View the article online at http://citywire.co.uk/money/article/a884151
EU 'Mifid' directive drives UK tech fund to New York
Manager of Herald investment trust blasts European Union directive for a shortage of brokers working for smaller companies.
Herald (HRI ), the rare beast that is a UK-focused technology investment trust, is opening a research office in New York blaming what it says is a dearth of suitable smaller tech companies in this country and anti-shareholder European regulation that discourages US firms from visiting London.
Katie Potts, the £700 million trust's outspoken fund manager, blamed the European Union's markets in financial instruments directive (Mifid) for a damaging reduction in the number of brokers promoting smaller companies, particularly US firms.
Mifid has sought to increase transparency in stock broking by separating the costs fund managers pay for share dealing from the research and access to companies that brokers provided them for free in the past.
Nowadays research has to be paid for separately although regulators are opposed to brokers charging fund managers to see companies.
Potts complained that Mifid had driven down share dealing commission and made research and work on behalf of smaller companies uneconomic for brokers to undertake.
'Every week we seem to be saying goodbye to another broker contact who has been laid off,' she lamented.
'In particular overseas brokers, who do not have the benefit of corporate retainers, but have the expense of bringing companies to London, have been in retreat,' Potts added in the trust's annual results.
As a result US tech companies no longer visited the UK before listing on the stock market, making it difficult for Potts to assess them.
'There are increasingly webcasts, but it is an inferior medium when compared to meeting a company face to face,' she said. 'In consequence we have decided to open a New York office, because North American companies travel there most.'
This is a big move for Herald, which unusually for a technology fund invests nearly two thirds of its assets in the UK, rather than Silicon Valley in the US.
Potts attacked Mifid for making her job more difficult saying 200 of the 275 stocks in her portfolio were researched by three or fewer brokers. 'It will not be a viable business model for us to pay for research and no one or even ten brokers stand out as must haves,' she said.
The lack of brokers was most acute in small, overseas territories, she said, where direct access to companies was more difficult. This increased the risk of her making bad investments.
'We find it bizarre that the regulator is making rules which seem so far against protecting shareholders' interests and from our perspective, it is hard to see how London can maintain its status as a leading global fund management centre,' she added.
Potts also took a swipe at the reluctance of other UK investors to back early-stage tech stocks before they made a profit. She said the market had become 'unforgiving' to loss-making businesses and fearful of becoming stuck in cash-burning companies given the shortage of co-investors. This was short-sighted as some of Herald's best returns had come from backing tech giants such as ARM, Imagination Technologies and Autonomy in their early days, she said.
Last year Herald generated what its chairman Julian Cazalet said was a 'steady' 8.4% rise in net assets, with half the return provided by takeovers, for example of Kofax, Opsec, Phoenix IT, Chime and Hellerman Tyton.
Cazalet said in the past nine years 66 of the trust's UK holdings had been acquired, mostly by overseas or private equity buyers which was another reason for expanding its presence in the US. 'We have commented for some years about this problem, but the flight of capital from the quoted UK equity market has now reached a point where we must consider reallocating capital.
'There is no shortage of entrepreneurialism and innovation in the UK, but an evident shortage of capital, so it seems perverse that we may be forced to exacerbate matters by reducing own exposure to the UK,' he stated.
Potts made it clear she would not diverge into private US tech companies, in the way that Scottish Mortgage Trust (SMT ) has done, saying the Californina internet sector was 'hot' with 100 so-called 'unicorns' valued at over £1 billion.
'This boom was distinctly flagging by the year end with press reports suggesting that some of the players new to the private development capital market were writing down values and many have missed their revenue projections,' she said. '
Noting that ten times as much money had been invested last year in private tech companies rather than raised through stock market flotations, Potts said she was prepared to be patient. 'There is a big backlog of IPOs (initial public offers) which we look forward to with interest.'
Potts has managed Herald since its launch in 1994. The shares trade at a 20% discount below net asset value and have generated a 68% shareholder return over ten years. This is some way behind its main rivals Allianz Technology Trust (ATT ) and Polar Capital Technology (PCT ), which are more focused on the US.
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In this guide to investment trusts, produced in association with Aberdeen Asset Management, we spoke to many of the leading experts in the field to find out more.
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by Daniel Grote on Apr 26, 2017 at 11:17