/ GEARING & DISCOUNTS /
SUPER-SIZE ME !
Daniel Lanyon looks at two powerful techniques for pumping up your investment trust returns
M ORE THAN 400
YEARS AFTER POLONIUS TOLD HIS SON LAERTES “ neither a borrower nor a lender be ” in William Shakespeare ’ s Hamlet , closed-ended fund managers – particularly those with a high conviction – don ’ t seem to have received the message .
Unlike the more “ vanilla ” openended funds , investment trusts offer two potential routes for investors to ratchet up their long-term returns , the most important of which is gearing . This is the process by which the managers of these vehicles can borrow money and invest it on behalf of their shareholders , thereby increasing returns .
The flipside is that it will also increase losses if the market tanks or their investments fail – meaning greater volatility is a natural byproduct of this process .
JP Morgan Asset Management ’ s head of investment trusts Simon Crinage says gearing is one of the most important tools available to closed-ended funds in terms of giving them an edge over their open-ended counterparts . Simon Evan-Cook , a fund manager in the multi-asset team at Premier , agrees with him : “ If your tradesman is skilled , then a sharper tool is exactly what you ’ d want him to have ,” he says . “ But if he isn ’ t , he can cause an awful lot of damage with it . So it ’ s very important to understand what the trust is , who is managing it and what they ’ re trying to do .”
Historically , investment trusts have tended to apply only a modest level of gearing – the figure across the AIC universe currently stands at around 10 per cent – but Crinage says this trend is shifting .
“ With interest rates still at , or near , historic lows , many investment trusts are looking at their gearing arrangements and are considering locking in these rates for the longer term ,” he explains .
For some trusts , the rate is much , much higher : JPMorgan Income & Capital is the most geared trust in the AIC universe at 140 per cent , which includes zero dividend preference shares ( meaning the income from these shares goes to the trust rather than their holders ), all prior charges ( anyone who is entitled to the money before the shareholder ) and an overdraft of approximately £ 2m .
ONE OR THE OTHER There are two main types of gearing . Structural gearing , where a trust is permanently geared , and tactical gearing , where the manager increases or decreases this measure according to their view on the market .
A short-term revolving credit facility or overdraft-type lending is the more standard type of gearing , offering flexibility for the manager to tilt the portfolio defensively or aggressively depending on opportunities – in other words , 20 per cent bank debt allows the manager to invest 120 per cent in the market if they feel confident – alternatively , they can pay it back if they aren ’ t .
Rob Morgan , pension and investment analyst at Charles Stanley Direct , says he is generally in favour of more long-term structural gearing so long as it is done in a sensible way and at a low cost to investors . He adds this is often the reason why investment trusts outperform open-ended funds over the long term .
“ Tactical gearing can be used to good effect too , but as an investor you are not so sure what you are getting – plus there is no guarantee a manager will make the right call on the market – so I would be more cautious . It is a good indicator of conviction , though , probably better than how much they have invested which often just stays the same .”
Morgan says that Mark Barnett ’ s Perpetual Income and Growth Investment Trust offers a good example of where gearing has been used successfully .
“ Structural gearing and good stock selection have enhanced both the trust ’ s capital growth and its ability to generate income ,” he adds . The trust is currently 17 per cent geared .
trustnetdirect . com 3