Investment Road Test: Macquarie Equity Lever

PORTFOLIO POINT: Equity Lever offers relatively low-risk leverage, but in a fast-falling market investors might be better off with new forms of ASX-listed instalments.

With the stockmarket defying gravity, and with some brave souls predicting it could reach pre-GFC levels before the end of the year, the “greed vs fear” factor is rapidly re-emerging in the psyche of most investors. The decision to buy or to stay in the market at these levels will be massively important for any investor looking to insulate their portfolio from damage after the GFC.

Staying out of the market could mean missing out on one of the golden opportunities to recover from the massive losses experienced last year '¦ but staying in or increasing exposure could be a great wealth destroyer if we do experience the “W” shaped recovery some commentators still expect.

The need now is for investors to secure exposure to the market with some form of risk minimisation in place at the same time.

Unfortunately, although Macquarie’s recently launched “Equity Lever” investment has some excellent features for a low-cost product that employs relatively low-risk leverage (ideal for rising markets), it has the potential to cause unintended consequences in rapidly falling markets, consequences that can be avoided by using similar but less risky investments such as some of the newer ASX-listed instalments that we have reviewed in this column over the past few months (July 27, August 3, September 7).

Even though the Australian economy and stockmarkets generally are showing solid fundamentals – far better than the US or many other developed nations – it’s the sheer weight of money that has rushed into our market that makes it so vulnerable to falling back to lower levels.

How much of the money now in our market is “hot” – money that placed by global institutions that look to make short-term profits and then to move on to the next opportunity – is hard to gauge. But the hotter our market gets this year, the more likely it is to retract as profit-taking kicks in.

Like the newer forms of ASX-listed instalments, Macquarie’s Equity Lever provides leverage suitable for use by SMSFs, up to 50% loan to valuation ratio, with relatively low-cost interest rates (currently 8.65% pa).

The technology used involves the “limited recourse” loan that the SIS Act allows for, meaning that investors can choose whether to repay the loan or to walk away instead. Payment of the loan happens by way of the investor making payment of a “final instalment”.

If the investor walks away, Macquarie only has recourse to the specific assets that have been purchased with the Equity Lever facility. The investor’s other assets aren’t able to be accessed by the lender – and that is one of the significant and real benefits that the Macquarie product provides (in the same way as ASX listed instalments).

Like the newer ASX listed instalments, Macquarie Equity Lever does not contain expensive, embedded “put” option protection. Instead, the issuer protects itself from the risk that it will be left holding potentially worthless securities by involving an “Instalment Acceleration Event” mechanism.

Initial loan to valuation ratios are set at about 50% and there is a maximum of 65% over a wide range of blue-chip ASX shares. If share prices fall such that the overall facility ratio reaches 65%, this triggers an “Instalment Acceleration Event”, which effectively acts like a margin call.

Like the newer ASX-listed instalments that include this feature, investors need to be aware that in falling markets they can be required to make cash payments to reduce the gearing levels below the maximum permitted.

This is obviously a real risk in falling markets – as many margin loan investors experienced last year. Prudent gearing levels are a good weapon against this event occurring, as well as ensuring that suitable cash levels are maintained to cover the risk of an “Instalment Acceleration Event”.

Unlike the newer ASX-listed instalments, the Macquarie Equity Lever works on a “whole of secured portfolio” approach. That is, if an investor doesn’t pay in the event of an “Instalment Acceleration Event”, Macquarie can choose which shares it will sell down to cover this quasi margin call.

In practice this means that “good” shares may be forced into sale, to cover losses on weaker stocks. This is very similar to the problems experienced last year when margin lenders (and worse still, stock lending based-loan providers) sold down quality stocks to cover losses on the rest of the client portfolio.

While it’s clear the Macquarie Equity Lever product does not involve stock lending – and that the risk in the event of an “Instalment Acceleration Event” is very similar to that involved in normal margin lending – the Macquarie product does not provide the same level of risk minimisation as single-stock, ASX-listed Instalments.

Equity Lever has some great features, including good interest rates and automatic repatriation of dividends to reduce the size of the loan within the investment, but in a rapidly falling market it exposes investors to risks that can be avoided by using some of the newer forms of ASX-listed instalments.

The score: 3 stars
0.5 Ease of understanding/transparency
0.5 Fees
0.5 Performance/durability/volatility/relevance of underlying asset
1.0 Regulatory profile/risks
0.5 Innovation

Tony Rumble is the founder of the ASX-listed products course LPAC Online, a provider of investment training to financial services professionals.