A cheap way to invest in British technology stocks

Last week, I wrote that most investment trusts are getting rather expensive-looking. It’s partly due to the rising market, and partly because they’ve become more popular – the ban on commission payments means financial advisers no longer have any reason to favour unit trusts over investment trusts.

But there are a few cheap trusts left – and I’ve just found one that’s both cheap and attractive.

One of the big attractions of an investment trust is that you can – if you’re lucky – buy the trust itself for a lot less than the value of its underlying portfolio.

This opportunity arises from the fact that investment trusts are listed on the stock market. This means their share prices move independently of their portfolios.

When the share price is lower than its net asset value, it’s trading at a ‘discount.’ Right now, the average investment trust discount is a measly 3%. But the trust I’m highlighting today has a 13% discount – in other words, you’re getting £1 of assets for less than 90p…

A long-term technology sector survivor

So what is this trust, and why is it cheap?

I’m talking about arguably the best technology investment trust in London – the Herald Investment Trust (LSE: HRI).

The trust’s share price has gone up by 680% since it was founded 20 years ago, and it’s up 294% over the last five years alone. That compares very well to the benchmark FTSE World index which has risen by just 97% since 2009.

The trust has also had the same manager – Katie Potts – for the last 20 years, which is a reassuring sign; she is a true technology specialist with an excellent reputation.

Potts is not in the business of lazily tracking her sector. If you’re looking to buy the big tech giants such as Google, Microsoft and Apple, this probably isn’t the fund for you. She prefers to focus on smaller technology companies that have greater growth potential.

Indeed, Potts recently told one interviewer that she likes to invest in companies “where the downside is 100% and the upside is 1,000%”. In other words, she’s prepared to accept significant risk that a company in her portfolio might go bust if it also has the potential to be a ‘ten-bagger’ if things go well.

To my mind, this is the only sort of active fund management you should ever be willing to pay for. A manager with a decent record who actually uses all their supposed expertise to dig into a sector, take big bets, and stick their neck out.

So if the fund is so good, why is it trading on a 13% discount, when the average trust is only on a 3% discount?

Well, Herald’s discount has been relatively high for pretty much the whole of the last five years. I suspect the main reason for this is that it holds a lot of small, relatively illiquid stocks in the portfolio.

In other words, if the Herald Investment Trust was wound up in a hurry and all the stocks sold, the trust might have to sell some of the stocks at low prices in order to get rid of them quickly.

But that seems pretty unlikely to me. Potts successfully navigated the dotcom crash in the early noughties, as well as the 2008 credit crunch. Those were pretty brutal, so the trust should be able to survive any future crisis that awaits us.

The UK might be where the best value tech stocks are to be found

The size of the discount wasn’t the only thing that surprised me about the Herald trust. You often hear pundits complain about how small Britain’s technology sector is compared to the US. Yet a full 65% of Potts’ fund is invested in UK-listed stocks.

There’s nothing in trust’s remit that restricts it to the UK. The fund is free to invest in any small technology or communications company in any part of the world.

In the interview I mentioned earlier, Potts justifies the UK slant on two grounds.

Firstly, she thinks that by and large, Asian technology companies aren’t terribly attractive. They’re just manufacturing technology products cheaply for Western companies that have developed the technology.

As for the US, Potts feels that valuations are often too high. So the UK is a great place for her to find tech bargains.

Looking at the trust’s portfolio, one of the biggest UK holdings is Diploma (LSE: DPLM). This very successful company supplies a wide range of technical products, including seals, controls and life science products.

A big chunk of the life science products are for healthcare research. So that part of the business is pretty resilient regardless of economic conditions. The controls division, meanwhile, supplies wires and other products to the defence and aerospace industries.

Diploma has a great track record of earnings growth and strong cash generation. Admittedly, on 22 times earnings, it doesn’t look mega-cheap, but it’s one to keep an eye on.

A long-standing member of the portfolio is Imagination Technologies (LSE:IMG), a chip designer that has relationships with the likes of Apple and Google. The shares tumbled last summer after a profit warning, which was triggered by the fact that some of Imagination’s customers – including Texas Instruments – were leaving the smartphone market.

However, Imagination still has a good relationship with Apple. So if you think Apple is going to maintain a strong position in smartphones, Imagination will probably be a decent performer over the medium term.

Overall, I’d say that if you’re looking for a good way into the more interesting, and less over-hyped parts of the tech sector, Potts’ trust is one of the best choices right now.

Oh, and if this sector appeals to you, the cover story in the next issue of MoneyWeek magazine is all about the latest big trend in the technology sector – ‘immersive tech’. If you’re not already a subscriber, you can subscribe to MoneyWeek magazine.

● And if you and five friends would like to attend a champagne reception followed by a three-course dinner with Merryn Somerset Webb, MoneyWeek’s editor in chief, you can place your bid here. It’s all for an excellent cause – an appeal in aid of World Child Cancer.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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