Investing with portfolio financing is an aggressive strategy.
Quite simply, it is borrowing (leveraging) to invest MORE than what you have!
Private banks have been offering this as a method to potentially enhance returns but today, you can get it on a retail level.
In this post, you'd see how the IFAST portfolio financing works plus the pros and cons of investing this way.
Invest more with less capital
Imagine this, you want an investment into FIRST STATE DIVIDEND ADVANTAGE of $100,000 but don't want to put the full capital for it.
First state dividend advantage is merely used for illustration and a fund I've covered before
I'd personally suggest that you are at a stage of "don't want to put" the full capital than "don't have the full capital" when considering this solution.
Portfolio financing is a solution to achieve it and this is how it works.
You could buy $40k of First state dividend advantage and "pledge" it to borrow another $60k.
Hence, you've gotten a $100,000 portfolio with just a $40,000 initial outlay.
In this situation, your $100,000 portfolio has a loan to valuation (LTV) of 60%.
Notes:
First state dividend advantage currently has a LTV of up to 70% (can be subjected to change)
Current steps based on the financing structure will be from the $40k pledged, $28k is disbursed and it is also pledged to get $19.6k. The $19.6k is lastly pledged to get $12.4k disbursed. Total of $100k.
Factors to consider with leverage
The $60k borrowed incurs a borrowing cost.
Hence, interest is payable for it and current interest rate (subjected to fluctuations and changes) for this facility is around 3%. This interest is payable regardless of the portfolio performance.
Now, let's assume a positive outcome whereby First state dividend advantage price increases by 10%.
This is the effect with portfolio financing/with leverage and interest of 3% factored in for illustration.
The leverage has increased the gains significantly.
Risk of portfolio financing or leveraging
I've used margin accounts to buy shares before and in the GFC of 2008, it helped me afford more shares during the downturn.
But when markets went south, the value of the portfolio falls. There were periods of margin call (which is requirement to add more funds to avoid force-selling).
Now, let's assume a negative outcome whereby First state dividend advantage price decreases by 10%.
This is the effect with portfolio financing/with leverage and interest of 3% factored in for illustration.
The leverage has exacerbated losses.
That is why I suggest for new investors to avoid leveraging and it is one of my tips in the video below for new investors.
Portfolio tolerance before margin call happens
All portfolios experience ups and downs. It is handling the down phases that determines the success of the portfolio.
Understanding this topic requires understanding the LTV.
If unsure, look for a qualified adviser. But in a nutshell, if the portfolio is at 60% LTV, it can tolerate roughly up to 13% decline before margin call.
I looked at First state dividend advantages history. It is in end 2015 and end 2018 that really saw a possible > 13% decline phase. The end 2018 is illustrated below.
However, we are in a bull market phase that is lasting more than 11years already.
Good times will not last forever and looking back at 2008 Global financial crisis, this fund (including most equity funds) declined >30%. Hence, be cautious.
Quick conclusions
If you leverage (through share financing) and buy a REIT for example, a sector mentioned well by many, a swing of 13% downwards will easily happen.
With funds, it is a more diversified approach and with a lower volatility compared to an individual share. Hence, I do view portfolio financing strategy (for an aggressive investor) favourably .
The drawdown amount from the portfolio financing is deposited as cash into your bank account.
It need not be reinvested as illustrated above.
You could use the cash for emergency or for other purposes like property downpayment.
If you are keen to find out more, drop me an email at josh.tan@promiseland.com.sg.
Quick disclaimers:
The above sharing on first state dividend advantage is not a suggestion to buy but only for illustration.
Not all funds are approved for margin.
LTV ratios and borrowing costs are subjected to changes by IFAST and its partners
There may be other cost for setting up an account.