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Young investors are using long-term debt to juice returns

Lewis Jackson  |  23 Jul 2021Text size  Decrease  Increase  |  
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Alex, a 29-year-old start-up founder from Sydney, was looking for ways to invest his cash. With the property market out of reach, he took a five-figure equity loan from the National Australian Bank.

“Coupling the word loan with equity is a real trigger for a lot of people,” he told Morningstar.

“When I went to explain it to my parents, I started by reminding them I had an economics and finance degree.”

Alex is one of many young investors with a NAB “Equity Builder” loan. The only product of its kind in the market, the principal & interest loan can be used to buy pre-approved managed funds and exchange-traded funds (ETFs). But unlike normal equity margin loans, the product has no margin call.

For Alex, it’s a way to access the leverage that homeowners get with a mortgage but without having to invest in the property market, which he says is out of reach.

He’s not alone. The four-year-old product has a cult following in retail investing forums like Reddit. Originally designed to be distributed via advisers, word of mouth among retail investors has created so much demand that applications have been replaced by a waiting list.

Most interest now comes directly from retail investors, not advisers, says Craig Saunders, a regional director in NAB’s private wealth business. While its popular with retail investors of all ages, it’s “weighted” to younger investors, with an average loan size of $80,000 and a term of 11 years.

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NAB wouldn’t comment on how many applications it receives or the size of the program.

The product makes the benefits of leverage available to younger and less established investors, says Saunders.

“To gear yourself into a property is a large decision. The amount of debt you need to take on to buy a single asset is enormous,” he says.

“Equity builder lets people benefit from that leverage effect that more established clients use all the time when they’re buying investment property.”

Mortgage like products for equities

Australians are no strangers to leverage. At 119 per cent in 2019, the ratio of household debt to GDP is second highest in the world after Switzerland. Much of that debt is linked to housing.

“Using leverage to acquire assets is a well-worn path in Australia but its typically for property assets,” says Saunders.

Leverage in the equity market is normally only available through margin loans. In a standard margin loan, the assets act as security but whenever their value falls below a certain point, borrowers must make up the shortfall. This downside risk has kept margin loans the domain of high-net worth and institutional investors.

However, Saunders says equity builder is a “retail proposition”, with no margin calls and a restricted list of diversified assets.

Investors must commit to a principal and interest repayment program and are restricted to pre-approved managed funds or ETFs. The 957-strong list includes some of Australia’s largest ETFs, managed funds and LICs, such as Vanguard Australian Shares (VAS), Magellan’s Global Fund and Milton Corporation (MLT).

The higher risk thematic ETF ETFS Global Robotics and Automation (ROBO) is also approved.

Investing in individual equities is not allowed and available leverage varies between 70 and 80 per cent depending on the fund, with loan terms ranging from 3 to 10 years.

An income and asset test is used to determine the size of the facility an investor can access.

“When you add in a diversified asset base and P&I payments you end up with equity builder, which looks more like a property investment loan than a margin loan,” says Saunders.

The standard variable rate is 3.75 per cent, higher than the NAB base variable rate home loan of 2.69 per cent.

Leverage helps explain why returns are often higher for those who can get into the housing market versus those left out.

Between 2002 and 2020 the ASX’s total return was 307 per cent versus 175 per cent for the Sydney housing market . But $73,000 as down payment on the median house in 2002 bought you an asset worth over $1 million in 2020, versus $297,000 had the sum been left in the stock market unlevered.

The use of leverage in equity markets is a global phenomenon. Wealthy investors in the US are taking advantage of low rates and using their appreciated equity portfolios as collateral to borrow for more assets .

Risk and retail

To make a return on the equity builder loan, investors like Alex need their long run returns to outpace the rate of interest.

But while leverage means outsized returns on the up, it amplifies losses during corrections. Regular interest payments further deepen losses, especially should rates rise from historically low levels.

In a year where the market returns 10 per cent, $10,000 nets $1000, while $40,000 levered at 75 per cent—a $30,000 loan and $10,000 in investor money—is almost three times more at $2,800.

But in a 10 per cent downturn, the levered portfolio loses five times as much at $5,200 versus $1000.

The Dow Jones plummeted 2 per cent the day after Alex’s first used his facility. He’s sanguine about the risks of taking out a ten-year loan to buy a volatile asset class.

“A 10-year decline isn’t unprecedented, but I don’t consider it likely,” he says.

“I think the most likely risk is equities flatlining, and I don’t get much capital gain in exchange for the cost of the loan, but it’s not a risk that’s bothers me much.”

The S&P/ASX 200's ten-year annualised total return was 9.38 per cent as of 22 July 2021.

Will Mceniery-Wallace, a financial adviser with Infinity Financial Consultants, says the program is only suitable for high growth investors with long investment horizons. Even then, it should only be one ‘bucket’ among cash, property, super and other investments.

“The real risks are not being able to make the loan payment and compounding losses,” he says.

“You wouldn’t be interested in this without an investment horizon of ten plus year. It’s very rare markets stay down for 10 years in a row.”

For younger investors considering the product, he recommends against borrowing too much too soon.

“Don’t destroy your lifestyle. You can always borrow more in the future if you want.”

Equity builder takes away margin calls, but Saunders acknowledges that “anything with leverage” is more aggressive and not suitable for all investors.

For now, the equity builder team has a backlog of applications and prospective applicants must complete an expression of interest, with several investors telling Morningstar they had waited months.

Alex isn’t surprised.

“Once I explained things, my dad was really supportive,” he says. “He thought it was a no brainer.”

The author uses the NAB equity builder program.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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