Hargreave Hale AIM VCT 2 plc : Interim Management Statement

Investment Manager's Report

This report covers the first quarter of the 2017/18 financial year, 1 March 2017 to 31 May 2017.

Investment Report

Global equity markets had a strong quarter on the back of positive economic data.  President Trump's promises to cut taxes and reduce business regulations were well received by US equity markets, which hit new highs. In the UK, the Bank of England put through a small upgrade to their projections for economic growth this year, principally because of stronger than expected consumer spending, although we have since witnessed some signs of consumer retrenchment in the face of higher inflation and decreases in real wage growth. 

Despite posting large gains, UK equity markets were volatile over the period as investors responded to the uncertain economic outlook and political instability within the UK. As is the way these days, each quarter brings with it new challenges and risks. Brexit chat is not a regular feature in our company meetings beyond the implications of weakness in Sterling, although we expect it to re-emerge as a talking point once we get a better feel for the mechanics and implications of our exit from the European Union.  We remain cautious on certain sectors such as financials and consumer discretionary; however, we still see ample opportunity for growth within our investee companies, particularly those with strong product differentiation and/or structural growth in their end markets.  Weaker companies are vulnerable, particularly those in consumer discretionary, traditional retail or where there is a high risk of substitution.  We continue to find interesting investment opportunities in qualifying companies.

Performance

In the three months to 31 May 2017, the NAV increased from 109.86p to 119.58p. No dividends were paid, giving investors a total return of 9.72 pence per share, which translates to a gain of 8.9%. During the same period the FTSE AIM All-Share Total Return gained 9.9% and the FTSE 100 Total Return gained 4.7%.

The qualifying investments made a net contribution of 4.94 pence per share with thirty-two out of the seventy-five making gains, ten marking time and thirty-three losing ground. The balance was a mixture of non-qualifying portfolio gains, costs, income and small gains made through share buy backs.

ECSC was the top performing qualifying investment (+142.9%, +1.00 pence per share). The company operates as a cyber security consultant and managed services provider. After floating in December 2016, the shares rallied hard as investors sought exposure to a sector that is expected to benefit from new UK legislation to be introduced next year.  Interest was further boosted by a series of high profile cyber-attacks that further highlighted the potential consequences of an attack.  The rally took the shares considerably beyond fair value, triggering a series of disposals that significantly reduced our exposure. Management have since announced downward revisions to their 2017 revenue projections, which have now pushed the shares back towards IPO price. Faron Pharma (+120.3%, +0.86 pence per share) performed very well following a positive update in May that confirmed their continued progress towards the conclusion of its Phase 3 clinical programme for Traumakine. We expect an update later this year.  Having added to our position in February, we decided to lock in some profit as the valuation increasingly looked to price in a successful outcome ahead of publication of the trial data.  Eagle Eye (+123.3%, +0.75 pence per share) and Hardide (+78.9%, +0.75 pence per share) also performed well.

The biggest losses within the period came from DP Poland (-17.0%, -0.38 pence per share) which saw its shares slide gradually lower. The shares have had a remarkable run and we do not believe there is anything structurally wrong with the investment. The company raised £5m in June 2017 and recently reported trading in-line with management expectations with 17% growth in like-for-like system sales. Other losses came from Medaphor (-40.0%, -0.13 pence per share), Paragon Entertainment (-23.8%, -0.12 pence per share) and Creo (-7.8%, -0.12 pence per share).  Medaphor is still dealing with the fallout from a US patent dispute (resolved in Dec 16); Paragon and Creo continue to progress in line with our expectations.

We made six qualifying investments over the period, which included three additional investments into existing qualifying companies (one private) and three IPOs. We invested a total of £2.2m into qualifying investments over the quarter.

Following strong runs, we reduced the size of our investments in ECSC, Faron Pharma, and Gfinity. Due to persistent poor performance, we exited investments in Directa Plus, Haydale Graphene and Audioboom.

Portfolio Structure

The VCT is comfortably through the HMRC defined investment test and ended the period at 86.75% invested as measured by the HMRC investment test. By market value, the VCT had a 47.8% weighting to qualifying investments.

The allocation to non-qualifying equity investments increased marginally from 20.6% to 22.0%, representing the funds on-going participation in non-qualifying equity investments. In line with the investment policy, we continued to make use of the Marlborough Special Situations Fund as a temporary home for proceeds from fundraising. The allocation marginally increased from 12.0% to 15.2% this year. We are pleased to report that the non-qualifying investments contributed +5.12 pence per share to the overall gains. Fixed income as a percentage of the fund fell from 0.4% to 0.3% and cash fell from 20.3 to 15.1%.

The HMRC investment tests are set out in Chapter 3 of Part 6 Income Tax Act 2007, which should be read in conjunction with this section of the interim management statement. Funds raised by VCTs are first included in the investment tests from the start of the accounting period containing the third anniversary of the date on which the funds were raised. Therefore, the allocation of qualifying investments as defined by the legislation can be different to the portfolio weighting as measured by market value relative to the net assets of the VCT.

Buybacks

In total, 279,206 ordinary shares were purchased between 1 March 2017 and 31 May 2017, at a total value of £306,132. Since the period end, a further 89,267 ordinary shares were purchased at a total value of £100,343.

Dividends

There were no dividends paid out in the 3 months to 31 May 2017, a final dividend of 4 pence per ordinary share was paid on 25 July 2017.

Post Period End Update

Deal flow has been strong since period end with five additional qualifying investment made in DP Poland, Gousto, Honest Brew, Imaginatik and Surface Transforms.  We have executed an investment agreement for another investment with completion delayed pending HMRC advanced assurance.  We have several other deals that may complete in the coming weeks.

For further information please contact:

Date: 28 July 2017