Join our investing community

Help on Protected Equity Loan advice

Discussion in 'Investing Strategies' started by lync, 5th Dec, 2007.

  1. lync

    lync Member

    Joined:
    4th Dec, 2007
    Posts:
    9
    Location:
    Adelaide, SA
    Hi all,

    This is my first real post, so here goes. I am in my forties, and as of recently no longer support my children, so am in a new phase of my life. So, our thoughts turn to wealth building.
    My partner has an IP which used to be his PPOR, with equity of about $200k. The PPOR has equity of about $100k. We have switched from Margin Lending facilities to $100k equity loans against the PPOR due to the lower interest cost. We are using some of this at the moment on Direct share investment

    We have just refinanced our PPOR and IP loans into a package with a big 4 bank, and as part of that, our banker suggested we could see an FP at the bank. Despite our reservations about the value to us of a FP, we decided to check it out. He initially suggested an equity loan to invest in Managed Funds. This was prior to preparing an SOA. We asked lots of questions about costs, but agreed to go ahead with paying him to prepare the SOA. He changed his recommendation in the SOA to suggest a Direct Share Portfolio using a Protected Equity Loan product, over a 5 year period. His explanation was that there is a risk of market downturn in the future. We have about $10k p.a. of free cash flow that we are prepared to apply to whatever we decide to do.

    I punched his stuff into a spreadsheet of my own, as I couldn't make any sense of the one he provided, and I'm buggered if I can make such a product stand up, mainly because the interest rate (which includes cost of a put option and capital protection), is around the 14% mark. I calculated that I would still be better off if such a portfolio lost 5% p.a over a 5 year period by just investing directly using the equity loan at, say, 8%. Actually, in this instance, we might as well just pay off the mortgage on our PPOR.

    Now, since my partner is highly sceptical of Managed Funds , and would prefer direct investment, we think we're probably seeing the wrong guy, as he can't (and probably won't) advise us on direct share investments without it being linked to a bank product). My problem, is I feel like we need to do something structured, due to my own lack of financial discipline in just paying off my mortage. We are thinking about going to see a Sharebroker and signing up to some kind of Portfoio Management service, for about 1% p.a.

    I'm sorry this is very long-winded, but I have a gut feel that that, for our risk profile of Medium to High, then the capital protection premium we would be paying on the PEL product is really too high, as we don't mind taking a few losses along the way? Does anyone have an opinion on this?

    Thanks
     
  2. samaka

    samaka Well-Known Member

    Joined:
    30th Sep, 2007
    Posts:
    308
    Location:
    Sydney
    Maybe ETF's? Liquidity and control of a share. Diversification of a managed fund. Returns (hopefully) comparable to an index.
     
  3. Nigel Ward

    Nigel Ward Team InvestEd

    Joined:
    10th Jun, 2005
    Posts:
    1,172
    I can't comment on your specific circumstances but I really don't think there's any place for these high priced capital protection products...

    IMHO they only benefit the promoters...
     
  4. lync

    lync Member

    Joined:
    4th Dec, 2007
    Posts:
    9
    Location:
    Adelaide, SA
    Thanks for the replies.

    Nigel, you confirmed what we thought about the costs of the PEL.

    Samaka, thanks for the suggestion on ETF's. I'll have a look into them. I like the idea of exposure to LPT's or Internationals through these vehicles.

    We have invested in LIC's over the years, eg Argo.
    Is the only difference the fact that ETF's are purely index-hugging funds?

    Lync
     
  5. AsxBroker

    AsxBroker Well-Known Member

    Joined:
    8th Sep, 2007
    Posts:
    1,448
    Location:
    Sydney, NSW
    Hi Lync,

    I am interested in why the financial planner changed his mind...You didn't pay him to change his mind. If he thought the information was so important he could have added it in.

    "He initially suggested an equity loan to invest in Managed Funds. This was prior to preparing an SOA. We asked lots of questions about costs, but agreed to go ahead with paying him to prepare the SOA. He changed his recommendation in the SOA to suggest a Direct Share Portfolio using a Protected Equity Loan product, over a 5 year period"

    The five years sounds like a Macquarie product which is usually more expensive than most others. Perpetual also has a similar product which is cheaper cost comparatively though is in managed funds, which your partner probably won't like.

    I'd be going to kick some more tyres and speak to some more financial planners, if the stuff isn't adding up there is probably a reason
    "I punched his stuff into a spreadsheet of my own, as I couldn't make any sense of the one he provided, and I'm buggered if I can make such a product stand up, mainly because the interest rate (which includes cost of a put option and capital protection), is around the 14% mark. I calculated that I would still be better off if such a portfolio lost 5% p.a over a 5 year period by just investing directly using the equity loan at, say, 8%. Actually, in this instance, we might as well just pay off the mortgage on our PPOR.
    "

    14% is a massive cost, I'd be looking around for another planner because it sounds like it's going to end in tears. There is NO way the planner can tell you that ANY risk profile can make that as an average return.

    Good luck,

    Dan

    PS The above is general information and not a recommendation for any product. Before making an investment decision speak to your FPA registered Financial Planner, Accountant or Tax Adviser.
     
  6. willy1111

    willy1111 Well-Known Member

    Joined:
    5th Jul, 2006
    Posts:
    54
    Location:
    Melbourne
    Sure 14% sounds high off the bat, but your probably paying 9% for the loan and 5% for a 1yr put option. You probably wouldn't get it any cheaper trying to get both the loan and put option yourself.

    You just need to weigh up whether you think it is worth paying 5% p.a. to protect your money.

    If we were to hypothetically have a 1929 or 1987 style crash of 50% in the market - I think you would be kicking yourself saying we could have only lost 5% if we went for a PEL.

    on the otherhand if the market continues on its merry way - you'll be kicking yourself for waisting 5% a year.

    Realistly though - considering some of the major banks pay dividends of 5% plus franking credit, you would be looking at a return of 7%, provided they have capital growth of 7% you would be infront.

    So if you looked at your risk on $100,000 for a year, you would basically be risking $7,000, (as you would get the dividend/franking credit). If the market crashed or the stock didn't perform that is your worst case scenario.

    If you went direct without protection, you would probably pay interest of 8%ish, so a negative cashflow of $1,000 for the year, but your worst case scenario could be risking $50,000 if the stock fell 50%. Ok - most likely a pretty low low probability of this happening - but a possibility you need to consider all the same.

    I don't think there is a right and wrong answer, you just need to weigh up what risk/returns are right for your personality.
     
  7. Rob G.

    Rob G. Well-Known Member

    Joined:
    6th Jun, 2007
    Posts:
    717
    Location:
    Melbourne, VIC
    My guess is that the put option is priced very high as they expect a correction is nearly certain within the 12 month timeframe.

    Rather than jump in with all your equity in one go when the market is at a peak, why not borrow in smaller bites over the next couple of years to average your cost without completely missing out on any remaining gains that might still be there.

    That way, if your property values are suppressed, you are not forced to sell securities in a falling market without your put option as well.

    If you do go for a put option with direct investment, you will need advice on whether it affects your dividend imputation eligibility. The option cost is also not deductible, but adds to your cost base for CGT.

    Cheers,

    Rob
     
  8. lync

    lync Member

    Joined:
    4th Dec, 2007
    Posts:
    9
    Location:
    Adelaide, SA
    Thanks all,

    Re your comments ASXBroker, I too was intrigued as to why he changed his advice. I think he picked up from us that we weren't keen on the Managed Funds with a Wrap Platform scenario that he originally suggested (I'm not opposed to MF's per se, but wonder about the cost effectiveness of a Wrap account when we are perfectly happy and capable to manage the tax and admin matters without one). I also got the impression that he thought we might be interested in something a little more "sexy", and also they probably have a view lately that there is going to be a correction.

    It's actually a Westpac product. Each stock within the portfolio is protected individually, you hand back any loss makers at the end of 5 years, and keep the profit makers. I agree that the risk premium is too high. After all, the time horizon is 5 years (it's locked in until then). So if we have, say a 50% correction next year, chances are in 5 years time that loss will have been made up, and we will have the worst possible outcome from such an arrangement, ie, a small positive return on all stocks, which means I paid a massive premium for something I didn't need. At least at 8% in such a scenario, I am better off than that.

    I just don't think we are that risk averse.

    Rob, I have been considering what you suggest, ie don't go in boots and all. Say start with 60%, and keep some up our sleeves to buy up if/when the correction comes, or do a constant drip feed. We wouldn't try the put option strategy on our own. I prefer to keep it simple at this stage.

    An article in the News Money section this morning on Top 20 stocks has me considering doing a "10 of the Top 20" set and forget kinda thing. Here's the link.

    Top 20 a rock solid investment | NEWS.com.au
     
  9. bundy1964

    bundy1964 Well-Known Member

    Joined:
    22nd Dec, 2006
    Posts:
    351
    Location:
    Adelaide, SA
    I do hold 18 of the top 20. SFY does get you into the top 50 and STW gets you the top 200 which is easier than spreading yourself around too thinly to diversify. SFY does pay a slightly higher dividend but is around 25% of the liquidity of STW it can work for you or against you. I can margin both at 70% and the property index at 60%. I do also use the Ishares indexes as well for diversification out of Australia.