This article appeared in the November 2014 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.
By Peter Mermelas, UBS
If an investor believes the cost of borrowing to buy additional shares will be less than the total return on them, and that proves to be correct, then borrowing to invest can provide a better return. Total return includes share price appreciation as well as dividends, and on an after-tax basis will take into account any franking credits and interest deductions.
There are various ways to borrow to invest in the sharemarket, with the more common approaches being:
- borrowing against other assets, such as a full recourse loan against your home or other assets; or
- margin lending, with full recourse to the shares purchased and other personal assets, and the need to meet margin calls.
- Another possibility is limited recourse loans, such as UBS Dividend Builders, where only the shares purchased with the loan are held as security over it.
(Editor's note: The UBS product is a variation on instalments. You can learn more about the features, benefits and risks of Instalments by take the free, online ASX Warrants and Instalments course.)
UBS Dividend Builders are designed to avoid three aspects of leveraged investment that can discourage investors:
- there are no margin calls to meet,
- there are no credit assessments and,
- because the loan is limited recourse, you do not have to make any payment from your own funds to repay the loan if the loan amount exceeds the value of the shares at maturity.
A popular strategy for achieving a leveraged dividend yield is to combine an investment in shares or ETFs with exchange-traded put options and a loan. UBS Dividend Builders combine a loan and shares through a single transaction on ASX. Furthermore, because the loan is limited recourse, the instruments are one of the few ways a superannuation fund can borrow to invest.
Leveraged dividend yield strategy
This strategy can be used to enhance dividend income and potential franking credits from high-yielding listed shares or ETPs. For example, stocks with a track record of consistently paying fully franked dividends, such as the big four banks and Telstra, are commonly used. However, this strategy could also be implemented using UBS Dividend Builders over other high-yielding shares.
Steady dividend income is the core to the strategy, so looking at a dividend calendar is a good start. The first step involves buying your chosen UBS Dividend Builder before the underlying share goes ex-dividend. To be eligible for franking credits, certain criteria must be satisfied, including you must be an Australian resident taxpayer, satisfy the "45-day holding period" rule, and meet the "at risk" requirement. Further explanation is given in the taxation summary in the Master Product Disclosure Statement for UBS Dividend Builders, dated 17 October 2014 (Master PDS).
If you choose to hold for longer, you will receive further dividends paid on the share but an additional interest cost will also be incurred and added to your loan each year on the annual interest date (generally early June).
Putting the strategy into practice
Looking at a hypothetical example below, assume you buy a UBS Dividend Builder over ANZ, say ANZISI, and hold it for a seven months, during which ANZ pays two dividends totalling $1.74. Also assume ANZ was trading at $32.47 at the time of your investment and each ANZISI was purchased at $17.36.
For every UBS Dividend Builder purchased, the investor becomes the beneficial holder of one ANZ share, giving them entitlement to price performance, dividends and franking (if eligible).
Because the price for ANZISI is lower than the price for an ANZ share, for the same amount of cash invested, the UBS Dividend Builder gives exposure to more shares and the increased exposure translates into a greater amount of dividends and franking credits.
Example - ANZISI vs ANZ*
|ANZ shares||UBS Dividend Builder (ANZISI)|
|Purchase price per share (or UBS Dividend Builder)||$32.47||$17.36|
|Number of shares (or UBS Dividend Builders)||616||1,152|
|Total share exposure||$20,000||$37,448|
|UBS loan ($15.70 per ANZISI)||$0||$18,086|
|Pre-paid interest over 7 mths (at 6.05% p.a.)||$0||-$638|
|Assumed dividends (total of $1.74 per share/ANZISI)||$1,071.84||$2,004.48|
|Franking (assumed 100% franked)||$459.36||$859.06|
|Gross dividends less interest cost||$1,531.20||$2,225.24|
|Gross dividend less interest expressed as a percentage of total amount invested||7.66%||11.13%|
|Total amount invested||$20,000||$20,000|
Source: UBS* This is a hypothetical example for illustrative purposes only. It is not based on any actual prices for any UBS Dividend Builder, nor is it an indication, projection or forecast of underlying share price performance, dividends, loan amounts, interest costs, brokerage and fees which may, in practice, be significantly different to the numbers in this example. The example illustrates the effect of leverage on dividend income but it does not show how leverage can also magnify losses (as well as gains) resulting from changes in variables such as the underlying share price. This is explained more fully under Key Risks below.
Are they right for you?
Before deciding whether to adopt this particular investment strategy, be sure at a minimum to form a view on future share price performance, expected dividends, expected franking, your investment timeframe, and assess the following key risks.
- Borrowing to invest will magnify and accelerate losses as well as gains, and borrowing costs such as interest will reduce any returns. And remember that the underlying share price and the UBS Dividend Builder price can go up or down and be volatile. Also, there is no capital protection. You can lose your entire purchase price. There is an interest charge on the loan element and the interest rate applicable to each UBS Dividend Builder will vary over time. Bear in mind also that the interest rate for future interest periods will not be determined until the relevant annual interest date.
- Enhancing your dividend yield is a key driver for investing in this product so the dividends paid on the underlying shares is critical to performance. Actual dividends may be lower than you expect, which will reduce the effectiveness of your strategy.
- Tax legislation changes may reduce your after-tax return.
- UBS Dividend Builders may be terminated on an annual interest date or under certain extraordinary circumstances. Refer to the Master PDS for details and implications of such early termination.
- You are exposed to risk if UBS (as issuer of UBS Dividend Builders) and UBS Nominees Pty Ltd (as security trustee holding the underlying shares) do not perform their obligations.
- A more detailed description of the key risks of investing in UBS Dividend Builders is included in the Master PDS. You should consult your financial, legal and taxation advisers if you need help to analyse these risks or the terms of UBS Dividend Builders set out in the Master PDS and Term Sheet.
About the author
Peter Mermelas is Director, Equity Solutions at UBS Australia, where he is responsible for the distribution of equity products into wholesale and retail markets through licensed financial advisers and brokers. He is a keen investor and enjoys sharing his knowledge on structured and fund investments. He is an ASX Accredited Derivatives Adviser and has a Diploma in Financial Planning.
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