By MIKE SHEEN FOR THIS IS MONEY, 10 March 2023:
The rising cost of borrowing could leave some buyers of investment trusts nursing heavy losses and a sharp fall in income.
Investment trusts’ use of borrowing – known as gearing – is designed to supercharge returns and income when a vehicle’s strategy pays off, but investors must be aware of the potential risks as interest rates continue to climb.
Investors relying on trusts for income face the potential for a squeeze on their trust’s yield, while a fall in total returns can turn into heavier losses in falling markets.
What is gearing?
Investment trusts are able to borrow in a number of ways at favourable rates.
Gearing allows trusts to boost exposure in rising markets, potentially lifting investor returns and income, but can also leave them nursing even heavier losses if the value of their investments fall.
Gearing is calculated as a percentage of a trust’s total assets.
London-listed investment trusts currently have on average gearing of 7 per cent, according to Association of Investment Companies data…
Which trusts use the most gearing?
Gearing is most aggressively utilised by trusts investing in inherently illiquid assets, such as property. They borrow money to buy assets that will then deliver a return…
Why rate rises could spell trouble for gearing
Interest rates are rising globally, with the Bank of England expected to hike by another 25 basis points to 4.25 per cent later this month, and like all borrowers this can mean trusts must pay more to borrow…
Matthew Read, senior analyst QuotedData, added that lenders often impose requirements on borrowers, such as forcing immediate repayment if certain thresholds are breached, which can restrict payments to investors.
He said: ‘Asset cover covenants are commonplace – assets must exceed twice the value of the debt, for example.
Read more here