The use of gearing, or borrowing, is one of the main advantages closed-ended funds have over their open-ended rivals, as it means they can rally faster in a rising market. The flip-side to this, however, is that they also fall further when markets correct.
Walsh, deputy manager of the Monks Investment Trust, says he and his co-managers are keeping their gearing levels relatively low because he is concerned that equity markets are looking toppy. Monks’ level of gearing currently stands at just 4 per cent.
"We are just not bullish enough to be fully geared," he said.
Walsh says that he and Gerald Smith – Monks’ lead manager – were relatively cautious with their gearing in the early parts of the year, which he now admits was a mistake. However, he says that now is not the time to be leveraged.
"We felt there were significant risks in the market, but since the tail-end of last year we have increasingly been of the view that nothing very nasty [a full-blown crash or eurozone collapse] was going to happen. However, we are not out of the woods yet by any means," he explained.
"There are still major challenges facing the developed economies and the emerging markets still face the precarious challenge of moving from an industrial-driven economy to a consumer-orientated one," he added.
Monica Tepes (pictured), investment company analyst at Cantor, agrees that investors should be cautious when it comes to gearing in this environment. "It all comes down to your own view, but I don’t think you want to be in high-beta trusts with leverage," she said. "If you think there are risks out there, you want to be in lower-beta portfolios with no leverage or net cash."
Developed world equity markets have been on an upward trend since the start of the year.
According to FE Analytics, the S&P 500, FTSE All Share and MSCI Europe ex UK index have had a good run, with all three returning more than 19 per cent so far in 2013.
Performance of indices year-to-date
Source: FE Analytics
However, market sceptics have warned that this rally is unsustainable, because although equity valuations have rocketed, earnings growth has remained subdued, which has led to P/E multiples expanding.
Walsh points out that while no-one can predict the direction of markets, big question marks remain over the reduction of QE.
The manager is concerned that there will be volatility when the Fed eventually tapers, or reduces, its asset-purchasing programme, because the excess stimulus has artificially inflated markets.
Although he says QE could continue for a while to come, he feels being too highly geared in this environment is overly risky.
"At some stage, interest rates will have to rise again and you can’t be sure what the impact will be. However, there has been a huge amount of money introduced into the system," he said.
"You have to take the view that it has inflated asset prices, but we don’t know which ones for sure. The global economy does seem to be picking up, but you can’t just say that everything is going to be great," he added.
Tepes takes the view that markets will correct in the short- to medium-term and is also concerned that parts of the equity market have been inflated artificially.
"QE is what has kept asset prices high and the optimistic argument is that they will put more money into the system," she said.
"They can continue doing so, and if you think you can time the market and keep investing with the momentum and get out at the right time, then you could do that,"
"Long-term investors who don’t want to time the market may be selling out early before the top or you could end up holding on too long and end up a long way down," she added.
The Monks Investment Trust has returned 164.93 per cent over 10 years, beating its benchmark – the FTSE World Index – by more than 20 percentage points.
Performance of fund vs index over 10yrs
Source: FE Analytics
However, the closed-ended fund’s performance has been more subdued recently. Walsh says the main reason for this is that he and Smith still had a fairly bearish view when markets began to rebound last year.
The trust also had a high weighting to commodity-related companies, emerging markets stocks and gold miners, which have all struggled. Because of that, the trust has underperformed against the index by 16 percentage points over three years.
However, that underperformance has left Monks on a wide 12.23 per cent discount. It is a global portfolio, with 30 per cent of its assets weighted in the US and a further 23 per cent in the UK.
Ongoing charges are 0.59 per cent.
