Using instalment warrants to enhance yield
How a Dividend Builder strategy works and the key risks and benefits.
Yield enhancement strategies are becoming increasingly prevalent as investors seek to maximise returns in a low interest rate environment.
UBS Dividend Builders are ASX-quoted securities that combine a share with a limited-recourse loan and are vehicles for investors seeking to achieve enhanced yields. Furthermore, because the loan embedded in the structure of UBS Dividend Builders is limited recourse, these instruments are way superannuation funds can borrow to invest.
Put simply, a yield enhancement strategy (when compared to unleveraged direct share ownership) will be successful if the cost of borrowing to buy the share is less than the total return on the share. This means investors can potentially enhance their returns using the same capital outlay. Alternatively, UBS Dividend Builders can make an investor’s money work harder and potentially achieve the same return for a smaller initial outlay (of course borrowing to invest can magnify losses as well and gains).
A case study
We can examine this through a hypothetical example. Assume you buy a UBS Dividend Builder over ANZ, such as ANZISI, and hold it for seven months. In that time ANZ pays two dividends totalling $1.60. Also assume ANZ was trading at $30.47 at the time of your investment and each ANZISI Dividend Builder was purchased for $11.72.
For every ANZISI Dividend Builder purchased, the investor obtains a beneficial interest in one ANZ share; entitling them to price performance, dividends and franking credits.
Because the price of an ANZISI Dividend Builder is lower than the price of an ANZ share at the time of purchase, for the same amount of cash invested, the UBS Dividend Builder could give exposure to more shares, which in turn translates to greater dividends and franking credits.
|ANZ shares||UBS Dividend Builder
|Purchase price per share (or UBS Dividend Builder)||$30.47||$11.47|
|Number of shares (or UBS Dividend Builders)||656||1,706|
|Total share exposure||$20,000||$51,982|
|UBS loan ($19.45 per ANZISI)||$0||$33,182|
|Pre-paid interest over 7 months (at 5.80% p.a.)||$0||-$1,123|
|Assumed dividends (total of $1.60 per share/ANZISI)||$1,049.60||$2,729.60|
|Franking (assumed 100% franked)||$449.83||$1,169.83|
|Gross dividends less interest cost||$1,499.43||$2,776.78|
|Gross dividend less interest expressed as a percentage of total amount invested||7.50%||13.88%|
|Total amount invested||$20,000||$20,000|
* This hypothetical example 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 this example. It illustrates the effect of leverage on dividend income but 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.
This enhanced dividend yield strategy can be used over a wide variety of shares, allowing for a diversified underlying portfolio that can be built to generate enhanced sustainable yield.
While the case study looks at a holding period of seven months, which was sufficient time to capture two dividends from the underlying share, the holding period can in practice be much longer. For example, the loan could be maintained for several years, allowing for leveraged exposure to the underlying share, the dividend stream and any associated franking credits.
The holding entity for the investment can also make a difference, particularly the taxation rate that may apply to the holding entity. For example, holding the UBS Dividend Builder in your own name, where a marginal tax rate may apply, versus holding it in an SMSF in accumulation phase where the taxation rate is 15 per cent.
When buying underlying shares that pay fully franked dividends using UBS Dividend Builders in SMSFs, the fully franked dividend yield may be further enhanced because of the franking rate being 30 per cent and the taxation rate of the SMSF being 15 per cent.
In this case, the leveraged exposure to the share price and dividends could be further enhanced on an after-tax basis because of the difference in the franking rate versus the tax rate.
- Borrowing to invest will magnify and accelerate losses as well as gains, and borrowing costs such as interest will reduce any returns. Investors should be aware 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 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. 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
Further case studies, brochures and other information, including PDS and pricing sheets for UBS Dividend Builders, can be found here.
About the author
Peter Mermelas is a Director of UBS.
This information is communicated by UBS AG Australia Branch (ABN: 47 088 129 613, AFSL: 231087) and/or its affiliates ("UBS"). Before making an investment decision, you should read the corresponding Master Product Disclosure Statement (PDS) (for UBS Share Builders the Master PDS dated 25 September 2014 or 16 October 2015 (as applicable), and for UBS Dividend Builders the Master PDS dated 17 October 2014), the relevant Term Sheet applicable to the Series they wish to invest in (together the "PDS") and any applicable Supplementary Product Disclosure Statement(s) ("SPDS"), including sections relating to Key Risks. These documents are available by calling UBS on 1800 633 100 or on the website www.ubs.com/investmentbuilders
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Peter Mermelas is a Director of UBS.
Warrants has information on the features, benefit and risks of investment and trading warrants.