Geared Managed Funds

Strategies for a rising market

With many DIY investors focused on control and choosing their own investments, geared managed funds have typically been overlooked.

We consider how the current climate has also provided an opportunity to investors looking to gear their portfolio for a rising market and how these funds can offer a greater investment opportunity than margin lending.

Geared share funds
Often considered as an alternative to margin lending, geared share funds ease of administration, low cost of borrowing (around 6% rather than 8.35%+ through margin lending) and availability to SMSFs offer a number of advantages over margin lending.

Utilising current conditions to your advantage
As is the case with un-geared managed funds, geared share funds are regulated under trust tax law which requires the fund to distribute income and realised capital gains to investors each year.

As a result, gearing strategies centred around managed funds can often fall short of the tax nirvana for which they are intended as the annual distribution of realised capital gains means investors are often realising gains in each tax year as a part of the normal buys and sells incurred by the fund.

The sweet spot
Many non-geared managed funds are still nursing a 30% realised loss on the value of their investments held prior to the GFC as a result of investors cashing in their investments or the portfolio managers pruning their portfolio. The subsequent recovery we’ve had since the bottom of the market is likely to have already offset a large part of the realised capital losses.

Geared Managed Funds - No Entry feesNow that we have survived the GFC, geared share funds that were forced to redeem holdings to maintain their loan to value ratios in 2008 harbour a significant amount of realised capital losses. A taxation sweet spot remains for investors as they are unlikely to pay a capital gains distribution for some time as they work their way through realised capital losses.

Investors considering margin loans to invest in the Aussie share market would do well to consider geared share funds as an alternative as the low cost of borrowing coupled with the current taxation benefits means that these funds offer a compelling after tax investment alternative to margin loans.

Analysis of geared share fund offerings

We recently preformed an analysis of Australian Geared Share Funds. While the majority harbour significant losses, a number of these funds are still relatively small and benefits of accrued losses can quickly be diluted if the fund sees a large amount of new fund inflows. We would therefore recommend that investors looking to defer capital gains should favour the larger fund sizes such as Colonial’s Australian Geared Share Fund.

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Geared Share Funds - Overall level of losses available to offset against gains
Feature on Margin Lending – Page 4

Feature on Flexible Limited Recourse Loans – Page 6

Feature on Self Funded Instalment Warrants – Page 7

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