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A '2 for 1' opportunity to ease back into sharemarket using gearing.

Photo of Asanth Sebastian By Asanth Sebastian, ASX

If you have made cash contributions to your self managed super fund (SMSF) it may be an opportune time to gain exposure to Australian blue-chip companies you believe offer value. A strategy using instalment warrants provides the opportunity to use less capital to get similar exposure to shares without buying them.

(Editor's note: Do the ASX's free online warrants and instalments courses to learn about this market. Then register for the ASX Instalment Warrants Roadshow in six capital cities in February and March.)

Investors receive 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.

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 great flexibility to use leverage to diversify within a SMSF. SFIs provide a means of reducing the gearing or borrowed component of the instalment, as the dividends received from the underlying share are used to reduce the loan.

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

More SMSFs likely to use instalments

Westpac is a large SFI issuer, with 81 instalments listed at December 31. The bank will issue more instalments this quarter, says Cathy Kovacs, Westpac's head of structured products, equities.

"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.

"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. And they can create more options for SMSFs by freeing up cash for other investment uses."

Kovacs says instalments over exchange 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 who has an SMSF and is looking to get back into the market but does not want to outlay her entire cash contribution. By using instalments, she can maximise her exposure to the market for a minimal capital outlay.

The following scenario is not dissimilar to that discussed between Westpac and its network of retail advisers (brokers and financial planners) on behalf of their clients who seek to get back into the market.

Sally has $200,000 cash in her SMSF. With the sharemarket being relatively flat last year she would like to take advantage of current prices and purchase a portfolio of Australian blue-chip shares, using her capital as effectively as possible. She also wants a high level of diversification and is still a little uncertain about market direction, so does not want to use all her cash straight away.

Instead of investing $200,000 directly into the market, Sally invests in an instalment portfolio. She can invest over blue-chips and gain broad diversification by investing over the STW SPDR ASX 200 ETF.

Sally's SMSF invests $100,000 in SFIs, but because of the leveraged nature of instalments she gains exposure to a $200,000 share portfolio.

By adopting this strategy the SMSF receives the benefit of any capital growth, dividends and franking credits for a $200,000 share portfolio while only investing $100,000. This 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 wants to do so.

Since Sally is in the accumulation phase she is also comfortable with the fact that she will not receive dividends as cash, because dividend payments will by used to reduce her loan over time. Sally 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.

Share Portfolio Instalment Portfolio
Investment Amount $200,000 $100,000
Share Exposure $200,000 $200,000
Excess cash $0 $100,000
Total Portfolio Exposure $200,000 $300,000

Illustrative example only. Actual figures which apply to your investment may differ materially.

More information on Westpac instalment warrants. ASX Self funding instalments has more information on the features, benefits and risks for this products.

About the author

Asanth Sebastian is a business development manager at ASX.

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.

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