Gearing up: Utilising leverage in investment portfolios | BetaShares

Gearing up: Utilising leverage in investment portfolios

BY BetaShares ETFs | 5 April 2016
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Like most kids (and many adults I dare say), my three young girls love playing with Lego.

With such a big age difference between my eldest (11) and youngest (4) we regularly have both “Lego” and “Duplo Lego” out simultaneously. For those who don’t know, Duplo is Lego for smaller children being twice the length, height and width of traditional Lego. While building towers using both types of Lego and watching the Duplo tower growing at twice the rate of the traditional Lego tower using the same number of blocks, I started thinking about building wealth using a gearing strategy within an investment portfolio. A gearing strategy is, in some ways, similar to those Lego towers – investors employ the same amount of their own funds (or building blocks in my analogy), and combine these with borrowed funds creating a larger investment (the Duplo in my example), which has the potential to grow wealth faster. Of course, unlike Lego, using leverage is not child’s play so let’s look at some research.

According to the ASX/Russell Investments Long-Term Investing Report released in June 2015, an investment which used gearing compared to an ungeared investment lead to an outperformance in returns for both Australian shares and residential property over a 10 and 20-year timeframe to end December 2014.  In addition, for investors in the lowest marginal tax rate, geared Australian shares outperformed geared investment property over both time periods after tax. This is likely in part due to the additional benefit of franking credits.  The full report can be found here. Please note that past performance is not an indicator of future performance and that geared investments involve much higher risk than non-geared investments, so it may not be for all investor types.

BetaShares offers investors a simple way to obtain a cost-effective geared exposure to the returns of the Australian share market via our Geared Australian Equity Fund (hedge fund) (ASX: GEAR). Like all our Funds, GEAR can be bought and sold just like any share on the ASX. By combining funds received from investors with borrowed funds, GEAR invests in a share portfolio consisting of the largest 200 equity securities listed on the ASX weighted by market capitalisation, as measured by the S&P/ASX 200 index. As an investor in GEAR you can expect to receive dividends, franking credits and magnified exposure to the capital movements, up or down, of the underlying share portfolio.

One of the major benefits of an investment in GEAR is that it’s “internally geared”, meaning that the gearing obligations are managed by the Fund. The Fund actively monitors and adjusts the gearing level to between 50 – 65% (the gearing level is defined as the total amount borrowed by the Fund expressed as a percentage of the total assets of the Fund). As a result there are no margin calls or credit check requirements for investors, and any losses are limited to the initial capital outlay.    In my coming posts, I will look at a number of strategies where GEAR can be used to potentially enhance Australian Equity investment returns.  Look out for my upcoming blog posts or visit our website for more information.

Please note: Gearing magnifies gains and losses and may not be a suitable strategy for all investors. Investors in geared strategies should be willing to accept higher levels of investment volatility and potentially large moves (both up and down) in the value of their investment. Geared investments involve significantly higher risk than non-geared investments. Investors should seek professional financial advice before investing, and monitor their investment actively. An investment in the Fund should only be considered as a component of an investor’s overall portfolio. The Fund does not track a published benchmark.

4 Comments

  1. David  |  April 6, 2016

    Hi Tania,

    Does your LVR range cause you to buy when the index is high (as you borrow more to keep the LVR in the correct range) and sell when the market drops (to reduce your LVR)?

    If so, does this drag on returns and to what extent?

    1. Tania Smyth  |  April 11, 2016

      Hi David,

      Thanks for your question.

      The gearing level will generally vary between 50% and 65% which is reviewed daily by the Responsible Entity (RE) of the Fund . If the maximum gearing level of 65% is breached, which means that the value of the assets in the fund have fallen in value, the RE may decrease the gearing ratio by selling some of the fund assets (underlying shares held) to repay a portion of the borrowing and therefore bring the gearing level back into the stated range. Conversely if the assets appreciate in value leading to the gearing level falling below 50% the RE will increase the funds borrowing and therefore purchase more of the underlying assets.

      Just on the second part of your question, this would be dependent on the gearing level at the time of purchase. If the gearing level is lower at the time of purchase and the market falls significantly to a point where the RE needs to adjust the gearing level, it will take a greater gain in the underlying assets to recoup losses. For example, if gearing level at time of purchase was 60% and the assets fall in value (a 10% fall would equate to the gearing level being 66%) the RE being required to adjust the gearing level down to the mid-range of 57.5%, you would need approximately a 15% appreciation in the underlying assets to breakeven. This is a guide only as other factors, including the income and interest costs can impact the outcome.

  2. Hi Tania,

    Could you please advise how liquid the GEAR and BEAR ETFs are compared to, say, other standard ETFs (e.g. NDQ), given that they have an internal leverage component and you may want to exit a position relatively quickly without excess slippage.

    1. Michael Brown  |  May 28, 2018

      Hi Joe,

      Thanks for your comment.

      All the ETF’s you mentioned are open-ended. Due to the open-ended structure of ETFs, the best measure of an ETF’s liquidity is the liquidity of the underlying assets (such as company shares) it holds. In most cases, therefore, this means ETFs are highly liquid – especially ETFs like GEAR and BEAR.

      The role of a market maker is to satisfy supply and demand for units. They do this by providing liquidity to the market by acting as the buyer and seller of units on the ASX during the day, and by creating and redeeming units off-market. This helps to ensure the number of units on issue matches supply and demand, which in turn seeks to ensure that the price of the ETF does not trade at a material premium or discount to its net asset value (NAV).

      If you had any further questions, please feel free to contact us on 1300 487 577

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