DFP 4.
10 MANAGED INVESTMENTS
Use of Leverage
BY PETER ANDREWS, MBA, CPA, B. Economics, B. Arts
Former lecturer at Macquarie University
Peter Andrews is a specialist trainer in
Financial Planning.
After an early career in corporate finance
and banking, Peter became a lecturer at
Macquarie University.
He has also taught in the Graduate School
of Management at the University of
Sydney and the School of Banking and
Finance at the University of New South
Wales.
Peter has a Bachelor of Arts and a
Bachelor of Economics from the
University of Sydney and a Master of
Business Administration from the
University of Florida. He is also a Certified
Practicing Accountant.
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.
This articles looks at other examples of gearing, as well as the risks
associated with gearing and the obligations the Corporations Act
places on both advisers and lenders.
CONTENTS
Introduction to Financial Leverage ...............................................................2
Leverage Explained ...................................................................................2
Negative Gearing .......................................................................................2
When is Leverage Suitable? ......................................................................2
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
INTRODUCTION TO FINANCIAL
LEVERAGE
A distinguishing feature of financial leverage is the
use of debt. This separates it from leveraging with
derivatives, which is achieved without debt.
With all financial leverage, the interest cost of the
debt can be written off income generated by the
asset (such as dividends or rent) for taxation
purposes.
LEVERAGE EXPLAINED
Leverage exists whenever a loan or other borrowed
funds (debt) is used to assist with the purchase of
an asset. The value of the asset is then made up of
debt and equity in the following fashion:
Market value of asset = Loan + Equity
A term that you will become used to is the loan to
valuation ratio (LVR). 1 It can be defined as:
Loan
LVR =
Market value of asset
Leverage provides a higher return on equity (ROE)
whenever the interest cost of the loan is lower than
the return on the asset (ROA).
That is always its attraction.
Example – Use of leverage
Assume that an investor buys an asset for $100,000,
using a bank loan of $80,000 to assist with the
purchase. Assume further that the borrowing rate
is 10%, and that the asset provides a return of
$20,000 in the first year.
The ROA in this case is:
$20,000/$100,000 = 20%.
1 The ratio as indicated may be expressed as a percentage, in which
case it is multiplied by 100.
About
However, the return on equity is the dollar return
less the dollar borrowing cost divided by the value
of the equity:
($20,000 - $8,000)/($100,000 - $80,000)
= $12,000/$20,000
= 60%
This illustrates the basic attraction of gearing – the
way it can greatly magnifies a return.
Leverage, however, is a two-edged sword. This is
because it magnifies losses as well as gains. If the
asset produces a loss, the investor experiences the
loss in value while still having to pay the borrowing
costs.
NEGATIVE GEARING
Negative gearing is a special case of leverage. It
occurs when the interest cost is greater than the
income or return produced by the asset. In that
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
property normally satisfies this condition. So can
shares and managed funds financed through
margin lending.
WHEN IS LEVERAGE SUITABLE?
Returns are magnified through leveraging. At the
same time, it magnifies the volatility of return. It is
therefore only suitable when the investor has:
 has a suitable risk profile; and
 a longer investment horizon.
A Suitable Risk Profile
ASIC has pointed out that forms of leverage such as
margin lending are not normally suitable for retail
investors.2 That means that clients with a risk
profile that makes them suitable for highly
leveraged investments are likely to be an exception.
If that is the case, financial planning firms and
product providers should avoid promoting
2 Jeremy Cooper (Deputy Chairman of ASIC), ‘Swimming Between
the Flags’, Company Directors Magazine (May 2009).
 3 DFP 4.10 MANAGED INVESTMENTS
3
leveraged investments as if they are suitable for all
investors, or even a certain category of investors.
A Longer Investment Horizon
A longer investment horizon is in keeping with the
usually recommended approach of holding higher-
risk investments for longer periods. This is because
an investor who holds an asset for longer may
achieve an average return that is not affected by
short-term variations in the return.
There are risks, however. Even bonds can have
sudden price falls when there is a change in yield,
as was the case in Australia in 1995. With shares,
the risks are far greater. There have been several
times in the last hundred years when Australian
share prices have declined substantially from a bull-
run peak, with market falls as large as 59%
occurring. When that happens, highly leveraged
investors can be badly caught out.
Warren Buffett has a saying that describes the
situation:
‘Only when the tide goes out do you discover
who's been swimming naked.’
In other words, the long-term may be fine, but if
leverage is being used to achieve long-term goals
plans should be made ahead of time to ensure
survival of market downturns that may happen
along the way. This means keeping leverage to a
reasonable level, and having some back-up liquid
assets as well.
Investors who leverage their investments need to
remember that there are always times when the
tide goes out!
RISKS ASSOCIATED WITH LEVERAGE
A number of risks associated with leverage that
need to be explained to the client when a leveraged
investment is being recommended.
3 Tom Valentine, Modern Financial and Investment Planning
(2007), p.344.
About
Capital Value Risk
This is ‘the risk that the capital gain will not be large
enough to provide a satisfactory return’.3 In other
words, the asset may not provide a suitable return,
no matter how well it is chosen. Since, as explained
earlier, the return from the asset must be greater
than the cost of finance, this is a critical
consideration.
Because of this risk, some asset classes, such as
cash and fixed interest securities, are not likely to
be suitable for leveraging.
Capital value risk is greater during times of market
uncertainty. This explains why Australian investors
have shown less interest in geared equity
investments such as margin loans since the global
financial crisis.
Capital value risk is also something that should be
taken into account with margin loans when interest
rates are low. The risk is that any rise in interest
rates, particularly long-term rates, will lead to a fall
in bond prices with a flow-on effect to share prices.
Interest Rate Risk
Having the same effect as a low return on assets,
but working in the opposite direction, is an interest
rate rise. If interest rates rise, interest costs can
become higher than the net return from the
investment.
The importance of interest rate risk was evident in
late 2013 when APRA expressed concerns about
property investment loans. Its concern was that
borrowers might have difficulty servicing their loans
if interest rates rose.
Cash Flow Risks
While the returns from the investments may be
high, they may include unrealised capital gains. The
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
4 Tom Valentine (2007), p.344.
 4 DFP 4.10 MANAGED INVESTMENTS
4
If the investor’s other income is being relied on to
service the debt, perhaps because the returns from
the asset are almost entirely in the form of capital
gains, there is the risk of a fall in or cessation of
income so that it becomes more difficult to meet
the interest payments.
This is always a risk with negative gearing where, at
least in the early years, the borrower’s non-
investment income is used to make loan payments.
Regulatory Risk
For the most part, this is the risk of taxation change.
For example, while in opposition the current
government confirmed that it would examine
ending negative gearing in its upcoming tax review.5
Such a move would save the Budget $4 billion a year
at a time when the government is considering
savings to a variety of programs. It would, however,
meet extensive opposition, as the Hawke
government found when it attempted to abolish
negative gearing in 1997.
Margin Lending Calls
Margin lending is often used to create leverage. A
rise in interest rates or a fall in the value of the asset
could lead to a margin call on the borrower. This in
turn, because of failure to meet the margin call,
could lead to a forced realisation of assets when the
market is already down.
Financial planners can substantially reduce the risk
of a margin call in the way they provide advice to
their clients. How this might be done will be
discussed shortly.
Recourse to Other Assets
With some, but not all, forms of leveraged
investment, the lender has a claim to the
borrower’s other assets if the assets being financed
are insufficient to meet a claim. For example, if a
client with a margin loan fails to make a margin call,
the lender first sells the investments that were
financed by the loan. If the proceeds are
insufficient, the lender then has a claim over all the
borrower’s other assets, including the family home.
5 West Australian, 21 May 2013.
About
In legal and banking terms, this is described as
having ‘recourse’ to the borrower.
Loans with recourse to the borrower’s other assets
are known as ‘recourse’ loans. Conversely, loans
without recourse are known as ‘non-recourse’
loans.
Example - Lending with recourse
One of the victims of the bad margin lending
practices that preceded the global financial crisis
was Tracy Richards, a 46-year old Brisbane
receptionist on an annual salary of $45,000. She
had received a $1.48 million margin loan from
Macquarie Bank, including an annual interest bill of
around $115,000.
She failed to meet margin calls in late 2008
following the onset of the global financial crisis.
After Macquarie Bank had sold her investments and
taken other recovery action, she was left living with
her three children in a rented caravan and still had
debts of $300,000 that she was unable to pay.6
Just as the risk of a margin call can be reduced with
proper advice and monitoring, so can the risk of a
lending institution exercising a claim to the other
assets of the borrower can be reduced. This is
another instance where a financial planner can
control the risks their clients face.
CORPORATIONS ACT REQUIREMENTS
Because of the situation Tracy Richards and others
found themselves in in 2008 with the beginning of
the global financial crisis, the Corporations Act (CA)
was amended in 2009 to introduce requirements
for leveraged forms of investment. These
requirements, which are known as the Responsible
Lending Provisions, came into effect on I January
2011.
These requirements apply directly to banks and
other financial institutions providing finance as well
as advisers such as financial planners who provide
the banks with information. Arguably, they also
apply to financial planners providing any advice on
6 Stuart Washington, “A $1.48 million margin loan on a salary of
$45,000”, SMH, 20 June 2009.
 5 DFP 4.10 MANAGED INVESTMENTS
5
leveraged investments because of their fiduciary
duty to clients.
Essentially, the Responsible Lending Provisions
require the lender to collect the information
required, and verify it, to assess whether the loan is
unsuitable for the client.7
The assessment as to whether the loan is unsuitable
is commonly referred to as the ‘unsuitability test’.
It consists of assessing whether the client would be
able to:
 service the loan; and
 meet margin calls
From income and liquid assets, rather than from
long-term savings or from equity in a residential
home, without suffering significant hardship.8
In simple terms, this means that clients must have
sufficient income to make regular loan payments. In
addition, if there is a possibility of margin calls, they
must have sufficient liquid assets to pay a margin
call without dipping into long-term savings or taking
out a mortgage on, or selling, the family home.
MARGIN LENDING
Financial planners are able to provide advice on
margin lending, either for the purchase of shares or
for investing in a managed fund.
Margin lending was actively promoted in the years
before the global financial crisis but, as is evident
from Figure 1, has been in decline since then. The
names of failed margin lending promoters, such as
Storm Financial and Opus Prime, which led many of
their clients to financial destitution because of
margin loans they were unable to support, must still
resonate in investor’s ears. Investors are also aware
of the fall in share prices that followed the global
financial crisis. For these different reasons they are
now less interested in margin lending than they
used to be.
Figure 1: Total Volume of Margin Loans
Outstanding, June 1999 to June 2013 ($ million)9
7 9
CA s985E(1)(c), s985G(1)(a), s985(1)(b), & s985F and s985F.
8 Explanatory Memorandum to the amending legislation, Para.
1.75
About
$50,000
$40,000
$30,000
$20,000
$10,000
$0
Jun-1999
Jun-2001
Jun-2003
Jun-2005
Jun-2007
Jun-2009
Jun-2011
Jun-2013
This, incidentally, is different to the situation on
Wall Street, where margin loans were increasing in
2013 at a time when market prices were also rising.
It may be that the Corporations Act’s Responsible
Lending Provisions (discussed earlier) are having an
effect.
MARGIN LENDING FOR THE PURCHASE
OF SHARES
Investment in equities10 can be leveraged using a
margin lending facility where a financial institution
lends against the value of shares purchased from an
approved list of most of the companies listed on the
ASX, and perhaps some international companies as
well. The maximum loan to valuation ratio (LVR)
may be from 60% to 80% depending on the financial
institution involved. Clients in effect use their
shares as security for margin lending purposes.
The shares are therefore purchased with:
 an equity contribution from the margin lending
client; and
 a borrowed component provided through the
margin lending facility, which is secured by
shares bought with the equity contribution.
Margin Lending Related Risks
Margin lending has the advantage of magnifying a
positive rate of return from an investment, but it
can also magnify a loss In addition, an increase in
the margin loan interest can erode the investment
return even if markets aren’t declining.
Source: RBA
10 Equities for this purpose includes common shares, preference
shares and convertible notes.
 6 DFP 4.10 MANAGED INVESTMENTS
6
A further disadvantage that has to be considered
with this type of investment is that in a falling share
market the financial institution will make a margin
call when the value of the parcel of shares falls
below the maximum margin LVR.
The client may, however, choose to meet a margin
call requirement in two other ways:
 sell off some of the shares to reduce the loan;
or
 add more shares to the portfolio.
A client who fails to meet a margin call requirement
in one of the above ways will find the margin loan
provider selling off some or all of the shares
themselves, as well as extending a claim to the
client’s other assets if there is still an amount
outstanding. This is because a margin loan is an
example of recourse lending.
Example - Margin call
Figure 2 illustrates a margin loan used to assist in
the purchase of a share portfolio worth $100,000.
The amount of the loan drawn down to purchase
the shares is 50%, giving an LVR of 50%.
The maximum permitted LVR in this case is 70%, so
the total value of the shares cannot fall below
Loan/LVR = $50000/70%
= $71,429
if the maximum permitted LVR of 70% is not to be
exceeded.
A fall in the value of the shares to $71,429
represents a fall of
($100,000 - $71,429)/$100,000 = 28.6%
In this example, a margin call would not be
triggered so long as the value of the portfolio
remains above $71,429. However, if the value of
the parcel of shares falls by 40% to $60,000, then
an $11,429 margin call would be triggered to bring
the LVR back to the maximum permitted LVR of
70%.

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
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Managing the Risks
The Responsible Lending Provisions, which were
discussed earlier, cover the considerations which
are important when advice on gearing is being
provided or information is being provided to a
lending institution, They do not, however, cover
how the risks of a margin lending facility should be
managed once the facility has been put in place.
Client’s responsibility. Clients should be advised of
the risk of margin calls and encouraged to regularly
monitor their account and manage their facility
position, and they can do this by using online access
to their account provided on their margin lender’s
website. Regular monitoring provides opportunity
to lessen the risk of a margin call by either ‘topping
up’ the investment or reducing the amount of the
margin loan.
Clients should also ensure that their contact details
are up to date so that they receive margin call
notices that are made.
Financial planner’s responsibility. As a financial
planner, you will need you ensure that your client
maintains an actual LVR that is substantially less
than the maximum permitted LVR. Most financial
advisers recommend an LVR of 40% to 50% to
provide an adequate buffer in the event of a falling
share market.
Mention was made earlier of the harm done to
clients of Storm Financial when they were unable to
meet margin calls in December 2008. Fortunately
the damage was largely limited to Storm Financial
clients, who only accounted for 3,040 of a total of
233,000 margin loan accounts that were operating
at the time.11 Most financial planners had advised
their clients to maintain conservative LVRs, and this
enabled most of them to weather the 30% fall in the
All Ordinaries Index that occurred over the course
of the December quarter without receiving a
margin call.12
11 Source: RBA
12 As indicated in the previous example, with an actual LVR of 50%,
clients would have to experience a 28.6% fall in their asset values
before they received a margin call.
About
Example – Margin lending excesses
Sydney solicitor, Chris Murphy, was Opus Prime’s
largest client with a portfolio worth around $140
million in the shares of Challenger Group before the
entire amount was lost when the company’s share
price fell by 65% over a six-month period beginning
in July 2007.13
During a preliminary court hearing in August 2011,
he testified that the principal of Opus Prime had
assured him several times that he would never face
a margin call.
Favours that had been granted because of his
favoured client status included:
 an LVR of 90%, in spite of the speculative nature
of his investment and its lack of diversification;
and
 a Maserati given to him over lunch. 14
MARGIN LENDING TO INVEST IN A
MANAGED FUND
Banks also provide margin lending facilities for
investing in managed funds. Investors are able to
choose the form of their interest rate, i.e. fixed and
variable and choose from a list of approved
managed funds. The list is usually extensive and
covers far more than the in-house products of the
bank. For example, the NAB’s list of approved
managed funds covers twelve pages.
Investors either with an existing managed
investment or considering a new one can approach
the bank to have a margin lending facility put in
place. This makes further funds available for
investment.
LVRs for most share funds range between 70% and
75%, with fixed interest funds having LVRs of 80%.15
Depending on the maximum LVR allowed,
therefore, the additional funds may be up to five
times the amount of the original investment.
13 Chris Merritt and John Lyons, 'Market genius' loses $140m in
Opes Prime collapse’, The Australian, 1 April, 2008.& “Chris
Murphy Breaks Silence on Opus Prime, SMH, 13 April 2008.
14
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%.
 8 DFP 4.10 MANAGED INVESTMENTS
8
As with margin lending for the purchase of shares
(or other securities), clients may be faced with
margin calls, as well as with the lender exercising a
claim to other assets if unmet margin claims cannot
be met by the forced sale of investment assets.
As with margin loans used for the purchase of
shares, clients with such investments should:
 ensure that their actual LVRs are conservative –
around 50% or less; and
 regularly monitor their positions, particularly if
share prices are falling.
INSTALMENT GEARING
An option also exists for retail clients to have an
instalment gearing investment plan whereby they
invest in a managed fund on a regular basis (e.g
once a month) at an agreed margin lending ratio
(e.g. $1 invested for $1 borrowed). Usually, an
initial investment of, say $1,000, is required by the
client, with the bank adding a loan amount to it.
Example – Instalment gearing
When instalment gearing is used for an investment
in a managed fund, BT requires an initial investment
of $1,000 and provides a loan qual to 2.5 times the
initial investment (i.e., $2,500 if the initial
investment of $1,000).
The investor can then make minimum monthly
investments of $250, with the bank providing an
equal amount as a loan advance.
This combines the advantages of the discipline of a
regular savings plan with the power of gearing. It
also results in a reasonably conservative LVR.
OTHER WAYS OF LEVERAGING
SECURITIES
Financial institutions have been innovative in the
development of leveraged products, with a growing
variety of leveraged products now being available.
About
INVESTMENT WARRANTS
Investment warrants are leveraged financial
securities issued by banks and other financial
institutions. There are two types of investment
warrant:
 Endowment warrants
 Instalment warrants
Both have the advantage of allowing a leveraged
investment in shares or other securities without the
risk of margin calls. They can also both be used by
SMSFs. However, the financing cost can be greater
than the interest rate on a margin loan.
Endowment Warrants
Endowment warrants cover an underlying asset
consisting of individual shares or a basket of shares
and normally have a term of 10 years. An initial
payment, which is usually around 50% of the
current market value of the share, is made at the
time of issue. An ‘outstanding amount’ is payable
at maturity. If the outstanding amount is not paid
ownership of the underlying asset is not transferred
to the investor. Payment of the outstanding
amount is voluntary, but if it is not made the right
to receive the underlying securities is forfeited.
A unique feature of endowment warrants is that
the outstanding amount is not fixed in advance. The
idea is that dividends paid by the underlying
securities should reduce the outstanding amount. If
the outstanding amount reduces to zero before the
end of the term, the underlying asset is transferred
to the investor with nothing more to pay.
Unlike instalment warrants, endowment warrants
are not listed on the ASX. They are therefore
normally held until maturity.
Instalment Warrants
Instalments warrants are available over a range of
individual shares, baskets of shares, and listed
managed investments such as exchange traded
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.
 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
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easier investment process because it is not
necessary to apply for a margin lending facility and
lower borrowing costs because the fund may be
able to borrow at lower rates than the individual
investor may. Also, there are no margin calls.
Example – Geared share fund
The Advance Australian Geared Equity Fund adds
leverage to an underlying equities fund, the
Advance Share Fund.17
Gearing levels within the Fund vary between 40%-
60%, being based on a balance between dividend
yields and the prevailing rate of interest. The
maximum LVR is 60% and the fund is positively
geared to ensure all franking credits are passed
through to investors.
BORROWING BY SUPERANNUATION
FUNDS
Superannuation funds were investing in
endowment warrants and instalments warrants
from their inception, but by 2007 there were
concerns that they were contravening the
prohibition of borrowing by superannuation funds
by doing it. The matter cleared up, however, in
September 2007 when the SIS Act was amended to
invest in instalment warrants and, by extension,
endowment warrants.
The amendment led to a legal loophole that
allowed superannuation funds to invest in
structured investments that mimic the
characteristics of an instalment warrant with
features that include:
 investments held by a trustee;
 regular payments;
 gearing already in place; and
 expectation that the underlying investment will
eventually be owned by the investor.
This appeared to allowed SMSFs to entered into
geared property investment provided the
investment had the required structure. The ATO
17
A value fund with stock selection by Maple-Brown Abbott.
18 Michael Bailey, ‘Blame Negative Gearing for Property Bubble, Not
US: SMSF Lobby’, BRW, 26 September 2013.
About
issued a tax ruling May 2012 that settled any doubts
on the matter.
In spite of the new opportunity, SMSFs did not jump
immediately into geared property. Leveraged
property investments accounted for less than 0.5%
of total SMSF investments at the end of 2012.18
A residential property boom in late 2013 created a
new interest in geared property investments. Some
financial planning firms specialising in SMSF advice
began promoting residential property loans to their
clients. At the same time, some property
developers began offering financial planners large
front-end commissions for clients who took up their
geared property investments. As for the clients,
there were reports of them being offered overseas
holidays as incentives.19
Example – SMSF Geared Property Investments20
In later 2013, a New South Wales firm, J R &
Associates, was contacting financial planners,
offering to go through their client lists to help then
identify clients that might be suitable for a geared
SMSF property investment. They offered to do the
marketing themselves using the financial planning
firm’s name.
They also offered to put on seminars for clients who
were attracted, again using the financial planning
firm’s name.
A ‘healthy referral/consulting fee’ was promised for
each client placed in this way.
It is hard to see how any financial planner that was
aware of their fiduciary duty and the Responsible
Lending provisions of the Corporations Act could
enter into such an arrangement. Also, given ASIC’s
point that margin lending is not suitable for most
retail clients, an arrangement that has SMSF
trustees placed into geared property investments
without any form of risk profiling would seem to be
a risky one.
19
AFR, 10 September 2013.
20 Source: http://jrnassociates.com/superannuation.htm
 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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