What a typical margin lending client looks like – Margin Lending Roundtable Part 3

Your typical margin lending client may not be who you expect him/her to be, especially when the pursuit of tax breaks is left out of the equation, 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

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MT: Well, who is lining up for leverage in margin lending at the moment? I mean, there was a very distinct cohort pre-GFC. Unfortunately, some of them were inappropriately geared. But there seems to be some much more settled approach to it post-GFC and more appropriate advice in that area. So if I could ask particularly the planners at the table here, what do you think defines the client who's looking to take leverage?

KF: Well, we've got probably two or three distinct groups of people who are doing this. We have the young upwardly mobile people who potentially don't want to buy property or can't afford to buy property yet, and who are saving for a particular goal in mind. Or those people who have forked out a large amount of money for their first property and are trying to look for a mortgage offset or mortgage elimination scheme over a 10, 15-year period.

So we've got those two lots of clients who are thinking about a long-term strategy, but we've also got a large group of clients, and also a growing group of clients, who are saying, "Well, we've got a lot of money. We're earning good money at the moment. We've put our $30,000 each in for mum and dad into super. That's all we can put in," and if they're over 50 we can put in $35,000. What next? We've got — if they're earning $600,000, $700,000, $800,000 a year and they're a medical specialist, well, they've still got excess capacity. They've got their house, they've got their beach house, they're got their superannuation maxed out. What do I do now?

Those are a growing number of clients in that area at the moment, and they're growing again for — potentially to help with school fees down the track, to potentially pay off the mortgage down the track, or to supplement their superannuation, because there's still a number of people who are still sceptical about super, the changes with super, what they're going to do with super, how they're going to — what sort of tax they're going to make you pay on super. So I think a lot of people like this idea of having this money outside super to be able to dip into, as I said, to take a trip and buy the holiday house, or offset the mortgage, or to put the kids through the best school. They're the people who we're looking at, at the moment, who fit into those categories.

MT: Earl?

EE: Look, very, very similar. I think that for us, it's a function of again, going back to the original comment, holding clients' hands and actually trying to work through a process of education with the client, because I think your comments are right. Pre-GFC, there was certainly some bad gearing, but the propensity is — I think in share markets it's far more emotional with property because of that mark to market.

The thing for us, there's a whole range of clients, and if you take out your certain pockets — whether they be the young, middle aged or whatever — and you just look at the opportunity, for me and for our strategy team, it's about going back to basics and saying buying people are selling, selling people are buying. You have to think that if you correlate interest rates to property movements, rates have gone down, property prices have gone up. That train's coming to the end of its cycle.

You would have to think maybe there's another quarter to half per cent on interest rates, so educating your clients — and we've got plenty of avenues to acquire property syndicates or whatever. We're not just generic equities. But then you look at equities and there's something like 1,000, 1,500 points off our all-time low. Banks essentially can buy in if they cut their yields by 25 per cent and still be positively geared if we take the franking credits. It is an extremely unique situation, very unique, and these windows I think are not there for a long time.

So I think there's a whole range of clients — there's not one particular group, but what we're trying to do, and we actually spend a lot of time educating through presentations and client groups, getting them in to try to take the noise out of the equation, stop reading the newspaper [and to] just go back to the real fundamentals and broaden their time horizon.

I think the challenge is so many people set a strategy and within three to six months read the newspaper and the strategy just changes, because every front page of the paper says something's going to change. It goes back to what you were saying, about every 20 years. My guess is you'll be doing it 20 years, we'll be doing it 20 years, and the strategy will still be the same, the legislation will be pretty close to the same, and not much will be changed.

It probably doesn't really answer your question specifically in terms of what group, but I think it's young, middle aged. Obviously every client situation is different. We're not finding any particular area that's exploding as opposed to others, but we're certainly spending a lot more time than what we did five or six years ago. We're really educating the client to an opportunity that exists now to try to get really steely focused on that medium to long-term goal, which is probably our biggest challenge, I think. Once you explain the strategy to them, that's the easy part. It's actually trying to keep the buggers focused on the provisional plan.

WC: My gearing strategy with my clients are very strict and specific. There's only one strategy I will undertake for them, which is gear with a collar, which means downside protection. What I look for in the clients who will use this strategy is cashflow capacity. They may be very high in salary, they may be high net worth, asset rich, but if the cashflow doesn't justify the amount of cash that will be needed to spend on hedging or interest payment, they won't be included in the gearing strategy.

Even those in the medical profession who have come through, $600,000, $700,000 type of income a year may have their other obligations like children's education and mortgages and what else. If the cashflow capacity isn't there, the strategy cannot be applied to them.

What we say is [we're taking] a long-term focus on what we're trying to achieve for you [which] is a long-term growth strategy with gearing, but with protection as well. But if cashflow does not justify taking this strategy then we have to stop, or not undertake the strategy, regardless of what tax aspect they might get out of gearing. So that is one key criteria — cashflow capacity of the client.

KH: I don't think there's one target market for gearing or borrowing to invest, but I guess that's the beauty about gearing, because you can have the young accumulator saving or accelerating your initial house deposit, using gearing to get to that point so they can then get a mortgage.

[It] can then follow the life cycle — education for school children down the track, et cetera. Then, as you were saying Kevin, outside of superannuation, doing something outside of the superannuation regime so that you're not solely relying on any legislative changes around that, but having a nest egg outside of that.

KF: Superannuation has inherently — it continues to change, and I think there's still a number of people who have this fear of super; that Government's going to change something or do something, and there's also the question of preservation — we all know, you can't just access your super when you're 53 when you need it.

There could be a situation that's existing for a child or for a family member they want to help. We have a continual number of clients who want to give their money or help the next generation before they retire, not after they retire, so they can make a meaningful contribution to the next generation while they're alive and while they're seeing it — while they need it, not when they're in their 50s or 60s.

So this gearing pot, we've had many clients, for example, who've said, "I want to use it to use for my first deposit for my first home". They paid off their mortgage and now they're using it to say, "I'm going to use it for the kids' education," and may not even use it for that. They maybe use that to help their kids buy their first apartment or their first house. So with — the strategy can be a moving, changing strategy as well, so as long as you keep the fundamentals right, the strategy can go from a 25-year-old to a 55-year-old. If the strategy and the right cash flow and the right management, the right everything's — if all the stars align, it's a great strategy, and as relevant today as it was 20 years ago, and 20 years from now will be as relevant as it is today.

JM: Well, I think it's been covered. I think as we've said, in summary, it's suitable across all life stages. I think that the cashflow comment is absolutely critical irrespective of whether you're doing a collar strategy or not a collar strategy. I think also — as has been said around this table, it doesn't start from a tax perspective. It starts from a what's your goal, how do we get there, what's the long-term, how do we keep it in mind, can you afford it in terms of cashflow, and all that sort of stuff.

I think this is often the problem with the way gearing and so forth has been talked about, it starts off this conversation about tax and whatever and sit there and say well, you know and I don't think that's the reality of what good advisers do to their customers. I think it's everything you guys are talking about. So unfortunately, I think you're quite right as well in terms of the true worrying — the concern, I think, for a lot of investors or customers or people out there, is not so much negative gearing or not negative gearing, whatever that might look like. It's what are going to be the next round of changes to superannuation, because that's continually being tinkered with.

Leverage a valid strategy if used correctly – Margin Lending Roundtable Part 1
Leverage and volatility a safe mix? – Margin Lending Roundtable Part 2
Matching leverage to the right clients – Margin Lending Roundtable Part 4