Protected lending surged in popularity in the June quarter with a 31 per cent increase, according to the Reserve Bank of Australia (RBA). The RBA also found the total industry dealing in lending money to invest in the share market has increased strongly at a compounded rate of 29 per cent a year over the past seven years.
In the last year alone, it was above 35 per cent. The total loan book seven years ago for margin and protected lending was just under $5 billion. It is now about $25 billion as of June 2006.
And according to Macquarie Bank, a record $6.54 billion turnover in warrants as of December 2005 is on target to be broken this year. From Macquarie's experience, financial advisers are increasingly using or recommending gearing for their clients, Macquarie margin lending head of sales and marketing Peter van der Westhuyzen says.
Macquarie offers a wide range of products to cater for this market, including warrants, margin lending products, instalment gearing, protected loans over direct shares or over managed funds, which could be either active or passive indices, to name a few.
In response to research that found first-time investors were concerned about margin calls, it recently launched Macquarie Investment Multiplier, the first specialist investment loan in Australia without a margin call. It suits those who want the benefits of investing in the share market using gearing, but who do not have much up-front capital. Applicants must have a financial adviser.
"It's for people who might have a mortgage but who also want to start creating wealth, save for their children's school fees or for those who see it as a way of investing in the share market without the worry of a margin call", van der Westhuyzen says.
"In the worst-case scenario, margin calls force people to sell some or all of their portfolio in what is generally a low point in the market. A margin call is almost like an internal risk management tool, so a margin call in itself is not a bad thing, but where it does cause people some concern sometimes, is where it can be an unknown quantity. You may not know how much it will be for and when it will occur."
With Multiplier, investors can borrow up to 75 per cent across a broad range of 1400-plus managed funds, covering diverse sectors, including Australian equities, international equities and small companies. There are also potential tax benefits. If gearing reaches 85 per cent of the portfolio value, there is a principal loan repayment plan.
"We are trying to give investors the benefits of compounding, dollar cost averaging and leverage. If you combine all those together, you could accelerate your portfolio returns", van der Westhuyzen says.
Colonial Geared Investments general manager Craig Keary admits its business emphasis has switched from traditional margin lending to a suite of products. While there will still be a need for traditional margin lending, the competitive nature of the adviser space means there is increased demand for alternative geared products.
"Advisers are becoming more sophisticated at the high end and one of the best ways to get wealth is by gearing, so there is demand for different tools and products to suit different age brackets and different needs," Keary says.
As a result, Colonial has created CALIA+, a combination of a margin loan and a home loan, which allows clients the flexibility to have up to 12 different loan accounts in different names. The product lets advisers develop strategies to accelerate debt reduction by increasing good debt and reducing bad debt.
"A lot of advisers are changing focus and going into wealth creation. This product enables clients to take the equity out of their home and put it into investment strategies which may be a combination of other investment properties or gearing into a managed fund or shares", Keary says. He believes this innovative product represents the next age of margin lending. Although it is a few years old, it is gaining traction after some adviser education.
Colonial has launched another product, Adviser Trading Centre, which allows advisers to trade in direct equities, either geared or non-geared.
"The adviser has a dynamic platform they can use to view clients' holdings. They can look at model portfolios and they can get access to CommSec research which then allows an adviser to get more into direct equities", Keary says. Colonial also offers protected portfolio loans. Advisers can use the product to protect a client's risk or to develop a particular strategy for that client. A more recent development is capital protected products, which will be offered every three months.
"We also offer warrants. Some advisers like them, some don't. But we think they will become more popular over time. The minimum investment amount for capital protected products and warrants is $5000", Keary says.
Of the increasingly popular warrants market, Macquarie has a 60 per cent share, according to Macquarie equity markets group senior manager Pia Cooke. Cooke says the increased appeal for gearing is due to several factors: the market has been kind to most, warrants are eligible within a super fund, and, in the past 12 months, significant changes to super have made it more attractive.
"As a result, if you do have cash in your super fund or intend to invest more heavily into super with regard to gearing, you can using instalments. That is the aspect that has grown dramatically. The range of warrants is pretty much available over the top 250 shares and they trade on the market just like shares so you can monitor their price daily", she says.
"In the past three months we have experienced a fairly volatile period. The market has fallen rapidly on the back of resources coming off and concerns over the US economy. Other gearing strategies have resulted in margin calls, but the warrants market is immune to margin calls so you can ride out volatility. You can take a view on a stock whether medium or long term without worrying on a short-term basis that you may have to be subject to margin calls and front up additional cash.
"Warrants can offer easy leverage into a wide range of stocks, enhancing growth and yield. As they are eligible for self-managed super funds, much of the demand has come from this market. Also, warrants can offer tax efficiencies. There are a variety of different warrants: instalments where you receive dividends in cash; self-funding instalments where you use the dividends to pay off your loan making them a neat set to use in a super fund; and a hybrid income instalment, where you take the dividend in cash but any interest due on the loan gets capitalised onto the loan without you having to pay it out", she says.
"There are traders who hold a warrant for an hour. They use it like an option, they buy into a stock then an announcement will come out, then they sell out and take a profit. Then you have the other extreme where someone invests for 10 years and uses the dividend to pay off the loan then over time they are left with a fully paid share", she says.
As with any leveraged product, when the market dips, your losses are enhanced. "You have to a have a positive view of what you are investing in for a gearing strategy to work. If you take a longer-term view, if the stock recovers then gearing comes back to being your friend", Cooke says. She adds that capital protection is still popular with retail investors who are worried their nest egg may succumb to capital losses, particularly if they are investing in emerging markets, such as India and Russia.
Structured products work in a variety of ways. Usually clients invest an amount up front, which is protected for x amount of time, say between five and seven years, with a minimum investment of $10,000. The aim is to receive capital growth over the medium term. It is a means of offering retail investors access to wholesale markets, Cooke says.
Lift Capital is responsible for product creation, working with financial planners and stockbrokers to develop structured products for their respective clients. Managing director Bassem Jammal says one of the key trends is lending against shares and managed funds, but mitigating margin calls.
"We have a product that allows clients to buy put options and embed those in their portfolios against individual stock holdings. That eliminates a margin call against that particular investment until the put option expires. We have planners who buy a 12-month put and they can eliminate a margin call against that particular holding", Jammal says.
"Another popular strategy is investing in unlisted property trusts; an area of the market that is not well serviced, mainly because they tend to be illiquid," he says. "They are a good investment providing good yields, and in many cases there are tax benefits. We structure a solution for the client who comes through planners and stockbrokers who want to invest in those funds", he says.
He says another trend is generating additional income from portfolios. For those who don't want to sell their shares in case of crystallising a capital gain and who are comfortable with their shares, they can sell call options against the shares, allowing clients to receive a premium by selling the call options and therefore increasing their embedded yield in the portfolio.
Adelaide Bank general manager of margin lending Eric Blewitt says it offers lending against capital guaranteed products with key partners.
"What you have got at product level is a number of players launching protected products with underlying capital guarantees for varying terms and then you have got people like us and other margin lenders offering them on a margin basis", Blewitt says.
"Depending on the nature of underlying guarantees, we may offer anything from 60 to 70 per cent all the way to 100 per cent on an investment loan. They provide a good investment opportunity for things like saving for a kid's education or as a solid investment vehicle.
