Cash extraction to leverage

Are you looking to leverage your exposure from existing shares?

Whether you are looking to diversify your portfolio or wish to increase the exposure to some of the shares you currently hold, there is one thing you will always need: cash to invest. Unless you have spare funds to allocate to achieve these goals, you may be forced to sell some holdings.

Instalments offer an alternative way to extract cash from your existing shareholdings, with the benefit of:

  • maintaining exposure to future capital growth;
  • maintaining your income stream – dividends and franking credits; and
  • no immediate capital gains tax (CGT) implication at the time of the cash extraction.

Implementing the strategy

‘Cash extraction’ or shareholder application involves lodging shares you already hold with the issuer (through the instalment’s PDS), and in return receiving an equivalent number of instalments plus a cash payment. The cash payment represents a loan by the issuer to you of a portion of the value of your shares.

The following formulas are used to determine how much cash can be extracted from a share holding via the cash extraction strategy:

Cash per share:

                                 Cash received (per share) = Share price - Instalment price                                     

Cash per holding:

Total cash received = Size of holding converted x Cash received per share

The cash received can be used to diversify your portfolio and invest in other shares, bonds or any other assets. Alternatively you may want to accelerate capital growth in shares you already own by investing the extracted funds into more instalments over those assets.

Example

AMP is currently trading at $6.23. You are bullish on the shares and would like to double your share exposure and income stream of currently 2,000 shares. Out of many instalments available, you chose the one that best fits your risk profile, in this example a regular geared instalment.

AMP share portfolio AMP instalment portfolio
Share/instalment price $6.23   $3.11
Number of shares/instalments 2,000 4,006
Capital invested $12,460 $12,460
1 % change in share price $124 $250
% change* in capital invested 1% 2%
Full year dividend income (excluding franking credits) $440 $881
Portfolio exposure $12,460 $24,957

*Does not take into account funding cost decay on instalments

The leverage effect accelerates both the capital growth and income stream of the investment. A 1% change in share price in this example leads to a 2% change in the instalment portfolio value, positively and negatively. Therefore, it is crucial for the success of the strategy that the share price performs as expected.

The gearing level of the instalment will impact the performance of the portfolio. The more highly geared the instalment, the greater the amount of cash that can be extracted from the share holding and reinvested.

At the end of the instalment’s life, you may choose to:

  • Repay the loan in order to regain possession of your original shares, (no CGT implications);
  • Sell the instalment, (CGT may be payable); or 
  • Roll into a new instalment series and maintain exposure to the underlying asset (CGT deferred)

Note that this strategy is not eligible for Self Managed Super Funds (SMSF).

Main benefits of the strategy

  • Ability to leverage an existing portfolio while deferring CGT consequences
  • Increase share exposure and income stream (dividends and franking credits)
  • No obligation to repay the loan – limited risk

Main risks of the strategy

  • The share price underperforms over the term of the instalment
  • The more highly geared the instalment, the greater the funding cost

Disclaimer
The information is for educational purposes only and does not constitute financial product advice. ASX does not represent or warrant that the information is complete or accurate. You should consider obtaining independent advice before making any financial decisions. To the extent permitted by law, no responsibility for any loss arising in any way (including by way of negligence) from anyone acting or refraining from acting as a result of this material is accepted by ASX