Benefits of conservative gearing over Exchange Traded Funds

Photo of Robert Hay, BT Financial Group By Robert Hay, BT Financial Group

min read

Self-Funding Instalments attracting more attention from SMSF trustees.

Editor’s note: The ASX Warrants market celebrated its 25th anniversary in late 2016. As part of that milestone, ASX Investor Update is running a series of warrants stories over three issues, each focussing on a different portfolio strategy. This is the second story in that series.

There were 2,804 warrants on ASX at December 2016. To learn more about the features, benefits and risks of warrants and instalments, take the free online ASX Warrants and instalments course.

ASX-quoted self-funding instalment warrants (SFIs) can provide investors, including self-managed superannuation funds (SMSFs) potentially more exposure to Australian equities for every dollar invested than if they bought the same stock or exchange-traded fund (ETF) outright.

Specifically, SFIs are a way of buying exposure to a share or ETF in two parts, with the second part an optional completion payment (loan repayment). You can take full ownership of the share or ETF at any time by making the second payment.

SFIs are also one of the few eligible forms of gearing within an SMSF because of the limited recourse nature of the loan.

Revisiting investment strategy

Recent trends have indicated a renewed uptick in interest in SFIs from SMSFs, particularly those revisiting their investment strategy to see if they remain on track to meet their goals, given the new rules around contribution limits. SMSF trustees (particularly wealth accumulators) may be considering whether changes are required for goals and objectives to be met.

If changes are required and SMSF trustees are comfortable with the concept of leverage, it is important they understand the differences between the many types of instalment warrants on issue and the risk associated with them.

Distinguishing features include loan size, time to expiry, eligibility for franking credits and if dividends are used to reduce the loan or paid to the investor as cash.

Notwithstanding these differences, and thinking just about SFIs, there are a number of common benefits that may be attractive to a wide cross-section of investors, such as being listed on ASX, the packaged nature of the loan (which does not require any credit checks) and no margin-call risk.

Moreover, investors receive many of the benefits of direct security ownership such as exposure to capital growth, dividends and franking credits if eligible. Ordinary dividends and distributions are automatically used to reduce the loan amount.

The first payment includes an initial interest amount and subsequent annual interest is prepaid by an increase to the loan amount. If the price of the share or ETF is less than the loan amount at maturity, you can walk away with no further payments required. Alternatively, the SFI can be sold on ASX at any time before maturity.

Portfolio construction trends

ETFs over the top 20, 200 and 300 stocks on ASX are becoming increasingly popular as a low-cost diversified core holding strategy within the Australian equities component of an investment portfolio.

This investment might be blended with satellite holdings (either direct or through a managed investment) across stocks/sectors, which may lend themselves to potentially higher returns in the portfolio, such as small to mid-cap stocks.

Westpac offers several SFIs over ETFs linked to the Australian sharemarket. These SFIs are available with various gearing levels and terms designed to suit different investor risk appetites.

When SMSF investors want to increase the size of their Australian equity asset allocation but may have limited funds available to make this investment, Westpac SFIs may provide the required exposure to core Australian equity assets without the risk of a margin call.

For example, Westpac recently launched several conservatively geared Westpac SFIs over ETFs (Westpac SFI ASX codes: ILCSWX, IOZSWX, STWSWX and VASSWX).

At the time of writing, with an initial gearing level around 30 per cent and June 2020 maturity, these Westpac SFIs could provide additional exposure of approximately 35 per cent to the underlying ETF than if the same capital was used to purchase the ETF outright.

This could mean more exposure to a diversified portfolio of Australian equities and potentially enhanced levels of franking credits that are attached to the distributions generated by a bigger investment.

The lower gearing compared to other warrants may suit an investor with a lower risk tolerance who is comfortable with a conservative level of leverage.

However, SFIs may not be appropriate for all investors because of the increased risks of gearing. Investors need to carefully consider the risks associated with a borrowing-to-grow investment strategy.

What are the risks?

Because of the differences between warrants, it is important to review the product disclosure statement specific to the warrant you are looking at, to understand the risks associated with it. That said, some of the general risks of instalment warrants include:

  • Interest costs, dividends/distributions and tax treatment may all change.
  • For SFIs, the interest amounts that are capitalised to the loan may be higher than the dividends or distributions received from the underlying securities used to reduce the loan amount, causing the loan amount to increase.
  • Leverage can magnify losses.
  • The gearing level may change materially as the price of the underlying securities and the loan amount changes.
  • Corporate actions may unwind your position or not be treated in accordance with your preferences.
  • The product issuer may not make good on their obligations.


Now may be an opportune time to ensure your investment strategies (personal or SMSF) are on track to meet financial goals and objectives. In some instances, this may require thinking outside the square and reviewing different investments you may not have considered before.

This does not mean you need to go it alone. Selecting investments that are right for you is an important task and all investors should consider seeking professional advice from a licensed professional.

About the author

Rob Hay is a national structured investments specialist, BT Investment Solutions, at BT Financial Group. Westpac Banking Corporation is the issuer of Westpac self-funding instalments. A copy of the product disclosure statement and any supplementary PDS can be obtained by calling 1800 990 107 or visiting here.

From ASX

To learn more about the features, benefits and risks of instalments, take the free online ASX Warrants and instalments course.

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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