Herald Investment Trust plc (HIT) raised £65m at launch in February 1994. Katie Potts was a technology analyst covering UK stocks at Warburg Securities. She believed that smaller companies offered greater potential for capital appreciation than larger companies, while many required capital to realise potentially exciting growth. She recognised that, as many of these were earlier stage, there was also a high degree of stock specific risk, and limited liquidity, making it difficult for professional investors, and retail investors alike to gain exposure to the opportunities. It seemed appropriate to address this exciting market with a closed end collective vehicle, so that the risk could be diversified over a large number of holdings. In addition, focused specialist management would enable stock selection with a higher success rate.
Initially the focus was in the UK and Europe, but Katie quickly realised that to aspire to be expert in the sector coverage had to be global. In particular the US has provided the intellectual and commercial leadership in the sector, and tends to be at the forefront of emerging markets. Shareholders, therefore, supported a ‘C’ share issue in 1996 when a further £30m was raised, and the fund’s investment remit was globalised, and US and Far East coverage assumed. Since then no further capital has been raised. Indeed over the three years to 31/12/2013 2.2m shares have been bought back for cancellation for c£12.2m. Buy-backs are carried out on an opportunistic basis to facilitate liquidity, but only when the fund has available liquidity, and when the interests of continuing shareholders are not adversely affected.
When the fund was launched the personal computer had become an established market. However, it only achieved mass adoption when Windows enabled a more user friendly interface. Initially the word processor, and the spreadsheet were the killer applications. The 1990s saw the growth of the LAN (local area network), which enabled users within an organisation to share information, and applications. By 1994 multimedia was the buzz word, and CDs (compact discs) emerged as a convenient method of storing sufficient data to save video as well as audio. The internet was beginning to stir in a commercial sense. This appeared to be another disruptive additional killer application for personal computers. The late 1990s saw an explosion in the use of e-mail, which had limited data, and was not real time, so worked effectively over what today seem primitive networks. 56kb modems became a standard, and Cisco has emerged as the networking giant from small beginnings, as Microsoft had the previous decade. Web browsing was also in its infancy, and there was a turf fight for both web browsers (remember Netscape), and search engines (remember Alta Vista, Yahoo and Excite all predate Google). The potential opportunity and disruption for traditional media was perceived at the time of Herald’s launch, hence the inclusion of media in the remit. The internet is a medium, and the PC analogous to a TV or radio, albeit with much more capability. This now needs less explanation than it did then.
Assets grew particularly strongly in 1999 as the investment world became excited about the potential for the internet, and most would agree that internet usage and penetration has exceeded the most optimistic expectations. However, the optimism was excessive. While stock market valuations peaked in the first quarter of 2000, too much capital had been thrown at the sector, and “land grab” became the expression, with companies attempting to buy market share at vast expense in terms of pre tax losses. This included the telecommunications sector, and a plethora of suppliers. We raised cash in HIT at this time. In fact £100m was realised in the first quarter of 2000, which exceeded the outside capital raised. The peak was obvious. We had a plethora of unexecuted sell orders, but only small private client buying driving valuations ever higher. Whilst more realisations would have been desirable, it gave us cash to invest in the subsequent hangover in 2002, which was enhanced by the use of gearing, at exceptionally good valuations, and there was a strong bounce in 2003. Companies made steady progress in 2004-2006, and companies adopted more conventional and appealing goals like making profits and generating cash. However, as all are now aware, the credit boom led to more excitement in other sectors. Housebuilders, property companies, and resource companies were demonstrating strong growth on lower multiples, and the technology sector had a dull phase.
2007 saw the onset of the credit bubble bursting. While demand for technology remained steady financial markets did not. HIT was leveraged by £50m in the middle of 2007, and when LIBOR started soaring it seemed a warning signal. In September 2007 we decided to purposefully raise cash. By October liquidity was dire, and failed sell orders simply accelerated the decline in share price of a number of our investments. Fortunately by the year-end we did have £40m net cash, and take-over bids provided further realisations. The valuations of most of these take-over bids were disappointing. For the long term health of the market for primary capital to invest in emerging companies, successful companies need to make good returns, and it is disappointing to see some of the companies that we had nurtured through the loss making phase to become strong profitable businesses, taken out with inadequate returns to their founders, However, from a HIT point of view, it was helpful liquidity in order to make further investments at even lower valuations. While it is exciting to be able to invest at what appears to be “bargain” valuations, there is a disturbing change in the market. There has been a net cash outflow from smaller companies every year since 2000, hence the proliferation of take-overs at low valuations. Fund managers need the cash. Institutional investors have largely disappeared from the micro-cap market, and have much reduced allocations to smaller companies. This reflects the effort to cover a large number of companies for small investments, and an increasing drive for homogenous portfolios across large amounts of capital precluding smaller investments. This is an opportunity for patient investors, but there can be no certainty when value will be realised.