New ways of gearing

GEARING is widely accepted as a sound strategy for investors who want to increase their market exposure.

In simple terms, it means borrowing money in order to buy income-producing assets, typically shares or property. By borrowing, an investor can purchase more assets than by using just their own capital.

Two prominent fund managers, Colonial First State and Macquarie, have products designed to make life simpler and easier for investors wanting to gear into the sharemarket.

Colonial First State’s Geared Global Share Fund was launched earlier this year. Like many other ‘global share funds’, it aims to achieve long-term capital growth by investing in a broad selection of companies around the world.

The difference with this fund is that, for every $2 that investors put in, Colonial borrows an additional $1.

The fund aims to maintain a 33.3 per cent gearing ratio, so any returns are magnified. If the market goes up, your returns are increased. But if the market falls, your losses also increase.

A very similar product, Colonial First State’s Geared Share Fund, has been operating since 1997. It invests in blue chip Australian shares that are part of the S&P/ASX100 Index and have very strong balance sheets.

The Geared Share Fund aims to meet all borrowing costs from net dividend income, with the gearing ratio therefore depending on interest costs and dividend yields. Currently the fund has a 50 per cent gearing level.

These products are particularly attractive to self-managed superannuation funds, which are prohibited by law from borrowing. By investing in these products, a super fund is achieving the benefits of gearing without borrowing.

The Geared Shares Fund has returned 13.2 per cent over the year to October and 27.6 per cent per annum over the past three years.

This compares favourably with Colonial’s ungeared Australian Share Fund, which returned 4.6 per cent and 13.0 per cent per annum over the same periods.

A very different option is Macquarie Bank’s Geared Equities Investment, which has several novel features.

Macquarie Bank will lend 100 per cent of the funds invested, starting at a minimum of $50,000, so investors do not have to put up any of their own money.

Investors can then select which stocks they invest in, from a menu of about 50 blue chip companies.

Another novel feature is that the loan capital is 100 per cent protected. This means any shares that have fallen in value at maturity (either three years or five years) are given back to Macquarie in full repayment of that part of the loan.

But when shares rise in value, the investor keeps the entire gain. Investors also retain any dividends and franking credits.

Macquarie is able to offer 100 per cent capital protection because it buys options and other derivatives to manage its own risk.

It recoups the cost by charging investors a very high interest rate, currently 16.10 per cent pa for a three-year loan or 14.10 per cent pa for a five-year loan.

A second shortcoming of this product is the limited stock selection. Investors borrowing less than $100,000 can hold only four stocks. The maximum number of stocks, for investors borrowing $250,000 or more, is eight.

Given these constraints, the product will not suit all investors. However it may be appropriate for investors with an existing share portfolio or surplus cash flow who are seeking a tax-deductible investment.


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Total Shareholder Return as at 30/06/16

1 year TSR5 year TSR
168thNewcrest Mining76%-8%
261stRamsay Health Care38%36%
314thSonic Healthcare25%19%
544thMacquarie Group-11%24%
722 WA (and selected non WA) listed companies ranked by 1 year TSR relative to other companies with similar revenue
Source: Morningstar


17th-Macquarie Group$9,368.0m
18th↑Ramsay Health Care$8,690.5m
24th↑Sonic Healthcare$5,048.4m
25th↑Newcrest Mining$4,476.2m
77 listed non wa companies ranked by revenue.
Source: Morningstar

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