Ask an Adviser - What is a capital protected margin loan?

Top answer provided by:

Brendan O'Reilly

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Hi Ian, thank you for your question. There are currently numerous types of capital protected loans (usually called protected equity loans) in the market and they should not necessarily be categorised together with margin loans. The typical protected equity loan enables investors to borrow up to 100 per cent of the portfolio and they use various financial derivatives to ‘protect’ the investor. This protection often comes at a cost, such as:

• higher fees, both initial and ongoing
• higher interest rates, meaning a higher breakeven point
• you normally have to elect a maturity date for the loan eg 1, 3 or 5 years
• an increase in counterparty risk, often there are terms stating the protection does not apply if you close the facility prior to the maturity date
• there are usually significant break costs and you may lose any pre-paid interest
• increased complexity for your investment portfolio
• stringent terms and conditions

Product Disclosure Statements (PDS) for structured loan products are complex and difficult to interpret.  When it comes to investing (especially when using leverage) we value simplicity above all.

Margin loans have received a lot of attention since the GFC, however, if you get the basics in order, then a margin lending or leverage strategy can enhance the returns of a portfolio over the long term. 

So what are some of the basics you can focus on when investing with leverage?  Here are some of our key thoughts and rules we use:

• Firstly, maintain a modest level of borrowing.  Most people who got into trouble during the GFC with margin loans simply had too much leverage to begin with. If you have a starting Loan to Value Ratio (LVR) of 75 per cent or higher, then you are asking for problems.
• Ensure you have access to emergency cash. In addition to maintaining a well-diversified portfolio, having access to cash is important to minimise the impact of unpredictable market events and being forced to sell investments to avoid a margin call. 
• Lastly, ask yourself the question. Can you achieve your goals and objectives without the use of leverage?  If yes, then you do not need to take on the additional risk that leverage brings. Remember, leverage amplifies potential gains, with the risk of magnifying potential losses.

If you are unsure whether you will achieve your goals then a financial planner should be able to determine whether you are on track or not. They can then make suggestions to improve the likelihood of you succeeding.

Bridges Financial Services Pty Limited (Bridges). ABN 60 003 474 977. ASX Participant. AFSL Number 240837. This is general advice only and does not take into account your objectives, financial situation and needs. Before acting on this advice, you should consult a financial planner.

While the Adviser Ratings Website facilitates the question and answer functionality, all such communications are between users and authorised financial advisers, of which Adviser Ratings has no affiliation. Adviser Ratings is not the advice provider and does not provide financial product advice and only provides information that is general in nature.

Article by:

Ian from Doncaster, Victoria

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