Monthly Commentary

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January 2018

Market Review

Equities rallied sharply in local terms during January although this was largely offset by US Dollar weakness/Sterling strength, the FTSE World Index TR gaining 0.5% (in GBP terms). Macro-economic data remained supportive, the IMF revising higher their latest global growth projection by 0.2% to +3.9% for both 2018 and 2019.  Particularly noteworthy was China GDP data which showed full-year growth of +6.9% in 2017, above the +6.7% achieved in 2016 and the first full-year acceleration since 2010. 

Unfortunately, the sell-off in US treasuries that began in January continued into early February causing ten-year US sovereign yields to breach 2.8% following better than expected US Payroll and hourly earnings data, triggering a “Taper Tantrum” a la 2013. The VIX Volatility Index jumped sharply (crossing 50 in early February) as risk aversion spiked and equities dropped sharply. The magnitude of the move was seemingly exacerbated by losses from highly speculative short volatility products and compounded by quantitative and momentum investors. Prior to this correction the S&P had enjoyed over 300 trading days without a meaningful pullback; as such we are inclined to view this as a necessary and healthy correction after an exuberant start to the year.

Stepping back, the US and global economy remain in excellent shape. To quote the Economist “To say that the fundamentals are strong tempts fate, but the fundamentals are as strong as they have been in over a decade”. While we recognise that inflationary pressures are likely to build over coming years, for now they appear contained. The US Core CPI data for December lifted annual inflation to +1.8% year-over-year (y/y) with annualised 3/6 month core inflation exceeding 2%. As such, we remain of the view that central banks will continue to tighten policy but at a measured pace (3-4 US rates hikes expected this year). Meanwhile, the stronger economy should provide a tailwind to corporate earnings and a supportive backdrop for equity markets – albeit with more volatility than in 2017 – at least as long as the rise in yields remains orderly. 

Technology Review

The technology sector outperformed the broader market during the month, the Dow Jones World Technology Index gaining +2.0% in Sterling terms. We are midway through fourth-quarter 2017 (Q4 2017) earnings season and although stock reactions have been somewhat muted (largely reflecting strong January stock price moves), technology reports have been generally robust.  There have been some exceptions but these have been largely smartphone related (particularly Apple*) or stock specific news (such as PayPal* losing an eBay** contract) rather than suggestive of any broader demand slowdown.  

Amazon* produced a particularly impressive quarter, with North America retail margins jumping to 4.5% the highest Q4 margin since 2010. Other revenues increased +60% y/y in part due to the growing advertising business within Amazon.  Meanwhile, AWS experienced both margin improvement and a re-acceleration of growth to 44% y/y – an impressive feat considering this is now a US$17.5bn revenue business on a trailing twelve month (TTM) basis.

ServiceNow* delivered strong results, beating on revenues, EPS and billings as large deal momentum remains durable. Adoption of their newer products outside ITSM continues with 18 out of the top 20 deals this quarter including at least four products.  Games software stocks performed strongly during the month with Activision*, Nintendo* and Electronic Arts* all advancing.  EA announced an in-line quarter which was better than expected as anticipated weakness in Star Wars Battlefront II game sales was offset by strong growth of +39% y/y in Live Services. Meanwhile Nintendo launched its Labo range of cardboard accessories for the Switch console, a product which garnered strong reviews and has to be seen to be appreciated (https://www.theverge.com/circuitbreaker/2018/2/3/16965900/nintendo-switch-labo-cardboard-features-youtube-video).

Alphabet* delivered strong top-line revenue growth +24% y/y ahead of expectations, but this was offset by lower operating margin (increased costs associated with data centres, mobile mix shift, hardware products and content acquisition costs for YouTube).  Whilst the shares fell on the resulting EPS miss, we believe they remain attractively valued. PayPal* also saw strong demand with constant currency revenue growth accelerating (to +24%) for the third straight quarter alongside margin expansion. Net customer additions of 8.7million was a record. Unfortunately, the gloss was taken off earnings by the news that eBay will incorporate its own payment option to compete with PayPal in 2021, although the current contract stipulates PayPal will remain an option until at least 2023.  We believe that the power of the PayPal brand will ensure that at least from a consumer’s perspective, PayPal remains a prominent payment option on eBay.

Apple*, announced weak iPhone unit sales of 77.3m, essentially unchanged y/y – fortunately offset by a higher than expected average selling price (ASP) of US$796.  Unfortunately, management guidance suggested this pricing tailwind may diminish next quarter. Whilst the resulting stock fall hurt our absolute returns, our relative performance benefited from our underweight Apple position which we had further reduced modestly ahead of numbers based on our own experience of the new phone and industry supply chain data. That said, other Apple-related stocks including Universal Display*, Lumentum*, TSMC* and Dolby* did drag on both absolute and relative performance even though most are yet to report.  

For now, the so-called iPhone X ‘super-cycle’ thesis has been dispelled as total iPhones sold are likely to be close to flat for the third successive year. However, the stock remains supported by a Services segment that continues to impress (+18% y/y) at higher than corporate margins, the likelihood of significant cash return to shareholders as part of the repatriation process and the potential for a larger screen OLED iPhone that could be released in the autumn.

While January proved a strong month for the sector and the Trust, there were a number of detractors to performance. These included Universal Display, Netease, Lumentum, Renesas and Dolby, underweight positions in Microsoft and Nvidia and the drag from cash. 

Outlook

Equity markets experienced an extremely strong start to 2018 but gave up these gains in early February amid rising bond yields, increased risk aversion and what appears to be a technically driven spike in volatility amid overbought conditions. To date, technology sector performance has been encouraging – demonstrating leadership during the upward move and giving back less during the correction – supported by strong balance sheets, tax reform, repatriation of overseas earnings and robust earnings growth as the sector continues to attack the profit pools of other industries. The latest high-profile examples of technology disruption being Amazon’s push into both healthcare (in partnership with Berkshire Hathaway and JP Morgan) and groceries (following its acquisition of Whole Foods).

Whilst bouts of inflation angst may cause 2018 to be a more volatile year, gradual interest rate tightening should not be a concern in itself if reflective of economic strength. However, we are mindful that – at some point – higher inflation and/or rates will likely limit upside to equity valuations which are already above long-term averages. As we have previously opined, this should result in equity returns becoming increasingly dependent on underlying revenue and earnings growth, which should provide a tailwind for active investors and hopefully benefit our underlying active/growth centric approach. 

Turning back to technology, we remain excited about our new cycle thesis that appears to be gathering strength every earnings season with a growing divergence between incumbents and next-generation companies now that the Cloud has become the default computing platform. This bifurcation is intensifying as workloads continue to gravitate towards the public cloud, while emerging technologies such as artificial intelligence (AI) – where the Internet platforms enjoy a leadership position – are likely to accelerate this trend.  Our eight core secular themes remain unchanged; eCommerce and digital payments, digital marketing and advertising, cyber and physical security, Cloud computing and artificial intelligence (AI), software as a service (SaaS), digital content and gaming, robotics and automation and rising semiconductor complexity. However, we have reduced exposure to the Apple iPhone X product cycle including semiconductor/component stocks which are exposed to overall smartphone demand.  

In terms of the portfolio, we used the exceptional start to the year to take profits in selected robotics, payments and software as a service (SaaS) stocks which had performed well, aided by multiple expansion. Despite rotating some of the proceeds into our preferred holdings, our cash remained somewhat elevated at month end. Given the recent reversal in market direction/volatility, we expect to retain some of this additional liquidity for the time being but will look to add back to our preferred names as earnings season progresses, or on further market weakness given the pullback has little to do with technology fundamentals.

Ben Rogoff

* Held

** Not held

*** Not held, not listed

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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The securities of Polar Capital Technology Trust referred to on this website (the "Securities") have not been and will not be registered under the US Securities Act of 1933, as amended (the "Securities Act") and may not be offered or sold in or into the United States or to, or for the account or benefit of, US persons (as defined in Regulation S under the Securities Act) absent registration under the Securities Act or pursuant to an applicable exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and in compliance with any applicable securities laws of any state or other jurisdiction of the United States. Polar Capital Technology Trust will not be registered under the U.S. Investment Company Act of 1940, as amended, and investors in the Securities will not be entitled to the protections of that Act.

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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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