This article appeared in the November 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.

Self-funding instalments offer leverage benefits and some protection.

Photo of Jeremy Dean By Jeremy Dean, Westpac

Sharemarket volatility is not new and experienced investors have learned that, especially during times like these, it is important to keep an eye on the bigger picture. Investors with a longer time horizon and an appropriate risk profile might want to take a deep breath, step back and look for potential value in the sharemarket, and ways to access that value using products, such as Self-Funding Instalments (SFIs).

Where they see value in terms of longer-term capital growth and dividend yield, it may be appropriate to use borrowing to capitalise on the opportunity, despite current market conditions. We know leverage (borrowing) has the potential to increase exposure to the underlying security for the same capital outlay and therefore magnify returns. It can, of course, work both ways: losses can also be magnified.

But there are ASX-listed investment products that offer the benefits of leverage and at the same time provide some protection against the possible downside, for a cost.

Eligible gearing within SMSFs

Self-funding instalment are an easy way for individuals and self-managed superannuation funds (SMSFs) to increase their exposure to ASX-listed shares and exchange-traded funds (ETFs). They are one of only a few eligible forms of gearing within a SMSF.

SFIs are an easier way to gain access to leverage because they do not require any credit assessment and there is no risk of margin calls. Not only is share exposure, including benefits flowing from it such as dividends and franking credits, increased by nearly 50 per cent for the same upfront cost, but some SFIs have a built-in downside protection facility.

That means you can avoid the risk of early termination of an SFI because of temporary share price volatility. Also, if any of the shares drop below the loan value at maturity, the shares can be handed back and no additional future payment is required.

(Editor's note: Learn about the features, benefits and risk of warrants through the free online ASX Warrants and Instalments course. This interactive course has been structured to cover all aspects of the warrants market and enable you to progress through all topics or select one of particular interest).

How self-funding instalments work

Investors purchase the SFI in two instalments. The first is paid upfront and is typically around 50 per cent of the cost of the underlying security. It also includes a premium for the protection referred to above.  Investors also commonly pay the first year of interest upfront, although some products offer interest loans with monthly repayments.

Paying the second instalment is optional. You pay it if you want to own the underlying shares or units outright. Alternatively you can sell the SFI on ASX at any time.

For high-dividend shares such as Telstra and the top four banks, the second instalment will reduce over time, resulting in a smaller optional second payment.  For shares that reinvest profits and pay smaller dividends to investors, such as BHP Billiton and Rio Tinto, the second instalment may remain the same or increase slightly as interest is capitalised to the loan.

Ongoing interest is charged once a year and is automatically added to the loan. Dividends or distributions paid by the underlying securities are used to reduce the loan. Interest deductions and franking credits can be used to reduce the tax payable by an individual or SMSF.

Any capital gain from shares that have increased in value above the loan amount can be retained, depending on personal circumstances.
Selecting and buying SFIs

SFIs increase the exposure of the underlying shares, so before buying an SFI you need to determine which underlying shares you want to buy and what your share-price expectations are. It is important to choose your investment using a stockbroker or adviser, or other sources of reputable research.

The SFI codes quoted on ASX have six letters, for example, Telstra SFI (code: TLSSWG).

  • TLS is the ASX code for Telstra
  • S identifies this as a self-funding instalment
  • W identifies the issuer, in this case Westpac
  • G is the series of Westpac SFIs to which this particular SFI belongs. There may be more than one issue currently available.

Each SFI will have a different expiry date, gearing level and interest cost. This enables you to pick the SFI that best suits your particular circumstances, including risk profile, time horizon and cash flow commitments. You can access more information via the SFI issuer's product disclosure statement or at ASX Self-Funding Instalments.

By calculating the after-tax holding cost of the SFIs you can determine the capital growth you need to break even.

SFIs are traded on ASX and can be bought through a broker or by lodging an application form with an issuer. If you purchase through a broker you will need to read the ASX's SFI booklet and sign an agreement form.

Liquidity should always be a consideration, especially in volatile times. Issuers of SFIs have a continuing obligation to provide a price at which it is prepared to buy the SFI back from the investor. This ensures there is liquidity in the market so an investor can sell at any time.

Buy the shares or buy the SFI?

For this example we will use Telstra because of its higher dividend yield. (Editor's note: Do not read this as a recommendation to buy Telstra shares or an SFI over Telstra.)

Let us assume Telstra's dividend will be $0.40 per share (being $0.14 fully franked) paid semi-annually, and that its current share price is $3.14, and your broker's 12-month target share price for Telstra is $3.24.

You have $50,000 to invest, so you can purchase 15,924 Telstra shares. Alternatively, you can use the leverage provided through an SFI to gain exposure to more shares for the same capital outlay. If we assume Telstra SFI (TLSSWG) is trading at $1.83, using the $50,000 will give immediate exposure to 27,322 Telstra shares.

Based on these assumptions we can build a potential first-year cash flow and estimate the differences in potential first-year pay-offs.

First-year comparison, pre-tax

(Editor's note: The example below is used for illustrative purposes only.)

 Year 1 (pre-tax) comparison


Current share price1 $3.14 $1.832
Forecast dividend (100% franked) $0.28 $0.28
12 month target price $3.241 $2.263
Investment amount $50,000.00 $50,000.00
Number of units purchased 15,924 27,322
Forecast cash dividends $4,458.72 $7,650.164
Forecast franking credits $1,910.88 $3,278.64
Dividend yield (fully franked) 13% 22%
Sale proceeds (at 12-month target price) $51,593.76 $61,747.72
Profit (Loss) $1,593.76 $11,747.72
Total return $7,963.36 $11,747.72
Total return % 15.43% 19.03%
  1. Prices sourced from Bloomberg and Iress at 18/10/11.
  2. The first instalment of $1.83 includes pre-paid interest for year 1 and the cost of protection for the life of the loan
  3. The future share price of TLSSWG is calculated by taking the future spot price of TLS, $3.24, plus interest, minus the projected dividends of $0.28 for the full year.
  4. Past performance is not a reliable indicator of future performance.
  5. The dividend proceeds are used to pay the second instalment down, and so while they form part of assessable income, they are not received by the investor. The franking credits are received by the investor.

What has been achieved?

Here are some key benefits from the self-funding instalment:

  • Increased exposure to potential dividends and franking credits.
  • Increased exposure to potential share price movements.
  • A leveraged position in Telstra, with known cash flows, no margin calls and the ability to hold the securities in an SMSF.
  • The ability to sell your SFI at any time on the market.
  • The ability to walk away from the second instalment. If the value of the underlying shares has fallen in value below the value of the loan, there is no obligation to pay the second instalment.

But you can't ignore the risks:

  • If Telstra's share price does not increase or reach the expected share price return, the expected returns on the SFI will differ.
  • If the share price falls, you have a leveraged exposure and the gearing will accelerate your losses.
  • Dividends may change, resulting in the change in the second instalment price.
  • Interest rates, although fixed until 2012, may increase.

SFIs are a simple and easy way to gain access to leverage in the sharemarket, especially for SMSFs. As with any leveraged position, you should monitor your investment on a regular basis to ensure it is still appropriate for your financial goals.

About the author

Jeremy Dean is a Director at Westpac Equities. For more information about Westpac SFIs, speak to your broker or financial adviser, call 1800 990 107, or email Westpac.

From ASX

Self-Funding Instalments has useful information about the features, benefits and risks of this product.


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