This article is part of Morningstar’s Guide to Investment Trusts, highlighting the benefits of these unique investment vehicles – busting the investment trust jargon, revealing potential pitfalls and celebrating those experienced managers who have earned the top ranking from Morningstar fund analysts.
Gearing is the ability to borrow money to invest that money on behalf of your shareholders and is a tool uniquely available to investment trust managers, rather than managers of open-end funds. As investment trusts are listed companies, they operate under company law and just like any other corporate entity can can borrow money against their assets and then invest the proceeds. This will increase returns to investors in a rising market – but can increase losses in a falling market.
One thing to be careful of is that managers should only be using it where they think they can make more than the cost of servicing that debt. So, they've got to have pretty high conviction in the markets to be able to invest it for their shareholders.
A gearing factor of 20% means that for an investment trust that has assets of £100 million, 20% or £20 million would be held in debt. This would formerly have been represented as gearing of 120, but the investment industry recently simplified gearing statistics to percentages to make it easier to understand. You will therefore see gearing expressed as a percentage of total assets on all Morningstar investment trust reports and investment tools.