By Jean-Baptiste Andrieux, Reporter, Trustnet, 31 August 2023:
The ability to borrow money is one of the weapon in an investment trust’s arsenal. In many cases, it has contributed towards the outperformance of investment trusts relative to their equivalent open-ended versions, as they take out money to invest, making higher returns each year above the interest payments.
For the best part of a decade, low interest rates meant that trusts could borrow extremely cheaply, allowing them to turbocharge returns at a time when the market was broadly rising. However, with interest rates now at their highest since the global financial crisis, it is perhaps worth taking a closer look at how gearing is being employed…
When using tactical gearing, timing the market can be difficult and is often deemed impossible. Looking at valuations relative to history can be a better metric in that regard.
James Carthew, head of investment company research at QuotedData, said: “Many boards and managers will tell you that attempting to ‘time’ markets by putting on extra gearing close to a market low and taking it off again close to market highs is impossible – and I think that they’re right.
“However, many managers will look at valuations relative to history to determine whether their investments are cheap or expensive and act accordingly – that makes more sense to me.”
An example of a trust using gearing sensibly is Ecofin Global Utilities and Infrastructure, he said. The trust is limited to a maximum gearing of 25%, although the trust was meant at launch to operate with a natural level of gearing of about 15% and a realistic upper limit of 18-20%.
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