Beyond the AI headlines: A Q+A with Katie Potts

Katie Potts, Lead Manager of Herald Investment Trust, discusses opportunities among smaller companies and across the broader technology sector.

Beyond the AI headlines: A Q+A with Katie Potts



How have you observed opportunities in AI evolve over the past year?

Data centre capital spending has surged, pushing demand higher and straining supply chains, particularly for memory. More significant for HIT has been the performance of several smaller portfolio companies that supply data-centre components. Share prices moved sharply: during the second quarter alone, our 20 largest AI-related holdings gained an average of 99%, then gave back roughly 25% in Q3. The excess optimism was clear by the end of Q2, so we cut those positions aggressively; the proceeds helped fund the Trusts tender offer in July. AI model advances and better software-development tools have also shaken up the software industry. Many software companies, though, are using AI to improve existing products, develop new ones, and work more efficiently. That makes selectivity essential: we need to identify which companies can gain from AI over the long term. Software stocks fell sharply in Q1 as investors feared homegrown AI tools would replace them. That concern looks overstated, and valuations now offer far more attractive entry points for carefully chosen investments. 2. How are smaller companies adopting AI and benefiting from it?
Smaller businesses benefit from the capex boom, but they also have another advantage: decisions travel through fewer layers, and entrepreneurial managers can move quickly. Many have already adopted AI to cut internal workloads, speed up software development, automate processes, support customers, and improve their products. The technology remains at an early stage of practical use, so further development could create attractive investment opportunities. Entry costs have fallen, too. Rather than buying their own processing capacity, storage, and applications, smaller companies can rent them from data centres, avoiding much of the capital spending that once stood in the way. 3. Are valuations more compelling for smaller technology companies than larger ones?

Over the past few years, investors have directed most of their attention and capital toward a relatively small group of large technology companies. Microsoft, Alphabet and Amazon, for example, have recurring revenue and wide profit margins that support their valuations. Semiconductor companies have also been rerated to high levels, while some larger software businesses trade at excessive valuations because investors do not see them as vulnerable to AI substitution. This year, though, the market has started to recognise the scale of AI infrastructure investment and the benefits reaching smaller companies throughout the supply chain. Performance has broadened, and smaller technology companies have begun to outperform their larger peers. Index trackers have reinforced the gap: companies with market capitalisations large enough to draw index flows generally command higher valuations. Meanwhile, small-cap funds have faced withdrawals, especially in North America and the UK, where valuations look more appealing. 4. What percentage of the Trust's holdings are private, and what opportunities are you seeing in private markets?
The Trust does not invest in private companies. 5. Which non-AI technology areas does the Trust invest in?

AI is just one part of the opportunity set. We invest in markets with long-term structural growth, from digital transformation and automation to cybersecurity and defence tech. Software remains another focus, especially companies built into critical workflows and supported by proprietary data. The portfolio is actively managed, giving investors diversified exposure across technology. We set position sizes and portfolio weightings from the bottom up. Subsector exposure is monitored, but it does not determine where capital is allocated. About 25% of the portfolio has direct AI exposure; many of those companies generate revenue from other sources and do not depend solely on the data-centre build-out. 6. What is the geographic balance in the Trust? Do you find more sources of growth in particular markets?

The Trust gives investors access to technology growth across international markets. Where a company is domiciled or listed generally makes little difference, since technology stocks compete within the same global marketplace. UK exposure has dropped from more than 60% of NAV at the end of 2017 to roughly 20% today, as the available opportunities have narrowed. Many UK-listed companies have been acquired or taken private, while too few IPOs have emerged to replace them. Asia now accounts for about 20%: companies there have moved higher up the technology value chain and benefited most from the surge in AI-related capital spending. North America remains the Trust's largest regional exposure, at around 32%, reflecting the market's broad range of opportunities. Manufacturing has shifted to Asia, much as it has in the UK, yet several North American-listed companies with Asian subsidiaries have worked in our favour. US-focused software and media stocks have also been sluggish, echoing the UK market, though their valuations now look more attractive. 7. How do you source your ideas?
We meet management teams from companies around the world, many of which sell to, buy from, or compete with one another. Over time, those conversations give us a broad network of industry contacts and a connected view of the businesses we follow. New positions usually come from overseas conferences, industry events, broker research, or our search for companies with strong growth prospects at attractive valuations. IPOs mattered more in the past; now that cash withdrawals have increased, takeovers are more common. Our sector focus lets us compare what management teams tell us across different parts of the technology supply chain and across regions, which helps us test their claims and spot emerging themes. 8. Can you give two or three examples that bring your portfolio to life?

Silicon Motion designs controllers for solid-state storage and operates as a fabless semiconductor company. We first invested in 2006, when its market value was below US£500 million and the shares traded at a low earnings multiple. Since then, its end markets have changed, and demand from datacentres and AI infrastructure has added to the growth. The investment reflects the benefit of recognizing a strong business early and holding it patiently. BizLink makes cables and connectors for specialist applications. We first met its management in 2015, then waited until 2024 to invest, when the valuation matched the company's exposure to high-performance computing. Sometimes that means tracking a business for years before buying it. Trustpilot, an online review platform, is one of the few relatively new holdings in the UK. After it listed in London in March 2021, we met management and were drawn to its subscription model, network effects, and high gross margins. We decided not to participate because the valuation was too high. Within a year, the shares had dropped by about 50%, prompting us to establish a holding. Since then, the business has expanded into new geographies, become profitable, and begun generating cash. These examples reflect the portfolio's range and the shared approach behind it: specialist research, disciplined valuation, and patience. Investment Objective:
To seek capital growth by investing in smaller listed companies involved in technology and communications. Investments may be made worldwide.

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