Gearing in Super

With much debate at the local Sunday BBQ around the ever-changingrules around super I wanted to add  somehopefully, thought provoking investment ideas which highlight the continuedpositive benefits of the benefits of superannuation as a long term investment vehicle.

One of the most attractive features of a SMSF for youngerinvestors is the ability of the funds to borrow to buy property. Once you startlooking into it you will find this strategy has been widely executed and buyand large probably been quite successful strategy weather it be for residentialinvestment, retain, industrial properties or even the property you run yourbusiness from.

The concept of gearing to buy assets has long been a great,tax effective investment strategy. It certainly makes sense when you can claimthe interest on the loan as a tax deduction, then only have to pay tax on halfof the gain when you sell.

Many people will also be familiar with the concept of marginlending, a somewhat riskier strategy which involves taking a loan out against aparcel of shares, typically to buy more shares. If the value of the shares heldas security drops below a certain value (LVR), you move into buffer zone andthen can receive a margin call. This is the scary party and one investors needto consider carefully before entering into any such arrangement.

A lesser known or spoken about gearing strategy for equitiesis that of self-funding instalment warrants, otherwise known as ‘SFI’s’.

What’s an SFI? Self-funding instalments allow investors togain exposure to securities by making a part payment upfront and delaying afinal payment (which is optional) until a later date.

How do they work?

• The initial     payment is generally approximately 50% of the underlying share price and     includes an interest cost, put option fee and borrowing fees.

·        The put option gives investors the option to sell the underlying assetat an agreed price upon maturity back to the provider, so there’s no obligationto make the final payment. Instalment warrants are a type of limited recourseloan as the lender’s rights in the event of default by the borrower are limitedto the shares. There’s no access to the other assets of the borrower.

·        Further payments are generally not required during the investmentterm.

·        Due to the convenient ‘self-funding’ feature, investment cash flows areautomatically managed. This means interest is automatically added to the loanon 30 June each year while dividends and any reimbursements of pre-paidinterest go to reduce the loan.

·        Available on ASX top 100 shares, and the larger index based ETF’s including US markets.

The main benefit of the SFI structure is leverage, that is getting a bigger market footprint in risk based assets than you would have been able to achieve without borrowing.

The risk associated with these securities are those standard to investing in shares, plus the risk of borrowing, albeit to a limited extent as the underlying security is limited to the share itself.

Where SFI’s are particularly handy is for lumps of capital where the investment timeframe is at least 7 years. Say you have $1mthat you want to invest for a period of 10 years and you want buy quality shares across developed local and international markets. Using SFI’s in this strategy would enable you to achieve a total market footprint of $2,000,000 over that given period. period. A great addition to any investment portfolio with a focus on long term capital growth