High interest rates and poor returns means borrowing to invest in shares can be precarious, writes Lesley Parker.
Margin loans are still out of favour, more than three years after the global financial crisis (GFC) began, with fewer investors than ever inclined to use them - and those that do opting for much more conservative levels of borrowing.
Total margin loan borrowings are at their lowest in seven years, Reserve Bank of Australia (RBA) data shows. Investors have less than $16 billion in margin loans, down from a peak of almost $42 billion in December 2007, nine months before the GFC first took hold.
On average, investors are borrowing about 35 per cent of the value of the securities their margin loan is funding, RBA data shows, well down on 60 per cent-plus gearing during the sharemarket boom and the 60 per cent loan-to-value (LVR) ratios many lenders still allow.
Financial advisers canvassed by Money last week said that if they suggest margin lending at all to clients, it is to a maximum of 50 per cent gearing: that is, clients must have a minimum 50 per cent "deposit" for the shares or managed funds they are buying.
"It's not that it's being entirely disregarded but the appetite for margin loans is down, definitely," the national manager of advice strategy for ipac Securities, John Dani, says.
"We've seen a drop-off in two areas: the sheer number of people wanting to pursue margin loans as a wealth-accumulation strategy, basically as a result of the impact of the GFC, and those clients who are interested in being much more conservative in the level of debt they want to take on.
"Before the GFC, while some investors were comfortable with 60 per cent to 70 per cent gearing, now 40 per cent to 50 per cent is probably more typical of what investors are comfortable taking on," Dani says. "They want to avoid the dreaded margin call."
Margin calls are made when the falling value of a portfolio means the borrower breaches his or her maximum loan-to-value ratio (LVR) and must bring back the loan into balance by topping up with cash or by selling investments, in all likelihood at the worst time to do so.
The rate of margin calls peaked at an average of 8.6 a day per 1000 clients in December 2008, up by only 0.6 a day on a year earlier. The average is now about two calls a day per 1000 clients.
"My attitude is that margin lending remains reasonable for a certain cross-section of investors who have the income certainty to service the debt and the discipline to remain invested when markets fall," a certified financial planner with Align Financial, Darren Johns, says, adding that clients are less inclined "to borrow ... at higher than reasonable interest [rates] to invest in an asset class whose short-term outlook is uncertain at best."
Among the margin loans on the database of researcher RateCity, interest rates range between 8.1 per cent and 9.7 per cent (with some of the difference depending on the term and the sum involved). At the top end, this is a margin of 5.4 percentage points over the Reserve Bank's official cash rate.
The alternative of dipping into your home equity to fund investments, perhaps using a redraw facility, means you can access a mortgage rate, in theory as low as 6.5 per cent. "With markets going nowhere for several years, clients aren't prepared to borrow at 8 per cent-plus through margin lending," a planner with Centric Wealth, Dean Easterby, says.
He says the irony is that the markets are offering reasonable value at the moment "and for clients that have the cash flow to support a gearing strategy, reliable income, a minimum seven-year time frame and a clear plan to repay or eliminate the debt in the future, now is not a bad time to at least be looking at this strategy."
Anne Graham, of McPhail HLG Financial Planning, says those clients who are still interested in margin lending tend to be more "aggressive" investors, in a high tax bracket and without property as security for gearing.
"[They] are generally greater risk-takers and will want a higher LVR, say 70 per cent, but usually we convince them to manage risk better by reducing the LVR," Graham says.
Kate McCallum of Multiforte Financial Services isn't a fan. "Our view is that margin lending is too risky for the potential return," she says.
"In most cases we can find alternative strategies that can add value for a client without exposing them to the risk of capital loss, and sleepless nights, that the combination of margin lending and a market downturn can bring."
Jonathan Philpot of HLB Mann Judd says an alternative is using home equity.
"If the client's circumstances are appropriate - that is, good cash flow, low level of home mortgage debt, investing for a period of at least 10 years and understanding the volatility of sharemarkets - I don't have a problem recommending to clients they utilise the equity in their home to borrow to purchase shares," Philpot says.
"This avoids the risks of margin calls and lowers the cost of borrowing."
Ipac's Dani agrees, adding that people should build at least 50 per cent equity in their home before borrowing against it.
He also suggests people stagger any geared investment, buying into the market gradually rather than investing a lump of borrowed money in one go. This way the "timing risk" is lowered.
As for other gearing avenues, Ray Albrighton of Announcer Financial Planning says capital-protected products tend to be expensive.
"The protection mechanism is built into the ongoing interest rates, which can be in excess of 15 per cent. You can't have your cake and eat it, too," Albrighton says.
Centric's Easterby says structured products have three potential pitfalls: complexity, cost and illiquidity. "It can be very difficult for retail investors to understand what they're actually investing in and if we have all learnt one lesson from the GFC, it has been to only invest in what you understand."
- In the current market, margin lending is too risky for the potential return, some advisers say.
- It's hard to recoup the relatively high interest you'll pay for a margin loan.
- Advisers are telling clients not to borrow more than 50 per cent of a portfolio's value.
- They also suggest an investment horizon of at least seven years.
Using equity in your home to fund investments is a cheaper alternative.