Geared returns without a margin call? Yes, it's possible

This interview was taped on Tuesday 18 June 2024.

There would be few seasoned investors who haven’t heard or accrued a few of their own war stories about gearing. Say, the investor who copped a margin call and lost the house. And, while that certainly is part of the realm of gearing, it’s far from the complete modern universe.

ETFs have changed investing in so many ways, and the idea of gearing is not exempt from these changes. They are increasing accessibility, ease of use, and enticingly for many – taking the threat of a margin call off the table.

Cameron Gleeson, Senior Investment Strategist for Betashares, explains this is because the costs of borrowing are borne by the issuer – with the bonus that this allows access to institutional rates of borrowing – which can be cheaper.

At a point in time where two things remain high (and only one of those things brings joy) – markets and the cost of living – now might be the time to take a closer look at what gearing means in a portfolio and what it means for returns.

In this episode of The Pitch, Gleeson discusses how gearing works in ETFs and what it means for returns. He also discusses the newly listed Betashares Wealth Builder Funds and why these are long-term geared solutions, rather than the traditional trading-focused geared products.

Edited Transcript

Can you give me a quick overview of how gearing works in ETFs?

Gearing is the idea of using some of your own capital and borrowing capital to invest in an asset or an investment.

For example, if I had $2,000, I might decide to go out and use an investment loan, like a margin loan to borrow $1,000 to invest $3,000 in a market. Now, with regards to a geared ETF like Betashares Wealth Builder Australia 200 Geared (30-40% LVR) Complex ETF (ASX: G200) and the Betashares Wealth Builder Diversified All Growth Geared (30-40% LVR) Complex ETF (ASX: GHHF), you would simply invest that notion of $2,000 in the ETF. By buying units in the ETF on the ASX, the fund itself will borrow $1,000 and invest the total capital of $3,000 in the underlying portfolio. 

So, unlike when you need to go out and borrow that money yourself, the pain factor goes away. You don’t need to go through the loan application process, and in fact, you’re able to access much cheaper rates of borrowing too. There are a lot of advantages to using a pre-packaged solution.

Could I get a margin call on a geared ETF?

With a geared ETF, you’ll never be subject to margin calls, and you will never be required to repay the loans. Again, it's one of the great advantages of this solution.

How do you manage the cost of borrowing in a geared ETF?

With these ETFs, the cost of borrowing or the interest, if you like, is paid by the fund, not by you as the investor. But, critically, because this fund is managed by an institutional investor in Betashares, we are able to access institutional rates of interest, which are typically far lower than an individual could get when they’re looking to use an investment loan to buy houses or shares. It’s a cost-effective way of getting geared exposure to the market.

You've recently launched two new geared funds. What level of gearing is used in G200 and GHHF and how do you manage this?

The funds are managed such that the LVR (loan-to-value ratio) sits between 30 and 40%. Now what this means is, on an exposure basis in terms of exposure to daily movements, you are going to see the fund move up or down in value by approximately 142-167% of the underlying portfolio movements. Think of this as roughly around 1.5 times leverage.

What impact does gearing have on the returns?

If we take a fund that was 1.5 times levered and thinks of the daily movements in its underlying portfolio. Say those movements were 2%, on that day the value of the fund would be 3%. 1.5 times 2%. Now that gives you an idea as to the short-term relationship.

Over the long term, you’re also going to see the returns of the fund are impacted by compounding over time, as well as rebalances, the cost of the interest and the management cost of the fund.

But, in simple terms, for a geared investment solution to outperform the non-geared equivalent, you need to be able to invest in an asset or an investment that has the potential to generate capital growth and income which are going to be greater than the interest burden over the long term. 

Build your wealth

Betashares are excited to announce the launch of a new ‘Wealth Builder’ range comprising Australia’s first ‘moderately geared’ exchange traded funds on the ASX. The ETFs are anticipated to provide a gearing ratio generally between 30-40% on a given day. For more information, please visit the Betashares website.

ETF

Betashares Wealth Builder Australia 200 Geared (30-40% LVR) Complex ETF (G200)

Australian Shares

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ETF

Betashares Wealth Builder Diversified All Growth Geared (30-40% LVR) Complex ETF (GHHF)

Global Shares

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