Since the financial crisis, it’s been common to hear from fund managers and boards of investment trusts that new borrowing facilities have been nigh-on impossible to negotiate. That is, until the last 12 months or so, when banks started to lend once again. Indeed, we have seen a fair few investment trusts increase their gearing facilities through new or renegotiated facilities, and furthermore a few have changed the nature of their gearing, too.
For some time, it has been common to see revolving unsecured loans in use as an investment trust’s mode of gearing as this continues to be relatively cheap money with only a short-dated commitment. Take the example of Aberforth Smaller Companies (ASL). Earlier this month it announced a new three-year revolving unsecured debt facility with Royal Bank of Scotland; although this replaced an existing facility, they have negotiated the maximum amount at a level that’s 25% higher than previously. To a large part that reflects growth in the asset value of the fund itself, but it also gives the fund’s management team significant flexibility in how and when they wish to deploy any of that cash.
Another example is Murray International (MYI): in June 2013 the company announced that RBS had agreed to the provision of both a new £120 million loan and also the renewal of two short-dated Japanese yen loans. The latter aren’t a play on the currency as manager Bruce Stout hedges out that currency exposure; rather, it’s a reflection of the fact it’s very cheap debt, originally drawn down at a time when UK financial institutions were not willing to lend.
Yet another is Standard Life Equity Income (SLET). The board here has agreed the provision of a revolving credit facility with Scotiabank at a rate of around 1.6% and they’ve subsequently cancelled their previous facility with RBS. At Aberdeen Asian Income (AAIF), that board’s facility that’s been agreed with Scotiabank is a multi-currency one, giving even more flexibility to the investment team in charge of the fund. Here, the interest rates being levied are less than 1.2%.
However, there is a rising tide of longer-dated debt being negotiated. Not only does this play well to the strengths of the investment trust structure, it’s also a sign of optimism on the part of the managers and boards that long-term returns at their funds should outperform the cost of that borrowing.
One of the first funds to announce a new long-dated facility was Temple Bar (TMPL). In July 2013, the board announced a new 15-year private placement note, at a coupon of just over 4%. Not only was this a step away from the traditional sources of debt financing, it was the first investment trust in several years to take that bigger leap with a new, long-dated debt facility.
Others have since followed suit. City of London (CTY) announced a 15-year private placement in December 2013, adding another string to its debt bow, alongside long-held debentures, an overdraft and several small debentures due for redemption at the end of 2014. Perpetual Income & Growth (PLI) announced a similar arrangement in March this year, also for 15 years, to replace a debenture that’s due to redeem in July. At both funds, the new facility ensures the balance between short- and long-dated debt is maintained.
It’s clear that investment trust boards are now able to negotiate highly competitive rates for short-term debt and it’s good to see them taking advantage of this. It affords the investment managers excellent flexibility in the management of their funds, at a rate that’s not overly penal should they choose not to make full use of that facility at all times. Indeed, it highlights one of the key benefits of investment trusts—namely, the use of gearing to add value in rising markets, and to express their conviction in stock names when confidence in those names is high.
But we also like the re-introduction of long-dated debt once more. Granted, it hasn’t always been the best move with the benefit of hindsight and debentures taken out some 20-plus years ago have been a noose around the neck of a number of fund managers. However, boards are now able to negotiate at rates that are significantly better than was the case in the late 1980s/early 1990s. So the cost of borrowing will be much less of a drag on future returns than has been the case historically. That should bode well for investors.
This article was a Morningstar contribution to Investment Week
