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Top 10 geared investment trusts
With markets swinging back and forth we look at which investment trusts have the highest level of borrowing, or gearing.
One of the big advantages of investment trusts over 'open-ended' funds such as unit trusts is the ability they have to 'gear up', or borrow to invest more money on behalf of investors.
However, this advantage can be double edged. Although gearing can accelerate returns in a rising stock market, it can also magnify losses when investments are falling.
With markets volatile as a result of the uncertainty over the eurozone debt crisis, Iain Scouller, investment trust analyst at Oriel Securities, has drawn up a list of trusts with the highest levels of gearing.
Scouller says: ‘Investors need to be aware of high levels of debt. It could have a negative effect if you see a correction in the equity market.
‘If you have 20% leverage in a trust, you’d expect the impact to be magnified. Then again, we could get some good news from the eurozone, which would push the markets higher and give a good result for the trusts.’
Another aspect of leverage that investors should consider is the rate and term at which the debt was issued. Some trusts have long-standing debt, locking them into a higher interest rate then if they were borrowing the money today.
Scouller explains: ‘Some trusts have long-term debentures [secured loans], such as Merchants and Edinburgh investment trusts. The problem is they have debentures, which run for about 30 years and they may be 20 years into the agreement, which was made when interest rates weren’t so favourable.’
Highly geared equity investment trusts
|Fund||Net leverage* 30/06/12 (% of NAV)|
|Edinburgh Investment Trust||23|
|Perpetual Income & Growth||21|
|Jupiter European Opportunities||19|
|Fidelity China Special Situations||18|
|Baillie Gifford Japan||18|
|Foreign & Colonial||16|
|BlackRock Latin American||16|
*Figures based on AIC monthly information as at 30/06/2012, complied by Oriel Securities. Net leverage is calculated as a percentage of net asset value (NAV). Excludes trusts with a market value below £50 million and those with dual share structures.
Gearing tends not to be a problem in the hands of a good fund manager. For example, the Edinburgh investment trust, managed by Invesco Perpetual's star manager Neil Woodford, has the highest level of gearing at 23% of its gross assets, with £200 million borrowing from two debentures. However, its shares also trade at a 8.5% premium above the value of its investment portfolio, which shows that investors are comfortable with the situation.
Gearing has contributed positively to its net asset value (NAV) total return, which has risen 21% over the past five years and 69% over the past three years, outperforming the FTSE All Share's total return of 10% over the past three years and 37% over the past five years.
‘Neil Woodford, who manages the Edinburgh Investment trust, and Alexander Darwall of Jupiter European Opportunities have both been doing quite a good job of investing despite the high levels of debt through cautious investing,’ Scouller says.
Merchants trust comes in second place, with leverage of 22%. However, it is currently trading at a 9.3% discount to NAV, after the highly geared trust was hit in 2008. It has returned a 0% total NAV return over the past five years and 51% over the past three years.
Peter Walls, manager of the Unicorn Mastertrust , a fund of investment trusts says: ‘I’m not sure whether people looking for income are keen on the gearing aspect but Merchants is an example where the gearing is historic and they can’t repay it until it comes to its final maturity and the debt was taken in a completely different interest environment.’
However, the trust has a high dividend yield of 6.3%, outshining Woodford’s Edinburgh trust yield of 4.2%.
The Invesco Perpetual Income & Growth trust comes in third place, with leverage of 21%. The trust is managed by Mark Barnett and has given strong returns over the past one, three and five years to beat the FTSE All Share total returns benchmark.
Jupiter European Opportunities trust has gearing of 19% and has given the strongest NAV total return performance among European trusts over the past one, three and five years with 12%, 90% and 48% respectively.
Manager Alexander Darwall has used the leverage to outperform the sector average, as the trust’s NAV has added 12% over the past year while the sector has lost 3%.
Walls adds: ‘Jupiter European Opportunities has been doing really quite well against the backdrop of difficult markets. I think that probably shows if you’re looking for a geared play it’s even more important to get your trust manager right. It’s very much down to good stock picking and a high conviction portfolio.’
Less successful so far is the Fidelity China Special Situations trust run by Anthony Bolton. The former star manager of the Fidelity Special Situations fund has conceded that the trust's 18% gearing has been a disadvantage as its portfolio has fallen more than the Chinese stock maket. Its investment total return is -20% over the past year. However, Bolton is convinced that the policy of gearing will work for shareholders in the long run as it enables investors to get the maximum return from the theme of the rise of the Chinese consumer, which he is exploiting.
New to investment trusts? Try this video
This video from The Lolly Investor Programme series will tell you more about the pros and cons of investment trusts.
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Look up the investment trusts
- Edinburgh Investment (Ordinary Share)
- Jupiter European Opportunities (Ordinary Share)
- Invesco Income Growth (Ordinary Share)
- Merchants Trust (Ordinary Share)
- Fidelity China Special (Ordinary Share)
Look up the fund managers
More from us
- The Lolly guide to investment trusts: a 'hidden jewel' no more!
- What is a unit trust and how does it help me invest?
- The Lolly Investor Programme: a video guide to investing
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by Robert St George on Dec 10, 2013 at 17:50