Gearing Liquidity and Risk · Investment Trusts
Gearing adds investment exposure using borrowing or other arrangements. It can amplify a good outcome and a bad one, while financing costs create a hurdle that assets must overcome.
Start with a balance sheet
Suppose shareholders provide £100 million and the trust borrows £20 million. If all £120 million is invested, a 10% asset gain produces £12 million before expenses and interest. With the debt unchanged, shareholder net assets rise to £112 million, a 12% gain.
A 10% asset loss instead reduces investments to £108 million. After subtracting £20 million debt, shareholder net assets are £88 million, a 12% loss. Borrowing magnifies both directions. It does not simply add a bonus to returns.
Include financing and definitions
At 5% annual interest, £20 million of debt costs £1 million for a full year under a simple assumption. That reduces the gain or increases the loss. Actual accounts can include different borrowing periods, fees and financing instruments.
Gearing measures vary. Gross borrowing, net borrowing after cash and effective market exposure are not identical. A company with a borrowing facility may not have drawn it. Compare definitions before comparing percentages.
Watch risk rise after losses
If debt stays £20 million while shareholder net assets fall from £100 million to £80 million, debt relative to net assets rises from 20% to 25%. The company becomes more geared without borrowing an additional pound.
Look for policy limits, lender covenants and a plan for stressed conditions. Derivatives and obligations inside underlying assets can add exposures that a simple headline debt figure misses.
Try it yourself
A trust invests £150 million financed by £120 million equity and £30 million debt. Assets fall 8%. What happens to equity before interest?
Show the worked answer
Assets fall by £12 million to £138 million. Subtracting £30 million debt leaves £108 million equity, a 10% loss.
Further reading
Educational material, not a recommendation to buy or sell a fund. Numerical examples are hypothetical. This guide focuses on listed investment companies commonly called investment trusts in the UK. Product terms, access and tax treatment vary by jurisdiction.
