City of London (CTY), the biggest UK equity income investment trust, is more than doubling its long-term debt with £50 million of new borrowing as it becomes the latest listed fund to take advantage of ultra-low interest rates.
Although both UK and US interest are set to rise slowly from their post-financial crisis lows, investment trusts and investment companies can still secure very attractive loan rates.
The ability to borrow and 'gear' a portfolio is a key advantage investment trusts have over open-ended investment companies and is one reason why their long-term returns tend to be better.
City of London, a £1.4 billion flagship of Janus Henderson managed by Job Curtis, is borrowing the additional £50 million at a fixed interest rate of 2.94% for 32 years.
The blue chip fund yields 4% and last year was the first investment trust to achieve the landmark of 50 years of unbroken dividend payments. In the past 10 years it has provided shareholders with a total return, including dividends, of nearly 116%, just below its sector average of 116.5%, according to AIC data.
It is issuing a series of secured, fixed rate notes to institutional investors to whom it will pay two coupons a year. It will access the money from 17 November with the loans to be repaid in 2049.
In a stock exchange announcement the company said the loans would ‘secure fixed-rate, long-dated sterling-denominated financing at a pricing level the company considers attractive’.
The refinancing comes as City of London's two existing, more expensive long-term loans, or debentures, come up for repayment in a few years' time.
A spokeswoman said the new borrowing was not ‘a direct end-to-end replacement’ for the £10 million, 10.25% debenture maturing in 2020 and the larger £30 million 8.5% loan ending in 2021. This suggests it might use the money to repay the short-term debt on its £120 million credit facility with HSBC bank. Last year's annual report revealed it drew down £26 million on this.
City of London's borrowing currently stands at 8% of net assets, broadly in line with other UK equity income trusts though up slightly from 6.7% at the start of the year.
Gearing can boost long-term returns but makes trusts' share prices more volatile, exacerbating rises and falls in the stock market.
Like other trusts, the maximum level of gearing allowed by City of London is 20% of net asset value. It can also use FTSE 100 index futures to vary its gearing up and down.
‘The new loan money does not come in until 17 November so as yet has not affected the current gearing level of 8%,’ the spokeswoman said.
City of London's new loan is not quite as cheap as the £30 million borrowed by Witan (WTAN) last month, when the global multi-manager fund revealed it was paying a fixed rate of just 2.74% over 37 years.
This year Scottish Mortgage (SMT), managed by Baillie Gifford’s James Anderson and Tom Slater, raised £125 million through issuing long-term debt with an interest rate of just over 3%.
Troy Income & Growth (TIGT), managed by Francis Brooke, also arranged a two-year credit facility of £20 million with ING Luxembourg bank, paying an interest rate of just 0.9% over Libor, the inter-bank lending rate currently set at 1.16%. It said it would not draw on this straight away but use it on a ‘tactical basis’.
At the end of last year Lowland (LWI), managed by Curtis' colleague James Henderson, issued £30 million of private 20-year debt fixed at 3.15%, using the proceeds to repay a short-term bank debt.
City of London shares stand at just over 420p today at a 2% premium over their estimated net asset value per share of 411.7p, according to Morningstar. The shares have returned 6.8% so far this year, just ahead of the FTSE All-Share's 6.2% gain.