New-found respectability for sophisticated product

Margin lending is a product that has traditionally polarised finan-cial planners. While it has enjoyed strong support from a number of planners, some have preferred to steer clear of gearing altogether.

However recent growth suggests this level of polarisation is consid-erably diminishing among financial planners, and that margin lending is gaining wider acceptance.

This can be seen in the fact that the number of margin lending pro-viders continues to grow - again this year we have seen seve

Margin lending is a product that has traditionally polarised finan-cial planners. While it has enjoyed strong support from a number of planners, some have preferred to steer clear of gearing altogether.

However recent growth suggests this level of polarisation is consid-erably diminishing among financial planners, and that margin lending is gaining wider acceptance.

This can be seen in the fact that the number of margin lending pro-viders continues to grow - again this year we have seen several new entrants, with the number of providers growing to 18 from around five in 1995. The growth is also reflected in our own adviser-dominated business, with the number of new loans received this financial year more than double that of last year.

So why then does margin lending continue to experience such wide-spread growth - especially when noise from the ever-present debate on whether now is a good time to gear is as loud as ever?

One obvious reason is increasing sharemarket awareness among the gen-eral public. Successful public floats like Telstra, and the recent demutualisation of AMP have given people a better understanding of equity markets, with many taking the next step to gearing.

But perhaps a more important reason for margin lending growth, and indeed for sustainable growth, is the way that financial planners have been applying the product to their clients' investment strate-gies. In particular, we've seen a marked trend towards tighter risk management, and an increased level of sophistication.

Tighter Risk Management

Evidence suggests that financial planners are adopting a tighter ap-proach to risk management. A recent review of our client base shows:

* In the current market advisers are gearing their clients quite con-servatively. The average gearing ratio is presently 42 per cent, as opposed to 51 per cent just three years ago.

* Advisers are diversifying their clients more effectively. Individu-als with a margin loan hold on average eight stocks, as opposed to shareholders in general who hold on average three stocks (source ASX).

* While the public often relates gearing only to listed securities, advisers are gearing their clients' managed funds. Out of more than 500 securities against which individuals can borrow against, the most popular security is an Australian share managed fund

To quantify the above trends, we could apply the above assumptions to a hypothetical investor. In this case, an investor using our facility and geared at 40 per cent into a Australian share managed fund, would need to experience a 42 per cent fall in the value of this fund to experience a margin call. Clearly advisers are taking advantage of the fact that, as an inherent part of the product, they can control the level of risk taken by their clients at a given point in time.

Sophistication

The basics of margin lending appeal to a wide range of investors. On the positive side, margin lending gives clients the possibility of creating wealth, through increased sharemarket exposure and increased diversification. On the downside, increased exposure could also am-plify losses.

Also, the benefits on the tax side of things are broadly recognised - any interest prepayment made for the following financial year may be eligible for a tax deduction in the current year.

But while the basics remain, a number of planners are introducing some of the more sophisticated margin lending strategies to their clients. For instance, some financial planners recommend third-party loans - giving their clients the possibility of miminising a couple's tax burden through the rearrangement of income and debt structures.

Perhaps more sophisticated are two strategies that were the theme for a recent series of BT Margin Lending seminars - gearing into interna-tional share funds, and borrowing to make additional superannuation contributions. These strategies raised significant interest among planners, because it was previously believed that there were much greater tax implications in gearing into international shares, while legislation prohibited the use of margin lending and superannuation.

International shares

Gaining exposure to offshore markets makes a lot of sense, particu-larly because some of the major sectors of foreign markets aren't ac-cessible in Australia - technology, pharmaceuticals, and electronics to name a few. The benefit of margin lending is that it allows inves-tors to use their existing Australian holdings, and not realise capi-tal gains to enter these foreign markets through an international managed fund.

One issue associated with this strategy is that interest costs against foreign income may not be fully tax deductible. However, what is not realised by most is that foreign income generally only makes up a small portion of the income distributed by international share funds. The remaining amount is generally realised capital gains, which is actually treated as Australian sourced income for taxation purposes. Hence the impact of foreign income on tax may not be sig-nificant. We believe that once armed with this knowledge, financial planners will see margin lending as a viable way of getting their clients internationally diversified.

Superannuation

While it is true that you can't gear a superannuation fund with mar-gin lending, you can use existing holdings that aren't in a superan-nuation environment to make additional contributions. This has par-ticular relevance now, with superannuation preservation rules chang-ing on July 1.

The benefit of this strategy is that earnings made in a superannua-tion environment are only taxed at 15 per cent, as opposed to your client's marginal tax rate. The downside is that interest costs aren't tax deductible, and the investment isn't accessible should you need to access funds.

Ends