The most highly geared investment trusts

Fund managers could be forgiven for acting with a degree of caution following the January sell off and the prospect of monetary tightening (see Lessons from the sell-off, IC 04.02.22). But several offer a way to double down on sectors and regions that seem appealing amid the volatility.

Investment trusts that are borrowing money to gear up their portfolios are a case in point. Once again, as we reported last year ('The most heavily geared investment trusts', IC, 28.0.21) and in 2020 ('Top gear: how equity investment trusts are using borrowing', IC, 26.06.20), certain trusts are increasing their borrowings in a bid to take advantage of a potential market rebound, and others are sticking with the high levels of gearing that they have had in place for several years.

As usual, we would caution that a trust’s level of gearing is just one metric and no substitute for a well-researched investment case. But our list of sewlected trusts with high amounts of gearing shows aggressive ways to play appealing markets. That said, some trusts with high stated levels of gearing are excluded from our list because they take a different approach to their sector peers or the gearing is part of the trust’s structure rather than an indication that its manager has made a bullish call.

Special situations

While it tends to come with higher risk and greater volatility, gearing can pay off richly if a trust's assets are due a resurgence. So it’s interesting to see that some investment trusts which took a battering last year appear in the list.

A standout among equity investment trusts in this respect was Fidelity China Special Situations (FCSS) which had gearing of 24 per cent on 10 February, according to the Association of Investment Companies (AIC). Like other China funds, the trust struggled amid the regulatory blitz of 2021, and its manager Dale Nicholls has been attempting to navigate that environment and pick out bargains.

Investors interested in this trust’s approach would do well to read a stockmarket update released by the trust on 25 November, spelling out Nicholls’ thoughts at the time. He noted that the trust’s level of net gearing had risen as a result of adding to long equity positions and closing some short positions - betting on the price of an asset falling. Also, at the time, big portfolio moves included reducing exposure to the consumer discretionary sector predominantly because of high valuations, and upping exposure to the materials and industrials sectors. Nicholls said that “the thesis around industry consolidation in areas like building materials remains very much in place,” though he did cut back some positions because of concerns about a residential property slowdown.

In the financials space, he remains upbeat on the outlook for life insurance companies and has invested in Postal Savings Bank of China (HK:1658) – despite a broader underweight position in the banking sector. Perhaps more interestingly, given the composition of Chinese, Asian and emerging market indices, the manager added that the risk/reward payoff in the tech sector was “tipping much more in our favour in these companies” following last year's sell-off. “While there is still risk of new regulation, as we think about what could come next, there is a good chance that we are near or close to a peak in terms of news flow,” he explained.

JPMorgan China Growth & Income (JCGI), meanwhile, had gearing of 18 per cent at the time of writing according to the AIC. In the trust’s final results for the year ended 30 September 2021, released in December 2021, its managers declared that they would stick to a growth oriented strategy and maintain their original sector preferences. As of 30 September, the trust’s biggest overweight allocations were in information technology, healthcare and industrials, and key holdings still include Tencent (HK:700), WuXi Biologics (HK:2269), Meituan (HK:3690), Pinduoduo (US:PDD) and Alibaba (HK:9988). Its managers added that the automation and digitalisation of Chinese companies remained a major investment theme.

By contrast, Baillie Gifford China Growth Trust (BGCG) and the recently repurposed abrdn China Investment Company (ACIC) have little to no gearing.

Hopes of a comeback

A handful of investment trusts in other beaten up sectors are levering up. International Biotechnology Trust (IBT), whose gearing came to 18 per cent, has been caught up in a fierce sell-off for the broader health sector and its shares are down 17.5 per cent over the year to 11 February.

Highly geared trusts can be found in a few other investment trust sectors and include abrdn Latin American Income Fund (ALAI) which had gearing of 15 per cent as of 10 February, and has struggled relative to regional equity indices in recent years.

But many of the usual suspects still top our chart. A number of UK equity trusts have high levels of gearing, from small and mid cap play BlackRock Throgmorton Trust (THRG) to income fund JPMorgan Claverhouse Investment Trust (JCH) and Mercantile Investment Trust (MRC).

These names are not alone, with various UK trusts running double-digit levels of gearing. But the extent of this levering up is not out of sync with the levels of recent years.

Some commentaries and disclosures can be more revealing than others, as is the case with Fidelity China Special Situations and BlackRock Throgmorton, both of which can take short positions.

BlackRock Throgmorton’s results for the year to 30 November 2021, published in early February, noted that a net market exposure of around 118 per cent was still “comfortably above the long-term average”, though the figure had come down very slightly as the trust entered more short positions.

Its manager Dan Whitestone argued: “The rising tide of the stock market has lifted the valuations of many companies with unattractive business models that continue to face long-term structural pressures, and where more recently the twin headwinds of cost inflation and supply challenges create additional difficulties for such low margin ‘undifferentiated’ companies with limited price power.” He also took some short positions in companies he believed had ‘over traded’ through 2020 and which were subsequently seeing a sharp reversal of trading patterns not current reflected in analyst forecasts.

Finally, some Japan equity trusts, such as Fidelity Japan Trust (FJV) and CC Japan Income & Growth Trust (CCJI), have high levels of gearing. But this is in line with our findings of recent years.