Falling assets have led to the average amount of leverage in the highest-geared equity investment trusts to rise from 15 to 18 per cent in the three months to the end of September, the group said.
Top-five most highly leveraged equity investment trusts
| Trust | Net leverage 30.09.11 (%) | Net leverage 30.06.11 (%) |
| Merchants | 27 | 22 |
| Jupiter European Opportunities | 22 | 15 |
| Edinburgh Investment | 22 | 21 |
| Perpetual Income & Growth | 20 | 20 |
| Baillie Gifford Japan | 19 | 19 |
Source: Oriel Securities
"With equity markets continuing to be volatile, we think it is worth analysing leverage levels on trusts across the sector," analyst Iain Scouller said.
"Given that the ability to leverage is potentially a key advantage for investment trusts and the size of the trust universe, it appears that most boards and managers are currently using leverage fairly cautiously. We calculate that only 12 trusts have equity leverage of greater than 15 per cent of net asset value."
Performance of Merchants Trust vs sector over 3-yr
Source: FE Analytics
Merchants invests in FTSE 100 companies and pays a high dividend yield of 6 per cent. Our data shows it has returned 3, 52, and 0.01 per cent over one, three and five years. It is trading at a discount of 3.06 per cent.
Its board traditionally leaves the fund relatively highly geared.
Other highly leveraged investment trusts in the study include the top-quartile Baillie Gifford Shin Nippon fund and the 143-year-old Foreign and Colonial investment trust.
"A number of the UK equity income specialist trusts are relatively highly leveraged and they have tended to maintain this stance throughout the recovery in the UK equity market over the past few years," Scouller added.
The analyst also says that investors should keep an eye on sectors such as property and private equity, which also use high levels of leverage. Oriel Securities has calculated that F&C Private Equity was 23 per cent leveraged at 30.06.11.
Industry experts say investors should keep a keen eye on the level of borrowing their investment trust takes on.
"While gearing can increase the potential returns of investing through trusts, it can also significantly increase the risks. It is important for investors to understand the level of gearing that fund managers are able to undertake and also how much they actually do. Without this information investors could be taking more risk than they know," AWD Chase de Vere’s Patrick Connolly said.
Tim Cockerill, Rowan Dartington’s head of collectives research, agreed.
"It is important to watch how leveraged a fund is and how easily it is to pay that leverage back. If it can be paid back quickly and easily that’s good, but if a trust is tied in for the long-term that’s not so good."