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Margin of error

By Fiona Rotherham

Friday 1st April 2005

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In Christchurch there's a chap who has borrowed money to buy shares for more than 20 years. The investor (who didn't want to be named) says he favours margin trading because he's able to buy about three times as many shares as he would otherwise. His gains are higher. So, too, his losses.

If you think investing on the sharemarket is a gamble, then leveraged equities are high stakes roulette. It won't suit every punter.

Margin trading got a bad name in the 1980s when every man and his dog jumped in and then got badly burned in the 1987 sharemarket crash. It's taken some years for investors to look favourably at it again. In Australia, Reserve Bank figures show interest in margin lending has leapt in the past year on the back of the bull market. Similar figures are not kept in New Zealand but, anecdotally, the same trend is said to be happening.

Margin loans are borrowings to finance share purchases. The money is secured by the shares and personal guarantees by the investor. There are a handful of specialised margin lenders here. Say you had $30,00 to invest in Air New Zealand shares. The lender would provide a further $70,000 (the amount loaned depends on the stock) and charge interest until the loan is repaid. Interest rates are around 14%.

The shares are bought under the lender's name but the investor decides what to buy and when to sell. The trick is to make enough before selling to cover the interest charges and pocket a profit, which is fine when share prices are rising. The trouble comes when stocks drop, as the lender makes a margin call on the investor, which means they're given 24 hours to provide more capital as security for the loans to make up for the cut in share values. The margin call usually kicks in once the share price has dropped more than 10% below the purchase cost, says Fulcrum Securities' boss David Oliver, a long-time margin lender. If the investor doesn't pay, the shares are sold. Not everyone wins, Oliver says, but most of his clients have a diverse portfolio to spread the risk.

Our veteran Christchurch investor says he's made more money than he's lost on margin trading but says you have to be able to dispassionately sell shares and keep a daily watch on the market.

"A lot of sharemarket investors can't be bothered keeping up with their investment. They just put their shares in the bottom drawer and forget about them. If you're not prepared to keep an interest in your investment, you shouldn't be purchasing them."

McDouall Stuart Securities managing director Andrew McDouall says leveraged equities may suit more knowledgeable investors who have calculated the risk and returns in using leverage. "For investors, history has shown significant upside in doing so, provided there are good quality shares being purchased as the underlying security."

On McDouall's calculations, if you bought $100,000 of Auckland International Airport shares five years ago by putting up $30,000 and borrowing $70,000, your $30,000 would now be worth around $200,000. Still, if you purchased Tower shares at a similar level, then you would have sold out or had to put in additional equity.

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