Can Gen X and Y investors save margin lending?

The last year has not been kind to the Australian margin lending market, with further declines in the number of active investors. But a potential rally in the equities market and interest from a new generation of investors could be providing a few glimmers of hope, writes Freya Purnell.

A mortgage with training wheels – it’s a term you probably won’t find in any of the marketing spiels about margin loans, but that’s exactly how a new generation of investors is using margin lending.  

While the numbers might still be small, Gen Xs and Ys are choosing to open new margin lending accounts at the instigation of a financial adviser.  

They’re bucking the prevailing trends in margin lending in a number of ways.  

“It’s very much part of a deliberate wealth creation strategy at the advice of a professional,” says Alexandra Tullio, head of wealth markets, Bendigo Wealth.

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“They are using their margin loan facility to build wealth for their first mortgage, or to upgrade their current house to a more premium property.”  

While Gen Xs are more aggressive in gearing levels and have larger account balances, the Gen Ys have smaller balances and are still being quite cautious in their forays into gearing.  

“This is a new generation of people looking at gearing as a wealth creation strategy, and it does bring new opportunity to the industry, but they are going into it with the lessons learned from the previous generations over the last decade,” Tullio says.  

It’s a bright spot in what is otherwise a fairly gloomy picture for margin lending.  

In 2012, the Australian margin lending market continued its decline. From a high of $42 billion five years ago, by September 2012, the total value of the margin lending market in Australia had shrunk to $12.7 billion, according to RBA figures. 

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The Investment Trends September 2012 Margin Lending Investor Report showed that the number of active margin lending investors fell from 119,000 in September 2011 to 95,000 in September 2012. This compares to around 150,000 active investors in December 2009.  

While 6000 new borrowers entered the margin lending market last year, compared to 9000 in 2011, and 4000 ‘dormant’ borrowers re-entered the fray, 30,000 stopped using margin lending. 

This lack of interest can be partially attributed to the generally uninspiring picture painted by the equities market in recent times.

But the blame must also still be laid at the door of the fear and risk-aversion characterising the post-GFC investment environment – a world in which ‘gearing’ or ‘leverage’ seems to have become synonymous with ‘loss’. 

The legacy of Storm Financial, the collapse of other businesses such as MFS Global, where leverage was a key part of the mix, and a tidal wave of margin calls is proving difficult for advisers to shake off, with many choosing to steer clear of margin lending.

But investors’ memories may be shorter – and margin lenders are hoping to woo them with more conservative lending strategies, products that reduce the risk of margin calls and access to new technology options to bring investors closer to the market.  

 The next wave 

Another promising sign is a surge in the number of ‘next wave’ borrowers – identified by Investment Trends as those who do not currently borrow to invest, but who have stated an intention to potentially do so within the next 12 months.

While this group has also been in decline over the last couple of years (from 90,000 down to around 30,000 in 2011), in 2012 it suddenly doubled to 57,000.  

Typically the conversion rate of those who said they intended to commence borrowing and then actually did so is around 20 per cent, so if this rate was maintained, 11,000 potential borrowers would be expected to commence margin lending over the next 12 months, compared to only 6000 over the previous year.  

Investment Trends chief operating officer Eric Blewitt says: “It sounds like the ears are pricking up and the eyes are starting to look.

Not everyone will effect a margin loan, but historically a fair number have”. 

A higher proportion of current margin lending investors also expect to increase their borrowing level over the next year at 39 per cent, compared with 33 per cent last year, while 41 per cent expect to keep their level of borrowing the same.  

Blewitt believes this upturn is being driven by investor perceptions of an improving market outlook and lower interest rates. 

“When we carried out this research [in September 2012], about 78 per cent of investors were saying that Australian stocks are currently undervalued, so they’re seeing potential value in the market.

Interest rates on margin loans have come down, and the yield on the market generally speaking is around 5 to 5.5 per cent in terms of dividends.

So the ducks are starting to line up at an investor level,” Blewitt says. 

And while there is still a high level of conservatism among investors, who are questioning whether we are seeing a genuine rally in the market, margin lenders are reporting a significant lift in the number of new accounts which have been established over the last three months.  

Brian Phelps, general manager, retail division, CommSec, says that the CommSec client base is mobilising quite quickly, with 30 to 40 new margin lending accounts being established each day now, compared with around 15 a days six months ago.

He admits that there is not a huge amount of activity on those new accounts - rather clients are “putting their toe in the water and testing what the opportunities are”.  

NAB head of margin lending Adrian Hanley also reports a threefold increase in the number of applications between now and this time last year.

There has been a substantial increase in the number of margin lending applications coming from self-directed investors, with 30 to 40 per cent now coming from this group rather than financial planners and stockbrokers, up from around 10 per cent, which he attributes to the launch of NAB’s online trading platform in November 2012.  

Hanley has also observed a shift in the sentiment around margin lending.  

“As cash rates were drifting down towards the second half of last year, people began to see the opportunity to generate a positive carry on geared portfolios.

"Then obviously what we saw in the tail end of last year to now is obviously [improved] sharemarket performance, so the growth that has kicked in for a lot of portfolios has stimulated a higher degree of interest in margin loans,” Hanley says.  

Coming out of hibernation 

Uncertainty about global debt issues and the general market conditions drove an increase in the number of dormant investors over the last year, from 18,000 in 2011 to 46,000 investors in 2012. 

With 22 per cent of dormant borrowers becoming active in 2012, if this conversion rate remains the same, there could be an additional 9000 dormant clients returning to the pool of active margin lending investors over the next 12 months.  

Tullio says Leveraged Equities has seen investors start to draw down on their existing loans. 

“For example, investors have had loans sitting there ready to go based on what the market is doing but not necessarily drawing down, so we’re seeing that start to increase,” she says. 

At CommSec, much of the current margin lending activity is coming from its existing base of clients – demonstrating the ‘dormants’ may be getting ready for action. 

“We’re seeing a great deal of stock being pushed back into margin loans that had previously been moved out and just sitting in equity accounts. That suggests that these clients are ready and waiting in the wings to take advantage of any market movement or opportunity they see,” Phelps says.  

Financial planners holding back 

Investors may be getting more bullish on margin lending, but planners are still much more circumspect.  

Blewitt says that though 84 per cent of advisers shared a similar view to investors that Australian stocks are undervalued or substantially undervalued, and a vast majority believe that most investors are unaware of how to use margin lending in the market, only 34 per cent of advisers feel that margin lending is a safe investment strategy – a view which is not borne out in fact, in his view. 

“We still see sentiment and perception driving a lot of things. Much as there was a fair amount in the press about margin lending and how bad it was with Storm and all the margin calls at the time, the harsh reality of the situation was that looking at the RBA figures on margin calls, it was actually only about 20 per cent of borrowers [who were affected],” Blewitt says.

“If people are utilising margin lending, well-constructed, conservatively geared, against a diverse range of assets, it definitely has a place as part of a genuine wealth creation strategy.”  

Phelps says advisers are slowly reactivating in relation to margin lending, showing more interest than they have in the last three years.  

But planner reticence could be a major issue in whether or not the promise of changes in market conditions actually translate to increased use of margin lending facilities.  

“We’ve almost got this consumer demand building up, so the advisers are saying, if the client wants it, fine, but we’re not necessarily proactively going down the route of recommending, given the legacy,” Blewitt says. 

Being able to respond to client requests is also the driving force behind financial planners seeking to add margin lending as a financial product to their AFSL [Australian financial services licence].

Though Innoinvest principal Su-King Hii is seeing considerable demand for this, it is mainly so that advisers can have the option of recommending margin loans to clients, rather than the momentum generated by a high take-up rate. 

“From the SOAs [statements of advice] I’ve seen, margin lending is virtually non-existent in the recommendation strategy,” Hii says.  

Best interests duty not the best for margin lending  

Ongoing regulatory changes may also be tempering planner enthusiasm for margin lending.  

Margin loans were regulated as a financial services product in 2010, with responsible lending provisions and a suitability test for all clients introduced.

The duty to ensure that the margin lending products that they recommend are suitable for the individual client seems to have been absorbed relatively easily by providers and advisers. 

“It affords clients and advisers a greater level of comfort in that we certainly cannot provide a margin loan these days to a retail client unless they provide us with enough information to make a proper assessment as to whether they have the ability to service the loan and meet margin calls,” Hanley says. 

But the ‘best interests duty’ introduced as part of the Future of Financial Advice (FOFA) reforms is causing more consternation.  

“From an adviser’s point of view, they have some concerns about FOFA and what the best interests obligation might mean, so that’s why I think people are still shying away from it,” Hii says.

“They say they don’t know what is best interest, especially if you’re talking about geared product like margin lending.”  

With guidance from the Australian Securities and Investments Commission on the best interests obligations still forthcoming, this uncertainty is expected to continue beyond the legislation start date of 1 July 2013. 

Loan sizes and gearing levels down 

With the ‘scar tissue’ from the GFC still present, investor and planner conservatism is being expressed through lower gearing rates and smaller loan sizes, with average gearing levels across the industry falling from 35 per cent to 33 per cent just in the last quarter.

This is a very different picture to December 2008, where gearing levels were well over 50 per cent. 

At Leveraged Equities, average gearing levels are sitting at 30 per cent, with average loan balances of $90,000, while at CommSec the average margin loan is $75,000, with average gearing levels of 40 to 42 per cent.  

“I think investors have heard the warnings of the last couple of years and they’re using margin lending far more conservatively than they may have been five years ago,” Phelps says.  

Among active investors, there is also a shift in the way they are using margin loans.  

“What we’re seeing is that our margin lending portfolio is very heavily skewed to the top 50 stocks in the ASX 200, and our clients are using margin loans as more of an investment-driven tool to pick up new dividends over time,” Phelps says.

“Interest rates have come down, so there is a greater opportunity for return there, and it is about being able to trade larger volumes.”  

Competing for investor dollars 

Following a post-GFC consolidation in the industry, from around 15 players to the current eight – a list dominated by large institutions – there has been little change in the number of margin lenders.

What does change is how the survivors try to attract more of the small pool of money, by competing on price, service or various product enhancements and options. 

Canstar senior financial analyst Mitchell Watson says: “There are some lower cost providers such as Macquarie Prime which in comparison to some of the other lenders are priced quite competitively. 

“With the cash rate cuts which occurred last year, some of those were passed on in full to margin lending customers, whereas some only passed on a portion, so that could be viewed as some lenders looking to compete on price for margin lending.” 

Reducing the risk of margin calls is at the top of the priority list for many investors, and some margin lenders have introduced product enhancements in response to regulator requests for them to become more robust in the configuration of clients’ portfolios, according to Phelps.  

“We noticed in 2008 that investors had about four shares securing their margin loans. By offering them a better LVR [loan to value ratio] if they diversified their portfolio to eight to 10 stocks, we’ve been able to get clients to massively diversify.

"Now we see that most of our clients hold 10 or 11 stocks in their portfolio on average,” he says. “Work we’ve done with our quant analyst shows the chance of a margin call reduces to less than 1 per cent in that circumstance.”  

CommSec also penalises clients who only have one or two stocks in a margin loan portfolio by reducing the available LVR. 

The closest thing to a ‘no margin call’ product Leveraged Equities offers is its Investment Funds Multiplier.

Currently restricted to managed funds, Tullio says the company is currently in the process of adding exchange-traded funds as one of the acceptable securities.  

“Our research tells us that many investors want a product that doesn’t carry the risk of a margin call. So what we have done with this product is structured a repayment program to kick in where a traditional margin call would otherwise have been triggered,” she says. 

For its part, NAB has gone after the SMSF market, launching NAB Super Lever in July last year, which allows SMSFs to borrow to invest in listed shares and unlisted managed funds.

Hanley says there has been significant interest in the product to date, but education of clients and advisers to choose the right strategy has been critical due to the complexity of the environment.  

“Because the clients operate in a low-tax environment, it’s not as attractive to be negatively geared as it is in a higher tax environment, so we see clients looking to employ strategies where they’ve got positive cashflow in a margin lending facility in the self-managed superannuation fund,” Hanley says. 

He also sees demand for broadening lending lists, providing access to international stocks or corporate bonds.  

“Having the ability to lend against those assets so people can broaden their investment universe is important.” 

Access to technology 

While some investors are happy to effectively ‘set and forget’ their margin lending strategy and to rely on their adviser’s guidance, others want to be much more hands-on in their monitoring of the market and their active positions – and margin lenders are upgrading their technology to respond.

Being more informed could also make slightly jittery investors feel more confident that they are on top of things.  

Watson says many margin lenders are introducing changes and innovations in the mobile space, creating specific applications for iPhone, iPad and Android for use with margin lending facilities – particularly those which are attached to a trading platform.  

For example, NAB Equity Lending has recently invested in optimised reporting for clients and advisers who wish to access their website through mobile devices.  

“Investors want to be close to the market, and typically when people are looking at websites or logging in to view their financial positions, they’re using smartphones to do it, so the optimised website now offers a much better client and adviser experience,” Hanley says. 

Similarly, CommSec has also developed a strong mobile application capability, which has been strongly adopted by users.  

“We now find that as many as 50 per cent of our clients are now logging in during the course of any week to check on the configuration of their portfolio, look at the research offerings we have, check the watch list they operate around their accounts and basically administer their accounts,” Phelps says.

“They’re not using it dramatically for trading, although that is starting to grow. They’re using the technology to keep abreast of the happenings in their account, then they go back to their home or work computer and place their trades, and think more deeply about how they’re going to transact.” 

Having this mobile capability also allows CommSec to take client notifications of looming margin calls one step further. In the past, when clients reach the buffer zone for a margin call, they typically received a text message by SMS, advising them of their options.  

“What we’ve found over the last couple of years, the volume of people going into margin call is negligible, on the basis that they react to this message.

"With the prevalence of smartphones and iPads among our clients, we can push those messages out intra-day, and they could have reacted before market close in the afternoon,” Phelps says. 

These developments will improve the user experience as well as helping investors to obtain market insights, from the trading software or independent research.  

“These are all going to assist the user make a more informed decision on the outlook to gear into a product or invest their own money in shares,” Watson says.  

Providing a high degree of integration between margin lenders and platforms used by financial planners and stockbrokers is also crucial to simplifying the process of managing margin loan facilities on behalf of clients. 

“When advisers are sitting in their office, they don’t even have to log onto our website, they can access that information from their own desktop. That’s where we see technology playing an increasingly important role,” Hanley says.

“If we can bring our business closer to the market, so clients can see exactly what’s their position and how it’s changing through the day or week, that’s really critical. Then the client and adviser are making more informed investment decisions based on what’s happening.” 

Outlook 

Despite these positive changes and the promise of a new generation of investors, the consensus is that to see sustained growth from the margin lending market, more consistent market performance will be required, and with some not expecting the full effects of a market correction to be felt until the end of 2013, the support of these fundamentals may be a way off yet.  

Investors are still holding cash, the number of online traders in Australia has dropped off to one of the lowest levels in some time, and while money is entering the market, it’s coming from normal flow, not from where it is has been parked in cash.

Ultimately, margin lenders may still have to overcome the effect of conservatism and caution to gain a real foothold again.  

“To see a substantial uptick in the market, first people have to have the confidence to invest on an ungeared basis,” says Blewitt.

“That defies logic, because if you’ve got the conviction to invest, a sensible wealth accumulation strategy using margin lending is probably sensible – but that’s logic, and we’re not dealing with that.”