Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 48

The decline of margin lending

One of the features of the equity market bull run into 2007 was rapid growth in margin lending. Between January 2000 and September 2007, the total amount of outstanding margin loans in Australia grew from around $6 billion to over $40 billion. While this still did not represent a large fraction of the total capitalisation of the Australian market (around 3% of the total in 2007), it was a significant development for the retail end of the market.

When the equity market plunged during the GFC, so too did the volume of margin lending. In March 2009, total margin lending had shrunk to around $20 billion.

This makes intuitive sense. With the value of collateral sharply diminished, and confidence at reduced levels, it’s no surprise that margin lending levels fell sharply. What’s more interesting is what has happened since then.

As the chart below shows, since the bottom of the market in March 2009, equities have made good headway. While still not at pre-GFC levels, they have delivered healthy returns in recent years. Total margin lending, however, has continued to slide towards $10 billion, even as confidence has been returning to the market.

Chart 1. ASX200 and total margin loans outstanding

To our way of thinking, this is a healthy development. Some reasons to be wary of margin lending include:

  • it tends to be an expensive form of funding. Margin lending only benefits the investor where the return on the equities exceeds the cost of the debt. With the long run average return on equities running at perhaps 11% per annum, there isn’t much room left after paying interest rates close to 8% 
  • this benefit disappears altogether if margin calls force you to sell at the wrong time. After a significant fall in share prices, the most successful investors tend to be the ones buying. Often, they are buying from margin borrowers, who have no choice but to sell 
  • debt funding of any sort tends to bring with it sleepless nights. A cool head is a prerequisite to good investment decisions, and when things get challenging, high levels of debt are a menace to good order.

At Montgomery, we sit in the far corner of the room. We use no leverage, and usually have a material part of our funds sitting in cash. We also avoid investing in companies that have material debt on their balance sheets. This absence of leverage helps foster a steady approach to our decision-making when market conditions become challenging, as they often do.

It is unlikely we will change our attitude towards debt any time soon, but if we were to wake up one day and decide that some leverage would be good, it is unlikely to be a margin loan.

It will be interesting to see what happens to the margin lending industry from here. We expect that having learned some of the above lessons the hard way, investors who do gear into shares are increasingly doing so by borrowing against residential property. Provided gearing levels are kept to prudent levels, this type of borrowing is likely to deliver a much better experience for borrowers. Nevertheless, if markets continue to rise, it is likely that investors will become more adventurous and margin lending may return, with its higher cost of borrowing.

Over time, of course, a new generation of investors will emerge. Without the benefit of first-hand experience of the GFC, they may embrace margin lending as a shortcut to wealth. When that happens, we will be checking our valuations closely, probably starting to count the rows to the nearest exit.

This cautious approach will no doubt cause some investors to miss out on heady gains. However, patience is a great virtue in investing. On the road to wealth there are many shortcuts that offer themselves to the unwary, and for long-term investors, it’s wise to think carefully about these shortcuts, or avoid them altogether.

 

Roger Montgomery is the founder and Chief Investment Officer at The Montgomery Fund, and author of the bestseller 'Value.able'

 

RELATED ARTICLES

Duh! Of course geared funds won, but know the risks

Mortgage funds: if only we had a trendier name, like P2P

Financial leverage in real estate: friend or foe?

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

Latest Updates

Shares

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Exchange traded products

AFIC on its record discount, passive investing and pricey stocks

A triple headwind has seen Australia's biggest LIC swing to a 10% discount and scuppered its relative performance. Management was bullish in an interview with Firstlinks, but is the discount ever likely to close?

Superannuation

Hidden fees are a super problem

Most Australians don’t realise they are being charged up to six different types of fees on their superannuation. These fees can be opaque and hard to compare across different funds and investment options.

Shares

ASX large cap outlook for 2025

Economic growth in Australia looks to have bottomed, which means it makes sense to selectively add to cyclical exposures on the ASX in addition to key thematics like decarbonisation and technological change.

Property

Taking advantage of the property cycle

Understanding the property cycle can be a useful tool to make informed decisions and stay focused on long-term goals. This looks at where we are in the commercial property cycle and the potential opportunities for investors.

Investment strategies

Is this bedrock of financial theory a mirage?

The concept of an 'equity risk premium' has driven asset allocation decisions for decades. A revamped study suggests it was a relatively short-lived phenomenon rather than the mainstay many thought.

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.