0% over the two years affected by the pandemic. Furthermore, Bloomberg estimates of the P/E (price to earnings) of the portfolio has only increased by a tenth over the two years and has actually declined a little over the last year. This NAV increase reflects takeover premiums, earnings growth, and the highly rated software sector being usefully rerated, while more modestly rated stocks have appreciated as a proportion of the whole. This provides a more solid base from which to go forward.

The fact that we have managed to operate relatively normally during the Covid period is due in large part to the dedication of the Herald Investment Management team. There have been many examples of team members going beyond what could have been reasonably expected and I am immensely grateful to them for their support during this difficult period.

As ever there is much to worry about geo-politically with uncertainties in Russia/Ukraine, China/Taiwan/US and the US/Iran of particular concern. Added to these, this year we have the new challenge of soaring energy prices which, when combined with supply-chain inflation, and inevitable fiscal tightening, seems bound to put pressure on consumer spending. However, much of the technology sector has become non-discretionary spend for consumers, businesses and governments alike and we still see strong growth prospects in our chosen sector. This, combined with the quality of the companies in the portfolio, means that your board remains optimistic about our future prospects.