Herald Regulatory News (HRI)

LEI number: 213800U7G1ROCTJYRR70

Herald Investment Trust plc

Annual Financial Report

For the year ended 31 December 2023

Results and dividend

The net asset value ('NAV') of the Company as at 31 December 2023 was 2,219.2p per ordinary share (2022 - 2,099.1p). This represented an increase of 5.7% during the year, compared to an increase in the comparative total return indices of 3.2% Numis Smaller Companies plus AIM (ex. investment companies) Index and an increase of 21.0% Russell 2000® Technology Index (small cap) (in sterling terms). The discount at year end was 13.4% (2022 - 15.1%).

The directors do not recommend a dividend for the year ended 31 December 2023 (2022 - nil) as the revenue reserve is in deficit.

STATISTICS AND PERFORMANCE - YEAR'S SUMMARY

A Alternative Performance Measure

B Investments and indices valued at USD/GBP exchange rate of 1.275 at 31 December 2023 (1.209 31 December 2022).

® Russell Investment Group.

CAPITAL RETURN SINCE INCEPTION

A Alternative Performance Measure (APM). See Glossary of Terms and Alternative Performance Measures in the financial report for details of the explanation and reconciliations of APMs.

* At 9 April 1996 being the date funds were first available for international investment.

? The Russell 2000® Technology Index (small cap) was rebased during 2009 following some minor adjustments to its constituents. The rebased index is used from 31 December 2008 onwards.

Chairman's Statement AND REVIEW OF 2023

This is my first annual statement since assuming the chairmanship of the Company in April 2023. I would like to thank my predecessor Tom Black and my board colleagues for entrusting me with the role and making my job much easier through their constructive and collegiate approach.

The Herald Investment Trust has a remarkable long-term record. Had you bought shares at inception in 1994, you would have made 22 times your money, a compound annual return comfortably into double figures. Since 1996 the Company has not issued any new shares and has bought back more than £340m worth of its own shares. The successive boards of the Company, and the Manager, have exercised commendable capital discipline, recognising that the size of the Company should not outgrow the strategy of investing only in smaller technology and communication companies worldwide. In the year to 31 December 2023 alone the Company bought back £107.4m of shares, representing some 9.7% of the outstanding shares at the start of the year.

Stepping back, the purpose of an investment trust remains the same as it was when the vehicle was invented in the 19th century: to allow savers, whether directly or indirectly through, for example, pension funds, to gain exposure to a portfolio of shares, expertly managed, which they would almost certainly be unable to do on their own. The Herald Investment Trust represents a classic use of the vehicle. In the Company's case, its investment strategy inevitably involves investing in stocks which are comparatively illiquid by virtue of their small capitalisations. Part of the reason for the Company's success is that it can take a long-term view of growth and value, and not be looking over its shoulder for short-term liquidity. A closed-end vehicle is well adapted to that role, with selling of the Company's own shares representing the way for shareholders to realise cash if needed, as opposed to redemptions of units, which would require the Company to sell the underlying shares to effect the redemptions. The Company's strategy cannot be successfully executed through an open-ended fund, which would compel the Company either to sell illiquid shares at a forced seller's price to finance redemptions, and/or change its successful strategy and invest only in the larger, more liquid, segment of the target market, which would run counter to the long-term interests of the Company and its shareholders.

There will be times when the focus of the Company on smaller stocks leads to underperformance against the wider stock market. 2023 was one such year. Growth in the Company's NAV per share was 5.7% against stronger returns from the global stock markets. As detailed in the Manager's Report, the main cause of the Company's sluggish relative performance is illustrated by the divergence between the performance of the Company's larger stocks and smaller ones, which was extreme in 2023. The 39 investments with a market cap of greater than $3bn delivered returns of 72.1% in the year against -9.2% for the 283 companies capitalised at less than $3bn. This reflects a similar, if less exaggerated, divergence within the wider stock markets of the world. This in turn reflects in part a stage in the interest rate cycle: after many years of very low rates, with the cost of capital similarly very low, rates have returned to 'reality' leading to the current reversal of popularity between small cap stocks and larger companies, whose current valuations are less dependent than smaller cap companies on a terminal value many years out which is then discounted at the prevailing cost of capital. Savers were also for the first time for many years able to earn a material return on cash deposits. The divergence was enhanced by the fact that 40% or so of the Company's holdings by value are in the UK. With 2023 seeing an underperformance in wider markets for the UK against the rest of the world, the Company's portfolio suffered from a 'double whammy' of focus on smaller stocks and the UK. Again, the Manager's Report sets out the relative underperformance of the UK, driven not by poor performance overall of the stock picks, but by a contraction in price to earnings ('p/e') multiples applied to the earnings, against a material expansion in p/e multiples in all other regions.

As is typical of cycles, the underperformance of both small cap and the UK will turn: eventually their relative good value will be hard to ignore. In the meantime patience is needed. The factors at work are the subject of frequent dialogue between the Company's board and the Manager: it is right to question the fundamental tenets of the investment strategy when there is underperformance. Part of this underperformance may result from a structural shift as an increased share of investment dollars is taken by index tracker funds, which do not invest in small and micro stocks. However, the board remains confident that the Company is operating in a sector of the capital markets, namely small cap technology and communications (in which there are more than 5,000 public companies globally) which is going to continue to prosper in the long run by comparison with many other sectors. The typical investor has few options to gain exposure to the sector on a global basis - for example there is no way to invest in that sector through an ETF - and the Company fulfils that requirement, with the added benefit of the Manager's proven investment process and stock picking skills. Similarly the Company plays a vital role in providing primary capital to companies especially in the UK. Because Herald is 'one of a kind', it is in a position to pick and choose the companies it will support, and as deal flow picks up, it will be the destination of choice for relevant companies wishing to raise equity capital.

The Company's performance in the various geographies is discussed in the Manager's Report. Although there was underperformance by some measures against the market in smaller companies in the UK, albeit not versus the AIM Technology sector, there was a strong outperformance in the US. Needless to say, over the longer term the Company compares very well on every measure.

On the income account, the Company itself benefitted from higher rates of interest receivable on its cash and near cash. However, with a deficit in revenue reserves, no dividend is payable.

The Manager details in its report that selling pressure in the Company's own shares has been the greatest in its history. Again this reflects a wider market phenomenon, driven largely by the changed interest rate background, with selling of investment company shares and redemptions from open-ended funds, both pretty universal and at an elevated level. In the case of UK investment companies, the position is not helped by certain regulatory challenges, most notably a perverse requirement to aggregate investment companies' charges (already discounted in share prices) with the wealth or fund manager's own costs. The practical effect has been to drive away what should be natural sources of demand for the Company's shares and deny the ultimate retail investor the opportunity to invest in a sector otherwise tailor-made for them. Hopefully 2024 will see sense prevail amongst the authorities.

The Company has entered 2024 with over £100m cash and near cash, representing some 8.5% of net asset value. Having avoided over-priced opportunities in recent years, this cash will allow the Company to take advantage of placings and perhaps IPOs at the more sensible valuation levels now prevailing. In that same time, as detailed in the Manager's Report, the Company has taken advantage of many takeover bids for its holdings, not unusually at 100% or more of the undisturbed price, and these have been the primary source of the Company's current liquidity.

The board is confident that long-term shareholders, who form the significant majority, will continue to be well served by the Company, and their investment aspirations of long-term growth will be fulfilled.

In December we welcomed Priya Guha MBE to the board. As detailed in the annual report, Ms Guha brings wide experience in the technology sector and a history of working across the UK private and public sectors. The latter is relevant for the Company, given the need for improvement at the regulatory level on a number of fronts to ensure a healthy market in smaller tech companies in the UK.

Karl Sternberg will not be standing for re-election at the forthcoming AGM, having served a nine year term. The board wish to record its appreciation for his many and varied valuable contributions since he joined the board in 2015, a period during which there have been many changes to the markets in which the Company operates, and which has seen the Company grow to become a constituent of the FTSE 250.

ANDREW JOY

Chairman

21 February 2024

Investment Manager's Report

It is a relief to report growth in the Company's net asset value per share of 5.7% thanks to a rally in the last two months of the year. In the technology sector the excitement has focused on artificial intelligence, which has fed through to strong demand, and even stronger share price performance, for a handful of stocks in this portfolio which have been significant enough to deliver a creditable performance for the Company in 2023. AI enthusiasm has been much more significant in the global large capitalisation technology indices.

Otherwise, sentiment has been dominated by the end of quantitative easing, and the normalisation of interest rates, and there has been an extraordinary divergence between the performance of larger companies and small ones. It is difficult to determine how much the small company underperformance has reflected expectations that smaller companies would be more challenged in the economic environment of higher interest rates and slower growth, and how much it reflects redemptions in smaller company funds which are the most significant investors on many small companies' share registers.

The table below shows the regional returns and highlights how badly the UK has done. However, the greater divergence is market capitalisation, where the returns for stocks below $3bn market capitalisation are much more comparable, and poor in all regions. The median market capitalisation in the UK is much smaller than North America and Asia. Most of the investments operate globally and are exposed to global demand, yet valuations and stock market dynamics are more regional.

At the start of the year, there were 22 holdings with a market capitalisation in excess of $3 billion, being an aggregate value of £226m, by the year-end, market movements took this to 39 companies with an aggregate value of £309m. The returns of these groups are as follows:

*IRR for year to 31 December 2023.

It appears to be more than just a cyclical divergence, but a structural change. There have been positive cash flows into index tracking funds, which do not invest in smaller companies, and when companies grow into the radar screen they benefit from a rerating. To a degree this has always been the case, but this effect seems more extreme now. Of greater concern is the withdrawal of investors from the smaller company public markets. In the US, this is reflected in companies scaling to a greater extent funded by venture capitalists, who in recent years have used an initial public offering as an exit rather than as a final round of development capital. In consequence, valuations have generally not attracted us. In the UK and Europe, IPOs are still used to raise development capital, because venture pockets are less deep, but in the last year the withdrawal of capital has meant the public markets have been virtually closed for primary capital raises apart from necessary secondary offerings, often at distressed valuations.

There have been noticeable areas of demand weakness in parts of our targeted sectors. In particular, there has been reduced demand for IT services, which seems to reflect a slowdown in capital expenditure associated with the higher cost of capital and a weaker advertising market. In addition, the high order backlogs associated with covid related supply issues have evaporated. A few investments have had their own particular challenges, but, in general, trading conditions have been benign. A greater effect on returns has been p/e multiple expansion and contraction.

Regional Price to Earnings

Source: Bloomberg. Analyst earnings estimates, where available, are aggregated using the Bloomberg weighted harmonic average calculation. This excludes loss-making companies from the P/E calculation. A weighted harmonic average will normally be lower than a geometric or arithmetic average.

On Bloomberg estimates, the forecast p/e has expanded materially in all regions except the UK. This implies that there have been material reductions in profit expectations in Asia and EMEA where multiple expansion far exceeds share price returns. In North America, the share price performance exceeds the multiple expansion implying rising profit expectations, whereas on average UK profit expectations have marginally slipped and valuations are a little lower. There is also of course the mid cap rerating which has had a greater effect in Asia and North America.

There have been fourteen takeovers announced during the year. There was a quiet patch reflecting economic uncertainty in the first half, and it is noticeable that twelve of these were announced in the second half. In contrast, we have not participated in any IPOs. This is the inevitable result of more sellers than buyers, largely due to redemptions from small company funds and professional managers moving up the size chain where there is more liquidity.

We have been quite surprised by the scale of net selling in Herald Investment Trust's own shares, which has resulted in a record level of buybacks (£107m) and a discount player accumulating a stake not dissimilar in size. Since launching the Company nearly thirty years ago, the scale of selling this year has been without parallel. Some of this will reflect investors switching into fixed income, some will be investors cautious about the global economy and UK smaller companies in particular, but we are also aware of some wealth managers removing all investment trusts from their recommended lists because of the cost disclosure requirements. At the IPO in 1994 our own investors were mainly pension funds and insurance companies. There was a rotation on the register from 2000-08 when these investors exited, reflecting regulatory and tax changes, and they were largely replaced by wealth managers. More recently, retail investors through platforms have appeared, and now represent over 15% of the register.

We fervently believe in the target mandate long-term and believe that specialist active management is required to provide capital intelligently for growing businesses. Having invested over £600m in primary capital, in spite of only ever raising £95m of outside capital ourselves and having delivered a total return of over 22x per share, we are well placed to continue this. However, a challenging 2024 seems likely as the bond markets are hungry for cash and fiscal deficits in the major economies must be reduced. It seems a discount to net assets is an appropriate compromise for short-term challenges and long-term opportunities. I observe that the investment trust sector as a whole has seen widening discounts and selling pressure, but open-ended funds have similarly seen outflows.

REGIONAL ALLOCATION CHANGES (STERLING THOUSANDS)

* Equities includes convertibles and warrants.

+ The total assets figure comprises assets less current liabilities.

UK

The UK remains the largest region, accounting for 40.5% of net assets in spite of our withdrawing over £200m in recent years. The return of -8.04% (Time Weighted Return - TWR) is disappointing relative to the Numis Smaller Companies plus AIM (ex. investment companies) Index total return returning 3.2%, but the return for the AIM Technology index has been considerably worse. In contrast, over 5 years the UK IRR is 45.3% versus the Numis index returning 24.0%, with technology companies having strongly outperformed the more general small-cap index during the coronavirus pandemic, but this trend partially reversing during the most recent year. There have been a small number of companies that have performed badly - notably Zoo Digital, Cirata, S4 Capital, IQE and Spirent. In aggregate they delivered a negative return of £35.2m during the year. However, collectively over the entire period of ownership they have yielded a positive return of £29.4m, reflecting significant profits that have already been realised. Only S4 Capital has delivered a cumulative negative return of £1.1m. Zoo Digital suffered from strikes in Hollywood, Cirata from the unwinding of fake orders, although fortunately sufficient profits had been taken for £1.9m profits to have been realised overall. IQE suffered from mobile phone destocking and share losses, while Spirent suffered from reduced telecom company capital expenditure, particularly in China. However, 84 other UK holdings also yielded a negative return despite underlying trading generally being adequate or better.

On a brighter note, in percentage terms the best performing stocks included a number of takeover approaches including SmartSpace, OnTheMarket, Sopheon and Smoove. Of note is that the premiums to the trading period prior to a bid were frequently in the region of 100%, demonstrating the value that lies in these small companies. Volex has been a marginal beneficiary of the AI boom. Trustpilot has been the only material addition to the portfolio and has contributed usefully.

There is no doubt that the UK public market is in a more fragile state than during any previous downturn in living memory. The question is whether this is cyclical or whether the damage is more structural. The UK public market is currently a fairly difficult environment for entrepreneurs to raise capital and I am saddened by how much management teams have been diluted by fund raisings at distressed levels. I believe that value in our portfolio will be realised through takeovers but that the costs incurred by listed companies in the UK, with the recent added burden of ESG and auditing requirements, has become too high to attract new companies. Similarly, the costs for managing small investments have increased considerably, with additional ESG and regulatory costs. Unfortunately, active investment management does not scale, and it is conspicuous that larger players have withdrawn and funds have shrunk. There are now too few players in the UK to have an efficient market, and too few co-investors. It is a pity because public markets have provided long-term risk capital for the benefit of the wider economy, but the skillset is disappearing rapidly. It seems the UK will inevitably shrink as a percentage of the Company's assets.

We are proud that cumulatively UK listed and AIM companies have delivered gains for the Company of £965.4m from total capital raised of £95m (£65m in 1994 and £30m in 1996), and that capital of £525.9m has been invested through IPOs and follow-on fund raisings, to directly finance small companies.

North America

The North American performance has excelled this year with a return of 31.06% (TWR). This compares to a sterling return of 21.0% for the Russell 2000® Technology Index. The star contributor was Super Micro Computer which returned 226.8% in 2023 and has now appreciated 1,935.2% over five years. Furthermore, the £55.5m return this year, and cumulative return of £74.8m, makes it the most profitable stock for the Company throughout history. It builds custom computers sourcing processors for Nvidia, AMD, Intel and others, and has benefitted from booming demand for artificial intelligence. Fabrinet, which is the leading contractor for fibre optic manufacturing has also benefitted from Nvidia demand, and Celestica has also been a strong performer rising 146.8%. Arlo Technologies has returned 156.0% and QuickLogic 154.5%, but they are smaller positions. It is worth noting that there are now 21 North American holdings which have grown to have market values in excess of $3bn, albeit we continue to limit buying to below that threshold. These 21 holdings returned £100.9m during the year, which exceeds the return of the whole North American portfolio. In other words the 75 holdings with a market capitalisation below $3bn delivered an IRR of -9.8%. These figures are of course distorted by the success bias. Nevertheless, the divergence is remarkable.

In a normal stock market cycle, returns should feed through to smaller companies. However, there is a structural change with so much cash flow feeding into index tracking funds leading to demand whatever the valuation. It reinforces our belief that we should focus on stocks below the index tracking momentum size, and benefit from the companies that grow into the radar screen and have the associated revaluation. The other factor is that venture capitalists have been floating companies at a later stage, with much of the growth already achieved, at valuations that seem uninteresting. Many of the IPOs in the 2020-2021 bull market are trading below and often materially below the IPO price and offer more appeal. Now that interest rates have normalised, there may be less capital available privately, and in order to get exits, companies may come to market at more realistic valuations. Furthermore, the later stage private equity houses will have less ability to use creative leveraged structures with tax advantages versus public companies. In 2023, the market has been closed to new issues, which is anomalous when the large technology indices have had a staggeringly good year (58.2% sterling total return on the Russell 1000® Technology Index). The market was knocked by the failure of Silicon Valley Bank, but gradually recovered confidence as the US economy has proved more resilient than many economists feared in the face of rising interest rates.

Europe Middle East and Africa

The overall return of 4.64% (TWR) is respectable in a difficult market for companies. However, the performance has been lifted by an outstanding return from the largest holding, BE Semiconductor, of 144.1%. It accounts for 21.6% of the EMEA portfolio at the year end. BE is a manufacturer of semiconductor packaging equipment. Smaller geometries and faster processing speeds have required innovative semiconductor packaging, which BE is continuing to develop. The rest of the portfolio has delivered a return of -11.7%. However, EQS, a listed German company, has risen over 50% following the announcement of an agreed takeover by Thoma Bravo, the US based private equity house. Somewhat surprisingly this takeover will be the fifteenth takeover of one of the Company's holdings by Thoma Bravo. The market value of EQS at the period end was c?400m, with the Company's stake being 2.6% of the outstanding shares. EQS struggled to raise the necessary capital in the public markets, with the Company being one of the few participants in the last funding round, and it has c?40m debt. In consequence management actively sought a buyer. This demonstrates that lack of capital is a feature across Europe, not just the UK.

Asia

Although the Asian return is 14.72% (TWR), markedly better than the UK and Europe, it is a little more disappointing in relative terms. The South Korean return for the year of 36.7% has been good and the Taiwanese return of 47.7% has been even better. However, these sparkling numbers have been offset by poor returns in Australia (-1.5%) and Japan (+1.5%). The latter is also the heaviest weighting, and the weakness of the Japanese Yen has not helped. By sector, technology hardware stocks (Bloomberg defined sector) which account for 36.8% of the Asian portfolio returned 46.8%. In contrast, software and technology services stocks, which account for a similar percentage weighting, returned -3.4%. Media only has an 8.3% weighting and returned -9.5%.

Sector Analysis

*IRR to 31 December 2023.

There has been a conspicuous divergence in performance between sectors. Technology hardware and semiconductors have done well, except in the small exposure in the UK. This sector has benefitted from expectations of an inventory restocking cyclical recovery and the artificial intelligence boom. It is not just hype. There is a conspicuous upturn in demand, and revenue and profits have exceeded expectations and forecasts have been raised in a number of companies in the hardware supply chain. Artificial intelligence in the long run is not about hardware. That is only the enabling technology. The effects of applications are so far less evident. Some investee companies have expressed optimism about efficiencies, particularly related to software development, while others have expressed initial concern about higher costs. For example, Microsoft's Office 365 Copilot AI product has been priced at £28/seat/month. The short-term winner is Microsoft and in due course there may be efficiency benefits. Many companies have already been using AI in software products that hardware improvements offer scope to improve further. Many new applications and markets will inevitably be developed which will be a driver for the sector in years to come.

In contrast, software and technology services have had a dull year returning -2.7%. In part, this reflects optimistic valuations, in part greater cost control in terms of licenses, and in part slower decision making on new investments. Unfortunately, this sector has the largest weighting and accounts for 40.7% of the total investment value. It delivered negative returns in every region except North America where the return was 11.6% versus 53.5% from technology hardware and semiconductors.

Media is the third segment, but only accounts for 13.5% of investments. Overall, it had a flat year. There is also a heavy UK bias. Poor performances by S4 Capital and Next15 were largely offset by gains on YouGov and Trustpilot late in the year when people realised the economy was not as adverse as feared.

Economic Background

Maintaining wealth, let alone creating wealth, will be a challenge in a world with so much government debt and in which fiscal deficits will have to be both funded and reduced. Money will be sucked into bond markets and consumers and businesses will be squeezed by higher tax. It seems obvious that good returns may only be achieved through growing markets, and that technology continues to evolve, and that innovation creates new markets offering more potential than other sectors. Entrepreneurial management can exploit these opportunities but need access to capital to do this. Equally growth will occur where people work for $2/hour and there is evident migration of labour-intensive manufacturing to countries like Indonesia and Vietnam. The outlook for Europe including the UK seems challenging because labour is too expensive for low-cost manufacturing and there is limited availability of capital.

The UK does have an innovative, creative entrepreneurial spirit and had already lost energy intensive industries prior to the Russia/Ukraine disruption of the energy markets, so does not have the headwind faced in other economies. The headwind of rising corporation tax and ESG costs in the UK will now be reflected in profit expectations, and other countries will probably follow with higher taxes. The trouble is that the UK stock market also seems broken, and unlikely to provide capital to emerging businesses, and therefore unlikely to provide the investment opportunities that it has in the past. Nevertheless, having capital in a capital constrained world will present opportunities. There is still world leadership in the media sector and the creative industries, but the semiconductor sector, which was so important in the development of the smartphone, has diminished. Key UK-developed technologies included the processor (Arm), the graphics processor (Imagination), audio (Wolfson) and Bluetooth (CSR). Arm has now gone public again on NASDAQ and Imagination seems to be considering a US IPO in 2024, but the US/China semiconductor politics complicates both the valuations and the prospects. New companies will emerge using artificial intelligence. Necessity may lead to Government policy that is more sympathetic to the wealth generating element of the economy. It seems to have been hostile or at least careless for this century to date.

China has driven growth through infrastructure investment and property. There are now too many empty dwellings and too much debt for this to provide growth in future. Wages are now too high for low-cost manufacturing, which is another headwind. The bright spot is that China is emerging as the leading electric vehicle manufacturer. This will be particularly challenging for the German automotive industry, which is not just losing an important export market, but facing a new competitor. The important German chemical industry is endangered by higher energy costs, and East German labour costs are no longer cheap. It seems possible that Germany will face the deindustrialisation that the UK experienced in the 1970s and 1980s.

North America has been the engine of growth in 2023, but this has been driven by extraordinary fiscal and trade deficits, and anomalously low fixed rate domestic mortgages. The technology sector has brilliantly scaled businesses and has had cheap capital to do this. The trouble is that salaries are too high for smaller emerging companies, and in the quoted world the reporting of adjusted earnings per share which excludes share based payments is quite deceitful, and unsustainable in valuation terms. San Francisco is troubled economically and socially, and the elevated pay there seems anomalous in a world of remote working. However, the US is leading the way in artificial intelligence, albeit with an Asian supply chain.

Developed Asia including Taiwan, South Korea and Japan has the most vibrant stock markets, and an enviable work ethic. It has to be the area of greater focus for this Company. The overhanging cloud is President Xi's ambitions towards Taiwan.

At the time of writing, the markets have taken the negative effect of conflicts in the Ukraine and Israel lightly. There could be an upside surprise from peace in these regions, but continued and even increased tensions seem more likely. This will drive increased defence spending, and investment in technology led defence solutions, not least in cybersecurity.

UK investors are acutely aware of the challenges faced by the UK economy following the explosion of Government spending and the high debt levels. It seems they are less aware that these challenges are faced in almost all developed counties. I fear they may move money to North America where valuations are high and the widespread use of adjusted earnings per share excluding share-based payments which is effectively understating both the costs of running a company and the price/earnings ratio. In the technology sector in particular share-based payments can be material. We are privileged to meet management teams around the world on a daily basis, and aware of the widespread challenges. The greatest concern is that the bond markets will force fiscal discipline, particularly in the United States, which will make global growth challenging. The key is to find strong management teams addressing growth markets to offset these headwinds.

Outlook

I suspect there will be more takeovers in the UK in particular. The US IPO market may open up if there is not an upset like the failure of Silicon Valley Bank in 2023. There are headwinds from corporate debt costs rising, trade tensions with China and elections with difficult choices in several countries. Although the macro environment is uncertain, we retain our belief in the growth prospects for the technology and communications sectors and that we will continue to discover entrepreneurial management teams that merit backing with the Company's capital.

Sector Performance

(Sterling Millions)

Source: BICS (Bloomberg Industry Classification Standard).

Katie Potts

21 February 2024

Classification of investments

* Source: Bloomberg Industry Classification Standard.

** Cash, current assets and liabilities.

Top 20 Equity Holdings

AS AT 31 DECEMBER 2023

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

STATEMENT OF COMPREHENSIVE INCOME

For the year ended 31 December 2023

There is no final dividend proposed (2022 - nil). More information on dividend distributions can be found in note 7.

The total column of this statement is the profit and loss account of the Company, prepared in accordance with UK Accounting Standards.

The profit/(loss) after taxation is the total comprehensive income and therefore no additional statement of comprehensive income is presented. The supplementary revenue and capital columns are presented for information purposes in accordance with the Statement of Recommended Practice issued by the Association of Investment Companies. All items in the above statement derive from continuing operations of the Company. No operations were acquired or discontinued in the year.

The notes form part of these financial statements.

STATEMENT OF FINANCIAL POSITION

At 31 December 2023

The financial statements of Herald Investment Trust plc (company registration number 02879728) were approved by the board of directors and authorised for issue on 21 February 2024 and signed on its behalf by

ANDREW JOY

CHAIRMAN

The notes form part of these financial statements.

STATEMENT OF CHANGES IN EQUITY

For the year ended 31 December 2023

For the year ended 31 December 2021

The notes form part of these financial statements.

STATEMENT OF CASH FLOWS

For the year ended 31 December 2023

Cash flow from operating activities includes interest received of £2,663,000 (2022 - £1,078,000) and dividends received of £12,235,000 (2022 - £12,924,000).

As the Company did not have any long term debt at both the current and prior year ends, no reconciliation of the net debt position is presented.

The notes form part of these financial statements.

INCOME

Included within dividend income are special dividends of £964,000 (2022 - £655,000).

Included within deposit interest is interest received of £1,598,000 (2022 - £449,000), and interest paid of £2,000 (2022 - £5,000).

STATUS

The Company is an investment company within the meaning of s833 of the Companies Act 2006 and operates as an investment trust in accordance with s1158 of the Corporation Tax Act 2010 as amended ('s1158'). The Company is subject to the Listing Rules of the Financial Conduct Authority and governed by its articles of association, amendments to which must be approved by shareholders by way of a special resolution. The Company obtained approval from HM Revenue and Customs of its status as an investment trust under s1158 and the directors are of the opinion that the Company has and continues to conduct its affairs in compliance with s1158 since this approval was granted.

BUSINESS MODEL

The Company has appointed Herald Investment Management Limited ('HIML') as the Alternative Investment Fund Manager to provide all portfolio management and risk management services. HIML is authorised and regulated by the Financial Conduct Authority both for investment management and as an Alternative Investment Fund Manager.

Administration of the Company and its investments has been delegated by HIML to the Bank of New York Mellon (International) Limited ('BNYMIL') and company secretarial duties have been delegated to Apex Listed Companies Services (UK) Limited ('Apex').

BNYMIL is the depositary under a tripartite agreement between HIML, the Company and BNYMIL. The depositary is also responsible for custody activities.

OBJECTIVE

The Company's objective is to achieve capital appreciation through investments in smaller quoted companies in the areas of telecommunications, multimedia and technology.

INVESTMENT POLICY - STRATEGY

?While the policy is global investment in smaller quoted companies in TMT, 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 $3bn at the point of purchase, there tends to be a correlation with the performance of smaller companies, as well as that 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.

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 permitted 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).

PRINCIPAL RISKS AND UNCERTAINTIES

The audit committee, on behalf of the board, regularly undertakes a robust assessment of the principal, including emerging, risks facing the Company. These include those that would threaten its business model, future performance, solvency or liquidity . Principal risks are also considered as part of the board's annual strategy meeting. The principal risks that follow are those identified by the board after taking account of mitigating factors.

All risks are documented on a risk register and are grouped into six main categories: strategic risk; market, economic and geopolitical risk; investment management risk; operational risk; emerging/external risk; and regulatory risk. Risks are rated by impact and likelihood of occurrence, with the ratings charted on two risk matrices: a pre-mitigation and a post-mitigation one. Mitigation takes into account processes, procedures and internal controls, and the post-mitigation matrix is used to identify the Company's principal risks. The risk register is reviewed on an ongoing basis, in an attempt to capture all risks and ensure appropriate mitigation is in place, and to enable directors to concentrate on principal risks whilst ensuring all risks are considered.

As part of the risk review, the board considered the challenging global economic and geopolitical environment including: the continuing effects of the Russia/Ukraine war, the Gaza/Israel conflict and the tensions between China/Taiwan and China/USA, with attendant global supply chain issues; and the risks from climate change. Inflation and interest rates were also discussed.

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.

The Company is exposed to counterparty credit risk from the parties with which it trades and will bear the risk of settlement default. Counterparty credit risk to the Company arises from transactions to purchase or sell investments held within the portfolio.

There were no past due nor impaired assets as of 31 December 2023 (2022 - nil).

The counterparties engaged with the Company are regulated entities and of high credit quality.

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. Further detail is contained in the strategic report in the annual report.

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. Listed 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 1(c)). These valuations represent the fair value of the investments.

Other Price Risk Sensitivity

13.1% of the Company's total equity investments at 31 December 2023 (2022 - 14.9%) were listed on the main list of the London Stock Exchange and a further 30.0% (2022 - 34.1%) on AIM. The NASDAQ Stock Exchange accounts for 24.4% (2022 - 21.5%), New York Stock Exchange for 5.4% (2022 - 3.6%) and other stock exchanges or unlisted 27.1% (2022 - 25.9%). A 10% increase in equity investment prices at 31 December 2023 would have increased total net assets and profit & loss after taxation by £113,987,000 (2022 - £114,687,000). A decrease of 10% would have the exact 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 bonds, the interest rate and maturity dates of which are detailed below. Interest is accrued on cash balances at a rate linked to the UK base rate.

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

FINANCIAL ASSETS

The benchmark rates which determine the interest payments received on cash balances are the Bank of England base rate, the European Central Bank rate and the United States Federal Reserve rate.

Interest rate risk sensitivity

(a) Cash

An increase of 100 basis points in interest rates as at 31 December 2023 would have a direct effect on net assets. Based on the position at 31 December 2023, over a full year, an increase of 100 basis points would have increased the profit & loss after taxation by £423,000 (2022 - £804,000) and would have increased the net asset value per share by 0.75p (2022 - 1.29p). 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 2023 would have decreased total net assets and profit & loss after taxation by £195,000 (2022 - £224,000) and would have decreased the net asset value per share by 0.35p (2022 - 0.36p). A decrease in bond yields would have had an equal and opposite effect. The loan stocks having an element of equity risk are not included in this analysis as given the nature of the businesses and the risk profile of their balance sheets; they are considered to have more equity like characteristics.

(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 Iin 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 2023

At 31 December 2022

Foreign currency risk sensitivity

At 31 December 2023, had sterling strengthened by 10% (2022 - 10%) in relation to all currencies, with all other variables held constant, total net assets and profit & loss after taxation would have decreased by the amounts shown below based on the balances denominated in foreign currency. A 10% (2022 - 10%) weakening of sterling against all currencies, with all other variables held constant, would have had the exact 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.

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 and for risk management purposes excluded from the credit risk analysis.

Credit Risk Exposure

The exposure to credit risk at 31 December was:

During the year the maximum exposure in fixed interest investments was £75,518,000 (2022 - £85,394,000) and the minimum £38,735,000 (2022 - £27,013,000). The maximum exposure in cash was £79,533,000 (2022 - £91,114,000) and the minimum £23,504,000 (2022 - £50,164,000).

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.

Equity Securities

The Company's unlisted investments are not readily realisable, but these only amount to 1.2% of the Company's total assets at 31 December 2023 (2022 - 1.1%).

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. 15.1% (£169 million) (2022 - 13.9% (£158 million)) of the listed equities in the portfolio are 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 2.7% (2022 - 2.4%).

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:

Fair Value of Financial Instruments

The company's investments, as disclosed in the Company's balance sheet, are valued at fair value.

Nearly all of the Company's portfolio of investments are disclosed in the Level 1 category as defined in FRS 102.

Categorisation is based on the lowest level input that is significant to the fair value measure in its entirety.

The three levels set out in FRS102 follow:

Level 1 - The unadjusted quoted price in an active market for identical assets or liabilities that the entity can access at the measurement date.

Level 2 - Inputs other than quoted prices included within Level 1 that are observable (i.e. developed using market data) for the asset or liability, either directly or indirectly.

Level 3 - Inputs are unobservable (i.e. for which market data is unavailable) for the asset or liability.

The investment manager considers observable data to be that market data that is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided by independent sources that are actively involved in the relevant market.

The analysis of the valuation basis for the financial instruments based on the hierarchy as at 31 December is as follows:

At 31 December 2023

At 31 December 2022

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

At 31 December 2023

VIABILITY STATEMENT

The directors' view of the Company's viability has not changed since last year. The Company, as an investment trust, is a collective investment vehicle designed and managed for the long term. The directors consider that three years is an appropriate forward-looking time period. This recognises the Company's current position, the investment strategy, which includes investment in smaller companies, some of which are early stage and for which a three-year horizon is a meaningful period over which to judge prospects, the board's assessment of the main risks that threaten the business model and the relatively fast-moving nature of the sectors in which the Company invests. Inevitably, investment in smaller and early-stage companies carries higher risks, both in terms of stock liquidity and longer-term business viability and this risk is accepted by the board as necessary to seek to deliver high returns.

There are no current plans to amend the investment strategy, which has delivered good investment performance for shareholders over many years and, the directors believe, should continue to do so. The investment strategy and its associated risks are kept under constant review by the board. The board undertook a robust assessment of the risks pertaining to the Company, including risks to the Company's viability, and this is set out in the principal risks and uncertainties section. This included emerging risks such as ongoing global tensions - for example the war in Ukraine, the conflict in Gaza and associated tensions in the Middle East, and tensions over Taiwan- and continuing negative growing effects of climate change. As part of this, the board considered several severe but plausible scenarios, including the impact of significant market movements.

Other items relevant in the directors' assessment of the Company's viability were: income and expenses projections and the expectation that the majority of the Company's investments comprise readily realisable securities as substantiated by liquidity analysis of the portfolio; any borrowing facilities in place - noting there were none at the year end; and the fact that as a closed ended investment company the Company is not affected by the liquidity issues of open-ended companies caused by large or unexpected redemptions. The board also takes account of the triennial shareholder vote on whether the Company should continue as an investment trust. At the AGM in April 2022, 99.99% of votes cast were in favour of continuation. The next continuation vote will be at the AGM to be held in 2025.

The directors confirm that, based on the above and on reviews conducted as part of the detailed internal controls and risk management processes set out in the annual report, they have a reasonable expectation that the Company will continue to maintain its status as an investment trust, to implement its investment strategy and to operate and be able to meet its liabilities as they fall due for at least the next three financial years.

On behalf of the board

ANDREW JOY

Chairman

21 February 2024

Statement of Directors' Responsibilities in respect of the financial statements

The directors are responsible for preparing the annual report and the financial statements in accordance with applicablelaw 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), including FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland". 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;

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

· prepare the financial statements on the going concern basis, unless it is inappropriate to assume that the Company will continue in business.

The directors are responsible for the keeping of adequate accounting records that are sufficient to show and explainthe Company's transactions and disclose with reasonable accuracy at any time the financial position of the Companyand enable them to ensure that the financial statements and the Directors' Remuneration Report comply with theCompanies Act 2006. They are also responsible for safeguarding the assets of the Company and hence for takingreasonable 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 ofthe Manager's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

The work carried out by the auditor does not involve any consideration of these matters and, accordingly, the auditor accepts no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the website. Each of the directors, whose names and functions are listed in 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 loss of the Company;

· the annual report and financial statements 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 and the Directors' Report contains those matters required to be disclosed by applicable law; and

· they consider that the annual report and financial statements, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company's position, performance, business model and strategy.

On behalf of the board

ANDREW JOY

Chairman

21 February 2024

Financial Information

This announcement does not constitute the Company's statutory accounts. The financial information for the year to 31 December 2023 is derived from the statutory accounts for 2023, which will be delivered to the Registrar of Companies. The auditor has reported on the 2023 accounts; their report was unqualified and did not include a statement under Section 498(2) or (3) of the Companies Act 2006.

The Annual Report for the year ended 31 December 2023 was approved on 21 February 2024. It will be made available on the Company's website at www.heralduk.com.

The Annual Report will be submitted to the National Storage Mechanism and will shortly be available for inspection at: https://data.fca.org.uk/#/nsm/nationalstoragemechanism

This announcement contains regulated information under the Disclosure Guidance and Transparency Rules of the FCA.

Annual General Meeting

The AGM will be held at 11.30am on 23 April 2024 at the Company's registered office, 10-11 Charterhouse Square,London, EC1M 6EE. The Investment Manager will provide an update on the investments and take questions after the formal business of the meeting. Members of the board will also be available to discuss the Company.

About Herald Investment Trust

Herald Investment Trust invests globally in the excellent opportunities available in the smaller quoted technology and communications sectors. The Company was established in 1994 and raised £65 million on launch and a further £30 million in 1996. No further capital has been raised. 

Since inception Herald has delivered a 22x NAV total return - with the NAV per share, on a total return basis, having compounded at an annualised rate of 11.0%. Herald has grown to become a constituent of the FTSE 250 index with total assets of approximately £1.1 billion. The Company is currently ungeared and has also returned in excess of £300 million to shareholders through share buy backs - a multiple of its original capital.

The Board believes that this outstanding performance is primarily attributable to the Company's distinctive investment strategy which is focused entirely on smaller quoted companies in the global technology and communications sectors. This strategy requires specialist expertise, an extensive network and sound investment judgement from the Investment Manager. Target companies within the Company's investible universe often receive very limited institutional investor participation, creating opportunities for the Investment Manager to find excellent companies at attractive valuations, and to support them as they grow.

HIT occupies a unique position as the only investment trust offering expert access to such a wide range of small and micro technology and communications stocks to both retail investors and institutions, and performs a vital (and very successful) role in enabling the returns from such companies to be shared by a wide range of investors.

Since inception, the Company has invested approximately £660 million of primary capital, of which over £500 million has been invested in UK listed and AIM companies. In addition to providing outstanding returns to shareholders, the Company's initial capital has been reinvested multiple times providing much needed capital to a growth sector of the UK economy, helping to build businesses, create skilled jobs and enhance the UK's productivity. Of the total profits of approximately £1.4 billion made by the Company since 1994, over £900 million is attributable to UK listed investments and AIM stocks.

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