Going by the frequency with which investors using margin loans are facing margin calls currently, there has rarely, if ever, been a safer time to gear into shares or funds. That should suggest that business is booming for margin lenders but the reverse is the case; demand for margin loans is weak.
According to the latest Reserve Bank margin lending figures, published last week, there were 0.2 margin calls per 1000 clients per day during the September quarter – down from 0.22 margins calls per 1000 clients per day during the March quarter. That is a low rate of margin calls.
At their worst, during the December quarter in 2008, there were 8.61 margin calls per 1000 clients per day. Since then the rate has been between 0.5 and one, before dropping to around 0.2 this year.
A borrower receives a margin call when their loan exceeds the maximum loan-to-valuation ratio. In such a situation the borrower must do one of three things: provide additional security, repay part of the loan or sell securities. Lenders say that in most cases borrowers are able to settle margin calls by putting in extra cash.
Most margin loans are used to fund share purchases and the low rate of margin calls reflects the low rate of volatility in the market over the past 12 months. What the figures suggest is that the risk of funding the purchase of shares of funds with a margin loan has never been lower.
Despite this, investor interest in margin lending remains subdued. There were 127,000 margin loan accounts open during the September quarter – down from 128,000 in the June quarter.
The margin loan market was at its peak in the December quarter in 2009, when there were 260,000 open accounts. With the onset of the financial crisis, investors lost their appetite for geared investing and the margin loan market went into a decline. The number of margin loan accounts has been falling steadily ever since.
Loan balances stood $11.5 billion in September – down from $11.7 billion in the March quarter. At the market’s peak, loan balances were worth more than $40 billion.
Leverage increases access to markets and offers the prospect of higher returns. The benefits of leverage can only come with a commensurate increase in downside risk.
The 2008 sharemarket correction, which formed part of the global financial crisis, killed investors’ interest in gearing into shares and funds. While investors’ enthusiasm for gearing into property has returned with a vengeance, gearing into equities and funds has not.
Maybe that’s a prudent approach but on the latest evidence a geared equity portfolio would have been a low-risk option and rewarding over the past couple of years.