For margin lending clients, the climate is ripe for a review of their managed funds, equities, risk profile and even a serious rethink on whether the vehicle is worthwhile, Paul Resnik Consulting Group principal Paul Resnik says.
"It's a good time to do a review of what the funds are doing, what the equities are doing, for example, what is happening in those companies, are the shares vulnerable to the huge discounting the market has given and what is the client's risk capacity, then decide if the whole thing is appropriate for them," Resnik says.
"There is more to life than a margin call."
Having scrutinised margin lending for 10 years, he believes it is largely under-researched and an easy sell. All too often people rely on it as a product solution without looking at the issues and other avenues, such as reaching goals by maximising resources through better management of cash flow, looking at whether funds are held in the right entity, whether they are in super or non-super, and examining the tax efficiency of investments. These housekeeping issues should be tidied up before even considering the risky strategy of gearing.
"The world has now changed and it is not what it was three months ago," Resnik says.
"If the margin loan was geared into managed funds, you need to look at what the manager has been doing to re-settle the fund. What are the consequences of that? Six months ago you knew what was going on in that fund. Now you have no idea. Unless you know the cash flows into that fund and what the manager is doing, there could be a bucketful of tax liabilities. Gearing is not a set-and-forget strategy and certainly not now. This is risky space."
Timing right for some
However, many in the industry believe now is a good time to enter the margin lending market as there is some good buying and conservative loan-to-value ratios (LVR) and a good cash buffer have reduced the risk of margin calls. Others are not so sure.
AMP Capital Investors head of investment strategy and chief economist Shane Oliver believes it is a tricky time to use margin lending, which works optimally in markets trending high. Oliver says the best time to take out a margin loan was in 2003 and 2004 when interest rates were lower and the global economy was recovering. Now, markets are in a more volatile cycle, interest rates are higher and there is more risk for investor strategies depending on margin lending.
"Some would say cash is king. The interest rate of margin loans is about 10 per cent so you have got to be pretty confident the market will rebound. I don't doubt there are good bargains out there. It's just that I think the path for recovery will be volatile and may even fall below the January low," Oliver says.
"I think the next six months will be rough. The better approach to use debt is to use your mortgage, but some people don't feel comfortable with that. At least with a mortgage secured against your home, you don't face margin calls so you don't get turfed out at the wrong moment."
He says margin calls may have made the market more vulnerable to a sharp sell-off whenever there is bad news offshore. Once the selling is over, the market rebounds.
"Sometimes it may be easy for hedge funds and market manipulators to work out which stocks investors put their money into. The whole phenomenon of increased margin lending and hedge funds taking advantage of it may be making it more difficult for investors using margin loans to trade the market," he says.
However, Paul Moran Financial Planning principal Paul Moran thinks it is a good time to take out a margin loan because the risk is low that the market will continue to fall significantly. "We had about 25 per cent of our portfolios in cash and we have put 15 per cent into the market in the last two or three weeks," Moran says.
"If there were margin lending clients who had a buffer left, we have been buying. If they are coming to us as new clients, we are taking out margin loans. Now is an ideal time to be borrowing money and placing the investment."
He adds that no clients had a margin call because all had a good cash buffer with conservative LVRs between 30 per cent and 50 per cent, particularly when the market was at its peak.
He believes those investors who did experience a margin call elsewhere were too highly geared.
His priority is not to get into a situation where clients have a margin call. If they are highly geared, they should have access to other short-term funding such as an equity loan on their house to prop up the loan temporarily until the market recovers. If they cannot cover the loan, they need to understand they are taking a significant risk.
"People may have been using margin lending as a tax-planning tool and wanting to get maximum tax deductions. They may have ignored it as an investment tool. If you just focus on the tax side, you are not focused on what you are paying for," Moran says.
For others, such as Colonial Geared Investments head of investment lending John Clothier, it is more about a lack of diversification than being too highly leveraged. Those with margin loans who had a lot of money tied up in single stocks have been hurt through the credit crunch.
But Clothier believes the viability of margin lending is just as attractive now as it was in mid-January because clients are investing for between five and seven years so the market will grow in the long term with periods of volatility.
"I think there are a lot of advisers reviewing portfolios. We have had such a strong run for five years. It is a good wake-up call for people to see how they have structured their investments," he says.
In January, Colonial Geared Investments experienced increased call volumes and call wait times as panic swept investors. Yet in the last two weeks of January, it increased its $4.7 billion loan book by about $30 million net. Of its 40,000 margin lending clients, with an average LVR of 38 per cent, 500 experienced a margin call.
"A very large portion of our business is into the managed funds space so that tends to protect us. When you look at such a conservative LVR in conjunction with a diversified portfolio, it does bring down the potential threat of margin call," Clothier says.
On the other hand, CommSec went backwards in January with its margin loan book reduced by $150 million as a result of cash payments to reduce loan balances and stock selling. This figure had been reduced to $100 million by the end of the month. By mid-February, these funds had been re-drawn and the book had recovered the previously reduced balances.
"There was no advice so people were more prone to sell out. It's a very lumpy business, the CommSec book. When the market rallies, it might have $100 million in one week then $100 million goes out the next," Clothier admits.
He says a key positive that came from January was the volume of clients who proactively managed their accounts to avoid a margin call. Much of the $100 million book reduction came about as a result of this proactive account management.
Australian Unity head of financial planning and home loans Ross Johnston, says his firm, which has $30 million in margin loan products, has not had any margin calls.
Most clients were geared at around 50 per cent LVR. Johnston agrees with Moran that it is a good time to consider a margin loan. Higher interest rates were also not an issue as the margin lending strategies were targeted at high-net worth clients who recouped most of the interest costs via their tax deduction.
"I think it is a good opportunity while markets are a lot cheaper. If you look at Australian and international equities on a long-term forecast, the outlook is very good. It is volatile, but having said that, the markets are good value. If clients came to me today and we were going to set them up in a margin loan, we would still be looking at 50 per cent LVR."
Australian Unity group executive of investments David Bryant says January was a good reminder that markets don't always go up and what looks like conservative gearing often isn't. It has also driven home the message that some investors are too highly geared with debt on their home, a margin loan and property trusts, which typically have gearing.
"When they look at total gearing for all of their assets, it may be higher than they realise so in a lot of cases people are carrying too much gearing," Bryant says.
"Too many borrowed up to their limit and do not have a buffer to protect them. Investors should be going back and looking at their investment strategy and working out if they can get through this phase."
According to Bryant, those who sought advice were generally well advised. Those who acted without a financial planner did not get the implications of borrowing and margin calls, did not understand the way to set a margin loan and how much to borrow and could not get their hands on other cash.
"I am expecting to see problems in people who haven't had the benefit of advice, but I think that applies to any investment," Bryant says.
St George Financial Planning had a record 2700 margin calls among its 18,000 clients with margin loans. Yet in January, 282 new accounts were opened compared with 290 last year in the middle of the bull market. Talk of interest rates have been overshadowed by volatility, according to St George acting general manager of margin lending and direct shares Paul Lewis.
"When volatility returns to normal we will hopefully get back to a rising share market and the focus may return to interest rates," Lewis says.
"Then we may see clients moving or between margin lends purely on interest rates. But at the moment we are not seeing that.
"It is good for young people in the market from an advising and client point of view to realise there is volatility in these markets and they should have good sound financial advice when they enter into any sort of wealth investment such as margin loans."
At Financial Wisdom, clients with a total of $150 million in margin loans have not been panicked by market volatility, according to general manger Tim Browne.
In fact, he hasn't had one client call to express concern. He says clients' average LVR is 40 per cent, which is why there have been so few margin calls.
Clients who were requested to top up largely saw it as a buying opportunity.
"We keep a close eye on the gearing facility put in place for clients to make sure they are able to service the interest rate of the day and an additional 1.5 per cent increase," Browne says.
"Every adviser is accredited individually. If the client's risk profile is aggressive they need to have a time frame in excess of five years. We don't allow capitalisation of interest, we don't allow double gearing and insurance needs to be addressed. With those gearing standards in place, the clients' propensity to deal with market volatility is there and clients' expectations have been set for times like these."
For Resnik, it is immaterial whether there were margin calls.
"You could have no margin calls and still be in wretched circumstances. Not having a margin call doesn't necessarily mean you don't need to do a review. A margin call is simply a warning sign that the thing has blown up," he says.
