At a time of high interest rates and depressed markets, investment companies have taken varying approaches to debt, with some hiking or dropping their gearing by up to £140m since the Bank of England started hiking the cost of borrowing in January last year.

Investment companies’ ability to gear, or borrow, is often touted as a major beneficiary of listed closed-end funds, but with higher costs due to base rate jumping from 0.1% to 5.25% in less than two years, this tool can incur risks.

‘One advantage that investment companies have over open-ended funds is that they do not face outflows in tough market conditions. In fact, they can use gearing to buy assets at low valuations,’ explained Nick Britton, research director of the Association of the Investment Companies (AIC).

‘However, it’s important to remember that gearing increases risk on the downside as well as offering significant potential upside in the long run.’

Since the end of December 2021 the industry has maintained a steady weighted average gearing of 7% across the universe, according to Morningstar.

Britton said about half of all companies use gearing in order to ‘boost long-term returns, take advantage of tactical opportunities, or both’.

At the end of October the most highly-geared AIC sectors were leasing and four property sectors, with debt averages ranging from 24% to 57%, followed by Chinese and Japanese equity sectors where trusts were 22% and 17% geared on average.

Among funds investing in equities, UIL (UTL ) registered the highest level of gearing at 84% due to its use of zero dividend preference shares on top of loans to provide an additional source of capital.

UK equity income trust JPMorgan Claverhouse (JCH ) had the biggest drop in gearing from 21% to 5%.

These changes in gearing can result from more than just shifts in borrowing figures. They can change as a result of movements in net asset values and the level of cash held.

To understand which companies were the most bullish and bearish, Citywire examined data from the AIC and Morningstar on top of debt increases and decreases for equity companies, along with the corresponding gearing change.

Biggest debt rises

Since the Bank of England first hiked interest rates in December 2021 JPMorgan Global Growth & Income (JGGI ) has increased its debt the most of all equity companies, adding over £100m in leverage to its balance sheet by the end of September.

Since then it has dropped this debt and gearing stands at 0%, as of the beginning of December, according to the AIC.

JGGI’s bullish then cautious stance has paid off as it is a top performer in the AIC Global Equity Income sector. Its share price has returned 15.9% over one year, compared to the sector’s average of 2.7%.

Unusually in a year that has seen many investment trusts de-rate, the company continues to trade at a slight premium of 1.5% over NAV, enabling it to issue 31m shares worth £145m so far this year. 

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Company name	Net Gearing (%)	Gearing difference (%)	Debt	Debt increase
JPMorgan Global Growth & Income (JGGI )	6	5	£152,591,428	£101,086,933
Impax Environmental Markets (IEM )	6	5	£87,479,850	£38,366,810
Edinburgh Worldwide (EWI )	15	11	£102,840,986	£36,254,880
Fidelity Asian Values (FAS )	8	8	£51,127,912	£36,005,075
Henderson European Focus Trust (HEFT )	5	5	£30,196,708	£29,281,229
Baillie Gifford UK Growth Trust (BGUK )	5	5	£16,350,000	£13,900,000
The European Smaller Companies Trust (ESCT )	15	4	£95,938,060	£13,607,093
Henderson EuroTrust (HNE )	4	4	£17,349,063	£13,151,086
BlackRock Frontiers (BRFI )	17	11	£97,540,003	£12,946,726
CT UK High Income (CHI )	10	7	£15,000,000	£9,487,512

Source: Morningstar, AIC. Data to end of September

Impax Environmental Markets (IEM ) also made the list as it restructured its debt through a combination of privately placed notes, or bonds, worth €60m (£51.7m) and took out £35m worth of floating rate debt with Scotiabank.

Jon Forster, co-portfolio manager said the ‘current “out of favour” status of environment markets [is] an opportunity to implement a measured increase in gearing to return IEM back to historical levels.’

Nitin Bajaj, portfolio manager of Fidelity Asian Values (FAS ) also spotted opportunities as he increased his gearing to deploy more money into China, which has been suffering from ‘heighted perception of risks’.

‘This is probably the best time to be investing in China as we are able to buy good businesses when both expectations and valuations are low,’ he said. ‘By the time clarity emerges, we believe valuations will have moved upwards’.

Three trusts run by Janus Henderson also made the list: Henderson European Focus (HEFT ), The European Smaller Companies (ESCT ), and Henderson EuroTrust (HNE ).

Ollie Beckett, manager of ESCT and Jamie Ross, manager of HNE both said they increased gearing as they wanted to take advantage of falling valuations. Ross said he has bought into SGS, Heineken and Puma so far this year. Beckett did not name any stocks but said his market was trading as if a ‘severe recession was inevitable’.

Tom O’Hara, co-manager of HEFT, took a slightly different approach. He said that in January 2022 the company took on two long-term notes for €35m (£30m), which were fully used in September 2022 when European markets were hammered. However, he said now he is not deploying into stretched equity markets, but has placed about 5% of assets into short-term gilts, which yield close to 5%.

Biggest debt decreases

While some fund managers took advantage of low valuations and their ability to gear the portfolio, others were more cautious with the two equity companies dropping their debt by over £100m.

BlackRock Throgmorton (THRG ), the £675m long/short company which invests in UK smaller companies, dropped its gearing the most during the period.

In the company’s annual report for 2022, the board said that it had been ‘in close dialogue’ with manager Dan Whitestone about the challenging market backdrop and he had chosen to ‘reduce gearing…while continuing to focus on highly profitable, cash generative growth companies’.

Since the end of September gearing in the company has returned to 15%.

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Company name	Net Gearing (%)	Gearing difference (%)	Debt	Debt decrease
BlackRock Throgmorton Trust (THRG )	16	-7	£104,449,986	-£142,381,982
Alliance Trust (ATST )	4	-5	£223,500,000	-£117,000,000
Fidelity Special Values (FSV )	7	-5	£132,491,592	-£73,082,538
Murray International (MYI )	5	-7	£139,894,805	-£59,919,506
Bellevue Healthcare (BBH )	0	-5	£32,770,768	-£55,888,264
JPMorgan Claverhouse (JCH )	7	-14	£50,765,375	-£49,234,625
Abrdn UK Smaller Companies Growth (AUSC )	0	-6	£24,937,778	-£40,062,222
City of London (CTY )	3	-6	£115,589,566	-£36,815,335
BlackRock Greater Europe (BRGE )	5	-4	£27,055,666	-£34,085,716
Biotech Growth (BIOG )	3	-4	£11,437,082	-£24,741,450

Source: Morningstar, AIC. Data to end of September

Also on the list is Alliance Trust (ATST ) which reduced its short-term borrowing facility in 2022 as a result of its ‘cautious view’ on equity markets, rather than as a result of rising rates, a spokesperson said.

‘Since then equities have continued to go up, so we have given up a bit of extra return at the margin,’ the spokesperson said ‘But the portfolio is still geared, albeit at a low level, and has contributed to us delivering strong absolute returns and significant outperformance of our benchmark and most peers in the AIC global sector.’

Alliance Trust has delivered share price returns of 11.9% over the past year, while the AIC global sector is down 0.9% on average.

Alex Wright, of Fidelity Special Values (FSV ), which sits third on this list, said his gearing is ‘slightly lower versus history’ but ‘the difference compared to two years ago is far lower than it would appear’.

‘At the time a couple of sizeable holdings were subject to binding takeovers, effectively acting as cash proxies and overstating the trust’s effective gearing,’ he commented. ‘The current level of gearing should be put in the context of a higher cost of debt, near-term risk to earnings growth as well as our desire to keep some powder dry to take advantage of any forced sellers given the sizeable outflows seen by some funds especially in the small/midcap space.’

Derivative usage

Wright’s trust, along with Fidelity Asian Values and Blackrock Throgmorton use derivatives as a method of gearing, in conjunction with, or instead of, the typical loan strategy pursued by the trust sector.

In particular the companies use contracts for difference (CFDs) which allow a trust to gain access to the movement in a company’s share price without having to buy the underlying asset. It is a contract between the investment manager and a broker to exchange the difference in a company’s share price from when the contract opens and when it closes.  

‘CFDs are very cost effective, as we only incur a cost when we use them, unlike loans,’ said Wright. ‘They also offer a number of additional benefits such as allowing us to hedge out our non-GBP exposure, and unlike shares we pay no stamp duty on CFD positions.’

As lending markets have become more expensive CFDs are becoming popular with Schroders Japan (SJG ) asking its shareholders to approve their use in September.