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When to bale out, and switch to ITs?

General discussions about equity high-yield income strategies
Wizard
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Re: When to bale out, and switch to ITs?

#320636

Postby Wizard » June 23rd, 2020, 8:05 am

ReallyVeryFoolish wrote:As a matter of interest, does CITY gear up as a method of leveraging it's incoming dividends higher? With borrowing costs on the floor, it could be a useful strategy to employ if they haven't already. Something I would never encourage an individual person to do.

RVF.

According to the AIC entry they have about 9% gearing.

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Re: When to bale out, and switch to ITs?

#320637

Postby TUK020 » June 23rd, 2020, 8:14 am

Wizard wrote:
ReallyVeryFoolish wrote:As a matter of interest, does CITY gear up as a method of leveraging it's incoming dividends higher? With borrowing costs on the floor, it could be a useful strategy to employ if they haven't already. Something I would never encourage an individual person to do.

RVF.

According to the AIC entry they have about 9% gearing.


Over on the IT board
viewtopic.php?p=313983#p313983

"How safe is CTY dividend".
A lot of people seem to be of the opinion that CTY's borrowing facility should enable them to keep paying out, while riding out an incoming dividend drought over the next year or so.

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Re: When to bale out, and switch to ITs?

#320658

Postby Alaric » June 23rd, 2020, 9:19 am

ReallyVeryFoolish wrote:Thanks, the issue I have with gearing is the fact that it works in both directions and it isn't a free ride or magic bullet by any means. Under the circumstances though, I think a reasonable degree of gearing is sensible.


The premise seems to be this. Investment Trusts, depending on their holdings, may not receive enough income to finance the dividends they would wish to pay. Thus, how will they raise the shortfall? If they have cash balances, they can use those, but otherwise they would have to borrow or sell assets.

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Re: When to bale out, and switch to ITs?

#320680

Postby dealtn » June 23rd, 2020, 10:24 am

ReallyVeryFoolish wrote:As a matter of interest, does CITY gear up as a method of leveraging it's incoming dividends higher? With borrowing costs on the floor, it could be a useful strategy to employ if they haven't already. Something I would never encourage an individual person to do.

RVF.


That's an interesting statement. Whether the gearing is within the company, or at the individual level, isn't important from the investor's perspective.

If you have £50, and borrow an additional £50 to buy £100 of assets (in a unleveraged company), what difference do you see to having £50 and investing in a company that has £100 assets but also £50 of borrowing to part finance them?

If assets double in price in the first example you own £200 of assets and have £50 borrowing, so you are net £150. In the second you have a stake in a company whose net asset value has risen from £50 to £150. In both cases you have tripled your £50 investment into one worth £150.

(In the real world you have taxes, and differing rates of interest etc.)

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Re: When to bale out, and switch to ITs?

#320697

Postby dealtn » June 23rd, 2020, 11:00 am

ReallyVeryFoolish wrote:
dealtn wrote:
ReallyVeryFoolish wrote:As a matter of interest, does CITY gear up as a method of leveraging it's incoming dividends higher? With borrowing costs on the floor, it could be a useful strategy to employ if they haven't already. Something I would never encourage an individual person to do.

RVF.


That's an interesting statement. Whether the gearing is within the company, or at the individual level, isn't important from the investor's perspective.

If you have £50, and borrow an additional £50 to buy £100 of assets (in a unleveraged company), what difference do you see to having £50 and investing in a company that has £100 assets but also £50 of borrowing to part finance them?

If assets double in price in the first example you own £200 of assets and have £50 borrowing, so you are net £150. In the second you have a stake in a company whose net asset value has risen from £50 to £150. In both cases you have tripled your £50 investment into one worth £150.

(In the real world you have taxes, and differing rates of interest etc.)

Well, it may not matter to some people but the way I see it this -

"RVF, do you think I should buy £10000 of CITY shares? I like the dividend."

"Sure, a steady Eddie income portfolio, not keen myself, but many folks are."

"So, RVF, should I borrow £1000 and gear up my exposure to CITY shares. Get more dividend?"

"Personally, I wouldn't. That's adding personal gearing on top of corporate gearing. Myself, I'd leave that idea alone. A double layer of gearing, on an asset base likely already trading at a premium to net asset value isn't my idea of a prudent income strategy. However, everyone's mileage differs, so feel free if you wish to do so, nobody is stopping you".

RVF


I'm not examining a "double layer of gearing" though, just pointing out that the location of the gearing doesn't matter which I thought was what you were referring to. You said it "it could be a useful strategy to employ" (by CTY presumably), but also said "...never encourage an individual to do".

Have I misinterpreted what you are saying then?

Exactly the same happens when companies employ "hedging" for say FX risks, or commodity prices. It doesn't matter whether they do or not, investors can (in perfect markets) employ personal "hedges" that do the opposite according to their wishes. So an investor that likes company A but not the fact it hedges FX, can unwind it at the individual level, or another investor likes Company B but wishes they did hedge FX can adjust for that at the personal level.

What is important is knowing how a company is behaving and having trust that it will have consistent behaviours that are easy to follow (and mitigate).

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Re: When to bale out, and switch to ITs?

#320705

Postby dealtn » June 23rd, 2020, 11:24 am

ReallyVeryFoolish wrote:
dealtn wrote:
ReallyVeryFoolish wrote:Well, it may not matter to some people but the way I see it this -

"RVF, do you think I should buy £10000 of CITY shares? I like the dividend."

"Sure, a steady Eddie income portfolio, not keen myself, but many folks are."

"So, RVF, should I borrow £1000 and gear up my exposure to CITY shares. Get more dividend?"

"Personally, I wouldn't. That's adding personal gearing on top of corporate gearing. Myself, I'd leave that idea alone. A double layer of gearing, on an asset base likely already trading at a premium to net asset value isn't my idea of a prudent income strategy. However, everyone's mileage differs, so feel free if you wish to do so, nobody is stopping you".

RVF


I'm not examining a "double layer of gearing" though, just pointing out that the location of the gearing doesn't matter which I thought was what you were referring to. You said it "it could be a useful strategy to employ" (by CTY presumably), but also said "...never encourage an individual to do".

Have I misinterpreted what you are saying then?

Exactly the same happens when companies employ "hedging" for say FX risks, or commodity prices. It doesn't matter whether they do or not, investors can (in perfect markets) employ personal "hedges" that do the opposite according to their wishes. So an investor that likes company A but not the fact it hedges FX, can unwind it at the individual level, or another investor likes Company B but wishes they did hedge FX can adjust for that at the personal level.

What is important is knowing how a company is behaving and having trust that it will have consistent behaviours that are easy to follow (and mitigate).

Perhaps I just have a higher than normal aversion to debt of any kind. Other than my mortgage I never had debt and I paid the mortgage off as soon as I could. It's not wrong per se to borrow money of course, but I won't. And I wouldn't ever encourage anyone to borrow to buy shares in any company. But perhaps that is peculiar to me.

However, under the present circumstances it does make sense for CITY to borrow. We just have to trust they are managing the debt prudently.

RVF


Either you are missing the point, or not understanding. It doesn't matter if the debt is yours, or the company's, the effects are the same!

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Re: When to bale out, and switch to ITs?

#320711

Postby Alaric » June 23rd, 2020, 11:41 am

dealtn wrote:It doesn't matter if the debt is yours, or the company's, the effects are the same!


What about limited liability?

If you put 50 into a Company, the most you lose is 50. If you borrow 50, put the extra 50 into the Company, you could not only lose 100 on the Company, but still owe 50.

It's like whether a Company should be financed by equity or debt. In the case of equity, the Company can cancel dividends and let the equity become next to worthless. If it borrows, it has to service the debt and if it cannot not afford to do so, can be driven out of business when it defaults.

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Re: When to bale out, and switch to ITs?

#320751

Postby dealtn » June 23rd, 2020, 1:11 pm

ReallyVeryFoolish wrote:
Alaric wrote:
dealtn wrote:It doesn't matter if the debt is yours, or the company's, the effects are the same!


What about limited liability?

If you put 50 into a Company, the most you lose is 50. If you borrow 50, put the extra 50 into the Company, you could not only lose 100 on the Company, but still owe 50.

It's like whether a Company should be financed by equity or debt. In the case of equity, the Company can cancel dividends and let the equity become next to worthless. If it borrows, it has to service the debt and if it cannot not afford to do so, can be driven out of business when it defaults.

Exactly, but some people seemingly either don't understand or ignore the risk. Thanks. (My bold).

RVF


Ok, I am not ignoring the risk, I am aware of the risk, and further more am aware of the risks in both scenarios, are you?

I assume you saw the "maths" with the example of the prices doubling. Now let's consider if the assets halve in value.

So if you invest £50 in a company with £100 assets and £50 corporate debt you have 50 shares at £1 each.
Alternatively you borrow £100, using £50 debt and buy a company having £100 assets, but no debt. You own 100 shares at £1 each, but have £50 debt. Both routes you start with £50 and have net £50 of investments.

Now this time instead of doubling to £200 the assets fall from £100 to £50.

In the "safe" example where you have no personal debt, but the company has the leverage. The company now has £50 assets, and £50 debt and is worthless. You own 50 shares worth £0.

If you had borrowed the £50 you would have 100 shares in a company whose assets were £50 and had no debt. You own an investment of 100 shares worth 50p each, so worth £50 still. You would still have the loan, so the net worth is also £0.

It is only if you "allow" your personal situation to worsen such that you get negative wealth, that you get into a situation such as is described where your loans exceed your assets.

In the first example corporate bankruptcy "protects" you. In the second your own personal balance sheet "observation" protects you. Again the "location" of the gearing is irrelevant.

This is simply finance theory. Now I grant it is "theory" not "practice", and in the real world there will be both plenty of people that don't understand it, and also plenty of people who I am sure in the second scenario would be tempted to "run" the position, and risk "negative wealth" outcomes, believing "it will be all right/it will turn around" etc.

I am not suggesting you, or anyone, should do it, particularly if you don't understand it, or can't be disciplined to monitor/manage in the down scenarios, but that doesn't mean the point about the locality of the debt, and who has the gearing, the company or the investor, is invalid.

Crucial to the understanding of this is the fact you are not comparing a £50 investment in a company with £50 assets and no debt, and an alternative of investing £100 of your money, £50 of which is borrowed, in the same company with £50 assets and no debt. That is an entirely different proposition and clearly the personal gearing makes a big difference, to both the upside and downside scenarios in such a scenario.

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Re: When to bale out, and switch to ITs?

#320791

Postby 88V8 » June 23rd, 2020, 3:30 pm

Straw man.
Income ITs have reserves in varying degrees, to fund the divi.
CTY is a long way from borrowing.

And in any case, a company can borrow much cheaper than you or I can.

V8

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Re: When to bale out, and switch to ITs?

#320805

Postby dealtn » June 23rd, 2020, 4:09 pm

88V8 wrote:Straw man.
Income ITs have reserves in varying degrees, to fund the divi.
CTY is a long way from borrowing.

And in any case, a company can borrow much cheaper than you or I can.

V8


Are you sure about that?

I'm not an investor here, but looking at its Balance Sheet it has liabilities (explained in Note 15) and in the Income Statement has Finance Costs (Note 7 in this instance).

Odd you making a claim otherwise.

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Re: When to bale out, and switch to ITs?

#320808

Postby Alaric » June 23rd, 2020, 4:15 pm

88V8 wrote:Income ITs have reserves in varying degrees, to fund the divi.
CTY is a long way from borrowing.


Generally speaking ITs don't hold cash unless it's an investment decision. So when they receive 100 in dividends, distribute 85 of it, the balance of 15 is reinvested. If they need to draw against that 15 should they only receive 70 in dividends and want to pay 85, they will have to either sell or borrow to meet the shortfall. Their rules allow them to do this. That contrasts to an ETF or OEIC which would have to pay 100 and then 70 in the same circumstances.

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Re: When to bale out, and switch to ITs?

#320983

Postby jonesa1 » June 24th, 2020, 10:47 am

Alaric wrote:
88V8 wrote:Income ITs have reserves in varying degrees, to fund the divi.
CTY is a long way from borrowing.


Generally speaking ITs don't hold cash unless it's an investment decision. So when they receive 100 in dividends, distribute 85 of it, the balance of 15 is reinvested. If they need to draw against that 15 should they only receive 70 in dividends and want to pay 85, they will have to either sell or borrow to meet the shortfall. Their rules allow them to do this. That contrasts to an ETF or OEIC which would have to pay 100 and then 70 in the same circumstances.


Basically the rules for an IT allow them to pay dividends out of capital, if they have previously accounted for it as income which they didn't pay out. Alternatively, ITs can amend their company rules to allow them to pay dividends out of capital, even if they haven't accounted for it as a dividend reserve. For income investors that's potentially a benefit over funds and ETFs, but it comes at a cost of capital.

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Re: When to bale out, and switch to ITs?

#321222

Postby 88V8 » June 24th, 2020, 10:51 pm

dealtn wrote:Are you sure about that?
I'm not an investor here, but looking at its Balance Sheet it has liabilities (explained in Note 15) and in the Income Statement has Finance Costs (Note 7 in this instance).
Odd you making a claim otherwise.

Gearing up a little in a bull market is not a bad strategy. Not the same as borrowing to pay the divi.
Anyway, see little point in speculating about whether they'll borrow. They will or they won't.
Speculation and hypothesis is what makes the Today programme so annoying.

V8

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Re: When to bale out, and switch to ITs?

#321271

Postby dealtn » June 25th, 2020, 8:37 am

88V8 wrote:
dealtn wrote:Are you sure about that?
I'm not an investor here, but looking at its Balance Sheet it has liabilities (explained in Note 15) and in the Income Statement has Finance Costs (Note 7 in this instance).
Odd you making a claim otherwise.

Gearing up a little in a bull market is not a bad strategy. Not the same as borrowing to pay the divi.
Anyway, see little point in speculating about whether they'll borrow. They will or they won't.
Speculation and hypothesis is what makes the Today programme so annoying.

V8


I don't disagree with the strategy. Nor am I speculating, just observing the publically available information in the company's own reports where you can find the Balance Sheet.

I was just pointing out the disparity with your claim "CTY is a long way from borrowing". Clearly that's not true seeing as they are already borrowing.

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Re: When to bale out, and switch to ITs?

#321287

Postby 88V8 » June 25th, 2020, 9:25 am

dealtn wrote:I was just pointing out the disparity with your claim "CTY is a long way from borrowing". Clearly that's not true seeing as they are already borrowing.

True. But they haven't been borrowing to fund the divi, that was the context.

V8

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Re: When to bale out, and switch to ITs?

#321293

Postby dealtn » June 25th, 2020, 9:30 am

88V8 wrote:
dealtn wrote:I was just pointing out the disparity with your claim "CTY is a long way from borrowing". Clearly that's not true seeing as they are already borrowing.

True. But they haven't been borrowing to fund the divi, that was the context.

V8


Apologies then if I didn't get the "context".

Like some others I find it hard to see past the "literal", but it's something I am working on (although at 30+ years after leaving school it's taking it's time). Don't get me started on "emojis", they are literally unfathomable to me (and some others too).

regards

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Re: When to bale out, and switch to ITs?

#321693

Postby 88V8 » June 26th, 2020, 9:59 am

dealtn wrote:Apologies then if I didn't get the "context".
Like some others I find it hard to see past the "literal", but it's something I am working on (although at 30+ years after leaving school it's taking it's time). Don't get me started on "emojis", they are literally unfathomable to me (and some others too).

Apologies if I was too oblique.
Yes, there does seem much scope for misunderstandings in the online world.
I admire those who write endless screeds so as to lay bare every possible nuance. Or at least, I admire their typing speed.

V8


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