IT Portfolios - Top Ten Holdings

capital0ne

bowlhead99 wrote: »

Inconsistency of gearing and leverage formulas and terminology quoted by people discussing the concept is the bane of many an investment newbie's learning process. They all use some form of comparison of borrowing to assets or equity but beyond that there are a range of formulas.

Most places outside the US will refer to gearing as being "by what percentage is my return enhanced from using the borrowing". So a £100m fund portfolio using 20 million of borrowing is '25% geared'. You get the returns on the investments financed by your 80m of equity and then on top you get the returns on the investments which were financed by the 20m debt; your gross return before borrowing costs is 25% higher than it would have been if you had just got the returns on the 80 cash that you fronted.

However instead of using the debt over equity ratio, 20/80 = 25% formula, some people will quote debt over total enterprise value ie debt over debt plus equity, being 20/100 = 20%. That lets you know what proportion of your total gross return has come from the debt finance (a bit like saying your £100k house has a 20% LTV mortgage). But it's less useful as it requires you to do some further mental arithmetic to see what that would mean for your gross gain or loss compared to the first method where the simple calculation told you what extra gross gain/loss you'd have compared to investing raw without the "assistance" of borrowed money.

Then there are people like you who will say that gearing is gross assets over net assets i.e. 100/80 = 1.25 and not bother taking off the '1' to get 25%. They just confusingly (to many people) say that's 125% gearing because they talk about the returns being 125% of what they would have been rather than an enhancement of 25% on top of what they would have been.

If you said to me that a fund is 'over 100% geared' I would think, "wow that's pretty ballsy" - because in common (UK) parlance that sounds like a lot of returns enhancement that could go very wrong. Knowing Scottish Mortgage has 5.8 billion of shareholder's funds at end of Q3, if you gear that up by over 100% the implication is that over 11.6 billion of investment portfolio is at work, which could halve in value and wipe out your equity entirely. Whereas in reality the assets gross of debt are 6.3 billion ; you have about 8-9% gross gearing (some roundings in the rough figures). Net gearing would be a bit lower by deducting any uninvested cash off the debt before doing the calculation.

Per SMT's last factsheet, they quote 'potential' gearing according to AIC guidelines at 8% (the amount of borrowings drawn, expressed as a percentage of shareholders funds), while 'invested gearing' would be borrowings at par less cash and cash equivalents actively invested, at 7%. You could call those its gross gearing and net gearing figures, but nothing is anywhere near the 100%+ level.

I think you are doing the investment community a disservice when you imply that a lot of people buying the investment trust don't know its total assets exceed its net assets. Gearing is discussed in every annual and semiannual report as well as being stated on every monthly factsheet and on the website. The vast majority of pounds invested by shareholders in the IT are from people who comprehend the concept of gearing and how it may fluctuate over time and hopefully enhance long term returns. Of course, like with any fund, investment trust or individual company, there will be a minority of the shareholder base who just bought it because they saw a pretty graph of it going up a lot in price.

One of the things it might say is that perhaps you have not seen the gearing discussed because you do not take a great interest in investment trust discussions because you don't like actively managed funds ; you typically only pop up on threads that discuss them to remind us that you distrust active management and have done well for yourself by using passive vehicles.

Another thing it might say is that you have only been on the forum six months and the general concept of borrowing by closed ended funds is not something that has only started happening in that six month window so many of the discussions are conversations that have happened over the decade or more before you got here.

When people talk about comparing or contrasting ITs vs open ended fund vehicles there is usually some mention of some of the complexities or risk points such as discounts / premiums, gearing and the fact they do not have to pay out all their income in the year it is earned. However, there is not a lot of discussion about the specific gearing level of a specific trust from day to day. This is not a trading or marketwatch website. Before you mentioned the 8% gearing and I glanced at the factsheet, I couldn't have told you whether the current gearing was 8% or 12%; it is not something you reevaluate every day, you just employ the investment manager to go and follow his stated strategy and do his thing.

As an accountant with experience of the funds sector, I prefer working with closed ended funds to open ended ones because they are straightforward. The manager is managing a fixed set of assets and his day to day operations and production of a NAV is simple - compared to an openended fund there are no incoming and outgoing subscriptions and redemption to balance and no constant buying and selling of the assets to fund those investor inflows and outflows nor movement of the pricing point to reflect the costs of dealing with the inflows or outflows or deployment of cash into underlying assets.

Where the closed ended fund is itself listed on a stock exchange, the market will assign a price to the shares of the investment vehicle which might differ from the accounting value of the underlying assets it holds. Conceptually that is no different from saying the market will assign a price to Microsoft shares which might differ from the accounting value of its underlying assets around the world.

So, the workings of closed ended vehicles are quite straightforward to get your head around if you have the right mindset; and from the fund manager's perspective they are highly suited for holding illiquid assets (small companies, private equity, real estate, companies in which you have a relatively high percentage of ownership, etc) or indeed for any crazy strategy you might like involving any kind of assets. Little wonder that the concept of investment trusts have endured for more than a century.

You are dunstonH and I claim my prize!

bostonerimus

bowlhead99 wrote: »

Inconsistency of gearing and leverage formulas and terminology quoted by people discussing the concept is the bane of many an investment newbie's learning process. They all use some form of comparison of borrowing to assets or equity but beyond that there are a range of formulas.

Agreed, and I'm having to stop myself from typing "leverage"

If you said to me that a fund is 'over 100% geared' I would think, "wow that's pretty ballsy" - because in common (UK) parlance that sounds like a lot of returns enhancement that could go very wrong. Knowing Scottish Mortgage has 5.8 billion of shareholder's funds at end of Q3, if you gear that up by over 100% the implication is that over 11.6 billion of investment portfolio is at work, which could halve in value and wipe out your equity entirely. Whereas in reality the assets gross of debt are 6.3 billion ; you have about 8-9% gross gearing (some roundings in the rough figures). Net gearing would be a bit lower by deducting any uninvested cash off the debt before doing the calculation.

How financial numbers are calculated is usually easily accessible on a website, ie. it's easy to go the the H&L site look up Scottish Mortgage Investment Trust, scroll down and see "Gross Gearing = 108%" and then see exactly how that is calculated. But I still maintain that many people don't do that.

I think you are doing the investment community a disservice when you imply that a lot of people buying the investment trust don't know its total assets exceed its net assets. Gearing is discussed in every annual and semiannual report as well as being stated on every monthly factsheet and on the website. The vast majority of pounds invested by shareholders in the IT are from people who comprehend the concept of gearing and how it may fluctuate over time and hopefully enhance long term returns. Of course, like with any fund, investment trust or individual company, there will be a minority of the shareholder base who just bought it because they saw a pretty graph of it going up a lot in price.

We are arguing without any data, which is always dangerous, but can be fun. I feel that with the increased marketing if investment trusts to the general investor many people will own them simply for their impressive numbers, without really understanding the structure or how they might tilt the risk of their portfolio

One of the things it might say is that perhaps you have not seen the gearing discussed because you do not take a great interest in investment trust discussions because you don't like actively managed funds ; you typically only pop up on threads that discuss them to remind us that you distrust active management and have done well for yourself by using passive vehicles.

Mostly correct. I do read a lot of the IT threads, but don't comment on many of them because I don't buy ITs and don't have much useful to say.

Another thing it might say is that you have only been on the forum six months and the general concept of borrowing by closed ended funds is not something that has only started happening in that six month window so many of the discussions are conversations that have happened over the decade or more before you got here.

That could be true as well

So, the workings of closed ended vehicles are quite straightforward to get your head around if you have the right mindset; and from the fund manager's perspective they are highly suited for holding illiquid assets (small companies, private equity, real estate, companies in which you have a relatively high percentage of ownership, etc) or indeed for any crazy strategy you might like involving any kind of assets. Little wonder that the concept of investment trusts have endured for more than a century.

Closed End is a venerably fund structure, but I'm not sure it's understood by most investors. I could be completely wrong of course, As an accountant you will be familiar with it and I looked into them in the US a long time ago and obviously decided to go down another investing route. My goal here is just to raise questions. As I've said above "I hope that I'm wrong", but when I see some postings that plan to use an IT portfolio for retirement income I wonder if the risks are really understood.

cloud_dog

Audaxer wrote: »

Although the gearing shows as 108% I think that means the gearing is actually only 8%, as all ITs show gross gearing as over 100% as far as I can see.

Yes. Perhaps bostonerimus is correct...perhaps there are some people who don't fully understand gearing?

cloud_dog

Actually it is quite an interesting point, and one probably not many (any?) have actually considered but....

Of your portfolio how much of the return/risk is based on gearing?

So whilst we hammer the very naughty and bad ITs in to the ground I would think the majority of stocks/companies run with debt (with gearing) to boost the ROI. So, whilst ITs can increase the risk by employing gearing themselves it is not an on or off situation even for absolute tracker funds.

aroominyork

bostonerimus wrote: »

...but when I see some postings that plan to use an IT portfolio for retirement income I wonder if the risks are really understood.

I think you are wrongly tarring all ITs with the same brush. Some have increased their dividend every year over decades (City of London is often quoted) and seem to be perfectly good retirement income vehicles.

cloud_dog

aroominyork wrote: »

I think you are wrongly tarring all ITs with the same brush. Some have increased their dividend every year over decades (City of London is often quoted) and seem to be perfectly good retirement income vehicles.

Absolutely agree.

ITs can be far more advantageous in retirement; as an example IT income funds have the ability to retain income, smoothing the peaks and toughs of income whereas OIECs/ETF etc do not have that capability.

bostonerimus

Yes ITs can use a lot of tools not available to open ended funds. That can be good.....and it can be bad. There's a lot more going on under the bonnet of an IT that an open ended fund, active or index tracker. So there's more to consider when using ITs to come up with a portfolio.

bostonerimus

aroominyork wrote: »

I think you are wrongly tarring all ITs with the same brush. Some have increased their dividend every year over decades (City of London is often quoted) and seem to be perfectly good retirement income vehicles.

I'm not trying to tar, just pointing out that there are potential risks that come with ITs that you don't get with open ended funds.

Thrugelmir

aroominyork wrote: »

I think you are wrongly tarring all ITs with the same brush. Some have increased their dividend every year over decades (City of London is often quoted) and seem to be perfectly good retirement income vehicles.

Smoothing of dividends is achieved by holding reserves. Not quite what it might seem.

Thrugelmir

bostonerimus wrote: »

I'm not trying to tar, just pointing out that there are potential risks that come with ITs that you don't get with open ended funds.

Why do I want to buy shares in a company simply because everyone else is? Not necessarily a sound idea. Passive investing has it's pitfalls.