Join our investing community

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

Discussion in 'Managed Funds & Index Funds' started by artgul, 17th Jan, 2008.

  1. artgul

    artgul Well-Known Member

    Joined:
    16th Aug, 2005
    Posts:
    77
    Location:
    Sydney
    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
     
  2. Bantam Roosta

    Bantam Roosta Well-Known Member

    Joined:
    7th Feb, 2007
    Posts:
    115
    Location:
    Canberra, ACT
    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
     
  3. crc_error

    crc_error The Rule of 72

    Joined:
    1st May, 2007
    Posts:
    1,367
    Location:
    Melbourne, VIC
    according to the ASX russel report, the long term share market return is 12.8% PA.
     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

    Joined:
    9th Jun, 2005
    Posts:
    4,623
    Location:
    Sydney, Australia
    So be conservative with your gearing then ... at 50% LVR and 10% interest rates, you only need 5% distribution pa to cover your costs.
     
  5. artgul

    artgul Well-Known Member

    Joined:
    16th Aug, 2005
    Posts:
    77
    Location:
    Sydney
    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
     
  6. Simon Hampel

    Simon Hampel Co-founder Staff Member

    Joined:
    9th Jun, 2005
    Posts:
    4,623
    Location:
    Sydney, Australia
    Well then we need to ask yourself why would you even invest during a bear market ? Gearing will make it worse, but not gearing will still lose you money if the fund is going down in value. At least on paper anyway - although the holding costs are very real with gearing!

    Now since we are discussing Navra specifically, you need to ask yourself why you have invested in this fund.

    If (like me), you have invested for the cashflow it generates, and are happy to ignore the fluctuation in capital value as the market moves up and down ... then some modest gearing should help you generate higher income - even in a bear market.

    This of course assumes that the fund is able to continue to generate sufficient trading profits in a down market ... which we haven't really seen yet (last quarter doesn't count). Ask me again at the end of March and I might have a clearer picture for you :D

    I prefer to look at the income generated on an annual basis - I can cope with a couple of quarters of low income, provided that over the course of the year the fund is generating at least 10% (preferably 12%+) ... which I think it will most years.
     
  7. Rod_WA

    Rod_WA Well-Known Member

    Joined:
    18th May, 2007
    Posts:
    324
    Location:
    Inglewood, WA
    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%. ;)
     

    Attached Files:

  8. artgul

    artgul Well-Known Member

    Joined:
    16th Aug, 2005
    Posts:
    77
    Location:
    Sydney
    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?
     
  9. EMP

    EMP Active Member

    Joined:
    18th Feb, 2007
    Posts:
    30
    Location:
    Melbourne, VIC
    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.
     
  10. Simon Hampel

    Simon Hampel Co-founder Staff Member

    Joined:
    9th Jun, 2005
    Posts:
    4,623
    Location:
    Sydney, Australia
    The point is it depends on how much income the fund generates over and above the interest rate you are paying.

    If the fund continues to generate 16%+ income returns like it has for the past 4 years (yet to be seen), then increasing your investment via gearing at 10% is still worthwhile - although at some point you have to make a judgement about the risk factor.
     
  11. redrover

    redrover Well-Known Member

    Joined:
    16th Aug, 2005
    Posts:
    131
    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!:(
     
  12. Rod_WA

    Rod_WA Well-Known Member

    Joined:
    18th May, 2007
    Posts:
    324
    Location:
    Inglewood, WA
    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.