IN­VEST­MENT TRUSTS

We re­veal trusts with the ca­pac­ity and ap­petite to in­crease gear­ing in the wake of the re­cent mar­ket sell-off

Shares - - CONTENTS -

The in­vest­ment trusts bor­row­ing money to buy on share price weak­ness

Mar­ket cor­rec­tions are of­ten seen by re­tail and pro­fes­sional in­vestors as an op­por­tu­nity to ac­quire qual­ity stocks at a bar­gain price.

In­vest­ment trusts have con­sid­er­able flex­i­bil­ity to take ad­van­tage of these sit­u­a­tions be­cause they can bor­row money to in­vest, cre­at­ing a larger pool from which to earn div­i­dends or gen­er­ate cap­i­tal gains.

THE IM­PACT OF GEAR­ING

Bor­row­ing to in­vest is also known as gear­ing up (or in other words in­creas­ing the pro­por­tion of debt to eq­uity) and in a ris­ing mar­ket it can help to boost re­turns. Equally it can work against in­vestors when mar­kets fall by adding to the short-term volatil­ity.

It also means fund man­agers do not have to sell hold­ings they still like if they have other in­vest­ment ideas they want to ac­tion.

There are dif­fer­ent ways in which a fund man­ager can gear up a port­fo­lio in­clud­ing bank debt, loan stock, deben­tures, for­eign cur­rency loans or pref­er­ence shares.

Many trusts set strict in-house lim­its on how much gear­ing they can em­ploy, typ­i­cally a per­cent­age of their net as­set value and of­ten pitched at be­tween 25% or 30%. In re­al­ity, many trusts will bor­row a much smaller amount and some none at all.

DIF­FER­ENT VIEWS ON GEAR­ING

Some fund man­agers will re­duce gear­ing when they be­lieve we’re head­ing to­wards more dif­fi­cult mar­ket con­di­tions.

For ex­am­ple, JP Mor­gan Amer­i­can’s (JAM) Gar­rett Fish said in Oc­to­ber 2018 that the cur­rent mar­ket con­di­tions war­ranted a ‘re­vi­sion of the tac­ti­cal gear­ing level to 0% plus or mi­nus 2% from the pre­vi­ous level of 5%’, ef­fec­tively cut­ting the gear­ing level to zero.

It is worth point­ing out that US stocks had per­formed par­tic­u­larly strongly in the run up to the re­cent volatil­ity and many ob­servers had sug­gested val­u­a­tions had reached un­sus­tain­able lev­els.

In con­trast many Lon­don- listed shares have lagged be­hind the US mar­kets and so some fund man­agers are look­ing to take ad­van­tage of re­cent price weak­ness by de­ploy­ing more money in this mar­ket.

In this ar­ti­cle, we ex­am­ine which do­mes­tic-fo­cused UK trusts have the ca­pac­ity to in­crease gear­ing, as well as talk­ing to some man­agers about their in­vest­ment plans.

CON­SID­ER­ABLE HEADROOM TO GEAR­ING LIM­ITS

The ac­com­pa­ny­ing ta­ble, based on data from stock­bro­ker Nu­mis, shows a col­lec­tion of trusts with con­sid­er­able headroom within their agreed gear­ing lim­its. It shows their ‘ef­fec­tive’ level of gear­ing which strips out any cash the trust is hold­ing. It is worth point­ing out that some trusts may have ac­cess to un­drawn fa­cil­i­ties which are not in­cluded in these num­bers.

Charles Mon­ta­naro, who man­ages in­vest­ment trust Mon­ta­naro UK Smaller Com­pa­nies (MTU), notes gear­ing in his trust was neg­li­gi­ble at the end of the Septem­ber. Yet he ex­pects gear­ing on the trust to reach be­tween 5% and 10% by the end of the year.

‘Oc­to­ber has been re­mark­able: the UK small cap sec­tor fell 7.3%,

the worst month in over six years; AIM had its worst month since Oc­to­ber 2008; and UK small cap is now at the low­est val­u­a­tion since Novem­ber 2012.

‘For­tu­nately, we were well­po­si­tioned. We are en­ter­ing the sea­son­ally strong pe­riod for stock mar­ket re­turns. De­spite the gnash­ing of teeth over Brexit and the de­press­ing geopo­lit­i­cal land­scape, for most UK com­pa­nies it is busi­ness as usual. With in­vestor sen­ti­ment seem­ingly ex­tremely cau­tious, we would not rule out a Santa Claus rally.’

Ex­pe­ri­enced man­ager James Hen­der­son tells Shares he is plan­ning to in­crease gear­ing on three of the trusts un­der his charge, see­ing par­tic­u­lar op­por­tu­ni­ties among smaller com­pa­nies.

He says gear­ing could in­crease at Law Deben­ture (LWDB) from ef­fec­tively zero to be­tween 8% and 12%; on Low­land (LWI), where he says, ‘we don’t move it around a great deal’ po­ten­tially up to 20% ‘on weak­ness’; and on Hen­der­son Op­por­tu­ni­ties (HOT) up to 15% ‘over time’.

GEAR­ING TO SUP­PORT IN­COME

Low­land is an in­come-fo­cused fund and, as Hen­der­son ex­plains, gear­ing can be a par­tic­u­larly help­ful tool. He says: ‘At the mo­ment we would be bor­row­ing with Low­land at about 1.25% and the stocks we would be buy­ing would be yield­ing more than 3% and there would be things yield­ing 5%.’

The fund man­ager also notes that while gear­ing can in­crease volatil­ity, in­come stocks tend at the out­set to be lower beta or less volatile than the wider mar­ket.

While he con­cedes that you do need to be ‘re­ally care­ful’ with gear­ing, he sees lit­tle chance of higher bor­row­ing rates be­com­ing an is­sue in the near term as they were for trusts which used rel­a­tively ex­pen­sive debt to in­vest in the 1990s.

Other man­agers, with a re­mit which goes be­yond the UK, are also look­ing to take ad­van­tage of the re­cent mar­ket weak­ness.

For ex­am­ple, the co-man­ager of JP Mor­gan Euro­pean Smaller Com­pa­nies (JESC) Francesco Conte notes his trust has the dis­cre­tion to be 20% geared or 20% in cash.

It has op­er­ated at ei­ther ends of this ex­treme over the two decades he has been in­volved and un­til re­cently the trust had a small cash po­si­tion af­ter re­duc­ing gear­ing ear­lier this year.

Conte says: ‘The sharp­ness and in­dis­crim­i­nate na­ture of the sell­off opened up at­trac­tively priced in­vest­ment op­por­tu­ni­ties that we seized in the last few days of Oc­to­ber so that by the end of the month we were 3.5% geared. De­pend­ing on op­por­tu­ni­ties we find we may raise this fur­ther over the com­ing months.’ (TS)

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