DFP 4.

10 MANAGED INVESTMENTS

Use of Leverage
BY PETER ANDREWS, MBA, CPA, B. Economics, B. Arts
Former lecturer at Macquarie University

T he words ‘leverage’ and ‘gearing’ are used interchangeably in

finance. ‘Leverage’ is American in origin, while ‘gearing’ is
British.

Leverage is an American word. The more traditional Australian word

is gearing. Both words will be used in this Article.

‘Leverage’, or ‘gearing’, can be used to magnify returns, but at the

same time it introduces risk because it magnifies losses as well. You
have encountered examples of leverage in previous articles. For
example, futures and CFPs are examples of leverage because of the
small initial outlay. Investment products such as A-Reits and UPTs
also have in-built leverage because of their borrowings.
Peter Andrews is a specialist trainer in
Financial Planning. This articles looks at other examples of gearing, as well as the risks
After an early career in corporate finance associated with gearing and the obligations the Corporations Act
and banking, Peter became a lecturer at places on both advisers and lenders.
Macquarie University.
He has also taught in the Graduate School
of Management at the University of
Sydney and the School of Banking and
CONTENTS
Finance at the University of New South Introduction to Financial Leverage ...............................................................2
Wales.
Leverage Explained ...................................................................................2
Peter has a Bachelor of Arts and a
Bachelor of Economics from the Negative Gearing .......................................................................................2
University of Sydney and a Master of
Business Administration from the When is Leverage Suitable? ......................................................................2
University of Florida. He is also a Certified
Practicing Accountant. Risks Associated with Leverage .................................................................3
Corporations Act Requirements ................................................................4
Margin Lending .............................................................................................5
Margin Lending for the Purchase of Shares ..............................................5
Margin Lending to Invest in a Managed Fund ...........................................7
Instalment Gearing ....................................................................................8
Other ways of Leveraging Securities .............................................................8
Investment Warrants ................................................................................8
Capital Protected Equity Products ............................................................9
Geared Managed Funds ............................................................................9
Borrowing by Superannuation Funds ......................................................10
A Final Word ................................................................................................11
 2 DFP 4.10 MANAGED INVESTMENTS
2
However, the return on equity is the dollar return
INTRODUCTION TO FINANCIAL less the dollar borrowing cost divided by the value
LEVERAGE of the equity:
A distinguishing feature of financial leverage is the ($20,000 - $8,000)/($100,000 - $80,000)
use of debt. This separates it from leveraging with = $12,000/$20,000
derivatives, which is achieved without debt.
= 60%
With all financial leverage, the interest cost of the
debt can be written off income generated by the This illustrates the basic attraction of gearing – the
asset (such as dividends or rent) for taxation way it can greatly magnifies a return.
purposes.
Leverage, however, is a two-edged sword. This is
because it magnifies losses as well as gains. If the
LEVERAGE EXPLAINED asset produces a loss, the investor experiences the
Leverage exists whenever a loan or other borrowed loss in value while still having to pay the borrowing
funds (debt) is used to assist with the purchase of costs.
an asset. The value of the asset is then made up of
debt and equity in the following fashion: NEGATIVE GEARING
Market value of asset = Loan + Equity Negative gearing is a special case of leverage. It
occurs when the interest cost is greater than the
A term that you will become used to is the loan to income or return produced by the asset. In that
valuation ratio (LVR). 1 It can be defined as: case, the excess interest cost can be written off
against other income provided that the ATO is
satisfied that the asset will generate positive
returns at some time in the future. Investment
Loan property normally satisfies this condition. So can
LVR = shares and managed funds financed through
Market value of asset margin lending.

Leverage provides a higher return on equity (ROE) WHEN IS LEVERAGE SUITABLE?

whenever the interest cost of the loan is lower than
Returns are magnified through leveraging. At the
the return on the asset (ROA).
same time, it magnifies the volatility of return. It is
therefore only suitable when the investor has:
That is always its attraction.
 has a suitable risk profile; and
Example – Use of leverage  a longer investment horizon.
Assume that an investor buys an asset for $100,000,
using a bank loan of $80,000 to assist with the A Suitable Risk Profile
purchase. Assume further that the borrowing rate ASIC has pointed out that forms of leverage such as
is 10%, and that the asset provides a return of margin lending are not normally suitable for retail
$20,000 in the first year. investors.2 That means that clients with a risk
profile that makes them suitable for highly
The ROA in this case is: leveraged investments are likely to be an exception.
$20,000/$100,000 = 20%.
If that is the case, financial planning firms and
product providers should avoid promoting

1 The ratio as indicated may be expressed as a percentage, in which 2 Jeremy Cooper (Deputy Chairman of ASIC), ‘Swimming Between
case it is multiplied by 100. the Flags’, Company Directors Magazine (May 2009).
About
 3 DFP 4.10 MANAGED INVESTMENTS
3
leveraged investments as if they are suitable for all Capital Value Risk
investors, or even a certain category of investors.
This is ‘the risk that the capital gain will not be large
enough to provide a satisfactory return’.3 In other
A Longer Investment Horizon
words, the asset may not provide a suitable return,
A longer investment horizon is in keeping with the no matter how well it is chosen. Since, as explained
usually recommended approach of holding higher- earlier, the return from the asset must be greater
risk investments for longer periods. This is because than the cost of finance, this is a critical
an investor who holds an asset for longer may consideration.
achieve an average return that is not affected by
short-term variations in the return. Because of this risk, some asset classes, such as
cash and fixed interest securities, are not likely to
There are risks, however. Even bonds can have be suitable for leveraging.
sudden price falls when there is a change in yield,
as was the case in Australia in 1995. With shares, Capital value risk is greater during times of market
the risks are far greater. There have been several uncertainty. This explains why Australian investors
times in the last hundred years when Australian have shown less interest in geared equity
share prices have declined substantially from a bull- investments such as margin loans since the global
run peak, with market falls as large as 59% financial crisis.
occurring. When that happens, highly leveraged
investors can be badly caught out. Capital value risk is also something that should be
taken into account with margin loans when interest
Warren Buffett has a saying that describes the
rates are low. The risk is that any rise in interest
situation:
rates, particularly long-term rates, will lead to a fall
‘Only when the tide goes out do you discover in bond prices with a flow-on effect to share prices.
who's been swimming naked.’
Interest Rate Risk
In other words, the long-term may be fine, but if
Having the same effect as a low return on assets,
leverage is being used to achieve long-term goals
but working in the opposite direction, is an interest
plans should be made ahead of time to ensure
rate rise. If interest rates rise, interest costs can
survival of market downturns that may happen
become higher than the net return from the
along the way. This means keeping leverage to a
investment.
reasonable level, and having some back-up liquid
assets as well.
The importance of interest rate risk was evident in
late 2013 when APRA expressed concerns about
Investors who leverage their investments need to
property investment loans. Its concern was that
remember that there are always times when the
borrowers might have difficulty servicing their loans
tide goes out!
if interest rates rose.
RISKS ASSOCIATED WITH LEVERAGE Cash Flow Risks
A number of risks associated with leverage that While the returns from the investments may be
need to be explained to the client when a leveraged high, they may include unrealised capital gains. The
investment is being recommended. cash flow from the investment may therefore be
lower than the return from the investment, and as
such it may not be sufficient to meet the interest
costs associated with the borrowing.4

3 Tom Valentine, Modern Financial and Investment Planning 4 Tom Valentine (2007), p.344.
(2007), p.344.
About
 4 DFP 4.10 MANAGED INVESTMENTS
4
If the investor’s other income is being relied on to In legal and banking terms, this is described as
service the debt, perhaps because the returns from having ‘recourse’ to the borrower.
the asset are almost entirely in the form of capital
gains, there is the risk of a fall in or cessation of Loans with recourse to the borrower’s other assets
income so that it becomes more difficult to meet are known as ‘recourse’ loans. Conversely, loans
the interest payments. without recourse are known as ‘non-recourse’
loans.
This is always a risk with negative gearing where, at
least in the early years, the borrower’s non- Example - Lending with recourse
investment income is used to make loan payments. One of the victims of the bad margin lending
practices that preceded the global financial crisis
Regulatory Risk was Tracy Richards, a 46-year old Brisbane
For the most part, this is the risk of taxation change. receptionist on an annual salary of $45,000. She
For example, while in opposition the current had received a $1.48 million margin loan from
government confirmed that it would examine Macquarie Bank, including an annual interest bill of
ending negative gearing in its upcoming tax review.5 around $115,000.
Such a move would save the Budget $4 billion a year
at a time when the government is considering She failed to meet margin calls in late 2008
savings to a variety of programs. It would, however, following the onset of the global financial crisis.
meet extensive opposition, as the Hawke After Macquarie Bank had sold her investments and
government found when it attempted to abolish taken other recovery action, she was left living with
negative gearing in 1997. her three children in a rented caravan and still had
debts of $300,000 that she was unable to pay.6
Margin Lending Calls
Just as the risk of a margin call can be reduced with
Margin lending is often used to create leverage. A proper advice and monitoring, so can the risk of a
rise in interest rates or a fall in the value of the asset lending institution exercising a claim to the other
could lead to a margin call on the borrower. This in assets of the borrower can be reduced. This is
turn, because of failure to meet the margin call, another instance where a financial planner can
could lead to a forced realisation of assets when the control the risks their clients face.
market is already down.

Financial planners can substantially reduce the risk

CORPORATIONS ACT REQUIREMENTS
of a margin call in the way they provide advice to Because of the situation Tracy Richards and others
their clients. How this might be done will be found themselves in in 2008 with the beginning of
discussed shortly. the global financial crisis, the Corporations Act (CA)
was amended in 2009 to introduce requirements
Recourse to Other Assets for leveraged forms of investment. These
requirements, which are known as the Responsible
With some, but not all, forms of leveraged
Lending Provisions, came into effect on I January
investment, the lender has a claim to the
2011.
borrower’s other assets if the assets being financed
are insufficient to meet a claim. For example, if a
These requirements apply directly to banks and
client with a margin loan fails to make a margin call,
other financial institutions providing finance as well
the lender first sells the investments that were
as advisers such as financial planners who provide
financed by the loan. If the proceeds are
the banks with information. Arguably, they also
insufficient, the lender then has a claim over all the
apply to financial planners providing any advice on
borrower’s other assets, including the family home.

5 West Australian, 21 May 2013. 6 Stuart Washington, “A $1.48 million margin loan on a salary of
$45,000”, SMH, 20 June 2009.
About
 5 DFP 4.10 MANAGED INVESTMENTS
5
leveraged investments because of their fiduciary
duty to clients. $50,000
$40,000
Essentially, the Responsible Lending Provisions $30,000
require the lender to collect the information
$20,000
required, and verify it, to assess whether the loan is
unsuitable for the client.7 $10,000
$0

Jun-1999

Jun-2001

Jun-2003

Jun-2005

Jun-2007

Jun-2009

Jun-2011

Jun-2013
The assessment as to whether the loan is unsuitable
is commonly referred to as the ‘unsuitability test’.
It consists of assessing whether the client would be
able to:
This, incidentally, is different to the situation on
 service the loan; and Wall Street, where margin loans were increasing in
 meet margin calls 2013 at a time when market prices were also rising.
It may be that the Corporations Act’s Responsible
From income and liquid assets, rather than from Lending Provisions (discussed earlier) are having an
long-term savings or from equity in a residential effect.
home, without suffering significant hardship.8

In simple terms, this means that clients must have

MARGIN LENDING FOR THE PURCHASE
sufficient income to make regular loan payments. In OF SHARES
addition, if there is a possibility of margin calls, they Investment in equities10 can be leveraged using a
must have sufficient liquid assets to pay a margin margin lending facility where a financial institution
call without dipping into long-term savings or taking lends against the value of shares purchased from an
out a mortgage on, or selling, the family home. approved list of most of the companies listed on the
ASX, and perhaps some international companies as
MARGIN LENDING well. The maximum loan to valuation ratio (LVR)
may be from 60% to 80% depending on the financial
Financial planners are able to provide advice on institution involved. Clients in effect use their
margin lending, either for the purchase of shares or shares as security for margin lending purposes.
for investing in a managed fund.
The shares are therefore purchased with:
Margin lending was actively promoted in the years
before the global financial crisis but, as is evident  an equity contribution from the margin lending
from Figure 1, has been in decline since then. The client; and
names of failed margin lending promoters, such as  a borrowed component provided through the
Storm Financial and Opus Prime, which led many of margin lending facility, which is secured by
their clients to financial destitution because of shares bought with the equity contribution.
margin loans they were unable to support, must still
resonate in investor’s ears. Investors are also aware Margin Lending Related Risks
of the fall in share prices that followed the global
financial crisis. For these different reasons they are Margin lending has the advantage of magnifying a
now less interested in margin lending than they positive rate of return from an investment, but it
used to be. can also magnify a loss In addition, an increase in
the margin loan interest can erode the investment
Figure 1: Total Volume of Margin Loans return even if markets aren’t declining.
Outstanding, June 1999 to June 2013 ($ million)9

7 9
CA s985E(1)(c), s985G(1)(a), s985(1)(b), & s985F and s985F. Source: RBA
8 Explanatory Memorandum to the amending legislation, Para. 10 Equities for this purpose includes common shares, preference
1.75 shares and convertible notes.
About
 6 DFP 4.10 MANAGED INVESTMENTS
6
A further disadvantage that has to be considered The amount of the loan drawn down to purchase
with this type of investment is that in a falling share the shares is 50%, giving an LVR of 50%.
market the financial institution will make a margin
call when the value of the parcel of shares falls The maximum permitted LVR in this case is 70%, so
below the maximum margin LVR. the total value of the shares cannot fall below
Loan/LVR = $50000/70%
The client may, however, choose to meet a margin
call requirement in two other ways: = $71,429
 sell off some of the shares to reduce the loan; if the maximum permitted LVR of 70% is not to be
or exceeded.
 add more shares to the portfolio. A fall in the value of the shares to $71,429
represents a fall of
A client who fails to meet a margin call requirement
in one of the above ways will find the margin loan ($100,000 - $71,429)/$100,000 = 28.6%
provider selling off some or all of the shares
themselves, as well as extending a claim to the In this example, a margin call would not be
client’s other assets if there is still an amount triggered so long as the value of the portfolio
outstanding. This is because a margin loan is an remains above $71,429. However, if the value of
example of recourse lending. the parcel of shares falls by 40% to $60,000, then
an $11,429 margin call would be triggered to bring
Example - Margin call the LVR back to the maximum permitted LVR of
70%.
Figure 2 illustrates a margin loan used to assist in
the purchase of a share portfolio worth $100,000.

Figure 2: Margin Lending

Note: Depending on the contract entered into, the amount of the margin call would reduce slightly (to $8,000) if it was used to
reduce the margin loan or increase slightly (to $11,429) to buy more shares so as to maintain the maximum margin lending ratio of
30:70.

About
 7 DFP 4.10 MANAGED INVESTMENTS
7
Managing the Risks Example – Margin lending excesses
The Responsible Lending Provisions, which were Sydney solicitor, Chris Murphy, was Opus Prime’s
discussed earlier, cover the considerations which largest client with a portfolio worth around $140
are important when advice on gearing is being million in the shares of Challenger Group before the
provided or information is being provided to a entire amount was lost when the company’s share
lending institution, They do not, however, cover price fell by 65% over a six-month period beginning
how the risks of a margin lending facility should be in July 2007.13
managed once the facility has been put in place.
During a preliminary court hearing in August 2011,
Client’s responsibility. Clients should be advised of he testified that the principal of Opus Prime had
the risk of margin calls and encouraged to regularly assured him several times that he would never face
monitor their account and manage their facility a margin call.
position, and they can do this by using online access
to their account provided on their margin lender’s Favours that had been granted because of his
website. Regular monitoring provides opportunity favoured client status included:
to lessen the risk of a margin call by either ‘topping  an LVR of 90%, in spite of the speculative nature
up’ the investment or reducing the amount of the of his investment and its lack of diversification;
margin loan. and

Clients should also ensure that their contact details  a Maserati given to him over lunch. 14
are up to date so that they receive margin call
notices that are made. MARGIN LENDING TO INVEST IN A
MANAGED FUND
Financial planner’s responsibility. As a financial
planner, you will need you ensure that your client Banks also provide margin lending facilities for
maintains an actual LVR that is substantially less investing in managed funds. Investors are able to
than the maximum permitted LVR. Most financial choose the form of their interest rate, i.e. fixed and
advisers recommend an LVR of 40% to 50% to variable and choose from a list of approved
provide an adequate buffer in the event of a falling managed funds. The list is usually extensive and
share market. covers far more than the in-house products of the
bank. For example, the NAB’s list of approved
Mention was made earlier of the harm done to managed funds covers twelve pages.
clients of Storm Financial when they were unable to
meet margin calls in December 2008. Fortunately Investors either with an existing managed
the damage was largely limited to Storm Financial investment or considering a new one can approach
clients, who only accounted for 3,040 of a total of the bank to have a margin lending facility put in
233,000 margin loan accounts that were operating place. This makes further funds available for
at the time.11 Most financial planners had advised investment.
their clients to maintain conservative LVRs, and this
enabled most of them to weather the 30% fall in the LVRs for most share funds range between 70% and
All Ordinaries Index that occurred over the course 75%, with fixed interest funds having LVRs of 80%.15
of the December quarter without receiving a Depending on the maximum LVR allowed,
margin call.12 therefore, the additional funds may be up to five
times the amount of the original investment.

11 Source: RBA 13 Chris Merritt and John Lyons, 'Market genius' loses $140m in
12 As indicated in the previous example, with an actual LVR of 50%, Opes Prime collapse’, The Australian, 1 April, 2008.& “Chris
clients would have to experience a 28.6% fall in their asset values Murphy Breaks Silence on Opus Prime, SMH, 13 April 2008.
14
before they received a margin call. Ben Butler, ‘Opes gave lawyer a car’, The Age, 17 August 2011.
15 LVRs are lower when the risk is higher. For example, geared share
funds and emerging market funds tend to have LVRs of 40%.
About
 8 DFP 4.10 MANAGED INVESTMENTS
8
As with margin lending for the purchase of shares INVESTMENT WARRANTS
(or other securities), clients may be faced with
margin calls, as well as with the lender exercising a Investment warrants are leveraged financial
claim to other assets if unmet margin claims cannot securities issued by banks and other financial
be met by the forced sale of investment assets. institutions. There are two types of investment
warrant:
As with margin loans used for the purchase of  Endowment warrants
shares, clients with such investments should:
 Instalment warrants
 ensure that their actual LVRs are conservative –
around 50% or less; and Both have the advantage of allowing a leveraged
 regularly monitor their positions, particularly if investment in shares or other securities without the
share prices are falling. risk of margin calls. They can also both be used by
SMSFs. However, the financing cost can be greater
INSTALMENT GEARING than the interest rate on a margin loan.

An option also exists for retail clients to have an Endowment Warrants

instalment gearing investment plan whereby they
Endowment warrants cover an underlying asset
invest in a managed fund on a regular basis (e.g
consisting of individual shares or a basket of shares
once a month) at an agreed margin lending ratio
and normally have a term of 10 years. An initial
(e.g. $1 invested for $1 borrowed). Usually, an
payment, which is usually around 50% of the
initial investment of, say $1,000, is required by the
current market value of the share, is made at the
client, with the bank adding a loan amount to it.
time of issue. An ‘outstanding amount’ is payable
at maturity. If the outstanding amount is not paid
Example – Instalment gearing ownership of the underlying asset is not transferred
When instalment gearing is used for an investment to the investor. Payment of the outstanding
in a managed fund, BT requires an initial investment amount is voluntary, but if it is not made the right
of $1,000 and provides a loan qual to 2.5 times the to receive the underlying securities is forfeited.
initial investment (i.e., $2,500 if the initial
investment of $1,000). A unique feature of endowment warrants is that
the outstanding amount is not fixed in advance. The
The investor can then make minimum monthly idea is that dividends paid by the underlying
investments of $250, with the bank providing an securities should reduce the outstanding amount. If
equal amount as a loan advance. the outstanding amount reduces to zero before the
end of the term, the underlying asset is transferred
This combines the advantages of the discipline of a to the investor with nothing more to pay.
regular savings plan with the power of gearing. It
also results in a reasonably conservative LVR. Unlike instalment warrants, endowment warrants
are not listed on the ASX. They are therefore
normally held until maturity.
OTHER WAYS OF LEVERAGING
Instalment Warrants
SECURITIES
Instalments warrants are available over a range of
Financial institutions have been innovative in the individual shares, baskets of shares, and listed
development of leveraged products, with a growing managed investments such as exchange traded
variety of leveraged products now being available. funds (ETFs). Unlike, endowment warrant,
instalment warrants are listed on the ASX. There are
approximately 2,000 instalments quoted on ASX,
covering over 100 different underlying assets.

About
 9 DFP 4.10 MANAGED INVESTMENTS
9
Instalment warrants give the holder the right, but Entitled to No Yes
not the obligation to acquire the underlying asset dividend and
franking
by making one initial payment (usually around 50% credits
of the market value) and a final instalment
consisting of a fixed amount between 3 and 36
months later. Payment of the final instalment is CAPITAL PROTECTED EQUITY
optional, but if it is not made the right to receive PRODUCTS
the underlying asset is forfeited.
Some financial institutions have introduced capital
Instalment warrants can be bought on the share equity products that combine a leveraged share
market just like a share, or by filling out an investment with an embedded put option that
application form and sending it to the issuer. The protects the investor from downward movements
client as the holder of the instalment warrant is in the market. The investor can still benefit from
entitled to dividends and franking credits paid on share price gains and any dividends that may
the underlying securities during the life of the accrue.
warrant.
Lenders typically lend against a portfolio of shares
Endowment and Instalment Warrants – that the investor selects from around 70 large cap
What’s the Difference stocks. Minimum borrowing amounts generally
start at $50,000 and the interest rates charged can
Endowment warrants and instalment warrants are be fixed or variable. 100% gearing is permitted, with
contrasted in Table 1. investors therefore not having to contribute funds
separately.
Table 1 – Features of Endowment Warrants and
Instalment warrants Contrasted The loans, which have an embedded put option, are
Endowment Instalment interest only and have a term of 1-5 years.
warrants warrants
Issued by Banks and other Banks and other No premium is charged for the embedded put
financial financial option, but a higher interest rate is charged on the
institutions institutions loan. When the loan matures, if the shares are
Underlying Individual shares Individual shares, worth less than the loan, the lender takes the
asset and baskets of baskets of shares, shares in full satisfaction of the loan.16
shares and listed
managed
investments such Example–Capital protected equity investment
as exchange
traded funds The Macquarie Geared Equities Investment Plus
(GEI plus) allows 100% gearing for investment in
Term Normally 10 years Normally between
3 and 36 months either over 80 securities listed on the ASX or a pre-
selected portfolio. The embedded put option
Listed on the No Yes
ASX
ensures that investors are not required to repay any
portion of the loan that relates to securities that
First payment Usually around Usually around
50% of the 50% of the
have fallen in value. The loan interest is deductible
underlying asset underlying asset up to the RBA variable home loan indicator lending
rate.
Final payment An ‘outstanding A fixed amount
amount, which
takes account of GEARED MANAGED FUNDS
dividends that
have been Some equity funds, generally referred to as ‘geared
received. share funds’, are leveraged, generally with
borrowings from a bank. Advantages include an

16
Source: ASX.
About
 10 DFP 4.10 MANAGED INVESTMENTS
10
easier investment process because it is not issued a tax ruling May 2012 that settled any doubts
necessary to apply for a margin lending facility and on the matter.
lower borrowing costs because the fund may be
able to borrow at lower rates than the individual In spite of the new opportunity, SMSFs did not jump
investor may. Also, there are no margin calls. immediately into geared property. Leveraged
property investments accounted for less than 0.5%
Example – Geared share fund of total SMSF investments at the end of 2012.18

The Advance Australian Geared Equity Fund adds A residential property boom in late 2013 created a
leverage to an underlying equities fund, the new interest in geared property investments. Some
Advance Share Fund.17 financial planning firms specialising in SMSF advice
began promoting residential property loans to their
Gearing levels within the Fund vary between 40%- clients. At the same time, some property
60%, being based on a balance between dividend developers began offering financial planners large
yields and the prevailing rate of interest. The front-end commissions for clients who took up their
maximum LVR is 60% and the fund is positively geared property investments. As for the clients,
geared to ensure all franking credits are passed there were reports of them being offered overseas
through to investors. holidays as incentives.19

BORROWING BY SUPERANNUATION Example – SMSF Geared Property Investments20

FUNDS
In later 2013, a New South Wales firm, J R &
Superannuation funds were investing in Associates, was contacting financial planners,
endowment warrants and instalments warrants offering to go through their client lists to help then
from their inception, but by 2007 there were identify clients that might be suitable for a geared
concerns that they were contravening the SMSF property investment. They offered to do the
prohibition of borrowing by superannuation funds marketing themselves using the financial planning
by doing it. The matter cleared up, however, in firm’s name.
September 2007 when the SIS Act was amended to
invest in instalment warrants and, by extension, They also offered to put on seminars for clients who
endowment warrants. were attracted, again using the financial planning
firm’s name.
The amendment led to a legal loophole that
allowed superannuation funds to invest in A ‘healthy referral/consulting fee’ was promised for
structured investments that mimic the each client placed in this way.
characteristics of an instalment warrant with
features that include: It is hard to see how any financial planner that was
aware of their fiduciary duty and the Responsible
 investments held by a trustee; Lending provisions of the Corporations Act could
 regular payments; enter into such an arrangement. Also, given ASIC’s
point that margin lending is not suitable for most
 gearing already in place; and
retail clients, an arrangement that has SMSF
 expectation that the underlying investment will trustees placed into geared property investments
eventually be owned by the investor. without any form of risk profiling would seem to be
a risky one.
This appeared to allowed SMSFs to entered into
geared property investment provided the
investment had the required structure. The ATO

17 19
A value fund with stock selection by Maple-Brown Abbott. AFR, 10 September 2013.
18 Michael Bailey, ‘Blame Negative Gearing for Property Bubble, Not 20 Source: http://jrnassociates.com/superannuation.htm
US: SMSF Lobby’, BRW, 26 September 2013.
About
 11 DFP 4.10 MANAGED INVESTMENTS
11
A FINAL WORD
The property boom some Australian capital cities
were experiencing towards the end of 2013 is a
good note to finish on. There are regular ‘booms’
and ‘bubble bursts’ in financial markets. We usually
know when a boom is occurring because prices are
rising. The bubble burst, however, is much harder
to predict because it happens suddenly with little
forewarning.

This suggests that it is wise not to gear up when

prices are rising rapidly. A better precaution may be
not to invest at all.

A warning from a seasoned Australian property

investor watching the property boom of late 2013
may help:
‘The only explanation for investors buying in a
sharply rising market is the herd mentality,
otherwise known as stupidity.’21

This warning can be applied equally well to all

investing, particularly when leverage is being used.

21 Terry Ryder, ‘My advice for buying in a "hot" market? Don't’,

Property Observer, 8 October, 2013.

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