Margin Storm
More than a year since Storm Financial’s spectacular fall from grace, and just a few months on from the salary cap debacle of the Melbourne Storm, there are lessons to be learned by both investors and rugby teams about the dangers of risk-taking.
While both ‘brands’ represent completely different businesses, it was a similar trait that led to their downfall.
Just as Storm Financial peddled gearing-up through margin lending, the Melbourne Storm also geared up, up, up… and over the salary cap. And just when they thought they were above the eye of the regulators, the margin calls came.
For a light hearted take on margin lending, check out the video below:
Today’s equity markets are looking more akin to fair value than during the height of the boom and margin loan books have been decimated.
Having experienced the pain of the GFC, investors and institutions alike are wary of the realities of share market gearing.
But has the Storm subsided?
The scrutiny of the margin lending industry that came on the back of the GFC was warranted, no doubt.
This burningpants correspondent was once an administrator of the dreaded margin call, and was warned by that former employer that “margin lending was the cause of the Great Depression”.
Borrowing to fuel investments artificiallyinflates equity prices, which in turn escalates borrowing and more price inflation. With all this inflation, bubbles generally result.
But when the bubbles burst, the effect is much more dramatic than the euphoric ride up.
Equity prices fall faster than investors can meet their margin calls, resulting in plunging stock prices, and yet more margin calls.
This, combined with stop-loss triggers and widespread emotional panic by the average ma & pa investor, results in an equity market chart that has more gradient than a Warren Miller snowboarding film.
The Great Depression had a resounding impact on the everyday investor and the recovery was a painful reminder of just how devastating too much risk can be.
Yet many years later, in 2007, margin lenders’ loan books had reached record highs, and some had doubled in size in just a few years.
A new generation had discovered this wonderful, wealth generating investment philosophy called gearing.
And then the storm clouds came.
So is there still a place for margin lending? With margin loan interest rates hovering around 13% it’s a tough sell.
As with all types of investing it comes down to individual circumstances. Clearly anyone approaching retirement should not be within 100 feet of a margin lender or anyone peddling their services.
But a young individual or couple with secure, well-paying jobs that are on top of their mortgage and have spare investible assets are ideal candidates for margin lending.
Gearing up to 30% or 40% into blue chip equities or balanced funds, just enough to weather moderate market fluctuations, can prove very rewarding.
The key to succeeding is awareness on the part of both the adviser and the investor. The advisers’ role is to ensure the investor is clear about the risks involved and is prepared financially and emotionally should the storm clouds return.
And the storm will return.
bretto108 says:
With a 13% total return required to break even, the margin loan is a product that will be shelved for a few years. Lending institutions are now more risk averse, and this is really being shown in the pricing of the margin loan risk.
Buy the underlying, reinvest the dividends, and only gear up when BEP is a lot lower. If you want a quick gain, research some oil and gas, or mining exploration operations.
Like the footy and snowboarding analogies burningpants. Go get your ski.