From revenue reserves to gearing, the mechanics that separate investment trusts from open-ended funds are fairly well discussed. But it’s good to remember both that investment managers use these tools differently and no strategy is static.
So it should be with gearing. Given that borrowing can amplify both good and bad returns, you would generally expect a manager to use more gearing when they think future portfolio gains are more likely and lower levels if they are feeling cautious.
This may well influence your own fund choices. Investors who expect more of the big gains seen in markets such as the UK in the last half year, for example, may want a manager to put money where their mouth is via gearing. Those who now feel a need for prudence may expect managers to ease off.
This begs the question of how much debt managers are currently putting to work. When we looked at the most heavily geared equity trusts in June 2020, the list was dominated by UK portfolios betting big on an unloved market. How heavily geared are those trusts now?
A short answer might be “less than before”. Chelverton UK Dividend (SDV), which can have higher gearing than most because of its zero preference shares, has seen its gearing level fall from 55 per cent in June last year to 32 per cent on 21 May 2021, Association of Investment Companies (AIC) figures show. The gearing figure for Law Debenture Corporation (LWDB) has dropped from 26 per cent to 17 per cent, while Merchants Trust (MRCH), Mercantile (MRC), Lowland (LWI), Aberdeen Standard Equity Income (ASEI), Invesco Select Trust (IVPU), Dunedin Income Growth (DIG) and City of London Investment Trust (CTY) all have lower levels of gearing than they did in June 2020.
Given the enormous gains in the UK market, it is perhaps unsurprising that some of last year’s more bullishly positioned managers have eased off the gas slightly. But the word “slightly” is important: many only have a little less gearing now.
Six of the names discussed still seem to have double-digit levels of gearing. One other UK name included in June’s analysis, JPMorgan Claverhouse (JCH), has seen its gearing rise from 14 to 20 per cent. Elsewhere, BlackRock Throgmorton Trust (THRG), which did not feature in last year’s list of most heavily geared equity trusts, recently had gearing of 23 per cent.
Such bold approaches are hard to find in most other mainstream equity sectors, but a few names do stand out. The value-oriented global equity fund Scottish Investment Trust (SCIN) recently had gearing of 12 per cent, according to AIC statistics. A handful of global equity income names including Majedie Investments (MAJE) also had reasonably high levels of gearing, as did regional plays such as Utilico Emerging Markets (UEM) and Fidelity European Trust (FEV). As in our June analysis, a number of Japanese equity trusts were highly geared. Names such as Fidelity Japan (FJV) and CC Japan Income & Growth (CCJI) only appear to have upped the ante on this front since.
As with any analysis using a single metric, I should stress that gearing alone does not make or break the case for holding a trust. But it can have an important effect on returns, while big shifts can provide hints about a manager's mindset.
