Annual Financial Report

RNS Number : 7042C

Herald Investment Trust PLC

10 March 2011

 

Regulatory Announcement

 

HERALD INVESTMENT TRUST plc

 

ANNUAL REPORT AND FINANCIAL STATEMENTS

A copy of the Annual Report and Financial Statements for the year ended 31 December 2010 of Herald Investment Trust plc has been submitted electronically to the National Storage Mechanism (which replaced the UKLA's Document Viewing Facility on 1 September 2010) and will shortly be available for inspection at http://www.hemscott.com/nsm.do .

The Annual Report and Financial Statements for the year ended 31 December 2010 including the Notice of Annual General Meeting is also available on Herald Investment Management Limited's website at:

www.heralduk.com 

The unedited full text of those parts of the Annual Report and Financial Statements for the year ended 31 December 2010 which require to be published by DTR 4.1 is set out on the following pages.

Baillie Gifford & Co

Company Secretaries

10 March 2011

CHAIRMAN'S STATEMENT

The macroeconomic and stock market background was more benign in 2010. This was reflected in a continued recovery in the Company's market value and the net asset value (NAV) per share grew 41.2%, comfortably ahead of any relevant index.

The UK, which still accounts for the majority of the portfolio, had a total return of 42.4%. In comparison, the FTSE Small Cap index had a total return of 19.9%, and the FTSE 100 of 13.1%. The US portfolio performed even better with a $ return of 47.5%. This compares with the NASDAQ rising 18.2% and the Russell 2000 Technology Index rising 37.4%. The exchange rate enhanced these returns to 52.6% in £. The local currency return in Europe was a more modest 20.9%, 17.8% in sterling, but the Company's European exposure is now very modest. The Far East returned 15.6% in local currencies significantly enhanced by currency (27.5% in £). This lower return is consistent with the Manager's cautious weighting; the Taiwanese stock exchange Electronics index and the KOSDAQ IT index were relatively flat in local currencies.

In spite of the robust growth in NAV per share of 41.2%, the valuation of the portfolio is similar to last year in p/e terms illustrating the robust underlying growth in profits. This is somewhat higher than the long term growth rate and reflects a recovery in profits in certain companies that had been adversely impacted by the recession in 2009 and some of the funds raised through takeovers and profit taking giving the opportunity to reinvest on lower valuations. Nevertheless it provides an encouragingly solid base for further growth in 2011.

It is interesting to observe that smaller companies have continued to outperform larger ones in the technology sector in 2010, and the UK and the US have significantly outperformed the Far East and Europe, and the wider indices. The portfolio has been well positioned to exploit this. It might be worth illustrating some long term figures to highlight the long term performance divergences. 

Compound annual rate of return from inception and from full globalisation at the end of 1998

	21/02/1994	31/12/1998
HIT NAV (fully diluted)	11.2%	9.4%
HIT share price	10.4%	9.6%
HIT UK capital	15.7%	15.1%
HGSC capital	5.5%	7.4%
Russell 2000 Technology £	-	3.4%
Taiwan Electronics £ (total return)	-	5.0%
KOSDAQ IT £ (total return)	-	(0.2%)

Source: HIML

There are a number of interesting points to make. Firstly, the Company's NAV has compounded in capital terms since inception at 11.2% per annum.  The UK (+15.7% per annum) and European portfolios (+13.9% per annum) which were the Company's original focus, have compounded somewhat faster than this.  This is significantly ahead of the returns on the UK market as a whole and the various smaller companies indices and demonstrates that the UK has been, and the Manager believes will remain, a fertile area for investing in TMT stocks. The satisfactory UK return has also been enabled by the opportunity to exploit the market's volatility. In particular the Manager raised cash in 2000 but was a net investor in 2002, 2008 and 2009. Whilst the fund has benefited from its specialist focus on the sector, which is now unique in the UK, the US portfolio has performed satisfactorily relative to US indices but lagged the UK.  The focus on the US, where trends emerge first, has also enabled greater returns in the UK. The long term returns have been weaker elsewhere, which in part reflects a greater focus on the UK and US, but the asset allocation has correctly perceived the easier returns in the UK. The Taiwanese electronics index has performed marginally better than the Russell 2000 Technology Index, but the KOSDAQ IT index in Korea much worse.

It is pleasing to see that, as a consequence of the strength of the performance in the UK, over the long term the Company has outperformed all but one of the 87 surviving technology or TMT specialist funds managed in the US, UK and Europe since 31 December 1998, even in share price terms in spite of a wider discount. This seems a fair starting point because it includes the period over which the Company's mandate has been fully global and includes the boom and ensuing bust of 1999-2000, as well as the more recent financial turbulence. Undoubtedly the Company has benefited from its closed end nature as an investment trust, which has avoided cash inflows at times of excess enthusiasm and avoided cash outflows in the market troughs, which would have led to assets being sold on a distressed basis. The other closed end technology funds have also performed relatively well over the cycles.

Net income has been affected by the interest payable on the loan stock. As a consequence, no dividend is proposed in respect of the year.

Whilst the structural imbalances in the world economy cast a continuing cloud, the sector should fare relatively well in a background of inflation or deflation. Whilst investee company valuations are not as compelling as two years ago, they are attractive against the valuation of bonds and very modest versus the last time your Company had a NAV per share at this level in 2000. The launch of the iPad in 2010, from which the portfolio has benefited, epitomises how innovation can drive new markets.

Julian Cazalet

Chairman

22 February 2011

INVESTMENT MANAGER'S REPORT

At the start of the year I thought the portfolio was good value, with expectations of solid earnings. Candidly, I did not expect a return of over 40%. These seem to be the main reasons why my expectations were exceeded:

1)   Global growth exceeded expectations. The structural trade imbalances remain severe and excessive levels of debt proliferate. While there is an evident credit squeeze on private sector debt, global fiscal deficits have ballooned, stimulating demand growth and providing a sympathetic background for growth in corporate profitability for those with sufficient capital. I have experienced several recessions in my career, but 1980, 1984, 1991 and 2002 all seemed to have a greater adverse effect on profitability. I suspect this reflects more prudent business models in TMT companies since the ferocious 2002 downturn, low interest rates and also the continued buoyant levels of demand reflecting the pervasive adoption of technology in the enterprise and the home. Relative to bonds, property values and the wider equity markets, the portfolio's earnings yield continues to seem good value. However, I cannot fathom out how the excessive Government fiscal deficits in US, Japan, Europe and the Chinese local Government, combined with the continued deleveraging of the banks, will play out. The appetite and need for pensions in the developed world and the dramatic increase in life expectancy imply a higher savings ratio and subdued consumer demand. This in turn implies that returns on capital will be low - i.e. capital will be cheap and equities seem likely to become more expensive. This will be a change from the current environment of capital scarcity and where pension funds have been migrating into bonds, out of equities. Asset allocation seems to be driven by actuaries and accounting standards rather than fund managers.  The trick will be to find companies that can continue to grow profits in this environment.

2)   Continuing takeovers in the portfolio, with the ability to reinvest on substantially lower valuations means that in spite of further net outflows from the UK and US markets, redeployment of some of the proceeds has provided much needed liquidity. This year there have been 13 takeovers in the portfolio for cash realising £32.3m. In contrast the market for IPOs has again been minimal in the UK (only Digital Barriers appealed), and although it tried to get going in the US, many issues were withdrawn. There is a curious dichotomy between some of the larger technology companies in the US holding huge cash balances which generate an inadequate return on capital, while there is a shortage of capital for earlier stage companies. This mirrors the divergence in remuneration between the skilled workers and the unemployed. The knowledge based economy presents challenges for investors as it does for those starting their careers. The unwillingness by investors to participate in primary fund raisings has in the short term been helpful to the Company, both in providing reasonably priced investment opportunities and enabling the focus of available resources to support the secondary market as described. However, if the UK and the US are going to maintain their lead in developing leading edge technologies and growing companies with pricing power, then this capital drought in the venture market as well as the quoted market has to end. It is a source of frustration that more people do not share my enthusiasm for the sector in which I believe and invest, with an idealism that it is the sector which can enable the developed world to sustain and grow its living standards.

3)   Innovation continues to open new markets and in 2010 the iPad arrived, stimulating demand for component suppliers, internet traffic and paid content. This product was more disruptive than anticipated, has clearly stimulated the portfolio and contributed to upgrades in profit expectations. The drivers that have led to this eruption include 3G mobile telephones, 802.11n wifi, touchscreens, multi-threading technology, multi-core processing, increased integration, all of which have led to market share shifts and spectacular growth for certain companies other than just Apple.

UK

The UK portfolio has delivered a total return of 42.4%. Within this the biggest monetary returns came from the two biggest holdings, Imagination (+£10.0m) and SDL (+£8.3m), but 12 holdings yielded a return in excess of 100% and an increase in excess of £1m. These include CML Microsystems +536%, Avesco +378%, Telit +232%, Bango +189%, Andor +177%, Xaar +158%, Zoo Digital +153%, IQE +138%, Sandvine +139%, K3 +124%, Wolfson +117% and OMG +106%. Of these CML, Avesco, Telit, K3 and Wolfson were new holdings in 2008 or 2009. In addition we participated in secondary placings providing expansion capital for Bango, Xaar and IQE materially increasing the stake in each and a rescue financing at 15p for Zoo Digital.   The Andor, IQE and OMG stakes were all materially increased in the secondary market. Imagination had been the worst loss in the portfolio in 2008, but we materially added to the holding and then reduced it over time in 2010 until they too had a secondary placing towards the end of the year in which we also participated. It is extremely fulfilling to have been able usefully to provide capital to these businesses, while also achieving exceptional returns for investors. Unfortunately we bought back c9% of Herald's equity in the downturn. As I suspected at the time this has clearly adversely affected the net assets per share for continuing shareholders, because although the repurchases were on discounts up to 25%, the scale of outperformance of new or increased positions has almost invariably outperformed the portfolio as a whole by more than 25% and there simply was not the liquidity in other holdings to switch. Anyway, even the more resilient holdings were under pressure and we were determined to be supportive in fear of losing positions too cheaply to opportunistic acquisitions. Bear in mind that the portfolio had already risen 66.5% in 2009. Mercifully the Directors and a number of substantial wiser shareholders were supportive in resisting pressure from a small aggressive minority who were pushing for buy-backs, which either reflected their own distress or a failure to comprehend the market in which we invest and the outstanding opportunities that were available. With hindsight I regret not trusting my instincts more, resisting totally and utilising borrowing facilities more fully, but realistically it has probably only adversely impacted the NAV per share by 3-8%. Even more so, I regret my inability to convey my enthusiasm to the wider market. The sceptics and the pension funds and insurance companies seem to have significantly left the register, so I hope that 2011 might see an improvement in the share price relative to the assets.

It is interesting that in spite of two recovery years the market for IPOs ended the year firmly closed. In part this reflects a couple of overpriced issues getting away and disappointing, in part the continued shift of capital away from equities by insurance companies and pension funds and in part a fear of the illiquidity of smaller companies. This caused unfortunate volatility in Herald's NAV when there were distressed sellers in the market, but it has enhanced assets. Pension funds and insurance companies really are the investors that ought to be able to take long term stakes and I cannot help but believe that this dramatic switch into fixed interest will prove expensive.

Takeovers in the UK portfolio include Portrait Software, Innovision, Intec and Datacash, which was nearly a ten bagger.

US

The US portfolio rose 47.5% (52.6% in sterling) which is an even greater increase than the UK. This has been driven significantly by takeovers including Sonicwall, Virage Logic, Actel, Art Technology and ADC Telecom. Two of these rose over 100% in the year - ADC Telecom and Virage Logic and seven other holdings did too. In US$ terms, the percentage rises were as follows: MIPS +259%, Finisar +211%, Silicon Image +186%, MRV +151%, Support.com +147%, Radware +145% and Alliance Fiber +172%. MIPS has a similar business model to Arm, Imagination, Ceva and Virage Logic. They all receive royalties when their IP is designed in. Finisar and MRV are fibre component makers. The excess network build out in 2000 was accompanied by a bubble in fibre optics. The growth in internet traffic is leading to network capacity constraints and the fibre optic component market has consolidated, so sensible margins are now in sight. Finisar and MRV have benefited from this. Radware and F5 have both been outstanding contributors to the portfolio over the last two years supplying application delivery controllers. The latter was acquired in April 2008 when it dipped into the Herald size remit at a price of $18.7 per share at $2/£, and was sold in March at c $70 and c $1.50/£, when the market capitalisation was $6bn. By the year-end it had risen further to $130.16! There are signs of the momentum players re-emerging, and some of the larger smaller companies are now quite expensive, while others are still in the shade. To a degree this applies in the UK. Rarely have I seen such a two tier market, but it provides switching opportunities. The game is to spot the companies before they hit the radar screen and sell into the rush. Overall the US portfolio is now on its historic valuation premium making further relative returns more challenging than 2010.

Far East

After the 136.8% increase in the Asia Pacific portfolio in 2009, as growth returned to the global economy, the Asian portfolio had a muted 2010 with the Korean IT index down 2.1% and the Taiwan Taiex index up 3.6% in local currency terms. Sterling adjusted returns are more respectable in both markets with the Herald portfolio returning 27.5% (KOSDAQ IT 5.3%, Taiex Electron 17.7%). Herald has continued with the policy of avoiding investment in the Japanese market, believing the limited opportunities within the smaller companies arena do not justify the specialist resources required. JASDAQ sits at less than half the peak value of 2006.

Following the market movements in 2010, the key Asian technology stock markets are trading at p/e's of around 10x-12x - a more normal level of discount to the rest of the portfolio and broadly appropriate given the low margin, cyclical and capital intensive nature of companies in the region.

Europe

The European portfolio is small at £12m, but has risen 20.9% (17.8% in sterling). Highlights include the final sale of Logitech and United Internet, which have been trusty stalwarts over the years. Logitech was acquired in 1995 and returned over 10x (SFr14m), and United Internet I luckily managed to pick out of a great deal of Neuer Markt dross in October 1999. This has returned 5x yielding Euro8m profit. The best return for 2010 has been Nordic Semiconductor at +133%.

Sector Background

The internet is clearly the killer application, but if 2009 was the year of the mobile internet, 2010 has seen another kicker with Android and the iPad to the fore. Behind the end products the drivers have included multi-threading graphics, processors, capacitive touchscreens, mifi, flash memory (CML the best % rise in the portfolio supplies flash controllers to Cisco and Juniper), baseband IP, infiniband, 3D TV, virtualisation in the data centre, applications and online content-internet TV, eReaders, iNewspapers, and many more. SAAS software models have demonstrated durability.

P/E of stocks profitable in 2009	UK	US	EMEA	Asia Pac	Total
2009:	16.3x	30.4x	19.5x	16.3x	18.3x
2010:	15.0x	25.5x	19.2x	12.2x	16.4x
2011:	13.1x	20.4x	14.6x	10.1x	14.0x

P/E of all stocks with estimates	UK	US	EMEA	Asia Pac	Total
2009:	32.0x	67.8x	23.6x	27.0x	35.9x
2010:	16.7x	27.2x	19.7x	11.8x	18.1x
2011:	13.3x	20.3x	14.4x	9.5x	14.3x

It is difficult to be as positive as previously when the assets have risen strongly two years running and the economic flaws remain. Nevertheless, it is extremely encouraging that the valuation of the portfolio in p/e terms at the end of 2010 is similar to that at the end of 2009. Further profits growth is expected in 2011 albeit at a more modest rate than a year which included some holdings where profits recovered from a dip in 2009. When I compare our sector with alternative sector choices, I remain enthused. Cash generation is key. I cannot think of another sector outside TMT where companies can repeatedly generate such high margins and cash. We constantly seek investments with pricing power that enables premium margins, either through technical leadership, or a defensible market position and the technology sector has a plethora of such companies. The Far East is in general conspicuously different and generally has the low margin subcontract manufacturing. I continue to feel safer in technology stocks in US and UK at this juncture!

Performance Attribution (in sterling terms)

	Comparative index allocation		Herald asset allocation		Performance*			Contribution attributable to:
							Contribution to relative return
Equity Markets	01.01.10	31.12.10	01.01.10	31.12.10	Herald	Comparative index		Stock selection	Asset allocation†
	%	%	%	%	%	%	%	%	%
UK	66.7	66.7	66.2	65.4	42.4	31.5	5.3	5.4	(0.1)
Europe ex. UK	-	-	3.4	2.6	17.8	-	(0.3)	-	(0.3)
Americas	33.3	33.3	25.7	25.5	52.6	41.1	1.5	1.9	(0.4)
Asia Pacific ex. Japan	-	-	8.5	6.3	27.5	-	(0.5)	-	(0.5)
Emerging Markets	-	-	0.4	0.4	45.4	-	-	-	-
Bonds	-	-	7.7	4.2	5.8	-	(1.4)	-	(1.4)
Cash	-	-	4.7	8.0	2.8	-	(2.0)	-	(2.0)
Swap	-	-	(1.9)	(1.9)	n/a	-	(0.7)	-	(0.7)
Loans	-	-	(14.7)	(10.5)	1.4	-	3.5	-	3.5
Total	100.0	100.0	100.0	100.0	42.6	35.1	5.5	7.4	(1.8)

Past performance is not a guide to future performance.

Source: HSBC

*  The above returns are calculated on a total return basis with net income reinvested.  Dividends and interest are reinvested on a cash basis, unlike the NAV calculation where income is recognised on an accruals basis.  Relative performance may differ as a result.

Contributions cannot be added together, as they are geometric; for example, to calculate how a return of 42.6% against a comparative index return of 35.1% translates into a relative return of 5.5%, divide the portfolio return of 142.6 by the comparative index return of 135.1 and subtract one.

†   Asset allocation includes the contribution attributable to currency movements.

Katie Potts

22 February 2011

DISTRIBUTION OF ASSETS

 

			At 31 December 2010 %		At 31 December 2009 %
Equities:	United Kingdom		58.2		56.7
	Continental Europe		2.3		2.9
	USA		22.7		22.0
	Asia Pacific		5.5		7.3
	Emerging Markets		0.4		0.3
Total equities			89.1		89.2
Sterling denominated bonds			3.8		5.0
US$ denominated bonds			-		1.6
Net current assets			7.1		4.2
Total assets (before deduction of bank loans and derivative financial instruments)			100.0		100.0

TOP TWENTY HOLDINGS at 31 December 2010

 

A brief description of the twenty largest equity holdings in companies is as follows:

SDL
SDL is the leader in Global Information Management (GIM) solutions that help organisations to accelerate the delivery of high-quality multilingual content to global markets alongside their products and services. SDL's best-of-breed Web Content Management, eCommerce, Structured Content and Language Technologies, combined with its Language Services drive down the cost of content creation, management, translation and publishing. SDL solutions increase conversion ratios and customer satisfaction through targeted information across all customer touch points. Global industry leaders who rely on SDL include ABN-Amro, Bosch, Canon, CNH, FICO, GlaxoSmithKline, Hewlett-Packard, KLM, Microsoft, NetApp, Philips, SAP and Sony. SDL has over 1,500 enterprise customers, has deployed over 170,000 software licenses and provides access to on-demand portals for 10 million customers per month. It has a global infrastructure of more than 60 offices in 35 countries. SDL is in Gartner's leader quadrant for web content management.	Country                  United Kingdom % of total assets                            4.0 % of issued share capital held    4.3                            31/12/10      31/12/09 Valuation (£m)       21.55            15.23 Shares (m)              3.36               3.71
Imagination Technologies Group
Imagination Technologies is an international leader in the creation and licensing of semiconductor System-on-Chip Intellectual Property (SoC IP). Imagination creates market-leading embedded graphics, video and display acceleration, multi-threaded processing and multi-standard receiver technologies and licenses this IP (Intellectual Property) to global semiconductor and system companies. These technologies are used in the following markets: digital radio and audio, mobile phone multimedia, personal media player, car navigation and driver information, personal navigation, mobile computing, digital TV and set-top box, and mobile TV. Imagination has been particularly successful in selling graphics technology to the mobile phone and LCD TV sectors and is a pioneer in developing Digital Audio Broadcasting Technology (DAB). Imagination Technology incorporates this technology in its "Pure Digital" radio brand, which is the number one supplier of radios in the UK. The adoption of digital radio in other countries, France and Germany in particular, is opening up a bigger international market and they have launched an internet radio range for the US market. The group has a highly skilled workforce of over 600 people, of which over 80% are R&D engineers.  Apple and Intel are both investors in Imagination Technologies.	Country                  United Kingdom % of total assets                            3.9                            31/12/10      31/12/09 Valuation (£m)       21.00            22.25 Shares (m)             5.86             9.23

Phoenix IT Group
Phoenix IT was established in 1980, the Group provides a growing range of complementary IT infrastructure support services including systems management, communications, remote telephone support, high-touch field services, project and consultancy services as well as business continuity and disaster recovery services. Often these services are sold and delivered as a managed service where Phoenix manages complex IT infrastructures to agreed levels of service under long-term contracts. In May 2007 Phoenix acquired ICM for £130m in cash and shares, ICM had been a portfolio holding since 2002.	Country                  United Kingdom % of total assets                            2.6 % of issued share capital held    7.1                            31/12/10      31/12/09 Valuation (£m)       14.09              8.21 Shares (m)               5.35              3.10
Telecom Plus
Telecom Plus, which owns and operates the Utility Warehouse brand, is the UK's only fully integrated provider of a wide range of competitively priced utility services, spanning both the communications and energy markets. Telecom Plus supplies fixed wire and mobile telecommunications services, gas and electricity to over 350,000 residential and small business customers in the United Kingdom with a unified bill and good value utilities. Telecom Plus was incorporated in 1996 and began operations in 1997 providing a unique range of low-cost telephony services to the residential and SOHO markets. They use the collective buying power of individual users to negotiate bulk buying deals with major suppliers, passing the benefit back to their customers. Telecom Plus does not advertise and has no shops. Instead, they rely on word of mouth recommendations from satisfied customers and from a network of Independent Distributors.	Country                  United Kingdom % of total assets                            2.3 % of issued share capital held    3.9                            31/12/10      31/12/09 Valuation (£m)       12.07              8.06 Shares (m)               2.69              2.74
Group NBT
Group NBT is a leading provider of domain names, managed hosting solutions and other internet-related services. With five market-leading brands, Group NBT is now made up of the following companies: NetBenefit, providing high quality managed hosting services in both the UK and Continental Europe; NetNames, providing registration services for every top level domain available and providing corporate domain name management to large organisations through its industry leading NetNames Platinum Service, which is now used by over 30% of the FTSE 100; Easily.co.uk, a top UK provider of cost effective web hosting and domain name services to UK businesses and consumers; Speednames, the dominant provider of domain name services in Denmark; Ascio, which is responsible for the provision of domain name services indirectly through more than 300 partnerships including telecom operators, web hosting companies, internet access providers and IP law firms; and Envisional, whose services monitor the internet for brand abuse, fraud, counterfeiting and piracy. Group NBT currently has over 280 employees world-wide, with offices in London, Copenhagen, New York, Nice, Munich, Zurich and Oslo.	Country                  United Kingdom % of total assets                            2.0 % of issued share capital held     9.7                            31/12/10      31/12/09 Valuation (£m)       10.45              7.98 Shares (m)               2.52              2.53
IQE
IQE is a leading global supplier of advanced compound semiconductor wafers with products that cover a diverse range of applications, supported by an innovative outsourced foundry services portfolio. IQE uses advanced crystal growth technology (epitaxy) to manufacture and supply bespoke semiconductor wafers ('epi-wafers') to the major chip manufacturing companies, who then use these wafers to make the chips which form the key components of virtually all high technology systems. IQE is unique in being able to supply wafers using all of the leading crystal growth technology platforms. IQE's products are found in many leading-edge consumer, communication, computing and industrial applications, including a complete range of wafer products for the wireless industry, such as mobile handsets and wireless infrastructure, Wi-Fi, WiMAX, base stations, GPS and satellite communications; optical communications, optical storage (CD, DVD), laser optical mouse, laser printers and photocopiers, thermal imagers, leading-edge medical products, barcode, high efficiency LEDs and a variety of advanced silicon based systems. The manufacturers of these chips are increasingly seeking to outsource wafer production to specialist foundries such as IQE in order to reduce overall wafer costs and accelerate time to market.	Country                  United Kingdom % of total assets                            1.7 % of issued share capital held    4.0                            31/12/10      31/12/09 Valuation (£m)         9.14              3.34 Shares (m)               20.64           19.95
Advent Software
Advent supplies investment management companies with integrated software products and services in portfolio administration, including workflows within the managers and external portfolio reporting. Each solution focuses on specific mission-critical functions of the front, middle and back offices and is designed to meet the needs of the particular client, as determined by size, assets under management and complexity of the investment environment. With more than 4,500 client firms, Advent has established itself as a leading provider of mission-critical applications to meet the demands of investment management operations around the world. It has adopted a rental model.	Country                                       USA % of total assets                            1.7                            31/12/10      31/12/09 Valuation (£m)         8.88              6.30 Shares (m)               0.24              0.25
Euromoney Institutional Investor
Euromoney is a leading international business-to-business media group focused primarily on the international finance, metals and commodities sectors. It publishes more than 100 magazines, newsletters and journals, including Euromoney Institutional Investor and Metal Bulletin. It also runs an extensive portfolio of conferences, seminars and training courses and is a leading provider of electronic information and data covering international finance, metals and emerging markets. Its main offices are in London, New York and Hong Kong and nearly half its revenues are derived from the United States.	Country                  United Kingdom % of total assets                            1.6                            31/12/10      31/12/09 Valuation (£m)         8.65              5.88 Shares (m)               1.25              1.35
Alterian
Alterian features in Gartner's Enterprise Marketing Management (EMM) Quadrant. It focuses on campaign management, marketing resource management and online marketing with the use of proprietary databases. Alterian's integration of analytics, content and execution through industry leading tools, such as the Dynamic Messenger email platform, SM2 Social Media Monitoring platform and the award winning Content Management solutions, enables companies to build integrated communication strategies. Alterian distributes through a number of marketing service providers including Acxiom, Experian, Epsilon, Harte-Hanks, Merkle, Allant, Donnelley Marketing and KnowledgeBase Marketing. It generally licences the products on a one year term. Alterian also has a number of direct customers.	Country                  United Kingdom % of total assets                            1.5 % of issued share capital held     6.6                            31/12/10      31/12/09 Valuation (£m)         8.08              7.66 Shares (m)               4.04             4.14
StatPro Group
StatPro is a leading provider of portfolio analysis and asset valuation software and services for the global asset management industry. The company's focus is on delivering a SaaS-based analytics and data platform on a rental basis to investment management companies, allowing them to analyse portfolio performance, attribution, risk and GIPS® compliance. StatPro also provides market data and valuation feeds including a Complex Asset Pricing service. StatPro has over 250 clients and generally experiences in excess of a 90% annual renewal rate.	Country                  United Kingdom % of total assets                            1.4 % of issue share capital held     11.3                            31/12/10      31/12/09 Valuation (£m)         7.71              6.98 Shares (m)               6.88              6.98
M&C Saatchi
M&C Saatchi is a global marketing services business working for clients across a wide variety of industry sectors. The Company was founded in 1995. Starting with a strong base in the UK and Australia, Saatchi have added new agencies and disciplines in Asia, USA and Europe, employing over 1,100 staff in 18 countries.	Country                  United Kingdom % of total assets                            1.3 % of issued share capital held     8.7                            31/12/10      31/12/09 Valuation (£m)         6.86              3.52 Shares (m)               5.40              4.40
Electrocomponents
Electrocomponents is the world's largest distributor of electronics and maintenance products serving 1.5 million customers with 500,000 products worldwide. Starting in 1937 in London selling spare parts for radios, the Group now has operations in 27 countries. Revenue is close to £1bn, with 52% of sales now coming via e-commerce. Electrocomponents trades as RS in the UK, most of Europe and Asia, Radiospares in France, Radionics in Republic of Ireland and Allied Electronics in North America.	Country                  United Kingdom % of total assets                            1.3                            31/12/10      31/12/09 Valuation (£m)         6.80              4.30 Shares (m)               2.56              2.66
NCC Group
As a trusted adviser, NCC Group provides business critical IT assurance and protection to over 15,000 organisations worldwide, including 94 out of the FTSE 100. The Group operates two main complementary divisions, Escrow and Assurance: Escrow, includes ensuring source code, data or other business critical material is protected and accessible should anything happen to a key supplier. Furthermore NCC confirm the material held is properly protected by verifying that it can be rebuilt from its source code components. NCC trades under the NCC Group Escrow and Escrow Europe brands. Assurance, incorporates expert led security testing, covering forensics, vulnerability research and the development of expert software to aid organisations in their on-going battle with information security breaches. NCC trades under the NGS Secure, iSEC Partners, SDLC Solutions, Meridian and Site Confidence brands.	Country                  United Kingdom % of total assets                            1.2 % of issued share capital held     3.6                            31/12/10      31/12/09 Valuation (£m)         6.66              1.16 Shares (m)              1.21              0.3
Diploma
Diploma is a group of specialised distribution businesses serving industries with long term growth potential and with the opportunity for sustainable superior margins through the quality of customer service, depth of technical support and value-adding activities. The three sectors the company focuses on are life sciences, seals and controls	Country                  United Kingdom % of total assets                            1.2                            31/12/10      31/12/09 Valuation (£m)         6.46              5.64 Shares (m)               2.35              3.20
Fidessa Group
Fidessa supplies trading systems to the world's financial markets. It is the leading supplier of multi-asset trading, portfolio analysis, decision support, compliance, market data and connectivity solutions. Fidessa's products and services make it easier to buy, sell and own financial assets of all types on a global basis and uniquely, serves both the buy-side and sell-side communities globally. Fidessa has developed its products over 28 years, investing heavily in their continual evolution. Fidessa's products are used by over 85% of tier-one, global financial institutions. Headquartered in London and with regional operations across Europe, North America, Asia and the Middle East, Fidessa supports over 26,000 users across 900 clients, serving a broad spectrum of customers from major investment banks and asset managers through to specialist niche brokers and hedge funds.  The product is supplied on a rental basis.	Country                  United Kingdom % of total assets                            1.1                            31/12/10      31/12/09 Valuation (£m)         6.00              4.57 Shares (m)               0.39              0.39
Bango
Bango provides technology that powers commerce for businesses targeting the growing market of internet enabled mobile phone users. Bango's payments products collect payment from mobile users for on-line content and services. There are over 30 million users worldwide transacting with content providers across mobile networks using Bango. Bango also provides in-app billing for the BlackBerry AppWorld and is in discussions with other application store owners. Bango Analytics provides data about mobile visitors, reporting precise customer insights in real-time giving website owners and application developers information about customers visiting their site. Customers include RIMM (Blackberry), Fox Mobile Group, EA Mobile and Turner Broadcasting System Inc.	Country                  United Kingdom % of total assets                            1.1 % of issued share capital held  10.1                            31/12/10      31/12/09 Valuation (£m)         5.93              2.34 Shares (m)               3.83              4.33

Radware
Radware is a global leader in integrated application delivery solutions and a member of the RAD Group. Radware products have been sold to over 10,000 enterprises and carriers worldwide.The key target markets Radware serves are: Application Delivery and Network Security. The Application Delivery product portfolio consists of advanced application delivery platforms, which offer, in addition to Layer 4-7 switching, benefits in terms of business continuity and resiliency, agility and efficiency by optimising the delivery of applications across IP and web-based networks. Radware is identified as a leader in Gartner's magic quadrant for Application Delivery Controllers (ADC's). Network Security solutions consist of firewall/Virtual Private Networks (VPN), Unified Threat Management (UTM), intrusion detection systems, intrusion prevention systems, network behavioral analysis (NBA) systems and Secure Sockets Layer/Internet Protocol Security (SSL/IPSec) VPN appliances. Radware's security offering focuses on network intrusion prevention and attack mitigation systems, which can react, in real-time, to block or prevent malicious activities. Radware is a visionary in Gartner's magic quadrant for Network Intrusion Prevention Systems.	Country                                       USA % of total assets                            1.1                        31/12/10       31/12/09 Valuation (£m)         5.81              2.90 Shares (m)                0.24              0.31
Websense
Websense is a global leader in integrated web, data and e-mail security solutions. Distributed through its global network of channel partners, Websense software, appliance and Software as a Service (SaaS) security solutions help organisations block malicious code, prevent the loss of confidential information and enforce internet use and security policies. In March 2007 Websense acquired its main competitor SurfControl for $400m in cash, SurfControl had been a portfolio holding since 1998.	Country                                       USA % of total assets                            1.1                        31/12/10     31/12/09 Valuation (£m)         5.75              5.03 Shares (m)               0.45              0.47
Digital Barriers
Digital Barriers provides consulting, integration services and technology to the international homeland security and defence sectors. The focus is on counter-terrorism, cyber-security and specialist areas of defence, helping clients select, architect and deploy effective and proportionate solutions to enhance the physical and electronic security of high-profile, high-value potential targets. Digital Barriers deployments protect airports, public transportation systems, secure government locations, border crossings, critical national infrastructure facilities and computer systems and networks in a significant number of locations around the world. Digital Barriers also provide advanced technology to support military operations, particularly in the areas of counter-insurgency and force protection. Digital Barriers was founded by the team behind Detica Group plc, a UK-based FTSE 250 specialist consultancy acquired by BAE Systems in 2008. Detica was a portfolio holding within the Trust from just after the Detica IPO in 2002 until its takeover by BAE Systems.	Country                  United Kingdom % of total assets                            1.1 % of issued share capital held     6.8                        31/12/10         31/12/09 Valuation (£m)         5.66                   - Shares (m)                2.98                   -
Kofax
Kofax is the leading provider of document driven business process automation solutions. For more than 20 years, Kofax has provided solutions that streamline the flow of information throughout an organisation by managing the capture, transformation and exchange of business critical information arising in paper, fax and electronic formats in a more accurate, timely and cost effective manner. These solutions provide a return on investment to thousands of customers in financial services, government, business process outsourcing, healthcare, supply chain and other markets. Kofax delivers these solutions through its own sales and service organisations and a global network of more than 700 authorised partners in more than 60 countries throughout the Americas, EMEA and Asia Pacific.	Country                  United Kingdom % of total assets                            1.0                        31/12/10          31/12/09 Valuation (£m)         5.13              3.19 Shares (m)                1.72              1.82

Note: A figure is presented for % issued share capital held only if greater than 3%.

 

RELATED PARTY TRANSACTIONS

The Directors' fees for the year are detailed in the Directors' Remuneration Report contained within the Annual Report. No Director has a contract of service with the Company. During the year no Director was interested in any contract or other matter requiring disclosure under the Companies Act 2006.

Herald Investment Management Limited is appointed as investment manager under a management agreement which is terminable on twelve months' notice. Their fee is calculated on a monthly rate of 0.08333% of the Company's net asset value based on middle market prices. The management fee is levied on all assets except the holding in Herald Ventures II Limited Partnership managed by Herald Investment Management Limited.

The details of the management fee are as follows:

	2010 £'000		2009 £'000
Investment management fee	3,966		2,773

 

PRINCIPAL RISKS AND UNCERTAINTIES

In accordance with the corporate objective of maximising capital appreciation the Company invests in securities on a worldwide basis. The Company makes use of gearing to achieve improved performance in rising markets and has an interest rate swap, the purpose of which is to hedge the variability in cash flows arising from interest rate fluctuations on bank loans. The Company's other financial instruments consist of cash, short term debtors and creditors.

The main risks arising from the Company's financial instruments are:

A.   Market Risk

(i)    Other price risk, being the risk that the value of investment holdings will fluctuate as a result of changes in market prices caused by factors other than interest rate or currency rate movement.

(ii)   Interest rate risk, being the risk that the future cash flows of a financial instrument will fluctuate because of changes in market interest rates; and

(iii)   Foreign currency risk, being the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates.

B.   Credit Risk, being the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.

C.   Liquidity Risk, being the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities.

These risks and the policy for managing them have been applied throughout the year and are summarised below.

A.  Market Risk

(i)    Other Price Risk

The Company's investment portfolio is exposed to market price fluctuations which are monitored by the Manager in pursuance of the corporate objective. Securities held by the Company are valued at bid prices, whereas material unlisted investments are valued by the Directors on the basis of the latest information in line with the relevant principles of the International Private Equity and Venture Capital Valuation Guidelines. These valuations also represent the fair value of the investments, see below.

An analysis of the investment portfolio by broad industrial or commercial sector and a review of the 20 largest equity investments by their aggregate market value, are shown above.

Other Price Risk Sensitivity

33.4% of the Company's equity investments at 31 December 2010 (2009 - 34.7%) were listed on the main list of the London Stock Exchange and a further 31.2% (2009 - 27.9%) on AIM. The NASDAQ Stock Exchange accounts for 25.3% (2009 - 23.9%) and other stock exchanges 9.4% (2009 - 12.6%). A 10% increase in stock prices at 31 December 2010 would have increased total net assets and net return on ordinary activities after taxation by £47,500,000 (2009 - £35,000,000). A decrease of 10% would have had an equal but opposite effect. The portfolio does not target any exchange as a benchmark, and the performance of the portfolio has a low correlation to generally used indices.

The shares of Herald Investment Trust plc have an underlying NAV per share. The NAV per share of Herald Investment Trust plc fluctuates on a daily basis. In addition, there is volatility in the discount/premium the share price has to NAV.

(ii)   Interest Rate Risk

The majority of the Company's assets are equity shares and other investments which neither pay interest nor have a maturity date. However, the Company does hold Convertible Bonds and Government Securities, the interest rate and maturity dates of which are detailed below. Interest is accrued on sterling cash balances at a rate linked to the UK base rate.

The Company has borrowings, from time to time. The aim of the use of gearing is to enhance long term returns to shareholders by investing borrowed funds in equities and other assets. Gearing is actively managed. How and where borrowings are invested is reviewed by the Board in consultation with the Manager at every Board meeting. In light of the decisions made, appropriate adjustments to the gearing position are then made by the Manager.

At the year end the Company had borrowings of £50 million (2009 - £50 million). Under the terms of an interest rate swap, the interest payable on the bank loans has been fixed.

The interest rate risk profile of the financial assets and financial liabilities at 31 December was:

Financial Assets

		2010			2009
	Fair value £'000	Weighted average interest rate/interest rate	Weighted average period until maturity/ maturity date	Fair value £'000	Weighted average interest rate/interest rate	Weighted average period until maturity/ maturity date
Fixed rate:
UK bonds	20,151	4.7%	4 years	19,620	4.7%	5 years
US bonds	-	-	-	6,407	4.5%	11 months
UK convertible bonds	843	6.9%	3 years	769	6.9%	4 years
Cash:
Other overseas currencies	2,278			1,041
Sterling	37,219	0.2%		17,510	0.3%
	39,497			18,551

The cash deposits generally comprise call or short term money market deposits with original maturities of less than 3 months which are repayable on demand. The benchmark rate which determines the interest payments received on cash balances is the bank base rate.

Financial Liabilities

		2010			2009
	£'000	Net Interest rate paid	Loan Facility expires	£'000	Net Interest rate paid	Loan Facility expires
Bank loan	25,000	1.3%	May 2011	25,000	2.3%	May 2011
	25,000	1.4%	May 2013	25,000	2.4%	May 2013
	50,000	1.4%		50,000	2.4%
Swap	50,000	4.2%		50,000	3.2%
		5.6%			5.6%

The effective fixed rate of interest on the loans of 5.6% (2009 - 5.6%) reflects a weighted average variable interest rate paid of 1.4% (2009 - 2.4%), with a further weighted average of 4.2% paid on the swap (2009 - 3.2%). The Company's facilities are rolling on a quarterly basis with the facility on a £25 million tranche expiring in May 2011 and a £25 million tranche expiring in May 2013. While the 30 year swap remains in place, the net interest payable will effectively be fixed for the duration of the term of the facility.

		2010				2009
	Notional contract amount £'000	Fair value assets £'000	Fair value liabilities £'000	Fair value balance £'000	Notional contract amount £'000	Fair value assets £'000	Fair value liabilities £'000	Fair value balance £'000
Total derivative assets/(liabilities) held for trading	50,000	49,370	(58,307)	(8,937)	50,000	34,211	(40,509)	(6,298)

Interest rate risk sensitivity

(a) Cash

An increase of 100 basis points in interest rates as at 31 December 2010 would have a direct effect on net assets. Based on the position at 31 December 2010, over a full year, an increase of 100 basis points would have increased the net return on ordinary activities after taxation by £395,000 (2009 - £186,000) and would have increased the net asset value per share by 0.49p (2009 - 0.23p). The calculations are based on the cash balances as at the respective balance sheet dates and are not representative of the year as a whole.

(b) Fixed rate bonds

An increase of 100 basis points in bond yields as at 31 December 2010 would have decreased total net assets and total return on ordinary activities by £678,000 (2009 - £803,000) and would have decreased the net asset value per share by 0.85p (2009 - 0.99p). A decrease in bond yields would have had an equal and opposite effect. The Convertible loan stocks having an element of equity are not included in this analysis as given the nature of the businesses and the risk profile of the balance sheets they are considered to have more equity like characteristics.

(c) Bank loans

The effect of an increase or decrease of 100 basis points in 3 month LIBOR interest rates as at 31 December 2010 on the interest cost of the bank loans and the net income return has been eliminated through a 30 year floating interest rate to fixed interest rate swap. The swap generates payments or charges that offset changes in the 3 month LIBOR interest rate, so that the interest payable on the bank loans is effectively converted to a fixed rate loan at 4.8975% (2009 - 4.8975%) plus margin cost. The initial term of the swap on commencement at 30 years did not match the term of the loans, therefore, hedge accounting is not used and mark to market gains or losses on the swap are captured in the net return on ordinary activities as set out in (d) below.

(d) Floating interest rate to fixed interest rate swap

A decrease of 100 basis points on 30 year interest rates as at 31 December 2010 would have a direct mark to market effect on the value of the swap and net assets. Based on the position as at 31 December 2010, over a full year, a decrease of 100 basis points would have decreased the gains on investments and net return on ordinary activities after taxation by £9,617,000 (2009 - £9,059,000) and would have decreased the net asset value per share by 12.03p (2009 - 11.18p). An increase of 100 basis points would have had an equal but opposite effect.

(iii) Foreign Currency Risk

The Company's reporting currency is sterling, but investments are made in overseas markets as well as the United Kingdom and the asset value can be affected by movements in foreign currency exchange rates.

Furthermore many companies trade internationally both through foreign subsidiaries, and through exports. The greatest foreign currency risk occurs when companies have a divergence in currencies for costs and revenues. A much less risky exposure to currency is straight translation of sales and profits. The List of Investments on pages 16 to 20 of the Annual Report breaks down the portfolio by geographic listing. However the location of the stock market quote only has a limited correlation to the costs, revenues and even activities of those companies, and so this note should not be regarded as a reliable guide to the sensitivity of the portfolio to currency movements. For example, the holdings in the portfolio that have suffered most from US$ weakness are UK companies with dollar revenues and sterling costs.

The Company does not hedge the sterling value of investments that are priced in other currencies. Overseas income is subject to currency fluctuations. The Company does not hedge these currency fluctuations because it is impossible to quantify the effect for the reasons stated above. However, from time to time the Manager takes a view by holding financial assets or liabilities in overseas currencies.

Exposure to currency risk through asset allocation by currency of listing is indicated below:

At 31 December 2010

	Investments £'000	Cash and deposits  £'000	Loans £'000	Other  debtors and creditors* £'000	Net exposure £'000
US dollar	120,967	-	-	3	120,970
Taiwan dollar	14,435	2,245	-	-	16,680
Korean won	9,952	33	-	-	9,985
Euro	8,994	-	-	(14)	8,980
Other overseas currencies	10,568	-	-	-	10,568
Exposure to currency risk on translation of valuations of securities listed in overseas currencies	164,916	2,278	-	(11)	167,183
Sterling	330,485	37,219	(50,000)	(10,325)	307,379
	495,401	39,497	(50,000)	(10,336)	474,562

*Includes net non-monetary assets of £49,000.

At 31 December 2009

	Investments £'000	Cash and deposits  £'000	Loans £'000	Other  debtors and creditors* £'000	Net exposure £'000
US dollar	94,068	-	-	47	94,115
Taiwan dollar	12,583	1,010	-	-	13,593
Korean won	12,451	31	-	36	12,518
Euro	8,420	-	-	7	8,427
Other overseas currencies	8,215	-	-	-	8,215
Exposure to currency risk on translation of valuations of securities listed in overseas currencies	135,737	1,041	-	90	136,868
Sterling	244,720	17,510	(50,000)	(8,202)	204,028
	380,457	18,551	(50,000)	(8,112)	340,896

*Includes net non-monetary assets of £28,000.

Foreign currency risk sensitivity

At 31 December 2010, had sterling strengthened by 10% (2009: 10%) in relation to all currencies, with all other variables held constant, total net assets and net return on ordinary activities after taxation would have decreased by the amounts shown below based solely on translation of securities quoted in currencies overseas. A 10% (2009: 10%) weakening of sterling against all currencies, with all other variables held constant, would have had an equal but opposite effect on the financial statement amounts. However companies whose cost base diverges in currency terms from its sales will in the longer term have a significantly greater effect on valuation than simple translation. In the short term investee companies generally cover their currency exposure to varying degrees. There is insufficient publicly disclosed information to quantify this, but in the long term this effect is expected to dwarf simple translation of foreign listings in terms of both risk and reward, because many investee companies trade globally. Furthermore the country of listing is not necessarily an indication of the geography of some or even any operational activities for investee companies. The Manager does not use financial instruments to protect against currency movements. From time to time financial leverage has been made using debt in overseas currencies.

	2010	2009
	£'000	£'000
US dollar	12,097	9,411
Taiwan dollar	1,668	1,359
Korean won	998	1,252
Euro	898	843
Other overseas currencies	1,057	822
	16,718	13,687

B.  Credit Risk

Credit risk is the risk that a counterparty to a financial instrument will fail to discharge an obligation or commitment which it has entered into with the Company. The Manager monitors counterparty risk on an ongoing basis.

The Company has investments in convertible loan stocks that have an element of equity. These securities are viewed as having a risk profile similar to the equity holdings. This is because the convertibles held are in nascent technology companies that may be loss making and may have weak balance sheets. For this reason these stocks are categorised as equity holdings.

The fixed interest securities held are UK Government securities and UK corporate bonds.

Credit Risk Exposure

The exposure to credit risk at 31 December was:

	2010	2009
	£'000	£'000
Fixed interest investments	20,151	26,027
Cash and short term deposits	39,497	18,551
Debtors and prepayments	1,316	1,593
	60,964	46,171

The maximum exposure in fixed interest investments was £27,331,000 (2009 - £28,417,000) and the minimum £20,041,000 (2009 - £15,948,000). The maximum exposure in cash was £45,239,000 (2009 - £32,900,000) and the minimum £13,213,000 (2009 - £13,008,000). None of the Company's financial assets are past due or impaired.

C. Liquidity Risk

The Company's policy with regard to liquidity is to provide a degree of flexibility so that the portfolio can be repositioned when appropriate and that most of the assets can be realised without an excessive discount to the market price. The Company's unlisted investments are not readily realisable, but these only amount to 0.7% of the Company's total assets at 31 December 2010 (2009: 0.9%).

In practice, liquidity in investee companies is imperfect, particularly those with a market value of less than £100 million. To reduce this liquidity risk it is the policy to diversify the holdings and generally to restrict the holding in any one company to less than 10% of the share capital of that company. Furthermore the guideline is for no single investment to account for more than 5% of the assets of the Company.

The market valuation of each underlying security gives an indication of value, but the price at which an investment can be made or realised can diverge materially from the bid or offer price depending on market conditions generally and particularly to each investment. 32% (£160 million) (2009: 36% (£135 million)) of the portfolio is invested in stocks with a market capitalisation below £100 million, where liquidity is expected to be more limited. If these stocks had on average a realisable value 20% below the bid price the value of the total fund would be adversely affected by 6.4% (2009: 7.1%).

Liquidity Risk Exposure

Contractual maturities of the financial liabilities at the year end, based on the earliest date on which payment can be required are as follows:

			2010					2009
	One year or less £'000	In more than one year but not more than two years £'000	In more than two years but not more than five years £'000	Five years or more £'000	Total £'000	One year or less £'000	In more than one year but not more than two years £'000	In more than two years but not more than five years £'000	Five years or more £'000	Total £'000
Bank loans	25,594	544	25,453	-	51,591	737	26,184	26,853	-	53,774
Derivative financial instruments	2,037	1,719	2,643	6,536	12,935	2,042	1,243	1,017	6,335	10,637
Other creditors	2,201	-	-	-	2,201	2,888	-	-	-	2,888
	29,832	2,263	28,096	6,536	66,727	5,667	27,427	27,870	6,335	67,299

Fair Value of Financial Instruments

Fair values are measured using the following fair value hierarchy:

Level  1: reflects financial instruments quoted in an active market.

Level 2: reflects financial instruments whose fair value is evidenced by comparison with other observable current market transactions in the same instrument or based on a valuation technique whose variables includes only data from observable markets.

Level 3: reflects financial instruments whose fair value is determined in whole or in part using a valuation technique based on assumptions that are not supported by prices from observable market transactions in the same instrument and not based on available observable market data.

The valuation techniques used by the Company are explained in the accounting policies on page 40 of the Annual Report.

The table below sets out the fair value measurements using the fair value hierarchy.

At 31 December 2010

	Level 1  £'000	Level 2 £'000	Level 3 £'000	Total £'000
Financial assets
Equity investments	471,350	-	3,900	475,250
Government debt securities	14,669	-	-	14,669
Other debt securities	5,482	-	-	5,482
Current assets	40,813	-	-	40,813
Total assets	532,314	-	3,900	536,214
Financial liabilities
Bank loans	50,000	-	-	50,000
Derivatives	-	8,937	-	8,937
Current liabilities (excluding bank loans)	2,715	-	-	2,715
Total liabilities	52,715	8,937	-	61,652
Total net assets	479,599	(8,937)	3,900	474,562

A reconciliation of fair value measurements in Level 3 is set out below:

At 31 December 2010

	Equity Investments £'000
Opening balance at 1 January 2010	2,949
Purchases	1,639
Sales	-
Transfers into Level 3	1,578
Total gains or losses:
-               on assets sold during the year	-
-               on assets held at 31 December 2010	(2,266)
Closing balance at 31 December 2010	3,900

Transfers into Level 3 relate to investments for which listing has been suspended during the year.

At 31 December 2009

	Level 1  £'000	Level 2 £'000	Level 3 £'000	Total £'000
Financial assets
Equity investments	351,319	162	2,949	354,430
Government debt securities	20,916	-	-	20,916
Other debt securities	5,111	-	-	5,111
Current assets	20,144	-	-	20,144
Total assets	397,490	162	2,949	400,601
Financial liabilities
Bank loans	50,000	-	-	50,000
Derivatives	-	6,298	-	6,298
Current liabilities (excluding bank loans)	3,407	-	-	3,407
Total liabilities	53,407	6,298	-	59,705
Total net assets	344,083	(6,136)	2,949	340,896

A reconciliation of fair value measurements in Level 3 is set out below:

At 31 December 2009

	Equity Investments £'000
Opening balance at 1 January 2009	2,898
Purchases	815
Sales	(1,738)
Transfers into Level 3	1,607
Total gains or losses:
-               on assets sold during the year	(1,639)
-               on assets held at 31 December 2009	1,006
Closing balance at 31 December 2009	2,949

Transfers into Level 3 relate to investments for which listing has been suspended during the year.

Other Risks

Other risks faced by the Company include the following:

Regulatory Risk - failure to comply with applicable legal and regulatory requirements could lead to suspension of the Company's Stock Exchange Listing, financial penalties or a qualified audit report. Breach of Section 1159 of the Corporation Tax Act 2010 (formerly Section 842 ICTA 1988) could lead to the Company being subject to tax on capital gains. The Manager's Compliance Officer and Baillie Gifford's Heads of Business Risk & Internal Audit and Regulatory Risk provide regular reports to the Audit Committee on their monitoring programmes. The Manager monitors investment movements and the Secretary monitors the level of forecast income and expenditure to ensure the provisions of Section 1159 are not breached.

Operational/Financial Risk - failure of the Secretary's accounting systems or those of other third party

service providers could lead to an inability to provide accurate reporting and monitoring or a misappropriation of assets. The Audit Committee reviews the Secretary's Report on Internal Controls and the reports by other key third party providers are reviewed by the Secretary on behalf of the Audit Committee.

Discount Volatility - the discount at which the Company's shares trade can widen. The Board monitors the level of discount and the Company has authority to buy back its own shares.

Gearing Risk - the Company may borrow money for investment purposes (sometimes known as 'gearing'). If the investments fall in value, any borrowings will magnify the extent of this loss. If borrowing facilities are not renewed, the Company may have to sell investments to repay borrowings.

All borrowings require the prior approval of the Board and gearing levels are discussed by the Board and Managers at every meeting. The majority of the Company's investments are in quoted securities.

 

STATEMENT OF DIRECTORS' RESPONSIBILITIES

The Directors are responsible for preparing the Annual Report, the Directors' Remuneration Report and the financial statements in accordance with applicable law and regulations.

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have elected to prepare the financial statements in accordance with applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, the Directors are required to:

·           select suitable accounting policies and then apply them consistently;

·           make judgements and accounting estimates that are reasonable and prudent; and

·          state whether applicable UK Accounting Standards have been followed, subject to any material  departures disclosed and explained in the financial statements.

The Directors are responsible for the keeping of adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements and the Directors' Remuneration Report comply with the Companies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Directors have delegated responsibility to the Manager for the maintenance and integrity of the Company's page of the Manager's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

Each of the Directors, whose names and functions are listed within the Directors, Manager and Advisers

section of the Annual Report confirm that, to the best of their knowledge:

·          the financial statements, which have been prepared in accordance with applicable law and  United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice), give a true and fair view of the assets, liabilities, financial position and net return of the Company; and

·          the Directors' Report includes a fair review of the development and performance of the business and the position of the Company, together with a description of the principal risks and uncertainties that it faces.

By order of the Board

Julian Cazalet

22 February 2011

INCOME STATEMENT

	For the year ended 31 December 2010				For the year ended 31 December 2009
	Revenue £'000	Capital £'000	Total £'000		Revenue £'000	Capital £'000	Total £'000
Gains on investments	-	137,953	137,953		-	139,718	139,718
Currency gains	-	347	347		-	311	311
Income (note 2)	7,277	-	7,277		6,077	-	6,077
Investment management fee	(3,966)	-	(3,966)		(2,773)	-	(2,773)
VAT recovered (note 3)	-	-	-		292	-	292
Other administrative expenses	(299)	-	(299)		(313)	-	(313)
Net return before finance costs and taxation	3,012	138,300	141,312		3,283	140,029	143,312
Finance costs of borrowings	(2,816)	-	(2,816)		(2,875)	-	(2,875)
Net return on ordinary activities before taxation	196	138,300	138,496		408	140,029	140,437
Tax on ordinary activities	(154)	-	(154)		(84)	-	(84)
Net return on ordinary activities after taxation	42	138,300	138,342		324	140,029	140,353
Net return per Ordinary share (note 4)	0.05p	171.87p	171.92p		0.39p	169.95p	170.34p
Dividend per Ordinary share (note 5)	-				0.30p

   The total column of this statement is the profit and loss account of the Company.

All revenue and capital items in the above statement derive from continuing operations. No operations were acquired or discontinued during the year.

A Statement of Total Recognised Gains and Losses is not required as all gains and losses of the Company have been reflected in the above statement.

BALANCE SHEET

		At 31 December 2010		At 31 December 2009
		£'000		£'000
FIXED ASSETS Investments held at fair value through profit or loss		495,401		380,457
CURRENT ASSETS
Debtors		1,316		1,593
Cash and short term deposits		39,497		18,551
		40,813		20,144
CREDITORS: Amounts falling due within one year (note 6)		(52,715)		(53,407)
Derivative financial instruments (note 6)		(8,937)		(6,298)
		(61,652)		(59,705)
Net current liabilities		(20,839)		(39,561)
TOTAL NET ASSETS		474,562		340,896
CAPITAL AND RESERVES
Called-up share capital		19,978		20,263
Share premium		73,738		73,738
Capital redemption reserve		1,974		1,689
Capital reserve		376,931		243,064
Revenue reserve		1,941		2,142
SHAREHOLDERS' FUNDS		474,562		340,896
Net asset value per Ordinary share (including income)		593.85p		420.58p
Net asset value per Ordinary share (excluding income)		593.80p		420.19p
Ordinary shares in issue (note 7)		79,913,283		81,053,283

RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS' FUNDS

For the year ended 31 December 2010

	Called-up share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve*    £'000	Revenue reserve £'000	Shareholders' funds £'000
Shareholders' funds at 1 January 2010	20,263	73,738	1,689	243,064	2,142	340,896
Net return on ordinary activities after taxation	-	-	-	138,300	42	138,342
Shares bought back	(285)	-	285	(4,433)	-	(4,433)
Dividends paid during the year	-	-	-	-	(243)	(243)
Shareholders' funds at 31 December 2010	19,978	73,738	1,974	376,931	1,941	474,562

*Capital reserve as at 31 December 2010 included investment holding gains of £119,429,000.

For the year ended 31 December 2009

	Called-up share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve*      £'000	Revenue reserve £'000	Shareholders' funds £'000
Shareholders' funds at 1 January 2009	20,852	73,738	1,100	109,072	5,948	210,710
Net return on ordinary activities after taxation	-	-	-	140,029	324	140,353
Shares bought back	(589)	-	589	(6,037)	-	(6,037)
Dividends paid during the year	-	-	-	-	(4,130)	(4,130)
Shareholders' funds at 31 December 2009	20,263	73,738	1,689	243,064	2,142	340,896

* Capital reserve as at 31 December 2009 included investment holding gains of £14,807,000.

 

SUMMARISED CASH FLOW STATEMENT
	For the year ended 31 December 2010			For the year ended 31 December 2009
	£'000	£'000			£'000	£'000
NET CASH INFLOW FROM OPERATING ACTIVITIES		3,580				3,729
NET CASH OUTFLOW FROM SERVICING OF FINANCE		(2,823)				(2,871)
FINANCIAL INVESTMENT
Purchase of investments	(77,590)				(59,037)
Sale of investments	102,455				55,350
NET CASH INFLOW/(OUTFLOW) FROM FINANCIAL INVESTMENT		24,865				(3,687)
EQUITY DIVIDEND PAID		(243)				(4,130)
NET CASH INFLOW/(OUTFLOW) BEFORE FINANCING		25,379				(6,959)
FINANCING
Shares repurchased	(4,433)				(6,037)
NET CASH OUTFLOW FROM FINANCING		(4,433)				(6,037)
INCREASE/(DECREASE) IN CASH		20,946				(12,996)
RECONCILIATION OF NET CASH FLOW TO MOVEMENT IN NET DEBT
Increase/(decrease) in cash for period		20,946				(12,996)
MOVEMENT IN NET FUNDS/(DEBT) IN PERIOD		20,946				(12,996)
NET DEBT AT 1 JANUARY		(31,449)				(18,453)
NET DEBT AT 31 DECEMBER		(10,503)				(31,449)
RECONCILIATION OF NET RETURN BEFORE FINANCE COSTS AND TAXATION TO NET CASH INFLOW FROM OPERATING ACTIVITIES
Net return on ordinary activities before finance costs and taxation		141,312				143,312
Gains on investments		(137,953)				(139,718)
Currency gains		(347)				(311)
Amortisation of fixed interest book cost		(19)				(5)
Changes in debtors and creditors		394				225
Income tax suffered		-				(1)
Overseas tax suffered		(154)				(84)
Realised currency profit		347				311
NET CASH INFLOW FROM OPERATING ACTIVITIES		3,580				3,729

 

NOTES

1.		The financial statements for the year to 31 December 2010 have been prepared on the basis of accounting policies which are consistent with those set out in the Company's Annual Report and Financial Statements at 31 December 2009. The Directors consider the Company's functional currency to be sterling as the Company's shareholders are predominantly based in the UK and the Company is subject to the UK's regulatory environment.
			31 December 2010 £'000				31 December 2009 £'000
2.	Income
	Income from investments and interest receivable		7,243				6,051
	Other income		34				26
			7,277				6,077
3.	VAT recovered In 2007 the European Court of Justice ruled that investment trust management fees should be exempt from VAT. In the year to 31 December 2009, £292,000 of VAT together with £171,000 of interest was received by the Company in respect of the repayment claims for the period from 1994 to 1996. Herald Investment Trust plc has joined a case which has recently been brought against HMRC to seek to recover the amounts relating to the period 1997 to 2000 together with interest on a compound basis.  No VAT or related interest recovery has been accrued or recognised as a contingent asset as the outcome of the case is expected to remain uncertain for several years.
			31 December 2010 £'000			31 December 2009 £'000
4.	Net return per ordinary share
	Revenue return		42			324
	Capital return		138,300			140,029
	Total return		138,342			140,353
	Net return per Ordinary share is based on the above totals of revenue and capital and on 80,465,858 Ordinary shares (2009 - 82,397,262) being the weighted average number of Ordinary shares in issue during the year. There are no dilutive or potentially dilutive shares in issue.

NOTES (Ctd)

			31 December						31 December
			2010			2009			2010 £'000			2009 £'000
5.	Ordinary Dividends
	Amounts recognised as distributions in the period:
	Previous year's final (paid 29 April 2010)		0.30p			5.00p			243			4,130
	Set out below are the total dividends payable in respect of the financial year, which is the basis on which the requirements of Section 1158 of the Corporation Tax Act 2010 are considered.  The revenue available for distribution by way of dividend for the year ended 31 December 2010 is £42,000 (2009 - £324,000).  The Directors do not propose a dividend for the year ended 31 December 2010 (2009 - 0.30p).
	Amounts paid and proposed in respect of the period:
	Proposed final dividend per Ordinary share	-			0.30p			-			243
6.	The Company has a £50 million multi-currency variable rate loan facility with The Royal Bank of Scotland plc, which comprises two £25 million tranches expiring on 31 May 2011 and 2013. At 31 December 2010, there were outstanding drawings of £50 million (2009 - £50 million). Interest on the loans is payable in quarterly instalments in January, April, July and October. The estimated repayment value of the loan at 31 December 2010 was £50 million. The indicative costs of repaying the loan as at 31 December 2010 were not material in the context of the above figures. The interest on £50 million of this facility has been fixed for the long term through a 30 year interest rate swap but may vary on periodic renewals of the debt facility to the extent that the mark up over LIBOR charged by a lending bank varies. The fair value of the interest rate swap contract at 31 December 2010 was an estimated liability of £9 million (2009 - £6 million) which was based on the marked to market value.
7.	At the Annual General Meeting in April 2010, Shareholders granted the Company authority to purchase shares in the market up to 12,115,409 Ordinary shares (equivalent to 14.99% of its issued share capital at that date). In the year to 31 December 2010, a total of 1,140,000 (2009 - 2,354,840) Ordinary shares with a nominal value of £285,000 (2009 - £588,710) were bought back at a total cost of £4,433,000 (2009 - £6,037,000). At 31 December 2010 the Company had authority to buy back a further 11,205,409 Ordinary shares. Under the provisions of the Company's Articles share buy-backs are funded from the capital reserve. The Company does not have any externally imposed capital requirements.
8.	During the period transaction costs on purchases amounted to £422,000 (2009 - £339,000) and transaction costs on sales amounted to £368,000 (2009 - £141,000).
9.	The financial information set out above does not constitute the Company's statutory accounts for the year ended 31 December 2010.  The financial information for 2009 is derived from the statutory accounts for 2009 which have been delivered to the Registrar of Companies.  The Auditors have reported on the 2009 and 2010 accounts; their reports for both years were unqualified and did not contain a statement under sections 495 to 497 of the Companies Act 2006.  The statutory accounts for 2010 will be delivered to the Registrar of Companies following the Company's Annual General Meeting.
	None of the views expressed in this document should be construed as advice to buy or sell a particular investment.

Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on the Company's website (or any other website) is incorporated into, or forms part of, this announcement.

- ends -

 

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