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All you need to know about Margin Lending

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What is Margin Lending?

Margin lending is the use of a combination of equity and debt in purchasing investments. Similar to a mortgage, typical margin loans allow investors to only put down 25% of total investment value while borrow the rest from lender. Investor brokers like E trade, owned by ANZ typically provide margin lending as part of the comprehensive service while brokers not aligned to a bank will allow investors to use a third party margin lender.

Margin Lending Rates and Best Margin Loan Rates

Rates on margin loans are typically 500 basis points above the RBA cash rate. If RBA interest rate is 2%, then margin loan rates averages 7%. We use interactive brokers which charges only 150 basis point above cash rate. It is one of the most competitive brokers for investors.

Margin Loan interest rates are not very competitive across most brokers. Investors should be aware that by using margin loan, it creates a higher hurdle for investment returns as the margin loan interest rate become the effective base where all investment returns will be evaluated against.

Key Features

Not all margin loans are the same. Most investors focus on the cost of the loan as the main criteria in selecting a margin loan provider but it is also important to know the feature differences and flexibility of the product.

  • The number of securities included in the approved investment list. Typically ASX 300 company shares can be used as security to borrow additional funding against but avoid small cap stocks outside the ASX 300 and in the All Ord index.. Smaller loan providers differentiate by including small and micro caps in lending list in selected cases.
  • Selection of managed funds that you could borrow again. Larger banks have integrated managed fund investment into the margin loan facility where investors can increase exposure to particular managed funds through borrowing. This is highly variable between each service provider.
  • Selection of ETFs are dependent on each lender. Investing using ETF can be considered lower risk as ETFs are index funds which owns a portfolio of shares.
  • Broker Selection. Smaller lenders usually are not affiliated with a big 4 bank. Hence their margin facilities can be linked to all the major brokers like E*trade, Commsec or NabTrade. If you have a margin with a big 4 bank then you are usually locked into using only their own broker to invest shares on the ASX.
  • One advantage of big 4 is the integration of margin facility with brokerage and internet banking. Hence it could be more flexible and faster in accessing funds for alternative uses.
  • CFD providers and interactive brokers (companies only) have integrated margin lending facilities. This means that there is no separate application process in setting up a margin facility unlike the big 4 lenders where it is like applying for a credit card and undertake a credit check. As margin is inherent in the provide they provide traders can have immediate access to use leverage.
  • Lender can allow dividend payments directly into the margin facility. Some investors prefer this as it reduce the paper work and transactions in banking the dividend and reduce the time between recieving the dividend and going to payoff the loan.

Margin Loan Calculator

Typical range of what the loan will cover is called Loan to Value Ratio or Margin Lending LVR. It can range from 75% covering large caps which means that the loan can be used to cover 75% of the total investment (with investor to provide 25% equity) to 25% for smaller stocks. Leverage enhance the power of compound interest only when the investment value is increasing. It will magnify losses if investment loses its value.

From the same example above, if the share falls by 25% the investors would have lost 100% of the original equity. Where the value of the security falls below the margin lending LVR the lender will make a margin call.

A margin call means the investor must provide additional collateral if the value of equity has fallen below the threshold determined by the broker. If investors cannot meet a margin call, margin lender will force liquidate the investment to protect their own position.

We use leverage cautiously in our portfolio with extreme caution. Portfolio LVR is consistently no where near the margin call level so we are never in a position where we have to provide additional capital or sell when the market is down significantly. On the contrary these situations usually are the best time to buy.

Risks

All investments come with risks. There are those that you see coming and those that you can’t. Investing using margin lending means that any risks inherent in the portfolio will be magnified. Investors should be aware of the power and damage a leveraged position can do to the equity in the portfolio. We only use leverage prudently with a low LVR across the portfolio and ramp up during period of market dislocation to take advantage of favorable prices provided by distressed sellers.

Margin Lender List