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Instalments a good fit for SMSFs

This article appeared in the March 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

A cautious opportunity to get back into sharemarket.

Photo of Asanth Sebastian By Asanth Sebastian, ASX

If you have made cash contributions to your self managed super fund (SMSF) it may be a good time to gain exposure to Australian blue-chip companies you believe offer value. By using instalments you can use less capital to gain a similar exposure to shares without buying them.

With instalments, investors receive many of the full benefits of owning the shares outright, such as entitlement to dividends and franking; the warrant issuer holds the physical shares in a trust structure and the holder of the instalment warrant is the beneficial owner.

Learn more about instalments, and register for upcoming ASX instalments events.

Gearing into your SMSF

Instalments are one of the few ways to gear into shares within an SMSF. The main benefit for the SMSF is the ability to build long-term wealth and manage earnings and contributions tax, all without the concern of a margin call. The limited recourse nature of an instalment warrant is a key feature and one reason it is eligible for use by SMSFs.

Self-funding instalments (SFIs) give investors greater flexibility to use leverage to diversify within a SMSF. They provide a means of reducing the gearing or borrowed component of the instalment, as the dividends received from the underlying share are automatically applied to reduce the loan.

As a consequence, SFIs over high-yielding shares (traditionally banking shares) enable SMSFs to maintain their long-term investment horizon, use less capital or achieve greater diversification from their capital, and to reduce gearing over the life of the instalment.

With no margin calls and no ongoing payments for up to 10 years, SMSFs using SFIs have the ability ride out short-term market volatility.

Westpac is a large SFI issuer - 81 such instalments listed at December 31 - and it will issue more instalments this year, says Cathy Kovacs, Westpac Equity’s head of structured investments.

“I expect more SMSFs to consider using SFIs to gear over shares this year,” says Kovacs. “SMSFs that still have a lot of money in cash may believe now is a reasonable time to increase share exposure through sensible gearing, as market volatility subsides.”

Have confidence in the underlying security

“As long-term investment vehicles, SFIs may work well in SMSFs that have long investment timeframes. Obviously, gearing can magnify gains and losses, so trustees who use SFIs in their SMSF must be confident in the underlying security on which the SFI is based. They should take time to consider the features, benefits and risks of SFIs before using them.”

“Assuming the security moves in the right direction, SFIs can potentially provide higher returns for SMSFs through gearing, and important tax efficiencies. They can also create more options for SMSFs by freeing up cash for other investment uses.”

Kovacs says instalments over exchanged traded funds (ETFs) may help SMSF trustees by providing gearing over a diversified basket of shares held through an ETF. Westpac is launching instalments over ETFs this year.

Exposure to a portfolio of Australian shares

Consider this SMSF example. Sally is a typical investor with an SMSF who is looking to get back into the market but does not want to outlay her entire cash contribution. By using SFIs issued by Westpac she can maximise her exposure to the market for a lower capital outlay.

The following scenario is not dissimilar to that discussed between the Westpac sales desk and its network of retail advisers (brokers and financial planners) on behalf of their clients, on a growing basis as investors seek to get back into the market.

Sally has $200,000 cash in her SMSF. With the Australian sharemarket being relatively flat last year she would like to take advantage of share prices at this level and purchase a portfolio of Australian blue-chip shares. However, she wants to use her capital as effectively as possible. She also wants the greatest possible diversification to ensure she is not exposed to a single share or sector. Sally is still a little uncertain about market direction and does not want to use all her cash right now.

Instead of investing the full $200,000 directly into the market, Sally invests in a SFI portfolio. She can invest in SFIs over blue-chip shares as well as gain broad diversification by investing in SFIs over the STW SPDR ASX 200 ETF.

By adopting this strategy, Sally’s SMSF receives the benefit of any capital growth, dividends and franking credits for a share portfolio of close to $200,000 while only investing $100,000. The actual share exposure achieved through the purchase of the SFIs depends on the gearing level of the chosen SFIs and any interest and borrowing cost. This strategy also leaves the SMSF with $100,000 remaining as cash to invest in other assets and further diversify the exposure of the SMSF when Sally wishes to do so.

Instalments and super accumulation phase

Because Sally is in the accumulation phase (Sally is trying to build wealth and is more focussed on capital growth) she is also comfortable with the fact that she will not receive dividends as cash, as proceeds of any dividend payments will be used to automatically reduce her loan over time. She will, however, receive the franking credits and will not receive a margin call even if the market is flat or falls in value over the life of the instalment warrant.

For more information on Westpac Instalments visit www.westpac.com.au/sfi.

About the author

Asanth Sebastian is an ASX business development manager.


The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

© Copyright 2013 ASX Limited ABN 98 008 624 691. All rights reserved 2013.

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