Monthly Commentary
July 2017

Market Review

Equity markets rebounded in July as the FTSE World Index gained +1.0%, while the S&P 500 Index rose +0.5%, all (in GBP terms). Strength was witnessed across most asset classes with emerging market equities the stand out performer as the MSCI Emerging Markets Index gained +4.0%. Commodity markets witnessed a reversal in July as the CRB Index gained +4.5% while the WTI Oil price increased +8.4%. This was aided by further US Dollar weakness during the month, the trade-weighted Dollar Index (DXY) falling 2.9%. This weakness likely reflected continued impasse in Washington as the Trump administration once again failed to repeal and replace ACA (‘Obamacare’), while the Eurozone economy surprised to the upside, evidenced by the 3.6% move in the EUR/US$ exchange rate.

The broad-based recovery in global growth continues as both developed and emerging markets are experiencing accelerating growth for the first time since 2010. The European second-quarter (Q2) GDP estimate printed at +2.1%, up from +1.9% in the first-quarter (Q1) and the highest rate since Q2 of 2011. In the US Q2 GDP increased to an annualised +2.6% from +1.2% in Q1. Central banks were in the spotlight during the month as the US Federal Reserve and the ECB made noteworthy announcements implying future policy tightening/balance sheet reduction. If data continues to strengthen it appears more likely that we are on the cusp of a co-ordinated global rate-hiking cycle – potentially the peak of the liquidity conditions that have been in place since the global financial crisis. However, for now the ‘low inflation conundrum’ persists with the Federal Reserve viewing inflation as running below their 2% medium-term inflation target. Presently, both the ECB and Federal Reserve are willing to look through the recent weakness in inflation prints and not extrapolate them as reflecting weak underlying aggregate demand – but the lack of inflation currently suggests that any move up in yields/rates should be gradual. A more sudden move caused by a resurgence of inflation remains a risk to monitor, especially as unemployment levels in many countries have reached the perceived full employment thresholds. 

Technology Review

The technology sector outperformed the broader market during the month, the Dow Jones World Technology Index gaining +2.7% (in GBP terms). Q2 earnings season dominated proceedings with most companies delivering in-line or ahead of expectations. There were a few exceptions/weak spots (such as IBM** and CyberArk*) but overall results were stronger than their stock price reactions suggest – with stock price strength over recent months already anticipating (pricing in) a strong result season.

In the Hardware sub-sector, Apple* delivered its third consecutive quarter of accelerating growth, with both iPhone and iPad shipments above consensus, alongside moderating declines in its China business. The Apple share price reacted favourably, reaching a new all-time high as next quarter guidance proved better than feared – easing concerns of a material iPhone 8/X delay. Video game stocks had an impressive earnings season. Nintendo* delivered a big beat due to impressive Switch console and first-party software sales. Importantly, the tie-ratio (software units sales/console unit sales) increased as consumers purchased more titles. The company is making strong progress towards the EPS peak seen in the Wii era, aided somewhat by a weaker Yen. Ubisoft*, Electronic Arts* and Activision Blizzard* all produced solid results, driven by improved monetisation of their core franchises with additional digital content.

The payment sector also produced a strong set of results with Visa*, Mastercard**, Paypal* and Square* all impressing.  Broad macro strength and cross-border travel both provided tailwinds to Visa in Q2 and the integration of Visa Europe is on track to exceed managements EPS accretion target.  Paypal continued its run of strong quarters with improvements seen in both volume and engagement metrics. The company achieved 6.5 million net new active accounts, the largest organic gain for over three years, alongside a plethora of recent partnership deals, supporting the management team’s aim of becoming the payment platform of choice.   

Within Semiconductors, Samsung* continued its impressive run of performance aided by strength in Memory (NAND/DRAM) and Galaxy S8 smartphone sales. Samsung reiterated its focus on profitability over share in DRAM which helped alleviate concerns that excess capital spending could upset the pricing status quo. We no longer hold Intel** but they produced a rare beat and raise and posted an impressive +14% organic revenue growth, the highest rate since 2011. However, strength was largely PC-related and longer-term concerns over its health and competitive threats in the server market remain unanswered. Part of our longer-term concern regarding Intel stems from a revitalised AMD* in which we have a large position. AMD delivered a healthy quarter driven by new product strength – Ryzen desktop and GPU sales both ahead of expectations, with cryptocurrency-related demand providing an additional tailwind. Semiconductor equipment companies also delivered strong reports, although muted share price reaction to numbers from Tokyo Electron*, LAM Research* and KLA-Tencor** reflected some concerns (we believe misplaced) around ‘peak cycle’ fundamentals, with 2018 predicted to be third consecutive year of year-on-year capex growth.

As expected, Internet leaders Facebook*, Amazon*, Netflix** and Alphabet* all delivered in-line to strong results with continued impressive top-line growth at scale. The strong revenue growth came with disappointing margins at Amazon, as higher investments in fulfilment capacity and digital video content impacted Q2 operating margins. Meanwhile, third-quarter (Q3) guidance indicates that the investment phase will continue. Notably, Amazon founder Jeff Bezos briefly surpassed Microsoft founder Bill Gates as the world’s richest person during July. In software, beats and raises were delivered by many of our mid-cap names including Zendesk*, New Relic*, ServiceNow*, Hubspot*, Ringcentral* and Proofpoint*. ServiceNow arguably reported the most impressive results within the software sector as it delivered another quarter of 40%+ year-on-year subscription billings growth. This was done alongside operating margin expansion of 400bps, considerably exceeding consensus expectations. However, in keeping with the trend of this earnings season the share price reaction to most of these results was lacklustre in the days that followed due to anticipatory strength over recent months. In the security software sub-sector, a negative pre-announcement from CyberArk* set the tone for a mixed earnings season for the sub-sector. CyberArk cited elongating sales cycles in EMEA as the reason for their disappointing results while others in the space (which we don't have exposure to) including Checkpoint Software**, Barracuda Networks** and Fortinet** blamed a combination of holiday timing, service provider lumpiness or short-term customer distraction due to recent high-profile breaches. Proofpoint* proved to be one of the few exceptions within its peer group delivering another clean beat and raise.  

Outlook

Despite strong year-to-date performance, we remain hopeful that equity markets can add to their gains during the balance of the year. Although valuations have continued to drift higher, the US is currently experiencing its fastest pace of earnings growth in five years supported by a strong second-quarter reporting season. In addition, we continue to believe that the current investment backdrop remains unique, with accommodative policy and the prevailing rate of inflation supportive of current equity valuations. As such stocks remain more attractive than both cash and bonds with c. US$9.5tr of global sovereign debt recently trading at yields below zero. However, we expect future equity returns to more closely resemble underlying earnings growth which we believe should suit our growth-centric approach.

While a number of central banks are beginning (or at least signalling their intent) to roll back earlier accommodation, we expect US monetary policy to remain both accommodative and somewhat data dependent. This view reflects the fact that persistently soft wage growth suggests that the labour market is less robust than headline employment data might indicate and our suspicion that technology has forever changed the labour/capital relationship. We also recognise that initial hopes for immediate change and pro-growth stimulus from Washington have reversed as the new president looks increasingly isolated, unable to thus far deliver on any of his key campaign pledges including the repeal/replacement of ‘Obamacare’. As a result, long-term US bond yields remain stuck in a range bounded by full employment and (non-inflationary) sub-trend global growth.

As ever, there are risks to our relatively sanguine view both to the upside and downside. In addition to those previously discussed, we are watching events in North Korea with interest as sabre-rattling and an escalating war of words shows little sign of abating. Although we do not anticipate actual conflagration the risk of unintended conflict appears to be increasing with the Chinese either unwilling or unable to rein in their neighbour. This exogenous risk, together with slightly disappointing stock action during what was a positive reporting season explains our decision to retain a modest amount of liquidity at present.

In terms of technology, we remain overwhelmingly positive as the combination of smartphone ubiquity and cloud computing has allowed our industry to mirror the earlier experience of electricity by enabling widespread reinvention beyond traditional technology boundaries. Aided and abetted by millennials that ‘engage with smartphones more than humans’, today’s technology winners are delivering products and services that change user behaviour and expectations. Every day c. 1.2 billion people use Facebook while more than 1 billion hours of video are consumed on YouTube. Half of Tencent’s WeChat users spend 90 minutes every day in the app while streaming music leader Spotify today accounts for c. 20% of global music industry revenues. However, widespread reinvention inevitably involves disruption to incumbent business and distribution models, most evident in retail where a reacceleration in e-commerce growth is in stark contrast to US store closures that this year are expected to exceed those during the Great Recession. Likewise, Netflix’s** success has come at the expense of the top five US TV networks which have seen their aggregate monthly minutes delivered fall 10% since 2011.

Widespread change is also hollowing out the enterprise-centric IT industry as the Cloud becomes the default computing platform. This represents the ‘beginning of the end for traditional IT’, a fact not lost on its practitioners, this year’s AWS re:Invent conference attracting more than 30,000 attendees, up 68% year-on-year. With the Cloud’s share of IT workloads expected to quadruple by 2022, we expect M&A to be a permanent feature of this cycle as incumbents attempt to reinvent themselves before their relevance dims and their cash flow runs dry. Strategic transactions are likely to be augmented by financial M&A with private equity increasingly drawn to our sector’s recurring revenues.

As any student of history will know, technology deflation represents one of the most powerful agents of change. When accompanied by positive demand elasticity, magic happens! We are seeing this begin to take root in the industrial/automation domain as the evolution (and falling cost) of advanced components such as machine vision, sensors and reduction gears are driving a significant market expansion. Advances in control systems and sensor technology have also made predictive maintenance possible, paving the way for manufacturers to avoid unplanned downtime said to cost on average 5% of total output value. Given the size of the replacement opportunity (60 million machines with c. 70% more than 15 years old) we have continued to add exposure to the automation/robotics theme.

In addition, we remain focused on our seven other core themes which include 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 and rising semiconductor complexity. We are also fascinated by artificial intelligence (AI) and machine learning (ML) which offer the potential to further reshape the technology landscape over the coming years. As Bill Gates stated, ‘a breakthrough in machine learning could be worth 10 Microsofts’ – praise indeed.

Ben Rogoff

* Held 

** Not held 

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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