Who needs gearing?

The question of gearing tends to be a divisive one for financial advisers, although whether they are considering abandoning margin loans and turning back to real estate backed finance via redraw accounts or lines of credit is so far unknown.

Perth-based investment adviser Philip Carman, never one to shy away from a contrary view, is critical of margin lending advocates.

“I think margin lending is a device to sell more shares. The golden rule is leverage — but conventional wisdom is nearly always wrong. Gearing is unnecessary. If you’re going to take risks, buy concentrated risk.”

Carman’s recommended portfolios contain only 30 per cent equities, no managed funds and no gearing.

“I have half a dozen equities, and I’m prepared to follow them closely. You put a stop sell on the downside and you also target the upside. You’re strict about both buying and selling.”

Carman claims he’s achieved 13 to 14 per cent from these portfolios, before tax, over the last few years.

“The trouble is that most people’s investment strategies tend to be set and forget. I think there’s still the possibility of a big drop in the broad Australian market.”

Nigel Littlewood, partner with Adelaide-based stock-picker MMC Asset Management, agrees with Carman’s gloomy forecast, saying the market is due for several years of underperformance.

He also points out that blue chip stocks can fall as easily as other stocks, giving Brambles, Mayne Nickless, Coles Myer, Lend Lease and News Corp as examples.

When asked for his views on margin lending, Littlewood repeated Warren Buffett’s quip that it was like driving a car with a stake aimed at your heart — difficult when you know what you’re doing, extremely dangerous when you don’t.

However, as befits his fund management role, Littlewood observed that margin lending against professionally managed funds made more sense than against individual stocks.

IFA proper authority holder Paul Hudson remains positive about the effects of margin lending, although mainly against managed funds.

“Who invests for just two years?” Hudson says, replying to a question about the effect of the market on the confidence of his clients. “You need at least five years,” he says.

“Margin lending is a wealth creation tool that suits people with high taxable incomes. I wouldn’t gear someone without a high taxable income.”

Having a high mortgage doesn’t preclude margin lending, he adds, “but it becomes an aggressive strategy. Clients should have income protection before they enter any gearing strategy.”

Hudson says his clients haven’t had any margin calls in his six years with IFA, partly due to his limit of 60 per cent on borrowings, and also to the fact that he unwound his clients’ gearing positions in international share funds a few years ago.

“For the adviser, it’s a much more intensive strategy than non-gearing,” Hudson concludes.

Glen Castensen, Berkley group managing director, is another who supports judicious use of margin lending, against both stocks and managed funds.

“Yes, some of our clients are geared, into stocks and managed funds. But it’s on an extremely selective basis. And the adviser must have a very transparent relationship with the client.”

KPR Financial Group planner Mark O’Leary says the group has some margin lending products on its approved list, but they are only available to a limited number of clients.

“It is a niche market and we recommend the products only to certain clients as part of a wealth-accumulation strategy,” he says.

“They must have a high disposable income and have the ability to service the debt at all times.”

O’Leary says potential clients for these products must understand investment risk.

“We do not over gear clients, only recommending gearing on a moderate basis such as a dollar-for-dollar.”

O’Leary says the planner must understand the need to diversify in margin lending to get the tax planning right and understand who owns the debt.

Banksia Financial Planning authorised representative Ray Page says his company has some margin lending products on its approved list, but he doesn’t use them.

“I see using margin lending products as a timing issue,” he says. “In the last five years, it has been the right time.”

Page argues the time to use margin lending is when the markets are down and there is value and growth still to be had in the investments.

“The problem is the clients do not want to use margin lending in bad times when there are opportunities, they only want to use it in good times, which is the wrong time,” he says.

“Margin lending is a product for tough markets with buying opportunities and not when markets are strong.”

Page says if margin lending is used the right way, it will deliver goals for clients.

Prime Time Financial Counsellors has no margin lending products on its approved list, principal Neil McMillan says.

“The client base we have here, which is mainly retirees, means it is extremely unlikely we would use a margin lending product,” he says.

“As a dealer, we also have to look at the compliance issues with the risk potential in the future.”

McMillan says he and his partner haven’t spent 14 years building up a business to have it come unstuck over offering an unsuitable product for their client base.

“If somebody came to us and asked about using a margin lending product, I would argue a case against,” he says. “If they insisted, we would go through the set of criteria we have to explain all the risks of margin lending. After that my partner would call them and run through the risks again so we have a double-filtering system that protects us for using a product without advice.”

Certainty Financial managing director Geoff Crewe says his group has margin lending products on its approved list, but they are used carefully.

“There has to be a commonsense filter before recommending them to a client,” he says.

“We are very conservative on loan ratios and we do look at other lines of credit that wouldn’t trigger margin calls.”

Certainty has a mortgage division that is used on some occasions and this avoids margin calls.

The group also limits who can sell margin lending products, mainly to the financial planning division. Plans using margin lending are cross-checked as a safeguard for both the client and the group.

“Margin lending is a viable option to maximise the accumulation phase of a client wealth creation, but it is not suitable for everyone,” Crewe says.