Margin lenders are keen to remind planners that by the time markets are soaring again it may be too late to get clients set.
Full In Focus feature, Options for gearing with less risk, available here
When sentiment in invest- ment markets turns, it can turn quickly. And there’s plenty of historical evidence to sug- gest that it’s in the earliest stages of
a turnaround that investors stand to make most money.
If financial planners and their clients are not already prepared, it won’t be surprising if they miss the boat. Again. Even so, talking to clients about investing in equity markets can be a difficult conversation, let alone talking to clients about gearing.
Figures published by the Reserve Bank of Australia (RBA) show that total margin loans had declined to about $15 billion by the end of December 2011, well below the $41.6 billion peak of December 2007.
Margin lenders are looking for ways to reignite planners’ and clients’ interest in borrowing money to invest in the sharemarket. They’re doing this by developing tools and services to support planners; and by developing new products that remove one of the things that frightens borrowers most about margin loans: margin calls.
Recent research by Investment Trends found a high level of interest among advisers for so-called “no-mar- gin-call” products. Pete Steel, general manager of Core Equity Services, says there are basically two ways to create a product that eliminates a margin call.
“One is to secure some debts and investments against an asset that is not likely to be revalued very often, like a house,” he says.
“So one of the forms of a no-margin-call product is using home equity. “You can leverage the equity [in a home] without a margin call occurring. “The second way – which is more towards the structured product route – is for the organisation providing the product to use derivatives or to look at the risk of a margin call occurring, and usually pricing in that risk and using derivatives to negate the need for that margin call.
“If the investment [falls] to a certain level, they can use a derivative that they’ve paid for to sell it out at no more loss. That implies cost, to do that upfront, to create that no-margin-call environment.”
Managing a margin call
The risk of a margin call rises with the loan-to-valuation ratio (LVR) of a margin loan. The higher the LVR, the smaller the fall in the market needed to trigger a margin call. Ron Bewley, executive director of Woodhall Investment Research, says financial planners can manage clients’ gearing levels effectively if they know how far the mar- ket has to fall before it triggers a margin call.
There’s a formula that can be applied to each client’s position to work out who is in greatest danger.
The trigger for a margin call is calculated as follows:
Trigger = 100[1-(AVR/(LVR+B))]
In this formula, LVR represents the maximum LVR that a lender will allow on a particular share or fund; AVR represents the client’s actual LVR; and B represents the buffer that the lender allows.
If the maximum allowed LVR is 70 per cent, and an in- vestor borrows right up to that limit, and assuming there also is a 10 per cent buffer, the trigger price for a margin call is calculated like this:
Trigger = 100[1-(70/(70+10))] = 12.5 per cent
As the AVR increases, the market fall needed to trigger a margin call naturally decreases. At an AVR of 65 per cent with a buffer of 10 per cent, it requires an 18.75 per cent fall in the market before the lender will be in touch to arrange the sale of securities or the addition of collateral to the facility.
The average gearing level across the industry currently stands at about 34 per cent (there is about $15 billion of debt, underpinned by securities valued at about $44 billion).
An investor with a gearing level of 34 per cent, and a 10 per cent buffer, can sustain a 57 per cent fall in the value of their investments before a margin call is likely.
