With the FTSE 100 hitting record highs, investment trusts with higher levels of gearing are well placed to take advantage of a UK stock market recovery. In this light, the AIC have asked managers of UK equity investment trusts with gearing of 10% or more, for their views on UK markets as follows:
The average investment trust is currently geared at 9%. However, several UK-focused trusts currently have higher gearing than this as they expect strong returns from UK markets.
Unlike open-ended funds, investment trusts can take on gearing, borrowing money to invest alongside shareholders’ capital. Investment trust managers often take on more gearing as a result of an optimistic market outlook.
Annabel Brodie-Smith, Communications Director of the Association of Investment Companies (AIC),said: “Being able to gear is an important advantage of investment trusts, giving them the ability to supercharge returns in rising markets. Higher than average levels of gearing by several UK-focused investment trusts suggests that their managers are optimistic about the future and recent record highs for the FTSE 100 reinforce that optimistic outlook.
“It’s important to remember that gearing increases risk and investment trusts using gearing can be expected to underperform during market downturns. There’s also no assurance any stock market recovery will continue. However, with many of these more highly geared UK trusts still trading at attractive discounts, there’s a clear opportunity for investors looking to increase their UK exposure.”
The Association of Investment Companies (AIC) has collated comments from managers of investment trusts in the UK All Companies and UK Equity Income sectors that are currently geared at 10% or more (see table at the bottom of this release for a full list of these trusts).
There are comments below from Mercantile Investment Trust (geared at 15%), Shires Income (15%) and Lowland Investment Company (11%)1.
Guy Anderson, Portfolio Manager of Mercantile Investment Trust, said: “At roughly 15%, our gearing is the highest it’s been in over a decade, so we are highly optimistic about UK equities. That optimism is underpinned by two key factors.
“Firstly, we see improving economic indicators. The UK’s recession last year proved to be briefer and shallower than anticipated, and consumer and business confidence measures are pointing to a brighter picture. This could lay the foundations for greater consumer demand, more business investment, and a better environment for corporate earnings growth. We are seeing this play out in our own portfolio, where companies are performing well at the operational level, leading to steady increases in earnings estimates.
“Secondly, the UK market is vastly undervalued compared to its own history and relative to other developed markets. Any improvement in the UK’s prospects could yield healthy market gains.”
Laura Foll, Portfolio Manager of Lowland Investment Company, said: “The current level of gearing on Lowland is in the low teens. The ability to use gearing is one of the key advantages of the trust structure – therefore our intention is to use leverage the majority of the time, and particularly at times like now when we are finding a large number of value opportunities across the UK market.”
Iain Pyle, Fund Manager of Shires Income, said: “Shires Income Trust currently has a high level of gearing compared to many trusts, but this lower cost debt is used to finance higher yielding preference shares which provide a source of stable income. Our approach is not to frequently adjust our debt strategy based on market fluctuations. Instead, we look to use leverage to boost income and augment long-term returns, steering clear of the challenging task of timing the market.
“Currently, we hold a positive outlook on UK equities, especially when compared to global equities. UK valuations are significantly lower, with an approximate 40% discount to global equities, which persists even after adjusting for sector composition. The UK’s sectoral mix has historically been less favourable, with underrepresentation in technology and overrepresentation in commodities, financials, and utilities. However, recent trends including commodity strength and a shift in performance dynamics, are tilting the balance in the UK’s favour, evidenced by robust performance in recent months.
“For income investors like us, the UK market’s yield premium is particularly attractive, further bolstered by a substantial volume of share buybacks. The enduring question is how to narrow the UK discount which has been surprisingly persistent in our view. We’ve observed a rise in M&A activity, progressive talks on regulatory reforms, and the prospect of political stability post-election, all of which could contribute positively.”
Risks for UK markets
Laura Foll, Portfolio Manager of Lowland Investment Company, said: “From a low starting valuation I think the main risk for the UK equity market is one of ‘more of the same’, in other words challenging net flows with an economy that would best be described as flatlining. Why might this be wrong? Global allocations to the UK are already low (indeed our own allocation to domestic equities via, for example, pension funds, is low) – weightings cannot go much lower than they already are. The economy might also be showing tentative signs of an uptick, although this likely needs interest rates to come down to gather momentum. From a low starting valuation, a gently improving backdrop may be all that’s required to see better UK market performance.”
Iain Pyle, Fund Manager of Shires Income, said: “Looking at risks for UK markets, the international nature of the index suggests that domestic issues should not be our sole concern. Nonetheless, any downturn in the UK economy could be detrimental. A potential risk is the emergence of a government that favours less market-friendly policies, though this seems unlikely. The market’s attractive valuation and high yield offer a degree of downside protection. A more pressing concern is the possibility of the UK market failing to enhance its relevance, which hinges on attracting companies to list in the UK and on investors allocating capital here. It’s crucial for the UK market to maintain its significance among asset allocators.”
Guy Anderson, Portfolio Manager of Mercantile Investment Trust, said: “As part of a global financial system, the key risks for the UK market are similar to those faced by other markets. Inflation remains stickier than many investors had imagined, and there are questions around when we might see some easing in monetary policy. In addition to broader geopolitical risks, we’ll also see half of the world’s population voting in elections this year.”
UK-focused investment trusts geared at 10% or more
| Share price total return (%) | ||||||
| Investment trust | AIC sector | Gearing (%) | Discount/ premium (%) | 1 year | 5 years | 10 years |
| Sector average | UK All Companies | 10 | -10.8 | 11.9 | 23.9 | 83.0 |
| Sector average | UK Equity Income | 6 | -5.6 | 3.5 | 26.7 | 75.3 |
| Chelverton UK Dividend Trust | UK Equity Income | 55 | -6.2 | -11.3 | 16.9 | 39.9 |
| Mercantile Investment Trust | UK All Companies | 15 | -10.9 | 16.6 | 27.5 | 96.9 |
| Shires Income | UK Equity Income | 15 | -12.7 | -3.2 | 12.2 | 54.6 |
| Schroder Income Growth Fund | UK Equity Income | 13 | -11.5 | -5.0 | 19.9 | 65.5 |
| CT UK High Income Trust | UK Equity Income | 13 | -6.2 | 14.8 | 26.5 | 64.4 |
| Lowland Investment Company | UK Equity Income | 11 | -12.7 | 5.1 | 13.4 | 28.3 |
| abrdn Equity Income Trust | UK Equity Income | 11 | -4.4 | -0.6 | -0.8 | 22.0 |
| Henderson Opportunities Trust | UK All Companies | 10 | -12.7 | 4.0 | 21.1 | 47.4 |
| Schroder UK Mid Cap Fund | UK All Companies | 10 | -14.8 | 3.9 | 19.4 | 52.2 |
| Merchants Trust | UK Equity Income | 10 | -1.3 | 1.5 | 48.9 | 89.7 |
Source: theaic.co.uk / Morningstar. Data as at 26/04/24.
