Gearing is often perceived as a stumbling block when completing due diligence on investment trusts. It can be difficult to pigeon-hole a trust into a certain risk category when gearing is present. Therefore, at this month’s investment trust webinar, which is part of the Best Advice: Closed-end Fund Forum series, we discussed everything related to gearing.
Gearing is an emotive topic, as investors are quick to cite their bad experiences, rather than highlight their good ones, and gearing as a concept got a lot of bad press in the previous decade. But, along with my fellow panellists, we tried to give a balanced view on why—in the right hands—gearing is a powerful tool that’s available to an investment trust manager.
The panel of speakers included Simon Moore from Bestinvest, Dennis Hall from Yellowtail, Peter Hewitt from F&C Investments and Ben Ritchie from Aberdeen Asset Management.
One question we put to the listening audience during the webinar was this: “Do you think gearing is an investment decision?” Every listener that voted was of the view that yes, it is. That’s in accordance with our own view, too. Boards are there to set the parameters within which an investment manager should operate, but we agree that the execution of gearing is something best done by the fund’s manager.
Ben Ritchie of Aberdeen, who runs Dunedin Income Growth (DIG) alongside Jeremy Whitley, shared his thoughts on how this worked in practice with his board. Decisions here are helped by the fact the fund has a fixed-term debenture at 7.875% which only matures in 2019. Not ideal but it makes for gearing that’s relatively straightforward to understand.
It gets more complex, however, when managers are using CFDs and these require more explanation to investors, says Dennis Hall of Yellowtail. While they aren’t necessarily a deterrent, they add another layer of complexity for his clients to take on board. He made an excellent point about individuals’ gearing: while some are put off by the idea of gearing, many live lives that already incorporate gearing, for example through their mortgage, which is simply gearing by another name.
Then we looked at where gearing can work and where it’s less ideal. Simon Moore of Bestinvest is not keen on emerging market funds that gear based on the view that there is sufficient risk built into them already. In times of stress, liquidity issues can make it difficult to sell holdings, so gearing would compound this problem.
Peter Hewitt of F&C Managed Growth (FMPG) and F&C Managed Income (FMPI) reminded us how gearing can be used to enhance income from investment trusts and we’ve talked already in this webinar series about the benefits of the revenue reserve account when it comes to income.
These are just a few highlights from the lively session. The one-hour session also covered:
- The different types of gearing used
- The markets in which it has been particularly effective
- How the decision is made to use gearing
- How investors can analyse gearing
- How geared investment trusts can be incorporated into traditional risk models
A full transcript of the session will be available soon and you can listen to the full recording here.
