Managed Funds To margin or not to margin. That's my question?

Hi all,

I'd like your opinion in something I've being thinking lately. I'm wondering whether or not a margin loan for any of the Navra Funds still makes sense in the current environment. Variable and prepaid in advanced interest rates are >9% pa. If the Fund delivers 10% distribution pa this will mean that I'm risking someone else $ for a possible 1% return and this doesn't take into account any paper loss for the period. It'd be like working for the Bank for nothing and holding a liability on top.

Am I missing something?. Your comments would be appreciated.

Rgds,

artgul

 

I think you've pretty much answered your question. If you're only expecting 10%, then there is also a fair chance that you'll get less then that. Another rate rise or two and a lot of margin loans will be over 10%.

BR

 

according to the ASX russel report, the long term share market return is 12.8% PA.

 

During a Bull market the strategy makes perfect sense but, what would be the financial reason to do this on a Bear market?.

Thanks,
artgul

 

Except your opportunity costs...

If you have half of your investment purchased with cash, you are forgoing 6.5% bank interest...

The intention with an income fund is to generate income (duh), but you can do this with a bank account. It's only capital growth that makes a fund like Navra worthwhile:

eg $50k cash in the bank at 6.5% returns $3250 pre-tax, or $2266 after tax.
Predictable and boring, but safe.
(Assume 31.5% tax rate)

vs Margin loan with LVR 50%, $50k cash, $50 borrowed at 10% ML interest rate.
Assume fund returns 5% income and 0% capital growth.
Does this cover costs?
$5k income; $5k interest.
Tax refund from interest payments = .315*5k = $1575
Tax payable on distributions = $1575 (assume 0% franked and no CGT discount)
Net return after tax = 5000 - 5000 + 1575 - 1575 = $0.

Therefore costs are covered, but zero net income from the income fund! It certainly won't help finance other investments, whereas cash in the bank would leave you with $2266.

So what return do you need to 'beat the bank' at 6.5%?
Assuming 50% LVR (and no capital growth, no franking, no CGT discount, no deferred distributions) leads to
8.25% income (all marginal tax rates)

Or, assuming you have $50k cash, what LVR is desirable?

IR = Income return required to beat the bank at 6.5%
(again assuming 10% ML rate, no capital growth, no franking, no CGT discount, no deferred distributions)

LVR IR
--------------
20% 7.2%
40% 7.9%
50% 8.3%
60% 8.6%
70% 9.0%
80% 9.3%

See the spreadsheet if you're curious.

Or, if you're maths inclined, there is a really simple way to do this:

Required income return in % = (ML% - Bank%) * LVR + Bank%.

 

I invest in it for the same reason and am happy with capital fluctuations too. The issue I have with the gearing is that at current interest rates levels, all income those extra funds (gearing) are producing or could potentialy produce will go back to the lender. So what's the point?

 

Well, it doesn't take such a big calculation to work out that if the interest you get is less than then interest you pay then you're losing money (on the borrowed part of the investment). I wouldn't be risking it for only 1%, unless I was really expecting more and the 1% return was the most conservative estimate.

 

Anyone had a call from their financial planner advising them to lighten up on their exposure to the market or margin lending in view of increasing rate rises!! Probably not, there goes their trailer commissions, so how much use are FP's in current market climates!

 

I just spoke to Macquarie Prime on the phone.
Gearing is up to 95% for blue chip AXS shares, no buffers to worry about.

In other words, with 70% gearing, you could handle a 26% fall in the market before facing a margin call.