Annual Financial Report

RNS Number : 3430F

Herald Investment Trust PLC

19 February 2015

 



ANNUAL FINANCIAL REPORT for the year ended

31 December 2014 (audited)

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

Results and dividend

The net asset value (NAV) of the Company at 31 December 2014 was 813.2p per ordinary share (2013 - 802.8p). This represented an increase of 1.3% during the year. The discount widened to 19.0% from 14.7% and the share price decreased by 3.8% to 659.0p.

The Company made a revenue loss of £1,464,000 giving a net return of (1.89)p per share. The Directors do not recommend a dividend (2013 - nil) for the year ended 31 December 2014.

The financial information set out in this document does not constitute the Company's statutory accounts for 2013 or 2014. Statutory accounts for the years ended 31 December 2013 and 31 December 2014 have been reported on by the Independent Auditor. The Independent Auditor's Reports on the Annual Report and Financial Statements for 2013 and 2014 were unqualified, did not draw attention to any matters by way of emphasis, and did not contain a statement under 498(2) or 498(3) of the Companies Act 2006. Statutory accounts for the year ended 31 December 2013 have been filed with the Registrar of Companies. The statutory accounts for the year ended 31 December 2014 will be delivered to the Registrar in due course.

The financial information in this Annual Financial Report has been prepared using applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice). The accounting policies adopted in this Annual Financial Report have been consistently applied to all the years presented and are consistent with the policies used in the preparation of the statutory accounts for the year ended 31 December 2014. The principal accounting policies adopted are unchanged from those used in the preparation of the statutory accounts for the year ended 31 December 2013.

STATISTICS AND PERFORMANCE

	31 December 2014	31 December 2013	% change
Total assets (before deduction of bank loans and derivative financial instruments)	£667.4m	£662.5m
Bank loans	£25.0m	£25.0m
Derivative financial instruments	£13.5m	£13.9m
Shareholders' funds	£628.9m	£623.6m
Net asset value per ordinary share	813.2p	802.8p	1.3
Share price	659.0p	685.0p	(3.8)
Numis Smaller Companies Index plus AIM (ex. investment companies)	4,390.7	4,728.3	(7.1)
Russell 2000 (small cap) Technology Index (in sterling terms)	1,450.3	1,269.4	14.3
Composite comparative index			(0.2)
Dividend per ordinary share	-	-
Revenue earnings per ordinary share	(1.89p)	(0.39p)
Ongoing charges	1.07%	1.04%
Discount to NAV	19.0%	14.7%

Long Term Performance Summary

The following charts indicate how an investment in Herald has performed relative to its comparative index (applied retrospectively) and its underlying fully diluted net asset value over the period since inception of the Company.

	31 December 2014	Inception 16 February 1994	% change
Net asset value per ordinary share (including current year income)	813.2p	98.7p	723.9
Net asset value per ordinary share (excluding current year income)	815.1p	98.7p	725.8
Share price	659.0p	90.9p	625.0
Numis Smaller Companies Index plus AIM (ex. investment companies)	4,390.7	1,750.0	150.9
Russell 2000 (small cap) Technology Index (in sterling terms)	1,450.3	688.7	110.6

Chairman's Statement AND REVIEW OF 2014

I am delighted to report Herald's net asset value per share closed its 21st year at a record high of 813.2 p (+1.3%). The UK portfolio returned only 0.4% in 2014, but this exceeded the Numis Smaller Companies Index excluding investment companies and including AIM ("NSCI"), which declined 4.8%. Furthermore the weighted return of the target sectors in which Herald invests declined somewhat more than the wider index. Most of the investee companies delivered solid performances, and a number of mishaps in the sector were avoided. The UK smaller companies market as a whole suffered from conspicuously heavy redemptions in open ended smaller company funds which constrained share price appreciation, but provides a better base for 2015. The US market performed better, and the Company's North American portfolio appreciated 13.5% in sterling versus the Russell 2000 Technology Index rising 14.8%. This return was significantly lower than the return of the large technology companies index (Russell 1000 Technology Index £ return +27.3%), which was driven by Apple and Microsoft, the two largest components of the index. The EMEA portfolio (Europe Middle East and Africa) is small but appreciated by 19.6%, and Asia's total return was 11.1%. The worst performing element of the portfolio was the interest rate swap which was taken out in 2008 to protect against potential interest rate rises. This year's fall in long term interest rates has wrong footed us. The capital loss during the year was nearly £10m. Towards the end of the year we took the decision to close half of this position.

The year has again produced a succession of takeovers with an aggregate value of £53m, and £9m of cash was received from takeovers announced in 2013. This takes the total value of takeovers over the last eight years to £308m. This is material in the context of the capital raised in the fund. £65m was raised in 1994, and a further £30m in 1996, and net outside capital after share buy backs is only £55m. In the UK it was disappointing to see Wolfson and CSR lose their independence because they were two potentially scalable businesses and at one stage appeared able to compete on the world stage. The currently challenging market conditions meant the takeover premiums were appreciated. We were also sad to see Allocate Software taken over by private equity. Herald Investment Trust plc together with Herald Ventures underwrote a rescue £2m funding for Allocate in April 2002 at 13p when the market value was only £5m, exiting at 155p. Since then the shares have delivered a compound annual growth of 22%. A number of the Company's US long term holdings have also been acquired including Supertex, ATMI, Micros Systems, Actuate and Spansion.

In the market as a whole this year, takeovers have been offset by a stream of investments in IPOs and secondary offerings. In 2014 the Company participated in 52 new issues or secondary placings with an aggregate value of £36.5m. The larger new issues in both the UK and US have generally been at high valuations and the smaller earlier stage ones have offered more value, albeit they may take time to give returns. There was a period when we were besieged with offerings which were hard to digest, and we have been reluctant to take too many early stage positions in the UK. In the US there are many interesting companies, but value has been hard to find. We have retained the cash from US takeovers in dollars and continue to seek opportunities.

Regulation has been a heavy burden on our time this year for both the Board and the Manager. The Company is now regulated as an Alternative Investment Fund, and Herald Investment Management Ltd has been appointed as the Alternative Investment Fund Manager, but the regulatory effects have been wide ranging, because counterparties including investors are affected in different ways and require different information. It is to be hoped that we will be able to give greater focus again to the business of wealth creation in the coming year.

The Company shows a deficit on the income account again in 2014, so a dividend will not be paid in 2015. There has only been a deficit in two previous years, 2007 and 2013. This deterioration reflects an absence of income on cash deposits and Government bonds that have been held as surrogates for cash delivering low income. Furthermore, aggregate dividends declined marginally in 2013, and have declined further in 2014 albeit by less than 1%. This reflects portfolio mix as profitable dividend paying companies have been taken over. Two UK companies have significantly cut dividends, which has offset growth in other companies' dividends. The closure of half the interest rate swap position will reduce the interest charge by approximately £1m in 2015.

Since inception, the NAV/share has appreciated over eight times and the UK portfolio has delivered a time weighted return of 1,031%.  Over this period the capital return of the FTSE-100 has been 298%. The technology sector overall has benefited from the continuing pervasiveness of the internet, but in many cases this represents revenue shifts within the sector, as new companies challenge legacy suppliers. While we cannot see any mega trends which will make easy wins in the technology space in the short term, we remain convinced that entrepreneurially managed small companies continue to have the ability to exploit opportunities, and offer much greater scope for profitable investor returns than large companies. The TMT space remains ripe for entrepreneurial opportunity as technology continues to open up new markets. The price for higher potential upside is poorer liquidity.

The recent weakness of sterling relative to the dollar will drive stronger growth in UK profits in 2015. Over the years we have endeavoured to hold a balance of high risk early stage pre-profit companies, offset by a portfolio in more mature profitable, dividend paying companies. The more mature companies have become more expensive than we have experienced in recent years, and takeovers have been focussed on these more mature companies. Consequently, there is the temptation to move to higher risk earlier stage companies where there remains such a shortage of capital. This, combined with macroeconomic uncertainties, tempers our enthusiasm, but that is more than offset by the difficulty of finding more attractive investment opportunities elsewhere, and the realisation that some of the best returns over the years have come from microcaps scaling up their businesses.

Stewart Newton has asked to step down from the board at the conclusion of the AGM on 21 April 2015. We are very grateful to Stewart for his contribution over the last three years and will miss his experience and wise counsel. We wish him well for the future.

Julian Cazalet
Chairman

Investment Manager's Report

This year the NAV has only appreciated 1.3% versus 26.9% last year. However in 2013 the performance of underlying investee companies had disappointed more than pleased. In 2014 the reverse has occurred. Performance has been solid, but share prices dull.

UK

There have been a number of high profile poor performing companies in the UK TMT sector including Quindell, Monitise, Carclo, Aveva, Spirent, Blinkx and Xaar, none of which we held. It seems to have been a year when avoiding the blow-ups was more important than being in the winners. The weighted total return of the TMT sectors within the Numis index has been -6.6% in 2014, and the positive return of 0.4% on our UK portfolio, though modest, is satisfactory. Importantly, the blow ups reflect the fact that the sector became a little frothy in the fourth quarter of 2013, and these particular stocks were on valuations that we could not understand, so to us they have been reassuringly grounded.

Allocate gave the best monetary return for the year following the takeover by private equity. The weakest returns came from Digital Barriers, where the market has punished an early stage company failing to develop as quickly as hoped, and Euromoney and Telecom Plus, which have been excellent long term performers, but gave back profits in 2014.

It is a relief that the stream of new issues has abated and we declined many, which were of mixed quality.  I worry that commissions to brokers have been cut, driving an even greater dependency of income from corporate clients. The recurring income derived from being a nominated advisor is sensible, and indeed this system is conspicuously better than elsewhere in the world including the US. It means that stocks do not get totally orphaned and provides a base of solid income for brokers, but the increased dependency on corporate fees is potentially damaging to the long term health of the market. It is only with a vibrant secondary market that the quoted stock market can realistically provide primary capital to companies. In the last few years too much of our return has come from takeover premiums, because the market has not been functioning sensibly while pension funds and insurance companies have been persistently selling holdings in order to reduce their exposure to UK equities. In 1994, they owned 60% of the market, but by 1998 that had fallen to 43.3%, and is now c.10%. Reassuringly they have little left to sell, and there remain more investable propositions than available capital. There is no shortage of entrepreneurialism in the UK, but there is a shortage of larger companies to train people in deep technical skills.

For the first time since 2000, there are anecdotal signs that there is an IT skills shortage in London. Too many people were sucked into the industry in the late 1990s, and then a big shift occurred as outsourcing to India became the fashion. This trend seems to be at least in part reversing, and the financial sector is recovering to more normal levels of investment. There are even signs that there is less of a race to offshore manufacturing. It seems that, thanks to working tax credits and immigrant labour, the UK has become more competitive in terms of labour costs, while inflation in Chinese labour costs is conspicuously making China a less desirable outsourcing country.

North America

The US has outperformed the UK. The relative strength of the US economy, with its new found oil and gas wealth and dominance in the computer sector, combined with its political stability, has attracted capital. Performance has been quite binary. There have been momentum stocks on valuations that we do not understand, and value stocks many of which have been acquired in takeovers. In fact this year the US portfolio has seen takeovers of £30m, which is 22% of the US portfolio's value at the start of 2014. The US continues to drive the technology sector, and has been so much more effective at scaling profitable businesses than any other territory. The US understands the value of brands and IP and is prepared to invest with prolific supplies of equity. Success breeds success because the profits are recycled. However, in consequence US companies use capital much less efficiently than in the UK, which is why in the long term returns from the quoted US technology sector, whilst better than the FTSE-100, have not been as good as we have been able to achieve in the UK and Continental Europe.

EMEA

The European portfolio is small, but the long term annualised time weighted return in Europe has been 12.7% per annum, and in 2014 this rate was exceeded at 19.6% in sterling terms. This return was driven by strong performances from BE Semiconductor in the Netherlands and Nordic Semiconductor in Norway.

Asia

The Asian return was 11.1%. The pattern of larger capitalisation companies demonstrating superior share price appreciation seen in the US was repeated in Asia - this was particularly the case in Taiwan with a significant contributor to the index being TSMC, which performed well as the foundry for the Application Processor (AP) used in Apple's iPhone 6 and iPhone 6+. Conversely Samsung as the prior incumbent AP supplier to Apple lost out, and its share in mobile smart phones was hit by the success of Apple at the high end and by the Chinese phone manufacturers (in particular Xiaomi) at the low end. Over 50% of the value of the portfolio at the start of 2014 had a degree of revenue exposure to the mobile phone manufacturing supply chain. The business and share price performance of these smaller Taiwanese and Korean portfolio companies reflected the mobile phone market share shifts, typically with the Korean companies losing out in 2014.

Portfolio Split by Geography

The UK element of the portfolio remains surprisingly large. However the breakdown disclosed is by country of listing. The allocation by country of issue is somewhat different. Of course by country of end user sales, the UK is dramatically, but unquantifiably, less significant with both exports and overseas subsidiaries contributing significantly to many companies.

By country of listing       By country of issue

UK                                67%                             58%

Americas                      23%                              20%

EMEA                           4%                               14%

Asia                              6%                               8%

Portfolio Split by Subsector

In 2014 the star performing subsector was semiconductors. Interestingly the performance was broadly based with ten companies appreciating by more than £1m, with the total sector yielding profit of £25.6m. This followed a more challenging year in 2013, when semiconductors declined modestly but the NAV appreciated 26.9%. In 2013 the star sectors were software, fixed line telecommunications and publishing.

	Market value £m 31/12/2014	% of equity portfolio 31/12/2014	Total return £m 2013	Total return £m 2014
Business Support Services	19.7	3%	4.0	(8.0)
Computer Hardware	10.5	2%	3.8	1.2
Computer Services	69.8	11%	13.7	4.7
Electrical Components & Equipment	19.1	3%	0.4	0.5
Fixed Line Telecommunications	27.0	4%	13.7	(1.5)
Internet	28.3	4%	6.2	(2.7)
Media Agencies	54.2	9%	12.5	3.0
Publishing	31.2	5%	14.4	(5.6)
Semiconductors	98.4	16%	(4.7)	25.6
Software	158.2	25%	40.9	9.1
Telecommunications Equipment	39.2	6%	14.7	5.0
Other	76.9	12%	17.8	(5.1)
Total	632.6	100%	137.2	26.3

If the regulatory changes have proved one challenge, the accountants have proved another. There is now a great deal of disclosure in company accounts, in the UK and the US, which takes effort to fathom out. Whilst we are all in favour of success being rewarded, we dislike the trend to issuing shares at below market price. In the UK there has been a surge in the issuance of nil cost options, and in the US RSUs (restricted stock units). Whilst at one level aligning managements' interests with those of shareholders is a good thing, at another level it makes it very difficult to determine the real costs to the company. When options were only issued at market price, adding back share based payments to give an adjusted EPS was not too much of a stretch. With nil cost or discounted share issues, share based payments have become a very real cost, and an adjusted EPS figure which adds back the non-cash element is misleading in terms of company valuation. The second murky area is amortisation. Amortisation of goodwill is a non-cash item, and it is again misleading that the same term is used for amortising capitalised research and development costs. The latter is a real cash cost. In short, the adjusted EPS that companies are inclined to put in the headline results announcement has become a very flawed measure. It is the policy of the Board to discourage the approval of share issuance at any price below the market.

There has been a benign environment for salary inflation outside company boards since the financial crisis, and even since the "TMT" bubble of 1999-2000. Anecdotally we now hear of higher staff churn, skill shortages and poaching. This is particularly challenging in Silicon Valley with Apple, Google, Facebook and others driving a hot market. Furthermore there is an appetite for smart developers to move to start-ups where they dream of millions from stock options. In the UK the market for IT services has conspicuously warmed, as the financial sector has increased investment to cope with revised risk and regulatory challenges. At least sterling weakness offsets some of this cost creep in the UK.

We are often asked about "Silicon Roundabout" and the growth of the sector in East London. We are frustrated by the sloppy terminology, which does not distinguish digital media which is largely the application of technology, from the development of real technology. The latter has a greater focus in Cambridge, Oxford and in the financial sector.

Outlook

After the strong performance of 2013 the market consolidation in 2014 is quite healthy, because fundamentals have been sound. The sector continues to have anomalous valuations, some of them conceptual, while the more sensibly valued are being picked off  by trade and private equity aquirors. In an uncertain political and economic world we treat fashion cautiously. We continue to be excited by the opportunities.

 

Time weighted total return by geography in sterling terms, compared with indices

				31/12/2013- 31/12/2014
Asia				11.12%
Europe Middle  East and Africa				19.56%
North America				13.47%
UK				0.41%
Foreign Bonds				-10.01%
Numis Smaller companies index (plus AIM ex investment trusts)				-4.79%
Russell 2000 (small cap) Technology Index				14.80%

Investment Changes (£'000)

	Valuation at 31 December 2013	Net acquisitions/ (disposals)	Appreciation/ (depreciation)	Valuation at 31 December 2014
Equities*
UK	432,880	900	(4,785)	428,995
EMEA	22,680	(2,588)	3,732	23,824
North America	136,402	(9,501)	16,826	143,727
Asia Pacific	32,823	183	3,019	36,025
Total equities	624,785	(11,006)	18,792	632,571
Bonds:
Euro bonds	19,281	(13,360)	(1,584)	4,337
Total bonds	19,281	(13,360)	(1,584)	4,337
Total investments	644,066	(24,366)	17,208	636,908
Net liquid assets	18,472	10,881	1,189	30,542
Total assets	662,538	(13,484)	18,397	667,450

The total assets figure above comprises assets less current liabilities before deduction of bank loans and derivative financial instruments.

* Equities includes convertibles and warrants.

Katie Potts

 

Top Twenty Equity Holdings 

AT 31 DECEMBER 2014

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

Imagination Technologies Group
Imagination Technologies - a global leader in multimedia, processor, communication and cloud technologies - creates and licenses market-leading processor solutions including graphics, video, vision, CPU and embedded processing, multi-standard communications, cross-platform V.VoIP and VoLTE and cloud connectivity. These silicon and software intellectual property (IP) solutions for systems-on-chip (SoC) are complemented by an extensive portfolio of software, tools and ecosystems. Target markets include mobile phone, connected home consumer, mobile and tablet computing, in-car electronics, networking, telecoms, health, smart energy and connected sensors. 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 a leading supplier of radios in the UK. Imagination's licensees include many of the world's leading semiconductor manufacturers, network operators and OEM/ODMs. Corporate headquarters are located in the United Kingdom, with sales and R&D offices worldwide.		Country                    United Kingdom % of total assets                         3.1 % of issued share capital held       3.4                          31/12/14    31/12/13 Valuation (£m)          20.74        11.45 Shares (m)                9.08          6.45

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                         2.4 % of issued share capital held       2.0                          31/12/14    31/12/13 Valuation (£m)          16.16        15.55 Shares (m)                2.30          2.30

SDL
SDL allows companies to optimize their customers' experience across the entire buying cycle. Through its web content management, analytics, social intelligence, campaign management and translation services, SDL helps organizations leverage data-driven insights to understand what their customers want, orchestrate relevant content and communications, and deliver engaging and contextual experiences across languages, cultures, channels and devices. SDL has over 1,500 enterprise customers, over 400 partners and a global infrastructure of 70 offices in 38 countries. SDL work with 42 of the top global 50 brands.		Country                    United Kingdom % of total assets                         2.1 % of issued share capital held       4.1                          31/12/14    31/12/13 Valuation (£m)          13.91        11.31 Shares (m)                3.35          3.15

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, M & C Saatchi have added new agencies and disciplines in Asia, USA and Europe. M&C Saatchi currently has 26 offices in 18 countries.		Country                    United Kingdom % of total assets                         2.0 % of issued share capital held       6.1                          31/12/14    31/12/13 Valuation (£m)          13.33        14.83 Shares (m)                4.14          4.45

Telit Communications
Telit is a global leader of machine-to-machine (M2M) communications providing wireless module technology via its brand Telit Wireless Solutions, enhanced by managed and value added services, including connectivity via its business unit m2mAIR. Telit has been dedicated to M2M communications for over 12 years and constantly advancing technological leadership from 6 R&D centers around the globe. Telit offers an extensive portfolio of quality cellular, short-range, and GNSS modules. By supplying business scalable products interchangeable across families, technologies, and generations, Telit is able to keep development costs low and uniquely protect customers' design investments. Telit sells its products through a network of 35 sales offices to more than 5,000 customers in 80 countries around the world.		Country                    United Kingdom % of total assets                         1.8 % of issued share capital held       4.4                          31/12/14    31/12/13 Valuation (£m)          12.00          8.90 Shares (m)                4.98          5.08

IDOX
Idox plc is a supplier of software solutions and services to the UK public sector and increasingly to highly regulated asset intensive industries around the world in the wider corporate sector. The Public Sector Software Division is the leading applications provider to UK local government for core functions relating to land, people and property, such as its market leading planning systems and election management software. Over 90% of UK local authorities are now customers. The Division provides public sector organisations with tools to manage information and knowledge, documents, content, business processes and workflow as well as connecting directly with the citizen via the web. The Engineering Information Management Division delivers engineering document control, project collaboration and facility management applications to many leading companies in industries such as oil & gas, architecture and construction, mining, utilities, pharmaceuticals and transportation in North America and around the world. The Group employs over 500 staff located in the UK, the USA, Europe, India and Australia.		Country                    United Kingdom % of total assets                         1.7 % of issued share capital held       7.8                          31/12/14    31/12/13 Valuation (£m)          11.04          9.08 Shares (m)              27.94        27.94

SQS
The SQS Group (SQS) is a leading specialist in software quality. The company's competitive edge stems mainly from its PractiQ methodology, which is based on many years of project experience and specialist knowledge across a wide range of industries. With over 7,000 completed projects, SQS has a strong customer base, including half of the DAX-30, almost a third of the STOXX-50 and 20 FTSE-100 companies. Customers include Allianz, Beazley, BP, Centrica, Commerzbank, Daimler, Deutsche Post, Generali, JP Morgan, Meteor, Reuters, UBS and Volkswagen. Founded in Cologne in 1982, SQS employs around 3,900 staff in offices in Germany, the UK, Australia, Egypt, Finland, France, India, Ireland, Malaysia, the Netherlands, Norway, Austria, Singapore, Sweden, Switzerland, South Africa, the UAE and the US.		Country                    United Kingdom % of total assets                         1.6 % of issued share capital held       6.2                          31/12/14    31/12/13 Valuation (£m)          10.84          9.37 Shares (m)                1.89          1.89

Euromoney Institutional Investor
Euromoney is a leading international business-to-business media group focused primarily on the international finance, metals and commodities sectors. It owns more than 70 brands including Euromoney, Institutional Investor and Metal Bulletin, and is a leading provider of economic and investment research and data under brands including BCA Research, Ned Davis Research, and the emerging market information providers, EMIS and CEIC. It also runs an extensive portfolio of conferences, seminars and training courses for the financial and commodities markets. The group's main offices are in London, New York, Montreal and Hong Kong and more than a third of its revenues are derived from emerging markets.		Country                    United Kingdom % of total assets                         1.6 % of issued share capital held       0.8                          31/12/14    31/12/13 Valuation (£m)          10.47        13.50 Shares (m)                1.00          1.00

GB Group
GB Group, the UK's leading identity management business, helps organisations realise the full value of their customer base by recognising and verifying all elements of a consumer's identity at every interaction. Through the application of technology, GB Group protects, predicts and provides information that is used to maximise customer value for some of the largest companies in the UK. The company provides an integrated and comprehensive range of data services to clients allowing them to interact effectively with their customers, improve long term profitability and reduce fraud.		Country                    United Kingdom % of total assets                         1.6 % of issued share capital held       5.8                          31/12/14    31/12/13 Valuation (£m)          10.37        10.82 Shares (m)                7.01          7.52

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                         1.5 % of issued share capital held       9.2                          31/12/14    31/12/13 Valuation (£m)           9.98          9.23 Shares (m)                7.62          6.93

NCC Group
As a trusted adviser, NCC Group provides business critical IT assurance and protection to over 15,000 organisations worldwide, The Group provides organisations worldwide with expert software escrow and verification, security testing, website performance, software testing and domain services. NCC has 18 locations across the UK, Europe, North America and Australia.		Country                    United Kingdom % of total assets                         1.5 % of issued share capital held       2.3                          31/12/14    31/12/13 Valuation (£m)           9.88          8.88 Shares (m)                4.80          4.80

Wilmington Group
Wilmington Group plc is one of the UK's leading providers of Information, Compliance and Education for professional business markets. The Group provides business intelligence, information, training, education, events and support services for a variety of markets including the accountancy, banking, charities, financial services, healthcare, insurance, legal, and pensions sectors.		Country                    United Kingdom % of total assets                         1.4 % of issued share capital held       5.1                       31/12/14       31/12/13 Valuation (£m)        9.52           10.53 Shares (m)             4.39             4.39

Opsec Security
OpSec Security is a market leader in fighting counterfeits for brands, transaction cards, government documents and currency. OpSec delivers a comprehensive suite of end-to-end solutions, including advanced physical security technologies, supply chain track and trace services, and online and e-commerce monitoring and analysis for more than 300 companies across industry sectors and 50 governments worldwide. OpSec operates manufacturing and software development facilities and laboratories in the USA, UK and Germany and has sales operations in the Americas, Europe, and Asia.		Country                    United Kingdom % of total assets                         1.4 % of issued share capital held     25.2                       31/12/14       31/12/13 Valuation (£m)        9.46             9.46 Shares (m)           30.51           23.65

Alternative Networks
Alternative is one of the UK's leading independent telecommunications service providers. Established in 1994, it has grown steadily and can provide a complete communications and technology portfolio, including cloud computing, virtualisation, managed hosting, fixed line voice, mobile, systems, IP networks and complex billing software solutions. Based across six sites in total, Alternative employs over 600 members of staff.		Country                    United Kingdom % of total assets                         1.4 % of issued share capital held       3.7                          31/12/14    31/12/13 Valuation (£m)           9.40          7.70 Shares (m)                1.81          1.83

Kofax
Kofax is a leading provider of data capture applications that enable enterprises to handle real-time, information-intensive communications from customers and provide an essential connection to their systems of record, which are typically large scale, rigid enterprise applications and repositories not easily adapted to more contemporary technology. Kofax software and solutions are utilised by 20,000 customers in financial services, insurance, government, healthcare, business process outsourcing and other markets. Kofax delivers these through its own sales and service organisation, and a global network of more than 800 authorised partners in more than 70 countries throughout the Americas, EMEA and Asia Pacific.		Country                    United Kingdom % of total assets                         1.4 % of issued share capital held       2.3                          31/12/14    31/12/13 Valuation (£m)           9.39          8.56 Shares (m)                2.10          2.10

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 provides over 550,000 homes and small businesses throughout the UK with Home Phone, Broadband, Mobile, Gas and Electricity all on a unified bill. 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                         1.4 % of issued share capital held       0.9                          31/12/14    31/12/13 Valuation (£m)           9.37        17.70 Shares (m)                0.75          1.00

Silicon Motion
Silicon Motion is a global leader and pioneer in developing microcontroller ICs for NAND flash storage devices and specialty RF ICs for mobile devices.  Silicon Motion is a fabless semiconductor company that designs, develops and markets high performance, low-power semiconductor solutions to OEMs and other customers in the mobile storage and mobile communications markets. For the mobile storage market, key products are microcontrollers used in solid state storage devices such as SSDs, eMMCs and other embedded flash applications, as well as removable storage products. For the mobile communications market, key products are handset transceivers and mobile TV IC solutions. Silicon Motion's products are widely used in smartphones, tablets, and industrial and commercial applications. The company was founded in 1995 in San Jose, California and is now headquartered in Taiwan, with design centers and sales offices in Taiwan, Korea, China, Hong Kong, Japan and the US.		Country                                   USA % of total assets                         1.4 % of issued share capital held       1.8                          31/12/14    31/12/13 Valuation (£m)           9.10          5.12 Shares (m)                0.60          0.60

Radware
Radware is a global leader of application delivery and application security solutions for enterprise and carrier virtual and cloud data centers. Application delivery solutions include Application Delivery Controllers which manage application delivery and application performance. Network security solutions include; firewall/VPN, Unified Threat Management (UTM), intrusion detection systems, intrusion prevention systems and network behavioral analysis systems. Radware's award-winning solutions portfolio delivers full resilience for more than 10,000 enterprise and carrier customers worldwide.		Country                                   USA % of total assets                         1.3 % of issued share capital held       1.4                          31/12/14    31/12/13 Valuation (£m)           8.75          6.73 Shares (m)                0.62          0.62

Eckoh
Eckoh is a leader in secure payment technology, specialising in assisting organisations that take payments securely when the payment card is not present, for example over the phone, web or mobile. As a PCI DSS Level One Compliant Service Provider, corporate customers trust Eckoh to protect their contact centre and customers from payment card fraud and breaches. In addition to these payments products Eckoh has a portfolio of customer service solutions that target organisations with contact centres. These services enable organisations to manage their customer communications more efficiently and securely. Eckoh's multi-channel products give customers the ability to make enquiries, get information or make transactions over the phone, web or mobile without needing to interact with a contact centre agent or advisor.		Country                    United Kingdom % of total assets                         1.3 % of issued share capital held       8.6                          31/12/14    31/12/13 Valuation (£m)           8.62          6.32 Shares (m)              19.16        19.16 Country                                   USA % of total assets                         1.3 % of issued share capital held       0.8                          31/12/14    31/12/13 Valuation (£m)           8.58          9.42 Shares (m)                0.44          0.45

Advent Software
Advent Software has provided trusted solutions to the world's financial professionals since 1983. Advent's focus is on supplying 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. Advent has worked with more than 4,400 client firms in 60 countries, 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                         1.3 % of issued share capital held       0.8                          31/12/14    31/12/13 Valuation (£m)           8.58          9.42 Shares (m)                0.44          0.45

DISTRIBUtion Of Investments

Classification	UK %	EMEA %	North America %	Japan and Asia Pacific %	2014 Total %	2013 Total %
OIL & GAS	1.3	-	0.3	-	1.6	1.0
Oil Equipment, Services & Distribution	0.5	-	-	-	0.5	0.5
Alternative Energy	0.8	-	0.3	-	1.1	0.5
BASIC MATERIALS	0.3	-	-	0.2	0.5	0.9
Chemicals	0.3	-	-	0.2	0.5	0.9
INDUSTRIALS	9.4	0.1	0.6	1.3	11.4	12.6
Construction & Materials	-	-	0.1	-	0.1	-
Aerospace & Defense	0.5	-	-	-	0.5	0.4
Electronic & Electrical Equipment	2.5	0.1	0.3	0.9	3.8	4.7
Industrial Engineering	-	-	-	0.1	0.1	-
Support Services	6.4	-	0.2	0.3	6.9	7.5
CONSUMER GOODS	0.6	-	0.1	0.1	0.8	0.4
Household Goods & Home Construction	0.1	-	-	-	0.1	0.1
Leisure Goods	0.5	-	0.1	0.1	0.7	0.3
HEALTH CARE	0.8	0.1	0.2	-	1.1	1.1
Health Care Equipment & Services	0.8	0.1	0.2	-	1.1	1.1
CONSUMER SERVICES	12.5	0.1	0.7	0.4	13.7	13.9
General Retailers	-	-	-	0.3	0.3	-
Media	12.5	0.1	0.7	0.1	13.4	13.9
TELECOMMUNICATIONS	4.0	-	0.1	-	4.1	3.9
Fixed Line Telecommunications	3.9	-	0.1	-	4.0	3.8
Mobile Telecommunications	0.1	-	-	-	0.1	0.1
FINANCIALS	1.0	-	-	-	1.0	1.5
Financial Services	0.4	-	-	-	0.4	1.0
Equity Investment Instruments	0.6	-	-	-	0.6	0.5
TECHNOLOGY	34.4	3.3	19.5	3.4	60.6	59.0
Software & Computer Services	25.5	1.5	10.5	0.9	38.4	37.4
Technology Hardware & Equipment	8.9	1.8	9.0	2.5	22.2	21.6
TOTAL EQUITIES (including convertibles and warrants)	64.3	3.6	21.5	5.4	94.8	94.3
Total equities - 2013 (including convertibles and warrants)	65.3	3.5	20.6	4.9	-	94.3
BONDS	-	0.6	-	-	0.6	2.9
NET LIQUID (LIABILITIES) ASSETS	4.6	-	-	-	4.6	2.8
TOTAL ASSETS (before deduction of bank loans and derivative financial instruments)	68.8	4.2	21.5	5.4	100.0	-
Total assets - 2013	68.1	6.4	20.6	4.9	-	100.0
BANK LOANS	(3.7)	-	-	-	(3.8)	(3.8)
DERIVATIVE FINANCIAL INSTRUMENTS	(2.0)	-	-	-	(2.1)	(2.1)
SHAREHOLDER'S FUNDS	62.3	6.4	20.6	4.9	94.3
Shareholders' Funds - 2013	64.3	5.2	18.6	6.0	-	94.1
Number of equity investments (including convertibles and warrants)	162	21	69	43	295	274

Income Statement

FOR THE YEAR ENDED 31 DECEMBER

	Revenue £'000	2014 Capital £'000	Total £'000	Revenue £'000	2013 Capital £'000	Total £'000
Gains on investments	-	17,208	17,208	-	126,239	126,239
Currency gains/(losses)	-	1,189	1,189	-	(742)	(742)
(Losses)/gains on derivative instruments	-	(9,405)	(9,405)	-	6,362	6,362
Income	8,245	-	8,245	9,004	-	9,004
Investment management fee	(6,283)	-	(6,283)	(5,648)	-	(5,648)
Other administrative expenses	(436)	(1)	(437)	(368)	-	(368)
Net return before finance  costs and taxation	1,526	8,991	10,517	2,988	131,859	134,847
Finance costs of borrowings	(2,783)	-	(2,783)	(3,108)	(3)	(3,111)
Net return on ordinary  activities before taxation	(1,257)	8,991	7,734	(120)	131,856	131,736
Tax on ordinary activities	(207)	-	(207)	(187)	-	(187)
Net return on ordinary  activities after taxation	(1,464)	8,991	7,527	(307)	131,856	131,549
Net return per  ordinary share	(1.89)p	11.59p	9.70p	(0.39)p	168.50p	168.11p

There is no final dividend proposed (2013 - nil).

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

	2014 £'000	2014 £'000	2013 £'000	2013 £'000
Fixed assets
Investments held at fair value through  profit or loss		636,908		644,066
Current assets
Debtors	1,253		1,554
Cash and short term deposits	30,850		18,008
	32,103		19,562
Creditors: Amounts falling due within one year
Creditors	(26,560)		(26,090)
Derivative financial instruments	(13,534)		(13,935)
	(40,094)		(40,025)
Net current liabilities		(7,991)		(20,463)
TOTAL NET ASSETS		628,917		623,603
Capital and reserves
Called up share capital		19,355		19,420
Share premium		73,738		73,738
Capital redemption reserve		2,617		2,532
Capital reserve		532,946		526,168
Revenue reserve		281		1,745
SHAREHOLDERS' FUNDS		628,917		623,603
NET ASSET VALUE PER ORDINARY SHARE  (including current year revenue)		813.19p		802.79p
NET ASSET VALUE PER ORDINARY SHARE  (excluding current year revenue)		815.08p		803.18p

Reconciliation Of Movements In Shareholders' Funds

FOR THE YEAR ENDED 31 DECEMBER 2014

	Called up share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve £'000	Revenue reserve £'000	Share- holders' funds £'000
Shareholders' funds at 1 January 2014	19,420	73,738	2,532	526,168	1,745	623,603
Net return on ordinary activities after taxation	-	-	-	8,991	(1,464)	7,527
Shares bought back	(85)	-	85	(2,213)	-	(2,213)
Dividends paid during the year	-	-	-	-	-	-
Shareholders' funds at  31 December 2014	19,335	73,738	2,617	532,946	281	628,917

FOR THE YEAR ENDED 31 DECEMBER 2013

	Called up share capital £'000	Share premium £'000	Capital redemption reserve £'000	Capital reserve £'000	Revenue reserve £'000	Share- holders' funds £'000
Shareholders' funds at 1 January 2013	19,830	73,738	2,122	403,415	2,841	501,946
Net return on ordinary activities after taxation	-	-	-	131,856	(307)	131,549
Shares bought back	(410)	-	410	(9,103)	-	(9,103)
Dividends paid during the year	-	-	-	-	(789)	(789)
Shareholders' funds at  31 December 2013	19,420	73,738	2,532	526,168	1,745	623,603

Cash Flow Statement

FOR THE YEAR ENDED 31 DECEMBER

	2014 £'000	2014 £'000	2013 £'000	2013 £'000
Net cash inflow from  operating activities		(6,554)		2,623
Servicing of finance
Loan and derivative interest	(3,075)		(3,019)
Net cash outflow from servicing  of finance		(3,075)		(3,019)
Financial investment
Purchase of investments	(85,031)		(89,152)
Sale of investments	109,715		113,498
Net cash inflow  from financial investment		24,684		24,346
Equity dividend paid		-		(789)
Net cash inflow before financing		15,055		23,161
Financing
Bank loans drawn down	25,000		50,000
Bank loans repaid	(25,000)		(75,000)
Shares repurchased	(2,213)		(9,103)
Net cash outflow from financing		(2,213)		(34,103)
Increase/(decrease) in cash		12,842		(10,942)
Reconciliation of net cash flow  to movement in net debt
Increase/(decrease) in cash for period		12,842		(10,942)
Decrease in debt for period		-		25,000
Movement in net debt in period		12,842		14,058
Net debt at 1 January		(6,992)		(21,050)
Net cash/(debt) at 31 December		5,850		(6,992)

Notes To The ANNUAL FINANCIAL REPORT

Accounting policies

The financial statements for the year to 31 December 2014 have been prepared on the basis of the accounting policies set out below, which are consistent with those in the Company's Annual Report and Financial Statements at 31 December 2013.

Income

	2014 £'000		2013 £'000
Income from investments and interest receivable
Total income	8,245		9,004
Total income comprises:
Dividends from equity securities designated at fair value through profit or loss	7,760		7,702
Interest from financial assets designated at fair value through profit or loss	448		1,170
Deposit interest	37		132
	8,245		9,004

Business model and status

The Company is an investment company within the meaning of Section 833 of the Companies Act 2006.

The Company carries on business as an investment trust. It was approved by HM Revenue & Customs as an investment trust under Section 1158 of the Corporation Tax Act 2010 for the year ended 31 December 2013, subject to matters that may arise from any subsequent enquiry by HM Revenue & Customs into the Company's tax return. In the opinion of the Directors the Company has subsequently conducted its affairs so as to enable it to continue to seek such approval. In accordance with recent changes to Section 1158, the Company has obtained approval as an investment trust from HM Revenue & Customs for accounting periods commencing on or after 1 January 2014.

Objective

The Company's objective is to achieve capital appreciation through investments in smaller quoted companies, in the areas of telecommunications, multi-media and technology (TMT). Investments may be made across the world. The business activities of investee companies will include information technology, broadcasting, printing and publishing and the supply of equipment and services to these companies.

Investment policy - strategy

While the policy is global investment in the above target areas, the approach is to construct a diversified portfolio through the identification of individual companies which offer long term growth potential, typically over a five year horizon or more. The portfolio is actively managed and does not seek to track any comparative index. With a remit to invest in smaller companies with market capitalisation generally below $2bn, there tends to be a correlation with the performance of smaller companies, as well as those of the technology sector. A degree of volatility relative to the overall market should be expected.

The risk associated with the illiquidity of smaller companies is reduced by generally restricting the stake in any one company to less than 10% of the shares in issue. A number of investments are in early stage companies, which have a higher stock specific risk but the potential for above average growth. Stock specific risk is reduced by having a diversified portfolio of over 250 holdings. In addition, to contain the risk of any one holding, the Manager generally takes profits when a holding reaches more than 5% of the portfolio. The Manager actively manages the exposure within the constraint that illiquid positions cannot be traded for short term movements.

The Company has a policy not to invest more than 15% of gross assets in other UK listed investment companies.

From time to time, fixed interest holdings, non equity or unlisted investments may be held on an opportunistic basis.

The Company recognises the long term advantages of gearing and has a maximum gearing limit of 50% of net assets. Borrowings are invested primarily in equity markets but the Manager is entitled to invest in other securities in the companies in the target areas when it is considered that the investment grounds merit the Company taking a geared position. The Board's intention is to gear the portfolio when appropriate. Gearing levels are monitored closely by the Manager and reviewed by Directors at each board meeting.

The Company may use derivatives which will be principally, but not exclusively, for the purpose of efficient portfolio management (i.e. for the purpose of reducing, transferring or eliminating investment risk in its investments, including protection against currency risk).

Share capital

At 31 December 2014 the Company's capital structure consisted of 77,339,546 ordinary shares of 25p each (2013 - 77,679,546 ordinary shares). During the year 340,000 (2013 - 1,643,737) shares were bought back and cancelled. There are no restrictions concerning the holding or transfer of the Company's ordinary shares and there are no special rights attached to any of the shares. On a winding up, after meeting the liabilities of the Company, the surplus assets would be paid to ordinary shareholders in proportion to their shareholdings.

Investment management agreement

The management of the Company and the implementation of its investment strategy is contracted to Herald Investment Management Limited ('HIML'). HIML is authorised and regulated by the Financial Conduct Authority.

The management contract is subject to 12 months' notice by either party. The senior director of HIML with prime responsibility for the management of the Company's portfolio is Katie Potts, who is also a substantial shareholder of HIML. HIML is remunerated at a monthly rate of 0.08333% of the Company's net asset value calculated using middle market prices. Compensation fees would only be payable in respect of this 12 month period if termination were to occur sooner. Careful consideration has been given by the board as to the basis on which the management fee is charged. The board considers that maintaining an appropriate level of ongoing charges for a specialist trust is in the best interest of all shareholders. The board is also of the view that calculating the fee with reference to performance would be unlikely to exert a positive influence over the long term performance.

The board is of the opinion that the continued appointment of HIML as investment manager, on the terms agreed, is in the interests of shareholders due to the experience of the Manager and the quality of information provided to the board.

Acquisition of own shares

At the Company's AGM held on 22 April 2014 the Company was authorised to purchase up to 11,644,163 of the Company's ordinary shares (14.99% of its ordinary share capital in issue at that time). During the year to 31 December 2014 the Company bought back 340,000 ordinary shares (nominal value £85,000 which comprised 0.44% of the issued share capital at 1 January 2014) on the London Stock Exchange for cancellation. The board continues to believe that the ability of the Company to purchase its own ordinary shares in the market will potentially benefit all shareholders of the Company. The repurchase of ordinary shares at a discount to the underlying net asset value ('NAV') should enhance the NAV per ordinary share of the remaining shares and may also enable the Company to address more effectively any imbalance between supply and demand for the Company's ordinary shares.

Significant financial issues relating to the 2014 financial statements

The Code requires us to describe any significant issues considered in relation to the financial statements and how those issues were addressed. There were no significant issues.

One matter that arose during the course of the audit was as follows. The Manager makes an estimate of the value of the unlisted stocks in the investment portfolio which the Board reviews and agrees. It is a part of the auditor's function to test whether those valuations meet the relevant accounting standards. The Committee has received reports from the Manager, with which it is satisfied, describing the basis for assumptions used and has discussed and agreed these with the auditor.

Following a detailed review of the financial statements and discussions with the Investment Manager, Administrator, Company Secretary and Auditor, the Audit Committee concluded that the financial statements themselves, and the annual report as a whole, are fair balanced and understandable and provide the information necessary for shareholders to assess the Company's performance, business model and strategy. That conclusion has been reported to and confirmed by the board.

Borrowings

The Company had a £50 million multi-currency variable rate loan facility with The Royal Bank of Scotland plc, which expired in December 2014 with full repayment of the £25 million that was drawndown. This was replaced on 31 December 2014 with a sterling loan facility of £25 million and up to a £25 million multi-currency revolving advance loan maturing 31 December 2017. The sterling loan was drawndown in full on 31 December 2014. There have been no drawings on the multi-currency revolving facility.

At 31 December 2014, there were outstanding drawings of £25 million (2013 - £25 million). Interest on the loan is payable in quarterly instalments in January, April, July and October. The estimated repayment value of the loan at 31 December 2014 was £25 million. The indicative costs of repaying the loan as at 31 December 2014 were not materially different in the context of the above figures.

The interest on the facilities 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 2014 was an estimated liability of £13.5 million (2013 - £13.9 million) which was based on the swap provider's valuation. The swap was part closed out on 23 December 2014. The Company paid £10 million to reduce the notional from £50 million to £25 million.

The loan has been disclosed as due within one year as the Company has an unconditional and irrevocable right to prepay the advance under the terms and conditions of the loan agreement. In connection with the revolving facility, the duration of the advance is 3 or 6 months and the decision to rollover the loan is made at quarterly board meetings based on circumstances prevailing at the time. The decision to continue with the swap arrangement is reviewed at the same time as the loan agreement. The swap is disclosed as due within one year as the Company can close out the swap at its discretion.

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 fair value or 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 policies 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 (Accounting Policy (b)). These valuations also represent the fair value of the investments.

Other Price Risk Sensitivity

           
26.6% of the Company's equity investments at 31 December 2014 (2013 - 26.5%) were listed on the main list of the London Stock Exchange and a further 39.3% (2013 - 38.2%) on AIM. The NASDAQ Stock Exchange accounts for 22.6% (2013 - 16.7%) and other stock exchanges 11.5% (2013 - 18.6%). A 10% increase in stock prices at 31 December 2014 would have increased total net assets and net return on ordinary activities after taxation by £63,200,000 (2013 - £62,500,000). A decrease of 10% would have had an equal but opposite effect. The portfolio does not target any exchange as a comparative index, 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. 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 £25 million (2013 - £25 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

	2014 Fair value £'000		2014 Weighted average interest rate/ interest rate		2014 Weighted average period until maturity/ maturity date		2013 Fair value £'000		2013 Weighted average interest rate/ interest rate		2013 Weighted average period until maturity/ maturity date
Fixed rate:
UK bonds	-		-		-		-		-		-
Euro bonds	4,337		4.9%		0.3 years		19,281		4.2%		3 years
UK convertible bonds	4,615		8.7%		2.7 years		256		8.0%		3 years
Cash:
Other overseas currencies	19,193						10,271
Sterling	11,657		1.0%				7,737		1.0%
	30,850						18,008

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

	2014 £'000		2014 Net interest rate paid		2014 Loan facility expired/expires		2013 £'000		2013 Net interest rate paid		2013 Loan facility expired/expires
Bank Loan	25,000		1.9%		Dec 2014		25,000		1.9%		Dec 2014
			1.9%						1.9%
Interest rate swap	25,000		4.3%				50,000		4.4%
Total			6.2%						6.3%

At 31 December 2014, the Company had an unutilised committed revolving credit facility of £25 million (2013: £25m), with a cost associated cost rate of 0.53%.

The effective fixed rate of interest on the loans of 6.22% (2013 - 6.25%) reflects a weighted average variable interest rate paid of 1.88% (2013 - 1.87%), with a further weighted average of 4.34% paid on the swap (2013 - 4.38%). The Company's facilities are rolling on a quarterly basis with the facilities expiring in December 2017.

While the 30 year swap remains in place, the net interest payable will effectively be fixed for the duration of the term of the loan facilities.

	2014 Notional contract amount £'000		2014 Fair value assets £'000		2014 Fair value liabilities £'000		2014 Fair value balance £'000		2013 Notional contract amount £'000		2013 Fair value assets £'000		2013 Fair value liabilities £'000		2013 Fair value balance £'000
Total derivative assets/(liabilities)	25,000		10,256		(23,790)		(13,534)		50,000		28,505		(42,440)		(13,935)

Interest rate risk sensitivity        

(a) Cash           

An increase or decrease of 100 basis points in interest rates as at 31 December 2014 would have a direct effect on net assets. Based on the position at 31 December 2014, over a full year, an increase of 100 basis points would have increased the net return on ordinary activities after taxation by £310,000 (2013 - £180,000) and would have increased the net asset value per share by 0.49p (2013 - 0.23p). A decrease of 100 basis points would have an equal and opposite effect. 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 2014 would have decreased total net assets and total return on ordinary activities by £16,000 (2013 - £576,000) and would have decreased the net asset value per share by 0.02p (2013 - 0.74p). 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 2014 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% (2013 - 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 changes in the fair value of 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 2014 would have a direct effect on the fair value of the swap and net assets. Based on the position as at 31 December 2014, 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 £6,285,000 (2013 - £10,181,000) and would have decreased the net asset value per share by 8.13p (2013 - 13.11p). 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. 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 2014

	Investments £'000		Cash and deposits £'000		Loans £'000		Other     debtors            and   creditors *        £'000		Net exposure £'000
US dollar	145,250		15,334		-		44		160,828
Norwegian krone	4,337		-		-		135		4,472
Korean won	13,852		-		-		139		13,991
Taiwan dollar	11,842		3,648		-		-		15,490
Euro	14,606		11		-		26		14,643
Other overseas currencies	18,024		-		-		11		18,035
Exposure to currency risk on translation of valuations of securities listed in overseas currencies	207,911		19,193		-		355		227,459
Sterling	428,997		11,657		(25,000)		(14,196)		401,458
	636,908		30,850		(25,000)		(13,841)		628,917

*Includes net non-monetary assets of £nil.

At 31 December 2013

	Investments £'000		Cash and deposits £'000		Loans £'000		Other    debtors         and creditors *       £'000		Net exposure £'000
US dollar	134,738		8,305		-		8		143,051
Norwegian krone	19,281		-		-		502		19,783
Korean won	14,489		-		-		110		14,599
Taiwan dollar	10,911		1,964		-		-		12,875
Euro	20,842		2		-		10		20,854
Other overseas currencies	10,930		-		-		11		10,941
Exposure to currency risk on translation of valuations of securities listed in overseas currencies	211,191		10,271		-		641		222,103
Sterling	432,875		7,737		(25,000)		(14,112)		401,500
	644,066		18,008		(25,000)		(13,471)		623,603

*Includes net non-monetary assets of £nil.

Foreign currency risk sensitivity 

At 31 December 2014, had sterling strengthened by 10% (2013 -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% (2013 - 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 their 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.

	2014 £'000		2013 £'000
US dollar	16,083		14,305
Norwegian krone	447		1,978
Korean won	1,399		1,460
Taiwan dollar	1,549		1,288
Euro	1,464		2,085
Other overseas currencies	1,804		1,094
	22,746		22,210

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 and Norwegian Government securities and UK corporate bonds.

Credit Risk Exposure

The exposure to credit risk at 31 December was:

	2014 £'000		2013 £'000
Fixed interest investments	4,337		19,281
Cash and short term deposits	30,850		18,008
Debtors and prepayments	1,253		1,554
	36,440		38,843

The maximum exposure in fixed interest investments was £18,813,000 (2013 - £38,570,000) and the minimum £4,337,000 (2013 - £19,281,000). The maximum exposure in cash was £40,974,000 (2013 - £61,320,000) and the minimum £23,582,000 (2013 - £13,702,000).

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.

 (a)       Equity Securities

The Company's unlisted investments are not readily realisable, but these only amount to 1.5% of the Company's total assets at 31 December 2014 (2013 - 1.5%).

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. 29% (£183 million) (2013 - 29% (£173 million)) of the portfolio is invested in listed 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 5.8% (2013 - 5.5%).

(b)        Floating interest rate to fixed interest rate swap

The fair value of the swap is estimated by RBS the provider of the swap and is compared to an external model and external prices. We believe the RBS valuation to be reasonable. The RBS valuation methodology and assumptions may change at any time.

The swap valuation gives an indication of fair value, but the price at which the swap can be unwound or realised may diverge materially from this valuation depending on market conditions and liquidity.

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:

	2014 One year or less £'000		2013 One year or less £'000
Bank loans	25,120		25,120
Derivative financial instruments	13,808		14,481
Other creditors	1,362		597
	40,290		40,198

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 tables below set out the fair value measurements using the fair value hierarchy.

At 31 December 2014

	Level 1 £'000		Level 2 £'000		Level 3 £'000		Total £'000
Financial assets
Equity investments	622,906		-		5,050		627,956
Government debt securities	4,337		-		-		4,337
Other debt securities	-		-		4,615		4,615
Current assets	32,103		-		-		32,103
Total assets	659,346		-		9,665		669,011
Financial liabilities
Bank loans	25,000		-		-		25,000
Derivatives	-		13,534		-		13,534
Current liabilities (excluding bank loans)	1,560		-		-		1,560
Total liabilities	26,560		13,534		-		40,094
Total net assets	632,786		(13,534)		9,665		628,917

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

At 31 December 2014

	Equity Investments £'000
Opening balance at 1 January 2014	9,391
Purchases	950
Sales	0
Total gains or (losses):
- on assets sold during the year	(1,387)
- on assets held at 31 December 2014	711
Closing balance at 31 December 2014	9,665

At 31 December 2013

	Level 1 £'000		Level 2 £'000		Level 3 £'000		Total £'000
Financial assets
Equity investments	615,394		-		5,529		620,923
Government debt securities	19,281		-		-		19,281
Other debt securities	-		-		3,862		3,862
Current assets	19,562		-		-		19,562
Total assets	654,237		-		9,391		663,628
Financial liabilities
Bank loans	25,000		-		-		25,000
Derivatives	-		13,935		-		13,935
Current liabilities (excluding bank loans)	1,090		-		-		1,090
Total liabilities	26,090		13,935		-		40,025
Total net assets	628,147		(13,935)		9,391		623,603

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

At 31 December 2013

	Equity Investments £'000
Opening balance at 1 January 2013	12,227
Purchases	2,093
Sales	(2,736)
Total gains or (losses):
- on assets sold during the year	3,334
- on assets held at 31 December 2013	(5,527)
Closing balance at 31 December 2013	9,391

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 Sections 1158 and 1159 of the Corporation Tax Act 2010 could lead to the Company being subject to tax on capital gains. The Manager, Depositary and Administrator provide regular reports to the Audit Committee on their monitoring programmes. The Manager monitors investment positions and the Administrator monitors the level of forecast income and expenditure to ensure the provisions of Sections 1158 and 1159 are not breached. Regulatory risk now includes the risk of failure to comply with the Alternative Investment Fund Managers ("AIFM") Directive. During the year, the Company appointed Herald Investment Management Limited as its AIFM.

Major regulatory change could impose disproportionate compliance burdens on the Company. In such circumstances representation is made to ensure that special circumstances of investment trusts are recognised.

Operational/financial risk - failure of the Administrator'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 Manager, Administrator and Company Secretary each have comprehensive business continuity plans which facilitate continued operation of the business in the event of a service disruption or major disruption.

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. 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 Manager at every meeting. The majority of the Company's investments are in quoted securities.

Directors' responsibility statement pursuant to DTR4

The directors confirm that to the best of their knowledge:

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

·      The management 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.

Copies of the Company's annual report and financial statements will be available from the Company's registered office or at www.heralduk.com once published on 13 March 2015.

By order of the board

Law Debenture Corporate Services Limited

Secretary

19 February 2015

 

END

 

 

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