Leverage and volatility a safe mix? – Margin Lending Roundtable Part 2

The market volatility which has marked the opening months of 2016 has served to create challenges for advisers, but volatility and leverage need not be mutually exclusive, according to a Money Management roundtable.

MT: Mike Taylor
         Managing Editor
         Money Management

JM: Julie McKay
        Senior manager, technical and research
        Leveraged

KF: Kevin Flynn
        Director and Financial Planner
        Epacris Securities

WC: Wai-Yee Chen
          Senior adviser, Ord Minnett
          Private Wealth

KH: Keith Hildson
         Head of distribution
         Leveraged

EE: Earl Evans
        Head of wealth management
        Shaw and Partners

MT: It's been a really interesting start to the year. Markets have been very volatile, very hard to read. We've got all sorts of factors going on out there, the least of which being politics in North America.

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So with so many factors in play, when you're talking to clients, how do you factor that in? I mean, taking leverage, buying shares, doing all those things that margin lending is all about is something that probably works best in definitively strong markets rather than markets that are as volatile as they are today.

I'll start with you, Wai-Yee. What is the message you've been giving your clients at the moment regarding the markets which have been volatile since January?

WC: Volatility stays. That's the first message; for them to expect volatility for the rest of the year. But the way I use leverage is quite specific in the sense that it applies to the particular stock that I'm interested in. It either is due to its yield potential or growth potential or income stability or whatever it may be. It's more a strategic, stock by stock kind of look into gearing.

Risk/reward is all still at the upfront because hedging is involved and upside is capped, because I use "collar" when I hedge for my clients, so it's quite clear what they're getting into on a stock by stock basis. So volatility will stay but we're going to pick stocks that will take us away from the downside volatility. We have a specific upside that we're capping but that you are happy to assume and as such, we go into the trade.

MT: Kevin?

KF: Volatility is the new norm for us, so we're telling clients yes, there's volatility in North America, there's volatility coming out of China, there'll be volatility in Australia. Volatility is the new norm so get used to it.

We use a very conservative instalment process, so the volatility's actually good news, take advantage of those downsides and getting clients used to what we call the four lows, which is low interest rates, low returns, low growth, and low inflation. It's what we're all going to be getting used to going forward. Gearing and ramping up their exposure gives them that opportunity to grow their wealth. That's where we see the things — I think this volatility and this jumping at shadows is going to continue.

MT: Earl?

EE: Probably very similar to Kevin, but I think in the sense that again, I think markets have a tendency to pick up sound-bites and new buzzwords and all that sort of thing. I've been in the business close to 30 years and yes, it's a little bit more volatile but I think it's always been volatile. You go back to the GFC, you go back to 2010, for argument's sake, post-GFC, and you have a look. Every second day Greece was mentioned. The market just tanked, every second day. You go back to Japan in the 90s, you can go right through the whole era.

So is it a little bit more choppy? Yes, it is, but I think again in terms of the negative gearing strategy, a little bit like Kevin, who's been around for a long time, I personally think it'll be [around] a long time to come. I think you have to see through into the distance a little bit with your investments. You just can't take a one-month or a three-month or a six-month strategy. It's a long-term view. Again, if you looked at the performance of funds as a good example of the GFC, if you looked on a yearly basis everything was sorted. If you looked at it over a 10-year basis, it looked relatively smooth. I think negative gearing's exactly the same.

Now, I think the choppiness in the market, yes, I think it's been around for a long time and it'll be here to stay. [You've] got to be a little bit more selective with your timing, but I think the little bit more volatility that we've had in the last couple of years actually creates better opportunity than a benign market.

JM: I think that's one of the fundamental differences between gearing into shares and gearing into property. Property is one big bet. You can only just do one big bet on a... because you buy a $350,000 investment property or whatever it happens to be. You've just got one big one. Whereas Kevin was saying a lot of what people do in terms of building up, gearing into a share portfolio is by instalment.

Instalment, regular savings plan. Bits of which allows them to buy on the dip or do the strategic investment when it's the right opportunity and that volatility can actually be an advantage in that you're taking as much of a chunk as suits your circumstances and your appetite at the time. You're not having to do the $350,000 lump amount for a property. You can just do — all right, just do $10,000 today, $2,000 in a month's time depending on your circumstances and strategy.

EE: I was just going to say — sorry to interrupt. There's also a propensity in the advice world for advisers to actually pull back from regular contact with clients when things get choppy. [But] it's a contact business and it's holding your clients' hands.

The difficulty with shares as opposed to property, it that they're marked to market every day. Because most people don't go and get their property valued every quarter, and there's this common theme that if you're in property, everybody's making money, which is just not correct. Might be in Mosman or the eastern suburbs in certain pockets, but there is a lot of areas in property in the last couple of years where you bought off the plan a six-figure unit in the Meriton Building, for argument's sake, and you're under water. Yet there's this schematic that the share markets underperform and it's terrible. I'm sure at this table we could show plenty of portfolios that have done very, very well.

READ THE OTHER PARTS OF THE ROUNDTABLE HERE:

Leverage a valid strategy if used correctly – Margin Lending Roundtable Part 1
What a typical margin lending client looks like – Margin Lending Roundtable Part 3
Matching leverage to the right clients – Margin Lending Roundtable Part 4